How do hedge funds work?
Investors put money into a fund, usually a limited partnership, and a management company invests it. The manager earns a yearly fee on the assets and a share of the profits, and investors can usually take money out only at set times.
The structure
The fund itself holds the investments. A separate management company, owned by the managers, runs it. Investors are limited partners; the managers usually invest their own money in the fund too. Many funds have an offshore twin, often in the Cayman Islands, for foreign and tax-exempt investors.
Fees
Traditionally "2 and 20": 2% of assets a year plus 20% of profits. Many funds now charge less, and some of the most sought-after charge more.
Getting money in and out
Investors commit for a lock-up period, often a year, and can then withdraw only monthly or quarterly with advance notice. That lets the fund hold investments it can't sell quickly.
Trading
A prime broker, usually a large bank, holds the fund's assets, lends it money and stock to sell short, and clears its trades.