Hedge Funds 101
Don’t spend any time regretting that you can’t afford to invest in hedge funds, because, generally speaking, you’re not missing much.
Hedge funds look a bit like mutual funds — both feature the pooled money of many people that’s then invested by professional money managers.
But while mutual funds are regulated by the Securities and Exchange
Commission (SEC) and offer prospectuses detailing their investment strategies, hedge funds are generally structured as limited partnerships, and face fewer restrictions on how they can invest their shareholders’ money. For instance, hedge funds can use more complex (and often risky) strategies such as investing with borrowed money, and they can invest in a wider range of things, such as derivatives and even currencies.
Some mutual funds charge a onetime “load” fee when you buy or sell shares, but many funds are “no-load.” Mutual funds get their income by charging a flat, specified annual fee, which averaged 0.47% of assets in 2021, down from 1.04% in 1996. Hedge funds, on the other hand, were long known for their 2-and-20 fee structure, charging shareholders 2% of assets each year, and also taking 20% of annual profits — with some funds charging more, such as 3% and 30%. (These fees have been falling, on average, in recent years, but they’re still far steeper than most mutual fund fees.) Steep fees might be acceptable if a fund’s managers are investing money so brilliantly that shareholders still do very well. But that often isn’t the case. Some hedge funds really have delivered outstanding gains to investors, but many don’t. A Forbes article earlier this year noted that in 2021, a year when the S&P 500 gained close to 27%, hedge funds averaged a gain of 10.4%. Fortunately, average investors can’t invest in hedge funds even if they want to. Only institutional investors (such as pension funds) or “accredited investors” (those with high net worths and/or high incomes) can do so. Average investors can still do very well, though, by investing in low-fee index funds.