Investing In Hedge Funds: 10 Tips
If you are investing your money in hedge funds, having an understanding of these "hedge funds: 10 tips" will keep your investment safe while maximizing your return. Hedge funds, aptly named because of their hedging strategy, can be an important part of any investor’s portfolio. However, to get the most out of investing in hedge funds, potential investors must be aware of hedge fund idiosyncrasies and tips to maximize their investment.
- Understand the fund’s underlying investments. Hedge funds invest in many different products including stocks, bonds, options, futures, derivatives, commodities, and limited partnerships. As an investor, it is your responsibility to know what your hedge fund invests in and how those financial products work. This allows you to determine if, and when, you want to get out of the fund (if you see "headwinds" that you think the hedge fund manager is ignoring, it’s time to take your money elsewhere).
- Analyze the fee structure of the hedge fund. As with most mutual funds, hedge funds have a fee structure that can eat away at returns. A useful tip for investors is to read the prospectus to understand what fees you will be charged and when they will be charged to determine how that will affect your rate of return.
- Research the investment style of the hedge fund. Most hedge funds fall into one of a few broad categories to describe their investment style: aggressive growth, distressed securities, income, macro, emerging market, market timing, opportunistic, value, and short selling to name a few. Understanding the investment style will help you determine the risk profile and if it is a fit for you.
- Research the past performance of the hedge fund. This is an important tip to follow. Past performance is never an indicator of future performance, but it will serve as a benchmark when analyzing the fund manager. Does the hedge fund perform as advertised – in all types of markets?
- Make your own determination of future performance. A successful investor always determines their expected rate of return before placing money in an investment. Hedge funds should be no different – analyze the underlying assets and your expected performance of those assets to determine your expected rate of return. Make sure this expected rate of return is adequate for your investment.
- Know who the fund manager is and their area of expertise. A great tip for investors is to pay attention to the fund manager. The fund manager plays in integral role in the performance of the fund. Make sure the hedge fund manager’s area of expertise matches the fund’s underlying investments and trading strategy.
- Understand the trading practices of the hedge fund. Know and be comfortable with the trading strategy of the hedge fund. Typical strategies include short and long positions, options trading and derivatives trading.
- Determine the appropriate benchmark. To determine the appropriate benchmark, you will need to know the basic strategy of the hedge fund. If the purpose of the fund is to beat the equity market, you should compare returns to an equity index. If the purpose is to provide a stable rate of return regardless of what the market is doing look at historical performance in bear and bull markets.
- Do not be afraid to bail. If the hedge fund does not meet your expectations, do not be afraid to take your money and walk. An alternative investment will likely suit you better.
- Make sure your hedge funds are part of a broader portfolio whose risk profile is appropriate for your situation. As with anything in life, it is unwise to put all of your eggs in one basket. Diversify your exposure and make sure your hedge funds are only one part of your investment portfolio.