Hedge Funds Explained: Strategies, Fees and Structure

Hedge Funds

Hedge funds are private investment pools using flexible strategies, leverage and short selling. Learn the main strategies, fee structures, regulation and risks.

Intermediate3 min readUpdated 3 Oct 2026

Lesson 20 of 44

A hedge fund is a privately offered investment fund that can use a wide range of strategies, including short selling, leverage, derivatives and concentrated bets, that traditional mutual funds often cannot. The name comes from early funds that hedged their stock holdings with short positions, starting with Alfred Winslow Jones's fund in 1949. Today hedge funds manage trillions of dollars for wealthy individuals, pension funds, endowments and sovereign wealth funds, with strategies ranging from conservative arbitrage to aggressive macro bets.

Key features#

Feature	Detail
Investors	Accredited investors and institutions, not the general public in most countries
Strategies	Flexible: long and short, leverage, derivatives, any market
Regulation	Lighter than public funds; large US managers register with the SEC and file reports such as Form PF and 13F. See Position Limits and Regulatory Reporting
Liquidity	Redemptions often monthly or quarterly, with notice periods and lockups
Fees	Management fee plus performance fee
Structure	Usually limited partnerships, often with offshore feeder funds

The main strategies#

Strategy	Approach	Lesson
Long short equity	Buy undervalued stocks, short overvalued ones	Short Selling
Equity market neutral	Balance longs and shorts to remove market exposure	Statistical Arbitrage
Global macro	Bet on rates, currencies, commodities and indices based on economic views	Macro Trading
Managed futures (CTAs)	Systematic trend following in futures	Trend Following
Event driven	Mergers, bankruptcies, spin offs	Event-Driven Trading
Relative value and arbitrage	Exploit pricing differences between related securities	Arbitrage Strategies
Credit	Corporate bonds, distressed debt, structured credit	Distressed Debt and Bankruptcy Trading
Multi strategy	Many teams and strategies under one firm with central risk management
Quantitative	Systematic models across many securities	Quantitative Trading

Fees#

The traditional model was "2 and 20": a 2% annual management fee on assets plus 20% of profits. Average fees have fallen over time, though top performing and multi strategy funds can charge more, sometimes passing through costs to investors.

Term	Meaning
High water mark	Performance fees are charged only on gains above the previous peak value
Hurdle rate	A minimum return before performance fees apply
Pass through fees	Some funds charge investors for costs such as staff and technology

Famous funds and failures#

Fund	Notable for
Bridgewater Associates	One of the largest hedge funds; known for its macro and All Weather strategies
Renaissance Technologies	Quantitative pioneer; its Medallion Fund, closed to outside investors, has reported exceptional returns
Long Term Capital Management	Collapsed in 1998 after leveraged bets went wrong; required a Federal Reserve organised rescue. See The Collapse of LTCM
Amaranth Advisors	Lost about $6 billion in natural gas bets in 2006. See Amaranth Advisors

Risks for investors#

Leverage and concentration can cause large losses.
Limited liquidity: money can be locked up or gated in crises.
High fees reduce net returns. See Active vs Passive Investing.
Limited transparency about positions.
Operational and fraud risk, as in the Madoff case, which posed as a hedge fund. See Operational and Model Risk.

Most hedge funds rely on one or more Prime Brokers for financing, stock borrowing and custody.

Frequently asked questions#

What is a hedge fund?#

A privately offered investment fund that uses flexible strategies, such as short selling, leverage and derivatives, mainly for wealthy and institutional investors.

What does "2 and 20" mean?#

A fee structure of a 2% annual management fee plus a 20% share of profits.

Who can invest in hedge funds?#

Typically accredited investors and institutions that meet income, wealth or professional criteria set by regulators.

Next, learn about the wider fund industry in Asset Management.

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Next lessonAsset ManagementAsset managers invest money for clients through mutual funds, ETFs, pensions and separate accounts. Learn the main types, how they earn fees and how they invest.