2020 was a devastating year for the global economy. The COVID pandemic wreaked havoc on businesses and investments alike. Hedge funds, however, were resilient during this time, with over 77% delivering a positive annual return, according to Citco’s 2020 Hedge Fund Report. Every investment category was in the green overall, but this isn’t surprising considering the whole point of a hedge fund is to beat the market regardless of its condition. 

Let’s explore what hedge funds are and determine if they have a place in your portfolio. But first, let’s qualify this by saying there are perhaps 15,000 or more hedge funds in the United States. Many of them are relatively small with diverse strategies, so generalizing has pitfalls.

What Is A Hedge Fund?

Like mutual funds and ETFs, hedge funds use pooled funds to buy various investments and securities. Their goal is to make investment strategies to generate high returns. Where they differ is that hedge funds often employ aggressive investment strategies like short-selling and leverage investing.

It’s the goal for the hedge fund to earn alpha, or excess return, for investors. Since these types of returns are achieved beyond normal returns, the investment risk is high due to the strategies employed to obtain these results.  

What Are Hedge Funds

Who Can Invest In Hedge Funds?

The Securities and Exchange Commission (SEC) holds strict regulations on who can invest in hedge funds due to the inherent risk of investing strategies used. Institutional investors make up most of the hedge fund market, including banks, insurance companies, pension funds, and mutual funds. These are the whales you hear about on Wall Street that can move markets at will. 

Individuals can invest in hedge funds, but they need to be accredited investors with a net worth of at least $1.1 million. The net worth excludes their primary resident’s value and individual annual incomes exceeding $200,000 for singles and $300,000 for married couples. According to the United States Census Bureau, less than 5% of households earned more than $300,000 needed to reach accredited investor status in 2019.  

Why Invest In Hedge Funds?

As all investors know, diversification is key to reducing overall volatility, which leads to a healthy portfolio. High net worth accredited investors or institutional investors will look for investments to offset the risk of negative price movements. They often look for investment hedges that are uncorrelated with the rest of their investments, particularly the stock market. 

Hedge funds provide another layer of diversification to institutional investors that aren’t accessible to a typical retail investor.

Various Investment Strategies

To generate alpha, hedge funds will use various investment strategies. It’s common to see investment strategies such as leverage, long/sh