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What is a "hedge fund"?

Hedge Funds

Scott Leonard, CFP (President, Leonard Wealth Management, Inc.) gives expert video advice on: Can I invest in a hedge fund?; What are the risks and rewards of hedge funds? and more...

What is a "hedge fund"?

A hedge fund is a private investment partnership, similar to a mutual fund in the sense that its a pooled investment. A hedge fund will be accredited high network investors that provide money to this partnership pool, and it's usually a professional manager that goes out and invests the money based on some investment strategy.

Can I invest in a hedge fund?

In order to get into and invest in a hedge fund, normally hedge funds have a high initial minimum investment. So, it's a large amount of money it would take to buy into a hedge fund. Secondly, you need to be an accredited investor which would mean either you have a very high income or you have a high liquid investful network.

What are the costs I pay for investing in a hedge fund?

When you invest in a hedge fund, you are going to have two real layers of cost. One cost is going to be the acquisition cost of whatever the hedge fund is investing in. The other cost is going to be the cost to actually run the hedge fund. That's going to be the cost of the hedge fund itself, then the expenses or the salary paid to the fund manager. As it relates to what those actual fees might be that the money manager is charging, usually there's two components. There's the straight asset-based fee that they're going to charge, and then there's usually a performance-based fee. The better the performance is that they're giving you on the hedge fund, the more they're going to take a piece of that performance as their management fee.

What are the risks and rewards of hedge funds?

When it comes to investments, it's really important to understand how does a single investment play out as part of your overall investment strategy. And what's difficult with hedge funds is they don't have long histories and we don't always know exactly what a hedge fund might be doing. And it might change a little bit over time. So it's hard to understand how does this hedge fund investment add value to my overall portfolio strategies.So it's kind of risk we have there because we don't know what the benefit is to that portfolio from this individual hedge fund investment.

Are hedge funds regulated by the government?

In the sense of hedge fund government regulation, hedge funds are not regulated by the Securities and Exchange Commission in the way that we think about a mutual fund. They are partnerships. There are regulations on how partnerships have to be structured, and how these pools have to be structured, but they're not really regulated in the traditional sense of an investment portfolio.