If you’ve been captivated by Showtime’s hit TV series “Billions” and want to enter the hedge fund world, let’s dive in! Hedge funds aren’t investment options you’ll discover in your 401(k) plan or at your local Edward Jones branch. These sophisticated and typically exclusive investment vehicles demand far greater commitment than standard stock or ETF investments.
Think you have what it takes? Here’s your complete guide to investing in hedge funds.
What Is A Hedge Fund?
According to Investor.gov: Hedge funds pool investor money and invest in securities or other investment types to generate positive returns.
While their core concept of pooling investor funds mirrors mutual funds, hedge funds face lighter regulatory oversight. This freedom allows managers greater flexibility to pursue sophisticated investment strategies and assume higher risks.
Hedge funds maintain a reputation for delivering superior returns compared to “conventional” investments. Due to stringent eligibility requirements, they’re widely viewed as exclusive territory for the wealthy elite.
What Do Hedge Funds Invest In?
What makes hedge fund investment strategies so distinctive and supposedly gives them an edge over securities like mutual funds and ETFs?
While conventional funds typically invest in publicly traded companies and common assets, hedge funds deploy highly sophisticated and intricate methods to generate their billions.
Forbes outlined several primary strategies hedge funds use to generate profits. Here are key approaches:
- Long/short. Balancing long-term stock positions with strategic short sales (betting on stock declines) to reduce volatility and minimize losses.
- Event Driven. Instead of simply buying rising stocks or shorting declining ones, this strategy capitalizes on both sides. It targets merger and acquisition scenarios, profiting from price spreads during corporate deals.
- Discretionary Macro. A speculative approach where managers bet on currency movements, commodities, interest rates, and market indices. These decisions typically stem from current global events and short-term market impact predictions.
- Systematic CTA (Commodity Trading Advisors). Utilizing computer algorithms to track market trends across various assets, then predicting optimal buy or short positions.
- Credit. Providing capital to corporations and trading complex financial derivatives.
How To Invest In A Hedge Fund
To invest in hedge funds, you must first qualify as an “accredited investor“.
Individuals with net worth exceeding $1 million (excluding primary residence value) qualify as accredited investors. You may also qualify by earning at least $200,000 annually (or $300,000 when filing jointly with a spouse).
These standards originate from “Regulation D,” a government publication that defines accredited investor status while limiting fund participation numbers, advertising restrictions, and more. Learn more about Regulation D here.
Why Are Hedge Funds So Mysterious?
Hedge funds appear vague and mysterious for good reason. Most public knowledge about hedge funds comes from fictional movies or media coverage—typically when someone connected to hedge fund investing commits wrongdoing, like Jeffrey Epstein.
Since hedge funds target such a narrow investor base and face advertising restrictions, typical middle-class citizens rarely encounter them or need to consider them.
The World’s Top 10 Hedge Fund Firms
If you qualify as an “accredited investor” and can participate in hedge funds, who would you contact?
Rather than approaching traditional full-service brokers like Vanguard or Fidelity, hedge fund investing requires specialized financial firms that focus on these investment strategies.
Here are the world’s top 10 hedge fund firms:
- Bridgewater Associates
- Renaissance Technologies
- Man Group
- AQR Capital Management
- Two Sigma Investments
- Millennium Management
- Elliott Management
- BlackRock
- Citadel
- Davidson Kempner Capital
Do Hedge Funds Really Deliver Higher Returns?
While hedge funds are portrayed as superior alternative investments guaranteed to outperform broader markets, does reality match the hype?
Data suggests the answer may be “no.” A study by Yale and NYU Stern economists examined a six-year period, finding offshore hedge funds averaged 13.6% annual returns while the S&P 500 gained 16.5% annually.
Consider another example: In 2008, Warren Buffett wagered $1 million (for charity) that simple index fund investing would outperform hedge fund managers. Buffett won decisively in 2018. His S&P 500 (OEX) pick gained 125.8% over ten years, while five hedge funds chosen by Protégé Partners returned only 36%.
A Better Strategy For The Common Investor
Don’t have $1 million for hedge fund investing? Don’t stress. The examples above suggest you might not be missing much.
Most investors today would benefit from simple index fund investing (typically mutual funds or ETFs) that mirror major market benchmarks like the S&P 500 stock index. Currently, the S&P 500’s long-term average return is 10 percent. That’s impressive performance, especially considering how accessible these investments are.
