How to invest money in hedge funds

Unless you are living in the desert, you must have heard the phrase “hedge fund” at least several times. It seems that everybody is talking about hedge funds, famous investors that own them, run them or invest their money in them. So what are hedge funds and how to invest in hedge funds of you are not a millionaire?

What are hedge funds

Hedge fund is a private investment partnership and funds pool that uses varied and complex proprietary strategies and invests or trades in complex products, including listed and unlisted derivatives.

Start a Hedge Fund

In a nutshell hedge funds are very similar to mutual funds, but there are few important differences.

1. Unlike mutual funds, hedge funds can implement more complicated strategies, including risk hedging with futures or complicated option strategies (this is where the name Hedge Funds came from). Because of the sophisticated investment methods hedge fund managers use, it is hard for a regular person to asses the risk/profitability ratio.
2. Hedge funds usually pursue higher profit and therefore carry some extra risks. They are not recommended for short term investments. Some countries, such as US limit participation in the hedge funds to qualified investors. This measure helps protect people with little investing experience from taking on extra risks, but ironically it also “protects” them from getting higher profit.
3. In a mutual fund anyone can buy shares and become a member. Hedge fund managers have a right to pre-screen their members and have a right to reject the investor.
4. The minimum deposit in hedge funds is significantly higher than in a mutual fund, which by itself can be an entry barrier for non-experienced investors. Depending on a fund it can vary greatly and be anywhere between $100 000 and $25 000 000 (it can be even more, but rarely happens to be less).

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Investing in hedge funds US

Investing in hedge funds in the US is mostly  limited to accredited investors. Most hedge funds in the US are registered as limited liability companies or limited partnerships, but under American law their shares are treated as securities. There are a few exceptions that still open the door for non-accredited investors. For example, a hedge fund can raise no more than 5 million dollars or have no more than 35 non-accredited members. For years advertising of hedge funds was prohibited by Securities and Exchange Commission, but this ban have been lifted a while ago. However, hedge funds don’t rush to advertise themselves.

Investing in hedge funds UK

Starting a hedge fund in the UK is a more complicated process than in the US and may take up to 3 months. There is no government restrictions in regard to pre-screening hedge fund participants, but the hedge fund managers are still being very selective and require high deposit. British law doesn’t give clear definition of what a hedge fund is and treats them as alternative investment funds. Most hedge funds run by British managers are located offshore and therefore don’t have to comply with FCA regulations.

Investing in hedge funds in India

There are over 150 registered hedge funds in India. Minimum investment in a hedge fund in India is nearly the same as in the developed countries: Rs.1 crore, which currently equals 150 000 US dollars. However most Indian hedge funds accept investors with at least 1 000 000 dollars. In order to be officially registered a hedge fund must meet the minimum capital requirement of Rs. 20 crores (that’s over 3 millions dollars). Detailed regulations are provided in SEBI guidelines for alternative investment funds.

Investing in hedge funds Australia

Australian hedge fund industry is the second largest in Asia-Pacific region after Hong Kong. According to Australian Securities and Investments Commission, the amount of money invested in hedge funds in Australia exceeds 95 billions of Australian dollars. These organisations are subject to the same regulations as open-ended retail funds. Stability and clarity of the rules attract rich investors from China and other Asian countries boosting the development of Australian hedge funds.

Advantages of investing in hedge funds

Hedge funds are run by top investment experts with established reputation (otherwise they won’t be able to raise required money and attract qualified members). This means that upon entering such fund one can count on professional investment advice. Because funds of this type usually run aggressive and more sophisticated strategies there are very good chances of higher returns than any other investment methods would bring – that is another major advantage of investing in hedge funds.

Disadvantages of investing in hedge funds

The major disadvantage of investing in hedge funds is their high management fees. Professional investors running hedge funds bring high profit but also want to receive high salary. It is very common in the industry to charge both management fee and performance fee. A management fee could be around 2% per year of assets under management (paid monthly) plus a performance fee which sometimes reaches 20% of yearly profit. Another common disadvantage of hedge funds is high possibility of drawdowns. As we already mentioned this method is not recommended for short-term investing, because of their aggressive strategies hedge fund can experience high drawdowns.

Hedge funds risks and profitability

Hedge funds are usually regarded as highly profitable investment options, however not all of them are equally lucrative. Because of the closed nature of hedge funds, calculating an average yearly return of a hedge fund investor is nearly impossible. According to Preqin, a firm constantly monitoring hedge funds, an average fund was up only 2.02% back in 2015. For comparison, an S&P 500 index which is often used as an investment benchmark grew by 1,38% during the same year. Preqin report shows that there are 829 hedge funds registered around the world in 2105 with 3.2 trillion dollars of assets under management. However, hedge funds results are best to estimate over at least 5 years long period, because their strategies are highly volatile and can lead to 40% profit one year which still compensates a 10% loss next year. Poor returns led to money outflow from the industry in 2016. According to Reuters, hedge funds from across the globe lost 1% of their portfolios, which was the first case of annual outflow since financial crisis. Hedge Fund Research Inc. Weighted Components Index which tracks hedge funds’ performance returned 5,57% in 2016, while S&P 500 have brought investors 11.96% during the same year, which raises further questions about the effectiveness of hedge funds with their high fees. Of course, there are funds that remain extra profitable and funds that go bankrupt. An average return doesn’t mean that investors should stay away from the hedge fund industry in general, but same as with other passive income investments it all comes down to hiring a right money manager.

The methods rich people use to make money are often not available for people with smaller initial capital. So if hedge funds minimum deposits are way over your limit, but you still want to become a next Warren Buffet, take a look at how he and other famous investors got started, not at how they invest right now. Investing in financial markets can be extremely profitable, but it takes time and patience to master required skills. Start small and keep investing in your financial education first of all. And if you want to be making money while you learn, consider hiring a money manager or investing part of the money in copy trading.