Hedge funds are a collective investment structure established for profit by a money manager or registered investment advisor. This pooled structure is commonly organized through a limited partnership or a limited liability company (LLC).
Hedge Fund Definition and Examples
Hedge funds are an investment option, not a specific type of investment. These funds pool money from investors to invest in high-cost, high-risk, high-reward securities, and other investments. They're actively supervised. Hedge funds are created with the goal of generating high returns. They are not as tightly regulated as mutual funds, allowing them to make investments with a higher risk of loss. Because of the high fees paid to their managers, hedge funds are only available to wealthy investors and institutions. Hedge funds include those that:- They specialize in "long-only" stocks, which means they only buy common stock and never sell it short.
- Take part in private equity, which involves buying entire privately held companies, frequently taking them over, improving services, and then supporting an IPO.
- Invest in junk bonds.
- Real estate is your area of expertise.
- Invest in specialized asset classes like patents or music copyrights to diversify your portfolio.
What is the Function of a Hedge Fund?
Hedge funds were created to hold long and short stock positions and reduce risk. Regardless of whether the stock market rose or fell, investors could profit. The moniker stayed with them. Later on, the term was used to refer to a wide range of pooled capital arrangements. Hedge funds can be an expert in a wide range of asset classes, including stocks, bonds, mutual funds, real estate, startups, art, rare stamps, collectibles, gold, and wine. Hedge funds can even be made up of hedge funds made up of hedge funds. A hedge fund manager raises funds from outside investors and invests them according to the strategy they promised to employ. The management of a hedge fund is outlined in an operating agreement. It will contain the price range, which typically includes a management fee of 1% to 2% of assets plus a performance fee of 20%, which means the fund manager will get 20% of any annual gains they make on your behalf. You'd keep the rest as profit. A performance fee incentivizes fund managers to take higher-risk investments. The more money the fund makes, the more money the investors and fund managers get. Many hedge fund managers are handed out the standard "2 and 20". Other hedge fund managers are compensated solely based on profits.Hedge Fund Legal Requirements
To invest money into a hedge fund, you must first have a certain amount of money and net worth. Due to government regulations, these funds are generally only available to "accredited investors." Individuals or corporations can be accredited, investors. Many federal regulations that protect ordinary investors are not applicable to hedge funds. As a result, they may be riskier than other investment options. To be considered, you must meet at least one of the following criteria as an individual accredited investor in a hedge fund: If you're single, you need to have a personal income of $200,000 or more per year, or if you are married, you and your spouse must have a combined earning of $300,000 or more per year. This level of income must have been sustained for at least two years, and you must have reasonable grounds to believe it will continue in the future. You must have a $1 million or more personal net worth, excluding your primary residence, whether alone or with a spouse. Accredited investors include institutions and entities that are:- A trust with a net worth of at least $5 million or more that was not created specifically to make the investment is managed by a "sophisticated" investor.
- Any entity in which each of the equity investors is a self-accredited accredited investor.
- A sophisticated investor is someone who has enough knowledge and experience in investing to make decisions about the risks of a potential investment, according to the Securities and Exchange Commission of the United States (SEC).
Important Takeaways
Hedge funds are commonly limited partnerships or limited liability companies that pool money from investors to invest in high-risk securities and other assets. Only "accredited investors" have access to these funds, which must meet stringent income needs and have substantial assets due to the high fees and investment risks. Hedge fund managers are paid according to the performance of their funds, which motivates them to take chances in order to increase their earnings. Hedge funds can invest in securities, businesses, junk bonds, real estate, and even patents and music copyrights.