By John Drachman
Is your portfolio of stocks, bonds and mutual funds enough for you? These traditional investments make up the core of most portfolios. However, you might be overly concentrated in securities liable to move south all at the same time during the volatile, pandemic-driven days ahead.
That’s why more investors are considering alternatives; specifically alternative investments like hedge funds. U.S. News recently profiled five of the top performers: “With 66% average annual returns since 1988 – 39% after fees – Renaissance’s Medallion fund is in a league of its own.” Institutional funds like this are not available, though, to unaccredited investors with less than $1 million in net worth.
The main allure of hedge funds is their potential to deliver returns unaligned with traditional stocks and bonds. Fortunately, investments that employ hedging strategies can be found for steely-eyed smaller investors looking for a Wall Street payday with the big players. For minimums as low as $2,000 investors can access any number of alternative mutual funds that specialize in such techniques as:
- Global macro strategies based on major trends such as moves in interest rates, currencies, demographic shifts, and economic cycles.
- Directional hedge fund strategies that bet with or against major market moves.
- Long/short strategies that bet with or against two securities in the same industry.
Before taking a seat at the hedging table, consider separating the myths from the facts that surround this glamorous, monied world. Remember Bernie Madoff? Currently serving a 150-year sentence for running one of the largest Ponzi schemes in history, he was just denied Covid-19 compassionate release in June. Not your typical hedge fund manager, Madoff kept investors and advisors in the dark about their underlying portfolio investments – which he busily pocketed. Luckily for you there are guardrails to follow as long as you undertake some due diligence.
- Transparency: Make sure your fund managers publicize the underlying investments. While a lack of transparency alone does not indicate fraud, you have to know whether the risk and reward tradeoff you’re undertaking is worth it.
- Autonomous custody: Your investment proceeds should never be directly handled by the money manager – as Madoff’s victims discovered.
- Independent oversight: Better fund managers ensure that all recordkeeping is conducted by leading third-party administrators.
- Fee disclosure: As we saw in the Renaissance example above, fees can get hefty quickly. Make sure they are clearly disclosed in sufficient detail to ensure you are receiving value.
- Audit: Best practices – and common sense – demand that your money manager obtain an unaligned third-party audit at least annually.
The bottom line
Blending alternatives with traditional assets in your portfolio can make good investment sense. However, even the most committed do-it-yourselfer should think twice before entering this sector without professional guidance. The Securities and Exchange Commission thinks so too. From its hedge fund investor bulletin, the SEC offered this guidance: “It is important that you read all the documents before making your decision to invest in a hedge fund – and consider consulting an independent financial advisor before investing.”
John Drachman is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. John is an IABC award-winning writer, who applies his 30 years of financial marketing experience toward advancing the dialog between investors and investment professionals.