Hedge funds have private investment pools and can have legal entities onshore (United States) or offshore (Caribbean tax havens).
This is typically set up as a limited partnership. The general partner of the limited partnership can be an entity or individuals, and in most circumstances is the fund manager, who may or may not have a portion of personal assets invested in the fund. The limited partners have limited liability depending on how much is invested in the partnership interest. General partners have unlimited liability since they assume legal responsibility for the hedge fund and thus could be subject to lawsuits.
This is typically a corporation or other investment company form (limited liability company or limited company) established in tax havens such as the Cayman Islands, Bermuda, and British Virgin Islands. The offshore entity does not have a general partner to manage the limited partnership; instead it has a management company. Due to tax implications, generally the investors in the offshore funds are non-U.S. residents.
Onshore and offshore hedge funds do not typically disclose all contents of their portfolios to their investors. A more recent trend is the increase in information (transparency) that is being demanded by investors; some portfolio information is being disclosed to these investors by hedge fund managers. This access to portfolio information by the investor is referred to as “transparency.”
The following hedge funds are categorized by their best-known strategies. Today, however, given the increasingly competitive industry, many fund companies offer investments in multiple strategies—and many fund managers are perfectly happy to grab opportunities as they see them, whether or not they technically fit in with the overall strategy.
These funds invest in the stock market, but have the option of shorting stock as well as going long. Critics say there's little difference between these and traditional long/short mutual funds, but these funds can also engage in the equity options trade, and are generally far more nimble in their investments.
Arbitrageurs seek to take advantage of opposing moves in a variety of markets. Risk and merger arbitrage is common amongst stocks, but arbs also find opportunities in the movements between stocks and bonds, bonds and currencies—almost any number of asset classes.
These hedge funds take advantage of shifts in global macroeconomics, particularly in a given nation's interest rate policy, which can affect bonds and currencies in particular.
When companies are in trouble, these hedge funds attend the fire sale. Increasingly, these funds aren't just buying distressed debt or stocks on the cheap; they're buying whole companies and, in many ways, becoming de facto private equity firms. One recent trend in this sector was the hedge fund industry’s rush in the mid-2010s to buy the loans of distressed energy companies, which were battered by declining crude oil prices.
More and more, fund companies are simply classifying themselves as multistrategy; they'll do anything if there's money to be made. Some will create specific funds for each strategy they employ, while others will simply pool the money—merger arbitrage one day, a macro play on European currencies the next.
These hedge funds are under the aegis of major investment banks and financial firms. They embrace a wide variety of strategies, but have one thing in common: They were designed (or in many cases, acquired) to keep wealthy clients' money in-house instead of seeing it siphoned off to independent hedge funds.
Funds of hedge funds may seem like a simple concept, but there's a lot of work involved in picking the right mix of strategies, risk, and returns to create a working fund. These companies assess hedge funds as closely as a mutual fund assesses stocks in order to find winning managers and strategies.