The primary investors in hedge funds areinstitutional investors. These are professional investors who manage large amounts of money. They work forpension fundsfor corporations, government workers, and labor unions. They also managesovereign wealth fundsfor entire countries. They handle the cash assets of insurance companies, other corporations, and trusts. Institutional investors provide 65%of the capital invested in hedge funds.
Key Takeaways
- Hedge fund investors must meet minimum wealth requirements, and they must be willing to pay high management fees.
- Many who invest in hedge funds do so to diversify their portfolios—they don't necessarily seek higher returns than broad index funds offer, and they might invest in index funds in addition to hedge funds.
- Pension funds have experimented with investing in hedge funds, but some of them have reversed course after underwhelming returns.
Qualifications
Hedge fund investors are required to have at least $1 million in net worth or must have earned income above $200,000 in each of the two preceding years. They also must reasonably expect to earn that amount for the current year. They need this cushion to weather significant downturns in their portfolio in their quest for higher returns. They also must be able to keep their money tied up for the three or more months, as may be required by hedge funds. Three years is a typical time frame to evaluate the success of a hedge fund’s performance.
Investors often must be willing to pay 2%of the assets they invest and 20%of any profits. This high fee is worth it to them tooutperform the market.Some are still tryingto recover losses incurred during thecrash of 2008.
These are sophisticated investors. They understand how leveraging works through options, futures contracts, and the other derivatives that hedge funds use to boost returns. They are willing to endure the risk of the investment going south.
They also need to be good judges of character. Most hedge funds don't reveal what they do to get their returns. That lack of transparency means that they can actually be Ponzi schemes, such as the one run byBernie Madoff.
Why They Invest in Hedge Funds
Those big investors put less than 20%of their assets into hedge funds. More conservative investors—like insurance companies, pension funds, and sovereign wealth funds—allocate less than 10% of their total investments.
Hedge fund investorsare looking for an investment that is uncorrelated with the rest of their investments. If the stock market loses value, the hedge fund investment might rise.In other words, investors use hedge funds to increase their diversification. They know that a diversified portfolio will increase total returns over time byreducing overallvolatility.
Note
Investors don't compare the performance of their hedge fund investments to standard indexes like the , the NASDAQ, or the Dow Jones.
Surprisingly, most hedge fund investors aren't looking for higher-than-average returns. Only 6% think they could achieve 10% or more annual returns. They just aren't willing to endure the risk that higher returns entail. Instead, 67%are looking for annual returns of between 4% and 6%. That's probably because they have to report to boards that might fire them if they sustain losses.
Family trusts use hedge funds to gain access to the best minds in the investment world. Why do hedge funds attract the smartest investors? Because they pay the most. But many investors may limit or even avoid hedge funds due to the high fees.
Investor Trends
Pension funds recentlystarted investing in hedge funds to boost returns. Theyrealized that they might not have the capital needed to cover the mass of retiring seniors and are trying to outperform the market to cover those obligations. Unfortunately, the risky nature of hedge funds and their lack of regulation means that these pension funds are less likely to cover their commitments.
There is some indication that hedge funds are becoming less popular. In 2014, they returned only 3.3% on average, much lower than the S&P 500. Almost as many hedge funds are liquidated each year as are created. Many savvy investors realize that they are taking all the risk, while the hedge funds aren't producing rewards to offset or justify that risk.
The California Public Employees' Retirement Systemannounced that it would withdraw all of its $4 billion in hedge funds in 2014. It had only received a 7.1% return in the past year. That sounded good until it was compared to the 12.5% return of a comparable investment, the Vanguard Balanced Index Fund, with an asset allocation of 60%stocks and 40% bonds.
It appears that institutional investors are continuing to view hedge funds as a source of alpha and diversification.
FAQs
Therefore, an investor in a hedge fund is commonly regarded as an accredited investor. This means that they meet a required minimum level of income or assets. Typical investors are institutional investors, such as pension funds and insurance companies, and wealthy individuals.
Who typically invests in hedge funds? ›
You generally must be an accredited investor, which means having a minimum level of income or assets, to invest in hedge funds. Typical investors include institutional investors, such as pension funds and insurance companies, and wealthy individuals.
