Do alternative investments have a place in a typical investment portfolio?
Listed below are some of the risks and considerations associated with hedge fund investing:
- Liquidity
- Fees and expenses (see below)
- Risk
- Performance reporting
- Valuation
- Fiduciary responsibility
One of the most significant issues associated with hedge fund investing is cost. The example below attempts to show the impact that costs can have on investment outcomes.
Hedge Fund Higher Math...or, the Great Compensation Machine
The most common hedge fund fee arrangement: 2 and 20...2% annual fee and 20% of any profits
Example #1: $1,000,000 invested in hedge fund that earns 10% per year for 2 years
- 1st year fees (2% plus 2%) 4%
- 2nd year fees 2% plus 2%) 4%
- Total both years 8%
Total Fees: ~$80,000...Total Gain (net): ~$120,000 (6% per year)
Example #2: $1,000,000 invested for 2 years...60% gain in year 1, 25% loss in year 2
- 1st year fees (2% plus 12%) 14%
- 2nd year fees (2% plus 0) 2%
- Total both years 16%
Total Fees: ~$170,000...Total Gain (net): ~$65,000 (3% per year)
Not bad work if you can get it!