Domestic Hedge Funds

A hedge fund that resides in the United States. Most hedge funds are structured in a limited partnership format. Therefore, the number of "limited partners" is limited to 99 "accredited" [see right] investors. The partnership is run by the general partner who is usually an unregistered investment advisor. Because hedge funds are unregistered entities, the limited partners (investors) are not afforded with the protection of the SEC (Securities and Exchange Commission). As a result, the investors must do a thorough due diligence since it is their responsibility alone

This structure/format allows hedge funds to operate differently, which is at the core of their strength: the flexibility to employ instruments and investment strategies not permitted conventional money management. For this reason, hedge funds are considered "alternative" investments or "nontraditional." They can use instruments such as options and futures and they can take advantage of a greater variety of techniques that include hedging, arbitrage and short selling. By comparison to conventional money management, this is extremely flexible because the "supervised" players can only utilize the technique of going "long."

Offshore Hedge Funds

Usually an offshore investment corporation is domiciled in an international tax haven, and structured as a mutual fund. These hedge funds have no legal restrictions limiting the number of non-U.S. investors. If the fund does wish to allow U.S. investors to participate, it must meet the requirements of the United States Securities and Exchange Commission. This means adherence to the SEC's rules of accreditation. Offshore hedge funds share the same investment flexibility as their domestic residing siblings -- they use financial instruments not available to domestic mutual funds.

Since most offshore hedge funds are structured as corporations, they are not restricted as to the number of investors who can invest in a fund even if the shares are offered privately. There are many offshore jurisdictions in which these investment corporations may be established. In general, these jurisdictions do not have developed capital markets, but offer tax and privacy advantages which attract large amounts of capital. These countries allow the formation of these companies/funds as long as they are not sold to citizens/taxpayers of the offshore jurisdiction. These jurisdictions are tax havens that usually reside within three geographic regions: the Caribbean basin, the Far East and Europe.

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Key Points - Domestic:

If a fund is domiciled in the U.S., it is usually structured as a private partnership (L.P structure). No more than 99 investors are allowed (as required by SEC). At least 65 of the 99 investors must be "accredited" (meaning they must have a net worth of at least $1 million, an annual income of at least $200,000, or they must invest at least $150,000 and this may not exceed 20% of the investor's net worth). The General Partner (usually the fund manager) receives a percentage of the profits (typically 20%) and is entitled to collect a management fee of 1% of the fund's assets.

* Accredited: This is defined under SEC regulation D. Such an investor has a net worth of $1 million dollars ... or they must have an annual income of of at least $200,000 ... or they must put at least $150,000 into the partnership, and the investment must not account for more than 20% of the investor's worth.

Key Points - Offshore:

Usually structured as mutual fund companies domiciled in tax havens such as the Bahamas or Bermuda

They can use hedging strategies to protect against downside risk

No legal limits on number of non-U.S. investors

If an offshore hedge fund wishes to accept U.S. investors, they must adhere to the SEC's requirements