Most investors have very little understanding of hedge funds. If you want to add another tool to your financial arsenal, you should find out how these funds work. The type of strategies that are used for hedge fund investment will vary according to the specific objectives of the investor.

This type of investment is a choice that has to be given serious consideration. Apart from meeting the financial qualifications, you have to also understand the risks that are involved. Once you have a clear understanding of how these funds work, you will know why they are very attractive to experienced investors.

• What Are Hedge Funds?
• What do You Learn at a Hedge Fund?
• What Should I Ask a Hedge Fund?
• Is it Smart to Invest in a Hedge Fund?
• What License is Required to Run a Hedge Fund?
• Why Are Hedge Fund Managers so Rich?
• Is Hedge Fund Stressful?
• Who is The Richest Hedge Fund Manager?
• How Many Years Does it Take to Become a Hedge Fund Manager?
• How Much Does The Average Hedge Fund Manager Make?
• How do You Answer Why do You Want to Work at a Hedge Fund?
• What Should I Wear to a Hedge Fund Interview?
• Do Hedge Funds Have Trustees?
• Can Hedge Funds Make You Rich?
• How Much Money do You Need to Get Into a Hedge Fund?
• Can I Start my Own Hedge Fund?
• What Percentage of Hedge Funds Fail?

What Are Hedge Funds?

Hedge funds are private investment funds with a reputation for using high-risk tactics such as leveraging and short-selling the market to make money. Compared to other types of investments, hedge funds are lightly regulated by the federal government, particularly in terms of what they are required to disclose to the Securities and Exchange Commission.

Composition

Hedge funds are comprised of a hedge fund manager and investors. The manager decides how to invest the investors’ capital. With this level of responsibility, the manager should be qualified to manage money and not have a disciplinary record with the SEC.

Structure

There are several organizational structures for hedge funds, including the following:

• Fund of funds: Invests in other mutual funds or hedge funds
• Master feeder fund: Combined hedge fund structure in which offshore and domestic funds form a single offshore master fund.
• Parallel fund: Side-by-side fund with a U.S. fund and a domestic fund that parallel each other in trading and have separate investment portfolios

What do You Learn at a Hedge Fund?

Hedge fund managers may have a degree in accounting, finance, economics or business administration. Students use their education to develop important analytical skills and to learn more about finances, hedge funds and stock investments. 

Read Also: Top Earning Certified Financial Planners

Many students also complete an internship with a financial firm. During an internship, a student gains hands-on experience in the field while making valuable connections with experienced professionals. Some master’s programs require students to undergo an internship to graduate.

Many hedge fund managers begin in an entry-level position in finance then work toward a career in managing hedge funds. Previous experience in careers like personal finance or financial analysis can prepare candidates for a career as a hedge fund manager. Some training in a management role can be useful as well. Some hedge fund managers begin with an entry-level position as a trader, analyst, risk manager or junior manager.

What Should I Ask a Hedge Fund?

Because hedge funds are structured as partnerships, you enter into a relatively intimate business relationship with the fund manager when you buy into the fund. Consider asking these questions as you build your knowledge — and your relationship with the fund manager who will handle your investments.

• What’s your investment objective? How do you achieve alpha?
• What’s your analysis and investment style? What would cause you to deviate from your style?
• What’s the average number of positions your fund holds? How long do you hold a typical position? What’s the level of portfolio turnover?
• Do you use sub-advisors? (Sub-advisors are money managers who handle a portion of the portfolio.) When and why? How do you compensate them?
• Is your fund more suitable for taxable investors or for tax-exempt ones?
• How does your fund keep enough liquidity to meet allowed withdrawals?
• Did you earn your performance evenly in the past year, or did you have one or two really good months? If so, what made those months so good for your strategy?
• What was the time (the peak-to-trough range) between your best month and your worst month?
• Who calculates your fund’s returns? How often? Where does this person get his/her data: from the prime broker or from the fund manager?
• How do you value the portfolio? When do you price it? How do you handle liquid securities?
• How does your fund use leverage? What’s the average leverage? What’s the maximum leverage allowed? How often are you near those limits?
• Does your fund always have some leverage?
• Does your fund borrow from one bank or broker, or from several?
• What’s your maximum exposure to any one security? Any one market? How often are you near those limits?
• How much of your borrowing is overnight? Short-term? Long-term? How has that changed over time?
• What risks have you identified? What are your strategies for managing them?
• What happens if a trader exceeds his or her limits?
• Do you use derivatives to hedge? To speculate?
• What are your data-backup and disaster-recovery plans? How quickly could you get back into business if your building shut down?
• Are you registered with the Securities and Exchange Commission? With the Commodity Futures Trading Commission? Why or why not?
• How much disclosure and reporting can I expect? How much transparency should any hedge fund investor expect?

