How to Define a Hedge Fund"How to define a hedge fund?" There is some controversy among various legal authorities, websites and even hedge fund managers themselves over this simple question.
To define a hedge fund one must look at the background and history of hedge funds, which I attempt to cover briefly below, but here is my carefully constructed, yet short definition: Hedge Fund Definition. A hedge fund operating in the United States is an investment vehicle, usually formed as a limited partnership, with a separate entity acting as the manager or adviser. The manager or adviser usually receives a 2% management fee based on a percentage of the assets under management, as well as some form of performance fee usually 20% of the increased value in the assets based on the investments being made. The hedge fund can either use one style or investment strategy or can use a multi-strategy approach. To truly "hedge" its positions, however, it must use some technique such as derivative instruments, shorting, convertible securities or reset provisions, otherwise it is not really a hedge fund it is just an "investment fund", also referred to in state and federal securities regulations as an "investment company." If you interested in formation click here: Hedge Fund Formation. An interesting observation that most people don't realize is that even though hedge funds and hedge fund managers are regulated at the federal and state level if you look at those regulations there is no reference to the term "hedge fund". At the federal level the body of law that regulates hedge funds is called "The Investment Company Act of 1940". Section 3(a)(1)(A) of the Investment Company Act defines an investment company as an issuer which is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting or trading in “securities.” Section 3(a)(1)(C) of the Investment Company Act defines an investment company as an issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding or trading in securities, and owns or proposes to acquire “investment securities” having a value exceeding 40 percent of the value of its total assets (exclusive of government securities and cash items) on an unconsolidated basis. If you need to talk to a Hedge Fund Attorney you can Contact Me. I have formed several hedge funds for clients over the years and represented them in closing numerous funding transactions. If you want to learn about what a PIPE Fund is and the types of investments they make you can click here:PIPE Fund - Define a Hedge Fund. There have been several books written on the subject of hedge funds and many websites give their their version of how to define a hedge fund. The shorter definitions don't really seem to tell the whole story and with regulatory changes every few years and the complexity of investment strategies the industry is becoming more and more specialized. The original long/short funds are still around, but they are now the minority.
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Originally hedge funds were simply private investment vehicles for the wealthy. An experienced money manager would invest the money on behalf on the investors in the fund. The key was diversification so that investments could do as well during recession, inflation, stagflation and even a depression. Years ago there were only a few investment styles or strategies, but that has changed with the creation of derivative instruments.