Hedge Funds: Strategies and How to Invest
Hedge fund investments may carry considerable risk, so consider your risk tolerance before investing.
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Hedge funds are actively managed investments that are only open to accredited investors.
Hedge funds are typically less regulated and riskier than more traditional investments such as mutual funds.
Hedge funds often charge significantly higher fees than other investments.
What is a hedge fund?
A hedge fund is a pool of money that a fund manager invests on behalf of the fund participants, with the goal of maximizing returns and minimizing risk. Hedge fund managers attempt to make money in both good and bad stock market conditions, sometimes by using aggressive trading strategies.
Hedge fund investments may carry a considerable level of risk, so investors should consider their risk tolerance and whether they're comfortable with this approach before investing. Hedge funds also tend to have higher minimums and higher management fees than other types of investments.
Hedge funds vs. mutual funds
The main difference between hedge funds and mutual funds is that mutual funds typically cannot invest in private equity, bankrupt companies, art, currency and derivatives, but hedge funds can
Most mutual funds aim to beat the returns of the overall stock market or some portion of it; hedge funds aim to deliver absolute positive returns but typically aren’t tied to any particular benchmark.
Mutual funds usually have lower management fees and are open to investors who can meet the minimum investment requirement (often $1 to $2,500); hedge funds usually have higher fees, higher minimums and only accept certain investors
U.S. Securities and Exchange Commission. Investor Bulletin: Hedge Funds. Accessed Oct 12, 2025..Mutual funds are registered with and regulated by the Securities and Exchange Commission; most hedge funds do not have the same regulatory disclosure requirements
Board of Governors of the Federal Reserve System. Hedge Funds. Accessed Oct 12, 2025..Mutual funds are often more liquid than hedge funds
Investment Company Institute. Mutual Fund Liquidity: FAQs. Accessed Oct 12, 2025..
Can anybody invest in a hedge fund? How hedge funds work
Here are the basic characteristics of hedge funds.
Strict shareholder requirements
Hedge funds typically only accept accredited investors. Federal law defines an accredited investor as someone who earned at least $200,000 (or $300,000 combined with a spouse) in each of the last two years and expects to continue to do so, or who has a net worth of $1 million or more, excluding the value of a primary residence
High minimums
Hedge funds may require minimum investments of thousands or even millions of dollars from each investor.
Less regulation and transparency
Hedge funds are not required to register with the Securities and Exchange Commission. They don’t advertise publicly, and they therefore aren’t subject to the same protections and disclosure requirements that apply to other investment vehicles, such as mutual funds
This lack of transparency makes it more difficult for investors to verify a hedge fund’s claims and see exactly how their money is being invested. The SEC has sued hedge funds that have misrepresented investment returns, account statements and fund managers' track records
Riskier trading strategies
Hedge fund managers may use aggressive trading strategies. They can make highly concentrated bets by investing the fund’s capital in just a few assets, and they often use leverage, which involves borrowing money to make trades
High performance-based fees
Hedge funds charge an annual asset-based management fee — also known as an expense ratio or advisory fee. Hedge fund investors also pay an additional performance-based incentive fee. A well-known setup is called “2 and 20,” in which investors pay an annual fee of 2% of their investment in the fund and 20% of any year’s profit above a preset percentage.
Low liquidity
Hedge funds sometimes invest in illiquid assets, so they often have lockup periods of several months to several years when redemptions are not permitted. Some hedge funds have looser lockup provisions, but they can still restrict access to your money by requiring you to provide notice well in advance of any withdrawal
Complex tax prep and reporting
Mutual funds can generate taxes on dividends, interest, and capital gains, which may require investors to deal with forms such as the 1099-DIV and 1099-INT. Hedge funds, on the other hand, generally issue a schedule K-1, which can be more complex and may require the assistance of a financial advisor or tax professional.
Hedge fund strategies
To hedge, an investor or fund manager makes two investments that react in opposite ways — if one investment goes down, the other goes up, which reduces overall risk.
One example of this is shorting. Hedge funds may short a stock if they think the price is going to fall in the near future, but also hold stocks they think will keep performing well
Hedge funds may also use a “global macro” strategy, through which they base their investments on an analysis of macroeconomic events. For example, fund managers may analyze a country’s interest rates and monetary policy, and use that information to make bets on currency and currency derivative products.
Other strategies include:
Buying distressed securities. This may mean buying stock in bankrupt or financially struggling companies.
Merger arbitrage. This approach takes advantage of stock price differences before and after a merger.
Fixed-income arbitrage. This strategy capitalizes on price changes in fixed-income securities, such as bonds.
» MORE: How to invest $100,000
How to invest in hedge funds
1. Scrutinize the fund manager’s record
If you have a fund manager in mind, first check their disciplinary record with the SEC. This can be found on the firm’s Form ADV, which investment advisors are required to submit. This form features information about the advisor’s business, its clients, business practices and any past disciplinary events. This form is also required to clearly explain fee structures, any potential conflicts of interest, services the advisor offers and any additional costs for those services.
In short, this is the place to go to weed out any hedge fund managers whom you don’t feel comfortable working with. You can find an advisor’s Form ADV on the SEC’s Investment Advisor Public Disclosure search function.
2. Consult a financial advisor
The level of assets a fund holds may not translate to the best fund for you. What’s more, hedge funds are not a uniform asset class; varying strategies result in a wide range of risk/return profiles. Even fund managers deploying the same strategies over the same period have seen widely varying returns, demonstrating the elevated risk of hedge funds. Choosing a winning hedge fund can be extremely difficult.
Hedge fund analysis tools and databases exist, but it may be best to work with a wealth advisor who can help you decide which funds match your investing goals. They can also help you find funds that are currently accepting new investors.
» Ready to get started? Here's how to choose a financial advisor
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