Is it Smart to Invest in a Hedge Fund?

Hedge funds are known for their riskier investments, attracting wealthier investors who seek greater returns and are willing to take larger bets.

Hedge funds have varying strategies, returns and fees, and managers usually have the ability to alter the fund’s strategy or assets without alerting shareholders. Some of the managers of these funds focus on improving your returns, while others offer diversification such as including exposure to cryptocurrencies.

“The first step in approaching hedge fund investments is to be very clear with your reasons for investing,” says Kristi Hanson, partner and director of Taxable Research at NEPC in Portland. “Is it for risk reduction, return enhancement, access to unique markets? This foundational decision will guide the approach to investing.”

When choosing a hedge fund to invest in, it is important to ascertain what role alternative investments will play in a client’s portfolio, Sweetman says.

“Some clients are searching for income, others downside protection and others growth. Depending on the client’s investment objective, certain hedge fund strategies may be more suitable than others, so consulting with your investment professional is of the utmost importance,” he says.

Investors who qualify under the definition of “accredited investor” and are interested in investing with hedge funds should consider the level of investment risk, fees and how hedge funds can add value to your overall investment strategy.

While working with hedge funds can potentially boost returns, balancing your risk and reward should always be top of mind for every investor.

What License is Required to Run a Hedge Fund?

A hedge fund manager does not necessarily need a specific license to operate the hedge fund as opposed to any other type of investment fund. Depending on the type of investments the fund makes, a portfolio manager may find it necessary or at least helpful to obtain certain licenses.

The legal requirements of the state in which the hedge fund is registered may necessitate the fund manager obtaining a Series 65 license, administered by FINRA.

The only universal license requirement for a hedge fund manager is an ordinary business license. Because hedge fund managers are not regulated as brokers, they do not usually need the Series 7 license unless they engage in trading on behalf of customers.

However, since a hedge fund manager is in the position of acting as an investment advisor, they may be required to take the Series 65 exam and obtain a Series 65 license. It is state laws that determine the licensing requirements for local operating investment advisors, and they vary.

Some states require official registration as an investment advisor and payment of a licensing fee, but most states require the Series 65 license. Also, some states set a Series 7 license as a prerequisite for obtaining a Series 65 license.

Additionally, if a hedge fund manager is managing more than $100 million worth of investment assets, they are required to register as an investment advisor at the federal level per the Investment Advisers Act of 1940.

If the hedge fund manager is considering investing in commodity futures, the fund manager probably needs to register as a Commodity Pool Operator or Commodity Trading Advisor with the National Futures Association (NFA), which requires obtaining the Series 3 license.

Why Are Hedge Fund Managers so Rich?

While pondering the question, you realize that the pay gap is so huge that it has become a much sought out job for those in the financial sector.

Hedge fund managers become rich by making money on the profits of their assets. They charge a 2% performance fee and cut the generated gains, which amounts to about 20%. Due to the above, they only allow wealthy and affluent individuals to invest in hedge funds. 

There is one more thing you need to realize; Not all hedge fund managers earn so much. The ratio mentioned is a ballpark figure and doesn’t work the same every time. It is a flat rate that applies only for average gains, but their cut reduces when the profits are meager.

Being a hedge fund manager is not fun; it is tiring work with long hours, but the high pay makes it worthwhile. Not all funds perform well, and indeed, not all managers earn as high. But as the years go by with experience, you can certainly crack the code.

