How To Invest In Hedge Funds?

A hedge fund is an investment that pools money from high-net-worth individuals and utilizes complex strategies to maximize returns while diversifying risk. They are managed by professional fund managers who employ various strategies like short-selling, leverage, and alternative asset classes to produce above-average returns on investments. 

Because of this, hedge funds are generally only available to high-net-worth individuals and don’t cater to ordinary retail investors. But who can invest in a hedge fund? While it is very difficult for individual investors to gain access to hedge funds, it is possible to invest in them through indirect methods. 

In this blog, we will discuss what is a hedge fund, who can invest in them, and how. Let’s get started. 

What is a Hedge Fund?

As mentioned above, a hedge fund pools money from investors to buy other types of investments. While this may sound a lot like mutual funds and ETFs, hedge funds make higher profits by using unorthodox strategies to reduce risk. 

They employ strategies like short-selling, leverage, and alternative asset classes. Moreover, hedge funds can purchase types of assets that other funds can’t invest in, like art, currency, and real estate. 

Hedge funds use these risky strategies to produce returns even when the market conditions are down. This is highly appealing to investors who want to earn significant returns in bad market conditions. Moreover, hedge funds have a sort of glamour associated with them. For instance, they are seen by some investors as exclusive clubs that you have to qualify for. 

Who are Hedge Fund Managers?

Hedge funds are managed by professional fund managers to minimize risks while maximizing returns. A hedge fund manager makes daily investment decisions for a particular fund. They choose how to distribute the invested money and manage the risks. 

Hedge fund managers are paid a handsome sum to be successful. They get paid a performance fee, which can be up to 20% of the fund’s profits. 

As they are crucial to a hedge fund’s success, it is important to make sure any hedge fund manager is qualified to handle your money. 

Key Characteristics of Hedge Funds

While hedge funds seem a lot like mutual funds and other pooled investments, they have glaring differences that set them apart. 

Qualification

One of the main characteristics of hedge funds is that they are only available to accredited investors. There is a minimum amount of $250,000 to $2 million that you must invest to qualify for a hedge fund and the total number of investors is also fixed. 

Lock-in Period

Hedge funds have a lock-in period of 12 months. The withdrawals are restricted to quarterly or bi-monthly depending on the scheme. 

Fees

Hedge funds have a fee structure known as “Two and Twenty,” where a 2% fee is calculated as 2% of the total assets of the company and 20% of the profits generated. 

Investment Strategy

Hedge fund managers use unorthodox investment strategies to minimize risk while maximizing returns. They can invest in any asset class they deem profitable, like art, real estate, currency, equity, and more. These are asset classes that are generally not available to other funds. 

Hedge Fund Fees and Minimums

Hedge funds have an initial investment minimum of $250,000 to upwards of $2 million. Moreover, they are not highly liquid like stocks or bonds and may only allow you to withdraw your money during set times of the year. 

Besides this, hedge funds also charge a hefty fee. Typically, they charge an asset management fee of 1% to 2% of the amount that you have invested. But that’s not all. You also have to pay a performance fee that is equal to 20% of the profit of the hedge fund. All of these additional fees may diminish your returns. 

This won’t be a major concern if hedge funds drastically outperformed the market but that is generally not the case. Due to this, ETFs and mutual funds, with an average expense ratio of 0.13% are slightly better options. 

Who Can Invest in Hedge Funds?

 Since hedge funds have a lot of risks associated with them, the U.S. Securities and Exchange Commission(SEC) placed several regulations on who can invest in hedge funds. 

Only accredited investors or institutional investors like pension funds can invest in hedge funds. Accredited investors have a net worth of at least $1 million, not including their primary residence, or annual individual income of over $200,000($300,000 for married). 

While that may not seem like much, it consists of a very small fraction of the U.S. population. Only about 4% of households earned more than $300,000 in 2019. 

All these regulations tell us that investing in hedge funds is not intended for average investors. 

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How to Invest in Hedge Funds?

Investing in hedge funds is quite tricky. Firstly, you must research funds that are currently accepting new investors. While there are several online tools available, we recommend consulting a financial advisor to identify suitable hedge funds. 

Once you have evaluated those funds’ investment goals and fund managers with the Form ADV, you have to contact the hedge fund manager and determine the minimum investment requirements. 

To actually invest in a hedge fund, you will also have to prove that you are an accredited investor. There is no standardized method and each fund has its own practices to determine your status. You may be asked to produce your income, assets, debts, and experience. 

How to Invest in Hedge Funds Indirectly?

If you fail to qualify as an accredited investor or don’t meet the hedge fund firms’s requirements, you still have a few options to invest in hedge funds indirectly. 

For instance, you can find ETFs or mutual funds that use similar strategies to hedge funds, like short-selling or leverage. The Global X Guru(GURU) ETF claims to follow the same strategies as hedge funds. 

However, it is also important to remember that there are better pooled investment vehicles out there that are better at growing your wealth. Historically, broad-market index funds have outperformed hedge funds. And the best part is if you are investing for the long term, continuing to invest in index funds when the market is down allows you to buy low and enjoy higher returns when the market recovers. 

Read Also:- Investing in Index Funds: Everything You Need to Know

Pros and Cons of Investing in Hedge Funds

No investment vehicle is perfect and each comes with its benefits and risks. So is the case with hedge funds. Here are some of the pros and cons of investing in hedge funds. 

Pros

• Hedge funds use unconventional investment strategies with multiple asset classes. 
• They offer portfolio diversification and allow you to profit from different market conditions. By investing in hedge funds, you can book profits during bullish and bearish markets alike. 
• They are managed by professional fund managers who ensure higher returns.

Cons

• Hedge funds have lock-in periods and are illiquid in nature. This means you can not withdraw your investment whenever you want. 
• You are highly relied on the fund manager’s strategy. In the event, that they fail, you will be suffering major losses. 
• Only available to accredited investors and have very high initial investment minimums. 

Is Investing in Hedge Funds Profitable?

If you qualify as an accredited investor and have hundreds of thousands of dollars to invest, investing in hedge funds is a great option to diversify your portfolio and hedge against market volatility. 

However, if you are an average investor like most, investing in index funds that track broad market indexes like the S&P500 or NASDAQ will likely get you better returns. It is also important to remember, that the goal of investment is to grow your wealth over time. Long-term investments are always better than short-term investments. 

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