What is a hedge fund?

Hedge funds have a reputation for secrecy and swagger, but strip away the mystique and they’re just investment funds with an unusually wide toolkit. What sets them apart is flexibility: they can go long or short, use leverage, and roam across asset classes in pursuit of returns. Here are the strategies that dominate.

Long/short equity

The most common hedge fund strategy: buy the stocks you expect to rise (going long) and short-sell the ones you expect to fall. The aim is to profit from the gap between your winners and losers while reducing exposure to the market’s overall direction. A "market neutral" fund balances its longs and shorts so that, in theory, it makes money whether the market rises or falls — as long as its picks are right.

Global macro

Global macro funds take big directional bets on whole economies — interest rates, currencies, commodities — based on macroeconomic analysis. The archetype is George Soros’s famous 1992 bet against the British pound. Because they trade highly liquid instruments like currency and rate futures, these funds can deploy enormous size, making them some of the most influential players in global markets.

Merger arbitrage

When one company announces it’s buying another, the target’s share price jumps toward — but not all the way to — the offer price. That remaining gap is the "arb spread," the reward for taking on the risk the deal falls through. Merger arbitrageurs buy the target (and often short the acquirer) to capture it. If the deal completes, they pocket the spread; if it collapses, the target usually crashes back down.

Relative value

Relative value strategies hunt for small mispricings between closely related securities — buying one and shorting another when their usual relationship stretches out of line. These trades often use very high leverage to turn tiny, frequent profits into meaningful returns. The catch: that same leverage can turn small losses catastrophic in a crisis.

The fees: "2 and 20"

Hedge funds are famous for their fee structure: traditionally "2 and 20" — a 2% annual management fee plus 20% of any profits above a hurdle. It rewards performance, but it’s asymmetric: managers share in the gains, not the losses, which can quietly encourage risk-taking. Under years of fee pressure the industry average has drifted closer to "1.5 and 17," but the maths still holds — after fees like that, a fund’s returns have to be genuinely exceptional to be worth it. That’s the same risk-and-return logic every investor faces, just at the sharp end.