# Hedge Fund: Definition, Examples, Types, and Strategies

> **Definition**
>
> A hedge fund is an actively managed investment that pools money from accredited investors and seeks high returns by using complex strategies and significant risk.

## What Is a Hedge Fund?

A hedge fund is an actively managed private investment fund whose money is pooled and managed by professional fund managers. These managers use a wide range of strategies, including [leverage](https://www.investopedia.com/terms/l/leverage.asp) and the trading of nontraditional assets, to earn above-average investment returns. Investing in hedge funds is often considered a risky alternative investment choice and usually requires a high minimum investment or [net worth](https://www.investopedia.com/terms/n/networth.asp). Hedge funds typically target wealthy investors.

### Key Takeaways

*   Hedge funds are actively managed funds focused on alternative investments that commonly use risky investment strategies.
*   Investing in a hedge fund is generally open to accredited [investors](https://www.investopedia.com/best-online-brokers-4587872) with a high minimum investment or net worth.
*   Hedge funds charge higher fees than conventional investment funds.
*   Hedge fund strategies depend on the fund manager and relate to equity, fixed-income, and event-driven investment goals.
*   A hedge fund investment is usually locked up for a year before shares can be sold.  
    

![Hedge Fund](https://www.investopedia.com/thmb/20INve0WrTd4ihgiZgHGTiMY_S8=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/hedge-fund-e24f63dddbea46509acc50e93e12132f.jpg)

*Hedge funds typically make money by levying a 2% management fee and a 20% performance fee. — Investopedia / Julie Bang*

## How Hedge Funds Work

Hedge funds pool money that's managed to [outperform](https://www.investopedia.com/terms/o/outperform.asp) average market returns. The fund manager often hedges the fund’s positions to protect them from market risk. This is done by investing some of the assets in securities whose prices move in the opposite direction of the fund’s core holdings. So, if the core holdings' prices drop, the securities' prices should rise. As a result, the hedge can offset any losses in the core holdings.

For example, a hedge fund that focuses on a [cyclical sector](https://www.investopedia.com/terms/c/cyclicalstock.asp), such as travel, may invest a portion of its assets in a non-cyclical sector, such as energy, aiming to use the positive returns of the non-cyclical stocks to offset any losses in cyclical stocks.

Hedge funds use risky strategies, [leverage](https://www.investopedia.com/terms/l/leverage.asp), and [derivative](https://www.investopedia.com/terms/d/derivative.asp) securities like options and futures. Therefore, a hedge fund investor is commonly considered an [accredited investor](https://www.investopedia.com/terms/a/accreditedinvestor.asp). This means that they meet a required minimum level of income or assets. Accredited investors are typically institutional investors, such as pension funds, insurance companies, and wealthy individuals.

Investments in hedge funds are considered [illiquid](https://www.investopedia.com/terms/i/illiquid.asp), as funds often require investors to lock their money in for at least one year—a time known as the lock-up period. Withdrawals may also only happen at certain intervals, such as quarterly or biannually.

## Types of Hedge Funds

The four common types of hedge funds are:

*   [**Global macro hedge funds**](https://www.investopedia.com/terms/g/global-macro-hedge-fund.asp): These are actively managed funds that attempt to profit from broad market swings caused by political or economic events.
*   **Equity hedge funds**: These may be global or specific to one country, investing in lucrative stocks while hedging against downturns in [equity markets](https://www.investopedia.com/terms/e/equitymarket.asp) by shorting overvalued stocks or stock indices.
*   [**Relative value hedge funds**](https://www.investopedia.com/terms/r/relativevalue-funds.asp): These funds seek to exploit temporary differences in the prices of related securities, taking advantage of price or spread inefficiencies.
*   **Activist hedge funds**: These aim to invest in businesses and take actions that boost the stock price, such as demanding that companies cut costs, restructure assets, or change the [board of directors](https://www.investopedia.com/terms/b/boardofdirectors.asp).  
    

> **Fast Fact**
>
> The appeal of many hedge funds lies in the reputations of their managers, which stand out in the closed world of hedge fund investing.

## Common Hedge Fund Strategies

Hedge fund strategies cover a broad range of risk tolerance and investment philosophies. They involve a large selection of investments, including debt and equity securities, commodities, currencies, derivatives, and [real estate](https://www.investopedia.com/ask/answers/110215/how-do-real-estate-hedge-funds-work.asp).

Common [hedge fund strategies](https://www.investopedia.com/articles/investing/111313/multiple-strategies-hedge-funds.asp) are classified according to the [investment style](https://www.investopedia.com/terms/i/investing_style.asp) of the fund’s manager and include equity, fixed-income, and event-driven investment goals.

