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Frequenty Asked Questions
About Hedge Funds and Alternative Investments
- What are Alternative Investments?
Alternative investments provide unique risk and return properties not found easily in traditional stock and bond investments. Portfolios of conventional, publicly traded stocks and bonds can qualify as alternative investments if they are constructed and managed in nontraditional ways. Although they have many unique characteristics, alternative investments can be defined at a basic level by their ability to utilize a wide array of trading techniques often (but not always) including selling securities "short" and employing leverage.
- What is the appeal of adding alternative investments to a portfolio?
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Although these investments do carry their own unique risks, there are many reasons why suitable investors may decide to add alternative investments to their portfolio. For example, managed futures and hedge funds in particular have historically proven to have low correlation with overall market activity. Investments such as these, tend to be good candidates to aid portfolio diversification. Portfolio diversification is one of the key elements of Modern Portfolio Theory, and can result in portfolios with more favorable risk versus return characteristics. There is no guarantee that the addition of alternative investments to a portfolio will increase returns or avoid losses.
- What are some examples of alternative investments?
Hedge funds, managed futures, venture capital, private equity, and leveraged buyouts are generally accepted as being alternative investments, as are farmland, timberland and oil & gas. Some investment professionals also include real estate in the alternative investments category.
- What are Hedge Funds?
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Hedge funds are often misunderstood. The term "hedge fund" has its origins at least as far back as sociologist Alfred Winslow Jones, who is often referred to as the father of the hedge fund industry. The idea of hedging and the concept of hedge funds came from his idea of reducing or eliminating market risk by offsetting (or hedging) long positions in undervalued equities (stocks he believed would rise in value) with other short positions (stocks he believed would fall in value). This in theory removed the reliance on a rising overall market in order for the hedge fund to make money. In effect, the hedge fund would depend less on the market and more on the skill of the hedge fund manager in determining the value of the stocks within the fund.
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Today, hedge fund styles and strategies have expanded, and the definition of a hedge fund has more to do with the structure of the investment vehicle rather than the method of investing. Hedge funds are commonly set up as a limited partnership with the hedge fund manager acting as the general partner and the investors in the hedge fund acting as limited partners. Hedge funds are able to invest using numerous strategies, which may include one or combinations of short-selling, arbitrage, leverage and, of course, hedging. These hedge fund strategies are applied across a diverse array of asset classes, including stocks, bonds, commodities, and currencies.
- Are there special risks associated with Hedge Funds?
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Yes. In addition to the general risks described for all alternative investments, investing in hedge funds may involve a high degree of risk. These investors often engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are not subject to the same regulatory requirements as mutual funds, often charge high fees which may offset any trading profits, and in many cases the underlying investments are not transparent and are known only to the investment manager. All hedge funds are unique and any investor should carefully consider all risks prior to placing money with a particular hedge fund. Specific risks can be found in the hedge fund's offering memorandum.
- Who invests in hedge funds?
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Hedge funds are generally only suitable for sophisticated, high net worth investors including qualified individuals, endowments, institutions, funds of hedge funds, family offices, and pensions.
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