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| Adrian Mastracci, president of KCM Wealth Management, says “Picking a winning hedge fund is more difficult than picking a stock or mutual fund." |
For Immediate Release
Vancouver, BC (June 1, 2005): Hedge funds are a different kettle of investments. One not well understood by investors.
Adrian Mastracci, investment counsel & president of Vancouver's “fee-only” KCM Wealth Management, comments, “There are deepening investor worries in considering hedge funds. Especially, in light of some recent ones heading for the loss bin. We’ve had Portus and Norshield in Canada, and KL Financial in the US.”
“One day, a retired investor asked me to elaborate on hedge funds,” recalls Mastracci, “He mentioned that the only hedge he knew was the one around his house. I suggested that it be left that way.”
“A little perspective. Canada now has in excess of 250 funds in the “alternative strategies” category, plus another 5,750 or so in all other categories,” notes Mastracci, “US investors have more than 8,000 hedge funds to select from.”
“Roughly 700 hedge funds go out of business every year,” adds Mastracci, “No wonder the debate has nine lives.”
1. Realities on hedge
First, the bottom line. Picking a winning hedge fund is more difficult than picking a stock or mutual fund.
The speed at which money can be won or lost in hedge funds is typically much faster than traditional vehicles. When things go astray, the major damage can unfold in a matter of days. Mostly with little or no advance notice that anything was amiss.
The end results are usually more dramatic and unsettling as compared to stocks or mutual funds. Such as hedge fund redemptions being suspended, major losses, concerns over the safety of invested capital, regulators stepping in, receivers being appointed or even bankruptcy proceedings. All things no investor dreams about.
Investors and their advisors can usually conduct the due diligence on selecting individual stocks and mutual funds. However, it’s not quite that easy for hedge funds.
The best you might get is a statement on hedge fund strategies and investment objectives. Generally, a list of holdings is not published, so they are more difficult to unravel. Besides, the holdings can change daily.
Hedge funds can employ a variety of investment strategies such as having short positions, currency hedges, options, derivatives and credit swaps. Things that investors know little about.
Hedge funds are not easily understood by most investors, especially the risks incurred. They are vehicles better suited for the "alternative investment class", and in small quantities. Say 5% of portfolio value.
The products are still somewhat unregulated. The total investment fees, including performance fees, make it a consideration restricted to fewer investors. Hedge funds can vary enormously, even in the same category.
There are liquidity issues and penalties surrounding minimum holding periods. Hedge fund investments may not be appropriate for investors who may want, or have to, liquidate early.
Hedge fund products are all over the map on risks, investment returns, volatility, investment strategies and policies that they follow. Some also use leverage by borrowing inside the funds; thus, magnifying the impact of a right or wrong call.
A recent case in the United Kingdom highlights this. One hedge fund value dropped from $1.3 billion to $600 million due to investment losses using borrowed money and subsequent investor redemptions.
The availability of information makes it a challenge to conduct proper due diligence on hedge fund products. Often, the investment strategies they employ generate plenty of trading commissions within the fund, but little benefit for the investor.
The tax treatment can vary depending on strategies followed. Some hedge fund results are treated as capital gains/losses, others as income gains/losses.
2. Taming the hedge
So, what’s an investor to do about hedge funds:
- Every investor ought to first ponder "what's important about the finances" before allocating funds to any investment, especially hedge funds.
- Investors have to sift through a lot of due diligence to arrive at the appropriate decisions.
- Investors must be able to withstand substantial risk tolerance before they can consider hedge funds.
- Investors ought to stay invested within their appropriate asset mix to achieve those personal goals, no matter how tempting the hedge prospects appear to be.
- Expect some of the hedge investments to bite the dust, despite all the best due diligence.
- Make sure that no one falling hedge fund affects the portfolio in a meaningful way.
“The reality is that hedge funds are not suitable for everyone,” suggests Mastracci, “There is a place for them in some portfolios in the appropriate quantities.”
“Diversify and keep a keen eye on your holdings,” concludes Mastracci, “The world of hedge funds moves at a fast pace.”
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