Hedge Fund Investing

Hedge Fund Investing should be based on your portfolio’s needs. These funds should be excess capital filling blank spaces in your constructed portfolio, and not large percentages. If you’re in need of coverage in specific asset classes, you can use these funds which manipulate that asset class for profit. The same is true for investment regions and market sectors.

Selected funds should not overlap with other investments, especially mutual, index, or exchange traded funds. Funds should be selected based on diversification in assets or strategy alongside the balance of risk and return the fund can potentially provide.

Seek Alternatives First

As an early note, you should always research potential alternatives to hedge fund investing in the sectors or areas targeted for investment. They are expensive vehicles, and you may retain more capital without investment. Research if you can gain the same exposure and diversification to the target investment sector without paying hedge fund costs. Index, exchange traded, or mutual funds often access the same investments, but may be limited in their tactical usage. Note that strategically, these alternative funds are highly limited in comparison. Index and mutual funds are barred from using certain strategies and asset classes which provide strategic advantages. Examples of investments or strategies alternative funds may be barred from accessing include: Short sales, leveraged plays, high yield bonds, futures, options, other derivatives, private equity, venture capital, mortgage based assets, synthetic assets, and more. The light regulation status of hedge funds allows them to exploit these opportunities. Regulated funds cannot exploit the opportunities that they can find in bear, bull, or stale markets.

If you do not desire those assets or strategies, index and mutual funds may provide diluted access to the same opportunities at lower costs. The most notably absent fees are performance fees, which can absorb ten to fifty percent of the hedge fund’s investment returns per year. Almost every other fee can be encountered in an index or mutual fund, but at a substantially lower level than hedge funds.

The difference is substantial: A hedge fund with equal market return as the market, or a mutual fund, will lose by its performance fee after costs are deducted. If the hedge fund, the mutual fund, and the market all have a 10% return, the hedge fund’s return is reduced to 8% purely by a 20% performance fee. To equal the market, the hedge fund will have to reach 12.5%, and more to beat it under a 20% performance fee. Asset management, withdrawal, and deposit fees make this concern even worse. If you’re unsure if a fund manager can beat the market by more than their performance fee, or simply don’t care due to diversification or strategic benefits, look at the cheaper alternatives.

Excess Capital Only

When hedge fund investing, money used in any fund needs to be excess capital you won’t need short term. Hedge funds are time gated; withdrawal fees and charged penalties are applied against those who exit too early. Returns are also a part of the problem: excessive fees slow the rate of return, so investors may need longer periods of time before returns add up.

Hedge funds often prepare to capitalize on opportunities they expect to happen years in advance. This requires purchasing investment positions relative to the strategy’s execution early. Hedge funds are not short term investments and withdrawal fees exist to dissuade this purpose. These investment vehicles are for long term or permanent investments only, but they may be used for mid-term investments if their structure doesn’t penalize withdrawals at your planned exit time.