We’re continuing our series on investing in alternative investments. This week, part two in our hedge fund series, the four things you should know before you invest in a hedge fund.
Check out part one of the series if you’re unfamiliar with hedge funds and why they make a good investment.
There are risks when investing in hedge funds. Let’s look at some of the risks.
1. You Could Lose Your Entire Investment
As mentioned previously, hedge funds can use higher-risk investment strategies. Because of these risks and others, investors may lose their entire investment.
2. Hedge Fund Research Can Be Difficult
A hedge fund’s investing strategy and performance can be difficult to research, verify and compare to other investments.
Hedge funds have traditionally been notoriously private about how they achieve their results and may be reluctant to disclose the information even to their investors.
You may be able to check into the background of a hedge fund’s manager–for example, whether the manager has a disciplinary history in the securities industry-by going to the SEC’s website and looking up the firm’s Form ADV.
Depending on how the hedge fund is registered, you may be able to get information from the National Futures Association’s website, your state securities regulator, or the Financial Industry Regulatory Authority (FINRA).
3. Hedge Funds Cost More Than Mutual Funds
Management fees for hedge funds generally are higher than actively managed mutual funds or separately managed accounts. Also, unlike mutual funds or other money managers, hedge fund managers typically receive a share of the fund’s gains.
These added costs are passed on to the fund’s shareholders in the form of higher management and administrative fees compared to mutual funds or separately managed accounts.
4. Hedge Funds Lack Liquidity
In most cases, hedge fund shares are not traded on any public exchange, so you may not be able to redeem your investment when you want to or at a price you paid.
As you can see, hedge funds may seem “cool,” but they have some significant risks and costs.
That’s not to say you should shy away from them. Quite the opposite; it’s all about due diligence and knowing what to expect.
How to Choose a Hedge Fund
As with any investment, you should take great care if you invest in a hedge fund. You will want to research which funds are suitable for your investment goals.
Because hedge funds are not typically publicly offered, you will likely need the assistance of an investment professional in evaluating and choosing a fund.
In making your selection, you must be comfortable with the strategies the fund employs, the types of assets the managers invest in, and the risks involved before investing in the fund.
Investing in hedge funds can seem overwhelming initially, but if you take your time and stick with it, it will pay off.