What Is a Hedge Fund?
Hedge funds are alternative investments using pooled funds that employ different strategies to earn active return, or alpha, for their investors. It is important to note that hedge funds are generally only accessible to accredited investors. One aspect that has set the hedge fund industry apart is the fact that hedge funds face less regulation than mutual funds and other investment vehicles.
Understanding Hedge Funds. Each hedge fund is constructed to take advantage of certain identifiable market opportunities. Hedge funds use different investment strategies and thus are often classified according to investment style. Legally, hedge funds are most often set up as private investment limited partnerships that are open to a limited number of accredited investors and require a large initial minimum investment. Withdrawals may also only happen at certain intervals such as quarterly or bi-annually.Key Characteristics
- They're only open to "accredited" or qualified investors.
- They offer wider investment latitude than other funds: A hedge fund's investment universe is only limited by its mandate. A hedge fund can basically invest in anything—land, real estate, stocks, derivatives, and currencies. Mutual funds, by contrast, have to basically stick to stocks or bonds and are usually long-only.
- They often employ leverage: Hedge funds will often use borrowed money to amplify returns.
- Fee structure: Instead of charging an expense ratio only, hedge funds charge both an expense ratio and a performance fee. This fee structure is known as "Two and Twenty"—a 2% asset management fee and then a 20% cut of any gains generated.
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