Hedge funds are a special type of mutual funds that follow a very high risk investment strategy. Hedge funds are a special type of mutual funds that follow a very high risk investment strategy. As their name implies, hedge funds often seek to offset potential losses in the principal markets they invest in by hedging their investments using a variety of methods, most notably short selling.
Hedge funds have five primary characteristics.
- Not Regulated
As opposed to regular mutual funds, the SEC does not regulate hedge funds. Very often, hedge funds are registered in foreign tax havens, and use various loopholes to avoid taxes. - High Initial Investment Hedge funds require very high initial investments in order to join. For some funds, that minimal investment might be $250,000, while for others it will be closer to one million dollars, and some funds might require an initial investment of 10 million dollars or more. For this reason, hedge funds generally serve institutional investors and the extremely wealthy
- Speculative Hedge funds generally adopt a very speculative investment strategy that can provide very high yield at a very high level of risk. Amongst other things, hedge funds invest in derivatives, such as options and futures. In order to increase their earnings potential, hedge funds often take out loans.
- Performance Fees In addition to the management fee that is paid for all mutual funds, hedge funds also charge a performance fee. The performance fee is calculated as a percentage of the fund’s annual profits. Generally, performance fees are around 20% of profits.
- Limited Number of Shareholders In order to avoid reporting to the SEC, hedge funds limit their number of shareholders.
