What Is A Hedge Fund? A Jargon-Free Guide

The popularity of hedge funds has exploded over the last few decades, and there are now almost 4 trillion dollars invested in hedge funds worldwide.

What Is A Hedge Fund? At its most basic, a hedge fund is a partnership between a professional fund manager and investors (often referred to as limited partners). The manager and investors pool money into a fund, using different strategies to grow the fund.

If this sounds a lot like an actively managed mutual fund, you’re not wrong. The main difference between a mutual fund and a hedge fund is the amount of risk and diversity of products that a hedge fund can invest in versus a mutual fund.

Usually, a mutual fund is limited to investing in stocks and/or bonds. A hedge fund can invest in many other, often exotic, financial products. These can include real estate, derivatives, commodities, currency, and more.

Hedge Fund Strategies

Global Macro Strategy

Hedge funds implementing a global macro strategy look at the big picture economic and political trends worldwide and attempt to capitalize on these large-scale ideas. Examples of this strategy would be looking at global trade imbalances, growth of emerging economies, business cycles, and supply and demand.

Directional Strategy

A directional strategy hedge fund uses market trends and directional market movements to identify equities or other securities. Often computer modeling is used to do technical trend analysis.

Event-Driven Strategy

An event-driven hedge fund strategy seeks to identify risks and opportunities in specific events and make trades that pay off if those risks or opportunities are realized.

Relative Value (Arbitrage) Strategy

A relative value strategy will attempt to take advantage of price discrepancies between securities, otherwise known as arbitrage. Investopedia defines arbitrage as “the simultaneous purchase and sale of the same asset in different markets to profit from tiny differences in the asset’s listed price.

How Can You Invest in Hedge Funds?

Investing in a hedge fund is not as simple as buying a stock. Due to government restrictions and minimum investment thresholds, the average person cannot invest directly in a hedge fund.

How Do Hedge Funds Make Money? Hedge funds make money through their fee structure, as well as their underlying performance. A typical hedge fund fee structure is “2 and 20”, which means they charge a 2% annual fee on the total assets under management, as well as a performance fee of 20% of the total profit.