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.

Hedge Funds

Although mutual funds and hedge funds generally perform the same functions (managing investment portfolios), mutual funds are registered with the SEC, 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 100 investors who are all considered accredited investors.
  2. A hedge fund is exempt from registration if all of the fund's investors (no matter the number) are considered qualified investors.

By meeting one of these two conditions, 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

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.

An unregistered mutual fund that is not a hedge fund can be a scam. The reason for not being registered may be to avoid the legal requirements that keep investors safer. They may disseminate fraudulent information about their holdings, causing a sharp uptick in the value of those holdings. Or they may invest in questionable or non-existent companies for the sake of looking good on paper. 

There are a number of requirements regarding issuing prospectuses, reporting expenses and reporting holdings that registered mutual funds must meet. An unregistered fund has no obligations for such reporting. 

The Bottom Line

There is no advantage in buying into an unregistered mutual fund. The odds of fraud are high, and it is unlikely that you will beat the performance of similar registered funds. The one exception is when you join or form an investment club. The club may pool investor's money and buy a variety of securities, much the same as a mutual fund does. The difference between an investment club and an unregistered mutual fund is that you have a say in anything the club buys and you can demand to see records of expenses. (See also: Mutual Funds and Taking a Look Behind Hedge Funds.)