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Professional hedge fund managers consolidate investors’ money and then reinvest it in an effort to make positive returns. Most hedge funds seek to profit in various markets through aggressive trading strategies.
New investors can make a hedge fund investment, but it isn’t as simple as investing in an ETF or stock. Hedge funds are private investments and getting into one can be difficult. Hedge funds aren’t heavily regulated, involve speculative investing and costly management fees. They’re considered high-risk investments.
How to Invest in Hedge Funds
Investing in hedge funds is limited to a select few investors. A few critical components make hedge funds different from other pooled investments like mutual funds. Here are 2 main requirements you need to meet to start investing in hedge funds:
- You must have earned an annual income of $200,000 (or $300,000 for a married couple) in each of the last 2 calendar years. This income should be greater or equal to that amount the year you apply to become an accredited investor.
- You can also qualify by proving that your net worth is $1 million or more — that figure excludes your primary residence.
Most hedge funds are structured like limited partnerships, where the investors become limited partners. Typical hedge fund investors include wealthy individuals and pensions.
If you meet the criteria to become an accredited investor:
Vet the Fund
Begin with a thorough review of the hedge fund firm you want to invest with. Pay more attention to its prospectus (the booklet that describes a financial security for prospective buyers) and marketing-related collateral. Understand the risk involved as well as how it fits your unique investment goals, needs and timetable. Avoid focusing entirely on a history of high returns — make a comprehensive risk evaluation before you decide on a hedge fund.
Know the Fund’s Assets
It’s important to know how many assets the fund holds. Usually, hedge funds hold investments that could be difficult to price and sell. A hedge fund manager could help you better understand the fund’s holdings.
Understand all Fee Obligations
Compared to mutual funds, hedge funds usually charge higher fees. Expect to pay anything between 1% – 2% of the total assets, in addition to a 20% performance fee, depending on the fund’s profit levels.
Familiarize Yourself With Your Redeemable Timelines
Hedge funds won’t allow you to redeem your shares at any time. Rather, you’re only allowed to redeem 4 times (or fewer) in a year. Hedge funds impose lockdown periods when you can’t access your money. Understand your fund’s share redemption timetable and whether it aligns with your future financial needs.
Know the Hedge Fund Manager
One of the most important tasks you should undertake is to research the fund manager before you invest your money. Check the manager’s form ADV, which outlines all information regarding a fund. Learn about investment strategies, past disciplinary actions or any conflicts of interest.
Investment Strategies and Techniques of Hedge Funds
Hedge funds are renowned for their diverse and sophisticated investment strategies, which distinguish them from more traditional investment vehicles. Here's a glimpse into some of their core techniques.
- Long-short equity: This approach involves buying (going long) stocks expected to appreciate and simultaneously selling short stocks expected to decline. The aim is to mitigate market volatility and capitalize on stock discrepancies.
- Global macro: Funds using this strategy base their positions on macroeconomic insights, predicting global economic shifts and investing accordingly, often using currencies, commodities and interest rates.
- Event-driven: This strategy targets specific events like mergers, acquisitions or corporate restructurings, aiming to exploit resulting price movements.
- Quantitative: Leveraging complex mathematical models and algorithms, these funds identify and exploit price patterns and market inefficiencies.
- Relative value: Here, the focus is on identifying and capitalizing on price differentials between related financial instruments, like two stocks or bonds from the same sector.
- Fixed Income arbitrage: This technique seeks to profit from price anomalies between related interest rate securities.
- Distressed securities: Hedge funds target companies facing financial duress or bankruptcy, betting on their recovery or further decline.
- Managed futures: This approach focuses on futures contracts, speculating on assets like commodities or financial instruments.
Hedge Funds vs. Mutual Funds
Hedge funds vs. mutual funds? Which makes sense for you? Once you understand the basics, you can decide whether mutual funds or hedge funds are ideal for your personal investment objectives.
There are a few similarities between mutual funds and hedge funds:
- Pooled investments: Both hedge funds and mutual funds are types of pooled investments, which means the assets comprise money from various investors consolidated into a single portfolio.
- Diversification: Diversification means a fund is invested in several securities. Hedge funds and mutual funds are generally diversified but some funds concentrate on a specific security type or economic sector.
- Professional portfolio management: Investors who put their money in mutual funds or hedge funds don’t choose which securities to invest in but instead a fund manager does it.
Although both funds pool money from different investors with the aim of multiplying it, they have their differences. Here are the main differences between the two:
- Accessibility: Hedge funds aren’t as available to the average investor as mutual funds. For instance, some hedge funds require investors to have $1 million in net worth. This is quite high compared to mutual funds which have a $100 minimum initial investment.
- Regulation: Mutual funds are highly regulated by the SEC, but that’s not essentially the case for hedge funds which are loosely regulated.
- Transparency: Mutual funds must annually publish their balance sheets/annual reports as well as the quarterly performance of their assets. Hedge funds, on the other hand, don’t disclose this information to the public but only provide it to their investors.
- Redemption: It is relatively easier to redeem mutual funds since they are relatively less. Hedge funds have a lock-in period (typically 3 years) which makes redemption of funds difficult.
