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Hedge funds sometimes make their way into the mainstream through shows like "Billions," but these private investment funds are typically limited to high-net-worth individuals or institutional investors like foundations and endowments.
The goal is often for participants to come out ahead no matter how the overall market is performing, but there's a lot of leeway and variance in terms of how hedge funds operate and their goals. At the same time, these investment vehicles can be high risk and have high costs, and they don't always lead to better results.
So, if you're eligible to invest in hedge funds or you just want to understand these vehicles more, such as if your company's pension fund invests in them, it's important to understand what you're getting into.
A hedge fund is often considered an alternative investment because it differs from exposure to more traditional asset classes like public equities. Still, hedge funds can involve investing in public stocks, along with a variety of other assets. Here's a closer look at what hedge funds involve:
A hedge fund is a private investment fund that pools money from high-net-worth individuals and/or institutional investors, often with the goal of achieving superior risk-adjusted returns.
As the name implies, hedge funds often hedge their investments so the overall fund can perform well whether markets go up or down — such as by investing long in some stocks and shorting others. That said, the term hedge fund nowadays applies to a broader set of private funds that use a variety of investment strategies, some riskier than others. For example, some hedge funds are less focused on hedging and more focused on making big, speculative bets.
Hedge funds in the U.S. are typically only open to accredited investors, meaning those who meet certain financial or professional requirements that potentially indicate they can handle the risks of investing in hedge funds and other complex investments.
Hedge funds have a lot of leeway in how they invest and operate. They can invest both domestically and around the world and use just about any investment strategy to seek returns. For instance, the fund may borrow money to make larger investments to try to amplify returns — known as using leverage — make highly concentrated bets, or take aggressive short positions.
Many hedge funds invest largely in stocks, but that can include private stocks, and they also have flexibility to invest in other asset classes such as bonds or use derivatives.
Another key characteristic is hedging. To protect against market uncertainty, the fund might make two investments that respond in opposite ways. If one investment does well, then the other loses money — theoretically reducing the overall risk to investors. This is actually where the term "hedge" comes from since using various market strategies can help offset risk, or "hedge" the fund against large market downturns. For example, hedge funds can use derivatives like credit default swaps as risk protection against a negative credit event, so that even if the issuer misses a debt payment, the holders will receive a payout. That said, not all hedge funds actually hedge.
Even with hedging, depending on your perspective and the particular fund, some see hedge funds as carrying more risk than other investment vehicles. That's because some funds invest aggressively, have complex and opaque strategies that are hard for investors to understand, and the fees can be high, such as with the common 2-and-20 fee structure, meaning a 2% annual management fee and a 20% annual performance fee based on returns above a predetermined benchmark. So, there's a risk that those fees can cause hedge funds to lag low-cost index funds, for example.
The elevated risk is why only accredited investors — those deemed sophisticated enough to handle potential risks — can usually invest in this type of fund. To be considered an accredited investor, you'll need to meet requirements like earning at least $200,000 in each of the last two years ($300,000 for married couples) with a reasonable expectation to also meet that level this year, or have a net worth of more than $1 million. There can also be ways to qualify based on professional criteria, like holding certain financial licenses.
Hedge funds and mutual funds are similar in that they are pooled investment vehicles, but a key difference is that mutual funds are open for sale to the general public, while hedge funds are solicited privately to qualified investors. This difference enables hedge funds to face much less stringent regulation.
One misconception is that U.S. mutual funds have to register with the SEC while hedge funds don't. In reality, hedge funds often still have to register with the SEC or state regulators, depending on size, but the amount of disclosure required for hedge funds is much less than that for mutual funds. For example, mutual funds have to publicly disclose their holdings and fees, while hedge funds do not.
This lack of transparency can make it difficult to research and verify a hedge fund before investing in this type of product. However, hedge fund investors are still protected against fraud by the SEC, and hedge fund managers still have a fiduciary duty to the funds they manage.
How hedge funds operate
Hedge funds have a lot of flexibility to operate as fund managers and their investment firms see fit. Still, specific funds often follow a specific strategy that's then marketed to private investors, as they need to raise funds in order to make investments and charge fees to make the fund profitable.
Hedge funds in the U.S. are often structured based on registering the fund itself as a limited partnership, LLC, or sometimes as an offshore corporation for tax purposes; behind the fund is then typically an asset management company or a particular investor that creates a corporation that acts as the advisor to the hedge fund. In other words, there are two legal structures involved usually: the fund advisor and the fund itself.
