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Female hedge fund managerHedge funds are an investment vehicle you may consider as an alternative to individual stocks or mutual funds. A hedge fund manager decides how pooled funds should be invested in order to meet certain objectives. Hedge fund managers can be individuals or investment firms, but regardless, they must be well-versed in the types of investments they specialize in. As a result, hedge fund managers can often command higher compensation for their services, knowledge and expertise.

If you want to move into riskier investments, such as hedge funds, talk to a financial advisor about the best way to do that given your resources and goals.

Understanding Hedge Funds

Hedge funds are a type of pooled investment vehicle, in which multiple investors contribute money. In that sense, they’re similar to a traditional mutual fund or even an exchange-traded fund. What separates hedge funds from other types of funds is how pooled funds are invested and managed.

A hedge fund relies on active management, meaning the fund manager takes a hands-on role in deciding what to buy or sell. This is different from passive investing, in which a passive fund may track the performance of a particular stock index. For example, many index funds track the S&P 500.

With index funds, the goal is to mimic the benchmark’s performance. With actively managed funds, including hedge funds, the goal is to deliver returns that outpace the market. These funds work toward that goal by relying on specific investment strategies that are designed to produce above-average returns. For example, a hedge fund may take a long-only position and avoid shorting stocks or it may specialize in real estate, commodities and other stock alternatives.

What Is a Hedge Fund Manager?

A hedge fund manager is an individual or investment firm that oversees a hedge fund’s management day to day on behalf of its investors. It’s important to note that this most often means accredited investors.

Accredited investors are individuals who meet certain guidelines established by the Securities and Exchange Commission (SEC) with regard to their income or net worth. This means someone with an annual income of $200,000 or more over the previous two years or a net worth of $1 million. The income requirement increases to $300,000 per year for married couples.

Hedge fund managers work on behalf of higher net worth investors to help them achieve their investment goals. They’re college-educated and they may hold certain professional credentials, such as a chartered financial analyst (CFA) or chartered alternative investment analyst (CAIA) certification.

SEC regulation is lighter with hedge funds than with other types of pooled investment vehicles

What Does a Hedge Fund Manager Do?

A hedge fund manager’s job centers on active fund management. The most important task involved is making investment decisions for the fund they manage. These investment decisions are central to driving fund performance and maximizing total returns for investors.

In terms of day-to-day tasks, hedge fund managers may do any of the following:

  • Researching and analyzing current or historical market trends
  • Comparing investment options against the needs and objectives of fund investors
  • Offering investment advisory services to clients
  • Tracking and reconciling investment values

Hedge fund investors rely on hedge fund managers to make decisions that can help further their investment goals. As a result, hedge fund managers can earn much more than traditional fund managers.

How Do Hedge Fund Managers Make Money?

Hedge fund managerFinancial advisors can charge fees in different ways. Fee-only advisors, for instance, only get paid for the services they offer. Fee-based advisors can charge flat fees but they can also make money through commissions based on financial products they sell to you. Hedge fund managers typically get paid through a nontraditional fee arrangement, in which part of their compensation is a flat fee and the rest is based on fund performance. For example, in a “2 and 20” fee structure, the hedge fund manager collects a  management fee that is 2% of the assets in the hedge fund, but they also get a 20% performance fee.

This second part of the fee is paid out based on how much profit the hedge fund manager is able to generate, usually above a certain threshold. Since hedge funds often cater to high net worth and ultra-high net worth investors who may have millions to invest, hedge fund managers can earn a healthy amount of compensation if the fund performs well. Some of the highest-paid hedge fund managers earn compensation ranging in the millions or even billions of dollars.

Is a Hedge Fund Right For You?

Whether you might consider hedge fund investing first depends on your status as an accredited or nonaccredited investor and what your investment plan is. If you don’t meet the income or net worth guidelines to be classified as an accredited investor, then hedge funds may be out of reach unless you’re investing in a hedge fund ETF.

Hedge fund ETFs can apply the same strategies and principles as a traditional hedge fund in a way that’s cost-effective for investors. These funds hold a basket of securities but trade on an exchange like a stock. The advantages of exchange-traded funds include increased tax efficiency since they often have lower turnover ratios and lower expense ratios.

If you decide to invest in hedge funds or hedge fund ETFs, it’s important to consider the pros and cons of doing so. On the one hand, hedge funds or hedge ETFs could deliver stellar returns compared to traditional mutual funds. But this depends largely on the hedge fund manager and their skill in making investment decisions.

Hedge funds, by nature, tend to be riskier than regular mutual funds or ETFs because of how they invest. Generally, hedge funds are more likely to use speculative investment strategies to generate higher returns. These funds are also subject to less government regulation, which means fewer protections for investors. Hedge fund managers are, however, bound to fiduciary duty guidelines when managing investments.

Aside from the risk factor, it’s also important to consider the costs of hedge fund investing. The fee structure used by hedge fund managers could mean paying much more than you might for a traditional mutual fund. Viewing the fees against the potential returns can help put the cost of owning hedge funds in perspective.

The Bottom Line

Woman standing in front of a big data chartHedge fund managers are highly compensated fund managers who work on behalf of wealthy clients to achieve the best investment returns possible. Investing in hedge funds is something that may not be right for every investor, based on net worth, income or investment goals. But those who choose to include hedge funds in their portfolio can benefit from their fund manager’s extensive knowledge and experience.

Tips for Investing

  • Consider talking to a financial advisor about the pros and cons of investing in hedge funds and whether it may be right for you. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s financial advisor matching tool makes it easy and quick to connect with professional advisors in your local area. If you’re ready, get started now.
  • If you’d like a good estimate of how your investments are faring and how well you’re advancing toward your goal, a free, easy-to-use investment calculator can give you a quick read on the matter.

Photo credit: ©iStock.com/grinvalds, ©iStock.com/celsopupo, ©iStock.com/Blue Planet Studio

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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