What is Hedge Fund?

• Investing in hedge funds is limited to those who qualify.profit/loss1 image by Warren Millar from Fotolia.com
  
  A hedge fund is similar to mutual fund, but with some very distinctive characteristics. First, hedge funds are limited to those individuals or organizations with the ability to invest a certain amount, typically at least $250,000, but this number could go as high as $1 million. Hedge funds are also limited to 100 investors to keep Security and Exchange Commission (SEC) restrictions at bay, as hedge funds are able to use techniques mutual funds are not, such as short selling and derivatives.
  
  

Hedge Funds Not So Much About Hedging

• Hedge funds can be a high-risk gamble.investment risks image by Pix by Marti from Fotolia.com
  
  Contrary to their name, hedge funds are actually incredibly aggressive and volatile forms of investing. Hedging often brings to mind protecting one's assets against the uncertainty of the market, but hedge funds actually promote doing the opposite. The greater the risk, the greater the return--hedge fund managers make it their mission to be one step ahead of the markets.
  
  

Simple Definition of Waterfall

• A waterfall is a tiered payment structure.Waterfall image by NAHL from Fotolia.com
  
  From a business standpoint, a waterfall can be defined a few ways. For example, when a company pays back a loan, it will typically begin paying back higher-tiered creditors principal and interest payments, while lower-tiered creditors begin receiving interest payments only. When the highest-tiered loan is paid in full, the next highest-tiered loan begins receiving principal and interest payments. This continues until the loan is completely paid off.
  
  

Waterfalls And Hedge Funds

• The waterfall definition differs in a hedge fund.waterfall 2 image by Joshua Peterson from Fotolia.com
  
  When it comes to waterfalling hedge fund payouts, they typically follow an 80/20 rule. At the close of the year, 80 percent of the profits, including existing income, are split evenly among the investors, while the general partner takes their cut of 20 percent. This is subject to any preferred return.
  
  

Considerations

• Hedge fund managers have to adapt.business image by Szymon Apanowicz from Fotolia.com
  
  Some firms have begun cutting manager fees, as the Wall Street Journal reported in early 2009. Though managers are high performing and should be compensated accordingly, the fees tend to be too rich for some investors' blood. Managers have restructured their payment schemes, and percentages have fallen a quarter as of late.