A hedge fund is an investment firm that utilizes complex strategies involving the use of short-selling, leverage, derivatives, and alternative asset classes to generate returns for its investors. Hedge funds are not only more complex than traditional mutual funds that invest in stocks and bonds, but they are also less regulated and far more opaque—meaning that investors might not understand what they've bitten off to chew. Because of this, hedge funds tend to cater to high net-worth individuals and require large sums to invest—leaving the ordinary investor out of luck.
It is possible to invest in hedge funds, but there are some restrictions on the types of investors who comprise a hedge fund's investor pool. In general, it is extremely difficult for individual investors to gain access to a quality hedge fund. This forces many to either find indirect methods of investing in hedge funds or just give up trying.
Key Takeaways
- Because they are not as regulated as mutual funds or traditional financial advisors, hedge funds are only accessible to sophisticated investors.
- These so-called accredited investors are high net worth individuals or organizations and are presumed to understand the unique risks associated with hedge funds.
- For ordinary individuals, investing in the stock of a financial company that operates hedge funds could be a way to gain indirect access.
Regulation D
SEC Regulation D, specifically rules 504 and 506, limit the total number of investors who can be admitted inside of a hedge fund. Hedge fund general partners and managers often create high minimum investment requirements. It is not uncommon for a hedge fund to require at least $100,000 or even as much as $1 million to participate.
Unlike mutual funds, hedge funds avoid many of the regulations and requirements within the Securities Act of 1933. In exchange, the Securities and Exchange Commission (SEC) requires a majority of hedge fund investors to be accredited, which means possessing a net worth of more than $1 million and a sophisticated understanding of personal finance, investing, and trading. These requirements exclude the vast majority of the investing public.
Funds of Funds
Many mutual funds were established to mimic the investment strategy of famous hedge funds. These so-called "funds of funds" (FOF) are inexact replicas, however, since hedge funds have access to a much wider range of investment options. Some hedge funds are actually listed on exchanges and have shares that can be purchased individually or through a broker.
There are also "replication" equity funds that try to imitate the performance of hedge fund benchmarks, similar to how an exchange-traded fund (ETF) aims to produce the same returns as an underlying index. Options such as these are good alternatives for investors who are interested in hedge funds but cannot gain access to them.
Publicly Traded Fund Companies
If you can't invest in a hedge fund directly, you might be able to capture some of that edge indirectly by investing in the companies that run hedge funds. Blackrock, for instance, has a large alternative investments segment that operates much like a hedge fund and handles billions of dollars for ultra-wealthy clients and organizations. By investing in Blackrock instead of its fund, you'll at least be able to capture (in theory) some of that segment's performance. There are several other publicly traded investment advisors and asset management firms that you can look at as well.
So, can you invest in hedge funds? Let's see what an expert has to say:
Advisor Insight
Matthew J. Ure, RMA
Anthony Capital, LLC, San Antonio, TX
Yes, assuming you meet the fund’s criteria for membership. Those usually follow the SEC’s minimum-income rules: You must have a net worth of $1,000,000 or have made over $200,000 ($300,000 for married couples) for the last two years and this year as well. Those requirements are to ensure that you’re an “accredited investor” and therefore should have the acumen to understand, and the money to risk, on the advanced, aggressive strategies that hedge funds typically use.
Funds can and do make exceptions to these criteria, usually for the proverbial family and friends. The SEC allows them to accept up to 35 non-accredited investors over the life of the fund. But they will usually just stick to the accredited-investor guidelines; some set even higher net worth or earned-income levels minimums.
FAQs
You generally must be an accredited investor, which means having a minimum level of income or assets, to invest in hedge funds. Typical investors include institutional investors, such as pension funds and insurance companies, and wealthy individuals.
Why can only the rich invest in hedge funds? ›
Because they are not as regulated as mutual funds or traditional financial advisors, hedge funds are only accessible to sophisticated investors. These so-called accredited investors are high net worth individuals or organizations and are presumed to understand the unique risks associated with hedge funds.
