What are hedge funds?
Hedge funds pool money from investors and invest in securities or other types of investments with the goal of getting positive returns. Hedge funds are not regulated as heavily as mutual funds and generally have more leeway than mutual funds to pursue investments and strategies that may increase the risk of investment losses. Hedge funds are limited to wealthier investors who can afford the higher fees and risks of hedge fund investing—and institutional investors, including pension funds.
What should I know if I am considering investing in a hedge fund?
• Be an accredited investor. You generally must be an accredited investor, which means having a minimum level of income or assets, to invest in hedge funds.
• Read a fund's prospectus and related materials. Make sure you understand the level of risk involved in the fund's investment strategies, and that the risks are suitable to your personal investing goals, time horizons, and risk tolerance. As with any investment, the higher the potential returns, the higher the risks you must assume.
• Understand how fund assets are valued. Hedge funds may hold investments that are difficult to sell and may be difficult to value. You should understand the valuation process and know the extent to which a fund's holdings are valued by independent sources.
• Understand fees. Fees impact your return on investment. Hedge funds typically charge an asset management fee of 1-2% of assets, plus a performance fee of 20% of the hedge fund’s profit. A performance fee could motivate a hedge fund manager to take greater risks in the hope of generating a larger return.
• Understand any limitations on your right to redeem your shares. Hedge funds typically limit opportunities to redeem, or cash in, your shares, to four times a year or less, and often impose a lock-up period of one year or more, during which you cannot cash in your shares.
• Research the hedge fund managers. Make sure the hedge fund managers are qualified to manage your money, and find out whether they have a disciplinary history within the securities industry.
• You can get this information by reviewing the adviser’s Form ADV, which is the investment adviser's registration form (the official name is the Uniform Application for Investment Adviser Registration and Report by Exempt Reporting Adviser). You can search for and view a firm’s Form ADV using the Securities and Exchange Commission’s (SEC) Investment Adviser Public Disclosure (IAPD) website.
• If you don’t find the investment adviser firm in the SEC’s IAPD database, call your state securities regulator or search FINRA’s (Financial Industry Regulatory Authority) BrokerCheck database.
• Ask questions. You are entrusting your money to someone else. You should know where your money is going, who is managing it, how it is being invested, and how you can get it back. In addition, you may wish to read FINRA’s investor alert, which describes some of the risks of investing in funds of hedge funds.
In Texas, hedge funds are investment vehicles that pool capital from accredited investors and institutions to invest in a variety of assets, often employing complex strategies and higher risk in pursuit of returns. Accredited investors typically must meet certain income or asset thresholds. Prospective investors should thoroughly read the hedge fund's prospectus, understand the associated risks, fees (usually including a management fee and a performance fee), and be aware of any restrictions on redeeming shares. Valuation of hedge fund assets can be complex, especially if they include illiquid investments. It's crucial to research the qualifications and disciplinary history of hedge fund managers, which can be done through the SEC’s Investment Adviser Public Disclosure (IAPD) website or FINRA’s BrokerCheck. Texas investors should also consult with the Texas State Securities Board for additional information or if they cannot find the investment adviser on the SEC's database. Before investing, individuals should ask detailed questions about the fund's strategies, management, and how to withdraw their investment. The high fees and risks associated with hedge funds make them suitable primarily for more sophisticated investors who can bear the potential for significant losses.
