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Determining What is Hedge Fund

In a global economy that had its ups and downs in 2011, hedge funds enjoyed more ups than downs. As of early 2011, over 225 hedge funds managed more than a billion dollars each, and collectively the 225 funds managed around 1.3 trillion. This financial prosperity in difficult economic times has led many to begin asking the question: what is hedge fund?

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In some ways, hedge funds are very similar to mutual funds. In both types of funds, investors provide the money that a fund manager uses to invest in stocks, bonds, and other securities. The investors then reap the benefits when those securities increase in value, and reduce their own risk by diversifying their investments. Despite the similarities, there are very distinct differences that allow one to determine what is hedge fund and what is a mutual fund.

The management of hedge funds, unlike that of mutual funds, was not, until recently, overseen by the Securities and Exchange Commission (SEC). Also, because most hedge funds are private investment partnerships, investment in hedge funds is not open to the general public. Instead it is restricted to accredited investors, a group that includes wealthy individuals as well as institutions like banks, pensions, insurance companies, and some corporations (among other entities). In short, accredited investors are those that can handle high risk investments, thus are able to invest in hedge funds.

Another consequence of being organized as private investment partnerships is that hedge funds cannot market themselves to the general public. Thus, while it is common to see mutual funds advertised in magazines and newspapers, hedge funds go relatively under the radar. Even the largest hedge funds in the world may be unheard of by the typical investor.

If you examine what is a hedge fund based on investment strategies, it can be seen that hedge funds have a more diverse investment strategy than practiced with mutual funds. Hedge funds invest in liquid and illiquid securities, and use methods like short selling and leverage or gearing, which are not generally utilized by mutual funds. Short selling involves selling borrowed securities with the intention of buying them back for a lower price at a later date. This is done when it is believed their value will fall, and thus the fund will be able to buy them back for less than the price at they they sold short. Leverage is simply a way to increase gains. It is often accomplished by hedge funds by providing money as collateral to cover credit risk.

Another unique factor to consider when considering hedge fund investments is that hedge fund managers often receive a portion of the profit made by the fund. This is not the case with mutual funds, as mutual fund managers receive a percentage of the assets without regard to the fund's performance. Hedge funds are more actively managed, and the management company frequently receives around 20% of the profits of the fund. The management fee alone for hedge funds, around 2%, is also typically higher than the fee for mutual funds (around 1%).

Here is an example of a very good Hedge Fund Database.

Hedge funds are a very unique investment. They have several features that make them different from other collective investments like mutual funds. Thus, when attempting to determine what is hedge fund, keep the above information in mind.