Hedge Funds

What are hedge funds?

A hedge fund is a private, unregistered investment fund. Hedge funds pool money from investors and invest in securities or other types of assets with the goal of getting positive returns. As discussed below, hedge funds are generally limited to individuals and institutional investors who meet certain sophistication criteria.

Hedge funds generally pursue more flexible investments and strategies than registered investment companies, like mutual funds and ETFs, which may increase the risk of investment losses. Moreover, unlike mutual funds, ETFs, and other types of open-end funds, hedge funds are not marketed to retail investors. They are not subject to the numerous regulations that apply to mutual funds and ETFs for the protection of investors—including requiring that mutual fund shares be redeemable on a daily basis based on the net asset value (NAV); protecting against conflicts of interest; ensuring fairness in the pricing of fund shares; requiring disclosure; limiting the use of leverage; and more. 

What should I know if I am considering investing in a hedge fund?

  • You must be an accredited investor or a qualified purchaser. Depending on how the fund is structured, you will need to be an accredited investor or qualified purchaser to invest in hedge funds. An accredited investor or a qualified purchaser must have a certain level of income or assets or meet other professional criteria.
  • Read a fund's offering memorandum and related materials. Make sure you understand the level of risk involved in the fund's investment strategies. Consider if the risks are suitable to your personal investing goals, time horizons, and risk tolerance. As with any investment, the higher the potential returns, the higher the risks.
  • Understand how fund assets are valued. Hedge funds may hold investments that are difficult to sell and may be difficult to value. You should understand the valuation process and the extent to which a fund’s holdings are valued by independent sources.
  • Understand fees. Investors in hedge funds typically pay an asset management fee of 1-2% of NAV. In addition, they also typically pay a performance fee of 15-20% of the hedge fund’s profit subject to certain measures, such as a high-water mark and a hurdle rate, which can limit when a manager is entitled to performance fees. Fees impact how much money you make. Over time, higher fees can significantly lower investment returns. In addition, a performance fee could motivate a hedge fund manager to take greater risks in the hope of generating a larger return.
  • Understand any limitations on your right to redeem your shares. Hedge funds typically limit opportunities to redeem, or cash in, your shares to four times a year or fewer. They also often impose a lock-up period of one year or more, during which you cannot cash in your shares. Furthermore, hedge funds may charge you a redemption fee before you are allowed to cash in your shares. Hedge funds may also have authority to suspend redemptions under certain circumstances, including in times of market distress or when their investments are not able to be quickly or easily liquidated.
  • Determine if the fund is using leverage or other speculative investment techniques. A hedge fund using leverage will typically invest both the investors’ capital and borrowed money to make investments in an effort to increase the potential returns of the fund. A hedge fund may also invest in derivatives (such as options and futures) and use short-selling (selling a security it does not own) to increase its potential returns. The use of these techniques will magnify both the potential gain and the potential loss from an investment.
  • Research hedge fund managers. Make sure the hedge fund managers are qualified to manage your money and find out whether they have a disciplinary history within the securities industry. If the manager is an investment adviser registered with the SEC, you can get this information by reviewing the adviser’s Form ADV, which is the investment adviser's registration form. You can find a firm’s Form ADV using the Check Out Your Investment Professional tool at Investor.gov.
  • Ask questions. You are entrusting your money to someone else. You should know where your money is going, who is managing it, how it is being invested, and how you can get it back.

Additional Information

Investor Bulletin: Hedge Funds
How to Use the Investment Professional Search Tool on Investor.gov | Investor.gov
Investor Bulletin: Form ADV-Investment Adviser Brochure and Brochure Supplement

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