What Are Hedge Funds?

Hedge funds are private investment partnerships that specialize in strategies that aim to make money in any market environment. The aim of a hedge fund is to generate returns no matter what the market does. If the market goes up, a good hedge fund would seek to match the market’s rate of return. If the market goes down, likewise the fund would aim to generate a positive return in excess of the risk free rate.

How Do Hedge Funds Make Money?

Hedge funds make money by buying under valued assets and selling over valued assets. When these assets return to their fair value the fund will generate a positive return. If the hedge fund in market neutral, this means that the assets that the fund has bought are matched by the assets that the fund has sold. If the hedge fund manager choose these assets wisely, this means that the combined portfolio should be unaffected by market movements and that it would generate a return greater than a risk free asset with no risk.

How Do Hedge Fund Managers Earn Their Money?
Hedge fund managers are typically paid 2% of assets and 20% of profits. This means that apart from the 2% asset based fee, they only make money if their investors make money. Most investors are willing to pay these fees because they expect the hedge fund manager to generate excess returns that will more than make up for their fees.

How Do You Invest In A Hedge Fund?
First you have to have a lot of money. The financial regulators require that hedge fund investors be accredited. The rules change frequently, but this typically means having close to a million dollars in liquid assets or a very high income. The assumption is that if you have a lot of money, you will be smart enough to choose a good hedge fund manager. Hedge funds are much more loosely regulated than mutual funds, which are open to all investors. This loose regulation is why regulators require hedge fund investors to be accredited.

How Are Hedge Funds Structured?

Most hedge funds are structured as limited liability partnerships. The investors are limited partners, while the fund manager is the general partner. To further reduce their liability the general partner is often a limited liability corporation that is owned by the hedge fund manager. Often hedge funds are setup off shore to take advantage of even lower regulation and higher levels of financial privacy.