A hedge fund is an investment fund open to a limited range of investors that undertakes a wider range of investment and trading activities than traditional long-only investment funds, and that, in general, pays a performance fee to its investment manager.
Every hedge fund has its own investment strategy that determines the type of investments and the methods of investment it undertakes. Hedge funds, as a class, invest in a broad range of investments including shares, debt and commodities. Some people consider the fund created in 1949 by Alfred Winslow Jones to be the first hedge fund.
As the name implies, hedge funds often seek to hedge some of the risks inherent in their investments using a variety of methods, most notably short selling and derivatives. However, the term "hedge fund" has also come to be applied to certain funds that, as well as (or instead of) hedging certain risks, use short selling and other "hedging" methods as a trading strategy to generate a return on their capital.
In most jurisdictions hedge funds are open only to a limited range of professional or wealthy investors who meet certain criteria set by regulators, and are accordingly exempted from many regulations that govern ordinary investment funds. The exempted regulations typically cover short selling, the use of derivatives and leverage, fee structures, and the rules by which investors can remove their capital from the fund. Light regulation and the presence of performance fees are the distinguishing characteristics of hedge funds.
The net asset value of a hedge fund can run into many billions of dollars, and the gross assets of the fund will usually be higher still due to leverage. Hedge funds dominate certain specialty markets such as trading within derivatives with high-yield ratings and distressed debt.