Hedge funds are alternative investment vehicles.

• Author: Manzano, Kris
• Position: Brief Article

Hedge funds have long suffered from misconceptions about high risks and volatility. Most recently, the media has focused on the failures of Long-Term Capital Management and, in North Carolina especially, D.E. Shaw, resulting in gross generalizations about the risks associated with hedge-fund investing. Adding to the mystery is the fact that the average investor rarely encounters hedge funds because the minimum investments are high (targeting wealthy investors) and the funds may not solicit the public for investors.

In reality, hedge funds are appropriate and viable investments for many wealthy institutions and high-net-worth individuals. The majority of hedge funds are more conservative than the ones highlighted by the media and are structured to suit the needs of investors. Over time, hedge-fund returns generally have outperformed standard equity and bond indices, with less risk of loss than equities.

What are hedge funds?

A hedge funds is a type of private investment pool that invests, on a hedged or nonhedged basis, in domestic and foreign securities, commodities and other securities. Because hedge funds are not required to be registered under the Investment Company Act of 1940 (as mutual funds are), hedge funds enable money managers to adopt flexible and diverse investment strategies. This enhances their ability to profit in a falling market as well as a rising one and allows for a broader range of investments.

To avoid the registration and prospectus-delivery requirements of the Securities Act of 1933, interests in hedge funds are offered privately to a select group of investors. Investors typically can withdraw their investment monthly or quarterly (after an initial one-year "lock up" period). This liquidity is a major advantage over private-equity or venture-capital funds, where the lock-up can last 10 to 12 years. The minimum investment ranges from $250,000 to $1 million, although the manager has discretion to accept less.

Who can invest in hedge funds?

Investors in hedge funds must be either "accredited investors" or "qualified purchasers." In general, an accredited investor is one with a net worth of at least $1 million or income of $200,000 ($300,000 with a spouse) for each of the last two years and, with reasonable expectation, the coming year or an entity with a $5 million net worth. A qualified purchaser generally includes an individual or family-owned company owning at least $5 million in "investments" and entities with...