The fund advisor — often called the fund manager from an investment perspective — typically acts as the general partner (GP) of the fund, and other investors then act as limited partners (LP). Some fund advisors/fund managers are part of larger financial services companies, while some are specifically set up to run a hedge fund.
Hedge funds have the flexibility to set their own fund minimums, which can vary widely based on factors like the fund's strategy, target investors, and demand for the fund. Typically, the bare minimum to invest in a hedge fund is around $100,000. However, larger and more popular funds often have higher minimums, such as $250,000. It's not uncommon to see minimums of $1 million or higher, particularly for well-established funds that may not actively seek new investors.
LPs earn money from the gains generated from hedge fund investments, but they generally pay much higher fees compared to other investments such as mutual funds. As mentioned, a typical fee structure includes a 2% annual management fee (vs. roughly 1% for active mutual funds) and a 20% performance fee if the fund does well (which mutual funds generally don't charge).
"The management fee is charged every year, regardless of performance, and the incentive fee is charged if the manager performs in excess of a specific threshold, typically its high-water mark," says Chris Berkel, investment advisor and founder of AXIS Financial.
Nowadays, though, some hedge funds use lower-fee structures, such as some large funds charging a 1%-1.5% management fee and perhaps a 15% performance fee.
Once you put money into the fund, LPs also have to follow GPs' rules on when they can withdraw your money.
"During market turmoil, most hedge funds reserve the right to 'gate,' or block, investors from redeeming their shares," Berkel says. "The rationale is that it protects other investors and helps the fund manager maintain the integrity of their strategy."
Outside of these lock-up periods, you can usually withdraw money at certain intervals such as quarterly or annually.
Although hedge funds have the flexibility to invest as the fund manager sees fit, there are some common hedge fund strategies that fall into different categories. In many cases, funds market themselves as following these particular strategies, in order to differentiate from other funds and let LPs understand how a particular fund can fit into their portfolio. Some common ones include:
A long/short equity strategy involves going long on some stocks, meaning making traditional investments in stocks with the goal of those stocks gaining value, while going short on other stocks, which involves betting on the price of stocks going down.
Note that going long doesn't have to mean holding stocks long-term — many hedge funds trade frequently. Long vs. short really just means up vs. down.
The goal is often that taking these opposing bets mitigates risk while potentially leading to higher returns. For example, a hedge fund might look at two tech companies and think one will gain market share, so they go long on the stock, while the other will lose market share, so they short the stock.
If their prediction is right, that could lead to big gains. If their prediction is partially wrong, such as if the whole tech industry booms, then their short losses could be balanced out by their long gains. Still, there's a risk that they're wrong on both fronts, i.e., the stock that was shorted ends up going up in price (a loss for shorts) while the stock they went long on ends up dropping. So that could lead to big losses overall.
An all-weather strategy, typically attributed to hedge fund manager Bridgewater Associates as the original creator, seeks to provide positive returns (or at least mitigate losses) in any environment. These funds might not take on as much risk, such as by using more hedging that's less for speculative purposes and more to provide balance. In doing so, the idea is that the fund can hold up in "all weather." If markets are down, the fund can still be up, and if markets are up, the fund can still take part in some of that upside.
Global macro strategy
Event-driven strategy might sound similar to global macro, but it usually focuses on particular corporate actions. For example, a particular corporate merger announcement might cause a stock to gain value, and a hedge fund might invest in that stock to try to capture a potential price increase if the deal goes through.
Here, too, there's a risk that the fund manager is wrong about their predictions or that they might be too late if events are already priced in.
Also note that a subtype of event-driven is the activist strategy, which many people associate with hedge funds — this is when the fund takes a more active role in trying to change a company, such as by campaigning for a change in the board of directors or aggressively pushing a merger.
Event-driven strategy might sound similar to global macro, but it usually focuses more on microeconomics/more limited events specific to equities. For example, a particular corporate merger might spark a hedge fund to invest in a competitor if they think that the merger will cause the new company to not be nimble enough to keep up with the competitor. Or, a change in corporate leadership might prompt an event-driven hedge fund to short a stock.
Here, too, there's a risk that the fund manager is wrong about their predictions or that they might be too late if events are already priced in.
