The lifeblood of the hedge fund industry are hedge fund investors, those persons and institutions which put their money at risk with the hope of generating positive investment returns.  While there have been recent predictions of large amounts of investor money leaving the hedge fund space due to poor performance, there are many potential hedge fund investors who are just beginning to warm to the idea of investing in a hedge fund.

Who can invest in a hedge fund?

In general there are two types of hedge funds which are open to different types of investors.

Section 3(c)(1) hedge funds are open to investors who are both accredited investors and qualified clients. An accredited investor is generally an individual with a $1 million dollar net worth (can include the equity in the investor’s primary residence) or an individual who has made $200,000 in each of the two most recent years (or joint income with that person’s spouse in excess of $300,000 in each of those years) and has a reasonable expectation of reaching the same income level in the current year.  A qualified client is generally an individual with a $1.5 million dollar net worth.  Because investors will need to be both an accredited investor and a qualified client, many hedge fund managers will just say that the investor needs to be a qualified client as it has the higher net worth threshold.

Section 3(c)(7) hedge funds are open to qualified purchasers, which is a higher net worth threshold than for the accredited investor or qualified client standard.  A qualified purchaser is generally an individual investor with a $5 million dollar liquid net worth (cannot include the equity of the investor’s primary residence).

Occasionally you will see some Section 3(c)(1) hedge funds which allow non-accredited investors to invest in the fund.  In such instances, the fund will typically charge the non-accredited investor a higher management fee because the non-accredited investor cannot be charged a performance fee.  In general, hedge fund managers will not allow non-accredited investors into the hedge fund except for very close family and friends.

Why would someone invest in a hedge fund?

Hedge funds have historically been viewed as nimble investment vehicles run by savvy managers who are able to produce steady and absolute returns.  Hedge funds come in a variety of different sizes (from the one-man shops to the multi-billion dollar operations) and strategies.  The great diversity of funds and their investment objectives is what makes them exciting, but which also makes it difficult to describe them as a whole.  Suffice it to say that whatever investment strategy an investor is looking for, there is a hedge fund which would be able to meet the needs of that investor.

Who can recommend hedge fund investments?

Hedge fund investments are made through private placements according to the Regulation D offering rules.  This means that only the hedge fund manager and certain hedge fund brokers can offer an investor interests in a hedge fund, and that is only if the manager or the broker has a pre-existing relationship with the investor.  There are some ways which investors can gain access to hedge funds, most notably through hedge fund databases.

What should an investor do before investing in a hedge fund?

At a minimum an investor should carefully read the hedge fund’s offering documents.  An investor should also discuss any questions or concerns with the hedge fund manager.  Additionally, I always recommend that investors conduct some sort of due diligence on the hedge fund and the manager.

HFLB note: we are not recommending that readers invest in hedge funds and we are not recommending any specific hedge funds.  If an investor makes an investment into a hedge fund, any such investments should be made only after consultation with such investor’s legal and accounting advisors.

Other articles you may be interested in:

• Hedge Fund Service Providers
• Hedge Fund Due Diligence