A Hedge Fund is a private investment fund that is generally unregulated or permitted by regulators to undertake a wider range of activities. Generally, Hedge Funds are open to a limited number of professional, institutional or wealthy investors. Hedge Funds have a manager that uses alternative investment techniques, such as short selling, margin investing, debt, commodities and derivatives. A Hedge Fund typically pays a performance-based fee to its investment manager. Top fund managers typically beat the general market performance and a manager with talent can furnish large capital returns not only for his or her investors but also for the managers themselves.
An accredited or sophisticated investor is an investor with a special status under financial regulation laws. The definition of an accredited investor vary between countries. Generally, accredited investors include high-net-worth individuals, banks, financial institutions and other large corporations, who have access to complex and higher-risk investments such as venture capital, hedge funds and angel investments.
Laws may require that some types of financial offerings may only be made to accredited investors.
Hedge Funds fee structures vary, dependant on jurisdiction, domicile and, most importantly, investor base. The most common fee structure is the standard “1 and 20”: a 1% management fee (% of assets) and 20% performance fee (% of profits), annually (Normally the management fee is collected in .25% quarterly trenches, in advance, and the performance fee is calculated annually). In addition to this, there are other performance-related restrictions and expansions on the collection of fees: high-water marks and hurdle rates being the most common.
Every Business carries risk, however, there is a common misconception into Hedge Fund risk.
Many individuals in the professional investment community believe Hedge Funds to be speculative investment vehicles which take highly leveraged, directional bets based on broad macroeconomic or market views. This tainted image is partly as a result of articles in the press which refer to Global Macro funds which opened the public’s eyes to other forms of Hedge Funds and the dangers of leverage but again distorted people’s views of the industry.
The reality is that the Hedge Fund industry is much more diverse and, for the most part, quite conservative. Most Hedge Funds are specifically designed to reduce risk and limit volatility. Global Macro funds represent a small part of the Hedge Fund universe which contains a diverse range of investment strategies. The leverage employed by most Hedge Funds is modest and some use none at all. This contrasts with the exceptionally high leverage employed by Global Macro funds.
The minimum investment varies from fund to fund. common starting range would be between US$100,000-$500,000. Established funds can have much higher minimums; $10,000,000 or more, depending on the fund and manager. The fund manager can waive the minimum at his sole discretion but this is usually only undertaken to accommodate serious investors who stipulate an intent to allocate substantially more than the stated minimum, depending on how this initial allocation performs.
A Hedge Fund is an absolute return-oriented fund which has its own portfolio of investments. A fund of Hedge Funds invests in a number of individual Hedge Funds and seeks to create a diversified portfolio of funds which will deliver comparable risk and return characteristics, but with a lower level of volatility.