Hedge funds offer returns for deep-pocketed investors - 08/16/02

While the markets are undergoing upheaval, The Herald will address questions investors may be asking. To ask a question, e-mail market@herald.com

QUESTION: Should I invest in hedge funds?

ANSWER: Hedge funds consist of private limited partnerships -- investment pools -- designed for so-called sophisticated high-net worth individuals. Under U.S. Securities and Exchange Commission regulations, hedge fund investors must have either a minimum net worth of $1 million or annual income of at least $200,000 for an individual and $300,000 for a married couple.

The hedge fund industry -- estimated at $400 billion to $500 billion -- generated controversy during the 1990s after a few high-profile cases of poor management. But as an asset class, hedge funds involve varying levels of risk and returns, and have outperformed major market indexes recently, according to industry data. From July 2000 though June 2002, hedge funds grew 3.22 percent, and the S&P 500 index fell 31.95 percent, according to industry data.

U.S. hedge funds operate with far less regulatory scrutiny than other investment funds. For that reason, the SEC limits the sale and marketing of hedge funds to qualified investors. Sold through private placements, hedge funds typically sport minimum investment levels of $250,000 to $1 million.

Compared with mutual funds, hedge funds use a broader range of investments, including distressed securities, foreign currencies, options, futures and short positions (investments made in anticipation of falling share prices). Unlike mutual funds, hedge funds also use leverage or borrowed funds for investment purposes. ''You can invest in any market or investment opportunity,'' says David Friedland, president of Magnum U.S. Investments, which is based in Aventura, with offshore operations in Nassau and the Bahamas.

With $300 million under management, Magnum has a minimum investment level of $100,000 and invests its funds in several other hedge funds.

Historically, that strategy yields less volatility and higher returns than standard mutual funds, Friedland says. That performance is attracting a wider audience on Wall Street.

''There's a scramble to create hedge fund products that are bite-sized for small investors,'' according to Jon Sundt, president of Altegris Investments, a California-based consulting firm.

For instance, earlier this month, Charles Schwab & Co. launched the Schwab Hedged Equity Fund, a mutual fund that will emulate a few hedge fund strategies such as short and long positions, says Lance Berg, a Schwab spokesman. The minimum investment is $25,000, with $5,000 for subsequent investments.

There is one other major difference between mutual funds and hedge funds: fees. Mutual fund fees range from zero to 5 percent, excluding fees for operating expenses. Hedge fund fees range from 1 to 2 percent -- with most managers also taking a 20 percent cut of new profits. Magnum, however, charges a 1.5 percent annual fee with and no performance fee.