The benefits of hedge funds come with plenty of negatives, though.
Hedge fund fees are extremely high. On a gross return of 15 percent, for example, the net to investors could be under 7 percent, after fees.
Capacity is constrained. Investors may find it difficult or nearly impossible to get into the top-performing hedge funds.
Illiquidity is another negative for hedge funds. There may be an initial “lock-up” period, followed by intermittent redemption rights.
Hedge funds are tax-inefficient. They should be held in retirement accounts, if possible, to defer taxes. Hedge fund returns tend to be heavily taxed as interest or short-term capital gains.
Minimum investments can be high. Minimums of $250,000 or more have been common.
Recently, though, some financial firms have been offering funds of multiple hedge funds, with minimums as low as $25,000. Generally, a fund of hedge funds will participate in 25 to 40 different hedge funds, although some might have as many as 50. Thus, investors get diversification among managers, strategies, and styles.
Another way to approach hedge funds is to go into mutual funds that adopt hedge-like strategies. Leuthold Core Investment, Schwab Hedged Equity, FPA Crescent, and Hussman Strategic Total Return funds have minimum investments as low as $1,000. They use hedge fund strategies that include short selling and dealing in derivatives. If you put a few of these together, you can get some of the benefits of hedge funds without all of the problems.
