How Does a Hedge Fund Work?

Video Transcript

"Hi, there. I'm Cathy Pareto, the founder of Cathy Pareto and Associates, certified financial planner, here in Miami, Florida. In this clip, we're going to be talking about how a hedge fund works. Now, hedge funds have traditionally been a tool for the rich, but more and more investors are having access to these hedge funds through what they call fund of hedge funds -- fund of funds. Hedge funds is simply a collection of different securities where the fund manager -- the hedge fund manager, who, by the way, gets pretty handsomely compensated for managing that fund, sometimes in excess of two percent per year, plus 20 percent on the profits -- is merely a collection of different stocks. You can buy commodities. You can buy all sorts of other investment vehicles insides of this structure. And basically, the fund manager is trying to do better than the market to control volatility, all of which you can probably do with another adviser or a broker or even on your own. The issue with the hedge funds, and my concern about them, is that they are very lightly regulated. So you may not often know what you're buying, and you may not know if you're dealing with the right firm. They're usually...it's a business structure called an LLC, and it's a collection of rich people's money, and so you don't often have the transparency that you might in a regular mutual fund. So just a word of caution if investing in hedge funds: Many of them have blown up, as they say in the industry, and have taken their investors' money with them. So that's a little bit about buying hedge funds, and this has been Cathy Pareto in Miami, Florida."