Hedge funds are pooled investment vehicles that use complex investment strategies to try and generate above-average returns. Investing in hedge funds can be risky, but rewarding if the fund meets or exceeds performance expectations.
Compared to traditional mutual funds or exchange-traded funds, hedge funds typically have more barriers to entry for investors. If you’re interested in how to invest in a hedge fund, it’s helpful to understand who these funds are designed for, and the minimum requirements.
Key Points
• Hedge funds are private investment vehicles using complex strategies to seek high returns, but they carry significant risks.
• Access is limited to accredited investors, typically requiring a net worth of more than $1 million, or a relatively high income.
• Hedge funds invest in diverse assets like stocks, derivatives, and real estate, using strategies like equity long, equity short, or equity neutral.
• Investing involves understanding fund strategies, performance, and costs, and that fees are often higher than mutual funds.
• Regulatory oversight by the SEC helps ensure legal compliance, with trends showing slower growth and evolving strategies.
What Exactly Is a Hedge Fund?
A hedge fund is a private investment vehicle that accepts funds from multiple investors. The hedge fund manager directs the investment strategy to attempt to generate the best possible returns for investors.
Hedge funds can hold a variety of investments, including alternative investments. Depending on the fund’s strategy and investment objectives, a hedge fund may offer exposure to:
• Stocks
• Derivatives
• Foreign currencies
• Real estate
• Commodities
• Fixed income investments
Fund managers may utilize a range of strategies to manage fund assets. Examples of hedge fund strategies include equity long, equity short, and market neutral (basically, strategies that take different time frames into consideration, as well as prevailing market conditions), which may be chosen in anticipation of or to hedge against anticipated market movements. The strategy or strategies employed can influence the fund’s risk/reward profile. Greater risk can bring greater rewards, but it also raises the possibility of losing money.
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Getting Started in Hedge Fund Investments
Getting started in hedge fund investing isn’t exactly straightforward — it’s not the same as firing up an investment account and buying stocks online.
Hedge funds are generally viewed as high-risk investments and as a result, the Securities and Exchange Commission (SEC) regulates who can directly invest in them. Access to hedge investment funds is limited to institutional investors, pension funds, and accredited investors. However, it’s possible for unaccredited investors to gain exposure to hedge funds in their portfolio through certain mutual funds or ETFs.
Under SEC guidelines, you’re an accredited investor if you have:
• Net worth >$1 million, excluding the value of your primary residence, and
• Annual income over $200,000 individually or $300,000 with a spouse or partner in each of the prior two years, with the same income expected for current and future years
Financial professionals with Series 7, Series 65, or Series 82 securities licenses also qualify as accredited investors.
Aside from those requirements, you must be able to meet the minimum investment requirements for a hedge fund. The amount you’ll need will vary by fund, but a typical investment minimum may range anywhere from $100,000 to $2 million.
Maximizing Potential for Returns and Managing Risks
The key to making money with hedge funds while minimizing risk generally lies in two things: Market trends and the fund manager. Like other investments, hedge funds are influenced by things like changing interest rates and volatility, and hedge fund managers need to do their best to contend with those risks to try and maximize returns for investors.
Managing risk, of course, starts with doing your research. Specifically, it’s important to understand what the fund invests in, the strategies the fund manager employs, and the fund’s track record. Helpful questions to ask include:
• How is fund performance determined?
• Does the fund use leverage or speculative strategies?
• Does the fund manager have any conflicts of interest?
• How are the fund’s assets valued?
• How are fund assets safeguarded?
It may also be wise to consider the costs, as hedge funds can charge higher fees than traditional mutual funds or ETFs. An investor might pay an asset management fee of 1%-2%, as well as a higher performance fee of 20%, which is intended to motivate the hedge fund manager to generate better returns.
Note that hedge funds are generally not liquid assets and you may be required to leave your capital in the fund for a certain period. There may be limits on when you can redeem your shares, so it’s important to consider how much money you’re comfortable putting into these investments.
Regulatory and Legal Aspects
Due to their complexity, hedge funds and hedge fund investments are subject to federal regulation. Some of the laws and regulations governing hedge funds include:
• Securities Act of 1933
• Securities Exchange Act of 1934
• Investment Company Act of 1940
• Dodd-Frank Wall Street Reform and Consumer Protection Act of 20106
The SEC regulates hedge funds to ensure that they act within the scope of the law concerning registration, investment offerings, and investor protections. Hedge funds that trade in commodities or futures may also be subject to regulation from the Commodity Futures Trading Commission (CFTC).
Hedge funds are required to file Form ADV with the SEC. This document includes relevant details about the fund’s assets, its investment strategies, and potential conflicts of interest. You have the right to review a hedge fund’s Form ADV before investing to learn more about it.
Evolving Trends in Hedge Funds
Hedge funds are not static, as new trends emerge and older ones fade away. Some of the most significant trends to watch right now, according to the CAIA Association, include:
• Slower growth as the hedge fund industry reaches maturity
• Increased focus on long/short equity strategies, private debt, and private credit
• Gradual reduction in hedge fund fees
Demand for hedge funds may slow, too, should the U.S. economy enter a recession. If you’re all interested in how to invest in hedge fund markets now, or in the future, it’s worth watching these and other trends to see how this investment space will develop.
The Takeaway
Hedge funds can help you build a diversified portfolio, with the potential to generate returns. If you’re interested in how to invest in hedge funds, you’ll first need to determine whether you’re an accredited investor. If not, consider other avenues for accessing these and other types of alternative investments, such as through investing in mutual funds or ETFs. You can quickly start investing online in funds that offer exposure to venture capital, real estate, and other alternatives.
Ready to expand your portfolio's growth potential? Alternative investments, traditionally available to high-net-worth individuals, are accessible to everyday investors on SoFi's easy-to-use platform. Investments in commodities, real estate, venture capital, and more are now within reach. Alternative investments can be high risk, so it's important to consider your portfolio goals and risk tolerance to determine if they're right for you.
FAQ
What are the requirements to invest in hedge funds as an individual?
Individual investors must typically be accredited to invest in hedge funds. That means having a net worth greater than $1 million, excluding the value of your primary residence, and an annual income of $200,000 (or $300,000 for couples).
Is it possible to start investing in hedge funds with a small capital?
It’s possible to find hedge funds that have a lower minimum investment of $20,000 or $25,000. But that may still be out of reach for the average person who’s just getting started with investing. It may be easier to invest in diversified funds that hold alternatives such as hedge funds, real estate, or private equity through a brokerage.
What are the key benefits of investing in hedge funds?
The most attractive feature of hedge fund investing is that it’s possible to see returns that beat the market. It’s important to remember, however, that hedge funds don’t always outperform and in some cases, returns may lag significantly behind returns generated by the S&P 500.
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