What is a Hedge Fund?

A hedge fund is a privately managed investment fund that pools capital from a small number of wealthy individuals or institutional investors and uses a wide range of strategies to generate returns. Unlike regular mutual funds or ETFs, hedge funds face far fewer regulatory restrictions on what they can do with the money.

What makes hedge funds different?

Ordinary funds are typically restricted to buying stocks and bonds and holding them. Hedge funds can do far more: short selling, using leverage, trading derivatives, investing in private companies, making bets on currencies or commodities, and employing complex algorithmic strategies. The name originally referred to funds that hedged their bets by taking both long and short positions simultaneously to reduce risk.

Who can invest in a hedge fund?

In most countries, hedge funds are only open to so called qualified or professional investors. Those with significant wealth or financial expertise. Minimum investments are typically very high, often $100,000 or more, sometimes into the millions. This is not an investment vehicle for ordinary savers.

Do hedge funds outperform the market?

As a group, no not consistently. After accounting for their high fees typically a 2% annual management fee plus 20% of any profits. The average hedge fund has underperformed simple index investing over most meaningful time periods. Some individual funds and managers have delivered exceptional returns, but identifying them in advance is extremely difficult.

Why does this matter for a beginner?

Mostly as context. You will hear about hedge funds frequently in financial news. Understanding what they are and what they do helps you make sense of that coverage. As an investment option they are not accessible to most people, and the evidence suggests that for most investors, they would not be worth the cost even if they were.