DEFINITION of 'Incubated Fund'

A fund that is offered privately when it is first created. Investors of this type of fund are usually employees associated with the fund and their family members. Incubation allows fund managers to keep a fund's size small while testing different investment styles before the fund is available to the public and subject to rules and regulations.

These types of funds are never officially called "incubated," but are instead called "limited distribution" funds.

BREAKING DOWN 'Incubated Fund'

There are two paths that can be taken by an incubated fund. If the fund is able to achieve excessive returns it is "born" and made available to the public. However, if returns are not adequate, the fund is liquidated and "buried."

The use of incubated funds has come under criticism in recent years. This is because incubated funds are not managed under normal conditions and, therefore, the returns achieved can be greater than normal. When the fund is advertised to the public, it may not be able to replicate the incubated returns it advertises. To avoid problems, investors must be able to identify whether a fund was first an incubated fund. However, this is easier said than done, as fund managers usually attempt to hide a fund's incubator origins.

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