Hedge fund investing can carry both significant risks and potential rewards, such as the following:
Hedge funds often have the potential to outperform other investment funds due to strategies like shorting and using leverage to amplify returns. Also, investing across asset classes might lead to better returns, though much depends on the particular strategy and the fund manager's ability to execute that strategy successfully.
Remember, though, that this potential does not mean hedge funds will have higher returns. Many underperform, but you might be willing to take that risk in the hopes that you'll find a fund that hits it big.
Hedge funds can provide good risk mitigation when hedging is used to balance risk, such as with all-weather strategies. For example, a fund might go long on some stocks but also use options like puts so that if those stocks do fall, there's limited downside.
Although some hedge funds are very risk-averse, others involve a lot of speculation, which can amplify risk. Even with research, making investment choices still involves some level of guessing/betting on what will happen next. As such, many funds end up underperforming benchmarks.
For example, even though it's tough to compare hedge funds to the S&P 500 because there are so many different types of hedge funds, and the markets hedge funds invest in might be global-oriented, "we can say that a broad index of hedge funds underperformed the S&P 500 over the last 10 to 15 years," Berkel says.
That said, hedge funds aren't always trying to beat the S&P 500. The lower returns could be a feature of some funds, such as those designed to limit risk.
"The S&P 500 is a systematic risk, which cannot be diversified away," Berkel says. A hedge fund may provide some safeguards to your portfolio, which you won't necessarily get with the S&P 500.
Because hedge funds have less stringent regulatory requirements, it's hard to know what exactly you're getting with particular funds.
"There's no transparency in hedge funds, and most of the time, managers can do whatever they want inside the fund," says Meghan Railey, a certified financial planner and co-founder/chief financial officer of Optas Capital. "So they can make big bets on where the market's going, and they could be very wrong."
This lack of transparency can increase risk, such as if you end up being overexposed to certain sectors without realizing it.
Hedge fund regulation varies somewhat around the world, but in general, these funds are limited to high-net-worth individuals or institutional investors. Still, the average person might have exposure to hedge funds, such as if they're part of a pension fund that invests in hedge funds, and the financial system overall is intertwined with hedge funds.
As such, there are many hedge fund regulations in both the U.S. and abroad to protect investors and the broader financial system, especially in the wake of the 2008 financial crisis and issues like Bernie Madoff's hedge fund Ponzi scheme, where regulators realized that hedge fund fraud or over-speculation can lead to widespread losses.
So, one key piece of legislation emerging from the Great Recession was the Dodd-Frank Act in the U.S. This law requires more hedge funds to register with the SEC and provide more disclosure via Form PF. This disclosure still isn't at the level of what mutual funds face, but it increases transparency over issues like how much leverage a fund uses (which can increase risk) and a fund's liquidity, which affects its ability to withstand downturns and investor redemptions.
Elsewhere, regulations like the Alternative Investment Fund Managers Directive (AIFMD) emerged in the EU. AIFMD arguably goes beyond Form PF in requiring more transparency about how private funds like hedge funds, such as in terms of fund performance and investors' rights. Now, AIFMD II is being put into national law among EU member countries, so starting in 2026 many hedge funds marketing to investors in Europe will face additional disclosure requirements.
Investing in a hedge fund isn't as easy as investing in a mutual fund, due to the private, more opaque nature of hedge funds. Still, there are some best practices to follow.
If you're thinking about investing in hedge funds as an individual accredited investor, you might start by getting some professional guidance, given the complex nature of these investments.
"Start by consulting a financial professional who's not incentivized to sell you a hedge fund," Railey says. "Read the offering memorandum, ask some critical questions about past performance, and ask what their strategy is going forward." Then, she suggests allocating no more than 5% to 10% of your overall investable assets into a hedge fund.
You can also use the SEC's Investment Advisor Public Disclosure (IAPD) website to check a hedge fund manager's Form ADV to see if it meets the requirements to register with the SEC, although this doesn't apply to certain funds that are exempt from registration.
Still, Form ADV contains important information about a fund, such as on conflicts of interest or past disciplinary actions, although it doesn't go into as much detail as Form PF, which is generally only available to regulators.
If you're not an accredited investor, you can potentially find some ETFs that try to replicate hedge fund strategies. So, you might decide to do so within an online brokerage account. Still, you probably don't want to rush into hedge fund investing, especially if you're new to investing.
"Just start simple, stay simple, and add on complexity as time goes and you have more experience to be able to understand the difference," says Railey.
