Hedge Fund
A hedge fund is a privately offered pooled investment vehicle that employs a wide range of strategies — including leverage, short selling, and derivatives — to generate returns uncorrelated with traditional markets.
The term originated with Alfred Winslow Jones, who in 1949 combined long stock positions with short sales to neutralize market risk while retaining stock-picking alpha. Modern hedge funds have evolved far beyond that original structure, encompassing strategies from global macro to quantitative statistical arbitrage, distressed debt, event-driven merger arbitrage, and long-short equity.
Hedge funds charge investors through the classic two-and-twenty fee structure: a management fee on assets under management and a performance fee on profits above a defined benchmark. The high-water mark provision ensures managers only earn performance fees on new gains, not on recovering previous losses. Some funds also impose a hurdle rate, meaning performance fees only accrue once returns exceed a minimum threshold.
Investors in US hedge funds must qualify as accredited investors or qualified purchasers, limiting access to institutions and high-net-worth individuals. Funds are typically structured as limited partnerships or offshore entities, with quarterly or annual liquidity windows and advance notice periods for redemptions. Some funds impose gates — restrictions on the percentage of assets that can be redeemed in a given period — to prevent forced selling during market stress.
Hedge fund performance is reported to databases such as HFR, but reporting is voluntary, which introduces survivorship bias. Funds that close after poor performance disappear from the dataset, inflating the apparent average returns of the surviving universe. Academic studies accounting for this bias consistently show that the average hedge fund has underperformed a simple stock-bond portfolio after fees over long periods, though top-quartile managers have delivered genuine alpha.
Despite this, institutional allocators continue to use hedge funds for portfolio diversification, tail-risk hedging, and exposure to strategies that are genuinely uncorrelated with public equity markets.