It is hard to give a general description of what a hedge fund is. At first, hedge funds would sell short on the stock market to protect themselves from stock market drops. Today, the term is used for any kind of private investment partnership, not just venture capital. Around the world, there are thousands of different hedge funds. Their main goal is to make a lot of money, which they do by putting money into all kinds of investments and investing strategies. Most of these strategies are riskier than what mutual funds do when they invest.
So, a hedge fund is a private investment fund that puts money into many different kinds of investments. The general partner is in charge of picking the different investments and running the day-to-day business of the fund. Most of the money comes from the investor or the limited partners, who also share in the profits of the fund. Most of the time, the general manager charges a small management fee and a big incentive bonus if the rate of return is high.
Even though this sounds a lot like a mutual fund, there are some big differences between a hedge fund and a mutual fund:
Mutual funds are managed by mutual fund or investment companies, and there are a lot of rules about how they can be run. As private funds, hedge funds have a lot less rules and restrictions.
Mutual fund companies invest their clients' money, while hedge funds invest both their clients' money and their own money in the underlying investments.
Hedge funds charge a performance bonus, which is usually 20% of all the gains above a certain rate, which is similar to the returns on the stock market. Even when the market is bad, some hedge funds have been able to earn annual rates of return of 50% or more.
Mutual funds aren't allowed to invest in derivatives, use leverage, short sell, have too much money in one investment, or invest in commodities because of disclosure rules and other rules. Hedge funds can put their money anywhere they want.
Hedge funds aren't allowed to ask for money, which is likely why you don't hear much about them. Some of these funds have more than doubled, tripled, or even quadrupled in value over the past five years. But hedge funds do take big risks, and just as many have gone out of business after losing a lot of money.