4 Tips on Hedge Funds.
Many people, especially new investors, are prone to confusing mutual funds and hedge funds. The fact is that these types of funds are very, very different. The Hedge Fund is considered a “private investment vehicle” and it is neither open to the public nor regulated by the SEC. A hedge fund also requires a large initial investment (your net worth in generally required to be over $1 million.) Hedge fund managers are also known to engage is riskier investment activities then mutual fund managers. With all that being said, however, hedge funds can be quite profitable. Here are some tips for investing in hedge funds:
Be Aware of Fraud – This is much more important than it is with mutual funds. The investor is well advised to never forget that hedge funds are private and unregulated. Fraud has plagued hedge funds in the past, and in some cases even their legality has been questioned. Hedge funds can also be prone to appearing and disappearing with little warning. Although this advice applies to any investment, it is extremely important to select a well known fund that has a solid reputation. Beware of new and unheard of funds that propose very unconventional investment strategies.
Don’t invest too heavily in hedge funds – Hedge funds may be quite profitable, but they should not constitute your sole means of investment, or even a large proportion of it. Hedge funds follow different investment strategies that are designed to pay off in bear markets, but may do poorly in bull markets (hence the “hedge” in the name.) Hedge funds can be a valuable part of a large investment strategy, but the fact that they often don’t follow market trends makes them a poor choice to base too much of your investments in.
Size doesn’t necessarily equal performance – Unlike mutual funds, the size of a hedge fund often bears little relation to its market performance. Often a small hedge fund is able to more efficiently target particular areas of the market that large mutual funds avoid, which can be an advantage.
Look beyond official rankings – Databases do exist that rank hedge funds in the way that Standard and Poor and the like rank mutual funds, but they don’t include all funds. Also, because they are unregulated, hedge funds are not nearly as transparent as mutual funds, and have almost no publicly-reported paperwork. It is thus important to seek out more personal, word-of-mouth type advice when looking for a hedge fund. Talk to other investors, seeking out those that have invested in hedge funds in the past.
Hedge funds are certainly a more risky investment than mutual funds: they require a large investment, and often behave more erratically than mutual funds. Precisely for these reasons, of course, they can be a profitable tool for an investor working with large amounts of cash. Just remember that hedge funds should be a “hedge” and not your main source of investment: many fortunes have been lost by relying too heavily on the promises of hedge funds.