What Is a Hedge Fund?
A hedge fund is a privately offered investment fund that pools capital from accredited or institutional investors and deploys it using flexible, often sophisticated strategies.
Unlike mutual funds, hedge funds are not restricted to long-only investing. They can pursue returns through:
- Long and short positions
- Leverage
- Derivatives
- Arbitrage
- Event-driven strategies
- Global macro positioning
The goal is not just market participation but risk-adjusted performance, regardless of whether markets are rising or falling.
Why Are They Called “Hedge” Funds?
Originally, hedge funds were created to hedge market risk by pairing long positions in undervalued securities with short positions in overvalued ones, aiming to reduce exposure to broad market movements.
Over time, however, the industry evolved. Many hedge funds no longer hedge in the traditional sense, but the name remained as strategies expanded.
Today’s hedge funds are typically oriented around generating absolute returns, preserving capital through varying market cycles, pursuing opportunistic positioning, and structuring investments to produce asymmetric payoff profiles rather than simply tracking market direction.
How Hedge Funds Are Structured
Most hedge funds follow a familiar legal and operational framework, but the quality of execution within that framework often determines how scalable and investable the fund ultimately becomes.
Fund Entity (Limited Partnership / LLC)
The fund entity is the core investment vehicle that legally holds the money contributed by investors. In most private funds, including hedge funds, this entity is structured as a limited partnership (LP), where at least one general partner (GP) manages the investment strategy and one or more limited partners (LPs) supply the capital.
Sometimes an LLC (limited liability company) is used instead of a traditional LP for tax or regulatory reasons, but the economic purpose is the same: to pool investor capital and allocate profits and losses according to the agreed terms.
The governing contract for this entity, called the limited partnership agreement (LPA), lays out how management fees are paid, how profits are shared, the process for capital calls and distributions, and the rights and obligations of all parties.
Importantly, this structure offers pass-through taxation, meaning the fund isn’t taxed at the entity level, and investors report profits or losses on their own tax returns.
General Partner (GP)
The general partner (GP) is the legal entity that has authority to manage the fund on behalf of investors. Under the limited partnership structure, the GP has the right to make investment decisions and direct how the fund’s capital is deployed, as defined in the LPA.
Because of this role, the GP may be subject to broader liability than the limited partners; however, in practice the GP is typically formed as an LLC or similar structure itself, which limits personal liability for the individuals running it.
The GP earns compensation not only through an annual management fee but also through a performance share (often known as carried interest) that aligns the interests of the manager with the investors. This alignment, where the GP benefits when the fund performs well, is a cornerstone of the limited partnership model.
Management Company
Although not always discussed in every basic overview, many hedge fund structures also include a management company that is distinct from the GP entity.
The management company is the operational business that employs the investment team, pays salaries and expenses, and runs daily operations. It earns revenue from the management fees paid by the fund, and its legal separation from the fund itself protects the investors’ capital from liabilities related to running the business (e.g., office leases, employee claims).
While the GP holds legal authority over the fund, the management company is effectively the team that executes the strategy with people, systems, and processes.
Limited Partners (Investors)
Limited partners (LPs) are the investors who commit capital to the fund entity but do not participate in management or investment decisions.
Their role is passive, and they benefit from limited liability, meaning they cannot lose more than the capital they contributed. This protection is a fundamental reason the limited partnership model is the industry standard: it aligns risk with commitment and separates investor liability from operational risk.
LPs provide the bulk of the capital that funds deploy, and in return they receive periodic reporting, profit distributions, and protections outlined in the LPA. Institutional investors, family offices, and high-net-worth individuals are common examples of limited partners.
Service Providers and Operational Support
While not unique to Carta’s description of structure, the broader industry practice and part of what makes these entities function together is the involvement of professional service providers.
Administrators, auditors, custodians, and legal counsel all support the structure by ensuring accurate valuation, compliance, and transparency. This ecosystem of support helps private funds operate in a way that institutional investors recognize and trust.
Though separate from the legal entity framework, strong coordination among these parties is critical to smooth capital raising, reporting, and investor confidence.
Common Hedge Fund Strategies
Hedge funds are defined by the strategies they use rather than a single investment model. These strategies vary widely in how they generate returns, manage risk, and perform across market cycles.
