Hedge funds are Regulation D offerings under the SEC code, and as part of the Regulation D requirement they are not an investment that can be offered to all investors, cannot be marketed directly to the public, and to meet the SEC guidelines they can only be offered to accredited investors or qualified purchaser depending on if they are considered 3c-1 or 3c-7 funds. An accredited investor is defined as:
1. a bank, insurance company, registered investment company, business development company, or small business investment company;
2. an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
3. a charitable organization, corporation, or partnership with assets exceeding $5 million;
4. a director, executive officer, or general partner of the company selling the securities;
5. a business in which all the equity owners are accredited investors;
6. a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase;
7. a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
8. a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.
A hedge fund can use a variety of investment techniques that mutual funds cannot, they can hedge positions by shorting stocks, purchasing derivatives, swaps, leverage arbitrage, etc.. They are a complicated investment, that can be very risky and require sophisticated investment knowledge to make an educated decision as to what to invest in. Though, contrary to the previous 2 posters answers the majority of hedge funds are actually far less risky an investment than most mutual funds, the reason people have concerns with them is actually due to the operational differences and smaller nature of the firms that run them, but as an investment they traditionally offer better than market returns with about 1/2 the risk.
As far as why they get so much media attention, I personally think its unjustified, 99?f the hedge fund managers out there are good quality people who do an outstanding job managing their client money with a lot less risk then the market. They also provide their investors with far more transparency than any mutual fund I've ever dealt with, as long as the client signs a non-disclosure agreement. The reason they make an easy target is because most people cannot invest in them, they make a lot of money (they are paid performance fees, which is based on the profits they make for investors), and in a few spectacular cases (Long Term Capital Management, Madoff) they have been huge failures and frauds. The truth is the same things happen in the mutual fund industry but they don't make as much of a headline to sell papers.
I am a portfolio manager for a hedge fund of fund and am responsible for hedge fund manager research for my firm, so if you have any questions feel free to ask me directly. : )
You can get a detailed description of a hedge fund on wikipedia and there's a good research paper I found on the basics.
Answered By: financegal27 - 5/8/2009