According to the probably untrue but well-known story, career criminal Willie Sutton was once asked why he robbed banks. He said, “Because that’s where the money is.”
In the investment community, the money is n the hands of individual investors. Of the $275 trillion to $295 trillion in global assets under management, individuals own half of it.
So it’s no surprise that individual investors are being targeted by hedge funds for growth. After all, today they account for only 16% of the assets under the management of so-called alternative investment funds.
There’s definitely interest on both sides of the market. Hedge funds see individual investors as a source of high asset growth, while investors and their advisers seek returns that they can’t get these days through more traditional routes.
Hedge funds are attractive because the best ones earn very large returns. The top earners these days have three-year annual returns in the 20% range, with a few in the 30% to 40% area. Meanwhile, the S&P 500 index increased about 13% to 14% annually during this time. And last year, while the market was down 20%, hedge funds lost only 4% on average.
How do they do it? First, hedge funds have a big toolbelt of strategies compared with, say, mutual funds. They can employ using leverage (borrowing to increase investment exposure), short-selling, and sophisticated but riskier tactics. Second, because managing a hedge fund can be extremely lucrative, they tend to attract some of the best minds on Wall Street.
As you can imagine, hedge funds involve more risk than many other types of investments. And their failures can be spectacular. Operations issues, bad investments, and taking on too much risk are some of the main causes for a hedge fund to crash. Many of these issues can be traced to a lack of transparency required for hedge funds.
To shield typical Main Street investors from the risks of hedge funds, they need to meet certain requirements to become what are called “accredited investors.” The standards include meeting minimum annual income ($200,000 for individuals, $300,000 for couples) or having a net worth of at least $1 million.
Those are pretty high, but not crazy high, barriers. If you find yourself meeting those standards and are looking for ways to increase your returns, there are worse options than hedge funds.
This is an asset class where you really need to do your due diligence. People tend to trust their financial advisers, but they really need to do their own homework and understand how the fund makes money, the manager’s background, the risks involved, how the fund’s performance is determined, how much you’ll pay for this potential extra return, and – crucially – how you can redeem your shares. Getting money out of a hedge fund can be relatively difficult.
I’m guessing that in future years you’ll see more efforts to make hedge funds accessible to more people. That isn’t necessarily a bad thing. But don’t let the promise of high returns lure you into putting too much of your portfolio into one. Diversity is your friend here.
Evan R. Guido is the founder of Aksala Wealth Advisors LLC, a 2018 Forbes Next-Gen Advisors List Member, and Financial Professional at Avantax Investment ServicesSM. Evan heads a team of retirement transition strategists for clients who consider themselves the “Millionaire Next Door.” He can be reached at 941-500-5122 or firstname.lastname@example.org. Read more of his insights at heraldtribune.com/business. Securities offered through Avantax Investment ServicesSM, member FINRA, SIPC. Investment advisory services offered through Avantax Advisory ServicesSM, insurance services offered through an Avantax-affiliated insurance agency. 6260 Lake Osprey Drive, Lakewood Ranch, FL 34240.