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A pooled investment
vehicle that is privately organized and is administered by
professional investment managers. It is different from
another pooled investment fund, the mutual fund, in that
access is available only to wealthy individuals and
institutional managers. Moreover, hedge funds are able to
sell securities short and buy securities on leverage, which
is consistent with their typically short-term and high
risk-oriented investment strategy, based primarily on the
active use of derivatives and short positions. US hedge
funds are exempt from Securities and Exchange Commission
reporting requirements, as well as from regulatory
restrictions concerning leverage or trading strategies.
is often to preserve investors' capital by taking positions
whose returns are not closely correlated to those of the
broader financial markets. Such vehicles may employ
leverage, short sales, a variety of derivatives and other
hedging techniques to reduce risk and increase returns.
Hedge fund management typically receives a significant
portion of compensation from incentive fees tied to fund performance—20% of annual gains over a
certain hurdle rate, along with a management fee equal to 1%
of assets is not uncommon.
hedged equities investment
A strategy that seeks to reduce exposure to market
volatility by hedging a portfolio of
common stocks with short positions and index options.
High water mark
indicates the highest previous NAV (net asset value) of a portfolio
at specified periodic measurement dates, e.g., calendar quarter
ends. The fund manager receives a performance fee only when the
portfolio value exceeds its previous high. A high water mark policy
prevents a manager from taking a bonus for good performance in a
given period without first making good any earlier absolute losses. For example, if the value of an
investor's contribution falls to, say, $500,000 from $1 million
during the first year, and then rises to $1.5 million during the
second year, the manager would only collect incentive fees from that
investor on the $500,000 that represented actual profits in
The return above which a hedge fund
manager begins taking incentive fees.
If, for example, the manager sets a hurdle
rate equal to 5%, and the fund returns 15%, incentive fees
would apply only to the 10% above the hurdle rate.