What Is a Hedge Fund?

Hedge funds are privately offered investment pools that deploy a wide spectrum of trading strategies—long and short equity, credit, derivatives, macro bets, quantitative models and, increasingly, digital assets—in pursuit of absolute returns that are uncorrelated with traditional markets. Unlike mutual funds, they operate under exemptions that let them accept only accredited or qualified investors and give managers far more flexibility in leverage, short‑selling and concentration.

A Brief Origin Story

The first hedge fund was launched in 1949 by Alfred Winslow Jones, who combined stock‑picking with short positions to “hedge” market risk. The model proliferated after the 1980s and today the industry commands an estimated US $4.5 trillion in assets under management—a record high reached in 2024. 

How Hedge Funds Are Structured

Most funds follow a limited‑partnership model:

  • General Partner (GP) – the management entity that makes investment decisions and earns performance incentives.
  • Limited Partners (LPs) – investors who supply capital but take no part in day‑to‑day management.

Because U.S. securities law treats hedge funds as private offerings, they rely on Investment Company Act exemptions such as 3(c)(1) (≤ 100 investors) or 3(c)(7) (qualified purchasers). Outside the U.S., managers frequently use offshore master funds in jurisdictions like the Cayman Islands, with Delaware or Luxembourg feeders for different tax cohorts.

Core Investment Strategies

  • Long/Short Equity – buying undervalued stocks and shorting overvalued ones.
  • Global Macro – betting on macroeconomic trends across currencies, rates and commodities.
  • Event‑Driven – profiting from mergers, restructurings or bankruptcies.
  • Relative Value / Arbitrage – exploiting price dislocations between linked securities.
  • Quantitative & Systematic – algorithmic trading based on statistical signals.
  • Multi‑Strategy – allocating capital dynamically across several of the above.
  • Digital‑Asset / Crypto – trading tokens, DeFi yields and blockchain infrastructure plays.

The Fee Model

Hedge funds traditionally charge “2 and 20”: a 2 % annual management fee on assets plus 20 % of profits above a high‑water mark. Competitive pressure has nudged averages closer to 1.5 % and 17 % in recent years, but performance fees remain the economic engine that aligns managers with investors.

Regulation and Recent Developments

Managers with more than US $110 million under management generally register with the SEC as investment advisers and file Form PF, while CFTC registration may apply if they trade futures or swaps. Notably, the SEC’s 2023 private‑fund adviser rules were vacated by the U.S. Fifth Circuit in June 2024, eliminating a slate of quarterly‑statement and fee‑restriction mandates—at least for now. 

Globally, regulators have tightened AML/KYC and valuation oversight, but leading offshore centers (Cayman, BVI, Bahamas) continue to offer tax neutrality and flexible fund structures favored by institutional allocators.

Risks to Consider

  • Leverage and illiquidity can amplify drawdowns.
  • Manager concentration—the GP wields broad discretion, so operational due‑diligence is critical.
  • Regulatory drift may alter transparency or fee economics, as the recent SEC episode shows.
  • Lock‑ups and gates can restrict redemptions during market stress.

Why Investors Allocate

Despite the risks and higher fees, hedge funds appeal because they can:

  • Deliver alpha uncorrelated with stocks and bonds.
  • Provide downside protection via hedging and tactical shorts.
  • Access niche strategies (distressed debt, volatility, crypto) unavailable in traditional funds.

Launching Your Own Hedge Fund

Forming a fund involves:

  1. Choosing an on‑shore (Delaware LP/LLC) or offshore (Cayman/BVI/Bahamas) vehicle.
  2. Drafting offering documents (PPM, LPA/LLC Agreement).
  3. Registering—or claiming exemption—with the SEC, CFTC and local regulators.
  4. Building an infrastructure of administrators, auditors, prime brokers and independent directors.

Our team at FundAttorney.com guides emerging managers through every step, from jurisdiction selection to ongoing compliance.

A hedge fund is best viewed as a flexible legal wrapper that grants sophisticated managers the latitude to pursue idiosyncratic returns—while demanding greater due‑diligence from investors and a disciplined governance framework from operators. As assets crest new highs and regulations evolve, the sector continues to innovate, making hedge funds a cornerstone of many institutional portfolios—and, potentially, of yours.