Hedge funds are investment vehicles that allow the fund to do more than just buy stocks. A hedge fund can go short a stock, use options on stocks, buy and sell in the commodity markets, and also invest in what are called derivatives. In other words, a hedge fund can use the entire gamut of the investment world to buy and sell in the hunt for profit.

Most hedge funds have very strict criteria as to who can be an investor in their fund. The criteria for being an investor centers on net worth and investment sophistication of the investor. These funds do not want risky adverse clients as investors or small investors with little understanding of what they are getting into.

Hedge funds have a history of imploding due to large losses of their investment capital. This usually is caused by the fact that they can use leverage in their investments. The leverage can get a fund in trouble almost overnight, as a big move in the underlying investment can be devastating to the invested capital.

Hedge funds as a group are not considered mom and pop investment vehicles. Sophisticated investors can use them because of their excellent net worth. Another feature of hedge funds that is different from the average mutual fund is the management fee that is charged by the hedge fund. Successful hedge fund managers can be paid 50% of the profit in addition to a 2% asset fee.

This can be detrimental to the investor, if the hedge fund has a very good year one year and a terrible year the next year. The net result can be a loss for the investor and a profit for the manager. Most investors are not suited for hedge funds. If you do have the required net worth and market sophistication, then pick a hedge fund with an excellent record over time.