A hedge fund is an pooled investment fund that manages money for large institutions, high-net worth people and large financial companies, with the goal of achieving alpha returns.
That sounds complicated, doesn't it.
If we break it down term by term, you’ll see this isn't rocket science.
A pooled investment fund: the investors in the fund pool together their money for the fund managers to invest.
If Steve puts in $40 and Liz puts in $60, the fund is emanating $100. What if the funds holdings rise 10% and now equals $110? Steve owns 40 percent of that and Liz 60%. Hedge funds make money by charging fees, about 1.5% or 2% of assets under management per year and they take about 17% of the profit on a gain on a stock when they sell it. The rest is for the investors, or limited patterns, like Steve and Liz.
Who are the investors?
Steve and Liz are wealthy people. They’re also in that fund with funds from institutions like university endowments, state pension funds, insurance companies and banks.
These investors are accredited, or wealthy and sophisticated investors who are not only allowed by regulators to invest in institutional funds, but meet the minimum amount of capital required by hedge funds to invest in the fund.
They’re looking for alpha return, or better returns than the broader market. They often have growing budgets and they need to invest their cash in something that will grow it aggressively.
So how do hedge funds protect against the big risks they take? See the short video above for the full explanation?