what is a hedge fund 
a hedge fund is a limited partnership of private investors whose money is pooled and managed by professional fund managers these managers use a wide range of strategies including leverage borrowed money and the trading of non traditional assets to earn above average investment returns a hedge fund investment is often considered a risky alternative investment choice and usually requires a high minimum investment or net worth hedge funds typically target wealthy investors investopedia julie bangunderstanding hedge fundsthe term hedge fund refers to an investment instrument with pooled funds that is managed to outperform average market returns the fund manager often hedges the fund s positions to protect them from market risk they do so by investing a portion of the fund s assets in securities whose prices move in the opposite direction of the fund s core holdings theoretically should the prices of the core holdings move down the prices of the securities acting as a hedge should move up as a result the hedge can offset any losses in the core holdings for example a hedge fund that focuses on a cyclical sector such as travel may invest a portion of its assets in a non cyclical sector such as energy aiming to use the positive returns of the non cyclical stocks to offset any losses in cyclical stocks hedge funds use risky strategies leverage and derivative securities such as options and futures therefore an investor in a hedge fund is commonly regarded as an accredited investor this means that they meet a required minimum level of income or assets typical investors are institutional investors such as pension funds and insurance companies and wealthy individuals investments in hedge funds are considered illiquid as funds often require investors to keep their money in the fund for at least one year a time known as the lock up period withdrawals may also only happen at certain intervals such as quarterly or bi annually 1types of hedge fundsfour common types of hedge funds are the appeal of many hedge funds lies in the reputations of their managers which stand out in the closed world of hedge fund investing common hedge fund strategieshedge fund strategies cover a broad range of risk tolerance and investment philosophies they involve a large selection of investments including debt and equity securities commodities currencies derivatives and real estate common hedge fund strategies are classified according to the investment style of the fund s manager and include equity fixed income and event driven investment goals examples of hedge fundsthe most notable hedge funds based on assets under management aum include hedge fund compensationaustralian investor alfred winslow jones is credited with launching the first hedge fund in 1949 through his company a w jones co raising 100 000 he designed a fund that aimed to minimize the risk in long term stock investing by short selling now referred to as the long short equities model in 1952 jones converted his fund to a limited partnership added a 20 incentive fee as compensation for the managing partner and became the first money manager to combine short selling the use of leverage and a compensation system based on performance 3today hedge funds employ a standard 2 and 20 fee system which refers to a 2 management fee and a 20 performance fee 1the management fee is based on the net asset value of each investor s shares so an investment of 1 million garners a 20 000 management fee that year to cover the operations of the hedge and compensate the fund manager the performance fee is commonly 20 of profits if an investment of 1 million increases to 1 2 million in one year 40 000 is the fee owed to the fund hedge fund vs mutual fundhedge funds are not as strictly regulated by the securities and exchange commission sec as mutual funds are 4mutual funds are a practical cost efficient way to build a diversified portfolio of stocks bonds or short term investments they are available to the general public and average investor hedge funds normally will only accept money from accredited investors who include individuals with an annual income that exceeds 200 000 or a net worth exceeding 1 million excluding their primary residence these investors are considered suitable to handle the potential risks that hedge funds are permitted to take 5a hedge fund can invest in land real estate stocks derivatives and currencies while mutual funds use stocks or bonds as their instruments for long term investment strategies unlike mutual funds where an investor can elect to sell shares at any time hedge funds typically limit opportunities to redeem shares and often impose a locked period of one year before shares can be cashed in hedge funds employ the 2 management fee and 20 performance fee structure in 2022 the average expense ratio across all mutual funds and exchange traded funds was 0 37 6read about investopedia s 10 rules of investing by picking up a copy of our special issue print edition 