What are hedge funds?

A question from Yahoo! Answers:

Can anyone explain what hedge funds are & the risk?

A hedge fund is an investment company that (1) is structured as a domestic limited partnership or an offshore corporation, and (2) pays the investment manager compensation that includes a performance fee (typical hedge fund manager’s fee schedule is 1% of assets under management annually plus 20% of all profits made during the year).

Risks vary depending on what the fund invests in. There are many different strategies hedge funds use; some (for example, fixed-income arbitrage or equity market-neutral) are relatively low-risk, others (such as emerging markets) are relatively high-risk. There are also multi-strategy funds that use multiple strategies and funds of funds that invest only in other hedge funds.

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