Hedge Funds: Pros and Cons.
Hedge funds pool investors’ money and invest those funds in financial instruments to make a positive return. Many hedge funds look at all sorts of possibilities in all types of markets. Hedge funds can be very speculative in their investment options. Many of these options include a very high level of leveraging that can increase both returns and exposure to loss.
Hedge funds are not required to register with the Securities and Exchange Commission. Hedge funds typically issue securities in “private offerings” that are not registered with the SEC. Also, hedge funds are not required to make periodic reports to the Securities and Exchange Commission. Hedge funds are subject to the same rules prohibiting fraud, and their managers have the same fiduciary duties as other investment advisers.
What do I need to know before investing in a hedge fund?
Carefully read a fund’s prospectus, offering information and marketing materials. Make sure you understand the level of risk involved in the fund’s investment strategies and ensure that they are suitable to your personal investing goals, time horizons, and risk tolerance. Hedge funds can return higher yields than mutual funds, but they can also expose the investor to higher risks.
Limitations on your right to redeem shares may cause the value to destabilize.Most hedge funds will limit opportunities to redeem, or cash in, your shares. Most hedge funds will allow redemption 3-4 times a year. Also, some hedge funds will require that a percentage of your funds be unavailable for a selected time period, such as one year or longer.
Understand how a fund’s assets are valued.
Funds of hedge funds and hedge funds may invest in highly illiquid securities that may be difficult to value. Many hedge funds give themselves significant discretion in valuing securities. Understand how the assets are valued and make certain that you understand the formula for liquidating your investment.
Understand fee structure.
Fees can impact your return on investment. A hedge fund typically charges an asset management fee of 1-2% of assets, plus a bonus of a percentage of the yield. These “performance” options can be very high and can offset your expected returns. A very high-performance fee may cause the manager to take a risk that can lead to exposure to loss.
Limitations on your right to redeem shares may cause the value to destabilize.
Most hedge funds will limit opportunities to redeem, or cash in, your shares. Most hedge funds will allow redemption 3-4 times a year. Also, some hedge funds will require that a percentage of your funds be unavailable for a selected time period, such as one year or longer.
Understand the ability and background of the hedge fund managers.
Complete due diligence is vital in selecting the correct hedge fund for investment.
Am I protected and are my funds guaranteed?
Hedge fund investors do not receive all of the federal and state law protections that commonly apply to most registered investments. Most hedge funds will not disclose all exposure potential and are not required to do so by the SEC. The SEC may investigate the background of hedge fund managers, but it is not a requirement before joining a hedge fund. In the event of fraud, the SEC may investigate and may become involved in fraud research for civil issues and department issues. Unlike insurance products and bank deposits, your funds are not guaranteed.