We at Perspective Financial believe certain investment products should be viewed with a great deal of caution, or even avoided completely.  Hedge funds are one example.

Hedge funds are like mutual funds in that they are pooled investments managed by a professional money manager. But that is where the similarities end. Unlike mutual funds, hedge fund managers have wide discretion to use aggressive, speculative (a.k.a  risky) strategies such as leverage, short-selling and derivatives.  As a result, hedge fund returns can be volatile and unpredictable. Hedge funds are typically illiquid with no secondary market, and investors often cannot get out when they want.  Also unlike mutual funds, hedge funds  operate with little to no regulation by the Securities and Exchange Commission (SEC).

Law requires that hedge funds be sold only to “accredited” investors, those with annual income exceeding $200,000 or a net worth of more than $1 million. Many successful professionals and business people may qualify and be tempted by claims of fantastic investment returns. Many other investors may find it disconcerting that a great deal of pension fund and endowment money is invested in hedge funds.

Due in large part to the extraordinarily high fees charged by hedge funds, these managers have been good at making money – for themselves. In his book The Hedge Fund Mirage, Wall Street author Simon Lack offers stinging commentary on the hedge fund industry. He describes a world where Ferrari-driving hedge fund managers live extravagantly, while most hedge fund investors have not fared so well.

“Who can name one hedge fund investor whose fortune is based on the hedge funds he successfully picked?” Lack writes. Unfortunately for most investors, he concludes, “If all the money that’s ever been invested in hedge funds had been put in Treasury bills instead, the results would have been twice as good.”

Lack’s claim has been disputed by some in the hedge fund industry; yet, many others say Lack got it right. As Ryan Cooper, business writer for Washington Monthly puts it, “It’s official.  Hedge funds are a rip-off.”