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How does a hedge fund work?

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Quick Answer

Hedge funds are a type of investment partnership in which the investor contributes money and the general partner manages the funds, according to Forbes. Hedge funds are intended to optimize the investor's return, while reducing overall risk. There can be multiple investors for a single hedge fund.

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How does a hedge fund work?
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Full Answer

As of 2013, investors must have a net worth of more than $1 million before they are allowed to invest in a hedge fund, states Forbes. Another feature of hedge funds is that they can be used to invest in stocks, land, real estate, currencies and deliveries, while other types of funds may be more limited.

To increase returns, hedge funds utilize borrowed money, notes Forbes. Hedge fund investors are charged a performance fee and an expense ratio. Fees are set up so that investors pay a 2 percent assessment fee and 20 percent for any gains they receive. The 2 percent fee is considered by some to be unfair because the hedge fund manager receives a percentage of the fund's assets even if he loses money.

Because hedge funds are only allowed to receive money from wealthy individuals, they are some of the least money-management regulated, according to Forbes. The Securities and Exchange Commission has the ability to scrutinize hedge funds and take action to tighten regulations.

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