A hedge fund is a pooled investment fund that holds liquid assets
and that makes use of complex trading and risk management
techniques to improve investment performance and insulate returns
from market risk. Among these portfolio techniques are short
selling and the use of leverage and derivative instruments.
While most modern hedge funds are able to employ a wide variety of
financial instruments and risk management techniques,[5] they can
be very different from each other with respect to their
strategies, risks, volatility and expected return profile. It is
common for hedge fund investment strategies to aim to achieve a
positive return on investment regardless of whether markets are
rising or falling ('absolute return').
Hedge funds are considered alternative investments. Their ability
to use leverage and more complex investment techniques
distinguishes them from others. Other than a fund's regulatory
status, there are no formal or fixed definitions of fund types,
and so there are different views of what can constitute a 'hedge
fund'.
A hedge fund usually pays its investment manager a management fee
(typically, 2% per annum of the net asset value of the fund) and a
performance fee (typically, 20% of the increase in the fund's net
asset value during a year). Hedge funds have existed for many
decades and have become increasingly popular. They have now grown
to be a substantial portion of the asset management industry, with
assets totaling around $3.8 trillion as of 2021.[7] Hedge fund
managers can have several billion dollars of assets under
management (AUM).
Hedge fund strategies are generally classified among four major
categories: global macro, directional, event-driven, and relative
value (arbitrage). Strategies within these categories each entail
characteristic risk and return profiles. A fund may employ a
single strategy or multiple strategies for flexibility, risk
management, or diversification. The hedge fund's prospectus, also
known as an offering memorandum, offers potential investors
information about key aspects of the fund, including the fund's
investment strategy, investment type, and leverage limit.
The elements contributing to a hedge fund strategy include the
hedge fund's approach to the market, the particular instrument
use, the market sector the fund specializes in (e.g., healthcare),
the method used to select investments, and the amount of
diversification within the fund. There are a variety of market
approaches to different asset classes, including equity, fixed
income, commodity, and currency. Instruments used include
equities, fixed income, futures, options, and swaps. Strategies
can be divided into those in which investments can be selected by
managers, known as 'discretionary/qualitative', or those in which
investments are selected using a computerized system, known as
'systematic/quantitative'. The amount of diversification within
the fund can vary; funds may be multi-strategy, multi-fund,
multi-market, multi-manager, or a combination.
Sometimes hedge fund strategies are described as 'absolute return'
and are classified as either 'market neutral' or 'directional'.
Market neutral funds have less correlation to overall market
performance by 'neutralizing' the effect of market swings whereas
directional funds utilize trends and inconsistencies in the market
and have greater exposure to the market's fluctuations.