But look a little closer.
You'll notice that the hedge fund manager, the guy in charge of the fund, dresses a lot nicer than the broker buying and selling you stocks. His office is nicer and your fellow investors all that have that super-rich look about them. And the hedge fund itself is making all sorts of promises about how it will perform.
What's going on? Do mutual funds somehow mean better appreciation for Prada?
Hedge funds are partnerships of a bunch of investors. A group of people basically enter into an agreement to invest money together with a manager in charge. Some funds are even set up as limited liability companies or other legal entities so that creditors can't go after the investors too much.
What Do Hedge Funds Do?
Hedge funds are managed so that they can make money in good markets and bad markets. That's the idea, anyway.
Now you'd hope that's what all mutual funds would do, but…not so much. Mutual fund managers (at least the good ones) are paid quite a bit more than the average fund managers because they're in charge of funds that are supposed to consistently make money. Worries about how the market is doing are so middle class.
One way that fund managers offer this consistency is by hedging the fund—i.e., they do all sorts of fancy financial footwork to reduce the risks in the fund. That might mean selling futures or leveraging the investments by borrowing money in specific ways. We don't know exactly what your hedge fund manager does; that's why he's paid the big bucks and why we eat at Five Guys.
The reason why your hedge fund manager might not eat fast food? Probably those huge fees you're paying on these funds. Hedge fund managers get their fees and commissions from the returns and income the funds make, and managers take a pretty generous cut. You're paying more for hedge funds than you'd pay for a retirement fund, mutual fund, or buying stocks direct. In theory, you're also getting more bang for your buck with better returns.
There are other differences between hedge funds and your average fund. For one thing, stocks and companies have to answer to the Securities and Exchange Commission (SEC), but hedge funds play by fewer rules. They don't have to answer to anyone except the investors, really.
Because of that, hedge fund managers tend to invest in stuff that most mutual funds don't touch. These companies might invest in movies (high risk and high reward) and may focus on buying up companies directly or investing directly through venture capital—or even by creating companies from scratch. Basically, anything that the fund charter says is fair game can be invested in.
Should You Invest in Hedge Funds?
A better question might be can you invest in hedge funds.
It's definitely a rich boys' and girls' club. Since the potential returns are pretty good and since hedge funds invest a lot of money, they only want the rich on board. Most hedge funds require you to pony up at least $100,000—and that number can go way, way up. Some funds require that you have a net worth of $1 million or more.
So yeah…good luck with that.