How To Invest In Hedge Funds
Written by
Chris Chisholm
Edited by
Emily Gadd
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Hedge funds are made up of several investors’ funds. They can earn more than other investments because they are allowed to use aggressive strategies. This also makes them riskier investments than mutual funds and ETFs.
Because of these strategies, the SEC requires there to be a high barrier to invest. Most hedge fund investors are large organizations.
Key Characteristics of Hedge Funds
- Higher risk, higher reward: Hedge funds can make big moves to maximize returns. This also means they can experience larger losses.
- Less regulation: They aren’t subject to the same strict rules as mutual funds. This allows fund managers to use a wider range of strategies.
- Limited access: Hedge funds typically are only open to accredited investors and need a minimum investment.
Types of Hedge Fund Strategies
Hedge funds don’t all work the same way. Here are some of the most common strategies they use to generate returns:
Long/Short Equity Funds
These funds use long positions and short-selling. This means they buy stocks they believe will increase in value, while betting against stocks they expect to decline.
Through this strategy, the fund is likely to get a return on investment regardless of whether the market is going up or down.
Global Macro Funds
These funds make investing decisions based on economic and political events happening in other countries. For example, they can trade foreign currency to profit off of exchange rates. They may also invest in bonds and stocks from other countries.
Event-Driven Funds
These funds focus on specific corporate events, such as mergers, acquisitions or bankruptcies. These events can cause huge spikes or drops in a company’s stock. By analyzing how these events will affect stock prices, fund managers aim to profit from the market’s reaction.
How to Invest in Hedge Funds
Investing in hedge funds isn’t as simple as buying shares of a stock or mutual fund. There are a few key steps to consider before you can get started.
1. Research Hedge Funds
Not all hedge funds follow the same investment strategy, so it’s important to do your homework. Here’s how to find the right one:
- Browse hedge fund databases or investment platforms
- Consult with a financial advisor who focuses on alternative investments
- Reach out to hedge fund managers directly if you meet their investment requirements
2. Understand the Fund’s Strategy
Each hedge fund follows a specific approach to investing. This affects how they generate returns and manage risk. Before investing, look into:
- The fund’s overall goal and strategy
- Past performance and how it has weathered market changes
- The amount of risk involved in the hedge fund’s investment approach
3. Meet the Minimum Investment Requirement
Hedge funds require significant upfront investments. These often start at $100,000 or more. Some funds set even higher minimums, making them inaccessible to many retail investors.
Who Can Invest in Hedge Funds?
Hedge funds aren’t open to everyone. Because of their high-risk nature, there are strict requirements for who can invest.
Accredited Investor Requirements
To invest in most hedge funds, you need to be an accredited investor, which means you must meet one of these financial thresholds:
- Income Requirement: Earn at least $200,000 per year (or $300,000 for couples) for the last two years.
- Net Worth Requirement: Have a net worth of at least $1 million, not including your primary residence.
These rules are set by the SEC to ensure that investors can handle the risks associated with hedge funds.
Institutional Investors
Many hedge fund investors aren’t individuals at all — they’re large institutions like pension funds, university endowments and insurance companies. These organizations have the resources to manage the risks and take a long-term approach to hedge fund investing.
Alternatives to Hedge Fund Investing
High investment minimums can make investing hedge funds out of reach for many. However, there are plenty of other investment options:
- Actively managed mutual funds and specialized ETFs can provide exposure to hedge fund-like tactics at a lower cost and with more liquidity.
- Private equity funds invest in private businesses. They are run similarly to hedge funds but focus more on long-term investments in companies.
- Robo-advisors offer automated investment strategies that balance risk and reward for investors looking for diversification.
Final Thoughts
Hedge funds can be an exciting choice for investors looking for higher returns and sophisticated strategies, but they aren’t for everyone. They come with high risks, high fees and high minimum investment. This makes them better suited for experienced or accredited investors.
If hedge funds aren’t a possibility for you, alternatives like mutual funds, ETFs or robo-advisors can still provide diversified, professionally managed investment opportunities without the high barriers to entry.
Before diving into any investment, make sure to research your options and understand the risks.
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- U.S. Securities and Exchange Commission. "Accredited Investors."
- U.S. Securities and Exchange Commission. "Hedge Funds."
