A hedge fund is an investment firm that utilizes complex strategies involving the use of short-selling, leverage, derivatives, and alternative asset classes to generate returns for its investors. Hedge funds are not only more complex than traditional mutual funds that invest in stocks and bonds, but they are also less regulated and far more opaque—meaning that investors might not understand what they've bitten off to chew. Because of this, hedge funds tend to cater to high net-worth individuals and require large sums to invest—leaving the ordinary investor out of luck.
It is possible to invest in hedge funds, but there are some restrictions on the types of investors who comprise a hedge fund's investor pool. In general, it is extremely difficult for individual investors to gain access to a quality hedge fund. This forces many to either find indirect methods of investing in hedge funds or just give up trying.
Key Takeaways
- Because they are not as regulated as mutual funds or traditional financial advisors, hedge funds are only accessible to sophisticated investors.
- These so-called accredited investors are high net worth individuals or organizations and are presumed to understand the unique risks associated with hedge funds.
- For ordinary individuals, investing in the stock of a financial company that operates hedge funds could be a way to gain indirect access.
Regulation D
SEC Regulation D, specifically rules 504 and 506, limit the total number of investors who can be admitted inside of a hedge fund. Hedge fund general partners and managers often create high minimum investment requirements. It is not uncommon for a hedge fund to require at least $100,000 or even as much as $1 million to participate.
Unlike mutual funds, hedge funds avoid many of the regulations and requirements within the Securities Act of 1933. In exchange, the Securities and Exchange Commission (SEC) requires a majority of hedge fund investors to be accredited, which means possessing a net worth of more than $1 million and a sophisticated understanding of personal finance, investing, and trading. These requirements exclude the vast majority of the investing public.
Funds of Funds
Many mutual funds were established to mimic the investment strategy of famous hedge funds. These so-called "funds of funds" (FOF) are inexact replicas, however, since hedge funds have access to a much wider range of investment options. Some hedge funds are actually listed on exchanges and have shares that can be purchased individually or through a broker.
There are also "replication" equity funds that try to imitate the performance of hedge fund benchmarks, similar to how an exchange-traded fund (ETF) aims to produce the same returns as an underlying index. Options such as these are good alternatives for investors who are interested in hedge funds but cannot gain access to them.
Publicly Traded Fund Companies
If you can't invest in a hedge fund directly, you might be able to capture some of that edge indirectly by investing in the companies that run hedge funds. Blackrock, for instance, has a large alternative investments segment that operates much like a hedge fund and handles billions of dollars for ultra-wealthy clients and organizations. By investing in Blackrock instead of its fund, you'll at least be able to capture (in theory) some of that segment's performance. There are several other publicly traded investment advisors and asset management firms that you can look at as well.
So, can you invest in hedge funds? Let's see what an expert has to say:
Advisor Insight
Matthew J. Ure, RMA
Anthony Capital, LLC, San Antonio, TX
Yes, assuming you meet the fund’s criteria for membership. Those usually follow the SEC’s minimum-income rules: You must have a net worth of $1,000,000 or have made over $200,000 ($300,000 for married couples) for the last two years and this year as well. Those requirements are to ensure that you’re an “accredited investor” and therefore should have the acumen to understand, and the money to risk, on the advanced, aggressive strategies that hedge funds typically use.
Funds can and do make exceptions to these criteria, usually for the proverbial family and friends. The SEC allows them to accept up to 35 non-accredited investors over the life of the fund. But they will usually just stick to the accredited-investor guidelines; some set even higher net worth or earned-income levels minimums.
FAQs
You generally must be an accredited investor, which means having a minimum level of income or assets, to invest in hedge funds. Typical investors include institutional investors, such as pension funds and insurance companies, and wealthy individuals.
Can a regular person invest with hedge fund? ›
Because they are not as regulated as mutual funds or traditional financial advisors, hedge funds are only accessible to sophisticated investors. These so-called accredited investors are high net worth individuals or organizations and are presumed to understand the unique risks associated with hedge funds.
