Hedge funds employ a wide range of investment strategies, and they generally aim to outperform traditional investment vehicles like mutual funds. Strategies can include positions in stocks, bonds, commodities, currencies, derivatives and alternative assets.
The name of this type of fund comes from one of their core investing approaches: Taking both long and short positions in various asset classes that yield profits no matter where broader markets are going—hedging their bets, as it were.
Here’s an example: Interest rates were rising throughout 2022, so a hedge fund might have chosen to go long on defensive stocks in the healthcare sector, and short stocks in the consumer discretionary sector, which were more sensitive to more expensive consumer credit costs.
Hedge funds pursue active portfolio management by default, making tactical shifts based on market conditions in an attempt to widely outperform common benchmarks like the S&P 500.
Funds typically charge a performance fee and a management fee, typified by the “two and 20” approach. The management fee is usually a fixed percentage of the assets under management—2%, for instance.
The performance fee is a percentage of the fund’s profits—typically 20%—providing an incentive for the managers to generate positive returns.