Accredited Investors: Hedge Funds and Private Placements

Individuals who meet the requirements of an “Accredited Investor” as defined by Regulation D of the U.S. Securities and Exchange Commission, have opportunities to invest in hedge funds, private placements of securities, and other investments requiring a higher level of knowledge and understanding and a reduced frequency of liquidity and redemption.

Hedge funds are not suitable investments for all types of investors, hence why accredited investors must meet both an income and net worth asset requirement.  To learn more about hedge funds: Please fill out the following to get personal consultation [HERE]... new article on Hedge Funds

Diversifying a portfolio to reduce risk is one of the fundamentals of portfolio management. Adding a well balanced hedge fund strategy may provide investors with diversification by investing in a group of securities whose investment returns do not move together.

In simple terms, investment returns for many types of asset classes move in the same direction; this is known as positive correlation.

The objective of hedge funds is to achieve positive returns regardless of market direction and reduce correlation to the direction of the general securities markets. As can be seen in the graph below, note the positive out-performance since 2000, especially including the period of 2000-2002, of the Hedge Fund Research Funds of Funds Index ("HFRI) Versus the S&P 500, NASDAQ Comp, and Lehman Bond Index

What is a hedge fund? A hedge fund is an investment partnership for “Accredited Investors” that utilizes strategies that are not available to the general investment public. Hedge funds:

    >Have the ability to short stocks, 
    >Use leverage to enhance returns, 
    >Are not quoted or priced on a daily basis,
    >Do not have a prospectus but a Private Placement Memorandum describing the fund and strategy,
    >Have redemption periods that generally are one year, and
    >Have performance fees as well as management fees.

Within the last 5 years, hedge fund assets have doubled to $1 Trillion with estimates for assets to double again within the next 3 years. Led by sophisticated institutional investors seeking to add non-correlated returns to the portfolios that they manage, hedge funds and hedge funds of funds have become important tools for portfolio allocation. Well known institutional investors in hedge funds include large corporate and public pension plans, large endowments and foundations, and high net worth investors and family offices. As hedge funds have become more main stream, greater reporting restrictions and higher levels of transparency have been required.

Hedge funds of funds are diversified portfolios of hedge funds that provide even greater asset diversification. Inclusion of a hedge fund of funds provides another asset class to compliment a traditional portfolio of stocks, bonds, and cash. A well designed fund of funds should lower the overall volatility of a portfolio of equities, while at the same time, compliment fixed income securities by adding a low beta, non-correlated asset to the portfolio. For high net worth investors that own tax exempt bonds, inclusion of a hedge fund of funds may compliment the overall portfolio.

Many financial advisors have historically recommended portfolio allocations of 50-60% stocks and 30-40% bonds in a normalized market environment. Cash positions will vary depending upon the investor’s market outlook. Investing in a portfolio of hedge funds via a hedge fund of funds provides diversification to both the stock and bond portfolio.

The interest rate hikes of 2006 to curb inflationary threats have put pressure on both bond and stock prices, demonstrating the correlation of bond yields and stock prices. Beta is a measure of volatility in a given market and today, many investors are looking for investment tools to reduce both risk and beta, the correlation to the public markets, and to add an asset class that seeks to achieve positive results regardless of market direction.

Hedge funds can appeal to both stock and bond investors alike. Equity investors may look to hedge funds to add alpha and to reduce volatility and correlation to the public markets while bond investors look to hedge funds to outperform in periods of rising interest rates.

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