Like mutual funds, hedge funds pool the assets of several clients and manage the pooled assets on their behalf. However, hedge funds differ from mutual funds with respect to disclosure, investor base, flexibility and predictability of investment orientation, regulation, and fee structure.

Directional funds take a stance on the performance of broad market sectors. Nondirectional funds establish market-neutral positions on relative mispricing. However, even these hedged positions still present idiosyncratic risk.

Statistical arbitrage is the use of quantitative systems to uncover many perceived misalignments in relative pricing and ensure profits by averaging over all of these small bets. It often uses data-mining methods to uncover past patterns that form the basis for the established investment positions.

Portable alpha is a strategy in which one invests in positive-alpha positions, then hedges the systematic risk of that investment, and, finally, establishes market exposure where desired by using passive indexes or futures contracts.

Performance evaluation of hedge funds is complicated by survivorship bias, by the potential instability of risk attributes, by the existence of liquidity premiums, and by unreliable market valuations of infrequently traded assets. Performance evaluation is particularly difficult when the fund engages in option positions. Tail events make it hard to assess the true performance of positions involving options without extremely long histories of returns.

Hedge funds typically charge investors both a management fee and an incentive fee equal to a percentage of profits beyond some threshold value. The incentive fee is akin to a call option on the portfolio. Funds of hedge funds pay the incentive fee to each underlying fund that beats its hurdle rate, even if the overall performance of the portfolio is poor.