WHAT ARE HEDGE FUNDS?
Q. What are hedge funds? Today, hedge fund styles and strategies have greatly expanded, and the definition of a hedge fund has more to do with the structure of the investment vehicle rather than the actual method of investing. Hedge funds are generally set up as a limited partnership with the hedge fund manager acting as the general partner and the investors in the hedge fund acting as limited partners. Hedge funds are able to invest in numerous strategies, which may include one or combinations of short-selling, arbitrage, leverage and, of course, hedging. These hedge fund strategies are applied across a diverse array of asset classes, including stocks, bonds, commodities, and currencies. Q. Are there special risks associated with hedge funds? Q. Who invests in hedge funds? Q. What types of fees do most hedge funds charge? Q. Are there minimum investments for hedge funds? Alternative investments provide unique risk and return properties not found easily in traditional stock and bond investments. Portfolios of conventional, publicly traded stocks and bonds can also qualify as alternative investments if they are constructed and managed in nontraditional ways. Although they have many unique characteristics, alternative investments can be defined at a basic level by their ability to utilize a wide array of trading techniques often (but not always) including selling securities "short" and employing leverage. Q. What are some examples of alternative investments? Q. Are there special risks associated with alternative investments? Q. What is the appeal of adding alternative investments to a portfolio?
A. Hedge funds are often very misunderstood. The term "hedge fund" has its origins at least as far back as sociologist Alfred Winslow Jones, who is often referred to as the father of the hedge fund industry. The idea of hedging and the concept of hedge funds came from his idea of reducing or eliminating market risk by offsetting (or hedging) long positions in undervalued equities (stocks he believed would rise in value) with other short positions (stocks he believed would fall in value). This in theory removed the reliance on a rising overall market in order for the hedge fund to make money. In effect, the hedge fund would depend less on the market and more on the skill of the hedge fund manager in determining the value of the stocks within the fund.
A. Yes. Investing in hedge funds may involve a high degree of risk. Hedge Fund managers can engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are not subject to the same regulatory requirements as mutual funds, often charge high fees which may offset any trading profits, and in many cases the underlying investments are not transparent and are known only to the investment manager. Hedge funds are unique and any investor should carefully consider all risks prior to placing money with a particular hedge fund. An investor should always refer to and read carefully a fund’s offering memorandum before investing.
A. Hedge funds are generally only suitable for sophisticated, high net worth investors including qualified individuals, endowments, institutions, funds of hedge funds, family offices, and pensions.
A. Most hedge funds charge a fee based on the amount of invested assets (a "management fee"), and a profit based fee (an "incentive fee"). Usually, the management fee may be set at 1%-2% of assets annually, and the incentive fee may be set at 20%-25% of yearly profits. These fees can vary depending on the manager and how they structure their fees. Many hedge funds also observe a "high-water mark." Under this structure, if an investor loses money with a hedge fund during a given period, no incentive fees will be charged in later periods until these losses are recovered.
A. There is no requirement as to a hedge fund’s minimum investments. Minimums are commonly set by the hedge fund manager themselves. Typically the minimums will range from a $250,000 or $500,000 minimum investment. However, there are hedge funds with minimums well over $1 million.
A. Hedge funds, managed futures, venture capital, private equity, and leveraged buyouts are generally accepted as being alternative investments, as are farmland, timberland and oil and gas. Some investment professionals also include real estate in the alternative investments category.
A. Yes. Alternative investment products, including hedge funds and managed futures, have risks that should be understood prior to investing. Although every investment is unique, in general, investors should be aware that these investments often engage in leveraging and other speculative investment practices that may increase the risk of investment loss. They can also be highly illiquid, are not required to provide periodic pricing or valuation information to investors, and may involve complex tax structures and delays in distributing important information. Alternative investments are often not subject to the same regulatory requirements as, say, mutual funds, and often charge high fees that may potentially offset trading profits when they occur. In addition to these general risks, there are other more specific risks to be considered, many of which can be found in the specific offering materials or disclosure documents for the investments in question.
A. Although these investments do carry their own unique risks, there are many reasons why suitable investors may decide to add alternative investments to their portfolio. For example, hedge funds in particular have historically proven to have low correlation with overall market activity. Investments such as these, can be seen as good candidates to aid portfolio diversification. Portfolio diversification is one of the key elements of Modern Portfolio Theory, and can result in portfolios with more favorable risk versus return characteristics. There is no guarantee that the addition of alternative investments to a portfolio will increase returns or avoid losses.