*   A long/short hedge fund strategy is an extension of [pairs trading](https://www.investopedia.com/terms/p/pairstrade.asp), by which investors go long and short on two competing companies in the same industry based on their relative valuations.
*   A fixed-income hedge fund strategy gives investors solid returns with minimal monthly volatility and aims for capital preservation; it takes both long and short positions in [fixed-income securities](https://www.investopedia.com/terms/f/fixed-incomesecurity.asp#:~:text=Fixed%2DIncome%20securities%20are%20debt,form%20of%20fixed%2Dincome%20securities.).
*   An [event-driven](https://www.investopedia.com/terms/e/eventdriven.asp) hedge fund strategy takes advantage of temporary stock mispricing, spawned by corporate events like restructurings, [mergers and acquisitions](https://www.investopedia.com/terms/m/mergersandacquisitions.asp), bankruptcy, or takeovers.  
    

## Examples of Hedge Funds

The most notable hedge funds, based on [assets under management (AUM)](https://www.investopedia.com/terms/a/aum.asp), include:

*   **Bridgewater Associates**: Founded in New York in 1975 and headquartered in Westport, Connecticut, with approximately $124.32 billion in AUM
*   **Renaissance Technologies**: Founded in 1982 and headquartered in East Setauket, New York, with mathematical- and statistical-based investment strategies as well as roughly $106.03 billion in AUM
*   **AQR Capital Management**: Founded in 1998 and headquartered in Greenwich, Connecticut, with applied quantitative research investment strategies and more than $94.52 billion in AUM

## Hedge Fund Compensation

Australian investor Alfred Winslow Jones is credited with launching the first hedge fund in 1949 through his company, A.W. Jones & Co. Raising $100,000, he designed a fund that aimed to minimize the risk in long-term stock investing by [short selling](https://www.investopedia.com/terms/s/shortselling.asp), now referred to as the long/short equities model.

In 1952, Jones converted his fund to a [limited partnership](https://www.investopedia.com/terms/l/limitedpartnership.asp), added a 20% incentive fee as compensation for the managing partner, and became the first money manager to combine short selling, [the use of leverage](https://www.investopedia.com/ask/answers/102015/how-do-hedge-funds-use-leverage.asp), and a compensation system based on performance.

Today, hedge funds employ a standard “2 and 20” fee system, which refers to a 2% management fee and a 20% performance fee:

*   The management fee is based on the [net asset value (NAV)](https://www.investopedia.com/terms/n/nav.asp) of each investor’s shares, so an investment of $1 million garners a $20,000 management fee that year to cover the operations of the hedge and [compensate the fund manager](https://www.investopedia.com/articles/professionals/100515/top-5-highest-paid-hedge-fund-managers.asp).
*   The performance fee is commonly 20% of profits. If an investment of $1 million increases to $1.2 million in one year, $40,000 is the fee owed to the fund.  
    

## Hedge Funds vs. Mutual Funds

### Hedge Funds

A hedge fund can invest in land, real estate, stocks, derivatives, and [currencies](https://www.investopedia.com/terms/c/currency.asp). It's normally only open to accredited investors or those with either an annual income that exceeds $200,000 or a net worth exceeding $1 million. These investors are considered suitable to handle the potential risks that hedge funds are permitted to take. Hedge funds also aren't as strictly regulated by the [Securities and Exchange Commission (SEC)](https://www.investopedia.com/terms/s/sec.asp) as mutual funds are.

Hedge funds typically limit opportunities to [redeem shares](https://www.investopedia.com/terms/r/redemption.asp) and often impose a locked period of one year before shares can be cashed in. They typically employ the 2% management fee and 20% performance fee structure.

### Mutual Funds

[Mutual funds](https://www.investopedia.com/terms/m/mutualfund.asp) use stocks or bonds as their instruments for long-term investment strategies. They're a practical, cost-efficient way to build a [diversified portfolio](https://www.investopedia.com/investing/importance-diversification/) of stocks, bonds, or short-term investments. They're available to the general public and the average investor.

Unlike hedge funds, mutual fund investors can sell their shares at any time. The average expense ratio for equity mutual funds was 0.40% in 2024.

> **Tip**
>
> Read about Investopedia’s 10 Rules of Investing by picking up a copy of our special-issue print edition.

## What to Consider Before Investing

As investors research hedge funds that meet their investment goals, they often consider the fund or firm’s size, the track record and longevity of the fund, the minimum investment required to participate, and the redemption terms of the fund. Hedge funds operate in many countries, including the United States, the [United Kingdom](https://www.investopedia.com/articles/investing/040915/how-start-hedge-fund-uk.asp), Hong Kong, Canada, and France.

