Hedge Fund

Hedge funds are private pools of capital usually limited to 100 accredited investors and run by a money manager, who also contributes his or her own money in the fund. The minimum investment has been $1 million or more, but some funds accept as little as $100,000. This number may come down even lower to $25,000. The fees charged by the funds are 1% to 2% as management fees and approximately 20% of the profits a year. 

Generally, the invested money has to leave in the fund for a minimum of year. The funds are unregulated unless in the event of fraud. Some funds use the high-water mark which is to limit the pay of 20% fees. For example, a fund increases its assets by $10 million from profits a year. A manager gets $2 million fees. However, the manager will not be paid 20% fees in the future unless the future assets from profits surpasses the previously set $10 million profit mark.

When many investors look at hedge funds, they see only the allure of these high-risk investments. In reality, hedge funds are the workhorse of the investment industry. They are considered successful only if they make money—in both up and down markets. Achieving success in all kinds of markets isn’t easy, so hedge funds use some creative—and risky—strategies. When shooting for absolute performance, a hedge fund might sell short, use leverage, trade put and call options, trade futures and invest in emerging markets. In a bull market, the best way to make money is to be long. In a bear market, the best way is to be short.

Gaining in Popularity

Hedge funds around the world have an estimated $450 billion in assets. In the first nine months of 2001, $22.3 billion flowed into these funds—$6.8 billion in the third quarter alone, more than in all of 2000. The number of hedge funds has climbed to nearly 6,000 today from 300 in 1990.

Beware What You Don't Know

Broadly speaking, hedge funds are unregulated investment pools. They generally are more nimble and dynamic in their trading strategies than other investment funds. These strategies can be very sophisticated. Contrary to the old saying, what you don’t know can hurt you.

Hedge funds are private entities, typically organized as limited partnerships or as limited liability corporations. Because the funds are private, they have tremendous flexibility in the types of investments they can make and the strategies they can follow. This flexibility is what makes it possible for hedge funds to offset risks against each other and perform well under all kinds of market conditions.

Because hedge funds are private, they aren’t required to report returns, don’t generally have to disclose their security holdings and sometimes lock up investors’ money for a year or more. In contrast, mutual funds post their net asset values daily, disclose their holdings quarterly or semiannually and can easily be bought and sold on a daily basis.

Hedge funds truly are a hush-hush business. Since they are nonpublic offerings, securities regulations prohibit them from advertising. They can’t cold-call prospective investors. Hedge funds typically secure investors by word of mouth and through referrals from investment consultants, registered representatives, stockbrokers and other financial professionals. Courting even a small group of investors can be tricky, since hedge funds are technically required by federal securities laws to have preexisting relationships with all of them.

Exhibit 1: Useful Links for More Hedge Fund Information

www.mfainfo.org. The Managed Funds Association is the trade group for the alternative investment industry, including hedge funds, funds of funds and futures funds.

www.aima.org. The Alternative Investment Management Association is a forum for hedge funds, managed futures and currency management.

www.hedgefund.net. This site provides an interactive hedge fund database.

www.tassresearch.com. The Tremond Tass (Europe) Limited Web site includes the company’s TASS Database, a comprehensive hedge fund database of more than 2,400 funds and managers.

www.iialternatives.com. This site provides access to Alternative Investment News, a newsletter published by Institutional Investor Inc.

www.iijai.com. The Journal of Alternative Investments, also part of Institutional Investor, provides original research on managing and investing in a range of alternative investments including hedge funds, private equity, commodities, futures, oil and gas, timber, funds of funds and other assets.

www.thehfa.org. The Hedge Fund Association is an international not-for-profit association of hedge fund managers, service providers and investors.

www.hedgefundresources.com. This site has a library of articles on hedge funds.

www.hedgeworld.com. The site is a source of hedge fund information and news and includes a service provider directory.

www.hedgefundnews.com. The site offers a database, articles and news.

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