No one hedge fund is structured like any other. There are a
number of factors that come into play, mostly having to do with what state (or
even country) the hedge fund is located in, the hedge fund manager’s practices,
policies, and specific skill set, and of course the amount of money in the fund
itself. Furthermore, the diversity of the investments in the hedge fund changes
the structure of the hedge fund as well; a typical, well-managed portfolio has
more than one type of investment at a time. In a way, hedge fund investments
can be “mixed and matched” in order to achieve the best results. Investment
managers can use a risk parity strategy with one investment, and on another use
fixed income arbitrage, for example.
Typically, a hedge fund is comprised of an investor (either
an individual or a company), and the investor enters into a partnership with
the hedge fund money manager – or (when there are multiple parties) else enters
into a company with the manager. Once established, the hedge fund company will
make investments; this is the hands-on part of the partnership or company. The
investor virtually has no role in the investment process, and is not nearly as
involved in the decision making, business practices part of the hedge fund.
Other people may provide services in a hedge fund as well.
These may include a distributor, who primarily markets the funds to investors;
a prime broker, who do the majority of the work with lending money and
securities; and an administrator, who handles the withdrawals and subscriptions
of investors. This is a very basic outline of what various people within the
hedge fund may do, and every hedge fund is different. A hedge fund never has
any employees or assets other than the investments within the fund itself.
The taxation and regulation of hedge funds varies greatly
depending on the location of the fund itself. For example, hedge funds in
America are considered very loosely regulated (they typically do not have to
report to SEC, for one). A lot of hedge fund companies take advantage of tax
opportunities by establishing the fund in an offshore financial center, so that
the investor pays taxes on the portfolio, and it doesn’t come out of the fund
itself. However, despite many hedge funds being technically located offshore, a
lot of investment managers are located onshore.
Legally, hedge funds are usually formed as limited
partnerships, or limited liability companies. The general partner is the
investment/money manager, and the limited partner(s) is the investor
themselves. Hedge funds are considered private investments and are not held up
to the same amount of regulation that other investments are. While hedge funds
are often referred to as “unregulated,” the fact is that there is some
regulation that has to take place by law – it is simply different than
regulation for other types of investment. An example of how hedge fund
regulation functions is that investors are heavily scrutinized and must meet
certain criteria before being approved.
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