Hedge Fund Overview
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 (typically under Section 3(c)(1) or Section 3(c)(7))
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 |
Section 3(c)(1) exemption:
- Fund has no more than 100 investors
- Not making a public offering
Section 3(c)(7) exemption:
- All investors must be qualified purchasers (generally $5 million+ in investments)
- No limit on number of investors
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
- Qualified purchasers - individuals with at least $5 million in investments (even more exclusive than accredited investors)
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.