The managers get paid on a 2 and 20 structure where they earn a 2% management fee irrespective of profit or loss and a 20% performance fee if the funds perform well.

Hedge funds do not allow anyone and everyone to invest. You should be worth at least $1 million or draw a salary of $200,000 per year for two consecutive years to be able to invest. The stakes are high, but they give a high return.

Is Hedge Fund Stressful?

Hedge funds have an extremely bottom line orientation and your portfolio is marked to market every day. This leads to unrelenting pressure to perform, especially for investment and front office staff. Meet performance expectations, then you get to stay in business. If not, then…….. Add to the mix aggressive personalities plus hard-edged office cultures, and it may not be your cup of tea.

Generally speaking, if you enjoy money management and an easier lifestyle (but still a decent paycheck, just not private jet/Hamptons estate money) then the large long only shops are a better bet. The only problem is that industry is getting its lunch eaten by ETF products.

That being said, the hedge fund industry, like any other, has a spectrum of cultures, some being relatively more academic and fuzzy (some quant firms) and partnership-oriented than others. But that is the exception rather than the rule.

The average workday for a hedge fund manager begins early and usually runs late. Hedge fund managing is rarely, if ever, a 40-hour-a-week job, however being on the ball and diligent can lead to a handsome salary and a rewarding, high-intensity career.

Who is The Richest Hedge Fund Manager?

The bar for entry into the top 25 richest hedge fund managers increased to nearly $3 billion this year, up from $2.1 billion in 2020. Of those who were on the 2020 list, 18 got richer, one is down (John Paulson) and four are flat.

There were two notable new faces this year. The wealthiest new hedge fund billionaire joining the ranks of The Forbes 400 is Philippe Laffont, with a net worth of $6.5 billion. Laffont is one of the so-called “Tiger Cubs,” having worked at Julian Robertson’s Tiger Management before starting his own hedge fund, Coatue Management, which has $25 billion of assets under management. Another new addition is Joseph Edelman, CEO of New York-based firm Perceptive Advisors, which returned 29% in 2020 and now manages $10 billion in assets.

1. Jim Simons

Forbes 400 Rank: #28

Net Worth: $24.4 billion

2020 Net Worth: $23.5 billion

America’s richest hedge fund manager for the fourth year running, Jim Simons founded Long Island-based Renaissance Technologies in 1982. His esteemed quantitative trading firm, which today manages some $50 billion in assets, is famous for its Medallion Fund, a $10 billion black-box strategy that is only open to Renaissance owners and employees. Though Simons officially retired in 2010, he is still involved at the firm and continues to benefit from its funds.

How Many Years Does it Take to Become a Hedge Fund Manager?

Financial employers are typically interested in candidates with extensive and professional knowledge in the finance industry. Working in a finance career can help you gain more knowledge regarding investment techniques, financial management and funding strategies.

Many employers expect to see at least three years of experience in hedge funds or investment areas. Gaining a professional career in finance can help you meet these qualifications.

Gaining hands-on experience can be an effective way to advance your industry knowledge and confirm if this is the career you want to pursue. You can shadow a hedge fund manager to learn their daily routine, gain insight on how to interact with clients and learn techniques for researching client investment opportunities.

Even if you have pursued a finance-related position previously, hiring managers may be more interested if you have specific hedge fund experience. It can be beneficial to pursue a part-time internship alongside your full-time finance career. This may increase your chances of landing a hedge fund management career if you have limited experience.

How Much Does The Average Hedge Fund Manager Make?

A hedge fund compensation survey by Forbes in 2018, determined the top earning hedge fund manager of 2017 made $2 billion, with each of the top four earners making over the $1 billion mark. The lowest earner in the top 25 earned $200 million in the same year.

A 2017 survey by SumZero determined that the average compensation for money managers hovered at an average of approximately $350,000, with pay ranges rising drastically, as years of experience in the industry add up. A person with 20 to 25 years of experience may have an average salary range from $260,000 to $705,000, according to the survey.

