Hedge Funds Practice Guide

Overview

Question 1: What is a hedge fund?

A hedge fund is a privately offered vehicle formed to facilitate investments by one or more investors in specific investment programs. Hedge funds may differ from other privately offered investment funds, such as private equity funds and venture capital funds, on a number of factors, including:

• Investment strategies that they pursue
• Subscription-based rather than commitment-based structure
• Perpetual offering period and perpetual duration
• Ability of investors to redeem

As discussed below, hedge funds are privately offered under the Securities Act of 1933, as amended (the Securities Act) and are not registered under the Investment Company Act of 1940, as amended (the Investment Company Act).

Hedge funds pursue a broad range of investment strategies, including many that overlap with those pursued by other privately offered and registered investment vehicles. Long/short equity funds are very common, with many such hedge funds focusing on generating returns through higher position concentrations, as well as effective and aggressive use of short sales and/or other techniques that mutual funds are generally restricted from utilizing. Hedge funds are active in strategies that utilize detailed research and broad knowledge bases such as global macro strategies that require substantial knowledge of world events and an in-depth understanding of the differing and unique investment products and opportunities available on a global basis. Many hedge funds pursue eventdriven strategies that seek to exploit advanced knowledge and expert analysis of the impact that pricing inefficiencies connected to material corporate transactions will have on the securities related to the involved companies. Quantitative hedge funds use enhanced research combined with expertise on systems and programming to design models to guide trading that can take advantage of even small inefficiencies in market values. Hedge funds are active in the credit markets, particularly as increased regulation has reduced the ability of banks to make corporate loans at the pace demanded by the market. Hedge funds have similarly expanded into markets such as real estate that have been traditionally connected to commitment-based funds to exploit similar gaps. Other hedge funds pursue more specialized knowledge and situations, particularly in commodities or specialized financial products.

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