Up ‘til now, there hasn’t been a hedge fund option for individual investors. Hedge funds traditionally required a minimum investment of several million dollars, so are offered to specific investors such as pension fund managers, foundations, endowments, and extremely wealthy individuals who can afford them. Because today’s market is so volatile, people are looking for different options where they can place their money. So as this new alternative, hedge funds are being redefined to reach a larger portion of the population through the creation of new mutual funds.
Hedge funds work by using advanced investment strategies – such as leveraged, long, short, and derivative positions – in both domestic and international markets to outperform the market. But do they do what they promise? As with any asset, history shows, sometimes yes, sometimes no.
A major problem with doing due diligence on the money managers and on the funds themselves is that investors may not understand the advanced strategies involved. These sophisticated tools are not easily explained, so do your research and read all the fine details. Understanding the terminology and concepts will build your confidence so you are not intimidated by this investment option. Do not accept that the functionalities are “too complicated.”
What you will find is some money managers have a proven track record of exceeding expectations, consistently outperforming the market. Are they anomalies? Perhaps. And perhaps these managers’ portfolios do support their claims.
But consider another factor you could face: Fees, fees, and more fees. That’s the cost of investing at this level. According to David F. Swensen, chief investment officer of Yale University, fees are becoming a huge issue with hedge funds. Check the money manager’s track record; be sure it warrants the extra money.
Here’s another trap to be sure you avoid: Investing in a hedge fund for the status—just because they are viewed as mutual funds for the super-rich. It is like showcasing that you are wearing a “limited edition” pair of Manolo Blahniks. Investing is serious business, so do it based on your needs and goals. Do not consider what anyone else might think.
Just to highlight, a recent Businessweek article indicated hedge funds perform about average in relation to other investments. A portfolio that is a 60/40 split in stocks and bonds gained 3.5% annually over the past 5 years compared to a loss of 2.2% in the Bloomberg Hedge Fund Index. Some do feel that despite these results, hedge funds have protected investors from the current economic conditions—a low interest rate environment and sputtering global economy.
I think hedging may be more about beating the odds. Everyone wants to be the one who has the winning strategy. But looking at the big picture, it appears that at the end of the day, the simple approach might end up getting you to retirement while buying you just as many stilettos.
I want to conclude with a 50 year old message from investment legend Warren Buffet. He says you can count on the market fluctuating 20–25% positive or negative during any ten-year period, but for most years the market will be somewhere in between. “I haven’t any notion as to the sequence in which these will occur, nor do I think it is of any great importance for the long-term investor.” Fluctuations are a normal part of the investment cycle. So you decide, is a hedge fund the right stiletto for you?