A hedge fund is an investing strategy that aims to maximize returns while minimizing risk regardless of the market environment. Strategies can vary widely from a sector-specific technology fund to commodity trading strategies to sophisticated strategies using derivatives to hedge against potential downturns in the market. They often use leverage to try and amplify returns, although leverage can cut both ways as it amplifies both on the upside and downside.
The structure of hedge funds is different from a normal mutual fund in that hedge funds are limited partnerships where the limited partners (investors) supply capital to the general partner (portfolio manager) who pools the money in order to invest in the strategy.
The fees associated with hedge funds also tend to be more expensive than your average mutual fund, with the industry-standard fee of a 2% management fee and a 20% performance fee. The 20% performance fee is subject to the high-water mark, which is the peak value that the fund has achieved. With a performance fee, the investor is only paying for outperformance and not poor performance.
Similar to mutual funds and ETFs there are a plethora of metrics by which one can evaluate a hedge fund’s performance. These types of investments are not suitable for everyone, as there are pros and cons to investing in them. Many of the strategies that were found only with the hedge fund format are now available in both mutual fund and ETF vehicles.
