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How are hedge funds structured?

12 Jan

No one hedge fund resembles another, and the name of the game in today’s world of hedge fund investments is diversity. There are any number of strategies used with hedge funds, and many different types of investments to boot (everything from regular stocks and bonds to internet startups and currency).

Let us not forget that hedge funds located outside of the United States function very differently from those within it! However, there are a few things about the structure of most hedge funds that everyone should know.

  • Hedge funds are private partnerships (or companies) between investors and skilled money managers. Investors do not make the investment decisions regarding the hedge fund portfolio; that is left up to the money manager. There are no assets or employees within the hedge fund – aside from, of course, the investments themselves.
  • There are other roles within the hedge fund aside from investor and manager. These may include: administrator, prime broker, and distributor
  • Depending on where the hedge fund is located, its legal status (including regulations and taxes) may differ greatly. In America, hedge funds are considered private investments and are therefore unregulated (although in some ways that is a misconception; there is indeed regulation for all kinds of investments, including hedge funds. The major difference is that in most cases the SEC does not regulate hedge funds). In offshore locations, the investor is required to pay fees, rather than the money coming from the fund itself. Taxes on offshore hedge funds are also paid out by the investment manager, according to how much they receive for managing the hedge fund.
  • Location really is a huge key to how hedge funds work. While many hedge funds may be technically located offshore, the majority of popular hedge fund managers can be found on shore, near financial hubs.
  • Most hedge funds are designed to be open ended. This means that investors can withdraw their money periodically from the fund, and also add money as time progresses. There may be a requirement for a minimum balance, and of course a requirement to open a hedge fund, but there are typically no other restrictions set on the balance amount. (Frequent withdrawals from hedge funds are not encouraged, however.)
  • Before redemption of the hedge fund, usually profits are not distributed to investors. The profits from hedge funds are typically arranged to be withdrawn either monthly, quarterly, annually, or bi-annually. Individual hedge funds may have specific policies about when money can be withdrawn from the hedge fund.

This was a brief outline of how hedge funds are structured and work. The reality of hedge funds is that they are complicated, diverse investment portfolios. As mentioned above, no hedge fund truly resembles another, even if the specialization of the investment(s) is similar, or if the strategies used are similar. A hedge fund located in New York is going to be very different from one located in London, and even two hedge funds both located in New York are going to be nearly unrecognizable from each other.