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How Safe Are Hedge Funds?

Seth Jentner09/17/2014

Some hedge funds ran into trouble and bailed out on investors. Yet, as investment markets were shaken over recent years, hedge funds have been touted as an alternative for investors seeking shelter and profit during volatile times.

Hedge funds are lightly-regulated investment pools for qualified investors. Hedge fund promoters cite their ability to go anywhere and do anything, such as shorting foreign currencies, buying and selling options and futures, and moving in and out of entire asset classes on a moment’s notice.

However, recent years have shown that hedge funds are no panacea. Unlike mutual funds, which are closely regulated by the Securities and Exchange Commission, hedge funds can close their doors at any time, giving investors no opportunity to make back their losses.

Over the past several years, a number of well-known hedge funds have thrown in the towel due to bad bets on the European debt crisis:

  • Expo Capital Management, a $458-million fund in Los Angeles, folded after two years of losses in its health-care stock portfolio
  • The Fortress Investment Group in New York City liquidated its $500 million commodities fund last May after losing 13% in the first four months of the year.

These are not isolated examples. Hedge Fund Research of Chicago reported that 775 hedge funds went out of business in one year. The BarclayHedge Alternative Investment Database reports there are more than 13,000 liquidated or non-reporting hedge funds.

Is there an alternative? You bet. Here are three recommendations:

  1. Consider a blend of index funds, which are transparent, low-cost and globally-diversified.
  2. Seek help from a trusted financial advisor who will help you design a risk-appropriate blend of investments to help you earn a reasonable, long-term investment return over the inevitable market fluctuations.
  3. Avoid sales people who make promises that are unrealistic and inappropriate.

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