Hedge Fund

A hedge fund is an investment vehicle, usually a private investment fund, with restricted number of investors. The hedge funds have substantial initial investment requirements, making them investment suitable only for wealthy investors. Alfred Jones started the first hedge fund in 1949 in US, with the idea to offer investors protection in falling markets (hedging) and at the same time to accomplish above-market returns. In general hedge funds look for superior returns.

Hedge funds are similar to mutual funds because both investment vehicles pool investors' money and invest it on their behalf, however the similarities end here. While mutual funds are heavily regulated around the world, most hedge funds are not, which allows them to employee a variety of investment strategies including but not limited to leverage, short selling, taking long positions, taking derivative positions, using arbitrage, and more.

There are 2 main markets where hedge funds are traded – exempt and retail markets. The retail market is heavily regulated (requires prospectus and disallows certain investment strategies) that's why the majority of Canadian hedge funds are traded in the exempt market (without a prospectus and without restrictions on the investment strategies they use). The exempt market services institutional investors and high-worth individuals. Canadian hedge funds use 2 main prospectus exemptions. The first one is the so-called “Minimum Investment Exemption” which allows the hedge funds to offer their securities without prospectus to investors who invest above certain minimum, which varies from province to province, but is relatively high in general. The second exemption is the “Accredited Investor” exemption. The accredited investor definition includes companies, trust companies, and pension funds with net assets of over 5 million Canadian dollars. Individuals may qualify as “accredited investors” if their net worth is greater than $1,000,000 Canadian dollars or if they pre-tax net income is over $200,000 CAD. Keep in mind that the prospectus requirement exemptions and rules vary in different Canadian jurisdictions.

Hedge Funds charge both management and performance fees. As with most other investment funds, the hedge funds management fees are calculated as a percentage of the fund net asset value and usually hover around 2%. The performance fees allow the hedge fund to claim a share of the hedge fund profits. The performance fees usually are in the 20% of gross returns range.

There are many different types of hedge funds, depending on their strategy (global macro, directional, event driven, etc.), the markets they are investing in (FOREX, bond, equity, commodity), the sectors they are investing in (tech, healthcare, etc.), the financial instruments they are using (long/short positions, derivatives, etc.), the investment methods they employee, their diversification, level of risk (heavily hedged, completely un-hedged, etc.), and more. However the two things in common between hedge funds are their pursuit for above-market returns and that the compensation of the hedge fund is largely tied to the performance of the fund.