Hedge funds can be described as pooled investment vehicles that use flexible strategies in order to generate returns while at the same time, preserving capital by hedging against market declines. Considered an alternative investment fund, a hedge fund trades and invests in various assets such as securities, currency, commodities and derivatives on behalf of its clients who are typically wealthy individuals.

Hedge funds are normally set up as limited partnerships where the fund manager is the general partner and the investors are the limited partners. They are loosely regulated which allows the fund managers to participate in the gains or losses of the money invested. These funds usually have large fees associated with them as fund managers habitually charge both a performance fee and an asset-based fee.

Hedge funds have greater flexibility than mutual funds in the investment policies they can incorporate and therefore are better able to hedge against downturns in the markets. In addition, mature hedge fund management firms structure their funds to include domestic and offshore investments. This provides the managers of hedge funds the distinct advantage of attracting capital worldwide.

Some of the investment methods hedge funds incorporate include short selling, arbitrage and leveraging. Short selling allows an investor to sell stock they do not own for the opportunity to profit when prices fall. Arbitrage allows for the simultaneous buying and selling of securities in different markets in order to profit from the difference in prices. Leveraging is the borrowing of money for investment purposes.

Hedge funds offer the sophisticated investor a diverse, alternative investment option.