What is a Hedge Fund?

As media buzz continues to intensify around "Hedge Funds" I have grown more an more curious- just what is a Hedge Fund?

From all the noise, I got the confusing picture that a Hedge Fund has no clear definition, can invest in anything it wants, is only for the very wealthy and charges absurd fees. I also assumed there was a "Hedging" component- meaning that the fund employs counterbalancing strategies.

As far as I can tell, this is pretty much it, with the exception of the "Hedging" part. While some Hedge funds do in fact, 'hedge'... they aren't required to, by definition. Well, maybe they are required to by definition (for all you grammatical literalists), but they are not required to by regulation or as a consistent matter of practice.

Any manager seeking to run an unregulated investment operation can start up a fund and call it a Hedge Fund as long as s/he follows a few guidelines.

1) Allow fewer than 100 investors or only accept clients who earn $200,000 or have investment assets worth more than $5 million. (Different source list different numbers of millions required- more than a million seems to be the case).

2) Don't advertise to the general public.

I'm not making this up folks. Somebody over at wikipedia might be making this up, but I'm not.

So after putting together a group of their closest buddies and pooling their gazillions, what does a Hedge fund manager do? Pretty much whatever s/he wants!

How much does this cost the 'average' investor? Fees appear to generally range from 2% annual fees combined with 20% of profits to 3% plus 30% of profits. Some fees run much higher, some are likely lower but 2/20 to 3/30 appears to be what you will likely run into after you put together your 5 million and start searching for a Hedge Fund to invest in.

I was recently contacted by Timothy Sykes to review his forthcoming book "An American Hedge Fund." I'm reading it now and will review it soon- highly entertaining so far!

I also found Veryan Allen's site. As a big fan of diversification (20 mutual funds in one portfolio?) I like Veryan's stratagey of investing in... I'm not making this up either: 20 Hedge funds. At the very end of this post he says: "Twenty hedge funds managing strategies that have little correlation to each other is probably the MINIMUM number necessary."

Is 20 a magic number for fund picking? I digress.

So anyway- many Mutual Fund Investors might scoff- 2% annual fee and 20% of profits... "That's way too high!"

Of course many mutual funds charge 5% or more up front regardless of whether they earn a cent or lose value in addition to annual expenses which sometimes hit 2% or higherin annual expenses. And I would rather pay 20% of profits on some profits than pay 0% on no profits:

The real issues here are 1) you must have a ton of money to even have access to Hedge Funds thanks to our government protecting us poor folks from ourselves and 2) researching Hedge Funds is not so easy. Finding a single good one, much less finding the 20 required by Mr. Allen, would be quite a chore...

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