7971 / What is a hedge fund?

There is no statutory or regulatory definition of hedge fund, a type of pooled investment vehicle, but such funds have several characteristics in common. As described by the SEC, “hedge funds are organized by professional investment managers who frequently have a significant stake in the funds they manage and receive a management fee that includes a substantial share of the performance of the fund.”¹

“Hedge funds were originally designed to invest in equity securities and short selling to ‘hedge’ the portfolio’s exposure to movements of the equity markets. Today, however, advisors to hedge funds utilize a wide variety of investment strategies and techniques designed to maximize the returns for investors in the hedge funds they sponsor.”²

Hedge funds are varied in investment style, strategies, and objects of investment. A 2004 SEC staff report noted that they “invest in equity and fixed income securities, currencies, over-the-counter derivatives, futures contracts, and other assets. Some hedge funds may take on leverage, sell securities short, or use hedging and arbitrage strategies. … Hedge funds offer investors an important risk management tool by providing valuable portfolio diversification because hedge fund returns in many cases are not correlated to the broader debt and equity markets.”³ A fund of funds is a fund that invests in several hedge funds.