What is a “Hedge Fund Investor”?

There is a broad list of characteristics that hedge funds consider in order to accept an investor – that may include wealth, sophisticated knowledge of investment products, tax status, risk profile, and even citizenship or domicile.

The two most common types of investors in hedge funds are institutional investors such as sovereign wealth funds or corporations and wealthy clients called high-net-worth individuals. There is no precise definition of a high-net-worth client, and the criteria may vary broadly – for example, a client with total assets in excess of $10 million or an investor with liquid assets in excess of $1 million may both qualify.

Key Learning Points

  • Unlike mutual funds, hedge funds are not marketed to the retail market, but instead to institutional and wealthy individuals.
  • As hedge funds are higher risk investments, it is important that the investor has very good knowledge of investment products and would be able to absorb larger losses.
  • Typically, hedge funds have the objective to achieve high absolute returns regardless of the prevailing market environment and are positioned more aggressively than regulated investment vehicles.
  • Investors could invest in hedge funds with the idea of achieving high returns or complement traditional portfolios to diversify the risk.

Who Can Qualify?

The criteria may vary from one hedge fund to another, but to invest in a hedge fund the investor must have a solid knowledge of investment products and a high level of accumulated wealth. The latter is required mainly for two reasons – there is usually a large initial investment to deposit but having additional funds will also cushion the significant downturns that the portfolio may experience. In addition, hedge fund investors must feel comfortable with lock-up periods and not having access to their funds as these are likely to be part of the strategy, especially for more illiquid ones.

Institutional investors such as sovereign wealth funds and other corporations are also typical hedge fund investors. High fees are also a distinct feature of hedge funds and investors should be willing to pay more in their quest for higher returns. A typical hedge fund industry fee structure is paying 2% of the assets invested and 20% of any profits. And this may be on top of other charges such as an administration fee.

Reasons to Invest

Depending on individual objectives and risk tolerance, hedge funds are traditionally perceived as an engine for achieving higher returns than the market and most strategies are designed to provide consistently high returns despite the prevailing market conditions.

However, due to their alternative nature, higher risk budget and ability to invest in non-traditional assets, hedge funds tend to show lower correlations to traditional asset classes. Therefore, they are also a popular instrument for diversification i.e., used to reduce the volatility risk in a portfolio.

Although some institutions like pension funds have tried to use hedge funds to boost their total return, over time this approach proved not to be a good solution due to their risky nature and lack of regulation. Nevertheless, many institutional investors still view hedge funds as a good source for above-market returns and diversification.

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