— Glossary
The hedge fund, decoded.
A hedge fund is a mutual fund with the guardrails removed, the client list shortened, and the bill roughly sixty times larger. The rest of the page is what that actually buys you.
— Hedge fund vs mutual fund
| Dimension | Mutual fund | Hedge fund |
|---|---|---|
| Who can invest | Anyone with a brokerage account | Accredited investors only (net worth >$1M ex-home, or $200k income) |
| Fees | 0.03%–1% expense ratio | Classic “2 and 20”: 2% management + 20% of profits |
| Liquidity | Daily, at NAV | Quarterly or annual, with lockups and gates |
| Strategies | Long-only, benchmark-tracking | Long/short, leverage, derivatives, macro bets, arbitrage |
| Regulation | SEC-registered, daily NAV, prospectus, 1940 Act | Lightly regulated; files Form ADV, usually 3(c)(7) exempt |
| Performance disclosure | Public, daily, benchmarked | Private, often reported monthly with delay, limited third-party verification |
— What they actually do
Long/short equity is the original trade and still the biggest bucket. You buy the names you think are undervalued, you short the names you think are overvalued, and you pocket the difference. If the long book and the short book are dollar-weighted the same size, the fund is market-neutral, meaning a 10% sell-off in the S&P does not care about you. The manager is paid for picking, not for riding the market up. In theory. In practice most long/short funds run net long because they want a piece of the index when it goes up, which is why they also give some of it back when the index goes down.
Global macro is the second big bucket. You bet on central bank moves, currency pairs, sovereign rates, commodities. The trade is a view on the plumbing of the world economy, expressed through whatever instrument is cheapest to express it in. The archetype is George Soros breaking the Bank of England in September 1992, shorting roughly $10 billion of sterling into a peg the market had already decided was untenable, and walking away with about a billion dollars when the peg snapped. Macro funds are lumpy. They lose money for years and then have one quarter that pays for everything.
Arbitrage and relative value is the third bucket, and the one with the best accent. You find two related securities that should be priced in a specific relationship and are not, and you bet on the gap closing. Convertible bonds versus the underlying stock. On-the-run versus off-the-run Treasuries. An ETF versus the basket it tracks. The gaps are usually tiny, a few basis points, which is why the trade only pays if you lever it up fifteen or twenty times. Which is fine until the gap widens before it closes, at which point the leverage works in reverse and the fund becomes a case study. See: Long-Term Capital Management, 1998.
— Why you should care anyway
You do not need a hedge fund to be affected by one. They set prices on the days that matter.
The global hedge fund industry runs about $4 trillion in assets, which sounds like a lot until you realize total U.S. equity market cap is over $50 trillion. The reason hedge funds matter out of proportion to their size is turnover and leverage. They trade constantly, they borrow against their positions, and on any given day their share of volume is a multiple of their share of assets. The marginal trader sets the price. On the days prices move, Fed days, earnings days, macro shocks, they are often the marginal trader.
The bigger issue is that they lever up and deleverage together. When a crowded trade reverses, every fund running that trade gets a margin call at roughly the same time, and the forced selling cascades through whatever else those funds own. Long-Term Capital Management in 1998 was one fund levered 25 to 1 whose collapse nearly took the Treasury market with it. Melvin Capital in January 2021 was short a lot of GameStop and had to cover into a retail squeeze that dragged down every crowded short on the Street.
March 2020 is the cleanest example. The Treasury basis trade, levered fifty to one by a handful of relative-value funds, unwound in a week, forcing $100 billion of Treasuries into a market that could not absorb them. The 10-year yield, the thing that prices your mortgage and every stock in your 401(k), traded like a small-cap for three days. The Fed had to buy a trillion dollars of Treasuries to stop the bleed.
You did not need a hedge fund account to live through that. You just needed a 401(k). The plumbing is the product, and when the plumbing breaks, it breaks for everyone.
— FAQ
The hedge fund, answered.
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