By Dan Barufaldi

Hedge funds can be complicated investment vehicles that are difficult to understand. This is due partly to the complex strategies they use, and partly to the high level of secrecy inherent in trying to prevent others from copying your investment methodology. It doesn't help the industry that the media usually only showcases hedge funds when there is a huge blow-up or, in a few cases, when a hedge fund has incredibly high returns.

The truth of the matter is that there are hedge funds that generate attractive (relative to expectations) returns, and sometimes the return pattern can be volatile while other times the pattern is very stable. There is a hedge fund to fit the risk/return guidelines of any investor and with proper education, evaluation, and familiarity with them, they become much less intimidating.

This is not to say that anyone should take a hedge fund investment lightly. As I mentioned earlier, there are more risks to a hedge fund than the probability of losing money. For example, there is the risk that an investor may not have access to their cash for extended periods due to lock-ups. And there is a much more subtle risk of a hedge fund having style drift and causing the investor's portfolio allocation to become sub-optimal.

As the industry continues to evolve, we may see additional regulation that may help to assess the merits of hedge fund investing. Or we may see third-party research companies increase their hedge fund coverage to provide opinions to investors. Morningstar has already begun to perform analysis on certain hedge funds and has their own hedge fund database. For now, most of the due diligence needs to be performed by the investor or their investment advisor.

For further reading, check out Hedge Funds Hunt For Upside, Regardless Of The Market and Hedge Funds: Higher Returns Or Just High Fees?





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