As of May 2017, the Bureau of Labor Statistics reports the average wage of a financial manager as $143,530. Managers in the securities, commodity contracts and in other financial investment areas earn an average of $203,460, and those with other funds and pools average $174,820.

The hedge fund analyst salary also varies, based on the analyst’s years of experience and on the size of the hedge fund. The average analyst salary is approximately $140,000 per year, with hedge funds holding less than $250 million in investments as of 2017. Funds with between $10 billion and $15 billion pay analysts the best with average compensation of approximately $270,000 annually, per the SumZero report.

• The average hedge fund manager makes $124,686 in the United States.
• The average hourly pay for a hedge fund manager is $59.95.
• The average entry-level hedge fund manager salary is $69,000.
• Highest paying states for hedge fund manager are Rhode Island ($136,760), Massachusetts ($135,314), Connecticut ($136,760) and New Hampshire ($136,760).
• Highest paying cities for hedge fund manager are New York, NY ($136,677), Dublin, OH, San Francisco, CA, Denver, CO and Dallas, TX.
• Hedge fund managers on the lower end of that spectrum, the bottom 10% to be exact, make roughly $69,000 a year, while the top 10% makes $225,000.
• The best-paid 25% made $170,000 that year, while the lowest-paid 25$ made $91,000
• Industries with the highest hedge fund manager salaries are manufacturing, technology and telecommunication.

How do You Answer Why do You Want to Work at a Hedge Fund?

If you have no prior experience working at a hedge fund, there is a 100% chance you will be asked this question. You need to answer both:

1. Why you do not want to do what you are currently doing

2. Why are you interested in working at a hedge fund

Think of the real reason why your current job is not what you want to do. Let’s use the example of Mr A as he narates, I was an analyst in investment banking. I knew that the more senior I became, the more my responsibility would shift to trying to bring in M&A deals. I would essentially turn into a salesman and have to build relationships with people in order to convince them to pay me to give them M&A advice.

I knew I did not want my success to be dependent on convincing others to make decisions, so it was not a good long-term path for me. I wanted to be the decision maker. Working on the buyside allows you overtime to make decisions directly.

To answer the second part of the questions, I was a bit behind during my time in banking because I did not know I was interested in working at a hedge fund until I was a year into banking. Unfortunately, I was never exposed to investing early on in high school or college, so I had to come up with a good story to convince people I was truly interested in working at a hedge fund.

I spent a ton of time reading the top investing books out there. Also, I was lucky enough to work on an M&A deal that was the result of pressure from activist hedge funds. I saw how much value these funds created by forcing change just by being minority shareholders.

What Should I Wear to a Hedge Fund Interview?

Most hedge fund interviews for research analysts start with a behavioral interview with a “gatekeeper.” This is usually a junior analyst or mid-level analyst. This round is to see whether the candidate is a good fit and, overall, an impressive candidate. There usually are not many technical questions at this point.

Below are some tips on how to dress for a hedge fund interview.

Men: Style & Colors

• Suit: Wear a solid colored suit, either dark grey or dark blue, with a two-button coat. Classy but conservative is the name of the game.
• Shirts: Wear solid shirts as well, white or light blue. No French cuffs.
• Tie: Wear something conservative.
• Shoes: Black cap-toes are the classic banker look.

Men: Suggestions on Brands

• Suit: Zegna (expensive but good), Hickey Freeman, Hugo Boss, Brooks Brothers
• Shirts: Brooks Brothers, Charles Tyrwhitt, Bloomingdales, Macy’s
• Tie: Brooks Brothers, Charles Tyrwhitt, Vineyard Vines, Zegna, Hickey Freeman, Ferragamo
• Belts: Brooks Brothers or similar
• Shoes: Allen Edmonds, Cole Haan, Salvatore Ferragamo

Women: Style & Colors

• Wear a conservative suit, generally either navy, dark grey or black
• If wearing a skirt suit, do not wear a tight nor revealing one
• Button-down shirt of a solid, light color
• Be conservative with respect to makeup and perfume

Women – Suggestions on Brands/Shopping

• J. Crew
• Banana Republic
• Zara
• Bloomingdale’s
• Macy’s

Do Hedge Funds Have Trustees?

