Hedge Funds:

Suitability

  

Sophisticated Investors

Position: Hedge funds are appropriate investment vehicles for those individuals/firms/funds that have:

• An understanding of the risks posed by sophisticated financial instruments and strategies, or can afford to hire someone with such understanding

• Sufficient financial resources to sustain possible losses

• Access to fund managers for updates and to know the backgrounds of managers

Rationale: Such individuals/firms/funds possess sufficient resources and expertise to know what they’re doing and to endure losses if they arise.

Where stated: EAC - FSA DP 16; USAC - SEC Hedge Funds 2003

 

Unsophisticated Investors

Position: Hedge funds are inappropriate for unsophisticated investors.

Rationale: The inappropriateness is because unsophisticated investors:

• Lack the expertise to understand the risks inherent in these types of investments

• Typically do not possess the kind of financial resources to hire the expertise needed, weather volatile performance, or endure financial losses;

and because these investment vehicles:

• Have limited transparency about investment strategies, instruments, and risks, and

• Do not provide the regulatory protections that retail investors receive when they put their money into other investment vehicles.

Where stated: EAC - FSA DP 16

 

Transparency Needed for Retail Investors

Position: Hedge fund investments might be appropriate for retail investors if the hedge fund and its manager were more transparent in their running of the fund.

Rationale: The manner in which most hedge funds are operated today would make it difficult for retail investors to recognize when the investment manager is changing its strategy or to understand how it might affect the risk of the investment vehicle. To make hedge funds more appropriate for retail investors, therefore, hedge funds and their managers would have to:

• Disclose the risks of the fund at the time of offering and on an on-going basis

• Disclose any changes to investment strategy and how that might affect the risk of the investment fund

• Disclose regular information about fund performance on an absolute basis and against an appropriate benchmark

• Separate the compliance function from that of the manager

• Subject funds to audits by an external, independent audit firm

• Structure funds of hedge funds to limit the correlation among returns for funds held in portfolio

Where stated: EAC - FSA DP 16; USAC-SEC Hedge Funds 2003

 

Risks of Hedge Funds

Position: Hedge funds may expose investors to risks associated with:

• Leverage
• Inadequate transparency
• Inadequate performance standards and measurement
• Risky or unknown counterparties
• Sector concentration
• Concentration in specific securities
• Lack of regulatory oversight

Rationale: None of these risks are associated with typical retail investments.

Where stated: USAC - SEC Hedge Funds 2003