HEDGE FUNDHedge Fund - over the years this definition has been expanded upon, misinterpreted and millions of pages have been written about them, even though 20 years ago hardly anyone new anything about them. It has only been in the past 10 years or so that people have really started to learn about them. To provide an accurate definition, one must look at their background and history, which I attempt to cover briefly below, but here is my carefully constructed, yet somewhat 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." Hedge Fund History - Most authorities on the subject would agree on the following explanation. During the 1940's and 1950's when limited partnerships were set up with investors they came under certain exemptions and did not have to register with the SEC under the Investment Company Act of 1940. All mutual funds must register, but certain investment companies did not have to register if they were exempt under certain provisions of the Investment Company Act of 1940 and the state laws of the state in which they had offices. Some early funds went long on undervalued stocks and short on overvalued stocks in a way "hedging" their investment portfolio. The term market-neutral strategy also became popular and is a very popular strategy used my hedge funds today. Many funds today, however, are not really hedged at all. It’s just that the term became so popular that it stuck and now everyone uses it. Today hardly anyone uses the term "investment company" unless they are discussing regulatory or registration issues, since the federal and state regulations use the term "investment company". Based on the above explanation, the same holds true for the term "Hedge Fund Manager" which really is the same as an "Investment Adviser", since none of the regulations use that exact term. If you look at the various state securities regulations, you aren't going to find anything since most of the state regulations somewhat mirror the federal regulations. While most funds can come under one exemption or another and therefore are not required to register, the same is not true for managers. Many mangers/advisers must register at the state or federal level because they do not qualify for one of the several exemptions available to managers/advisers.
There are many different strategies used by investment managers, and each year new ones seem to evolve. These strategies include but are not limited to: activist, long-short, long-short market neutral, special situations, long only, contrarian, emerging markets, futures, convertible arbitrage, bonds, opportunistic, distressed equity, macroeconomic, multi-strategy, fund of funds and many more. Websites and data reporting sources have their own definitions and categories, that sometimes makes matters a little confusing. For example, LeadDog Capital L.P. can be considered a Special Situations or PIPE Fund because it tends to make investments in companies based on a special situation or special relationship in microcap companies through private placement investments in convertible securities (such as convertible debentures, convertible preferred stock and warrants). If LeadDog were to diversify its investments into several other strategies such as long-short market neutral, distressed equities and long only, then it might be considered a multi-strategy fund. Regulation - The SEC and Congress are frantically trying to further regulate the industry to protect investors and the US economy. Several proposals are underway and by the end of 2010 we will very likely see a final and approved regulation that will increase record keeping and disclosure requirements, require more managers to register (based on a certain minimum of assets under management) and hopefully require annual audits of all funds by competent auditing firms. For more information on proposed regulation see Treasury Secretary Proposes Regulation and SEC Speech on Regulation. Visit this link if you would like information on Hedge Fund Formation. Visit this link if you would like information on steps for a Fund Start-up. Visit this link if you would like information on attorneys that advise and set up fund structures for clients Attorneys.
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It is important to consider the existing and proposed federal and state regulatory issues involved in setting up a fund. I have set up domestic and offshore funds for clients over the years and advised them on many regulatory, structuring, compliance and procedural matters. Contact me if you are considering setting up a hedge fund. 