Below are the most common hedge fund strategies, each with distinct characteristics and operational considerations.
Long/Short Equity
Long/short equity is one of the most common hedge fund strategies. Managers take long positions in stocks they believe are undervalued, and short positions in stocks they believe are overvalued.
This allows the fund to profit from both rising and falling securities while reducing exposure to overall market movements. Returns are driven primarily by stock selection rather than broad market direction.
Market Neutral
Market neutral strategies are a more tightly balanced form of long/short equity. The fund maintains roughly equal dollar amounts of long and short positions, aiming to eliminate market risk entirely.
The objective is to generate consistent returns based on pricing inefficiencies between securities, regardless of whether markets rise or fall.
Arbitrage Strategies
Arbitrage strategies seek to profit from price discrepancies between related securities. Common examples include merger arbitrage, where a fund trades stocks involved in announced mergers, and convertible arbitrage, which exploits pricing differences between convertible bonds and the underlying equity.
These strategies focus on relative value rather than directional market bets and often rely on precise timing and risk control.
Event-Driven
Event-driven strategies focus on corporate events such as mergers, acquisitions, restructurings, bankruptcies, or spin-offs. Managers analyze how these events may affect the value of a company’s securities and position the fund accordingly.
Returns depend on the successful completion or outcome of the event, making this strategy sensitive to legal, regulatory, and execution risks.
Credit Strategies
Credit-focused hedge funds invest in debt instruments such as corporate bonds, loans, or structured credit products. These strategies may target investment-grade, high-yield, or distressed debt and aim to profit from mispriced credit risk, yield spreads, or improving credit conditions.
Credit strategies often involve lower liquidity and require specialized analysis of balance sheets and cash flows.
Global Macro
Global macro strategies take a top-down view of global economic and political trends. Managers make directional bets across asset classes, including equities, bonds, currencies, and commodities, based on expectations around interest rates, inflation, policy changes, or geopolitical events.
These funds can be highly flexible and opportunistic but may experience higher volatility.
Quantitative or Systematic
Quantitative hedge funds rely on mathematical models, algorithms, and predefined rules to make investment decisions. Trades are driven by data and statistical patterns rather than discretionary judgment.
These strategies can scale efficiently but require robust technology infrastructure, high-quality data, and strong risk management to function effectively.
Multi-Strategy
Multi-strategy hedge funds combine two or more strategies within a single fund structure. Capital is allocated dynamically across approaches based on opportunity, risk, or market conditions.
This diversification can help smooth returns over time, but it also increases operational complexity and demands more sophisticated reporting and oversight.
The Real Challenge: Capital Raising
Many hedge fund managers assume that strong performance will naturally attract capital. In reality, performance is only one part of the equation. Capital raising is often the primary bottleneck, especially for newer funds and growing managers.
The challenge is rarely a lack of interest; instead, it’s friction. Investor information is scattered across spreadsheets and inboxes, outreach and follow-ups are manual, and messaging varies from one conversation to the next. Due diligence takes longer than expected, managers lack visibility into where investors are in the decision process, and unstructured communication increases compliance risk.
Over time, these inefficiencies slow momentum and quietly cap growth, even for funds with compelling strategies.
As a result, many managers are rethinking how capital raising is supported, moving toward technology and AI-driven infrastructure that brings structure, visibility, and efficiency to the process.
How AI Is Changing Capital Raising
AI is reshaping capital raising by replacing manual, fragmented processes with structured, data-driven workflows.
Instead of relying on spreadsheets, inboxes, and intuition, fund managers can use AI to organize investor data, prioritize outreach, and track engagement across the entire fundraising process.
This creates clearer visibility into investor intent, shortens diligence timelines, and allows managers to communicate more consistently and professionally, without adding headcount or operational burden.
What This Means for Fund Managers
Strategy determines what you invest in, but execution determines whether you can raise, retain, and grow capital over time.
Managers who understand what is a hedge fund at both a strategic and operational level and modernize how they manage investor relationships, diligence, and communication build a durable advantage well before returns appear on a performance report.
For anyone launching a fund, scaling one, or professionalizing their capital raise, the systems behind the strategy matter just as much as the strategy itself.
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