"Rich guys have all the fun," said my friend after reading
severalhedge fund prospectuses.
He added that he would love to diversify hisstock portfolio
with alternativeinvestments , but the best hedge funds typically
require a million-dollarminimum investment and the investor to be
It's just not my friend. Even most accredited investors can't
afford to plunge a million or more into a hedge fund and hope for
the best. Most individual hedge fund investors are in the
ultra-highnet worth class. For them, a million dollars in a hedge
fund merely represents thediversification of a portfolio rather
than the majority of its investable assets.
What Are Hedge Funds?
Hedge funds are loosely regulated privateinvestment partnerships
that invest in a wide variety of strategies. These strategies can
includederivatives , long and short positions, commodities,
currencies and just about any other investment strategy that can
This wide diversification choice is what gives hedge funds
their edge over more traditional investments. In addition,
because they're subject to less regulation and oversight than
other forms offunds permits hedge funds can quickly alter course
in search of profits. Furthermore, their ability to useleverage
and invest in exotic products increases their appeal among ultra
high net worth investors.
However, it's critical to remember that leverage, managerial
freedom and exotic products can work against you as easily as for
you. Just because it's a hedge fund, the profits are no way
As an example, my old firm was invested in five different
hedge fund partnerships. Out of the five, three lostmoney over
theyear , one broke even, and one made hugegains , saving the
firm and its investors. Had we not been invested in the one large
winner, it would have been a financial disaster.
In my mind, this experience solidified the need for
diversification, regardless of one's confidence in a particular
investment or manager.
Play In The Hedge Fund's Exclusive Sandbox
I explained to my friend that there is a solution to his dilemma.
Now every investor can take advantage of hedge fund tactics and
Known as alternative mutual funds, these funds attempt to
mimic hedge fund strategies -- only without the very high fees
and often lofty structural risk that are part and parcel with
private hedge funds. These alternative mutual funds invest
andhedge with derivatives, shorts, exchange-traded funds (
) and nearly anything else a hedge fund would be interested
Investors do not need to be accredited and may invest far less
money. These alternative mutual funds also do not charge the
standard yearly fees (2% on assets and 20% on performance) of
their hedge fund brethren.
There are limits on leverage that can be employed by
alternative mutual funds, but this can be a good thing, should a
The alternativemutual fund space has been exploding in
popularity. In 2007, there were just 112 alternative mutual
funds. Today, there are 357 -- more than three times as many. I
think this is just the start of the growth in alternative mutual
Offering most of the benefits of hedge funds, but with a much
lower entry price level, radically lower costs, and just enough
regulatory oversight to increase the safetyfactor , alternative
mutual funds may one day take the spotlight from the traditional
hedge fundmarket .
In fact,multiple large hedge funds have launched or are
considering launching alternative mutual fund products. It is
truly a niche that should be on your investment radar.
My Favorite Alternative Mutual Funds
Bridgeway Managed Volatility Fund (
: Thisfund has produced more than 6% returns in the past year
with 4% of that in 2013.
It seeks to provide high returns with short-term risk less
than or equal to 40% of the stock market. About 75% of the fund's
assets are invested incommon stocks and options on companies that
trade on regulated national exchanges.
Fees are low with anexpense ratio of 0.94, and Morningstar
lists risk at below average when compared with other funds in the
Dreyfus GlobalAlpha Fund (
: The word "alpha" in the hedge fund world means performance
above the norm, and this alternative mutual fund fits the
The fund seeks total return byinvesting in the globalequity
,currency ,bond and fixedincome securities. It primarily
usesfutures , options andforward contracts that allow the fund's
managers to make fast decisions. The fund has earned investors
more than 8% in the past year and just under 5% in 2013.
Global Alpha has an expense ratio of 1.85%, which is above
average, according to Morningstar, which also rates the fund as
high risk compared with similar funds.
Risks to Consider:
Alternative mutual funds should be used as a way of
diversification and not a primary investment. The strategies
employed often contain more risk than traditional mutual funds.
This risk can beoffset by higher rewards. Always use stops and
position size properly in your portfolio.
Action to Take -->
I like both of these alternative mutual funds as a means to
diversify a stock portfolio -- and hopefully capture profits.
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