Lesson 1 of 8 · 13 min
What makes a hedge fund different
A hedge fund is a lightly regulated private pool that is defined by how it invests (leverage, short selling, derivatives, concentrated bets) rather than by what it owns, and it pays for that freedom with lockups, gates, high fees and less transparency.
In short
- Hedge funds are private pooled vehicles for institutional and accredited (wealthy) investors; they are not an asset class but a set of strategies applied to ordinary assets.
- They aim for absolute returns or high risk-adjusted returns, so they are often judged against an absolute target rather than a market index.
- Seven distinguishing features: light regulation, flexible mandates (shorting, derivatives), a wide universe, concentrated and aggressive positions, liberal leverage, lockups and gates, and management plus incentive fees.
- Against mutual funds and ETFs: private, lightly regulated, less liquid, performance-based pay. Against private equity: shorter horizon and more liquid, mostly public assets.
- A soft lockup lets an investor leave early by paying a redemption fee to the fund, which protects the investors who stay.
- Light oversight and opacity raise fraud and operational risk, so due diligence on the manager, strategy, liquidity and fee calculation is essential.
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