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Hedge Funds

BASICS

Hedge Fund Basics

What is a Hedge Fund?
"Hedge fund" is a general, non-legal term that was originally used to describe a type of private and unregistered investment pool that employed sophisticated hedging and arbitrage techniques to trade in the corporate equity markets. Hedge funds have traditionally been limited to sophisticated, wealthy investors. In earlier markets, the term "hedge fund" referred to an asset class employing a strategy to offset its market risk exposure by taking an opposing position - for example, selling short or holding futures. In fact, a perfect hedge is one that totally offsets gains and losses, creating a position that is completely neutral. In today's markets, a hedge fund can be just about anything. They may or may not use leverage, make bets on a global basis or look at the technical aspects of a security in an attempt to find a mispricing in the marketplace. Over time, the activities of hedge funds broadened into other financial instruments and activities. Today, the term "hedge fund" refers not so much to hedging techniques, which hedge funds may or may not employ, as it does to their status as private and unregistered investment pools. 

Hedge funds are similar to mutual funds in that they both are pooled investment vehicles that accept investors' money and invest it on a collective basis. Hedge funds differ significantly from mutual funds, however, because hedge funds are not required to register under the federal securities laws. That's because they generally only accept financially sophisticated, high-net-worth investors. Some funds are limited to no more than 100 investors. 

Freed from regulation, hedge funds engage in leverage and other sophisticated investment techniques to a much greater extent than mutual funds (although they are subject to the antifraud provisions of the federal securities laws). 
• Direct Hedge: This is accomplished by hedging one asset, such as common stock, with another asset...