How to invest in a hedge fund

Investors poured $13.1 billion of new cash into hedge funds during a single quarter last year. How can you get in on the action, too?

Hedge funds grew larger in Q4 of 2010 than they have during any other quarter in history. The industry ballooned by $149 billion, according to Hedge Fund Research data, bringing assets under management in the industry to $1.917 trillion.

While most of the growth came from strong performance by the funds in Q4, investors also poured $13.1 billion of new cash into hedge funds. How can you get in on the action, too?

First, it’s important to understand what a hedge fund is. They differ from mutual funds in that they typically use a combination of derivatives and long and short positions to – as the name implies – hedge positions as a way to protect capital while pursuing gains. Thanks to relatively light governmental regulation and the ability to leverage positions, hedge funds can take risks that more traditional funds can’t. For that reason, most jurisdictions limit who can actually invest in hedge funds.

Hedge funds generally fall into two camps: a 3(c)(1) Fund, which is limited to 100 or fewer investors or a 3(c)(7) Fund, which is generally limited to accredited investors.

Since 3(c)(1) hedge funds cannot have more than 100 investors, they’re typically offered on an invitation-only basis (translation: you need to know someone or at least know someone who knows someone). To be eligible to invest in a 3(c)(7) fund, you’ll have to qualify as an accredited investor or qualified purchaser (translation: you need to have a high net worth).

How much money do you need to invest in a hedge fund? First of all, you’re going to have to meet the hedge fund’s initial investment requirements and accept the fund’s management and performance fees. Then you’ll have to qualify as an accredited investor, which means you have a minimum net worth of $1 million (or, alternatively, a minimum income of US$200,000 in each of the last two years and a reasonable expectation of reaching the same income level in the current year). Alternatively, you could qualify as a qualified purchaser, which means you’d need more than $5 million in investment assets.

A new and emerging way to invest in hedge funds comes via ETFs. The MW TOPS Global Alpha ETF, for instance, mirrors a basket of Marshall Wace’s TOPS investment strategies, which use mathematical models to evaluate and capture the best available ideas from brokers, Reuters reports. Shareholders in the ETF should, in theory, get the same returns as Marshall Wace’s TOPS hedge fund participants. The Global Alpha ETF currently trade on London and Frankfurt stock exchanges.

In general, though, hedge funds are operated by and for the wealthy, and they come with the expectation that both parties are sophisticated enough to recognize the unique risks and rewards hedge funds offer. Even once you get in, though, that’s no guarantee you’ll get great results. That trophy in the distance will be bigger, but so will the fish you’ll be swimming against to win it.

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1 thought on “How to invest in a hedge fund”

  1. Wealthy investors with a high Financial IQ, understand to be truly diversified you need to invest across all four primary Asset Classes which are:

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    Tyrone Phipps

    416-891-7787

    tyrone@onixconsulting.com

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