We Know: How Hedge Funds Work

What are hedge funds?

Hedge funds are similar to mutual funds because they pool investors' money to make a positive return. They differ from mutual funds because they are not required to register with the SEC, making them subject to very few regulatory controls. Hedge funds have generally been available solely to wealthy, accredited investors and large institutions because minimum investments start at 1 million dollars. Hedge fund managers have recently been required to register with the SEC as investment advisers under the Investment Advisers Act by February 1, 2006.

What are funds of hedge funds?

A fund of hedge funds is an investment company that invests in hedge funds, rather than investing in individual securities. Some funds of hedge funds register their securities with the SEC. These funds of hedge funds must provide investors with a prospectus and must file certain reports quarterly with the SEC. These funds are available to less wealthy investors with investment minimums as low as $25,000.

What information should I seek if I am considering investing in a hedge fund or a fund of hedge funds?

  • Make sure you understand the level of risk involved. It should meet your personal investing goals, time horizons, and risk tolerance.
  • Understand how a fund's assets are valued. Funds of hedge funds and hedge funds may invest in highly illiquid securities that may be difficult to value.
  • Ask questions about fees, which will affect your return on investment. If you invest in hedge funds through a fund of hedge funds, you will pay two layers of fees which include the fees of the fund of hedge funds and the fees charged by the underlying hedge funds.
  • Understand any limitations on your right to redeem your shares.
  • Research the backgrounds of hedge fund managers. Make sure hedge fund managers are qualified to manage your money, and find out whether they have a disciplinary history within the securities industry.

What protections do I have if I purchase a hedge fund?

Hedge fund investors do not receive all of the federal and state law protections that commonly apply to most registered investments. However, the SEC can take action against a hedge fund that defrauds investors. Ponzi schemes are a common method of misrepresentation used by hedge fund managers.

What should I do if I have a complaint about a hedge fund or a fund of hedge funds?

If you encounter a problem with your hedge fund or fund of hedge funds, contact the Securities and Exchange Commission.

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