Hedging Market Risk - Black Enterprise

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Black Enterprise Magazine July/August 2018 Issue

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Rich people may not be physically different from everyone else, but they certainly invest differently. For decades, the super wealthy (along with institutions) have been the only ones able to invest in hedge funds. “Over the past 10 years, hedge funds have outperformed the U.S. stock market by several percentage points per year, with about half the risk,” says Bill Santos, executive vice president and chief marketing officer at Montgomery Asset Management in San Francisco.

Now, these potentially high-return, low-risk investments are becoming available to millionaires, as well as billionaires. Moreover, mutual funds that mimic some aspects of hedge funds are also on the market. “Nevertheless,” says Santos, “hedge funds aren’t for everyone. Anyone who is interested should work with a knowledgeable advisor to see how a hedge fund might fit into a diversified portfolio.”

Hedge funds are also known as “absolute return” vehicles because their managers aim for positive returns in all types of market conditions, regardless of how stocks or bonds perform. In order to earn profits, hedge fund managers can sell short, use leverage, dabble in derivatives, and engage in arbitrage. Thus, whether they think Microsoft stock is overvalued or the Indian rupee is undervalued, hedge fund managers can place money anywhere they believe they’ll earn big profits.

Hedge funds are private investments, so you have to hear about them from a financial pro. “Some hedge funds are limited to 99 investors,” says Dan Geraci, chief executive at Pioneer Investment Management USA Inc. in Boston. “Traditionally, the minimum investment has been $1 million, or even more.”

Lately, though, the hedge fund universe has become a bit more accessible. “Some financial firms have put together ‘funds of funds,’ with minimum investments of $100,000,” says Geraci.

Jana Thompson, vice president for investment advice and products at Charles Schwab & Co. in San Francisco, explains, “Individuals who invest in a fund of funds wind up with interests in several hedge funds, all of which have been screened by the manager of the fund of funds. These investors participate with several different hedge fund managers, using various investment styles.”

What’s more, fund-of-funds minimums are coming down. Montgomery has a $50,000 required investment for entry, while Schwab may have a $25,000 to $50,000 minimum when it begins to offer and introduce some funds of funds later this year. (Pioneer has yet to announce the minimum investments for its upcoming funds of funds.) Thus, an investor with a $500,000 portfolio who wants to allocate $50,000 (10%) to hedge funds will be able to do so. The one catch: He or she must have a net worth of at least $1.5 million. “Investors in these funds of funds have to meet this requirement to be a qualified investor,” says Thompson.

But there are ways nonmillionaires can benefit, too. “A number of mutual funds now use some hedge fund strategies,” says Russ Kinnel, director of fund analysis at Morningstar Inc. in Chicago, “such as going short as well as long.” These “long-short” funds buy some stocks, in anticipation of appreciation, and

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