A hedge fund can help you achieve your investment goals, but you should be aware of the risks.
A hedge can be likened to a mutual fund, in that both are investment vehicles which pool investors' funds together in an effort to achieve a profit. While both are subject to the same provisions against fraud, the similarity between the two ends there, as mutual funds are highly regulated and hedge funds are not regulated at all. Additionally, mutual funds tend to be more transparent and more suited for general retail investors than hedge funds, which tend to keep their holdings private and have specific investor requirements.
Hedge Fund Definition
Hedge funds are investment vehicles that employ intricate investment strategies to mitigate or "hedge" portfolio risk. Usually, hedge funds are set up as a partnership, with the manager being the general partner and the individual investors being the limited partners. A hedge fund is generally identifiable by its structure, which traditionally involves high minimum investment requirements, performance-related fees, limited entry and exit periods, and restrictions on the type of investor allowed.
Hedge Fund Objectives
A hedge fund attempts to achieve positive absolute returns regardless of the market environment. Whereas more traditional mutual funds may only attempt to beat their peers, or provide returns in excess of a benchmark index such as the S&P500, a hedge fund tries to achieve both of these goals in addition to providing a positive return for investors, even if the market is down 20 percent.
Hedge Fund Strategies
Hedge funds are nearly limitless in the type of strategies they can employ to achieve their investment objectives. In addition to incorporating traditional market-based investments such as stocks and bonds, hedge funds also buy and sell currencies, commodities and derivatives. Additionally, hedge funds often use advanced portfolio management techniques such as shorting, leveraging, arbitrage and swaps.
Hedge Fund Fees
Hedge funds are notorious for charging high fees to their investors. Typically, hedge funds bill investors under the "1 and 20" system, in which the fund will charge you 1 percent of the net assets you have in the fund annually, along with 20 percent of any profits that the fund generates. Thus, if you invest $100,000 in a hedge fund with this structure, and the fund earns $20,000 for the year, your annual fee for that year will be $5,000.
Hedge Fund Investors
In order to invest in a hedge fund, you must be an accredited investor, which in essence means you must be very wealthy. The SEC outlines many specific categories of what qualifies as an accredited investor, but for an individual, it generally means that you must have a net worth in excess of $1,000,000.
Risks of Hedge Funds
Many hedge funds seek to increase their returns by employing aggressive investment strategies, such as using high amounts of leverage and investing in speculative securities. Additionally, hedge funds are not required to make periodic reports to the SEC under the Securities Exchange Act of 1934. They may invest in unregistered securities and are not required to register with the SEC, as mutual funds are.