What is the minimum to invest in a hedge fund? ›
a minimum investment of $1 million to $10 million. Despite such high thresholds, through Morgan Stanley, clients can often gain access to funds at much lower minimum investments. As discussed later, investments in single manager hedge funds may be as low as $100,000 per fund.
Are hedge funds good to invest in? ›
Hedge funds offer the potential for high returns and diversification benefits, but they also come at the cost of higher fees and less regulatory oversight. As with any investment, you should do your own research to determine whether they make sense for your portfolio.
Can anyone get into hedge funds? ›
If you want a hedge fund job, you'll typically need to have an excellent academic record and – if you want to be an analyst or a portfolio manager – you'll need to be no stranger to very hard work.
Can only rich people invest in hedge funds? ›
Therefore, an investor in a hedge fund is commonly regarded as an accredited investor. This means that they meet a required minimum level of income or assets. Typical investors are institutional investors, such as pension funds and insurance companies, and wealthy individuals.
Is BlackRock a hedge fund? ›
BlackRock manages US$38bn across a broad range of hedge fund strategies. With over 20 years of proven experience, the depth and breadth of our platform has evolved into a comprehensive toolkit of 30+ strategies.
What is the average return of hedge funds? ›
Historical studies show that as hedge funds tend to perform well during periods of high, stable interest rates, survey respondents have upgraded their return targets since 2022 to 9.06% from 7.45%, marking the highest such level in more than 10 years as they expect moving into a high stable rate environment.
What is the 2 20 rule for hedge funds? ›
The 2 and 20 is a hedge fund compensation structure consisting of a management fee and a performance fee. 2% represents a management fee which is applied to the total assets under management. A 20% performance fee is charged on the profits that the hedge fund generates, beyond a specified minimum threshold.
Which hedge fund has the highest return? ›
Billionaire Christopher Hohn's TCI led the annual ranking by 2023 returns, which were $12.9 billion after fees, while Citadel, Millennium Management and D. E. Shaw, all multi-strategy firms, were the top three hedge funds by lifetime gains.
Hedge funds are seen as too risky by some. Investors must be able to bear certain risks not always experienced in stocks and bonds. But adding hedge funds to a portfolio can reduce risks to overall wealth.
Do hedge funds beat the S&P 500? ›
Data from an article by The American Enterprise Institute charted the average hedge fund's performance from 2011 to 2020. Over that stretch, the typical hedge fund underperformed the S&P 500 every single year. Again, there will be an occasional manager who outperforms, but rarely does it last long.
Is my money safe in a hedge fund? ›
While hedge funds are only lightly regulated and carry high inherent risks, funds of hedge funds are thought to offer security because professional managers are picking the hedge funds that make up the pools.
Are hedge funds illegal? ›
Are Hedge Funds Legal? Yes, they are legal. That is, if they are doing the right thing. The usual problems that present are insider trading and market manipulation.
Who are the richest hedge fund managers? ›
Who Is the Richest Hedge Fund Manager? Ken Griffin of Citadel is both the richest hedge fund manager and the highest paid. In 2022, he earned $41. billion, and by the beginning of 2023 his net worth was estimated at $35 billion.
Why do hedge funds pay so much? ›
Hedge funds make money by charging a management fee and a percentage of profits. The typical fee structure is 2 and 20, meaning a 2% fee on assets under management and 20% of profits, sometimes above a high water mark. For example, let's say a hedge fund manages $1 billion in assets. It will earn $20 million in fees.
Can you just start a hedge fund? ›
In order to start a hedge fund in the United States, two business entities typically need to be formed. The first entity is created for the hedge fund itself and the second entity is created for the hedge fund's investment manager.
How do I join a hedge fund? ›
Polish your credentials through unpaid internships or related financial industry jobs so that your resume stands out.
- Make Sure This Is What You Want. ...
- Study the Hedge Fund Industry. ...
- Use the Three-Circles Strategy. ...
- Identify Hedge Fund Career Mentors. ...
- Get an Internship. ...
- Develop Your Unique Value Proposition.
