There is no standard legal definition of what a hedge fund is. They vary by country.
Let's look at the main criteria defining hedge funds.
Hedge funds fall into the category of alternative funds, meaning that they are not correlated to traditional equity, bond or money market indices. This means that they can be more flexible than traditional funds. Their objective is to generate an absolute performance – we speak of "absolute return" or "total return".
Hedge funds often use a high degree of leverage, i.e., taking on additional risk in relation to the amount of assets in the fund. They can achieve this leverage either through derivatives or through borrowing.
Another important criterion is the possibility of short selling, i.e., betting that the value of a given asset will decline.
The kinds of assets in which hedge funds can invest are more numerous than traditional funds. For example, they can invest in commodities.
The volatility of these funds is higher than traditional funds and the liquidity is lower since clients can exit the fund at best every month, or perhaps even less frequently. As a result, hedge funds are intended for a limited clientele.
The first hedge fund was created by Alfred Winslow Jones in 1950. Hedge funds represent nearly $4 trillion in investments. Today, the main hedge funds are Bridgewater Associates, Man Group, Renaissance Technologies and Millennium Management. It is worth noting that, before 2010 (The Alternative Investment Fund Managers’ Directive in Europe and the Dodd-Frank Act in the United States), hedge funds were not subject to any form of government regulation.