Hedge funds have been around for about 70 years and what was strictly a U.S. investment industry has now gone global with both investors and hedge funds participating from throughout the world.
I invested personally in a hedge fund for the first time in 1998. In 2001 when I launched our Eagle Rock Diversified Fund as a vehicle for investors to invest in a diversified portfolio of hedge funds there were about 3000 hedge funds to choose from with most being U.S. based. Now it is estimated there are perhaps over 13,000 hedge funds throughout the world and available to investors globally.
Plan to attend a unique September event for current and potential hedge fund investors
What are hedge funds?
Hedge funds are structured as limited partnerships with all investment decisions being made by the General Partner. Limited partner investors' risk is limited to the capital they invest in a hedge fund.
For the new comer to hedge fund investing an easy way to develop a quick understanding of hedge funds is to compare them to typical mutual funds. For example, hedge funds:
· are generally smaller and more concentrated than mutual funds
· have high minimum investment requirements (typically $1 million or more) while mutual funds have virtually no minimum investment requirement.
· typically require all investments to remain invested for at least a year (the "lock up" period). Mutual funds lack similar "lock-up" provisions....in today and out today is possible with mutual fund investments.
· are managed by the owner with his or her own skin in the game. Mutual funds generally are managed by portfolio managers working for salaries and bonuses and they may or may not be personally invested in the mutual fund they run.
· often use more investment tools than do typical mutual funds
· are limited to having either up to 100 or up to 500 investing limited partners (hence the reason for the high minimums) while mutual funds do not have similar restrictions.
· investors need to be accredited by annual income ($200,000/year individual or $300,000 household income)) or net worth ($1 million or higher). Mutual funds can accommodate essentially any type of investor regardless of their financial strength.
· have restrictions on their marketing efforts while mutual funds can aggressively market themselves.
· restrict when investors can withdraw capital from their funds after the "lock up" period and often provide monthly or quarterly redemptions. Mutual funds provide daily liquidity.
· are much more difficult to learn about. They are not listed on the exchanges. Mutual funds are easy to identify and track.
History of the industry
The earliest hedge funds were launched in the '40's and were designed for sophisticated high net worth individual and institutional investors looking to hedge their investments with portfolio managers using both long and short strategies. That is, investors were looking to generate gains whether the markets were going up or going down. It was a cottage industry back then.
Today the industry still appeals to high net worth individuals while being increasing used by large institutional investors including college endowments (Yale, Harvard, MIT, Notre Dame and 100s more), private and public pensions (teachers unions for example), trusts and non-profits all looking to diversify their investments in this alternative asset class which may provide above average returns while providing protection against market volatility and risk. Hedge funds typically provide greater liquidity than do other alternative asset forms of investing including venture capital, private equity and real estate.
Learning about hedge funds
Large investors learn about hedge fund investing opportunities by attending major international conferences, subscribing to hedge fund research services, getting guidance from their financial advisors and being called on by hedge fund marketing representatives.
Most individual and smaller institutional investors lack the same research capabilities as do large investors and have to rely on web sites tracking the industry (www.barclays.com and www.eureka.com are two such sites), attending industry conferences in their markets and advice from their investment advisors who may or may not be as knowledgeable as advisors to large investors.
Advantages to hedge fund investing
The key reasons I invest in carefully selected hedge funds is because:
· some of the world's best investment managers head their own hedge funds and have their own capital invested in their funds. I like investing side by side along with exceptional investment professionals
· generally the best hedge funds outperform the best mutual funds regardless of the market cycle.
· every investor in a hedge fund has her or his own tax basis which is not the case with mutual funds for example.
· I lack the skill and time necessary to invest successfully in this rapidly changing global economy in individual securities. Most individual and smaller institutional investors are in a similar boat. Investing in a hedge fund gives me the exposure with a single investment in a portfolio of secuties being managed by the hedge fund management team.
Concerns when investing in hedge funds
Generally the most important reasons investors shy away from hedge fund investing is because:
· they don't understand the industry and how to do it successfully
· their advisors also lack expertise and access to the best of the best hedge funds
· the "lock-up" periods for each investment can be an obstacle for investors needing quicker access to their invested capital
· the press on the industry is often negative. The solid, top performing hedge funds never seek publicity and don't need it. This industry is no different than any other. They all have their winners, losers and scoundrels.
Selecting the right hedge funds for your portfolio
In picking hedge funds to go into our Eagle Rock Diversified Fund I stick to ones that:
· have been around for at least three years. Hedge funds (like most businesses) that fail often do so in the first three years.
· have an audited track record. Never invest in a non-audited fund of any type. Make certain the audit firm is a well recognized one in the industry.
· have a track record that meets your investing objectives. In our portfolio I stick with hedge funds that exceed the S&P 500 returns by an average of 500 basis points/year
· have a "lock up" period of one year or less. There are plenty to choose from.
· are headed by a general partner with whom I can meet. I only want to invest with people heading the investment process I have met and have confidence in. Hedge fund investing is very much like picking the right ship captain.
· have an investment strategy and a risk management process that I understand. Never invest in any thing that you don't understand!
· have a reasonable fee structure which to me generally means the hedge fund earns 1% per year of the assets we invest and another 20% of any net gain they achieve for us in a year.
The role of funds of hedge funds
Fund of Funds offer the following advantages, particularly to individual and smaller institutional investors. They provide their investors:
· efficient access to a group of hedge fund managers, i.e. a single investment is diversified across all the underlying hedge funds in the fund of funds' portfolio.
· access to a group of hedge funds for a "moderate" investment. For example, you may be able to get into a fund of funds for say a $250,000 investment which could provide you with access to a pool of underlying hedge funds that might each require an investment of $1 million or more.
· with the expertise and industry access of the General Partner who selects and then monitors the hedge funds in the fund of funds.
The perceived disadvantage of fund of funds is that the investors are paying two sets of management and performance fees, one to the fund of funds and one to the hedge funds making up the portfolio.