In the investment context, paramount is the rule that trustees must use reasonable care and skill in deciding how their portfolio is to be invested and whether, within that investment strategy, there is room for investment in a hedge fund. Trustees will be told that risk and reward increase together. At least that is what they will be told. The rules tell them that they are allowed to take a prudent degree of risk. They must decide what proportion of their assets can be invested within a specified degree of risk.

What should be the response of a fund? Hedge funds should make trustee investors aware of what that degree of risk is. The usual list of risk warnings in an information memorandum or offer document goes a long way towards this, but they tend to be generic. It would be helpful to prioritize risk by likelihood and magnitude of damage.

For example, a statement that markets can go down as well as up really helps no one from this perspective. Nor does a statement that the whole of the investment could be lost. Does either a manager or an investor ever believe that? A statement that investments are in a particular currency and therefore there is an exchange risk is blindingly obvious. It has to be there as even unregulated documents would look racy without it.

Can Hedge Funds Make You Rich?

Working for a hedge fund is one of the most promising ways students from top universities try to get rich.

Elephant hedge fund managers make $100-million-a-year CEOs look like mendicants. Guys like David Tepper from Appaloosa, George Soros from Soros, Ray Dalio from Bridgewaters Associates, and James Simons from Renaissance Technologies have all pulled in $1 billion+ paydays for one year’s worth of work before.

Even Gabe Plotkin, the founder of Melvin Capital has made hundreds of millions of dollars despite being down roughly 50% in 2021!

The reality of the hedge fund industry is that performance has been poor for a while now. Just take a look at the Hedge Fund ETF, HDG as one financial benchmark to gauge performance. Hedge funds have underperformed the S&P 500 every year from 2009 – 2020.

Hedge funds make money by charging a management fee and a percentage of profits. The typical fee structure is 2 and 20, meaning a 2% fee on assets under management and 20% of profits, sometimes above a high water mark.

For example, let’s say a hedge fund manages $1 billion in assets. It will earn $20 million in fees. If the firm makes 20% and has no high water mark before the 20% kicks in, the hedge fund will earn $200 million X 20% = $40 million.

If the hedge fund has a 8% high water market, then the hedge fund can only earn 20% on $120 million, or $24 million in shared profits.

How Much Money do You Need to Get Into a Hedge Fund?

Minimum initial investment amounts for hedge funds range from $100,000 to upwards of $2 million. Hedge funds are not as liquid as stocks or bonds either and may only allow you to withdraw your money after you’ve been invested for a certain amount of time or during set times of the year.

Hedge funds also carry hefty fees. Typically, hedge funds charge an asset management fee that is 1% to 2% of the amount you have invested, plus a performance fee that is equal to 20% of the hedge fund’s profit. All of these fees can eat into your overall return.

This might not be a huge concern if hedge funds drastically outperformed the rest of the stock market, but this isn’t generally the case. This can make index-based ETFs and mutual funds, which have average expense ratios of 0.13%, even more appealing.

Because of the higher levels of risk associated with hedge funds, the U.S. Securities and Exchange Commission (SEC) places regulations on who can invest in them.

To invest in hedge funds as an individual, you must be an institutional investor, like a pension fund, or an accredited investor. Accredited investors have a net worth of at least $1 million, not including the value of their primary residence, or annual individual incomes over $200,000 ($300,000 if you’re married).

Overall, that’s a small fraction of the U.S. population. According to the United States Census Bureau, only about 4% of households earned more than the $300,000 necessary for a family to reach accredited investor status in 2019.

However, more people qualify now than was initially intended.

“Interestingly, the thresholds for an accredited investor haven’t been updated since the 1980s, and now include many more people than originally imagined,” says Gutierrez. If those numbers were adjusted for inflation, they’d be closer to net worths of $2.5 million or salaries of $500,000 ($750,000 if you’re married), she says. “Hedge funds are not intended for the average investor.”

SEC guidelines support this claim: In August 2020, the SEC introduced provisions to allow those demonstrating advanced investing knowledge, gained through qualifying work experience or certain financial licenses, to become accredited investors, even if they lacked the financial qualifications.

