How to Evaluate Hedge Funds

by Geri Terzo

Every hedge fund is not the same; by evaluating individual funds investors can learn which fund is the most appropriate. Performance is a key factor when evaluating the potential of a fund. Considering the lofty fees that hedge funds charge, returns should make the investment worthwhile. Price is important, but many funds abide by similar fee structures. An investor should also have a keen awareness of the type of strategy that a hedge fund uses to reduce the chance for surprises.

Performance

Subscribe to a hedge fund database in order to learn about the past returns of specific hedge funds. Professional hedge fund managers do not typically disclose performance publicly, but some do make returns available on online industry databases, such as Barclay Hedge or HedgeCo, to attract new clients.

Compare the returns of one hedge fund to another with a similar strategy to get a sense of how a fund performs relative to competitors. View historical performance over several one-year periods in case an extreme performance in any one period was an anomaly.

View the filings of those hedge funds that are publicly traded. Although most hedge funds are private, there are a select few that list shares in the public markets. In 2011, Och-Ziff Capital Management revealed a 17 percent increase in assets over one year from investment performance and investor deposits.

Risk

Read about the investment strategy tied to a particular hedge fund. A fund manager's strategy is typically outlined in a hedge fund's origination documents. Some funds might reserve strategy details for investors, in which case a database subscription will be useful.

Contact the hedge fund being evaluated and ask a marketing representative for details about leverage, which represents the level of debt a hedge fund uses in relation to assets. The higher the leverage, the riskier the investment strategy.

Ask a hedge fund representative about the management team. Experienced traders who have managed funds through different business cycles can be the difference between profits and losses in a market downturn. David Tepper founded hedge fund Appaloosa Management in 1993, and according to Business Insider he was the highest paid hedge fund manager in 2009 on the heels of the economic recession.

Expectations

Write out your investment goals, net worth and available assets. An individual who is investing for retirement should determine the date by which any hedge fund profits would be needed.

Contact the hedge fund's marketing representative to learn if a hedge fund has a minimum investment requirement. You can also obtain this information through a fund database.

Find out if a hedge fund imposes any restrictions for withdrawing assets. Many hedge funds use gates, which is a way to block investor withdrawals for a period of time so as not to interfere with the performance of the fund.

Tip

  • Funds composed of hedge funds offer investors exposure to multiple hedge funds at once.

Warning

  • Hedge fund managers are not risk averse and are willing to place big bets in the markets.

About the Author

Geri Terzo is a business writer with more than 15 years of experience on Wall Street. Throughout her career, she has contributed to the two major cable business networks in segment production and chief-booking capacities and has reported for several major trade publications including "IDD Magazine," "Infrastructure Investor" and MandateWire of the "Financial Times." She works as a journalist who has contributed to The Motley Fool and InvestorPlace. Terzo is a graduate of Campbell University, where she earned a Bachelor of Arts in mass communication.

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