Hedge Fund Eligibility & Fees

General characteristics

• We previously discussed the term “hedge,” which is often used as a synonym for “protection” or “insurance.” It’s easy to assume a hedge fund must offer protection in some form. ⚠️ Most modern hedge funds don’t.
• The term originally came from Alfred Jones, who in 1949 formed the first “hedge fund.” His fund invested in common stocks and reduced risk by using short positions. Many structural features from Jones’s approach still show up today, but hedge funds are no longer defined by protection-based strategies.

Features shared with other funds (mutual funds, ETFs)

• They pool investor capital into a single account.
• A portfolio manager oversees the investments.
• The manager aims to maximize shareholder return while following the fund’s stated investment objectives and is compensated for managing the fund.
• Shareholders earn returns through periodic distributions and by redeeming shares at values higher than their original cost.

🔑 The biggest difference: regulation

There are important differences as well. The biggest is regulation: most pooled investment vehicles are highly regulated, while hedge funds generally are not.

With fewer regulatory constraints, hedge fund managers can use strategies that publicly available funds are typically prohibited from using, including:

Definitions

🔑 Investor eligibility & minimums (EXACT)

Most hedge funds require a minimum investment of $1 million (or more) and restrict participation to accredited investors*. By limiting investors this way, hedge funds can avoid many regulations that apply to publicly available investment pools.

• *Investors meeting certain requirements tied to wealth or investment experience are defined as accredited investors according to Regulation D.

Regulation D

• The term “accredited” comes from Regulation D, a subsection of the Securities Act of 1933.
• Regulation D allows certain securities offerings to be conducted as an exempt transaction when they’re offered primarily to accredited investors. The result is limited SEC regulatory oversight and no registration requirement.
• ⚠️ In contrast, most securities offerings go through a registration process that includes significant investor disclosures and regulatory review. Hedge funds typically avoid that process.
• 📌 We’ll cover SEC registration in a future chapter.

Fees

• Because hedge funds operate with relatively little supervision and regulation, managers often pursue investments with unusual risk/return profiles. Many hedge fund managers are paid based partly on the fund’s gains, which can create an incentive to take on significant risk in pursuit of large returns.

🔑 “2 and 20” fee structure (EXACT)

A common fee structure is “2 and 20,” meaning:

• 2% of AUM (assets under management), plus
• 20% of the gains earned for investors

Worked example (verbatim)

This is the fee structure for several Bridgewater Associates hedge funds, one of the largest hedge fund companies in the world, with an approximate portfolio size of $92 billion (as of year-end 2024). Ignoring the 20% performance fee, 2% of $92 billion is approximately $1.84 billion. Bottom line: hedge funds can generate considerable fee revenue.

Unique investments

• Some hedge funds use exotic strategies and invest in unusual assets.

Madoff claims

For example, some hedge funds made significant gains by buying Madoff claims. Bernie Madoff ran a Ponzi scheme that defrauded investors of nearly $60 billion. Defrauded investors could file claims against his assets through a bankruptcy court process.

Bankruptcies are often slow and there’s no guarantee of a payout. Some hedge funds bought these claims from victims at deep discounts and then waited for a settlement. For example, someone with a $100,000 claim against the Madoff estate might sell that claim to a hedge fund for $10,000. If the claim ultimately paid out, the hedge fund could earn a 10x return.

Special purpose acquisition companies (SPACs)

Another investment hedge fund managers may pursue is special purpose acquisition companies (SPACs), also called blank check companies. These organizations raise money from investors without having a defined operating business at the time of the offering. Instead, the SPAC commits to acquiring or merging with another business within a short period (usually two years or less). Investors are essentially buying into the SPAC executives’ plan, even though they don’t yet know the specific company their money will be invested in.

Sidenote — Case study: NewHold Investment Corp. & Evolv Technologies

Let’s explore a real-world example to better understand this type of investment. In July 2020, NewHold Investment Corp. issued units of a new SPAC at a $10 public offering price. Each unit comprised one share of NewHold Investment Corp. common stock and a half warrant to purchase additional stock for $11.50 per share. 15 million units were sold by the end of the SPAC’s initial public offering (IPO), resulting in $150 million raised.

According to the SPAC’s prospectus:

“NewHold Investment Corp. is a newly organized blank check company [SPAC] formed for the purpose of effecting a merger, capital stock exchange, asset acquisition, stock purchase, reorganization or similar business combination…”

• While searching for a business, NewHold pledged to invest the raised capital in short-term Treasury securities held in a trust account. Eventually, Evolv Technologies, a weapons detection company, was identified as Newhold’s primary target. The SPAC merged with Evolv in July 2021, and the newly-formed company’s stock — Evolv Technology Holdings Inc. (ticker: EVLV) — began trading on NASDAQ (the former SPAC shares became EVLV’s new shares).
• Ultimately, NewHold SPAC investors invested in Evolv Technology, a privately held company until the merger. ⚠️ If the merger had never occurred, NewHold would have returned the raised capital to investors.

Blind pool investments

A blind pool investment is another hedge fund investment that resembles a SPAC, but is typically more transparent. SPACs don’t disclose the businesses or industries they intend to target, while blind pool investments usually disclose the industries or sectors they plan to target.

⚠️ SPAC vs. blind pool

Funds of hedge funds

While hedge funds aren’t available to the general public for several reasons, funds of hedge funds are more accessible to the average non-accredited investor. These funds typically invest in a dozen or more hedge funds, which can provide diversification.

Funds of hedge funds also tend to have lower minimum investments (often around $25,000). Even with diversification and lower minimums, they’re still risky investments and are generally suitable only for aggressive investors. Another key drawback is cost: funds of hedge funds charge their own management fees on top of the fees charged by the underlying hedge funds.

Key points

Hedge funds

• Unregulated investment funds
• Only accredited (wealthy) investors participate
• High risk and high gain potential
• Subject to lock-up periods
• Typically sold in Regulation D offerings

Special purpose acquisition companies (SPACs)

• Also known as a “blank check company”
• Raise capital from investors with no defined business in place
• Funds used to acquire or merge with a private business
• Invested capital placed in trust into safe securities
• Shareholders must approve proposed business acquisitions

Blind pool companies

• Similar to blank check companies, but provide more transparency
• Typically disclose targeted industries or sectors

Funds of hedge funds

• Portfolio of several hedge funds (diversification)
• Lower investment minimums than individual hedge funds
• Not required to be accredited to invest
• Potential lower liquidity risk (shorter lock-up periods)
• Higher fees than individual hedge funds

Sources

Primary/official references for the material in this chapter. Every link was fetched and returned HTTP 200 on 2026-08-15.