Are Hedge Funds Considered Asset Managers?

The roles of asset management and hedge funds frequently raise questions regarding their relationship. Understanding whether hedge funds fit within the broader category of asset managers requires a closer look at the definitions and functions of both. This article clarifies these distinctions and commonalities.

Understanding Asset Management

Asset management involves investing money on behalf of clients to increase wealth while managing risk. Asset managers make informed decisions about acquiring and overseeing various financial assets to meet investment objectives.

The scope of asset management is broad, serving a diverse client base that includes individuals, corporations, institutional investors, pension funds, and sovereign wealth funds. These professionals develop and execute investment strategies across a wide range of asset classes such as stocks, bonds, commodities, and alternative investments. Common types of asset managers include mutual fund companies, wealth management firms, pension funds, and exchange-traded fund (ETF) providers.

Asset management firms often operate with a fiduciary responsibility, meaning they are legally required to act in the best interests of their clients. This involves not only selecting appropriate investments but also continuously monitoring and adjusting portfolios. The ultimate aim is to maximize the value of an investment portfolio while adhering to the client’s risk tolerance.

Understanding Hedge Funds

A hedge fund is a pooled investment vehicle that gathers capital from multiple investors. These private funds are actively managed by professional fund managers, often employing diverse and complex investment strategies.

Hedge funds frequently utilize sophisticated techniques such as short selling, leverage, and derivatives. Unlike regulated products for the general public, hedge funds cater to sophisticated investors. Their legal structures often include limited partnerships or limited liability companies.

The philosophy behind many hedge funds is to achieve positive returns regardless of whether markets are rising or falling, often referred to as “absolute return” strategies. While the term “hedge” originally implied risk reduction, modern hedge funds employ a wide array of strategies that may or may not involve hedging in the traditional sense. Their ability to invest across various asset classes and use diverse instruments without the constraints faced by public funds is a defining characteristic.

Hedge Funds as Asset Managers

Hedge funds fall under the umbrella of asset management. Their core function involves managing pools of capital on behalf of investors.

Like other asset managers, hedge funds actively make investment decisions, construct portfolios, and manage risk for client capital. Their professional fund managers are responsible for allocating and overseeing these investments.

The primary commonality is the fiduciary relationship, where hedge fund managers are entrusted with client capital and manage it diligently. Regardless of strategy, their operation involves disciplined management of financial assets. Hedge funds perform the service of asset management for their investor base.

Unique Features of Hedge Funds

While hedge funds function as asset managers, several features distinguish them. One notable difference is their “2 and 20” fee structure. This typically includes an annual management fee (around 2% of AUM) and a performance fee (often 20% of profits), which may be subject to a high-water mark (fees paid only on new profits above the fund’s previous highest value) and a hurdle rate. This contrasts with many traditional funds that primarily charge a percentage of AUM.

Liquidity and redemption terms also set hedge funds apart. Investments are generally less liquid than mutual funds, often involving “lock-up periods” during which investors cannot withdraw capital. After the lock-up, redemptions are typically periodic and require notice.

The regulatory environment for hedge funds is less stringent compared to publicly offered funds like mutual funds. Due to their private nature and limited investor base, hedge funds are generally exempt from certain registration requirements under federal securities laws, such as the Investment Company Act of 1940. However, they are still subject to oversight, particularly following legislative changes like the Dodd-Frank Act, which increased reporting requirements for larger hedge fund advisers.

Hedge funds also have greater flexibility in their investment strategies and tools. They can engage in short selling, employ significant leverage, and invest in complex derivatives, which are often restricted for traditional mutual funds. This allows them to pursue a wider array of opportunities and potentially generate returns in various market conditions.

The investor base for hedge funds is highly specific, primarily sophisticated, high-net-worth individuals and institutional investors. To qualify, individual investors typically must meet specific criteria, such as having an annual income exceeding $200,000 (or $300,000 jointly with a spouse) for the past two years, or a net worth over $1 million excluding their primary residence. Some funds may require investors to be “qualified clients” or “qualified purchasers,” which are even higher thresholds. These stringent investor requirements reflect the complex nature and higher risks associated with hedge fund investments.