Articles on Hedge Funds
An article about Hedge Funds
Why you should sell hedge funds short and how to do it.
Hedge Fund Overview
The term hedge fund usually refers to private
investment vehicles that seek above-average returns through active portfolio
management. Hedge funds tend to be skill-based investment strategies that
attempt to obtain returns based on the unique skill or strategy of the
trader. These returns are considered "absolute," as they do not depend on
the relative long-term return of underlying traditional stock and bond
Investors are attracted to hedge funds for a variety of reasons. This
includes their potential to deliver positive returns under all market
conditions, low correlation to traditional asset classes, and access to
highly specialized strategies not typically available through traditional
Hedge funds are largely unregulated by U.S. security laws and are strictly
prohibited from advertising. As a result, hedge funds today are offered as
private investment partnerships, generally with fewer than 100 affluent
investors or institutional clients. Not all hedge funds are appropriate for
all prospective investors: most hedge funds are available only to persons
who meet specific financial requirements. Prior to investment, the law
requires that the hedge fund determine the investor's suitability (i.e. is
the hedge fund appropriate to the investor's risk tolerance, investment
goals, and investment experience).
A primary benefit of hedge funds is the low correlation many strategies have
to traditional investments. While past performance is not indicative of
future results, hedge fund strategies historically offer returns independent
from the performance of stock and bond markets. In fact, they aim to
diversify away from traditional "long-only" equity strategies and deliver
positive returns under all market environments.
Alternative investment products, including hedge funds and managed futures,
involve a high degree of risk, often engage in leveraging and other
speculative investment practices that may increase the risk of investment
loss, can be highly illiquid, are not required to provide periodic pricing
or valuation information to investors, may involve complex tax structures
and delays in distributing important tax information, are not subject to the
same regulatory requirements as mutual funds, often charge high fees which
may offset any trading profits, and in many cases the underlying investments
are not transparent and are known only to the investment manager.
Alternative investment performance can be volatile. An investor could lose
all or a substantial amount of his or her investment. Often, alternative
investment fund and account managers have total trading authority over their
funds or accounts; the use of a single advisor applying generally similar
trading programs could mean lack of diversification and, consequently,
higher risk. There is often no secondary market for an investor's interest
in alternative investments, and none is expected to develop. There may be
restrictions on transferring interests in any alternative investment.
Alternative investment products often execute a substantial portion of their
trades on non-U.S. exchanges. Investing in foreign markets may entail risks
that differ from those associated with investments in U.S. markets.
Additionally, alternative investments often entail commodity trading, which
involves substantial risk of loss.
IV. How To Invest
With an estimated 6000 hedge funds managing in excess of $550 billion, most
investors today are questioning where to begin. Many investors attempt to
conduct their own due diligence and invest directly with specific managers,
while others take advantage of professional hedge fund consultant firms to
research, advise and monitor their investments.
Investing with a hedge fund manager involves a complex evaluation process.
Identifying the best managers can be very difficult. Hedge fund managers are
not required, and in many cases not allowed, to advertise or report
performance data to any central authority. As a result, many of the top
hedge fund managers are not listed in commercially available databases.
Hedge fund consultants can greatly assist in this process. Research
specialists, with access to this data, screen the universe of hedge funds in
search of high quality candidates for further analysis. They perform
qualitative, on-site evaluations and review a manager's background,
financial statements and corporate documentation in an attempt to identify a
competitive advantage. This process often includes a quantitative review
focused on the performance statistics related to volatility, consistency,
and peer comparisons.
Consultants help investors define their investment profile and offer their
clients a unique range of comprehensive hedge fund solutions. They then help
clients monitor their investments to compare performance with their original
investment parameters. They may advise a client to redirect their investment
allocations as a result of changing market conditions, some asset classes
outperforming others, or a change in the investor's objectives.
While there are risks involved, and hedge funds are not suitable for all
investors, there is a compelling argument for the inclusion of hedge funds
in a traditional investment portfolio. Many hedge funds can offer enhanced
portfolio performance under various market conditions. It is hedge fund
managers' flexibility and skill-based strategies that make this investment
class inherently attractive. However, investors need to approach these
investments with the necessary information to make an informed decision.
Researching and evaluating hedge funds presents a host of challenges to even
the most sophisticated investor. Through an appropriate allocation, hedge
funds can be an attractive addition to a well-diversified portfolio designed
to deliver positive returns while attempting to reduce volatility and risk.
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