How to Invest in a Hedge Fund

Hedge funds are less regulated than traditional mutual funds and invest in different types of securities. This can mean higher returns, but it can also mean higher fees and a greater risk of loss. If you’re thinking of investing in a hedge fund, here’s what you need to know.

Work with a financial advisor who can help you determine the right investments to achieve your long-term financial goals.

What Is a Hedge Fund?

Hedge funds are like mutual funds, except that they’re designed to increase potential returns and hedge against market losses by investing in a wider array of assets.

However, this type of fund does not face the same regulatory scrutiny as mutual funds. This gives their managers more room to operate and take risks, using several strategies, such as:

Shorting stocks
Making leveraged investments
Betting on foreign currencies and commodities

This is one reason why hedge funds are restricted to accredited investors. These investors have the resources to withstand high fees and potential heavy asset declines.

To become a hedge fund accredited investor, you must meet two primary qualifications established by the SEC:

You must demonstrate earned annual income of $200,000 (or $300,000 for married spouses) in each of the past two calendar years. That income must be equal or greater in the year you apply to be an accredited investor.
You can qualify individually or as a married couple by showing you have a net worth of $1 million or more. Note that this does not include any assets linked to their primary residence.

Getting Ready to Invest in a Hedge Fund

If you meet the accredited investor criteria, there are some steps to take to ensure you invest in the right hedge fund for your investment goals.

Vet the Fund

Begin by thoroughly reviewing the hedge fund you’re considering.

Focus first on the fund’s prospectus, along with its marketing and performance-related collateral. It’s always a good idea to find a financial advisor at this stage of the process, so you can get a realistic view of the fund’s risk potential and how it fits into your own unique investment needs, goals and timetable.

Don’t focus solely on past high returns, and always make a thorough risk evaluation before writing any checks.

Focus on Fund Assets

Next, properly evaluate the value of a fund’s holdings. Hedge funds often hold investment vehicles that can be hard to sell and difficult to price.

A financial advisor with hedge fund evaluation experience can help you understand a fund’s holdings.

Understand Fee Obligations

Hedge funds charge higher fees than regular mutual funds. Expect to pay between 1%-to-2% of total assets, along with a 20% performance fee based on the hedge fund’s profit levels.

It’s common for hedge fund managers to take greater investment risks to earn that profit and collect that 20% fee.

Know Your Redeemable Timelines

Hedge funds don’t let investors redeem shares anytime they want. Instead, you can redeem your shares only a maximum of four times per year. There are also lockdown periods when you can’t get your money.

Before investing, review your hedge fund’s share redemption timetable and determine whether it meets your unique financial needs.

Know Your Hedge Fund Manager.

One of the most important tasks for a potential hedge fund investor is researching the fund manager before investing any money.

Specifically, be sure to check Form ADV, which provides all information about a fund, including its investment strategies, any conflicts of interest or past disciplinary actions. This is available via the SEC’s Investment Advisor Public Disclosure (IAPD) website.

Final Hedge Fund Considerations

A hedge fund manager reviewing investments.

Above all, do not deposit any funds until all of your questions about the fund are answered to your satisfaction. It is important to know who is managing your money and how they intend to invest it. You should also know if there are any potential roadblocks in getting your cash back.

If any of those questions aren’t answered to your satisfaction, keep looking for another hedge fund. You may also need to entertain the possibility that hedge funds aren’t the right investment for you.

If you think a particular hedge fund is right for you, the process will be a little more complicated. Investing in a hedge fund is not a simple matter of creating an online account and transferring funds, as is the case with a typical brokerage account. You likely will have to contact that hedge fund or have your financial advisor do it for you.

At that point, you may find that the fund is no longer accepting new investors or that the minimum investment amount is out of your reach.

However, if the fund is accepting new investors and you meet the criteria, you can become a hedge fund investor with all the risk and reward that this entails. Especially lately, there’s been significant risk when it comes to investing in hedge funds. Short squeezes coordinated by retail investors on platforms like Reddit’s WallStreetBets may make investing in hedge funds riskier.

It’s important to always ask the right questions so that you’re prepared for whatever the market may do to your hedge fund investments.

How the Hedge Fund Investment Process Works

Investing in a hedge fund typically begins with gaining access to the fund itself.

Most hedge funds do not accept investments through public brokerage accounts. Instead, investors gain entry through direct contact with the fund, private placement platforms, feeder funds or through a financial advisor with access to alternative investments. Availability depends on whether the fund is open to new investors and whether capacity limits have been reached.

Minimum investment requirements are a key gating factor. Hedge funds often set minimums ranging from $100,000 to $2 million or more, depending on strategy, structure and investor class. Some feeder funds lower the minimum by pooling investor capital, while institutional share classes may require significantly higher commitments. These thresholds are disclosed before any subscription materials are provided.

Once access and minimums are confirmed, the investor completes the subscription process. This involves completing an investor questionnaire, verifying accredited investor documentation and signing a subscription agreement. These documents outline the fund’s strategy, risks, fees, liquidity terms and investor obligations. The fund then reviews the submission before accepting capital.

Funding does not always occur immediately after acceptance. Many hedge funds use scheduled capital calls, meaning investors wire funds on a specific date, which is usually at the start of a month or quarter. Additional capital calls may occur later if the investor has committed more than the initial contribution. Funds provide detailed wiring instructions and deadlines for this process.

After investing, ownership is reflected through periodic reporting rather than tradable shares. Investors typically receive monthly or quarterly performance statements and an annual Schedule K-1 for tax reporting.

Redemptions are governed by the fund’s stated liquidity terms, including notice periods, redemption windows and lockup provisions, which dictate when and how capital may be withdrawn.

Bottom Line

A couple sitting down with a hedge fund manager.

A hedge fund is similar to a mutual fund, but it is less regulated and can be used to invest in a wider array of asset types. This can lead hedge fund managers to take on larger risk with the goal of realizing higher returns. You must be an accredited investor in order to invest in a hedge fund. Once you meet the requirements, you can access a number of tools to help you find the best hedge fund in which to invest your assets.

Tips for Building an Investment Portfolio

Whether you need guidance in picking investments or wish to build a financial plan, a financial advisor can help. If you don’t have a financial advisor, finding one doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Even if you don’t qualify for a hedge fund, you can still invest in the market with an online brokerage account. Through these web-based portals, you can research the investment performance of different equities and funds, then buy the assets that make sense for your portfolio.