Assessing hedge fund performance is difficult, considering the lack of transparency on returns compared to mutual funds. However, if you're an accredited investor that can meet the minimum investment of particular hedge funds, you might be able to speak with the fund manager themself or client support staff to gain more insights on past returns, as many hedge funds need to court investors. Also, a professional such as a financial advisor might be able to help you track down this information to compare funds.
Note, however, that you don't necessarily just want to choose the fund with the highest historical returns. For one, past returns aren't a guarantee of future performance. Also, you need to assess hedge fund performance based on your goals. For example, an all-weather fund might have lower returns, but you might be more comfortable with its performance if you don't like volatility.
What is the difference between a hedge fund vs. a mutual fund?
The difference between a hedge fund and a mutual fund is that a mutual fund is open for sale to the general public, while a hedge fund is generally considered a private fund that only accredited investors can access. As such, mutual funds face more disclosure requirements, while hedge funds can withhold information, such as about the particular investments they allocate to.
Can anyone invest in a hedge fund?
No, not everyone can invest in a hedge fund. Hedge funds are primarily for professional or sophisticated investors, not the general public. In the U.S., investment is mainly limited to accredited investors, which are those who meet a high financial threshold or have professional financial qualifications that enable them to invest in more complex vehicles like hedge funds. That said, there can be ways to get hedge fund exposure or similar exposure through publicly traded vehicles like some ETFs.
What are the fees associated with hedge funds?
The fees associated with hedge funds vary, but a common structure is a 2% annual management fee and a 20% performance fee that comes into effect if the fund surpasses a certain threshold of returns, depending on the fund. Some funds are trending toward slightly lower fees, though, such as a 1.5% management fee and 15% performance fee, but this is still much higher than most mutual funds.
What are some common hedge fund strategies?
Some common hedge fund strategies include long/short equity, all-weather, global macro, and event-driven, though there are many other types of strategies, and some hedge funds use a mixed approach.
Jake Safane
What is a Hedge Fund?
The goal is often for participants to come out ahead no matter how the overall market is performing, but there's a lot of leeway and variance in terms of how hedge funds operate and their goals. At the same time, these investment vehicles can be high risk and have high costs, and they don't always lead to better results.
So, if you're eligible to invest in hedge funds or you just want to understand these vehicles more, such as if your company's pension fund invests in them, it's important to understand what you're getting into.
What is a hedge fund?
A hedge fund is often considered an alternative investment because it differs from exposure to more traditional asset classes like public equities. Still, hedge funds can involve investing in public stocks, along with a variety of other assets. Here's a closer look at what hedge funds involve:
Definition of a hedge fund
A hedge fund is a private investment fund that pools money from high-net-worth individuals and/or institutional investors, often with the goal of achieving superior risk-adjusted returns.
As the name implies, hedge funds often hedge their investments so the overall fund can perform well whether markets go up or down — such as by investing long in some stocks and shorting others. That said, the term hedge fund nowadays applies to a broader set of private funds that use a variety of investment strategies, some riskier than others. For example, some hedge funds are less focused on hedging and more focused on making big, speculative bets.
Hedge funds in the U.S. are typically only open to accredited investors, meaning those who meet certain financial or professional requirements that potentially indicate they can handle the risks of investing in hedge funds and other complex investments.
Key characteristics of hedge funds
Hedge funds have a lot of leeway in how they invest and operate. They can invest both domestically and around the world and use just about any investment strategy to seek returns. For instance, the fund may borrow money to make larger investments to try to amplify returns — known as using leverage — make highly concentrated bets, or take aggressive short positions.
Many hedge funds invest largely in stocks, but that can include private stocks, and they also have flexibility to invest in other asset classes such as bonds or use derivatives.
Another key characteristic is hedging. To protect against market uncertainty, the fund might make two investments that respond in opposite ways. If one investment does well, then the other loses money — theoretically reducing the overall risk to investors. This is actually where the term "hedge" comes from since using various market strategies can help offset risk, or "hedge" the fund against large market downturns. For example, hedge funds can use derivatives like credit default swaps as risk protection against a negative credit event, so that even if the issuer misses a debt payment, the holders will receive a payout. That said, not all hedge funds actually hedge.
