What Is a Hedge Fund? (2024)

FAQs

What is a hedge fund in simple terms? ›

Hedge funds are financial partnerships that employ various strategies in an effort to maximize returns for their investors. Unlike mutual funds managers, hedge fund managers have free reign to invest in non-traditional assets and employ risky strategies.

1 2 Hedge fund general partners and managers often create high minimum investment requirements. It is not uncommon for a hedge fund to require at least $100,000 or even as much as $1 million to participate.

Hedge funds can use riskier investment strategies than mutual funds. They might use leverage—borrowing money to make bigger bets on the market. Hedge funds can also short-sell stocks. Short-selling is when you sell stocks you don't own because you intend to make a profit by buying them back later at a lower price.

Hedge funds originated as a vehicle to help diversify investment portfolios, manage risk and produce reliable returns over time. While hedge funds' investor base has evolved though the years – from individuals to institutions such as pensions, universities and foundations – their core goals have remained the same.

Key Takeaways

Hedge funds employ complex investing strategies that can include the use of leverage, derivatives, or alternative asset classes in order to boost return. However, hedge funds also come with high fee structures and can be more opaque and risky than traditional investments.

Hedge fund managers typically earn above-average compensation, often from a two-and-twenty fee structure. Hedge fund managers typically specialize in a particular investment strategy that they then use to power their fund portfolio's mandate for profits.

You generally must be an accredited investor, which means having a minimum level of income or assets, to invest in hedge funds. Typical investors include institutional investors, such as pension funds and insurance companies, and wealthy individuals.

In the world of finance, hedge funds have established a reputation for their high-risk, high-reward nature. At their core, however, hedge funds are simply pools of money controlled by professional analysts and hedge fund managers who aim to generate higher returns than traditional investment avenues.

One critical risk is the potential for investment losses. Hedge funds often employ complex strategies, which may involve higher risk levels than traditional investments. Additionally, hedge funds may have limited liquidity, meaning investors may need more time to withdraw their investments on short notice easily.

Hedge funds are actively managed by professional managers who buy and sell certain investments with the stated goal of exceeding the returns of the markets, or some sector or index of the markets. They take the greatest risks while trying to achieve these returns.

How do hedge fund owners get paid? ›

Key Takeaways

Hedge funds make money as part of a fee structure paid by fund investors based on assets under management (AUM). Funds typically receive a flat fee plus a percentage of positive returns that exceed some benchmark or hurdle rate.

Domestic hedge funds are generally not appropriate for tax-deferred investors, such as retirement plans, foundations and the like, because they generate unrelated business taxable income for such investors. Additionally, most hedge funds do not make annual cash dividends or other distributions to investors.

- High Fees: Hedge funds typically charge high fees, including management fees and performance fees, which can erode returns over time. - Lack of Transparency: Hedge funds are not required to disclose their holdings or strategies, which can make it difficult for investors to evaluate their performance and risk.

Funds achieved a weighted average return of 14.66% overall, with Equities, Fixed Income Arbitrage and Multi-Strategy funds all seeing double digit returns. Equities led the way, with a weighted average return of 21.91% for 2023, followed by Fixed Income Arbitrage at 12.63%, and Multi-Strategy at 12.56%.

They might not want to outperform the market

But the main one is that they might not want to, it might not be their goal: as the name implies, some *hedge* funds look for safer bets, rather than higher risk. The key is to obtain a much more stable return, so that the risk to reward ratio is actually better.

Hedge funds make money by charging a management fee and a percentage of profits. The typical fee structure is 2 and 20, meaning a 2% fee on assets under management and 20% of profits, sometimes above a high water mark. For example, let's say a hedge fund manages $1 billion in assets. It will earn $20 million in fees.

A hedge fund differs from so-called “real money” — traditional investment accounts like mutual funds, pensions, and endowments — because it has more freedom to pursue different investment strategies. In some cases, these unique strategies can lead to huge gains while the traditional market measures languish.