What Are Hedge Funds And Are They Legal? (2024)

FAQs

How are hedge funds legal? ›

Hedge funds are not subject to some of the regulations that are designed to protect investors. Depending on the amount of assets in the hedge funds advised by a manager, some hedge fund managers may not be required to register or to file public reports with the SEC.

Hedge funds are financial partnerships that employ various strategies in an effort to maximize returns for their investors. Unlike mutual funds managers, hedge fund managers have free reign to invest in non-traditional assets and employ risky strategies.

Key Takeaways. Hedge funds employ complex investing strategies that can include the use of leverage, derivatives, or alternative asset classes in order to boost return. However, hedge funds also come with high fee structures and can be more opaque and risky than traditional investments.

"Hedge funds engage in a variety of investment activities. They cater to sophisticated investors and are not subject to the regulations that apply to mutual funds geared toward the general public.

Typically the hedge fund is set up as a General Partnership, with a limited liability company acting as the funds General Partner.

Hedge funds use pooled funds to focus on high-risk, high-return investments, often with a focus on shorting — so you can earn profit even when stocks fall.

Typically, the manager of the hedge fund is compensated with a fee based on 2% of the gross assets of the fund, and a profits interest entitling the manager (or, more typically, its affiliated general partner) to 20% of the fund's return (subject, in many cases, to minimum guaranteed returns for the limited partners).

Hedge funds make money as part of a fee structure paid by fund investors based on assets under management (AUM). Funds typically receive a flat fee plus a percentage of positive returns that exceed some benchmark or hurdle rate.

Normally, the prices of the bonds and shares trade in a close relationship. Sometimes bond and stock market conditions cause the prices to get out of line. Hedge funds buy and sell the bonds and stocks simultaneously, pushing the prices back into line and profiting from market mispricing. Distressed securities.

The recent Forbes 400 (richest American billionaires) list has about 112 people, by my count, who made their fortunes in some form of Finance, Investments, Hedge Funds, insurance or banking.

Are hedge funds shady? ›

Most hedge funds are well run and do not engage in unethical or illegal behavior. However, with intense competition and large amounts of capital at stake, there are less than scrupulous hedge funds out there.

Hedge funds originated as a vehicle to help diversify investment portfolios, manage risk and produce reliable returns over time. While hedge funds' investor base has evolved though the years – from individuals to institutions such as pensions, universities and foundations – their core goals have remained the same.

Also, hedge funds are less transparent than traditional funds because some hedge fund managers do not reveal the securities they hold, or the extent to which they are leveraged. Hedge funds may have a higher turnover rate and be less tax efficient than traditional funds.

Hedge funds are subject to the same trading reporting and record-keeping requirements as other investors in publicly traded securities. They are also subject to a number of additional restrictions and regulations, including a limit on the number and type of investors that each fund may have.

Hedge funds hire teams of compliance officers and lawyers to keep them in check and ensure that they don't fall afoul of agencies like the Securities and Exchange Commission (SEC) in the United States or the Financial Conduct Authority (FCA) in the United Kingdom.

Hedge funds will need to be registered with the SEC if they have over $150 million in managed assets via accredited private fund investors. If there are investors in the fund that don't qualify as accredited private investors, that threshold drops to $100 million.

As a result, hedge funds are typically off-limits for most ordinary investors. There are still ways you can gain access to hedge funds, either through retail-oriented hedge funds or by trading the stock of public investment firms.

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.