Hedge fund.
In plain English
A hedge fund is a private investment partnership that uses a wide range of strategies, often including short selling, options, futures, currency trades, and borrowed money, in pursuit of absolute returns regardless of market direction. Fees are characteristically high: the classic '2 and 20' structure charges 2% of assets per year plus 20% of profits above a high-water mark. Hedge funds are open only to accredited investors and qualified purchasers (a higher net-worth threshold) and are largely exempt from the regulatory regime that governs mutual funds and ETFs.
01Why it matters
The hedge fund category in aggregate has underperformed a simple S&P 500 index fund net of fees for most rolling decades since 2000, though individual funds have produced extraordinary results. The 2 and 20 fee structure compounds against investors over time; even good gross returns often translate into mediocre net returns after fees.
02The math, step by step
Warren Buffett's 2007 bet that a low-cost S&P 500 index fund would outperform a hand-picked basket of hedge funds over 10 years ended in 2017 with the index up about 126% and the hedge funds up about 36% net of fees. He donated his winnings to Girls Inc. of Omaha. The bet remains the most-cited single piece of evidence in the active-vs-passive debate.