Investing In Hedge Funds: A Guide For Beginners

Updated on

Almost every investor aspires to become the next hedge fund billionaire. But with expensive buy-ins and limiting government restrictions, the exclusive nature of hedge funds may seem inaccessible to most investors.

Get The Full Series in PDF

Get the entire 10-part series on Charlie Munger in PDF. Save it to your desktop, read it on your tablet, or email to your colleagues.

Q2 2021 hedge fund letters, conferences and more


However, this may not be such a bad thing. Hedge funds are inherently riskier compared to other types of investments. Before you take on this risk, read on to know more about the basics of investing in hedge funds.

What Is A Hedge Fund?

A hedge fund is an investment partnership where money is pooled from investors to buy securities and other investments. It’s similar to mutual funds or exchange-traded funds (ETF), but hedge funds aren’t as limited as mutual funds are.

Hedge funds use aggressive investment strategies, such as short-selling, to buy other types of assets that other funds can’t invest in, like art and real estate. They take significant risks to produce returns despite current market conditions. Investing in hedge funds has its advantages and disadvantages. Investors enjoy a chance at higher returns, but there’s also a risk for illiquidity and volatility.

What Is A Hedge Fund Manager?

Hedge funds managers make daily investment decisions for hedge funds. They manage the fund’s risk level and distribute the money invested. They receive a performance fee, sometimes up to 20% of the fund’s profits, if it’s profitable.

It’s important to ensure that any hedge fund manager is qualified to manage your investments. You can check their qualifications, disciplinary history, fees, and investment strategies by checking their Form ADV, which you can find on their website or the U.S. Securities and Exchange Commission (SEC) Investment Adviser Public Disclosure database.

What Are A Hedge Fund’s Minimum Initial Investments?

Minimum initial investments for hedge funds usually range from $100,000 to $2 million. They’re not as liquid as stocks or bonds, so you can only withdraw funds when you’ve invested a certain amount of money during specified times of the year.

When it comes to fees, hedge funds charge quite a lot. You’ll have to pay for an asset management fee worth 1% or 2% of the amount invested, plus the hedge fund manager’s performance fee. These fees, though they may seem insignificant, can eat up your returns.

Who Can Invest In A Hedge Fund?

Given its high level of risk, the SEC enforced regulations as to who can invest in hedge funds. You need to be an institutional investor to invest in hedge funds like a pension fund or an accredited investor.

You also need to have a minimum net worth of $1 million (excluding the value of your primary home), or your annual income should amount to more than $200,000 ($300,000 if married). However, more and more qualify for hedge funds investments now, and the SEC supports this claim.

Their guidelines included new provisions that allowed people who demonstrate advanced investing knowledge gained through work experience or financial licenses to become accredited investors, even if they don’t meet the financial qualifications.

How Can You Invest In Hedge Funds?

The first thing you need to do is to research hedge funds that currently accept new investors. You research on your own or you can hire a financial advisor to guide you through the process. The next step is to look into fund managers and investment goals, and once you found the one you like, contact a hedge fund and request more information.

They may need you to verify that you’re an accredited investor. Each fund has its determining factors and practices to measure accreditation. You may be asked to provide your income, assets, debts, and experience and have third-party institutions, investment advisors, or attorneys confirm this.

Gaies Chreis, COO of MetaQuotes Ltd. a company developer of MetaTrader 5 for hedge funds says, “Hedge funds use a variety of software and apps to get an edge over the market. They need the latest information and the best tools to yield favorable results that will keep the investors coming.”

Investments Mean Risk

Except for things like savings accounts, which typically offer meager returns these days, every type of investment carries an element of risk.

While investing is a must when it comes to growing your wealth, you also have to accept:

  • Risks associated with specific investment types.
  • The risk of losing some or all of your cash, depending on where it is invested.
  • Even if your investment grows, it might not achieve the returns you thought you would get within the timeframe you set out.

In general, higher-risk investments bring higher potential returns. How you manage these risks and determine your portfolio's structure will depend on your investment objectives and your risk profile.

How Much Risk Are You Willing To Take?

These are typically the two biggest questions you need to ask yourself as an investor. Still, you must appreciate that the answers will change, and you need to be prepared to act accordingly.

If you have a relaxed outlook about seeing the value of an investment drop in the short term, you might err towards higher risk but potentially higher return investments. In contrast, if you feel more comfortable knowing your investment is growing slowly but surely, you may be better off opting for lower-risk investments.

Your desired investment timeframes may also influence your thinking, especially if you’re investing specifically with an eye on retirement. The most common approach investors adopt is to lower their risk exposure the closer they get to retirement.

Let's say you have 25 years to retire. If a high-risk investment fails, you have plenty of time to make other investments and grow your retirement fund. On the other hand, if you only have five years until your retirement, you don't want to lose a significant cash sum.

Understanding Asset Classes And Types Of Investment

You will have the opportunity to make various types of investments. It is worth speaking to a financial advisor about how you will approach investing so you can build a diverse portfolio that manages risk while maximizing your potential returns.

Some of the investments available to you include:

  • Cash investments, such as savings accounts, are among the safest investments around but provide meager returns.
  • Fixed interest investments, such as bonds and hybrid securities, can be worthwhile if you're looking for regular payments from your investment. These are longer-term investments that you should spend time researching as some can be high-risk and complex.
  • Property and infrastructure securities. Investing in securities can help you invest in these markets from a low capital base without needing the funds to buy a property yourself.
  • Share investments are ideal if you’re looking to combine the potential for capital growth with regular dividend payouts. You will have the choice between investing in specific companies or in things like exchange-traded funds (ETFs) that can help you have a naturally diverse portfolio.

Summing Up

Continuing to review your investments is just as crucial as choosing them in the first place. Market changes and the broader economy, among other things, can both influence the performance of your investments. As such, you may find yourself needing to react to these while also continuing to review your investments with your needs and timeframes in mind.

Investing in hedge funds may be a great way to diversify your portfolio and protect your investments from market volatility. But first, you need to qualify as an accredited investor and be willing to invest hundreds of thousands or millions of dollars upfront.

But if you’re like most people — an average investor seeking high returns, you might be better off investing in index funds that track indices. An investor’s goal is to own the whole market and grow their investments as the companies we invest in growing. In other words, unless you’re willing to invest millions, you don’t have to invest in hedge funds to earn significant returns.