Summary
- Investors pool money together in a hedge fund that uses advanced trading tactics and unconventional investments to generate returns.
- They’re considered high risk and require a high minimum investment, which doesn’t make them suitable for many investors.
- Other ways you can gain exposure to hedge funds include ETFs and mutual funds that use hedge fund strategies, publicly traded companies that invest in hedge funds, feeder funds, fund of funds, or even an existing pension.
- Unbiased can connect you to a financial advisor to answer all your questions about hedge funds and your portfolio.
What are hedge funds?
A hedge fund is a type of alternative investment that pools investor money to generate returns in both bull and bear markets using unconventional, aggressive, or advanced trading tactics. Hedge funds take many risks, lock up your money, have low transparency, charge high fees, and require a significant investment. So, why invest your money in a hedge fund?
Hedge funds may be seen as a key risk management tactic against market downturns and a way to diversify your portfolio. They offer a way to earn returns regardless of market conditions. Institutional investors, such as corporate and public employee pension plans, rely heavily on hedge funds.
Ways to invest in hedge funds
If you’re looking to invest in a hedge fund, there are several ways you can gain exposure to this type of investing.
Direct investment
A direct investment involves becoming a limited partner (LP) by investing a substantial amount of capital directly with the hedge fund. LPs allow the general partner to manage investment decisions on a day-to-day basis while the LP provides the capital.
Feeder fund
A feeder fund allows you to invest in a hedge fund with a lower minimum requirement. Minimum investments start around $100,000.
Pension plan
If a pension plan is part of your retirement, you likely already have exposure to hedge funds. Institutional investors that offer pensions often hold positions in hedge funds to diversify holdings and generate returns when traditional investing markets are down.
Publicly traded investment managers
You may be able to access hedge fund investing indirectly by investing in the companies that invest in hedge funds. Think BlackRock, Grosvenor Capital Management, Lighthouse, etc.
Mutual funds or ETFs
You may be able to invest in mutual funds and ETFs that follow a hedge-fund strategy with similar investments.
Fund of funds
You can invest in a hedge fund via a fund-of-funds (FOF), which is a fund that invests in a variety of funds to generate returns for investors. It may grant the investor broader access to many hedge funds.
Investing in hedge funds requirements
As hedge funds are private investments that aren’t heavily regulated, there are some requirements you need to meet before investing.
Meet eligibility requirements
To become an investor in a hedge fund, you need to be either an accredited investor or a qualified purchaser. Generally, this means you meet one of the following requirements:
- Income: $200,000 for individuals or $300,000 per couple.
- Net worth: Over $1 million, excluding the value of your home.
- Professional credentials: Hold a FINRA Series 7, 65, or 82 license.
Meet the minimum investment
Hedge funds typically have high minimum investments. While it’s possible to invest as little as $25,000 with some hedge funds, most will require $1 million or more.
Complete due diligence and subscription requirements
Read the fund’s offering memorandum, research the hedge fund manager, determine what techniques the fund is using to amplify gains (and losses), and ask every uncomfortable question you can. Read and sign the subscription agreement, which is a legally-binding agreement that demonstrates you’re an eligible investor.
Accept fund lock-up periods and fees
Hedge funds have restrictions that many other investments don’t. A lock-up period, for example, prevents you from liquidating shares in the hedge fund for a period of time, often a year or more in the beginning. It also limits how many times you can redeem your shares each year.
Fees are also high. The asset management fee is typically between 1 and 2% NAV, plus a 15 to 20% performance fee of the hedge fund’s profit.
Access the fund
You may find it challenging to find the right fund and be accepted as a limited partner (LP). You may find that a financial advisor can help point you in the right direction.
What are the pros and cons of investing in hedge funds?
Hedge fund investing comes with some clear pros and cons. Carefully consider how it fits with your investing style and financial goals.
Pros
- Flexible: Since hedge funds aren’t regulated by the SEC, they have more flexibility in how they earn returns, including complex trading positions, diverse asset classes, event-driven trades, credit investing, and more.
- High returns: Hedge funds pursue higher returns, but they can also underperform the market.
- Diversification: Hedge funds offer diversification with returns uncorrelated with public markets.
Cons
- High fees: Hedge funds charge high fees. You may pay a management fee of 2% of the net asset value (NAV) and 20% of profits.
- Higher risk: Hedge fund positions take on risk, especially with leverage. Large losses are possible.
- Less transparency and regulation: Hedge funds are not registered investments, so there’s less protection for investors.
- Accessibility: Only accredited investors can invest with hedge funds.
- Illiquid: You may not be able to access your money when you need it when invested with a hedge fund. You may be limited to monthly or quarterly redemptions. During turbulent markets, you may not be able to redeem your shares at all.
Is it worth investing in hedge funds?
Hedge funds are inherently risky. They’re unregulated, illiquid, and have high fees. They’re not for most investors. So, when is it worth it to invest in a hedge fund?
The key factor investors look for is uncorrelated returns. Because hedge funds can earn returns in any market, they’re seen as a way to diversify your portfolio and hedge against risk.
Consider your risk tolerance, time horizon, and investment goals to determine if investing in a hedge fund is right for you. Seek expert advice when needed.
The bottom line
Hedge funds are complex, but they can have their place. It’s wise to seek expertise before investing with one. Unbiased can connect you with a financial advisor to answer any questions you have about investing and constructing a financial portfolio just right for you.