Hedge fund activity currently constitutes approximately 30 percent of all equity trade volume. So if you have any experience with equity trading, or even a slight interest in this type of venture, then you’ve probably been tempted to get involved with one of these notorious private investments funds. And make no mistake, hedge funds and those who run them have made a name for themselves in recent years.
Hedge funds have been all over the mainstream news media of late, whether it’s due to huge successes, shocking defeats, or the way that their managers seem to treat billions of dollars as if it were Monopoly money.
Hedge funds are private by definition and only certain investors qualify to partake in them. If you’ve climbed your way into this category as a result of a strong record in equity or futures trading, you might feel compelled to throw your money in with the über-rich, thinking that it’s a sure way to become one of the elite. But be warned, hedge funds are not all that they are cracked up to be. In fact, for an educated and conscientious investor, hedge funds can be a nightmare.
These four curious characteristics of hedge funds make them different than many standard investments. If you don’t bat an eye at this list, then go for it and you’ll at least enter the fray with your eyes wide open. But if anything in this description of hedge funds surprises you or makes you the least bit uncomfortable, then it might be best to stick with what you know.
1. Lack of oversight:
The SEC does not require a private investment fund to register with them or any other regulatory body if it is comprised of fewer than 100 investors. Combine this with these funds’ tendency to lean heavily on offshore investments and hedge funds are operating in a virtual vacuum. While too much government oversight can hamper the performance of an investment vehicle, too little means that the people handling your money aren’t accountable to anyone, including you.
2. Managers with little to lose:
When investors are invited to contribute to a hedge fund, the manager sets a high-water mark for returns. If your manager meets this goal, he will retain a full 20 percent of your returns, in addition to the couple of points in assets that he is already collecting on an annual basis. And what happens if your fine manager doesn’t meet this lofty goal? With all that he has to gain, failure must destroy him, right? In fact, you and your fellow investors will eat all of the losses and your manager will merely move on and set up shop somewhere else, none the worse for wear.
3. Totalitarian mindset:
When you invest in a hedge fund, you are putting your assets entirely in the hands of one single person, and that is a dicey proposition any time that that person isn’t yourself. The manager of the fund makes all of the investment decisions that determine the success or downfall of the fund, and even a manager with a great track record is fallible. If your manager gets in a fight at home or catches a flu bug, your portfolio could suffer. Worse yet, if your manager steps down and hands the reigns to someone completely new, you and your fellow investors could be in serious trouble
4. Short life spans:
The average life of a hedge fund is only three years, which means that employing this vehicle is unwise if you have a long-term strategy in place. One out of every ten hedge funds collapses each year, making this industry as volatile as almost any other venture out there. An investment with such a short shelf life might not be the way to go if you are a typical investor who has the long haul in mind. Maybe better to keep your money in a high interest savings account instead.