I am sure you have heard the terms of hedge fund, either from television, radio, or your friends. But, you may be too shy to ask, “What is it?” since that will make you appear unknowledgeable.
Here, learn exactly what hedge fund is and how it works.
What is it?
The first thing you need to know is a hedge fund is not a specific type of investment. It is a pooled investment structure. A money manager or investment advisor usually set that structure.
The structure is often organized as a limited partnership or limited liability company. In recent days, limited liability partnership has become more popular than the previous one.
What does it do?
The hedge fund manager raises money from outside investors. After that, the manager invests it according to the strategy he has planned before.
The hedge funds are specialized in the long-only and private equities. The long equity means they only buy common stock, while never sell short. In contrast, private entity means it buys the entirely private businesses, take them over, improve their operation, later it sponsors an initial public offering.
Besides, it usually specializes in one kind of investment. Some of them trade junk bond, some other only specializes in real estate. In other words, hedge funds can specialize in anything.
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How hedge fund managers get paid?
The payment of hedge fund managers depends on the terms or arrangements within the operating agreement. Some of them receive the standard ‘2 and 20’. That means 2% of net assets per year plus 20% of profits above a predetermined hurdle rate.
Other managers get payment on a pure profit arrangement. Almost all hedge funds feature a “high water mark”. That means if the fund declines, then, the manager has to make up the losses before he or she can earn additional pay.