How many assets do you have in your investment portfolio? You may want to consider diversifying if the answer is only one or two. If, for example, you only invest in stocks, you won’t have a backup if the market plummets.
Investing in a hedge fund is one of the riskiest ways to diversify, but it can come with a hefty return.
What is a hedge fund? It’s a partnership between private investors whose assets are managed by a team of fund managers.
These managers use several techniques and strategies to ensure investors make their financial goals by delving into real estate, land, currencies, and more.
There are a few things you should know before you invest in a hedge fund. Check out this guide to learn more.
Pros and Cons of Hedge Funds
Again, hedge funds are one of the riskiest investments that a person can make. While they can bring in high financial rewards, there is also a large potential for loss.
Some assets will perform well, and others will flop. If you don’t understand that going in, you’ll be met with disappointment. Of course, you can mitigate some of the risks by choosing the right hedge fund manager, but you should consider all the pros and cons.
Flexibility
Hedge funds offer more flexibility than other investment options. There are many strategies to choose from.
If you’re fine with modest returns if it means keeping your risk to a minimum, there’s an option for you.
Diversification
If your investment portfolio is only comprised of one thing, you’ll experience a huge loss when its value declines.
Having a hedge fund will help you diversify your portfolio and keep your finances sturdy during times of uncertainty.
Lock-up
The biggest drawback of hedge funds is the lock-up period. You won’t be able to withdraw or use your finances.
Depending on the hedge fund, you may not be able to touch your assets for up to six months at a time.
Tax Burdens
Hedge funds can come with painful fees. That includes taxes. You could end up paying over 40% of your returns.
No Regulation
As we’ll talk about later, you’ve got to take your time and find the right hedge fund manager.
Regulators aren’t able to monitor a manager’s activity. That means if they make a decision that bankrupts the hedge fund, there’s not much that can be done about it.
Types of Hedge Fund Strategies
Once you understand the risks, the second step to choosing a hedge fund is to study the different strategies available.
Each strategy comes with advantages and risks. We’ll start with global macro hedge funds.
Global Macro
The global macro strategy comes with the highest amount of risk. It looks at how macroeconomics, such as interest rate policies and political events will affect investments. In some cases, global trends can create unique financial opportunities.
Global macro hedge funds are versatile. They can include everything from stocks to Bitcoin and other cryptocurrencies.
Equity
Equity hedge funds are the most simplistic. Managers will analyze various companies. If they believe that an equity will perform well, they’ll invest in stock.
While they use tactics to help mitigate losses, this strategy does require quite a bit of strategic planning. If a hedge fund manager makes the wrong call, it could damage the investor.
Market-Neutral
The market-neutral strategy is similar to the equity one. It involves creating balance by investing in both increasing and decreasing financial markets.
This strategy can help limit losses by helping an investor avoid overexposure to the market. It’s for this reason that it’s a little less risky than equity hedge funds.
Arbitrage
Arbitrage hedge funds are also known as mutual funds. Managers will buy and sell an investor’s assets in a variety of markets. This lets them look at price differences so that they may make the best financial decisions.
Arbitrage hedge funds mitigate risk on the investor’s part and can produce stable financial returns.
Quantitative
Quantitative hedge funds can be a bit difficult to understand because they involve a heavy amount of math.
Managers must use statics and complex formulas to predict an investment’s performance.
Credit
As the name suggests, this type of hedge fund strategy revolves around credit and lending.
When a business goes into debt, hedge fund managers may buy up that debt at a reasonable discount.
Event-Driven
The last type of hedge fund strategy to be aware of is event-driven. Managers that use this strategy keep an eye out for big events that could create huge financial waves in a company.
Some of these events include mergers, acquisitions, and bankruptcies. An event-driven strategy can also allow managers to take advantage of stock mispricing.
Consider Your Motives
While performance is a large part of investing in a hedge fund, it shouldn’t be your only motivator.
As stated above, the main purpose of investing in a hedge fund is to diversify your financial portfolio. Hedge fund managers don’t only take risks with stocks. They will also look into assets like real estate and foreign currencies.
Do Your Homework
In total, there are 15,000 hedge funds in the world. You don’t have to rush into a choice. Never commit to a hedge fund without performing a thorough investigation.
Look at its past performance. Think about how it may fit into your current financial plans and help you meet your goals.
During the beginning stages of choosing a hedge fund, it’s wise to get in touch with a risk manager or financial advisor. They’ll crunch the numbers and give you a realistic run down of how the hedge fund may perform.
Think About the Age of the Fund
The older a hedge fund, the more information you can gather about it. You can look at how it’s performed as time has gone on.
How did it hold up during stock market crashes and times of financial uncertainty?
Ask About the Fees
Once you choose a hedge fund, you’ll have to pay an upfront cost. Depending on the hedge fund, the initial investment could be $100,000 or more.
Most hedge funds will charge an asset maintenance fee of around 1% of the value of your investment. When your assets do well, you’ll have to pay a small performance fee, too.
Redeemable Timelines
You won’t be able to redeem your shares whenever you want. Most hedge funds have timelines in place that state when you can collect.
In the case of most hedge funds, this is about four times a year. Remember to also ask about lock-up periods.
Hedge Fund Managers
The difference between financial success and failure will depend largely on your hedge fund manager. It’s their job to analyze the market and make investment recommendations to their clients based on their data.
A good manager will change their strategy depending on how the market fluctuates. When the market plummets, they’ll know how to help their clients come out on top.
Look for a hedge fund manager who communicates. You must be informed when your assets are doing well, and when their performance is at a standstill.
Depending on the value of your assets, consider looking for a manager with a registered investment advisor certification.
Those with a chartered financial analysis certification must obtain their bachelor’s degree and complete a series of three financial exams. They also have to have four years of relevant work experience.
Hedge fund managers with a certificate in hedge fund regulation know everything there is to know about federal hedge fund laws.
How to Invest
Not everyone can qualify for a hedge fund due to the risk surrounding them. There are regulations in place that limit entry to accredited investors.
To become accredited, you must have a high net value of $1 million, not including your home.
The only exception to the rules is EFT hedge funds. They can serve the same purpose as a regular hedge fund, but you don’t have to be accredited.
Invest in a Hedge Fund That’s Right for You
As you can see, there’s a lot to consider before you invest in a hedge fund. The first step is understanding the various strategies and risks.
After that, you’ll need to research hedge funds and choose the right manager. When getting in touch with hedge funds, don’t forget to ask about fees.
Are you ready to get started with a hedge fund that will help your family’s wealth grow? Joshua M. Peck can assist you.
As the chief investment officer at TrueCode, he has all the knowledge and tools available to help investors with their portfolios. Schedule a consultation today!
