Myths about hedge funds

Perceptions of hedge funds are often coloured by myths. Here are four of the most common.

Myth 1: Hedge funds are risky and highly leveraged

Hedging is a strategy used to guard against the risk of loss. The perception of hedge funds as riskier than traditional investment vehicles is incorrect. In fact, the traditional, long-only approach to investing is unable to handle the risk of market downturns.

Hedge funds, on the other hand, use a wide range of tools to execute advanced investing and trading strategies (such as the ability to go long or short). What’s more, the use of leverage, which is typically controlled and monitored by a hedge fund’s prime broker, is minimized to protect the broader portfolio.

Myth 2: Hedge funds have high fees

The underlying philosophy of the hedge fund industry is that the skill of the manager should drive the performance of the fund. Traditional investment funds (e.g., mutual funds) typically charge a flat fee for active management regardless of performance.

Hedge fund managers, however, often derive a substantial portion of their fees when the investor sees a positive return. As industry best practice, hedge fund managers generally show their products’ historical performance net of fees and expenses.

Myth 3: Hedge funds are unregulated and lack transparency

Like all investment funds, hedge funds operate in a heavily regulated environment. Hedge funds designed for retail investors are often offered through a prospectus and require detailed information on the fund, its investment objectives, risks and the qualifications of the investment manager. Additionally, many of the hedge fund providers are publicly traded and subject to oversight.

While hedge funds in the exempt market (servicing the accredited investor community) do not require a prospectus, they are restricted by rules on marketing and promoting investment products. Money managers, including hedge fund managers, are registered with, and regulated by, provincial securities commissions.

Myth 4: Hedge funds are for the ultra-wealthy

Hedge funds were not traditionally offered by prospectus, so sales were restricted to accredited investors. But that’s changing.

For hedge funds offered by prospectus you don’t need to be an accredited investor. But fund providers may have minimum investment requirements, and these will vary from fund to fund.

The retail hedge fund marketplace in Canada continues to grow, giving greater access to new strategies and investment styles that can offer excellent diversification and enhanced returns with mitigated risk against broader financial market moves.