Melissa Ko discusses the basics of a hedge fund.

1. W H A T D O E S A
H E D G E F U N D D O ?
M E L I S S A K O

2. O U T L I N E
In a nutshell
Structure
Fees Involved
Other
considerations

3. Hedge funds remain a mystery for many people
outside of the banking and financial realms. If
you’re miles away from a central exchange or
business center, you probably haven’t heard of the
term yet or didn’t care much to search it online.
The fact of the matter is, hedge funds can be an
essential chunk of a well-diversified investment
portfolio and knowing what the underlying entity
does and how it operates can help you make more
informed investing decisions.

4. Hedge Fund in a Nutshell
Hedge funds are similar to mutual funds, which is
basically an investment program that pools
together investor capital to be traded in
diversified markets. What’s different, however, is
the style of investing that each fund exercises as
well as the prerequisites for joining as an investor.
Typically, hedge funds will only high net worth
individuals, such as those with at least $1 million
to invest in the fund. Hedge funds are also
notorious for implementing very aggressive
trading strategies that take on greater levels of
risk in exchange for higher payout potential.

5. Structure of a Hedge Fund
The typical hedge fund will be divided into two
tiers – a General Partner and a Limited Partner, or
investors. As a rule of thumb, general/limited
partnerships must comprise of at least one
General Partner and one Limited Partner. Due to
an SEC regulation, albeit, hedge funds can only
have a maximum of 99 investors.

6. More than that will require the hedge fund to
register with the SEC, which means more red tape
and more oversight of operations. The second tier
of the structure is the general partnership, which
is structured as an LLC. The amount of investor
risk is limited to the amount of their capital
invested in the fund. The general partner’s duties
is to grow and manage the fund and perform any
tasks necessary to keep the fund afloat.

7. Fees Involved
Hedge fund managers usually charge higher fees over time
than their mutual fund counterparts. In fact, their fee
structure is one of the primary factors why talented
managers decide to start their own fund. Not only are the
management fees higher for hedge funds, but they also
charge investors additional fees, such as an Incentive Fee,
that mutual funds don’t even ask for. Incentive fees can
vary between hedge funds, ranging from as low as 10
percent of the fund’s yearly profits to as high as 50 percent.
While this sounds ridiculous, the incentive fee is only
collected if the manager is able to exceed the previous
high, known in the industry as the High Water Mark.

8. Other Considerations
It’s important to note that hedge funds do not allow daily
capital withdrawal. Liquidity is limited compared to what
mutual funds offer its clients. Some hedge funds will have
monthly subscriptions and redemption dates while others
only allow you to withdraw capital on a quarterly basis.
These strict pullout schedules are necessary to ensure the
fund doesn’t get hit severely when a big investor decides to
withdraw his/her capital.