How to Invest in a Hedge Fund

by Ossiana Tepfenhart about a year ago in investing

Want to invest in a hedge fund? It's not so easy...

How to Invest in a Hedge Fund

Hedge funds have a tendency of carrying a lot of clout, simply by their reputation for exclusivity alone. These funds are pools of money from investors that are managed by professionals who "hedge" high risk investments against low risk investments to maximize profit.

A classic calling card of the ultra-wealthy, having a hedge fund has long been considered to be a must for people who want to have a fully diversified high net-worth portfolio.

The problem is that hedge funds are private investments, and getting into one is hard as can be. Do you want to invest in a hedge fund yourself? If you take a look at what you have to do, it might not actually be worth it.

Before you try to invest in a hedge fund, it's important to understand something about these funds.

Hedge funds are not low-risk. In fact, they are some of the most dangerous investments you can make. If you are looking for safe investments, don't look here. A lot of people can and do get burned by hedge funds.

They are private, so they aren't as heavily regulated as most other investments are. This can be both a good and a bad thing, depending on the fund and the goals you have.

Even the biggest hedge funds in the world carry their own risks, and you need to realize that. You shouldn't invest in a fund like this if you're just doing it to prove you're rich. It could be a move that makes you pretty darned poor.

Remember how we mentioned that only wealthy people can invest in a hedge fund? This is because the SEC legally limits investing in hedge funds to people who are cleared for this high risk endeavor.

To be an accredited investor, you will need to be approved by the SEC. This means you will need to make around $200,000 per year for the past two years or have a minimum net worth of $1 million.

Other restrictions apply, but that's basically the gist of it. If you're low income, you can't invest.

The standards might also be higher than just accreditation.

Most hedge funds also charge fees for entry and continued maintenance of the fund itself. To legally be able to charge fees for the performance of the hedge fund, funds may choose to offer opportunities exclusively to people called "qualified clients."

Qualified investors are people who meet at least one of the following standards:

  • They have a minimum net worth of $2.1 million. The net worth also excludes their primary residence.
  • They will need $1 million in asset management. Ideally, this will be under the person who will connect them to the fund.
  • They're a qualified purchaser. This is fancy lingo for saying you have $5 million or more in investments.
  • They're an employee of the advisor. You also can qualify if you're on the board of directors or have other high-ranking forms of associations to the fund.

Before you even go out seeking funds, you will need to furnish proof that you qualify.

There won't be a hedge fund out there that will start pitching you to invest without proof that you carry the amount of money necessary to make it legally possible. You will need to go through an accreditation application and gather up paperwork to ensure you get approved.

This is usually the hardest step to getting into a hedge fund. Once you're done dealing with approvals, you can actually seek out a hedge fund that you want to place money into.

If you manage to do all that, you're going to need to start looking for hedge funds.

You can't invest in a hedge fund without actually finding one, you know! That being said, all hedge funds are a little bit different and it's important to find one that aligns well with your principles and ideas.

Finding a hedge fund can be tricky, and many people start by asking their financial advisors where to go. However, you can also use sites like Hedgeco or EurekaHedge to find funds that might work with your financial goals.

Once you find a hedge fund you like, you're going to need to do due diligence.

Investing in these kinds of funds is tricky, primarily because they are not as well-regulated as stocks or bonds are. You may not be able to fully glean the details of the investment you're making, so to a point, it will be naturally riskier.

That being said, you should find out the following information and use it to determine whether the fund is worth it:

  • Who is the hedge fund manager? If they are not well-known and have no qualifications, you shouldn't invest in the fund. It's probably a shell company or a scam.
  • Who is the investment adviser firm? The firm who advises the fund is a huge factor to consider. A firm that isn't registered with the SEC is ultra high-risk and should be avoided. You can learn more about the firm through their Form ADV, which is on the SEC's Investment Adviser Public Disclosure site.
  • What are the fees like? Most funds will have fees associated with them. You need to make sure they don't eat away at your profit too heavily.
  • What assets are in the firm, and why? Some assets are harder to sell and valuate than others. If assets seem too risky or don't make sense, you may want to continue your search.

Once you find one that seems worth it, you're going to need to read the terms of the fund.

Most hedge funds will have a minimum amount of money that you will be required to deposit in order to be a part of the investors' group. You need to know if you have that money on hand in order to invest. If you don't, you will need to wait a while.

Hedge funds also typically have limits on how much money you can withdraw, when you can withdraw it, and how to do your withdrawals. It's good to know these things before you need to make a withdrawal.

Once you read everything you need to read and have done due diligence, you can invest.

Most people invest in private funds through their financial advisor, but you can also contact the fund directly to start your investment. From there, the funds will typically take it upon themselves to walk you through the process.

Congrats! You're now an investor in a hedge fund!

Too much work? We don't blame you.

Though it may seem glitzy to say you're a part of it, not everyone should invest in a hedge fund. If it's too much for you, it may be better to just invest in one of the best S&P 500 index funds instead.

Ossiana Tepfenhart
Ossiana Tepfenhart
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Ossiana Tepfenhart

Ossiana Tepfenhart is a writer based out of New Jersey. This is her work account. She loves gifts and tips, so if you like something, tip her!

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