BASIC CONCEPTS
Hedge funds are similar to mutual funds in that they combine and invest investors’ money in an effort to earn a positive return. However, hedge funds have more flexible investment strategies than mutual funds. Many funds seek to profit in all types of markets using leverage and other speculative investment practices that are not typically used by mutual funds. Unlike mutual funds, hedge funds are not subject to some of the regulations that are designed to protect investors. Also, depending on the amount of assets in a hedge fund, some hedge fund managers are not required to file or file public reports with the SEC. Fortunately for investors,
Hedge funds are not required to follow a standard procedure when calculating performance, and may invest in securities that are difficult to value and illiquid. On the other hand, federal securities laws specifically prescribe the methodology of a mutual fund to publish calculate current performance, total return and profit after tax. Mutual funds must also have detailed requirements for the types of disclosure that must accompany any performance data. Any investor provided with the performance data for a hedge fund should verify whether it reflects cash or assets actually received by the fund compared to the estimate of the direction of change in the value of the fund’s assets and whether the data includes deductions. of fees.
THE RISKS
Investing in hedge funds can pose several risks for inexperienced investors. One of the main risks associated with investing hedge funds is the use of leverage management. Generally speaking, leverage is the use of borrowed money to make an investment. Hedge fund managers use borrowed money along with investor-contributed capital to make investments with the goal of exponentially increasing the fund’s potential return. Conversely, using leverage can increase potential loss if an investment strategy doesn’t work. This can turn a generally conservative investment into an extremely risky investment.
Another risk associated with hedge funds is the limitation on investors’ rights to sell the shares. Hedge funds typically limit opportunities to sell shares on a monthly, quarterly, or annual basis, and often impose “lock” periods of one year or more, which prohibit investors from selling shares during the period. During that time, the value of the Fund could decrease significantly, which in turn could leave investors with a worthless investment. Furthermore, hedge funds are capable of suspending redemptions in certain scenarios, even in times of market distress or when your investments cannot be paid off quickly or easily. Too,
The funds may also invest in illiquid securities. An illiquid security can be difficult to value if the security is trading, or if there is a lack of a secondary market for the security. Hedge funds have wide discretion in the valuation of illiquid securities, and often overstate the true value of the securities. This constitutes a significant risk for investors because they may refrain from redeeming stocks if they believe that the value of an illiquid share remains stronger, when it is worth much less. Investors should fully understand the hedge fund valuation process and be aware of the extent to which a fund’s securities are valued by independent sources. Investors should also be aware that asset valuations of the fund will affect the rates charged by the manager.
THE COSTS
Investors should be well informed of the fees and expenses charged before investing in a hedge fund. Fees and expenses significantly affect the performance of a hedge fund investment. They typically charge an annual asset management fee that ranges from 1 to 2 percent of assets, as well as a “rate of return” of 20 percent of the fund’s earnings. The danger in such high yield rates is that the manager may make riskier investment decisions to generate a profit for him. This two-installment structure represents the obvious notion that profits tend to benefit their managers rather than their investors.
It is very important to do the homework before investing in a hedge fund. Potential hedge fund investors should begin the investigation with an evaluation of the hedge fund manager and their qualifications. Managers must have a solid investment history, demonstrating that they are qualified to manage money, and must have a clean disciplinary history within the securities industry. Additionally, investors should determine if a potential conflict of interest exists before investing. If an advisor recommends a hedge fund that is managed by the advisor, he or she may be motivated to recommend the fund because it may earn higher fees than other investment opportunities. Hedge funds may be liable for fraudulent activity to investors as an investment advisor may be liable for unfairly recommending a hedge fund. Investors who have suffered losses in a hedge fund are encouraged to consult an investment attorney to discuss possible claims that may recover lost capital.
