5 Questions: Hedge funds in the age of volatility
- June 1, 2020: Vol. 7, Number 6

5 Questions: Hedge funds in the age of volatility

by Lisa Vioni

The use of hedge funds in financial portfolios has grown dramatically in recent decades, taking off in the 1990s when high-profile money managers deserted the mutual fund industry for fame and fortune as hedge fund managers. Since then, the industry has grown substantially with total assets under management valued at more than $3.25 trillion. According to Barclays, the total AUM of hedge funds jumped by 2,350 percent between 1997 and 2019.

One of the organizations operating in the space is Hedge Connection, which connects hedge funds with investors seeking opportunities in alternative investments. Hedge Connection was co-founded by Lisa Vioni, the organization’s CEO, who has extensive experience in marketing alternative investments with organizations, including Ellington Management Group, Singleterry & Co. and Lehman Brothers Securities. She has also produced three Broadway shows, including “Long Day’s Journey into Night,” for which she won a Tony Award.

What is a hedge fund?

A hedge fund is a private investment vehicle (private placement) that is supposed to be designed to protect investors during market volatility while generating positive returns in up-and-down markets. The investment vehicle is a limited partnership comprised of a group of investors and managed by a fund manager. The goal of the manager is to maximize returns while minimizing risk. The fund can invest in almost anything such as stocks, bonds, options, etc. Fund managers often utilize leverage as a way to enhance returns and may invest in very illiquid and obscure securities making the investment strategy risky.

Who can invest in a hedge fund?

Unlike an open-end mutual fund or ETF, a hedge fund is a private placement vehicle and not regulated. Because of the liquidity risks associated with hedge funds, an investor must meet certain criteria before they can legally qualify to invest in the fund. Each investor must be verified to be an accredited investor, qualified institutional buyer (QIB) or a qualified purchaser (QP) and have a defined net worth or assets under management.

What factors should investors take into consideration when selecting a hedge fund?

Since hedge funds are private vehicles and not regulated, it is important for investors to do a fair amount of due diligence on the fund manager, as well as on the structure of the fund before making an investment. For example, an investor should meet with the manager and make sure they understand the underlying strategy. Investors should do background checks on the management team as well as ask for references. In addition, it is imperative to read the private placement memorandum (PPM) thoroughly to understand liquidity and fee terms. It is important that the manager is using recognized names as their service providers for legal work, fund administration and accounting. Finally, an investor should be comfortable with the level of transparency the manager will offer regarding the types of securities in which they invest.

Why are liquidity terms important when considering a hedge fund?

Hedge funds have much more restrictive liquidity rules at the investor level than do mutual funds and ETFs. Hedge funds generally require investors to have their money locked up for a certain amount of time, during which the investor cannot get access to their funds. In addition, many hedge funds have the ability to put up a “gate” during times of distress where a manager can restrict investor redemption requests until the manager deems that liquidity has returned to the market. It is important to know the types of securities in which the manager invests to understand the liquidity risk. The more illiquid the assets, the more risk the investor is taking to being “gated” under distressed periods.

What precautions should an investor take when scouting for hedge funds?

It is industry standard for managers to have a due diligence questionnaire (DDQ) that can be shared with investors and answers typical questions a sophisticated investor may want to know related to fund structure, fees, liquidity, what a manager can do in times of distress, and so on. If a manager does not provide a DDQ, you can give one to him. has a standard DDQ that you can download. In addition, if an investor is not interested in being commingled with other investors in a fund structure, many managers are now willing to manage investor money in a separately managed account (SMA). By using an SMA, the investor has complete transparency and liquidity, their money stays at their bank account and they may be able to negotiate fees.

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