How to Diversify Your Portfolio with Hedge Fund Investments

Hedge Funds: Key Reasons Why Hedge Funds Are Worth Investing

A hedge fund is an investment vehicle run by asset management companies that combines liquid assets with sophisticated trading strategies and risk management techniques. Doing so aims to enhance investment performance and shield returns from market volatility.

What Is a Hedge Fund?

A hedge fund is an innovative investment strategy where the investor takes more risk than regular investment funds and puts more money to make more profits. The primary focus of hedge funds is to make as much profit as possible. They might sound similar to mutual funds, but they are quite different because they are more aggressive, risky, and restricted to some people.

Due to its exclusivity and more return than other investments, the hedge fund industry has grown tremendously since it started. 

  • If we look at the data, there are around $3 trillion of assets under management in the hedge fund industry, more than 8,800 managers, and more than 27,000 funds globally.

  • Today, the US is the dominant player in the hedge fund industry, as it covers 67% of the world's funds. 

  • Much behind the US, Europe still stands in the second position with 17% of the world's hedge funds.

  • Hedge funds are actively managed investments that use risky strategies to maximize investors' profit.

  • They are primarily built for wealthy clients because they require a high minimum investment or net worth.

  • The returns on hedge funds are comparatively more than conventional investment funds, so they charge higher fees.

Who Can Invest in Hedge Funds?

As hedge funds are risky investments, not all investors qualify to invest in them. The US Security and Exchange Commission has set some rules for investing in hedge funds. Therefore, only certain types of investors can invest in this risky investment.

Institutional investors, like pension funds, etc., can invest in hedge funds.

However, to make it available to the general public, accredited investors who meet specific financial criteria can also invest in hedge funds. However, they should have a net worth of at least $1 million or a yearly income of over $200,000. If you are married, your annual income should be at least $ 300,000.

  • It is worth mentioning that the criteria for accredited investors have been the same since 1980. Therefore, more people are eligible to invest in hedge funds. However, only four percent of households are still considered accredited investors.

  • As the popularity of hedge funds is at its peak, in 2020, the Security and Exchange Commission also allowed some people with advanced investing knowledge or who have work experience or have a financial license to become accredited investors.

  • However, it should be noted that hedge funds are not for the general public or even for an average investor.

How Do You Invest in Largest Hedge Funds?

To invest in hedge funds, you must first qualify for accredited investor status.

  1. Do Your Research: If you feel you are an accredited investor, look for hedge funds that accept new investors. It is good to consider a financial advisor for guidance before making a move.

  2. Review Requirements:  Extract as much information as possible about the hedge funds and learn more about their managers, investment strategies, and objectives. You can find all this information in the ADV form.

  3. Criteria Requirements: Contact the hedge fund that suits your requirements and ask about the minimum investment requirements. Every fund has a different requirement. 

  4. Accredited Investor Status: Each fund has a process to certify whether you are an accredited investor. You must provide information about your income, assets, and investment experience. Some funds are even verified with third parties like your bank, investment advisor, or an attorney.

How Much Money Do I Need to Invest in a Hedge Fund?

To invest in hedge funds, you first need to qualify for the status of a credited investor. 

An accredited investor must have a network of at least one million or an annual income of at least $200,000. If you are married, your annual income should be at least $300,000.

How Do Investors in Hedge Funds Make Money?

Hedge funds firms generally charge a management fee, which is calculated on the value of your investment. To simplify it, investing one million in hedge funds will pay 2% management fees, totaling $20,000 for that particular year. This fee covers the fund operation and compensation of the manager.

On the other hand, the hedge fund also takes 20% of the profit that they have generated. To simplify this, if you have invested $1 million in a hedge fund, which after profit grew to $1.2 million in that year, then you will pay a $40,000 fee to the fund on $200,000 of profit.

Hedge fund management generally charges 1 to 2 percent as a management fee on your invested amount. In addition, you also pay 20% of the profit that the fund has made for you.

What is the 2/20 rule for hedge funds? 

There is a specific 2/20 rule for hedge funds, which is also a compensation structure.

The 2 Rule:

 The "2" rule is generally for a management fee applied to the total assets under management. It doesn't matter whether the investment performs well or not. It is the fixed percentage of the investor's money to the hedge fund. The 2% management fee covers the operational cost and compensates the fund manager.

The 20 Rule:

On the other hand, 20% is the performance fee charged on the profit generated by the hedge fund. It should be noted that the fee is only applied when the fund exceeds its specific minimum threshold or level of profit. It means for the hedge fund firm to earn the 20% performance fees, they have to deliver a return above the specific target.

What Is the 10-20 Rule for Hedge Funds?

Most hedge funds also collect a performance fee between 10 to 20% of the profit. To take out this performance fee, the hedge fund must hit the objective, which is also called a watermark.

The fund continuously exceeds its previous watermark and tries to hit the target. 

If the fund loses 5% from its previous high mark, the manager will only collect the performance fees once the fund makes up the 5% loss again.


                                                                                         A typical fee structure

What Is the Largest Hedge Fund in the World?

With 168 billion dollars in assets under management in 2022, Bridgewater Associates is now the world's largest global investment firm, which is not only the biggest hedge fund manager in the world but is also more than twice the size of the second largest firm.

Bridgewater Associates was started in 1975, and the firm got its attention through its expertise in macroeconomic analysis and investment strategies that change with the geopolitical and global economic landscapes.

Bottom Line

A Hedge fund is a vital investment strategy that involves higher risk than other traditional investment funds and aims to generate more profit. Hedge funds are more aggressive and are limited to a group of people who qualify for specific criteria specified by the Security and Exchange Commission. Today, the United States dominates the hedge fund industry, covering 65% of the world. Bridgewater Associates is the largest hedge fund firm worldwide.

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05 Dec, 2023


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