What is a hedge fund?

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last updated 8 August 2023

Hedge funds are just like any other fund. A manager pools money from a number of investors and invests it on their behalf, but unlike the traditional funds you and I might use, these funds are not open to your average private investors.

They’ll typically require minimum investments of upwards of £100,000 or more. This is because hedge funds tend to use more exotic investment strategies that financial regulators deem too risky for ordinary investors.

What is a hedge fund?

A hedge fund is a type of investment vehicle that pools money from accredited individuals or institutional investors to invest in a range of assets with the aim of generating a positive return. Hedge funds are typically managed by experienced professionals who use complex investment strategies to maximize returns while mitigating risk.

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One of the defining characteristics of hedge funds is that they are generally only available to accredited investors. This means that individuals or institutions must meet certain financial criteria to be eligible to invest. The idea behind this is that these investors are more sophisticated and able to bear the risks associated with hedge fund investments.

Hedge funds can invest in a wide range of assets, including stocks, bonds, commodities, currencies, and derivatives. They may also use a variety of strategies, such as long/short positions, options trading, and leverage, to generate returns. In some cases, hedge funds may also engage in short selling, which involves betting that the price of a particular asset will fall.

Hedge fund benefits

One of the key benefits of investing in a hedge fund is the potential for higher returns compared to other types of investments. Because hedge funds use complex strategies and invest in a wide range of assets, they have the potential to generate significant returns.

However, with this potential for higher returns comes a higher level of risk. Hedge funds are not regulated like other types of investments, which means that investors may be exposed to greater risk.

Another benefit of investing in a hedge fund is the potential for diversification. Because hedge funds invest in various assets, they can help spread risk across different types of investments, such as equities, bonds, property and even private businesses. This can help to reduce the overall risk of an investor's portfolio.

Hedge fund risks

However, there are also some disadvantages to investing in hedge funds. One of the main drawbacks is the high fees associated with these investments. Hedge funds typically charge a management fee, a percentage of the assets under management (typically 2%), and a performance fee, which is a percentage of the profits generated by the fund (typically 20%).

Another potential drawback of hedge fund investments is the lack of transparency. Because hedge funds are not regulated like other types of investments, investors may not have access to the same level of information about the fund's holdings and performance.

This can make it difficult for investors to make informed decisions about whether to invest in a particular hedge fund, although some details are usually obtainable via the fund’s 13F report, which is filed with regulators in the United States. The 13F report details any US equity holdings the fund might own.