Can I Start my Own Hedge Fund?

So you want to start a hedge fund. These alternative investments use pooled funds and a variety of strategies to achieve returns for investors. They are generally formed to identify and take advantage of specific investment opportunities, many of which come with a great deal of risk. But how do you go about setting yourself up to become a hedge fund mogul?

Getting a hedge fund up and running is a bit more challenging than forming a corporation or a limited liability company (LLC) for a private business. It involves navigating investment compliance laws, and you’ll need professional legal help at some point along the way.

State Laws Vary

The laws governing the business are different for every country and state in which you do business. They may also differ—sometimes drastically—based on where your potential investors are located, how you may contact new investor leads, what you are investing in, and how many investors in total your fund attracts. 

Wherever you’re doing business, these are the basics of getting a hedge fund up and running.

Hedge funds are expensive ventures with burdensome startup costs that can reach well over the six-figure range. Startup costs for a standard equity fund can run approximately one million dollars in the first year. Start-up costs for more complex credit and systematic funds can run around two million dollars.

Most hedge fund managers will spend the majority of their money the first year on costs related to salaries and for fees for third-party services, such as lawyers and consultants. The chief operating officer (COO) will be a key hire the hedge fund will need right away. The annual salary range for a COO is $130,000 to $190,000.

You’ll want to secure a significant amount of capital to manage and make running a hedge fund worthwhile. Raising capital is one of the biggest challenges for hedge fund startups, as potential investors will want to see that you have a significant amount of assets under management (AUM) before entrusting you with their money.

Read Also: Do you Really Need a Financial Advisor?

There’s no real prescribed target, but you should aim to have at least $5 million in AUM to be successful, while $20 million will make you noticeable to investors. Having $100 million will get you noticed by institutional investors. In general, hedge funds can only operate successfully with large amounts of assets under management due to the powers of leverage and economies of scale.

What Percentage of Hedge Funds Fail?

According to a Capco study, 50% of hedge funds shut down because of operational failures.

Investment issues are the second leading reason for hedge fund closures at 38%.

When breaking down everything that can go wrong, operations makes its case for number one.

Think about everything involved in day-to-day affairs:

• Costs (labor, software, technology, insurance, benefits, taxes, legal, regulatory)
• Legal and compliance matters (audits, reporting, taxation)
• Employee staffing (human resources, recruiting, hiring, and training)
• Monitoring efficiency in the middle- and back-office

Now think of everything that can go wrong:

• Rising operational costs / Failure to monitor and manage costs
• Lack of transparency / Failure to comply with legal and regulatory agencies
• Poor hiring and training practices
• Being understaffed or overstaffed
• Unethical and dishonest employees (embezzlement, fraud, misrepresentation of assets, unauthorized trades, conflicts of interest)
• Inefficient use of technology and labor

things haven’t always been so rosy. In 2019:

• Globally, investors pulled out $131.8 billion from hedge funds, per MarketWatch. 
• In 2019, more hedge funds closed than those that opened (Chief Investment Officer). 
• More than 4,000 hedge funds have shut down in the last five years. 

And even now, fund performance often still lags the market.

As a hedge fund manager, you must prepare for headwinds and expect the unexpected. How you handle those challenges will determine how long you survive and thrive.

Summary

As mentioned earlier, this is not a type of investment that you can jump into without careful thought. It is also not wise to leave the decision to a financial adviser. Take a little time to acquire a basic understanding of what is involved in this investment and the possible risks.

The investment strategy of the fund manager must also be agreeable to you. In the USA, there are certain financial qualifications that you must meet before you can invest in hedge funds. The capital requirement is also very significant therefore you should be sure that the risks are acceptable to you before you go ahead.

When hedge funds are managed successfully, the return on investment can be substantial. With the implementation of the right strategies, these funds have the potential to generate wealth for investors. It is important to get the right professional advice so that you can put together a portfolio that will enable you to generate substantial gains and profit. Taking time to understand how hedge funds work will help you to prepare a good foundation for a brighter financial future.