According to the SEC, investors should also do the following when deciding whether or not to invest in a hedge fund:

*   Read the hedge fund’s documents and agreements, which contain information about investing in the fund, the strategies of the fund, the location of the fund, and the risks anticipated by the investment.
*   Understand the level of risk involved in the fund’s investment strategies and whether they equate with your personal investing goals, time horizons, and [risk tolerance](https://www.investopedia.com/articles/pf/07/risk_tolerance.asp).
*   Determine if the fund is using leverage or speculative investment techniques, which will typically invest both the investors’ capital and the borrowed money to make investments.
*   Evaluate potential [conflicts of interest](https://www.investopedia.com/terms/c/conflict-of-interest.asp) disclosed by hedge fund managers, and research the background and reputation of the hedge fund managers.
*   Understand how a fund’s assets are valued, as hedge funds may invest in highly [illiquid securities](https://www.investopedia.com/terms/i/illiquid.asp), and valuations of fund assets will affect the fees that the manager charges.
*   Understand how a [fund’s performance](https://www.investopedia.com/articles/mutualfund/09/hedge-fundanalysis.asp) is determined and whether it reflects cash or assets received by the fund as opposed to the manager’s estimate of the change in the value.
*   Understand any limitations to time restrictions imposed to redeem shares.

## Explain Like I'm 5

A hedge fund is a private investment [pool](https://www.investopedia.com/terms/p/pooledfunds.asp) (i.e., capital collected from several investors) that's actively managed by a professional fund manager. These funds can invest in stocks as well as nontraditional assets like land and currencies, and their investors don't benefit from the same federal and state law protections as mutual funds. For this reason, hedge funds are often restricted to wealthy investors.

Hedge funds employ complex strategies in an effort to outperform average market returns. In order to hedge against market risk, a portion of a fund's assets are often invested in securities that move counter to its core holdings. A fund's investments are also typically locked in for a minimum of one year before shares may be sold.  

Hedge fund managers are usually compensated by levying a 2% management fee as well as a 20% performance fee. The former is based on the NAV of each investor’s shares in the hedge fund, while the latter is typically tied to its profits.  

## What Tools Do Investors Use to Compare the Performance of Hedge Funds?

Investors look at the annualized rate of return to compare funds and to reveal funds with high expected returns. To establish guidelines for a specific strategy, an investor can use an analytical software package, such as those offered by [Morningstar](https://www.investopedia.com/terms/m/morningstarinc.asp), to identify a universe of funds using similar strategies.  

## How Do Hedge Funds Compare with Other Investments?

Hedge funds, mutual funds, and [exchange-traded funds (ETFs)](https://www.investopedia.com/terms/e/etf.asp) all pool money contributed by many investors and attempt to earn a profit for themselves and their clients.

Hedge funds are actively managed by professional managers who buy and sell certain investments with the stated goal of exceeding the returns of either the markets or some sector or index of the markets. They take the greatest risks while trying to achieve these returns. Additionally, hedge funds are more loosely regulated than competing investments, and they can invest in options and derivatives as well as esoteric investments that mutual funds cannot access.  

## Why Do People Invest in Hedge Funds?

A wealthy individual who can afford to diversify into a hedge fund might be attracted to the high-performance reputation of its manager, the specific assets in which the fund is invested, or the unique strategy that it employs.

## The Bottom Line

Hedge fund investing is considered a risky alternative investment choice and requires investors make a large minimum investment or have a high net worth. Hedge fund strategies involve investing in debt and equity securities, commodities, currencies, derivatives, and real estate. These funds are loosely regulated by the SEC and earn money from the 2% management fee and 20% performance fee structure.

> **Article Sources**
>
> 1.  Investor.gov. “[Hedge Funds](https://www.investor.gov/introduction-investing/investing-basics/investment-products/private-investment-funds/hedge-funds).”
>     
> 2.  Forbes. “[Top 10 U.S. Hedge Funds of 2025](https://www.forbes.com/advisor/investing/top-hedge-funds/).”
>     
> 3.  CFO. “[A Short History of Hedge Funds](https://www.cfo.com/banking-capital-markets/2007/03/a-short-history-of-hedge-funds/).”
>     
> 4.  Investor.gov. “[Accredited Investors – Updated Investor Bulletin](https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins/updated-3).”
>     
> 5.  U.S. Securities and Exchange Commission. “[Investor Bulletin: Hedge Funds](https://www.sec.gov/investor/alerts/ib_hedgefunds.pdf),” Page 4.
>     
> 6.  Investment Company Institute. "[Trends in the Expenses and Fees of Funds, 2024](https://www.ici.org/system/files/2025-03/per31-01.pdf)," Page 1.
>     
> 7.  U.S. Securities and Exchange Commission. “[Investor Bulletin: Hedge Funds](https://www.sec.gov/investor/alerts/ib_hedgefunds.pdf),” Pages 1–4.