Interview with a Financial Expert : Chand Sooran

             

What is a Hedge Fund?

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Generally speaking, a hedge fund is a private, open-ended company formed for the purpose of investing. It is differentiated from other types of investment strategies by its organization, its membership, its activities and its compensation scheme.

Hedge Funds Are Privately Organized Companies

Most commonly, hedge funds are organized privately, though there are jurisdictions in which investment companies that resemble hedge funds in form or function may be accessible to the general public. These more readily accessible structures include UCITS in the European Union, structured notes or various forms of insurance participation.

Organizing Hedge Funds

Organizing as a private company gives the sponsor of the hedge fund flexibility in terms of the investment strategies the fund can employ. In addition, in targeting sophisticated, wealthy investors and institutions by raising funds via a private placement, the hedge fund qualifies for exemption from securities and mutual fund registration with the local jurisdiction.

In the United States, there are two types of safe harbor from prospectus registration requirements for the securities offerings of interests in the hedge fund under the Investment Company Act of 1940: Section 3(c)(1) and Section 3(c)(7). To merit the benefit of these legal carve-outs, the hedge fund must restrict itself to soliciting only a particular type of investor and there are limits to the number of investors in the fund under each proviso.

In the case of a 3(c)(1) fund, the interests may be offered only to “accredited investors” and the fund cannot have more than 100 of these accredited investors. An accredited investor is defined in the US Investment Company Act of ’40 as someone, individually or jointly with their spouse, having a net worth or annual income above a defined threshold. The minimum net worth for accredited investors is $1 million, individually or jointly. The minimum annual income is $200,000 ($300,000 for married couples) in each of the past two years with the expectation of earning at least that amount in the next year. There are also other types of institutional accredited investors.

For a 3(C) (7) fund, the hedge fund may offer its interests under a private placement to so-called “qualified purchasers”, defined (again, in the US Investment Company Act of ’40) as a natural person who owns at least $5 million in investments (securities and other permitted assets held for investment purposes). Again, there is a restriction on the number of qualified purchasers in a 3(c )(7) fund, with the limit imposed at 500 investors.

Hedge Funds Have Greater Flexibility With Respect To Investment Strategy

Restrictions and Regulations

There are a number of restrictions imposed on traditional, regulated investment vehicles such as mutual funds. These include limits on financial leverage, on the types of investments the fund can make, and the way in which the fund manages risk…read more

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