Thinking of a Hedge Fund? Think Again

Physician's Money Digest, February 2006, Volume 13, Issue 2

Some physicians may see hedge funds as a hot,high-status investment because they're marketedas wealth-creation vehicles that create theallure of sophistication only available to people withsubstantial assets. The phrase "If you have to askhow much, you can't afford it" adds to the mystique.

But they're risky, unregulated, nontransparent, illiquid,and fee-laden. You might do very well in a hedgefund, or you could lose virtually all of your money.Because of challenging financial and economic conditions,many hedge funds could implode in 2006.

Suspect Strategies

A hedge fund uses aggressive strategies unavailableto mutual funds, including selling short, leverage,program trading, swaps, arbitrage, and derivatives.Many use hedges, such as futures contracts, totry to control downside risk. Because of shorts andhedges, a hedge fund potentially can gain in a downmarket. But it also can fall in a rising market.

Hedge funds are exempt from many of the rulesand regulations governing mutual funds. Since theyare restricted by law to no more than 100 investorsper fund, most hedge funds set high minimum investmentamounts, typically $250,000 to $1 million ormore. Recently, some have begun offering minimumsas low as $25,000.

Like mutual funds, hedge funds charge investors amanagement fee. Unlike mutual funds, however,hedge funds also collect a percentage of the profits,usually a hefty 20%. Simplicity is an art form, andyou don't have to chase risk in the form of hedgefunds or other exotic investments to make money.You need a structure and a plan.

Clear Planning

Developing a plan takes a thought process similarto the one you use to diagnose illnesses. For a physician,the evidence includes a patient examination andmedical tests. For a financial practitioner, the evidenceresults from learning about the investor'shopes and dreams and reviewing the current financialposition. First, you must do some fact finding todetermine the time frame for your investment. Thiswill determine the rate of return you will need toachieve your goal and also the risk you will have toassume to get there. With the evidence in hand, afinancial professional can make a diagnosis and providethe right prescription.

Hedge funds give their managers carte blanche tomanage money any way they see fit. So, it's impossibleto say what role they play in your financial prescription.Let's say you need both income and longtermgrowth. You can find a mutual fund, or combinationof funds, designed to do just that. With ahedge fund, you don't know what's in the pill.

Mutual funds are nowhere near as sexy as hedgefunds, but are a lot more predictable. Liquidity isanother advantage: You can sell or change your portfolioif you change your mind or your risk tolerancechanges. Mutual funds are far more transparentbecause they're strictly regulated, and you can easilylook up a Morningstar rating to see how a fund hasperformed or compare it to its peer group to gaugeperformance. Funds also offer fee discounts toinvestors who make large purchases.

With liquid mutual funds, you can rebalance yourportfolio as market conditions and your needschange. A strategic asset-allocation service, whichcan do this for you automatically, has often outperformedmany hedge funds. Mutual fund companiesalso offer investor education, checking, and manyother services that hedge funds don't. If you're lucky,you may make a lot of money in a hedge fund. Youcan also do very well in Las Vegas, but no one wouldcall a casino an investment plan.

Frank Congemi is a financial advisor who works with many physicians

in several states. He lives in Deerfield Beach, Fla, and has

an office in Queens, NY. He welcomes questions or comments at

800-228-2309 or