Hedge funds: what they actually are

A hedge fund is an actively managed investment pool that uses strategies more complex than just buying stocks and bonds. Despite the mystique, the average hedge fund has underperformed a simple S&P 500 index fund over the past 15 years.

What 'hedge' actually means

Originally, the term referred to using short positions to hedge (offset) long positions. Today, hedge funds use a wide range of strategies — long/short equity, global macro, distressed debt, merger arbitrage, quant trading, and many others. Most don't 'hedge' in the original sense at all.

Who can invest

Generally limited to accredited investors — people with $200K+ income or $1M+ net worth excluding their home — and minimum investments are typically $250,000 to $1 million. Some funds require $5M+.

The famous fees

'Two and twenty' is the classic structure: 2% of assets per year plus 20% of profits. Some elite funds charge more (3 and 30). These fees compound brutally — to beat a simple index fund net of fees, the manager needs to outperform by ~5% per year before fees, which most fail to do.

The dispersion problem

Hedge fund returns vary enormously. The top funds genuinely produce excellent risk-adjusted returns. The bottom funds get crushed. The average is mediocre. The best funds are usually closed to new money — what's available to you is often not what you'd want to own.