The term ‘hedge fund’ originally derives from the investment strategy of ‘hedging’ against market movements, maximizing returns and eliminating risks by choosing either long (buy) or short (sell) positions within the market – the aim being to profit regardless of market direction.
Nowadays, with a total AUM of $3.61tn, the modern hedge fund sector encompasses a diverse group of strategies that can invest in an unconstrained manner to meet a variety of portfolio needs. Providing a single definition is therefore challenging. In fact, one of the simplest ways to define hedge funds is to look at what hedge funds are not
- Hedge funds are not a single asset class. With their light levels of regulation, hedge funds can invest across a wide range of asset classes and instruments, without the constraints that many public or mutual funds must adhere to.
- Hedge funds do not invest in a consistent way. Investment strategies differ considerably, with varying methods of portfolio construction and risk management techniques.
Historically, hedge funds
have been largely unregulated, but this is beginning to change. The Global Financial Crisis (GFC), some high-profile hedge fund collapses, and the changing investor audience have all helped create this shift toward regulation. Previously, only the most sophisticated (accredited) investors were able to invest in hedge funds. Over the past few years amendments on traditional products, for instance UCITS or alternative mutual funds, have made hedge fund investment more accessible for smaller and retail clients. UCITS and alternative mutual funds are explored in more detail in Hedge Fund Structures, Fees, and Returns
The structure of hedge funds is becoming more varied: funds are often available as pooled vehicles through limited partnerships or limited liability companies, but are increasingly offered as separately managed accounts, or via platforms. Hedge funds tend to be open ended, with all capital invested at the start of a relationship. This is unlike other alternative asset products (such as private equity
), where an investor may be called upon to provide capital at intervals throughout the investment relationship. Investors can periodically withdraw capital or increase their subscription.
Hedge funds have often been characterized by the high fee structure they charge. Historically, this is a 2% management fee (based on net asset value), plus a 20% performance fee – a ‘2/20’ fee structure – although in recent years these numbers have fallen on average.