What Is A Hedge Fund And How To Invest Like One

If your only information about investing comes from popular media, you’ve probably heard of hedge funds. Most people think of hedge funds as investments for the uber-wealthy that generate enormous investment returns.

Is that the case? And can a regular person like you invest in a hedge fund?

Let’s take a look at traditional hedge funds, what they invest in, how they work, and what you need to know.

What Is A Hedge Fund?

At its very core, a hedge fund is fairly simple. An investment manager manages a pool of money for limited partners. Often the limited partners are members of a wealthy family or business partners.

One of the most important characteristics of hedge funds is concentration. Whereas a vanilla ETF usually replicates the performance of hundreds of securities (e.g., an S&P 500 ETF replicates the 500 stocks in the index), a hedge fund is much more concentrated in the hopes of outperforming. For instance, some of the more classic hedge funds will often only own 15-30 stocks, but do rigorous amounts of research in selecting them.

The term hedge fund derives from the ability of the fund to “hedge” its investments. Oftentimes, a portfolio manager will bet against stocks in addition to buying them. For example, the manager may invest in Amazon while simultaneously betting against brick and mortar retailers.

However, the term can be applied broadly. For example, while Warren Buffett’s Berkshire Hathaway technically isn’t a hedge fund (they don’t bet against anything), it is often mentioned in the same breath given its concentrated strategy: invest only in a concentrated basket of securities.

Hedge fund managers also have the ability to “lock in” money for as long as several years. This ensures that the manager can properly manage the investments without investors pulling out of the fund.

Because investment managers have so much latitude to their investing techniques, most hedge funds are only open to wealthy people called accredited investors. Some hedge funds even require net worth in the multiple millions of dollars before you can invest.

Are Hedge Funds Good Investments?

Hedge funds may be designed to deliver long-term outperformance given their concentrated nature. However, in general, hedge funds tend to act as "hedges". That means they are seeking to create a specific investment performance that may or may not outperform a benchmark index like the S&P 500. It could, for example, be designed to outperform if the S&P 500 is experience a down year.

However, that doesn’t mean that hedge funds would make a good investment for you. On average, hedge funds have the following unfavorable characteristics:

• High fees. A typical hedge fund charges a 2% annual fee plus 20% of all profits.
• Lock up your money. As a hedge fund investor, you may not be able to get your money when you need it. Fund managers may legally lock you out of your investment for one to five years.
• Very complex. Fund managers can invest in everything from credit default swaps (yes, like in the movie the Big Short) to options against beef and everything in between.
• Risky techniques. While many hedge funds are designed to reduce volatility, the tools used are often viewed as risky. For example, a fund manager may leverage a portfolio which amplifies both gains and losses.

With these issues at play, most hedge funds aren’t a great investment for everyday people.

How Do Hedge Funds Perform

There are websites that track hedge fund performance. In general, it's nearly impossible to categorize hedge funds themselves as an asset class. You can't simply ask "how do hedge funds perform?" It's kind of like asking how golfers have been performing... it makes no sense - some are playing amazing, some are sucking. It depends on the course, the event, how you're measuring them etc.

Here's a popular site that tracks hedge fund performance: HedgeFollow.

Apps That Mimic Hedge Funds Or Access These Investments

One of the great things about technology today is that there are now investment apps that simply try to mimic the performance of hedge funds.

For example, the Titan App has built their own fund. Or you can look at apps like Arta Finance, which is a digital family office. Or apps like Frec, that allow direct index investing.

Or even something like M1 Finance, which allows you to create investment pies of your own design.

Bottom Line: Is investing In A Hedge Fund Right For Me?

If you’re a regular Joe or Jane, a traditional hedge fund is likely out of your reach.

But if you have the aspirations of investing like the wealthy, investing through Titan’s platform may be the right option. Weigh your options carefully, but consider the platform as one of the most accessible ways to compound your capital.