Hedge Fund 101: everything you need to know

Hedge funds are investments where a group of investors or an institution pool their money to make alternative investments that will bring them an active return. In some cases, these funds take advantage of leverage and derivatives to generate high income. Typically, those who decide to go for hedging can do so only after being accredited, and the funds themselves often receive less government scrutiny than other investment vehicles.

In the United States, the Securities and Exchange Commission (SEC) does not oversee hedge funds. Because they are not regulated, fund managers can invest in a wider choice of securities than other funds, for example mutual funds. It is not uncommon for one of these funds to invest in a variety of traditional investment vehicles such as stocks and commodities plus more diverse and risky investments. Strategies as well can vary, with many managers adopting a range of investing tactics to reach their goals such as long-short investing.

Hedge fund goals

All hedge funds are created with the same goal: making income for the fund-holders, but each fund is constructed following its own set of goals and strategy, with lots of diversity between funds in terms of risk and investment styles. It is not unusual for a fund to have been created as a private investment limited partnership for sophisticated or high-worth individuals.

Often these types of funds are open only to a limited number of investors who have been approved and who need to make a large investment. Many times, investors in a hedge fund are obligated to keep the money in the fund for a long period of time, such as a year. This is called a lock-up period, and even once the fund is opened for withdrawals, many funds stipulate when money can be withdrawn, for example, annually.

This illiquidity makes these funds impractical for all investors. Typically, as was initiated by the father of the hedge fund, Alfred Winslow Jones, fees are paid to fund managers depending on the NAV, the net asset value, of the fund as well as a percentage of the returns they were able to earn for the investors.

Main characteristics of hedging investments

• Available for accredited investors

History of the funds

The hedge fund came about in 1949 when a writer, Alfred Winslow Jones, was inspired by his research in funds to try managing one. He created it mostly with his friends’ money (less than half was his own). His idea was to hold long-term shares and short sell other shares. He altered the fund a bit over time. For example, he changed the structure, adding a fee that was based on his work as a manager as well as on the success of the fund, and added the use of leverage.

The popularity of hedge funds goes up and down, but since 1949, they have offered a valuable addition to the savvy investor who is looking for a managed fund that exploits various alternative investment structures.

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