Factors to Consider before Investing in Hedge Funds
From Financial Literacy Wiki
Factors to Consider before investing in Hedge Funds
Due to its nature, hedge funds are not easily understood by many lay investors. The investment strategies that hedge funds adopt make it even more difficult for lay investors to assess the risk involve. The following are some important factors that investors should consider before investing in hedge funds:
Performance
Hedge funds boasts high average returns and even high Sharpe ratios. Assessment techniques that most investors are familiar with assumes that the probability of return follows a normal distribution (or commonly known as bell-shape distribution) but for the case of hedge funds, due to the investment strategies they adopt, the probability of return is non-normal. There are other ways to account for the non-normality but these techniques are too complex and tedious for most investors to understand and use. The best strategy to use when investing in hedge funds is to invest across different hedge funds or limit your exposure in this investment tools.
Survival Rate
The average lifespan of hedge funds is around 3-4 years. Around 35% of newly founded hedge funds have to fold up due to poor performance. This translates to a high risk of losing a substantial portion of your capital.
Lack of Transparency
Hedge funds that are registered in other countries are usually not registered, private investment vehicles that are exempted from securities regulations. As such, hedge funds have great freedom to choose the investment strategies the implement. And they are not required to disclose their investment holdings or performance beyond what the sponsors voluntarily agreed to provide to investors.
Lack of Liquidity
Most hedge funds, unlike unit trusts, allow investors to cash out any business days. Depending on the rules set, investors can only cash out at certain time of the year.
High Costs
Hedge funds, like unit trusts, have upfront sales charge and annual management fees. Hedge funds also have performance fees that can be as high as 20%. Other hidden charges includes transaction costs and taxes. The more actively managed the fund is, the higher will be the hidden costs.
Fund-of-funds would have another layer of costs compared to single funds because you have another group of people to manage the assets.
