How to Invest in Hedge Funds?

New investors have it better than ever. For a tiny fee, the best funds will manage your money for the maximum profit. And we’re talking about professionals with trading equipment who invest for a living.

Too good to be true? Maybe.

When you trust your money to a mutual fund manager, you expect to get a return. Even if they’ve overperformed the market for years, it may not always be that way. You might sometimes earn nothing.

But don’t worry. There are different funds depending on your security and risk preference.

What if you want to get more money faster? The risk increases.

Unless you work with a professional, you’ll likely lose money. That’s why people invest in hedge funds.

What Is a Hedge Fund?

What Is a Hedge Fund

Imagine you had $100K. You find a crazy strategy to get 50% returns in 24 hours. There’s also a 50% chance of losing 50%.

If you wanted to reduce the risk of losing, you’ll need preparation:

  • Develop your market analysis skills
  • Research the market news every day
  • Know when to buy and when to sell

These factors may lower your risk from 50% to maybe 30%.

And there are trades who’ve been doing this for decades. Instead of competing with them, why not let them do it for you?

A hedge fund is a pool of investor money controlled by a manager. Their goal is to offer higher returns faster, which they achieve by increasing risk and using complex strategies.

So what makes it different from mutual funds? The risk and strategies used:

High Risk

Even with professional help, increasing the risk is dangerous. That’s why hedge funds have underperformed the S&P 500 for the last decade at least. However:

  • Out of all the fund managers, a few of them do well consistently
  • Even the best funds fail at times

Even if you find success, nobody knows for how long the fund will be profitable. If you just wait until it starts to fall, you’ll inevitably lose some money.

It’s not enough to trust a hedge fund manager. It also takes skill to pick the best fund, knowing when to get in and when to get out.

That’s why access is very limited.

With mutual funds, you open an account, deposit money, and that’s it.

But hedge funds are private. If you want to invest:

  • You have to get the firm’s approval since they allow a limited number of investors
  • You need to be an accredited/institutional investor
  • Your network must be above $1 million not including properties
  • Your minimum income should be a yearly $200K for at least two years
  • Your minimum deposit amount is $100K plus a 2% management fee
  • You have to patiently wait 12+ months for your first withdrawal

It’s risky because you’re putting down big money and giving away control. If you’re okay with that, there are profit opportunities.

Alternative Strategies

In trading, almost everything is a win-lose scenario. Odds are against you when you do what everyone else does. That’s why high-net-worth investors look for harder strategies, even if they’re less reliable.

What does ‘strategy’ mean without getting too technical?

It’s every possible way you can earn profits from the market. As a fund manager, however, you’re playing with other people’s money, which is why the SEC restricts what you can or cannot do.

Longing is the default. Fund managers buy and expect to sell when prices go up.

But hedge funds are private and not as regulated. That allows for more creativity with strategies, whether it’s shorting, options, or derivatives.

When you buy long, you only profit in one direction: uptrend. Hedge funds, by contrast, can profit in all market directions, provided they assess the risk.

More possibilities add complexity, which is why we hire professionals.

How to Invest in Hedge Funds?

How to Invest in Hedge Funds

Hedge funds are private groups. You will rarely find them advertising on the Internet, and the registration isn’t straightforward.

If you don’t want to waste time, first make sure you meet the requirements (qualify as an accredited investor). Fund managers will request documents to prove your income and accredited status.

With that ready, you contact your hedge fund manager. But if you don’t know who to trust, here are some of the most established firms:

  • Bridgewater Associates
  • Renaissance Technologies
  • Millennium Management
  • AQR Capital Management
  • Two Sigma Investments
  • Elliott Management
  • Man Group
  • BlackRock

Different companies have different requirements, and you can always contact client support to be sure.

On registration, you submit the requested documents and wait a few business days for their review.

Assuming you qualify, the next step is signing an agreement. Here, you can learn more about:

  • Risk management and investment strategies used
  • What exactly you’re paying for every year
  • How withdrawals work

And more importantly: they have no guarantee you will earn anything.

Are Hedge Funds Worth It?

Are Hedge Funds Worth It

Investing in hedge funds isn’t for everybody. Although their high entry barrier should increase rewards, those high-risk strategies have led to the opposite.

Should you put your millions here? Definitely not before looking into other options.

Here’s what you should know first:

Unpredictable

Suppose that a company discovers a strategy to make fast profits 90% of the time. With those statistics, who wouldn’t put their money there?

Say something changes in the market. Suddenly, the strategy no longer works. It loses money.

And while it’s easy to explain why something stops working, it’s not so easy to find a working system again. What worked today may not work tomorrow, and the contrary may happen too.

Do you think you will get out before things stop working out? Remember that the fund managers are the ones who research the market. If they find bad news and sell, you’ll be the last one to know.

Which leads to the next problem.

No liquidity

Hedge funds are a good choice if you’re okay with having someone manage your money, with no control whatsoever. Even though you’re trusting the absolute best financial analysts, the risks are still there.

It’s easier to profit when you can quickly move in the market. With hedge funds? You put your investment and wait for 1+ year. Then, you might be able to withdraw.

The power of investment funds is unity. If ten investors trade from the same account, they will only have to pay fees once. Things would get complicated if anyone were able to get out anytime.

Most people think the same way, which may lead to mass withdrawals. If that happens, your payment may delay for weeks, costing time and money.

You can’t time it. If you’re expecting the withdrawal to clear tomorrow and it delays for a week, your investment returns will change.

The fund managers will move your money the best way they know. And that means that every investor subscribed to the fund follows the exact same strategy (which is why they limit their number). If you don’t like how they work, you’ll need to get the money out and do it yourself.

High Service Fees

How much would you expect to earn with a world-class fund manager? Knowing that you’re one of the few you qualified for the hedge fund?

Your expectations aren’t wrong. These experts back them up with decades of financial history. It’s why we have high standards, and why they charge premium prices for the service.

You wouldn’t mind paying 2-3% in fees if you doubled your money. But if you lost 5% of your portfolio, it would look like a scam.

The problem is, you pay the fee once you sign up, before getting any profits.

Consider the liquidity problem as well.

Let’s say your hedge fund made good money but has gone downtrend recently. And while you want to get out, you need to wait one year before you can withdraw. So besides facing a loss, you’re still paying 2-3% for the service, waiting for the withdrawal.

Lack of transparency

As a private fund type, the SEC doesn’t regulate hedge funds as much as mutual funds. While that gives freedom to the company, it can be hard for the client to understand what the company is doing.

Without regulation, the firm doesn’t need to disclose as much information as a public fund. And even if it were visible, it’s still too complex to understand (unless you’re a financial analyst).

Mind that fund managers may be getting rich with a different strategy from the one disclosed. They manage your money with Strategy A, but they use Strategy B for their own. Add the 2% fee and a 20% cut from the profits, and it’s not surprising why managers get rich.

The Bottom Line

Although it sounds disapproving, our goal is to show you the possible ways to lose money. Because anyone can profit from the markets. It’s your risk management strategy that delivers consistent results.

If you know what you’re doing, hedge funds are the perfect opportunity to grow your account. Just don’t come with the wrong expectations:

  • Even the most consistent strategies come to an end
  • Even though the goal is to make you money, the firm may have its own interests
  • Even with the best managers, you’re still the only responsible one for your financial success
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