For informational purposes only. This document should not be construed as providing any type of investment, legal, tax or other advice to you and should not be relied upon as such. You should not consider this to be a solicitation, recommendation, endorsement or offer to you to purchase or sell any financial security or other financial instrument.
This summary of certain risks is not a complete list of the risks and other important disclosures involved in investing in a hedge fund and is subject to the more complete disclosures contained in a specific hedge fund’s respective offering documents. You should read those documents carefully before you invest to determine whether an investment is suitable for you in light of, among other things, your financial situation, need for liquidity, tax situation, and other investments.
The risks associated with investing in a Hedge Fund generally include:
LIMITED REGULATORY OVERSIGHT: Since Hedge Funds are typically private investments, they do not face the same oversight and scrutiny from financial regulatory entities such as the Securities and Exchange Commission (“SEC”) or the UK’s Financial Services Authority (“FSA”) and are not subject to the same regulatory requirements as regulated open-end investment companies, mutual funds or Undertakings for Collective Investment in Transferable Securities (“UCITS”), including requirements for such entities to provide certain periodic pricing and valuation information to investors, or certain closed-end investment companies. Hedge fund offering documents are not reviewed or approved by the SEC or any US state securities administrator or by the FSA or any other national, supra-national or local regulatory body. Also, managers may not be required by law or regulation to supply investors with their portfolio holdings, pricing, or valuation information.
PORTFOLIO CONCENTRATION; VOLATILITY: Many Hedge Funds may have a more concentrated or less diversified portfolio than an average mutual fund, UCITS, or other authorized collective investment scheme. For example, a mutual fund or other authorized collective investment scheme may have 100 to 200 positions while a Hedge Fund can average between 25 and 45 positions. While a more concentrated portfolio can have good results when a manager is correct, it can also cause a portfolio to have higher volatility.
STRATEGY RISK: Many Hedge Funds employ a single investment strategy. Thus, a Hedge Fund or even a fund of Hedge Funds may be subject to strategy risk, associated with the failure or deterioration of an entire strategy. Strategy specific losses can result from excessive concentration by multiple Hedge Fund managers in the same investment or broad events that adversely affect particular strategies.
USE OF LEVERAGE AND OTHER SPECULATIVE INVESTMENT PRACTICES: Since many Hedge Fund managers use leverage and speculative investment strategies such as options and short sales, investors should be aware of the potential risks. When used prudently and for the purpose of risk reduction, these instruments can add value to a portfolio. However, when leverage is used excessively and the market goes down, a portfolio can suffer tremendously. Also, managers can face additional risk when selling short. In theory, the loss associated with shorted stocks is infinite, because stocks can go up indefinitely. So, while selling short can add return and risk reduction to a portfolio, managers need to pay special attention to their short positions. In the same way, when options are used to hedge a portfolio (i.e., short calls and buy puts), the portfolio’s volatility can be reduced. However, when options are used to speculate (i.e., buy calls, short puts), a portfolio’s returns can suffer and the risk of the portfolio can increase.