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Hedge Funds Investing – Description of a Hedge Fund Account

June 28th, 2006

Hedge Funds Investing – Description of a Hedge Fund Account

New York Stock Exchange

A hedge fund got its name from Alfred Winslow Jones in 1949 by developing a way of selling short some stocks at the same time buying another stock.  He was hedging his bets so to say.  Hedge in the financial world means to attempt to offset possible loss on an investment by counterbalancing your financial portfolio to prevent a loss in money.

The hedge fund was intended originally from investing in stocks for both long and short term investing, however the ideas has expanded to investments that are not involving stock trading at all.

In the U.S., a hedge fund is created as a limited partnership or a limited liability company (LLC).  The general partner or manager is the hedge fund manager.  The investors are the limited partners or members of the hedge fund.  There is a limit to 499 investors in any one hedge fund.

 

Investors in a hedge fund will pool together their money to invest.  The hedge fund manager makes the investment decisions which are usually outlined in offering documents.  The hedge fund manager gets paid by both a management fee and also bonuses based on performance fee.

There can be limits to the performance fee, which is called a “high water mark” that can be in place. The hedge fund manager will not get the bonus performance fees unless the investments exceed the highest value.  There is a downfall to this because if the fund does not perform up to expectations the fund can be closed down, which means that the investor needs to invest elsewhere.

There are both US based hedge funds as well as international hedge funds.  Currently the trend seems to be that more off-shore hedge funds exist than US based funds.  It is estimated that two-thirds of the hedge funds are internationally based.  The hedge fund managers however usually live in the United States.  New York City and Greenwich, Connecticut are common locations for hedge fund managers to keep their offices.  You can also find a large amount of hedge fund managers based in London.

 

Each hedge fund manager will charge a different annual management fee.  It usually is around 20% of the profit of the hedge fund plus 2% of assets that are being handled.  They can go up considerably if the manager is well known and successful.  Some big time hedge fund managers can get up to 50% incentive or performance fee with no management fee.  It is important to know how much fees will be and if there are high limits on the performance fee.

Hedge funds are limited to individuals who are both "accredited investors" and "qualified purchasers.”  To be an accredited investor you must have and income of at least $200,000 per year or have a net worth over $1,000,000.  To be a qualified purchaser you need to own at minimum $5,000,000 in qualified investments.

If you don’t qualify for a hedge fund directly, you might be able to participate in a fund of funds.  This fund of funds will only invest in other investment funds such as hedge funds.  A fund of funds will not trade assets directly, but invest in other funds that will.  If the fund of funds in registered with the SEC they can take investors that are not accredited and are not qualified purchasers.  The starting investment is usually a lot less; sometimes it can be as low as $25,000.

 

Hedge funds are not regulated by the SEC as much as a mutual fund.  A hedge fund can be a riskier investment.  An alternative to a hedge fund would be a mutual fund which is carefully regulated by the SEC.  A mutual fund does not offer performance incentives like a hedge fund will do.

Hedge funds can be a risky investment, and could actually cost money to participate in.  If the fund makes profit one year and the next year it loses money.  You pay each year form the profit on the hedge fund to the hedge fund manager.  This could actually make financial losses add up quicker.  The hedge funds often look on the short term aspect on investing which can pose a problem when investing in this kind of fund; you stand to make a lot of money while at the same time you stand to lose just as much or more.

 
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Nicole Wilson
Best Syndication

Books on Hedge Funds at Amazon

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Important:  The material on Best Syndication is for informational purposes only and is not meant to be advice. You should always seek professional advice before making financial decisions. 
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