For the beginner investor, hedge funds can be very intimidating. Hedge funds are basically a lump sum of money from many investors that gets invested into securities or other investments in hopes of getting positive returns. The hedge fund can also be described as a “private partnership” between different individual investors that is managed by an individual person (i.e. a money manager). Hedge funds are set up this way so that in the event the company in which the investments lie goes bankrupt, collectors can’t go after the individual investors for money.
Who can invest in hedge funds?
Investing in hedge funds is no simple task. It is certainly something that requires a lot of prior research before jumping in head first.
In general, there are a few different ways you can invest in hedge funds, many of which are going to require that you have a lot of assets or a large income in order to invest.
The Accredited Investor
First, most of the time, if you want to invest in hedge funds you need to become an accredited investor. According to the U.S. Securities and Exchange Commission, an accredited investor is one who:
- …“earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the two prior years, and reasonably expects the same for the current year” …OR…
- …”has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence)”.
In addition to individuals that met these criteria, other entities that can become accredited investors are banks, partnerships, corporations, nonprofits, and trusts. In order for any of these entities to be considered accredited investors, they must fulfill these criteria:
- …”any trust, with total assets in excess of $5 million, not formed to specifically purchase the subject securities, whose purchase is directed by a sophisticated person”….OR…
- …”any entity in which all the equity owners are accredited investors”.
Note: A “sophisticated person” is basically someone that is highly knowledgeable about investing and about the company in which the investors are putting their hedge funds.
Aside from becoming an accredited investor, you still might not be able to get your hands dirty with hedge fund investing. For example, hedge fund partners can allow whoever they want into their “circle”, so even if you’re an accredited investor, they can easily say “no”.
Also, even if you meet the requirements to become an accredited investor, you still might not meet the minimum requirements for specific hedge funds themselves. Some require a $100,000 minimum, which if you become an accredited investor you obviously fulfill, but some hedge funds require upwards of a $25 million minimum investment, so if that’s the hedge fund you want, you won’t be able to invest if you don’t have those kinds of funds.
Hedge Funds For The Not-So-Super-Rich
For the longest time, hedge funds were only available to those with significant funds or assets as described above. However, in the more recent past, other opportunities to invest in hedge fund-like programs have become available for people who may not have the significant cash flow as tradition requires.
Now, these opportunities are not true hedge funds by SEC definition, however, for those people wishing to invest in hedge funds but simply can’t since they don’t qualify to become accredited investors, these similar programs may be a good way to increase their net worth so that one day they may qualify.
Alternative Mutual Funds
Dubbed “Hedge Fund Lite” by the Wall Street Journal and many others, these alternative mutual funds are probably as good as it gets for those people wanting to invest in hedge funds but can’t due to lack of funds. Similar to hedge fund strategies, these alternative mutual funds use long/short investing strategies. They allow you to invest in individual stocks that are “going up” and profit from individual stocks that are “going down”.
While these “hedge fund lite” programs don’t require the high performance fees that hedge funds do, they do require annual management fees that can reach upwards of 4% of your assets.
Replicating Returns
Sometimes called “liquid beta” or “replication funds”, replicating returns programs are another way for individuals to invest in a similar manner as hedge funds without requiring the massive income as assets as required for accredited investors.
These “liquid beta” fund programs try to follow a similar path as hedge fund benchmarks by “’backtest[ing]’ their portfolios of stocks, bonds, currencies, and other assets…until they approximately copy the trailing returns of the average hedge fund as tracked by research firms” (Source: WSJ).
Copycat Investing
Copycat investing is basically a way for non-hedge fund investors to act like hedge fund investors. With copycat investing, you in essence are shadowing the investing behavior of real hedge fund investors and trying to move investments the way you see them moving their investments. One issue here becomes is that once you get the information regarding what the real hedge fund investors did, it may be too late for you to perform the same action, thus potentially putting your assets in jeopardy of going bye-bye.
Conclusions
Unless you meet the requirement of becoming an accredited investor, which means you have to have a very large income and assets, you can’t truly invest in hedge funds. However, there are some similar types of investment strategies like the ones briefly described above, that can allow people without significant sums of money to invest in similar hedge fund-like manners.