Will hedge funds exist in 10 years? ›
Overall, the consensus is that hedge funds will continue to grow but will adapt to lower fees, greater use of technology, and increased access to retail investors.
Is my money safe in a hedge fund? ›
While hedge funds are only lightly regulated and carry high inherent risks, funds of hedge funds are thought to offer security because professional managers are picking the hedge funds that make up the pools.
Can everyone invest in a hedge fund? ›
To keep it simple, you can think of a hedge fund as a private mutual fund available only to wealthy people. Structurally, most American hedge funds are limited partnerships, and the investors are limited partners.
Do hedge funds actually make money? ›
Hedge funds make money by charging a management fee and a percentage of profits. The typical fee structure is 2 and 20, meaning a 2% fee on assets under management and 20% of profits, sometimes above a high water mark. For example, let's say a hedge fund manages $1 billion in assets. It will earn $20 million in fees.
Are hedge funds too risky? ›
Hedge funds are generally more aggressive, riskier, and more exclusive than mutual funds. Their managers have freer rein to invest in a wide variety of assets and to use bolder strategies in pursuit of higher profits, and are rewarded with much higher fees than mutual funds charge.
How much money do I need to invest in a hedge fund? ›
Some hedge fund entities require a minimum investment amount ranging from $25,000 to $100,000, or in some cases as high as $1 million from accredited investors. Those investing in hedge funds are typically wealthy individuals who can invest in the minimum without becoming too concentrated in one fund.
Are hedge fund owners rich? ›
Successful hedge fund managers tend to be highly paid and can be worth billions of dollars.
What do hedge funds do all day? ›
Hedge funds are actively managed by professional managers who buy and sell certain investments with the stated goal of exceeding the returns of the markets, or some sector or index of the markets. They take the greatest risks while trying to achieve these returns.
First, the hedge fund mortality rate in this sample is estimated at 8.43 per cent per year which is twice the size of those reported in mutual fund studies. We find that 59 per cent of hedge funds at the start of the sample do not survive the full sample period.
What is the failure rate of hedge funds? ›
One of the reasons for the perceived high failure rate of hedge funds is that their attrition rate is known to be high, approximately 9% per annum. The latter rate is generally estimated by counting the number of defunct funds in hedge fund databases.
Do hedge funds beat the S&P 500? ›
Reality Check: S&P 500 Outperforms Hedge Funds 🚀
Data shows that hedge funds consistently underperformed the S&P 500 every year since 2011. The average annual return for hedge funds was about 4.956%, while the S&P 500 averaged 14.4%.
Is BlackRock a hedge fund? ›
BlackRock manages US$38bn across a broad range of hedge fund strategies. With over 20 years of proven experience, the depth and breadth of our platform has evolved into a comprehensive toolkit of 30+ strategies.
Why do people invest in hedge funds if they don't beat the market? ›
There are two basic reasons for investing in a hedge fund: to seek higher net returns (net of management and performance fees) and/or to seek diversification.
How do I invest in a hedge fund? ›
To invest in hedge funds as an individual, you must be an institutional investor, like a pension fund, or an accredited investor. Accredited investors have a net worth of at least $1 million, not including the value of their primary residence, or annual individual incomes over $200,000 ($300,000 if you're married).
How do I get into a hedge fund? ›
Polish your credentials through unpaid internships or related financial industry jobs so that your resume stands out.
- Make Sure This Is What You Want. ...
- Study the Hedge Fund Industry. ...
- Use the Three-Circles Strategy. ...
- Identify Hedge Fund Career Mentors. ...
- Get an Internship. ...
- Develop Your Unique Value Proposition.
For individual investors, your annual income in the past two years must surpass $200,000, or $300,000 if you are married. If not, your net worth must be at least $1 million. After you fulfill one of these conditions you can be accredited as a hedge fund investor.
How much do hedge fund investors make? ›
The money is a big draw as well: if you're at the right fund and you perform well, you can earn into the mid-six-figures, up to $1 million+, even as a junior-level employee. The top individual Portfolio Managers can earn hundreds of millions or billions each year.
