Quick Answer
Hedge funds are private investment pools restricted to accredited or qualified investors, structured as a limited partnership with a general partner and limited partners. They are exempt from Securities and Exchange Commission registration under the Investment Company Act of 1940, giving them far less oversight than mutual funds.
Hedge funds are the most exclusive and least regulated alternative investment. Unlike Real Estate Investment Trusts (REITs), which are available to anyone, and some Direct Participation Programs (DPPs), hedge funds are restricted to wealthy, sophisticated investors, and the exam tests why.
What Is a Hedge Fund?
- A private investment pool available only to qualified or accredited investors
- Structured as a limited partnership or limited liability company (LLC)
- The fund manager acts as the general partner; investors are limited partners
- Not registered with the Securities and Exchange Commission (SEC) as an investment company
- Exempt from the Investment Company Act of 1940 under one of the private-fund exemptions
Regulatory Exemptions
Hedge funds operate with far less oversight than mutual funds:
| Requirement | Mutual Funds | Hedge Funds |
|---|---|---|
| SEC registration | Required (Investment Company Act) | Exempt |
| Daily net asset value (NAV) | Required | Not required |
| Prospectus | Required | Not required (private placement memo) |
| Share redemption | Daily, on demand | Limited windows + lock-ups |
| Leverage limits | Restricted | No limits |
| Short selling | Limited | Unrestricted |
| Investor disclosure | Extensive | Limited |
Who Can Invest?
Hedge funds are restricted to sophisticated, wealthy investors:
- Accredited investors - individuals with net worth exceeding $1 million (excluding primary residence) OR income exceeding $200,000 ($300,000 with spouse) in each of the past two years
Exam Tip: Gotchas
Hedge funds are exempt from SEC registration as investment companies, but fund managers (investment advisers) may still need to register with the SEC under the Investment Advisers Act. The fund's exemption does not extend to the manager's registration status.
What Should You Check on Exam Day?
- Can you state the net worth and income thresholds that qualify someone as an accredited investor?
- Do you know why a hedge fund's SEC exemption does not cover its manager's registration status?
- Can you explain why hedge funds do not need to publish a daily net asset value?
- Do you know which act exempts hedge funds from registering as an investment company?
- Can you explain why hedge funds face no regulatory limits on leverage or short selling?