What is a hedge fund?
A hedge fund is a type of investment vehicle, typically
structured as a private partnership, attempting to achieve
superior risk-adjusted returns in all market environments.
As a private partnership, hedge funds can use various techniques
and strategies not commonly employed by public investment
vehicles (i.e. mutual funds). Because of this, there can
be an inherently higher level of risk associated with hedge
funds.
What is a general partner?
A general partner oversees all aspects of the hedge fund
partnership including the investment strategy, daily operations,
and legal/accounting matters. The general partner invests
its own capital along with the capital of the limited partners.
What is a limited partner?
A limited partner is the technical term for an investor
who invests capital in a hedge fund partnership. To become
a limited partner, the investor has to read and sign the
limited partnership agreement and subscribe to the general
partner for partnership admission. Once accepted, the investor/limited
partner shares in the profits and losses of the hedge fund.
In most cases, a hedge fund will consist of 500 limited
partners or less. Limited partners are only liable for the
capital they commit to the partnership.
Who can invest in a hedge fund?
Hedge fund investments are not suitable for all investors.
Hedge fund investing is typically limited to accredited
investors, institutions, and a small number of “sophisticated”
non-accredited investors. Investors should speak with their
financial and tax advisors prior to making an investment
in a hedge fund partnership.
What is an accredited investor?
As an individual, an accredited investor will have a net
worth of at least $1 million or income in excess of $200,000
in each of the two most recent years and an expectation
of earning a similar level in the upcoming year. As a corporation
or entity, an accredited investor will have assets in excess
of $5 million and not formed for the specific purpose of
investing in a private partnership.
What is a Confidential Offering Memorandum?
The confidential offering memorandum outlines the specific
details of the hedge fund partnership, including the investment
strategy, the background of the general partners, and contribution/withdrawal
guidelines. An investor should read the confidential offering
memorandum and the limited partnership agreement in its
entirety before investing in a hedge fund partnership.
How are hedge funds traded?
Since most hedge funds are private partnerships, they are
not publicly traded like stocks or bonds. The general partner
handles all contributions and redemptions of the partnership
as a private transaction.
What is an investment management fee?
An investment management fee is the fee collected by the
general partner to offset the day-to-day operations and
administration of the hedge fund. Generally, it is 1% of
the partnership’s assets on a per annum basis.
What is an incentive fee?
An incentive fee is the fee earned by the general partner
after the hedge fund has achieved a pre-determined level
performance. If the hedge fund does not achieve this level
of performance, then the general partner does not earn the
fee. Typically, an incentive can range from 10% - 30% of
the partnership's profits.
What is a “lock-up” period?
A “lock-up” period is a contractually defined
period of time in which the general partner may restrict
a limited partner from redeeming his/her initial capital
investment. This period of time can range from 6 months
to over 2 years. Not all hedge funds have a “lock-up”
period.
How do hedge funds fit in an asset allocation strategy?
Depending on an investor’s risk profile and return
objectives, hedge funds can comprise a small or large portion
of an asset allocation strategy. A 5% to 10% portfolio allocation
to hedge funds is common, but every investor’s situation
is different. A professional independent analysis should
be conducted prior to deciding on a hedge fund allocation.
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