The basic definition of a hedge fund is not something one would come up with overnight. In the past, hedge funds were defined as a “hedge”, or a fail-safe against unexpected stock market declines, as they would sell the stock market short. However, right now this is a term that could apply to just about any private investment partnership. And when it comes to hedge funds, thousands are now in existence over the world. And their goal would generally be to make as much money as possible through myriad investment strategies and through different ways of investment. The strategies involved here are usually more obtrusive than the rather conservative approaches used by mutual funds.
Hence, a hedge fund would actually be a private investment fund engaged in a cornucopia of investment types or sources. The general partner chooses the different investments and also handles all of the trading activity and day-to-day operations of the fund. As for the limited partners, or investors, they would simply invest the money, or most of it, and gain profits from the fund. The general manager, in most cases, charges a management fee of nominal value, and large bonus for incentives in the event of a high ROI (return on investment).
There are several differences between mutual fund and hedge fund, even as the above example is very similar to how a mutual fund works.
Mutual funds are operated by mutual fund or investment companies and are heavily regulated. Since hedge funds are private funds, the restrictions are considerably fewer in number.
While mutual funds would only invest their client’s money, hedge funds would invest money from two sources in their investments – both from the clients and their own pockets.
Hedge funds charge the same performance bonus as equity market returns – about 20 percent of any gains beyond a specific hurdle rate. Some hedge funds have been able to generate annual rates of return of 50 percent or more, even during difficult market environments.
Again, mutual funds are subject to many stringent requirements and policies, and this may include, but is not limited to short selling, investing in commodities, investing in offshoots of other products or unfair use of leverage. However, hedge funds allow much more freedom – you can invest in whatever way suits you.
Because hedge funds are forbidden from soliciting investments, this may be why most of you may not be familiar with them. During the previous five years some of these funds have doubled, tripled, quadrupled in value or more. But there is an inherent risk to hedge funds, and there are a similar amount of funds that sank like the Titanic, so be careful.