Even with hedging, depending on your perspective and the particular fund, some see hedge funds as carrying more risk than other investment vehicles. That's because some funds invest aggressively, have complex and opaque strategies that are hard for investors to understand, and the fees can be high, such as with the common 2-and-20 fee structure, meaning a 2% annual management fee and a 20% annual performance fee based on returns above a predetermined benchmark. So, there's a risk that those fees can cause hedge funds to lag low-cost index funds, for example.
The elevated risk is why only accredited investors — those deemed sophisticated enough to handle potential risks — can usually invest in this type of fund. To be considered an accredited investor, you'll need to meet requirements like earning at least $200,000 in each of the last two years ($300,000 for married couples) with a reasonable expectation to also meet that level this year, or have a net worth of more than $1 million. There can also be ways to qualify based on professional criteria, like holding certain financial licenses.
How hedge funds differ from mutual funds
Hedge funds and mutual funds are similar in that they are pooled investment vehicles, but a key difference is that mutual funds are open for sale to the general public, while hedge funds are solicited privately to qualified investors. This difference enables hedge funds to face much less stringent regulation.
One misconception is that U.S. mutual funds have to register with the SEC while hedge funds don't. In reality, hedge funds often still have to register with the SEC or state regulators, depending on size, but the amount of disclosure required for hedge funds is much less than that for mutual funds. For example, mutual funds have to publicly disclose their holdings and fees, while hedge funds do not.
This lack of transparency can make it difficult to research and verify a hedge fund before investing in this type of product. However, hedge fund investors are still protected against fraud by the SEC, and hedge fund managers still have a fiduciary duty to the funds they manage.
How hedge funds operate
Hedge funds have a lot of flexibility to operate as fund managers and their investment firms see fit. Still, specific funds often follow a specific strategy that's then marketed to private investors, as they need to raise funds in order to make investments and charge fees to make the fund profitable.Structure of hedge funds
Hedge funds in the U.S. are often structured based on registering the fund itself as a limited partnership, LLC, or sometimes as an offshore corporation for tax purposes; behind the fund is then typically an asset management company or a particular investor that creates a corporation that acts as the advisor to the hedge fund. In other words, there are two legal structures involved usually: the fund advisor and the fund itself.
The fund advisor — often called the fund manager from an investment perspective — typically acts as the general partner (GP) of the fund, and other investors then act as limited partners (LP). Some fund advisors/fund managers are part of larger financial services companies, while some are specifically set up to run a hedge fund.
Minimum investments
Hedge funds have the flexibility to set their own fund minimums, which can vary widely based on factors like the fund's strategy, target investors, and demand for the fund. Typically, the bare minimum to invest in a hedge fund is around $100,000. However, larger and more popular funds often have higher minimums, such as $250,000. It's not uncommon to see minimums of $1 million or higher, particularly for well-established funds that may not actively seek new investors.
Fee models
LPs earn money from the gains generated from hedge fund investments, but they generally pay much higher fees compared to other investments such as mutual funds. As mentioned, a typical fee structure includes a 2% annual management fee (vs. roughly 1% for active mutual funds) and a 20% performance fee if the fund does well (which mutual funds generally don't charge).
"The management fee is charged every year, regardless of performance, and the incentive fee is charged if the manager performs in excess of a specific threshold, typically its high-water mark," says Chris Berkel, investment advisor and founder of AXIS Financial.
Nowadays, though, some hedge funds use lower-fee structures, such as some large funds charging a 1%-1.5% management fee and perhaps a 15% performance fee.
Lock-up periods
Once you put money into the fund, LPs also have to follow GPs' rules on when they can withdraw your money.
"During market turmoil, most hedge funds reserve the right to 'gate,' or block, investors from redeeming their shares," Berkel says. "The rationale is that it protects other investors and helps the fund manager maintain the integrity of their strategy."
Outside of these lock-up periods, you can usually withdraw money at certain intervals such as quarterly or annually.
Common hedge fund strategies
Although hedge funds have the flexibility to invest as the fund manager sees fit, there are some common hedge fund strategies that fall into different categories. In many cases, funds market themselves as following these particular strategies, in order to differentiate from other funds and let LPs understand how a particular fund can fit into their portfolio. Some common ones include:
Long/short equity strategy
A long/short equity strategy involves going long on some stocks, meaning making traditional investments in stocks with the goal of those stocks gaining value, while going short on other stocks, which involves betting on the price of stocks going down.
