Investing in Hedge Funds

In 2007, when the subprime mortgage crisis emerged, many financial market pundits pinned a large share of the blame on certain major Wall Street investment banks and brokerages, such as Bear Stearns, charging that they had actively promoted certain highly speculative hedge funds as prime investment vehicles. The extensive media exposure, in turn, resulted in many investors having negative views of all hedge funds.

Ignoring the media, other investors have continued to actively invest in hedge funds, considering them to be respectable investment vehicles.

Since many investors know little about hedge funds, due to their secretive nature, there are questions that one should ask before entering this sometimes volatile market:

What Is a Hedge Fund?

Appropriately named in 1949 by highly respected financial journalist Alfred Winslow Jones, “hedged funds” (as Jones called them) promised higher investment returns by "hedging" against market downturns. Jones’ investment philosophy involved investing for the long term in stocks that generally performed better than the market, and hedging this investment by short-selling stocks that generally perform worse than the market. The goal of Jones’ hedged approach to investing was sustained profitability at a predictable margin, regardless of market conditions.

Few, if any, of today’s hedge funds employ Jones’ disciplined strategy. Most hedge funds now focus on beating the market and achieving huge returns – a high-risk investment philosophy that has the potential for huge profits as well as devastating losses. Hedge fund managers pride themselves on their ability to produce returns significantly above the market, and many funds are very successful.

Hedge funds usually require a much higher minimum investment and often charge higher fees than other investment vehicles.

Should You Invest in a Hedge Fund?

As with all investments, buyers should enter the marketplace as educated and informed as possible.

Despite the subprime mortgage crisis and resultant negative press in 2007, many financial pundits had estimated that only 5 percent of hedge funds had indeed been guilty of gross mismanagement and/or fraudulent behavior, particularly in regard to high-flying speculation on faulty mortgage debt instruments.

In fact, since 1949, most hedge funds have been respectable investment vehicles comparable to other tried and true Wall Street investment vehicles.

Is a Hedge Fund a Mutual Fund?

At first glance, hedge funds are similar to mutual funds. Like mutual funds, hedge funds are a diversified "basket" of investments that may include a range of stocks, bonds, and/or money market instruments.

Unlike mutual funds, hedge funds are not directly regulated by the U.S. Securities and Exchange Commission because they fall under legal jurisdiction as private partnerships. However, the SEC does become directly involved in matters of fraudulent market practices pertaining to hedge funds.

Can an Average Investor Invest in a Hedge Fund?

While most mutual funds are open to a wide pool of investors large and small, most (if not all) hedge fund investments are only available to "accredited investors", a select group defined by federal securities laws. These accredited investors consist of individuals and/or institutions that are legally permitted to engage in higher risk investments including hedge funds.

Most hedge fund minimum investments start at $1 million, but smaller investors shouldn't give up hope. "Funds of hedge funds" are a type of super-hedge fund that offer lower minimum investments, typically $25,000. They invest, of course, in hedge funds.

How Do You Find the Right Hedge Fund?

Hedge Fund Research, Inc. (at http://www.hedgefundresearch.com/) is a good starting point for beginning and professional hedge fund investors alike. The Web site is part-financial newsletter and part-subscription service specializing in the aggregation and dissemination of "alternative investment information", including hedge funds.

Before investing in a hedge fund, gathering diversified financial information is a necessity. However, because there are many research services, pundit newsletters, and Wall Street newspapers available to the public, gathering this information can become expensive.