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Hedge Funds

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Hedge funds are a special type of investment company. They are like mutual funds in that a fund manager invests a pool of money for investors and takes his fee off the top. However, unlike mutual funds, hedge funds are not required to register with the SEC. They are only lightly regulated and are generally free to pursue almost any investment style they wish.

Hedge funds are also not required to maintain any degree of diversification or liquidity. They don't have to redeem shares on demand, and they have little in the way of disclosure requirements. The reason that hedge funds avoid many of the restrictions placed on mutual funds is that they only accept "financially sophisticated" investors. They do not offer their securities for sale to the public. Some types of hedge funds are limited to no more than 100 investors.

Hedge funds typically have a special fee structure, where, in addition to a general management fee of one to two percent of fund assets, the manager is paid a special performance fee. A modest fee structure might be one that charges an annual management fee of one percent of the fund's assets plus twenty percent of any profits realized; however, more elaborate fee structures are common.

Whether large or small, each fund develops its own investment style or niche. For example, a hedge fund may focus on a particular sector or global region. Alternatively, a hedge fund may pursue a particular investment strategy, like the market neutral strategy, in which the fund maintains a portfolio approximately equally split between long and short positions. By being long in some securities and short in others, the portfolio is hedged against market risk and said to be market neutral.

Short is a term meaning short selling. This is the sale of a security made by an investor who does not own the security. The short sale is made in expectation of a decline in the price of a security, which would allow the investor to then purchase the shares at a lower price in order to deliver the securities earlier sold short.