Hedge Funds: Key Questions to Ask
Listed below are seven key questions the advisor should get answers to before recommending a specific hedge fund.
[1] What is the strategy and can it change?
Most of the time, the investor should seek a hedge fund whose strategy is not correlated to the bulk of his/her other holdings. It is extremely important to find out the amount of possible leverage; the fund’s ability and extent to short positions is also a key concern. Try to find out if the fund intends to switch strategies often or suddenly.
[2] What is the track record?
Review annual return figures and discern the methodology used to arrive at return figures, since there is no uniform standard. Hedge funds are not required to report performance net of fees.
[3] Who is behind the fund?
The SEC ADV form describes fund mangers, fees, investment philosophy, and any disciplinary action.
[4] What are the fees?
Hedge funds typically charge a 1-2% annual management fee plus 20% of yearly profits. Find out the “hurdle rate” (the minimum return that must be obtained before performance fees are charged).
[5] Who else is a fund investor?
Usually a hedge fund will not disclose investor names, but it does not hurt to ask. Still, you may be able to find out what percentage of the manager’s net worth is in the fund.
[6] What access does the investor have to his/her money?
The typical hedge fund ties up a new investor’s money for a specified period. Redemptions for all investors are usually on a quarterly basis. Once requested, over 50% of hedge funds require investors to wait at least 16 additional days (source: Hedge Fund Research, Inc.).
[7] What are the tax implications?
Find out if the client will be receiving a 1099 or K-1. Since most hedge funds are organized as partnerships, it is likely a K-1 will be sent out each year. A K-1 can be sent out as late as September (meaning the investor will need to request a filing extension). Finding out if the fund is likely to generate short-term or long-term gains is also important.