Are Hedge Funds A Better Place To Put Your Money?

By Michelle Kennedy Hogan

What is a hedge fund anyway?

Recently, I read a report that stated hedge funds might actually be a better place to put your money than mutual funds. The report went on to say that, according to Van Hedge Fund Advisors International (they track hedge funds’ performance), that almost all of them are ahead of the average equity mutual fund, year-to-date.

“From preliminary results, it looks like April is going to be a very strong month for U.S. hedge funds,” says John Van, VP of Van Hedge Fund Advisors. “The average U.S. hedge fund is up 4 percent through March, while the average equity mutual fund is up only 1.7 percent”, Van says. Apparently, mutual funds are underperforming major indices due to the fact that the major indices are “being driven by a handful of stocks. Unless mutual fund managers hold the stocks that are driving the indices, they won’t be able to match the performance”. Because Hedge Funds are more “nimble”, the report states, managers have greater freedom to move in and out of positions. Further, Hedge Funds are smaller so they don’t move the market as much.

This brings us to a crucial point. What, exactly, is a Hedge Fund?

Well, as with mutual funds, investors pool their money and the manager gets to decide what to do with it. You generally need a lot of money to participate…at least $1 or $2 million in net worth. There have been funds with a minimum investment as high as $10 million.

These funds charge very high fees, often 20% of the profits that they make for the investors. You also cannot take out your money whenever you want to. There is generally a minimum commitment of a year or more. Hedge funds are unregulated, so they can do much more than trade stocks, bonds and Treasuries. Hedge fund managers can borrow huge sums of money, can sell short and trade options, mutual fund managers can not, or can only do so with severe limitations. Along with the possibility of huge profits, there is also a huge amount of risk, so these funds are very volatile. A fund might bet on particular moves in the market, such as waiting for the bond market to go up, or for a foreign currency to go up against the US dollar.

Hedge funds have had their share of troubles, and are not a place for a beginning investor, even with a high net worth, to place their money. However, Van Hedge Fund Advisors made this point: “The numbers show that in February, a volatile month in the markets, the average equity mutual fund was down 4%, S&P 500 Index was down 3.1% and the average US hedge fund was only down 1.9%.” Van believes the restrictions placed on mutual fund managers contribute to this decline. In March, several types of U.S. hedge funds again pulled ahead of the S&P 500. They include U.S. Several Strategies, which uses a combination of investment styles to diversify its approach. The best performers in the United States were Aggressive Growth and Emerging Markets, which returned 5.7 percent and 5.2 percent.

From CBS Marketwatch:

Year-to-date returns:

For the first quarter, U.S. Several Strategies and U.S. Market Timers followed with 7.5 percent and 7.3 percent returns, respectively. See strategy and sector definitions.

Large cap stocks powered the rise of the Dow Jones Industrial Average. The Dow returned 5.3 percent in March and the S&P 500 returned 4.0 percent, while Russell 2000 returned 1.5 percent.

On a year-to-date basis, the Dow is up 7 percent, while the S&P 500 has gained 5 percent. The Russell 2000 is down 5.4 percent.

Most hedge-fund managers tend invest in small- and mid-cap stocks. These numbers mean that hedge funds for the most part are outperforming the Russell 2000, perhaps a more meaningful benchmark.

It also appears that hedge funds have been capitalizing on significant shifts in emerging and rebounding markets. Globally, as economic conditions stabalize, the improvements could translate into increased US imports which would bring gains for managers of all types of funds. Van believes that hedge fund managers are more able to act on these improvements quickly. Thereby contributing to a second consecutive quarter of gains.

“What they’re doing is making markets more efficient. One thing people are blaming hedge funds for is making bad things happen,” Van says. What they’re doing is acting quickly on available information, he says. “What we’re seeing is an acceleration of market discipline. The market is much quicker to punish or reward countries and companies for their policies,” Van says.

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