It is possible to invest in hedge funds, but there are some restrictions on the types of investors who comprise a hedge fund's investor pool. In general, it is extremely difficult for individual investors to gain access to a quality hedge fund. This forces many to either find indirect methods of investing in hedge funds or just give up trying.
Regulation D, specifically rules 504, 505 and 506, limit the total number of investors who can be admitted inside of a hedge fund. Hedge fund general partners and managers often create high minimum investment requirements. It is not uncommon for a hedge fund to require at least $100,000 or even as much as $1 million to participate.
Unlike mutual funds, hedge funds avoid many of the regulations and requirements within the Securities Act of 1933. In exchange, the Securities and Exchange Commission (SEC) requires a majority of hedge fund investors to be accredited, which means possessing a net worth of more than $1 million and a sophisticated understanding of personal finance, investing and trading. These requirements exclude the vast majority of the investing public.
Many mutual funds were established to mimic the investment strategy of famous hedge funds. These so-called "funds of funds" are inexact replicas, however, since hedge funds have access to a much wider range of investment options. Some hedge funds are actually listed on exchanges and have shares that can be purchased individually or through a broker.
There are also "replication" equity funds that try to imitate the performance of hedge-fund benchmarks, similar to how an exchange-traded fund (ETF) aims to produce the same returns as an underlying index. Options such as these are good alternatives for investors who are interested in hedge funds but cannot gain access to them.
The Advisor Insight
Yes, assuming you meet the fund’s criteria for membership. Those usually follow the SEC’s minimum-income rules: You must have a net worth of $1,000,000 or have made over $200,000 ($300,000 for married couples) for the last two years and this year as well. Those requirements are to ensure that you’re an “accredited investor” and therefore should have the acumen to understand, and the money to risk, on the advanced, aggressive strategies that hedge funds typically use.
Funds can and do make exceptions to these criteria, usually for the proverbial family and friends. The SEC allows them to accept up to 35 non-accredited investors over the life of the fund. But they will usually just stick to the accredited-investor guidelines; some set even higher net worth or earned-income levels minimums.
Matthew J. Ure
Anthony Capital, LLC
San Antonio, TX