What Is Hedge Fund?

A hedge fund is a pooled investment vehicle, typically structured as a limited partnership, that uses a wide range of strategies to generate returns for wealthy investors and institutions. Unlike mutual funds, hedge funds can use leverage, short selling, derivatives, and other advanced techniques that are off-limits to traditional funds.

Hedge funds charge notoriously high fees, traditionally the "2 and 20" structure: a 2% annual management fee plus 20% of all profits. On a $100 million fund that gains 15%, the manager earns $2 million in management fees plus $2.6 million in performance fees -- $4.6 million total -- before investors see a dime. Some top funds charge even more.

Despite their sophisticated strategies, the average hedge fund has underperformed the S&P 500 over the past 10-15 years. Warren Buffett famously won a $1 million bet in 2017 that a simple S&P 500 index fund would beat a selection of hedge funds over a decade. However, some individual hedge funds have produced spectacular returns -- Renaissance Technologies' Medallion Fund, for example, has averaged 66% annual returns before fees since 1988.