Do you have a million dollars in your back pocket, or $200,000 a year in income? If not, you can't qualify as an accredited investor according to the SEC, and it means you are completely shut out of investing in hedge funds.
If you lack the buy-in, but still want a taste of what hedge funds have to offer, I have good news. Several mutual funds have popped up that use short strategies and other methods within their portfolios to be hedge fund-like, and anyone can invest. (To learn more about these mutual funds, check out The Rise Of The Hedge Fund.)
The Big Fuss About Hedge Funds
You might be curious as to why non-accredited investors are blocked from hedge funds investing in the first place. Essentially if you are an accredited investor, you have enough money to lose, or are still capable of earnings it back. Hedge funds are not necessarily more risky, but the managers do not have to disclose what they are doing like mutual funds.
This secrecy is a real risk. If a hedge fund does start to tank, an investor may not know to pull out until it there is no money left. But the accredited investor block out causes disadvantages as well; many of the non-market correlated strategies that hedge funds provide can help all investors with their diversification needs. Mutual funds have had some trouble since a mutual fund manager can not hold more assets short than long. (For more background on hedge fund strategies, check out Massive Hedge Fund Failures and Taking A Look Behind Hedge Funds.)
This dilemma has been somewhat diminished due to some pioneering mutual funds over the last few years. Mutual funds cannot have more assets short than long, but shorting is still possible, and an influx of funds have hit the market that have hedge-like strategies, such as long/short, market neutral and merger arbitrage.
To start there is the Grizzly Short Fund (GRZZX), which actually has all of its equity holding short, with no long exposure. This is possible since the management holds more than twice the amount of short equity in cash as a cushion. Even with two-thirds of the portfolio in cash, management has been able to approximately earn a 20% return year to date (YTD). The long-term performance of the fund has not been stellar with up-market years of 2003 and 2006 seeing losses of 31% and 12% respectively, but the fund could help long investors balance their investments a little.
For long/short strategies there are plenty to choose from. I stumbled across Ivy Asset Strategy (WASAX), which boasts a four-star rating from Morningstar, and while Morningstar doesn't classify it as long/short, it has a net short position in equities. This exposure is offset by a net long position in cash, and a long position in bonds. The fund has been down about 2% YTD, but has performed very well returning around 20% per year on average for both the three-year and five-year periods. Another great pick in this area is Diamond Hill Long/Short Fund (DIAMX). This fund gets a five-star rating from Morningstar, and despite low returns in 2007 and 2008, the fund had a 17% average return over the last five years.
Market neutral funds seek to have little or no correlation to the stock market by being long and short almost equal amounts leaving them neutral. Two notable funds in this category are Calamos Market Neutral Income (CVSIX) and TFS Market Neutral (TFSMX). The Calamos fund uses some interesting strategies such as convertible arbitrage and covered call writing against their investments. The fund has been able to provide small but stable returns over the long-term. Of these funds the TFS fund looks most promising. The fund has 15% of its net assets in stocks, and has proved itself. It has a 5-star rating, and a 12% three-year average return.
Finally I want to touch on merger arbitrage, something even mutual funds are getting in on now. An example of this is the aptly named Arbitrage Fund (ARBFX), which invests mainly in merger and acquisition risk arbitrage. The fund has a high expense ratio at nearly 2%, which causes it to only have a three-star rating, but the fund rose 5.9% in 2006 and 7.4% in 2007 with a relatively low risk strategy. (To learn more about Arbitrage, check out Trading The Odds With Arbitrage and Trade Takeover Stocks With Merger Arbitrage.)
The Bottom Line
If you are a non-accredited investor, but still want some of that hedge fund exposure; there are options out there. The mutual funds mentioned here are hedge fund-like, and give some of that exposure. Better yet, they give the exposure and still have to disclose what is going on. This list is by all means not all-inclusive, but does include funds that could help you lower the correlation of your portfolio with the market.