Playing the Hedge Fund Craze

Feeling left out of Wall Street's recent embrace of hedge funds? Take heart: A number of mutual funds use equally sophisticated strategies that may even be better than the real thing -- at least for the average investor.

Hedge funds were once reserved for well-heeled types looking for help in passing their wealth on to the next generation. Staggeringly high minimum requirements and exotic-sounding investment strategies kept retail investors on the outside looking in.

That has changed over the past few years, though. The mutual fund industry has gradually been rolling out new offerings that use intricate hedge fund strategies -- more on these below -- yet are tailored to meet the needs of the savvier retail set. Simultaneously, the number of hedge funds in the U.S. has mushroomed to an estimated 8,000 with about $1 trillion under management, leading to a greater awareness of the once-exclusive investment vehicle.

The explosion in hedge funds has also spawned talk of a "bubble." The danger that these funds could be in for a beating is why investors might want, at the very least, to test-drive mutual funds with hedged strategies before jumping into the real thing. Mutual funds, after all, can provide greater transparency and substantial liquidity at a much lower cost.

Hedge Funds vs. Mutual Funds

Like mutual funds, hedge funds pool investors' money and put it to work in financial instruments. But unlike mutual funds, hedge funds don't have to register with the Securities and Exchange Commission. This means that hedge funds are subject to very few regulatory controls, for now. Hedge fund managers won't be subject to regular SEC oversight until next February, when they will have to register as investment advisers.

"The rules under which mutual funds operate are clear and designed to safeguard investors," says Morningstar analyst Todd Trubey, scoring a point in favor of mutual funds. "Legal recourse is more of an option for mutual fundholders should something go wrong."