Online Financial Tips

Although hedge fund investing certainly has a lot of appeal to a lot of investors, there are some risks involved with these types of investments, unlike many traditional mutual funds. Even though these funds and traditional mutual funds share a lot of similarities — they are both considered pools of money, they are both managed by professional money managers with above-average market intuition and investment knowledge, they are both fee-based investments, etc. — there are actually some extremely important differences between the two. These differences should be taken into consideration before choosing one investment type over another.

1. Use of Risky Investments. Although traditional investment funds can use risky investments like derivatives and short sales to a marginal maximum, hedge funds are able to invest their entire asset base in these types of risky assets. In fact, one of the reasons why hedge investments performed so well during the market correction of 2008 was thanks to their ability to take a short position on collateralized debt obligations, or CDO’s, at the very time that these already complicated investments lost value to the tune of 80% and sometimes more. A traditional investment fund, in comparison, could not invest so aggressively.

2. Liquidity. For many hedge investments, there is a minimum amount of time that the investor needs to invest their money. Often just a single year, the fact that investor has no access to their funds can be off-putting to many investors. In addition, these funds will often invest in vehicles that are not so liquid themselves. That means that even if the investor can access their funds under the fund’s investment contract, accessing it may still take time because the investments themselves are not easily sold. Think of many non-public start up companies that a lot of hedge funds will invest in: since they do not trade on an open market, the hedge fund would have to find an actual buyer for that company in the event of large redemption requests.

3. Investment Minimums. There are many investment funds that allow investors to purchase into their funds with as little as $500. With hedge funds, the minimum is often $1,000,000 or higher depending on the manager and company in question. As well, mutual funds are available to virtually any investor who has access to a computer or a financial planner. Hedge funds are often closed investment pools that are sometimes only available to people who are invited to participate in that fund. Accessibility is obviously an issue with many hedge funds given their closed nature and minimum investment requirements.

Overall, hedge funds will take on greater risks, require a longer-term commitment and larger up-front investment dollars than traditional investment funds. While there is often an allure with hedge funds that is lacking with traditional investment funds, those risks could be particularly damaging to many investors. It is for that reasons that additional regulations require that hedge fund investors are considered “accredited,” meaning they will have high investment knowledge as well as a large net worth.

• What Are Hedge Funds?
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