Hedge Funds for the Rest of Us

Anyone with $30,000 to $40,000 can start a hedge fund. Hedge funds now manage $2.2 trillion in assets, up four fold in five years. Originally a hedge fund invested in equities and used leverage. It actually had to hedge to protect against market swings by taking long and short positions. Only a hedging fund could be called a “hedge fund.” Now hedge funds are simply private investment pools of money, normally structured as a limited partnership or limited liability company. These profits are referred to as a “performance fee” or an “incentive allocation.” They can amount to 20 or even 30 percent of the profits. Unlike a mutual fund, a hedge fund is not open to just any investor, and it cannot advertise for investors. However, a hedge fund can use any means necessary to make money, whereas the SEC prohibits the use of derivatives or shorting strategies by mutual funds; in other words, mutual fund are limited to taking long positions. There is more risk to the typical mutual fund than to the typical hedge fund because a hedge fund can employ long and short positions to make money in good and bad markets. Also, a mutual fund manager is paid on the basis of the amount of assets under management. A hedge fund manager is paid primarily based on results, and most hedge fund managers often invest their own money. Hedge funds engage in arbitrage and employ hedging strategies. Hedge fund managers who use traditional, long-only equity strategies do not hedge in fact but operate a type of mutual fund.