Q

WWhat is a hedge fund?

A

An investment that seeks to outperform the market by employing complicated trading strategies.

No, a hedge fund has nothing to do with investing in companies that specialize in shaping shrubbery into right angles. It’s rather a relatively new kind of investment vehicle usually dated to 1949 when a onetime Fortune magazine editor named Alfred Winslow Jones invested $100,000 using a method pretty much identical to how hedge funds still operate today. It’s no wonder he started a trend; his company’s investments increased by 1,000% from 1958-1968.

Unlike a mutual fund, which is an umbrella to simply acquire the stock of many different companies, a hedge fend uses many complicated methods to make money, including shorting stocks a manager believes will fall in price, leveraging in order to use borrowed money to increase the size of an investment, and using derivatives to sell essentially an insurance policy on the movement of asset prices. Great hedge fund managers like George Soros, Ray Dalio and Bobby Axelrod are renowned for being incredibly flexible in their approaches. While mutual funds and ETFs generally follow the ups and downs of the market indices like the S&P 500, hedge funds do not; stock-based investments will often outperform hedge funds in bull markets, but hedge funds are expected to really shine when markets are down. In fact, during this most recent bull market, many hedge fund masters of the universe suffered a reputational beating when the markets dramatically outperformed their funds.

Unlike mutual funds, hedge funds are not generally registered with the Securities and Exchange Commission, have strict limits on the number of investors they accept, normally fewer than 500 in total, and have an extremely high minimum investment, typically between $500,000 and $1,000,000. In order to instill confidence in prospective investors, hedge fund managers generally have skin in the game through what’s known as “self-investment.” They also pay themselves handsomely: the most common fee arrangement is known as “Two and Twenty,” meaning they’ll take 2% of all managed funds annually regardless of the fund’s performance, and on top of that reward themselves with 20% of any investor’s gains they make over the year.

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