The primary investors in hedge funds areinstitutional investors. These are professional investors who manage large amounts of money. They work forpension fundsfor corporations, government workers, and labor unions. They also managesovereign wealth fundsfor entire countries. They handle the cash assets of insurance companies, other corporations, and trusts. Institutional investors provide 65%of the capital invested in hedge funds.
Key Takeaways
- Hedge fund investors must meet minimum wealth requirements, and they must be willing to pay high management fees.
- Many who invest in hedge funds do so to diversify their portfolios—they don't necessarily seek higher returns than broad index funds offer, and they might invest in index funds in addition to hedge funds.
- Pension funds have experimented with investing in hedge funds, but some of them have reversed course after underwhelming returns.
Qualifications
Hedge fund investors are required to have at least $1 million in net worth or must have earned income above $200,000 in each of the two preceding years. They also must reasonably expect to earn that amount for the current year. They need this cushion to weather significant downturns in their portfolio in their quest for higher returns. They also must be able to keep their money tied up for the three or more months, as may be required by hedge funds. Three years is a typical time frame to evaluate the success of a hedge fund’s performance.
Investors often must be willing to pay 2%of the assets they invest and 20%of any profits. This high fee is worth it to them tooutperform the market.Some are still tryingto recover losses incurred during thecrash of 2008.
These are sophisticated investors. They understand how leveraging works through options, futures contracts, and the other derivatives that hedge funds use to boost returns. They are willing to endure the risk of the investment going south.
They also need to be good judges of character. Most hedge funds don't reveal what they do to get their returns. That lack of transparency means that they can actually be Ponzi schemes, such as the one run byBernie Madoff.
Why They Invest in Hedge Funds
Those big investors put less than 20%of their assets into hedge funds. More conservative investors—like insurance companies, pension funds, and sovereign wealth funds—allocate less than 10% of their total investments.
Hedge fund investorsare looking for an investment that is uncorrelated with the rest of their investments. If the stock market loses value, the hedge fund investment might rise.In other words, investors use hedge funds to increase their diversification. They know that a diversified portfolio will increase total returns over time byreducing overallvolatility.
Note
Investors don't compare the performance of their hedge fund investments to standard indexes like the , the NASDAQ, or the Dow Jones.
Surprisingly, most hedge fund investors aren't looking for higher-than-average returns. Only 6% think they could achieve 10% or more annual returns. They just aren't willing to endure the risk that higher returns entail. Instead, 67%are looking for annual returns of between 4% and 6%. That's probably because they have to report to boards that might fire them if they sustain losses.
Family trusts use hedge funds to gain access to the best minds in the investment world. Why do hedge funds attract the smartest investors? Because they pay the most. But many investors may limit or even avoid hedge funds due to the high fees.
Investor Trends
Pension funds recentlystarted investing in hedge funds to boost returns. Theyrealized that they might not have the capital needed to cover the mass of retiring seniors and are trying to outperform the market to cover those obligations. Unfortunately, the risky nature of hedge funds and their lack of regulation means that these pension funds are less likely to cover their commitments.
There is some indication that hedge funds are becoming less popular. In 2014, they returned only 3.3% on average, much lower than the S&P 500. Almost as many hedge funds are liquidated each year as are created. Many savvy investors realize that they are taking all the risk, while the hedge funds aren't producing rewards to offset or justify that risk.
The California Public Employees' Retirement Systemannounced that it would withdraw all of its $4 billion in hedge funds in 2014. It had only received a 7.1% return in the past year. That sounded good until it was compared to the 12.5% return of a comparable investment, the Vanguard Balanced Index Fund, with an asset allocation of 60%stocks and 40% bonds.
It appears that institutional investors are continuing to view hedge funds as a source of alpha and diversification.
FAQs
Therefore, an investor in a hedge fund is commonly regarded as an accredited investor. This means that they meet a required minimum level of income or assets. Typical investors are institutional investors, such as pension funds and insurance companies, and wealthy individuals.
Who typically invests in hedge funds? ›
You generally must be an accredited investor, which means having a minimum level of income or assets, to invest in hedge funds. Typical investors include institutional investors, such as pension funds and insurance companies, and wealthy individuals.
