To the People

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Thursday, May 17, 2007

A Hedge Fund Primer

The news lately is consumed with stories about hedge funds. The press reports on hedge funds do not explain what they are, so here goes.

A hedge fund is similar to a mutual fund in that its managers invest money from third parties. It differs from a mutual fund in two main ways:

One, a hedge fund's investors are required to be "sophisticated investors," which means that they have a net worth of $2 million or more. This "sophistication" test, which ensures that small investors are not at risk, enables hedge funds to avoid the reporting requirements of mututal funds.

Two, hedge funds are allowed to take "short" positions in a stock, which is called hedging, hence their name. Mutual funds are prohibited from shorting by the SEC as mutual funds accept any investor. A short position can be very prudent, but can also be risky. A short is when you borrow a stock in the hope that the stock goes down and when the date comes that you have to give it back to the owner he owes you money. If it went up, you owe the owner.

The Democrats don't like hedge funds. But if you are John Edwards, they are a good way to pay for your $400 hair cuts while you campaign about the Two Americas and actually live in the one that you campaign against.

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