What are “hedge funds” and what should you know about them? First, to correct a misunderstanding, they are not a separate assets class. They may be thought of as “alternative investments.” They can go long or short any asset class, including derivatives and collectibles but also plain old stocks and bonds. And they can double down on their bets with leverage. In other words, it’s how these funds invest that makes them different from, say, mutual funds or ETFs – not what they invest in.
Regulators limit participants in hedge funds to wealthy investors, defined as those with net worth of at least $1 million and income of over $200,000, under the assumption that they are particularly financially savvy. Take it from me, this is not necessarily so.
Then there is managers’ compensation. They are high compared with mutual funds. A typical hedge fund manager receives 20% of fund gains plus a 2% management fee. If they do well you win and they win. If they lose, you lose and they still win. This is the main reason why top performing mutual fund managers often open hedge funds. It’s where the real money is.