With the hedge fund Melvin Capital losing 53 percent of their assets in January from their GameStop short, investors are starting to realize that even these massive, elusive enterprises are fallible. Can any ol' retail investor tap a hedge fund for themselves?
The truth is there's a process involved in hedge fund investing, and it doesn't involve being an individual member of the general public.
Why just anyone can't invest in a hedge fund
Most investors in the stock market are familiar with (or even invested in) mutual funds. These types of investments pool together money from all kinds of people, and they're heavily regulated. On the contrary, hedge funds don't incur the same regulations. Because of this, the SEC limits the number of members they can allow.
Specifically, SEC Regulation D (rules 504 and 506) discerns that hedge funds must limit their total number of investors. Because of this, hedge funds usually require a high net worth. Oftentimes, the required value is $1 million or more.
Who are these preferred investors who hold stake in hedge funds?
Hedge funds refer to their investors as "accredited investors." They're wealthy individuals or organizations looking to maximize their return by getting involved in an enlarged swath of shares. Sometimes, the private or governmental organizations that take part in hedge fund investing have pension programs for working-class people. If you have a pension, you may actually hold a hedge fund stake (though your personal stake is undoubtedly quite minute in the grand scheme).
Are "funds of funds" the best a retail investor can get?
Because of the sheer inaccessibility of hedge funds for some investors, stock market movers have gone so far as to create mutual fund replicas. These are often referred to as "funds of funds" (FOF). They're inexact, but they may be the closest thing available for someone who's bent on hedge fund success. You may even be invested in one already if you hold shares of a target date mutual fund.
Do hedge funds invest in startups?
Nowadays, venture capital firms are more inclined to invest in startups. Hedge funds are straying away from the sector, but that doesn't mean they're all out of the game.
Most hedge funds invest in later-stage businesses with cash flows, assets, and infrastructure. Despite that, you will find side pocket investments periodically.
Hedge funds are more suited to the wealthy
If you're wondering whether a hedge fund is a good investment, it is—if your net worth is in the millions. At this rate, a larger pool of money has the potential to reap greater returns. Plus, hedge funds practice complicated investment strategies that you may not be able to access elsewhere.
Over the last two decades, hedge funds have outperformed the market by 1.5 percent. When you're dealing with high net worth investors, what feels like a mere 1.5 percent can really add up. This is especially true when you consider compound interest and reinvested dividends.