Articles for Financial Advisors

Hedge Fund Basics

Hedge Fund Basics

The term “hedge fund” was first used in 1952 by Alfred Winslow Jones, a sociologist and financial journalist, when he created an investment partnership that used leverage. The partnership’s strategy was to sell short securities it believed were overvalued and “hedge” itself by buying long positions it felt were fairly or undervalued. 

Today, most hedge funds use some type of hedging technique. Hedge funds typically use investment strategies more flexible than those used by mutual funds. Hedge funds frequently use leverage and some invest in illiquid holdings such as art, antiques, or thinly-traded securities.

The SEC allows only “accredited investors” to invest in hedge funds. The investor must have an annual income > $200,000 for the past two years or a net worth > $1 million excluding their residence. Most hedge funds do not allow an investment of < $250,000; the funds also limit how much can be withdrawn and when. The table below shows annualized return figures for 5 years through August 2013 (sources: Hedge Fund Research and Morningstar).

5-Year Annualized Returns [through August 2013]

Type of Hedge Fund

Annualized Return

Fund Weighted Composite (HFRI Hedge Fund Index)


Relative Value (Total) Index


Event-Driven (Total) Index


Macro (Total) Index



S&P 500


Barclays U.S. Aggregate Bond Index



Relative value hedge funds represent ~ 27% of hedge fund assets. These funds go long and short at the same time. Event-driven index funds, which represent ~ 26% of all hedge fund assets, invest in securities expected to be influenced by corporate activity (i.e., mergers, bankruptcies, hostile takeovers, etc.). Macro strategy funds anticipate changes in economic trends and policy decisions.

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