Note that going long doesn't have to mean holding stocks long-term — many hedge funds trade frequently. Long vs. short really just means up vs. down.
The goal is often that taking these opposing bets mitigates risk while potentially leading to higher returns. For example, a hedge fund might look at two tech companies and think one will gain market share, so they go long on the stock, while the other will lose market share, so they short the stock.
If their prediction is right, that could lead to big gains. If their prediction is partially wrong, such as if the whole tech industry booms, then their short losses could be balanced out by their long gains. Still, there's a risk that they're wrong on both fronts, i.e., the stock that was shorted ends up going up in price (a loss for shorts) while the stock they went long on ends up dropping. So that could lead to big losses overall.
All-weather strategy
An all-weather strategy, typically attributed to hedge fund manager Bridgewater Associates as the original creator, seeks to provide positive returns (or at least mitigate losses) in any environment. These funds might not take on as much risk, such as by using more hedging that's less for speculative purposes and more to provide balance. In doing so, the idea is that the fund can hold up in "all weather." If markets are down, the fund can still be up, and if markets are up, the fund can still take part in some of that upside.
Global macro strategy
Event-driven strategy might sound similar to global macro, but it usually focuses on particular corporate actions. For example, a particular corporate merger announcement might cause a stock to gain value, and a hedge fund might invest in that stock to try to capture a potential price increase if the deal goes through.Here, too, there's a risk that the fund manager is wrong about their predictions or that they might be too late if events are already priced in.
Also note that a subtype of event-driven is the activist strategy, which many people associate with hedge funds — this is when the fund takes a more active role in trying to change a company, such as by campaigning for a change in the board of directors or aggressively pushing a merger.
Event-driven strategy
Event-driven strategy might sound similar to global macro, but it usually focuses more on microeconomics/more limited events specific to equities. For example, a particular corporate merger might spark a hedge fund to invest in a competitor if they think that the merger will cause the new company to not be nimble enough to keep up with the competitor. Or, a change in corporate leadership might prompt an event-driven hedge fund to short a stock.
Here, too, there's a risk that the fund manager is wrong about their predictions or that they might be too late if events are already priced in.
Risks and rewards of hedge fund investing
Hedge fund investing can carry both significant risks and potential rewards, such as the following:
Potential for high returns
Hedge funds often have the potential to outperform other investment funds due to strategies like shorting and using leverage to amplify returns. Also, investing across asset classes might lead to better returns, though much depends on the particular strategy and the fund manager's ability to execute that strategy successfully.
Remember, though, that this potential does not mean hedge funds will have higher returns. Many underperform, but you might be willing to take that risk in the hopes that you'll find a fund that hits it big.
Risk mitigation through hedging
Hedge funds can provide good risk mitigation when hedging is used to balance risk, such as with all-weather strategies. For example, a fund might go long on some stocks but also use options like puts so that if those stocks do fall, there's limited downside.
Speculation
Although some hedge funds are very risk-averse, others involve a lot of speculation, which can amplify risk. Even with research, making investment choices still involves some level of guessing/betting on what will happen next. As such, many funds end up underperforming benchmarks.
For example, even though it's tough to compare hedge funds to the S&P 500 because there are so many different types of hedge funds, and the markets hedge funds invest in might be global-oriented, "we can say that a broad index of hedge funds underperformed the S&P 500 over the last 10 to 15 years," Berkel says.
That said, hedge funds aren't always trying to beat the S&P 500. The lower returns could be a feature of some funds, such as those designed to limit risk.
"The S&P 500 is a systematic risk, which cannot be diversified away," Berkel says. A hedge fund may provide some safeguards to your portfolio, which you won't necessarily get with the S&P 500.
Lack of transparency
Because hedge funds have less stringent regulatory requirements, it's hard to know what exactly you're getting with particular funds.
"There's no transparency in hedge funds, and most of the time, managers can do whatever they want inside the fund," says Meghan Railey, a certified financial planner and co-founder/chief financial officer of Optas Capital. "So they can make big bets on where the market's going, and they could be very wrong."
This lack of transparency can increase risk, such as if you end up being overexposed to certain sectors without realizing it.
Hedge fund regulations
Hedge fund regulation varies somewhat around the world, but in general, these funds are limited to high-net-worth individuals or institutional investors. Still, the average person might have exposure to hedge funds, such as if they're part of a pension fund that invests in hedge funds, and the financial system overall is intertwined with hedge funds.
