Hedge Funds: Structure, Fees, and What They Actually Do

The term "hedge fund" has a specific origin that contrasts with its common usage today. Alfred Winslow Jones created the first hedge fund in 1949. His strategy was innovative for its time: he held long positions in stocks he thought would rise and short positions in stocks he expected to fall. This method aimed to reduce his fund's overall exposure to market direction. If the market declined, losses from his long positions could be offset by gains on his shorts. He was hedging his net market risk. That's where the name comes from.

Hedge funds are usually set up as private limited partnerships. They're typically open only to accredited or institutional investors, not the general public. This creates a regulatory distinction that we’ll explore more in this module. The classic fee structure still referenced today, even if many funds charge a bit less, is "2 and 20": a 2% annual management fee on total assets, regardless of performance, plus a 20% performance fee on profits. Many hedge funds also have lock-up periods. During these times, investors generally can't withdraw their capital. This gives fund managers the stability to pursue strategies, even those that are less liquid, without facing sudden redemption pressure that might force them to sell at bad times.