Global Finance · Chapter 17
Hedge Funds and Alternative Investments
Exploring investment strategies beyond stocks and bonds — for accredited investors seeking uncorrelated returns.
What Is a Hedge Fund?
A hedge fund is a private investment partnership that uses advanced strategies to generate returns regardless of market direction. Unlike mutual funds, hedge funds are largely unregulated and available only to accredited investors (typically those with $1M+ in assets).
Key fact: The name "hedge fund" comes from early funds that "hedged" by taking both long and short positions to reduce risk. Today, many hedge funds are highly speculative.
Common Hedge Fund Strategies
| Strategy | Description |
|---|
| Long/Short Equity | Buy stocks expected to rise, short stocks expected to fall |
| Global Macro | Bet on macroeconomic trends (currencies, interest rates, commodities) |
| Event-Driven | Profit from mergers, bankruptcies, restructurings |
| Quantitative | Use algorithms and data to find patterns |
| Market Neutral | Equal long and short exposure to eliminate market risk |
The "2 and 20" Fee Structure
Most hedge funds charge 2% management fee (on assets regardless of performance) plus 20% performance fee (on profits). This means on a $1M investment earning 10% ($100k profit), you'd pay $20k management + $20k performance = $40k in fees.
Example: Ray Dalio's Bridgewater Associates, the world's largest hedge fund, manages over $150 billion using a "risk parity" approach that balances exposure across economic environments.
Alternative Investments
Beyond hedge funds, alternative investments include:
- Private Equity — investing in private companies not listed on exchanges
- Venture Capital — funding early-stage startups
- Real Assets — infrastructure, farmland, timberland
- Commodities — gold, oil, agricultural products
- Collectibles — art, wine, rare watches, trading cards
Benefit of alternatives: Low correlation with stocks and bonds means they can improve portfolio diversification and reduce overall volatility.
Chapter 17 Summary
- Hedge funds are private partnerships for accredited investors using advanced strategies
- The typical fee structure is "2 and 20" — 2% management + 20% of profits
- Common strategies: long/short, global macro, event-driven, quantitative
- Alternative investments include private equity, VC, real assets, and commodities
- Alternatives offer diversification through low correlation to traditional assets