Why do some people invest in hedge funds? ›
Hedge funds originated as a vehicle to help diversify investment portfolios, manage risk and produce reliable returns over time. While hedge funds' investor base has evolved though the years – from individuals to institutions such as pensions, universities and foundations – their core goals have remained the same.
Why are hedge fund owners so rich? ›
Hedge funds seem to rake in billions of dollars a year for their professional investment acumen and portfolio management across a range of strategies. Hedge funds make money as part of a fee structure paid by fund investors based on assets under management (AUM).
What is the main purpose of a hedge fund? ›
Hedge funds pool money from investors and invest in securities or other types of investments with the goal of getting positive returns.
Who is the target audience for hedge fund? ›
A hedge fund investment is often considered a risky, alternative investment choice and usually requires a high minimum investment or net worth. Hedge funds typically target wealthy investors.
Who are the largest investors in hedge funds? ›
Public pension funds account for the largest proportion of capital invested in hedge funds (25%) by the $1bn Club of institutional investors (Fig. 1), a figure which remains unchanged from the Preqin study conducted last year.
Why can only the rich invest in hedge funds? ›
Because they are not as regulated as mutual funds or traditional financial advisors, hedge funds are only accessible to sophisticated investors.
Do hedge funds actually beat the market? ›
There are over 3,400 hedge funds in the U.S. It's a big business. But almost none of them consistently outperform the broader stock market. Investing in the S&P 500 is the most straightforward path to stock market riches.
What is one disadvantage of a hedge fund? ›
- High Fees: Hedge funds typically charge high fees, including management fees and performance fees, which can erode returns over time. - Lack of Transparency: Hedge funds are not required to disclose their holdings or strategies, which can make it difficult for investors to evaluate their performance and risk.
Employees are often required to sign stringent non-compete agreements, ostensibly to protect trade secrets. And even basic information like fund returns is not commonly reported publicly. The conventional wisdom is that this lack of transparency is a trade-off for better performance.
What is the wealthiest hedge fund? ›
What are the Largest 100 Hedge Funds Ranked by AUM?
| Rank | Firm Name | AUM ($mm) |
|---|
| 1 | Millennium Management | $390,617 |
| 2 | Citadel Advisors | $339,079 |
| 3 | Bridgewater Associates | $196,834 |
| 4 | Balyasny Asset Management | $184,423 |
60 more rowsWhile hedge fund investors have no set average income, many high-net-worth individuals (HNWIs) who invest in hedge funds have annual incomes exceeding $200,000 or net assets of at least $1 million, excluding their primary residence.
What do hedge funds do all day? ›
A typical day in the life of a hedge fund manager usually involves constant market monitoring and investment evaluation, along with research and sales work.
Where do hedge funds get their money? ›
Because of the level of risk and capital involved, only accredited or high net worth investors are allowed to participate. Hedge funds get their investment dollars from any funds contributed by the general partner as well as the funds of other investors attracted to the fund, or limited partners.
Is BlackRock a hedge fund? ›
BlackRock manages US$38bn across a broad range of hedge fund strategies. With over 20 years of proven experience, the depth and breadth of our platform has evolved into a comprehensive toolkit of 30+ strategies.
What type of investors are in hedge funds? ›
Clients: Hedge funds tend to be tailored for institutional investors such as pension funds and insurance companies as well as high-net worth individuals.
What personality type is a hedge fund? ›
Hedge fund portfolio managers and analysts
“I'm right and I'm all over the details”… D & C personalities dominate hedge funds. Is are wonderful idea generators, but often get shaken out over the life of an investment as the market moves. S types tend to get runover in the hedge fund world.
Who is a qualified investor for a hedge fund? ›
3 In exchange, the Securities and Exchange Commission (SEC) requires a majority of hedge fund investors to be accredited, which means possessing a net worth of more than $1 million and a sophisticated understanding of personal finance, investing, and trading.
Who do hedge funds recruit? ›
Hedge funds typically hire for a variety of roles including portfolio managers, analysts, traders, risk managers, operations staff, compliance officers, and marketing and investor relations professionals.