Why would anyone invest in a hedge fund? ›
Their market-neutral, or balanced, approach to investing helps seek out positive returns by investing in varied instruments over long- and short-term periods. This positions hedge funds as nimble investors in the marketplace, able to anticipate – and avoid – undue risk for their investment partners.
Why are hedge fund owners so rich? ›
Hedge funds seem to rake in billions of dollars a year for their professional investment acumen and portfolio management across a range of strategies. Hedge funds make money as part of a fee structure paid by fund investors based on assets under management (AUM).
How do hedge fund investors make money? ›
Hedge funds make money by charging a management fee and a percentage of profits. The typical fee structure is 2 and 20, meaning a 2% fee on assets under management and 20% of profits, sometimes above a high water mark. For example, let's say a hedge fund manages $1 billion in assets. It will earn $20 million in fees.
Who is the target audience for hedge fund? ›
A hedge fund investment is often considered a risky, alternative investment choice and usually requires a high minimum investment or net worth. Hedge funds typically target wealthy investors.
What do hedge funds really do? ›
Hedge funds are financial partnerships that employ various strategies in an effort to maximize returns for their investors. Unlike mutual funds managers, hedge fund managers have free reign to invest in non-traditional assets and employ risky strategies. The U.S. is home to about 67% of the world's hedge funds.
Do billionaires use hedge funds? ›
The recent Forbes 400 (richest American billionaires) list has about 112 people, by my count, who made their fortunes in some form of Finance, Investments, Hedge Funds, insurance or banking.
What is one disadvantage of a hedge fund? ›
One of the biggest expenses associated with hedge funds is the management fee. Hedge funds typically charge around 2% of assets under management. This fee covers the cost of managing the fund, including research, analysis, and operational expenses. While 2% may not sound like a lot, it can add up quickly.
Do you have to be rich to invest in hedge funds? ›
Hedge funds tend to have specific characteristics and features. They require wealth to participate. Hedge funds typically require an investor to have a liquid net worth of at least $1 million, or annual income of more than $200,000. They often borrow money to use in an investment.
Put simply, a hedge fund is a pool of money that takes both short and long positions, buys and sells equities, initiates arbitrage, and trades bonds, currencies, convertible securities, commodities and derivative products to generate returns at reduced risk.
How much net worth do you need to have to be in a hedge fund? ›
3 In exchange, the Securities and Exchange Commission (SEC) requires a majority of hedge fund investors to be accredited, which means possessing a net worth of more than $1 million and a sophisticated understanding of personal finance, investing, and trading.
What is the minimum to invest in a hedge fund? ›
a minimum investment of $1 million to $10 million. Despite such high thresholds, through Morgan Stanley, clients can often gain access to funds at much lower minimum investments. As discussed later, investments in single manager hedge funds may be as low as $100,000 per fund.
Is BlackRock a hedge fund? ›
BlackRock manages US$38bn across a broad range of hedge fund strategies. With over 20 years of proven experience, the depth and breadth of our platform has evolved into a comprehensive toolkit of 30+ strategies.
What is a hedge fund for dummies? ›
Hedge funds use pooled funds to focus on high-risk, high-return investments, often with a focus on shorting―so you can earn profit even when stocks fall.
What type of investor can purchase hedge funds? ›
Specifically, hedge funds are restricted under Regulation D under the Securities Act of 1933 to raising capital only in non-public offerings and only from “accredited investors,” or individuals with a minimum net worth of $1,000,000 or a minimum income of $200,000 in each of the last two years and a reasonable ...
What is the minimum investment for hedge funds? ›
It is not uncommon for a hedge fund to require at least $100,000 or even as much as $1 million to participate. Unlike mutual funds, hedge funds avoid many of the regulations and requirements within the Securities Act of 1933.
Who do hedge funds recruit? ›
There are two main entry points into hedge funds: directly out of undergraduate as a Junior Analyst or Research Associate, or as an Analyst, after you work for several years in a field like investment banking, equity research, asset management, or sales & trading.
What is the threshold for hedge funds? ›
A common threshold level used is 8%. That means that the hedge fund only charges the 20% performance fee if profits for the year surpass the 8% level.