As such, there are many hedge fund regulations in both the U.S. and abroad to protect investors and the broader financial system, especially in the wake of the 2008 financial crisis and issues like Bernie Madoff's hedge fund Ponzi scheme, where regulators realized that hedge fund fraud or over-speculation can lead to widespread losses.
So, one key piece of legislation emerging from the Great Recession was the Dodd-Frank Act in the U.S. This law requires more hedge funds to register with the SEC and provide more disclosure via Form PF. This disclosure still isn't at the level of what mutual funds face, but it increases transparency over issues like how much leverage a fund uses (which can increase risk) and a fund's liquidity, which affects its ability to withstand downturns and investor redemptions.
Elsewhere, regulations like the Alternative Investment Fund Managers Directive (AIFMD) emerged in the EU. AIFMD arguably goes beyond Form PF in requiring more transparency about how private funds like hedge funds, such as in terms of fund performance and investors' rights. Now, AIFMD II is being put into national law among EU member countries, so starting in 2026 many hedge funds marketing to investors in Europe will face additional disclosure requirements.
How to invest in a hedge fund
Investing in a hedge fund isn't as easy as investing in a mutual fund, due to the private, more opaque nature of hedge funds. Still, there are some best practices to follow.
Steps to choosing the right hedge fund
If you're thinking about investing in hedge funds as an individual accredited investor, you might start by getting some professional guidance, given the complex nature of these investments.
"Start by consulting a financial professional who's not incentivized to sell you a hedge fund," Railey says. "Read the offering memorandum, ask some critical questions about past performance, and ask what their strategy is going forward." Then, she suggests allocating no more than 5% to 10% of your overall investable assets into a hedge fund.
You can also use the SEC's Investment Advisor Public Disclosure (IAPD) website to check a hedge fund manager's Form ADV to see if it meets the requirements to register with the SEC, although this doesn't apply to certain funds that are exempt from registration.
Still, Form ADV contains important information about a fund, such as on conflicts of interest or past disciplinary actions, although it doesn't go into as much detail as Form PF, which is generally only available to regulators.
If you're not an accredited investor, you can potentially find some ETFs that try to replicate hedge fund strategies. So, you might decide to do so within an online brokerage account. Still, you probably don't want to rush into hedge fund investing, especially if you're new to investing.
"Just start simple, stay simple, and add on complexity as time goes and you have more experience to be able to understand the difference," says Railey.
How to assess hedge fund performance
Assessing hedge fund performance is difficult, considering the lack of transparency on returns compared to mutual funds. However, if you're an accredited investor that can meet the minimum investment of particular hedge funds, you might be able to speak with the fund manager themself or client support staff to gain more insights on past returns, as many hedge funds need to court investors. Also, a professional such as a financial advisor might be able to help you track down this information to compare funds.
Note, however, that you don't necessarily just want to choose the fund with the highest historical returns. For one, past returns aren't a guarantee of future performance. Also, you need to assess hedge fund performance based on your goals. For example, an all-weather fund might have lower returns, but you might be more comfortable with its performance if you don't like volatility.
FAQs about hedge funds
What is the difference between a hedge fund vs. a mutual fund?
The difference between a hedge fund and a mutual fund is that a mutual fund is open for sale to the general public, while a hedge fund is generally considered a private fund that only accredited investors can access. As such, mutual funds face more disclosure requirements, while hedge funds can withhold information, such as about the particular investments they allocate to.
Can anyone invest in a hedge fund?
No, not everyone can invest in a hedge fund. Hedge funds are primarily for professional or sophisticated investors, not the general public. In the U.S., investment is mainly limited to accredited investors, which are those who meet a high financial threshold or have professional financial qualifications that enable them to invest in more complex vehicles like hedge funds. That said, there can be ways to get hedge fund exposure or similar exposure through publicly traded vehicles like some ETFs.
What are the fees associated with hedge funds?
The fees associated with hedge funds vary, but a common structure is a 2% annual management fee and a 20% performance fee that comes into effect if the fund surpasses a certain threshold of returns, depending on the fund. Some funds are trending toward slightly lower fees, though, such as a 1.5% management fee and 15% performance fee, but this is still much higher than most mutual funds.
What are some common hedge fund strategies?
Some common hedge fund strategies include long/short equity, all-weather, global macro, and event-driven, though there are many other types of strategies, and some hedge funds use a mixed approach.
