Want to Try Hedge Funds? First, Get Rich
How do the rich get richer? Here's one way: They invest in hedge funds.
You don't hear too much about hedge funds if you're not an "accredited" investor or "qualified purchaser" with millions in investment assets. But there certainly are a lot of investors who fall into that category and are willing to pay significant fees to get into a hedge fund.
According to industry source Barclay Group, hedge-fund assets have grown from $323 billion in 2000 to more than $1.8 trillion last year. And the number of hedge funds has leapt during the last seven years, from around 550 to more than 13,000.
Hedge funds use varying strategies in their efforts to outperform market benchmarks such as the S&P 500 stock index. Some take "short" positions to offset their ownership of stocks. Others use futures and options to hedge their outright stock purchases.Most don't explain exactly how they intend to "beat" the market -- and they aren't required to divulge their strategies. HFR (Hedge Fund Research, Inc.), which maintains a huge database of hedge fund performance, says $100,000 invested in their Global Hedge Fund Index in January 2000 would be worth $177,000 at year-end 2007 -- net of all fees. The same amount invested in the S&P 500 would have been worth only $114,000. That performance is truly outstanding when you realize that hedge funds typically charge performance fees of 20% of the profits, plus an annual management expense of about 1.5%. However, hedge funds are not required to report their results publicly. Thus, performance records of funds that lose money and quietly go out of business are probably not factored into the HFR index.
Choosing a Hedge FundMorningstar, the company that rates traditional mutual funds, has just launched proprietary performance ratings for thousands of hedge funds and 17 hedge-fund indexes it created. The categories are based not only on the funds' self-descriptions, says John Reckenthaler of Morningstar, but also on historical performance correlations. Since hedge funds are reluctant to reveal their positions, if not their strategies, this is admittedly a difficult task. Reckenthaler suggests these Morningstar Hedge Fund ratings are a "starting screen" and not the only way to judge hedge funds. Chicago money manager Kay Torshen, president of Torshen Capital Management, LLC, specializes in choosing hedge funds for her clients, who range from wealthy individuals to endowments and pension funds. She warns: "Hedge-fund managers are unusually sophisticated and intelligent, and can tell an attractive story. It's very important to evaluate the risk objectively and not get carried away by the glamour."
Hedge-Fund WarningsTorshen notes that the current market volatility makes investing in a hedge fund even more complicated for four reasons:
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