One of the beauties of alternative investments is the benefits they provide from portfolio diversification. It’s like expanding your profitable options with minimal risk.
Of course there is always risk, almost nothing is done without it but the goal as an investor is to always reduce your risk to its lowest possible value while simultaneously expanding your profit potential. Think of them as inverse proportions, one always going up(profit) while the other goes down(risk).
You never want them going in the same direction at the same time, that’s troubled waters you don’t want to be navigating.
Sadly, we can’t always have things the way we want them to be, but we can adopt strategies and systems that get us as close to our investment goals as possible and one of such systems is Hedge Funds.
You’ve probably heard the term being used a lot of conversations all over the news and wondered, what really is a Hedge Fund?
In simple terms, it’s an alternative investment vehicle that makes use of aggregated funds on various (investment) strategies to earn returns –or alpha, in more investment technical parlance- for investors.
Not so simple?
Okay, let’s say your friend Richard, who’s a successful and accredited investor, raises funds from a group of your high school friends and with those funds he employs different investment strategies that are actively highly rewarding for everyone in the group.
You get the idea?
Now it is important to note that hedge funds are generally only accessible to accredited investors.
This means Richard is or has one of these 3 things:
- An annual income exceeding $200,000 ($300,000 for joint income) for the last two years with the expectation of earning the same or a higher income in the current year.
- A networth exceeding $1 million, either individually or jointly with his spouse.
- A general partner, executive officer, or director for a company that is issuing the unregistered securities. (Securities here being the term used to refer to any financial asset that can be traded)
CHARACTERISTICS OF A HEDGE FUND
As with every alternative investment vehicle, a Hedge Fund has certain peculiarities that sets it from the others
- It’s only accessible to accredited investors.
- It provides a wider investment latitude. Richard has access to more opportunities and you have access to more returns.
- Executes with leveraged or borrowed money. Remember Richard isn’t investing with only his money.
- Fees are charged on both management and investment performance. Yes Richard gets paid twice.
- Fund investors have permission to withdraw capital periodically. Yes you are allowed to take your money out whenever you feel like. That is of course in line with the original agreement as agreed with the fund manager, like GMI for instance.
- Managers are significant investors in the fund as well. Richard also has a horse in this race, and a big one too.
BENEFITS OF HEDGE FUNDS
That being said, why should you be participating in a hedge fund anyway?
It goes without saying that for anyone to consider investing with hedge funds they should first be aware of the benefits.
What are these benefits?
I’ll name a few:
Risk management: Hedge funds were established, partly, to aid investors in investment risk management and mitigation. Their market-neutral, approach to investing seeks out positive returns by investing in varied instruments over long- and short-term periods.
This approach makes hedge funds flexible investors in the market place, providing an advantage to anticipate–and avoid–undue risk for their partners.
PORTFOLIO DIVERSIFICATION: Investors no longer have to rely on single strategies that lean heavily on fixed income assets to generate reliable returns and surpass financial obligations. Investors need comprehensive and diverse portfolios to stand a chance at being competitive in today’s in order to maximize returns and minimize risk. The luxury of comfortable portfolio diversification is another added layer of risk management that hedge funds provide more easily than most other alternative investment vehicles.
TRANSPARENCY: Hedge funds are allowed to do pretty much do what they want as long as they disclose the strategy upfront to investors. This definitely seems a little too risky, and it often is, given the sometimes conflicting principles and ethical leanings of investors. That been said, this transparency approach has yielded some of the most incredible long term returns from some exceptional fund managers and has proved itself more beneficial than not.
SHOULD YOUR FAMILY OFFICE INVEST IN A HEDGE FUND?
The answer to this is still as largely subjective as ever and mostly depends on the investment strategy and capital funding available to your family office at any given time.
Still is it important to consider, that the number of hedge funds has had an exceptional growth curve in the last 20 years and deservedly so.
Investing is a highly complex endeavour and nobody participates with the intention of losing. When you consider the risks, margins and unconventional opportunities in today’s market, it’s easier to understand how an actively managed alternative investment vehicle that is flexible enough to utilize non-traditional asset classes or investment strategies is a good player to bet on.
Even though they are generally more expensive compared to other conventional investment funds.
However as an added advantage because of their diversity, hedge funds provide an opportunity for you to accomplish a wider variety of investment goals. Their flexible approach and diverse unconventional strategies provide an edge you don’t find with other alternative or traditional investment vehicles.