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What are Hedge Funds?
Home » Investing » Hedge Funds » What are Hedge Funds?Like mutual funds, hedge funds are investment pools which trade in securities. Hedge funds are usually organized under a private investment, limited partnership structure. The general partner in a hedge fund starts the fund and controls the day-to-day operations of the fund. Limited partners provide the bulk of the capital for the fund, but they do not partake in day-to-day decisions about the hedge fund. As a limited partnership, hedge funds are not required to disclose their activities to third parties.
Hedge funds are lightly regulated by the SEC and, as such, are generally free to use any financial instrument. Although some hedge funds are relatively conservative in their approach, many hedge funds take advantage of their relative freedom by using short-selling, leverage and concentrated investments in order to mitigate risk and boost returns. Hedge funds also seek absolute returns, so hedge fund managers are less concerned with the performance of the market than with the yearly percentage return of a particular investment. As a consequence of such light regulation, however, hedge funds may not be offered or advertised to the public, and there are rarely more than a few hundred investors for each hedge fund.
The compensation of hedge fund managers is based on the performance of the hedge fund. General partners often operate under an incentive fee plan that pays up to 20% of the net profits of the hedge fund, and many partners also charge an administrative fee based upon the net asset value of the hedge fund. Remaining profits are then distributed among limited partners based upon ownership percentage.
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