Type of private investment fund that charges performance fees. Hedge funds are only open to a limited number of qualified accredited investors or qualified purchasers (QPs) and are largely exempt from regulation by the US securities laws and so may invest in riskier investments than would otherwise be permitted for other funds (such as mutual funds). They make greater use of derivatives, leverage, and short selling strategies. The name derives from their strategy to hedge their investments, though not all hedge funds actually do so today.

Hedge funds are similar to private equity funds in that both are lightly regulated, private pools of capital that invest in securities and compensate their managers with a share of the fund's profits. Most hedge funds invest in relatively liquid assets so they can permit their investors to withdraw their money from the fund frequently (typically quarterly). Private equity funds invest primarily in very illiquid assets such as newly formed companies and their investors are "locked in" for the entire term of the fund.

Usually the hedge fund manager will receive both a management fee and a performance (or incentive) fee intended to motivate the investment manager to produce the largest returns they can. A typical hedge fund fee is "2 and 20," meaning management fees of 2% and performance fees of 20%.

The Dodd-Frank Act largely removed the exemption for investment managers of large hedge funds and private equity funds from registration as investment advisers under the Investment Advisers Act of 1940, while creating new exemptions for foreign private advisers, private fund advisers, and venture capital fund advisers.

For further information, see Practice Notes: