A hedge fund is an entity that invests/trades its clients money for profit.
Hedge funds’ clients are usually limited to high net-worth individuals or institutions as dictated by regulations.
Active vs Passive Fund Management
Hedge funds are actively managed. This means that the fund manager and his/her team make active day-to-day decisions over investments and trading decisions.
On the other hand, funds such as mutual funds are usually passively managed. The mutual fund manager makes broad investment decisions and reviews them sporadically.
More info: Actively vs Passively Managed Funds
Alpha vs Benchmark Tracking
Active funds tend to seek alpha – i.e., they aim to make profits no matter how the general market is performing.
Passive funds tend to track benchmarks. They choose an index as a reference target, and aim to perform better than that target.
For example, a common target is the S&P 500. In this case, the mutual fund will need to perform better than the S&P 500. If the S&P 500 gains, they must gain more. If the S&P 500 loses, they aim to at least lose less.
Quantitative vs Non-Quantitative Fund
Quantitative funds emphasize on mathematical or high-tech methods to generate alpha. Such methods include analyzing/exploiting big data, alternative data (credit card, location data etc), computing speed and machine learning.
Non-quantitative funds use qualitative methods to generate alpha. Such methods include reading annual reports, talking to a company’s management, evaluating a company’s CEO and understanding the macroeconomic conditions of a country.
- What Quant and Discretionary Strategies Have in Common
- Non-traditional Investment: Quant versus traditional
Hedge Fund Fee Structure
In the past, it was standard to charge a 2% management fee along with a 20% performance fee.
The 2% management fee is deducted from the total amount that a client invests in. The 20% performance fee is deducted from the profits the fund makes over a period of time (usually a year).
Hedge fund fees have been decreasing in general as poor returns led to pressure by clients for lower fees.
Examples of Famous Funds
- Bridgewater Associates (Qualitative)
- Renaissance Technologies (Quantitative)
- AQR Capital Management (Mixed)
Links to Other Explanations
- Algorithmic Trading Strategies
- Quantitative Funds
- Mutual Funds