Independent traders often dream of one thing: running their own hedge fund.
But what exactly is a hedge fund?
Let me explain what you need to know.
What is a hedge fund?
A hedge fund is a private investment fund with relatively few restrictions and a lot of freedom.
It aims to maximise returns using more aggressive strategies than traditional funds.
Before looking at how they work, though, we need to understand why they exist.
Why do they exist?
Many investors already put money into traditional investment funds, such as ETFs, which offer diversified, regulated management.
But those funds have limitations:
- They take a more cautious approach to limit risk
- Strict regulatory constraints prevent some investment strategies
- Their returns may not satisfy every investor
Why settle for 12% a year when you could hope for 30%?
Hedge funds exist for investors looking for higher returns and more freedom.
How do hedge funds differ from traditional funds?
In French, a hedge fund may be called a fonds de gestion alternative, fonds spéculatif or fonds de couverture.
Beyond the name, the difference is the investment approach.
They use techniques such as:
- Leverage: borrowing money to amplify gains
- Short selling: betting on an asset’s decline
- Trading derivatives: options, futures and swaps
- Investing in unusual assets, making them more flexible but also less predictable
By definition, a hedge fund takes more risk than a traditional fund.
It might invest in collectibles if an opportunity arises, such as very rare artworks that become sought-after assets on the secondary market.
Another example: before Bitcoin ETFs arrived, traditional funds couldn’t invest directly in Bitcoin because of regulatory restrictions.
Hedge funds didn’t face the same constraint.
That investment freedom lets them pursue potentially higher returns, but also brings more extreme risks and greater volatility.
Who can invest in a hedge fund?
In the United States, France and most other countries, access is highly restricted.
Unlike traditional funds available to the public, hedge funds are reserved for qualified investors:
- Institutions such as banks, insurers and pension funds
- Wealthy individuals. Minimum amounts depend on local rules but are often several hundred thousand euros or dollars
"Hang on, Bobby. Why screen investors?"
As I’ve just explained, hedge funds take more risk and use complex strategies that can cause heavy losses.
To prevent inexperienced investors being ruined, regulators such as France’s AMF and the US SEC impose strict eligibility criteria.
Restricted access to your money
On top of being selective, hedge funds also restrict withdrawals.
Unlike traditional funds where you can get your money back quickly, hedge fund investors often have to wait several years before withdrawing their capital.
Why?
Because hedge funds often invest in illiquid assets.
If a fund owns shares in private companies, property or precious stones, it can’t always sell them whenever an investor wants their money back.
Imagine every investor asking at once. The fund would have to sell positions at a discount, potentially causing major losses for both the fund and its investors.
Does performance live up to expectations?
That’s one of the biggest debates around hedge funds.
Many people think they consistently outperform traditional funds, but the reality is more nuanced.
Not every hedge fund beats the market.
Some deliver disappointing results, and many fail to beat a simple S&P 500 ETF after fees.
In 2024, equity hedge funds returned an average of 12.75%, according to Goldman Sachs.
Not bad, right? Except the S&P 500 gained 23% over the same period...
There are exceptions. Some hedge funds deliver extraordinary results and comfortably beat the market year after year.
The best-known example? Medallion Fund.
I’ll let you look it up. It’s pretty impressive.
How hedge fund managers get paid
To borrow our friend GMK’s favourite expression, hedge fund managers’ pay is absurd.
If we’re listing well-paid jobs, hedge fund manager is right near the top.
Why so much?
Most hedge funds follow the familiar "two and twenty" model:
- A 2% management fee, charged on investors’ money whether the fund wins or loses
- A 20% performance fee: the manager takes a fifth of the gains
A fund managing one billion already charges twenty million a year in management fees alone.
If it generates one hundred million in profit, add another twenty million in performance fees.
Some funds use safeguards to limit abuse:
- High-water mark: no performance fee unless the fund exceeds its previous peak
- Hurdle rate: no performance fee unless the fund reaches a minimum return threshold
Who can start a hedge fund?
As I said at the start, running a hedge fund is a dream for plenty of people, myself included.
Millions under management, freedom to invest and large fees. On paper, it’s the perfect plan!
But it isn’t open to everyone...
A hedge fund isn’t just a trading account with more money.
Founders generally already have substantial experience in fund management or institutional trading.
Then there’s regulation.
You need a legal structure, licences and compliance with the regulators.
And then comes the hardest part: finding investors.
A good strategy isn’t enough. You need to convince institutions or wealthy individuals to trust you with their money.
Without a solid track record or industry connections, that quickly becomes mission impossible.
In practice, without capital, a network and a performance history, it remains a dream for most retail traders.
Some of the best-known hedge funds
There are plenty around the world. Here’s a short list of famous names:
- Bridgewater Associates: founded by Ray Dalio, it’s the world’s largest hedge fund
- Pershing Square Capital Management: founded by Bill Ackman. If you’ve watched Netflix’s Dirty Money, Bill shorted Herbalife and lost $1 billion in the process
- Medallion Fund: created by Jim Simons, with impressive annual returns averaging over 30%. The catch is that it’s closed to outside investors