A:

An unregistered mutual fund is a general name given to investment companies that are not formally registered with the Securities and Exchange Commission (SEC). On some occasions, these companies are actually breaking the law by running unregistered investment portfolios. However, in most cases, the term unregistered mutual fund is interchangeable with hedge fund.

Although mutual funds and hedge funds generally perform the same functions (managing investment portfolios), mutual funds are registered with the SEC and hedge funds are not. Hedge funds are unregistered because of one of two exemptions in the Investment Company Act of 1940:

  1. Hedge funds need not register with the SEC if they have fewer than one hundred investors who are all considered accredited investors.
  2. A hedge fund is exempted from registration if all of the fund's investors (no matter the number) are considered qualified investors.

By meeting one of these two caveats, hedge funds are able to avoid registration, allowing them to take on riskier positions in derivatives and options, use short selling, hold larger positions and use leverage to magnify their returns (or losses).

Mutual funds, on the other hand, are bound by more restrictions than their unregistered cousins, making them a more accessible and suitable choice for the average investor. The difference between a registered and unregistered mutual fund is small when it comes to operations, but vastly different when it comes to the way their portfolios are managed. (To learn more, see our Mutual Funds Basics Tutorial and Taking A Look Behind Hedge Funds.)

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