Arguably the greatest benefit of investing with hedge funds is the potential to get steady returns that surpass inflation while still minimizing the market risks. Unfortunately, the average investor won’t possess a high net worth or meet the hedge fund minimum investments’ obligations.
For a majority of investors, a broad portfolio of exchange-traded funds (ETF) and mutual funds is a better investment choice compared to hedge funds. Mutual funds are cheaper and more accessible than hedge funds and the long-term returns could be equal or greater than those of hedge funds.
Hedge Fund Fees
Check out the fee structure before you choose a hedge fund. Hedge funds adhere to a common fee structure of 2 and 20 which implies a 2% management fee and a 20% incentive fee. With the 2 and 20 compensation structure, the 2% management fee is applied to all the assets that are under management while the 20% incentive/performance fee is charged on profits generated by the hedge fund, usually above a specific minimum threshold.
It is worth noting that the 2% management fee is usually charged on all assets under management irrespective of the investments’ performance under the manager.
Hedge Fund Minimum Investments
The individual or persons running the investment fund could set the hedge fund minimum investment at their discretion. And since there’s a limit to the number of investors who can be admitted under into the fund, they’ll want to make the minimum investment figure high. It’s quite common for new hedge funds to open up with minimum investments of between $100,000 and $500,000. The more established funds will have greater minimums; $25,000,000 isn’t unheard of.
General partners could also waive the investment minimum to accommodate investors who are looking to make an investment that’s equal to or higher than the stipulated minimum over time, without starting so high.
Are Hedge Funds Safe Investments?
Hedge funds are very risky investments. Surprisingly, it’s the same risk that attracts many investors who believe that there are higher returns associated with higher risks. The 3 characteristics that let hedge funds promise higher rewards also make them incredibly risky.
First, the hedge fund managers receive a percentage of the hedge funds’ returns. But what happens when the fund loses money? Do they pay the hedge fund a fraction of the loss? Absolutely not. As a result, hedge fund fees structure makes managers highly risk tolerant. As a result, hedge funds could be very risky for investors, who could lose all the money they had put in the fund.
Secondly, hedge funds often invest in derivatives, which are risky due to leverage. Options ought to be delivered within a specific time frame. Should an unexpected economic event occur during that window, even if the manager was right about the long-term trend, all the investment could be lost.
While mutual funds are owned by public corporations, hedge funds traditionally were not regulated by SEC (Securities and Exchange Commission). A lack of regulation means that the fund’s earnings are not reported to SEC. And while funds are prohibited from fraud, the lack of oversight only creates more risks.
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Propel(x) now offers access to Svelland Global Trading Fund – a commodities trading hedge fund headquartered in the U.K. Svelland Global Trading Fund (SGTF) is a global macro commodities focused hedge fund. With a three year compound annual return of 47.61% from 2019 – 2022, SGTF was ranked second under the Global Macro category according to Barclay Managed Funds Report in 2022.
Since August 2017, the net value of invested assets (NAV) in the Svelland Global Trading Fund has grown 180.77%, net of fees (NAV calculated by Apex Group, a 3rd party Fund Administrator for SGTF).
SGTF typically requires an initial investment of no less than $3,000,000. However, through Propel(x), qualified purchasers may participate in the offering at a minimum investment of $25,000 through a special purpose vehicle managed by Planck Fund Management Corporation, a wholly owned subsidiary of Propel(x). Investors who participate may be able to take advantage of quarterly redemptions, subject to certain restrictions.
Private investments are highly illiquid and risky and are not suitable for all investors. Past performance is not indicative of future results. This message is not an offer to sell or the solicitation of an offer to buy any security, which only can be made through official offering documents that contain important information about risks, fees and expenses.The performance figures included here have not been audited but instead are based on independent calculations from the fund’s third-party administrator, Apex Group. Investment information contained herein has been secured from sources Propel(x) believes are reliable, but we make no representations or warranties as to the accuracy of such information and accept no liability.
Should You Invest with Hedge Funds?
While there’s a good chance to double your money, you could easily lose each dollar as well. Unlike a business failure that results in asset liquidation to pay back the investors, hedge fund failures have no asset liquidation and could result in losses worth billions of dollars. If you’re a new investor, you’re better off starting with a low-risk investment offering more predictable returns. If you must invest in hedge funds, ensure you can afford to take on all the risks. And even if you qualify as an accredited investor, hedge funds might not align with your investment needs.
Frequently Asked Questions
How much money do you need to be in a hedge fund?
The amount of money needed to be in a hedge fund varies significantly. Generally, the minimum investment requirement at a firm starts around $250,000. However, some funds require much higher minimum investments.
What is the main purpose of a hedge fund?
The main purpose of a hedge fund is to maximize returns for investors while minimizing risk. Hedge funds employ a variety of strategies to do this, such as long and short investments, derivatives trading, arbitrage, leverage and hedging. Hedge funds are often considered more aggressive investment vehicles than traditional mutual funds because they typically involve higher risk investments and greater volatility.
What is the most famous hedge fund?
The most famous hedge fund is Bridgewater Associates, founded by Ray Dalio in 1975. It is the largest hedge fund in the world with over $160 billion under management and is renowned for its innovative risk-management methodology.