Hedge funds are aggressively managed portfolios that use advanced investment strategies in effort to generate high returns (either in an absolute sense or over a specified market benchmark). They can be thought of as mutual funds for the super rich. They are similar to mutual funds in that investments are pooled and professionally managed, but differ in that the fund has far more flexibility in its investment strategies.

It is important to note that hedging is actually the practice of attempting to reduce risk, but the goal of most hedge funds is to maximize return on investment. The name is mostly historical, as the first hedge funds tried to hedge against the downside risk of a bear market, by shorting the market (mutual funds generally can't enter into short positions as one of their primary goals). Nowadays, hedge funds use dozens of different strategies, so it isn't accurate to say that hedge funds just "hedge risk." In fact, because hedge fund managers make speculative investments, these funds can carry more risk than the overall market.

Structurally, a hedge fund has some similarities to a mutual fund. For example, just like a mutual fund, a hedge fund is a pooled investment vehicle that makes investments in equities, bonds, options and a variety of other securities. It can also be run by a separate manager, much like a sub-advisor runs a mutual fund that is distributed by a large mutual fund company. That, however, is basically where the similarities end. The range of investment strategies available to hedge funds and the types of positions they can take are quite broad and in many cases, very complex. We will focus on specific strategies later in this section, so for now we'll focus on how hedge funds are structured.

Related Reading:


Organizational Structure

Related Articles
  1. Investing

    Hedge Funds' Higher Returns Come At A Price

    Learn how hedge funds win big gains for investors - and why they sometimes lose.
  2. Investing

    Understanding a Hedge Fund Manager's Worth

    Hedge funds pool investors’ money much like mutual funds. However, they are not as closely regulated as mutual funds, and although their investments may include stocks, bonds and other traditional ...
  3. Investing

    Evaluating Hedge Fund Performance

    Most investors are aware of hedge funds, but many don't know the dirty details of this unique investment type.
  4. Financial Advisor

    Why Hedge Funds Are Not Living Up to Return Hype

    Hedge funds are supposed to produce better returns while protecting your investments from the downside. Here's why they are not living up to their purpose.
  5. Financial Advisor

    4 Reasons to Still Consider Traditional 2 & 20 Hedge Funds

    Find out why traditional 2 & 20 hedge funds are still worth considering as an investment, even though they have underperformed for the last several years.
  6. Investing

    The Difference Between Mutual Funds And Hedge Funds

    Both mutual funds and hedge funds are managed portfolios. A manager chooses securities and then lumps them into a single portfolio.
  7. Investing

    Hedge Funds Tutorial

    Hedge funds can be an integral part of a well-diversified portfolio - if you know how to choose them.
  8. Investing

    Will Institutional Investors Change the Way Hedge Funds Invest?

    As market volatility rises, hedge funds could be capitalizing, but institutional investors may be holding them back.
Frequently Asked Questions
  1. Why Do Most of My Mortgage Payments Start Out as Interest?

    Fear not: Over the life of the mortgage, the portions of interest to principal will change.
  2. What is the difference between secured and unsecured debts?

    The differences between secured and unsecured debt, and how banks buffer risks associated with each type of loan through ...
  3. How Many Times has Warren Buffett Been Married?

    Warren Buffett has been married twice in his life, but the circumstances surrounding the marriages were unconventional.
  4. What's the smallest number of shares of stock that I can buy?

    Many people would say the smallest number of shares an investor can purchase is one, but the real answer is not as straightforward. ...
Trading Center