Hedge Funds Cater to Rich, But Others Have Access, Too

Hedge funds are among the most controversial of big-time investments. Unlike mutual funds, they are secretive and little-regulated. They buy esoteric, often volatile investments. And they have been blamed, in turn, for contributing to the overall volatility of the stock and bond markets.

Yet they have been lucrative performers in recent years. As the name implies, hedge funds have a partly defensive goal: to hedge against a market drop. They avoided losses, on average, in 1990 and 1994 as stocks fell, although stocks soared higher in last year's rip-roaring market.

Oh yes, hedge funds are also a tad expensive to buy into.

"The lowest minimum that I know of for a [US-based] hedge fund is about $100,000," says Mikhail Kimbarovsky, director of Hedge Fund Research, a Chicago consulting firm. Most hedge funds based in the United States require minimum investments of $500,000 or more (some as high as $50 million), with the average about $800,000, he reckons.

Some offshore funds are more consumer-friendly, requiring a minimum of $15,000 to $25,000, adds hedge-fund expert Antoine Bernheim.

"Money has been pouring in during the past few years," Mr. Kimbarovsky says. Assets have shot from about $90 billion two years ago to $150 billion today, he estimates. Perhaps 2,000 to 2,500 hedge funds now operate in the US and nearby offshore areas. Much of the money has come from large institutional investors: banks and pension or endowment funds.

The most famous offshore fund may be George Soros's Quantum fund, which has a minimum investment near $100,000.

WHAT do Mr. Soros and other hedge-fund managers invest in?

Sometimes they go for plain old equities and bonds, but often they buy complex derivatives of stocks, bonds, or currencies. These include option and futures contracts, which amount to bets that the price of, say, Treasury bonds will rise or fall. Hedge funds also sell short (entering a deal to sell a stock they don't own, on the bet that the stock price will fall and they can buy shares at a lower price by the time they must cover the sale). Mutual funds sometimes use these tactics, too, but to a lesser degree.

Hedge funds also differ from mutual funds in their legal basis. They are private-placement investment partnerships. The US-based funds are restricted to 99 or fewer investors. By putting the number of investors under 100, the partnerships are not regulated under the restrictive provisions of laws governing mutual funds. Thus, US hedge funds face little regulatory oversight, Kimbarovsky says.

Offshore funds are not restricted as to the number of investors, which is why some offshore funds have relatively low minimum investments, says Mr. Bernheim, who publishes Hedge Fund News, a quarterly newsletter, and "US Offshore Funds Directory," a listing of 400 funds based outside the US in places such as Bermuda, the Cayman Islands, and the British Virgin Islands. (The newsletter costs $175 a year, the directory $365. Call (212) 371-5935.)

In Bermuda and the Cayman Islands, offshore funds are monitored under mutual-fund type legislation. In the British Virgin Islands, regulatory legislation was recently passed, but is not yet signed into law, Bernheim says.

Investing and withdrawal requirements are very strict for the US-based funds. Most require an investor to enter the fund at the end of a quarter or a year; and you cannot pull out for at least a year, and then only at the end of a full quarter, Kimbarovsky says. Hedge funds are clearly "designed for long-term investing," he says.

At their best, they can be powerful performers. In 1993, hedge funds gained 23.2 percent, almost twice the average gains of growth-stock mutual funds. And in 1987, a year marked by a major market crash, hedge funds returned 14.5 percent, according to WPG-Hennessee Hedge Fund Advisory Group in New York. That compares with 1 percent for the growth funds and 5.2 percent for the Standard & Poor's 500 index.

Some experts argue that, despite their steady track record, hedge funds are not for the conservative investor with limited financial resources, because the funds use risky strategies and are less-regulated than mutual funds. Returns can be great. But so too are management fees, including 20 percent or so of total earnings as a "performance fee."

A savvy investor with ample financial assets could offset some market risk by investing in a hedge "fund of funds," a private-placement fund investing in several hedge funds. Entry fees are often about $100,000.

But the bottom line, experts say, is clear: To invest in the a hedge fund, you should do substantial research, including ferreting out as much information as possible about fund performance.