Hedge Funds and Funds of Hedge Funds

Stuart, Florida Securities and Investment Fraud Lawyer, Russell L. Forkey, Esq.

If you have lost money as a result of your investment in a Hedge Fund or Funds of Hedge Funds as a result of fraud, misrepresentation or subsequent mismanagement of the hedge fund or funds of hedge funds, contact the law office of Russell L. Forkey, P.A. for you initial free consultation.

For the most part, unless your agreement with the hedge fund or its manager contains a pre-dispute arbitration agreement, you will need to seek redress in state or federal court. These later type of proceedings are more complicated then arbitration proceedings. Therefore, competent and experienced counsel is a must to enhance your chances of success.

The purpose of this post is to provide the reader with general educational information about these types of investment. Please keep in mind that any information contained herein should not be considered as legal or investment advice. You should consult experienced professionals, if you have any questions concerning anything that you read on this page.

The Securities and Exchange Commission's Office of Investor Education and Advocacy has issued an Alert which is excellent in informing investors about the potential risks of hedge funds and funds of hedge funds. I have posted this Alert below, with minor modifications, to provide the reader with general information that should be reviewed and understood before considering or making such an investment. If you desire to review the original SEC alert relating to hedge funds or funds of hedge funds, without my modifications, follow the highlighted link.

What are hedge funds?

Like mutual funds, hedge funds pool investors' money and invest those funds in financial instruments in an effort to make a positive return. Many hedge funds seek to profit in all kinds of markets by pursuing leveraging and other speculative investment practices that may increase the risk of investment loss.

Unlike mutual funds, however, hedge funds are not required to register with the SEC. Hedge funds typically issue securities in "private offerings" that are not registered with the SEC under the Securities Act of 1933. In addition, hedge funds are not required to make periodic reports under the Securities Exchange Act of 1934. But hedge funds are subject to the same prohibitions against fraud as are other market participants, and their managers have the same fiduciary duties as other investment advisers. If you have suffered any investment losses as a result of your investment in a hedge fund or a "funds of hedge funds?"

What are "funds of hedge funds?"

A fund of hedge funds is an investment company that invests in hedge funds -- rather than investing in individual securities. Some funds of hedge funds register their securities with the SEC. These funds of hedge funds must provide investors with a prospectus and must file certain reports quarterly with the SEC.

Note: Not all funds of hedge funds register with the SEC.

Many registered funds of hedge funds have much lower investment minimums ( e.g., $25,000) than individual hedge funds. Thus, some investors that would be unable to invest in a hedge fund directly may be able to purchase shares of registered funds of hedge funds.

What information should I seek if I am considering investing in a hedge fund or a fund of hedge funds?

  • Read a fund's prospectus or offering memorandum and related materials. Make sure you understand the level of risk involved in the fund's investment strategies and ensure that they are suitable to your personal investing goals, time horizons, and risk tolerance. As with any investment, the higher the potential returns, the higher the risks you must assume.
  • Understand how a fund's assets are valued. Funds of hedge funds and hedge funds may invest in highly illiquid securities that may be difficult to value. Moreover, many hedge funds give themselves significant discretion in valuing securities. You should understand a fund's valuation process and know the extent to which a fund's securities are valued by independent sources.
  • Ask questions about fees. Fees impact your return on investment. Hedge funds typically charge an asset management fee of 1-2% of assets, plus a "performance fee" of 20% of a hedge fund's profits. A performance fee could motivate a hedge fund manager to take greater risks in the hope of generating a larger return. Funds of hedge funds typically charge a fee for managing your assets, and some may also include a performance fee based on profits. These fees are charged in addition to any fees paid to the underlying hedge funds.

Tip: If you invest in hedge funds through a fund of hedge funds, you will pay two layers of fees: the fees of the fund of hedge funds and the fees charged by the underlying hedge funds.

  • Understand any limitations on your right to redeem your shares. Hedge funds typically limit opportunities to redeem, or cash in, your shares ( e.g., to four times a year), and often impose a "lock-up" period of one year or more, during which you cannot cash in your shares.
  • Research the backgrounds of hedge fund managers. Know with whom you are investing. Make sure hedge fund managers are qualified to manage your money, and find out whether they have a disciplinary history within the securities industry. You can get this information (and more) by reviewing the adviser's Form ADV. You can search for and view a firm's Form ADV using the SEC's Investment Adviser Public Disclosure (IAPD) website. You also can get copies of Form ADV for individual advisers and firms from the investment adviser, the SEC's Public Reference Room, or (for advisers with less than $25 million in assets under management) the state securities regulator where the adviser's principal place of business is located. If you don't find the investment adviser firm in the SEC's IAPD database, be sure to call your state securities regulator or search the FINRA's Broker Check database for any information they may have.
  • Don't be afraid to ask questions. You are entrusting your money to someone else. You should know where your money is going, who is managing it, how it is being invested, how you can get it back, what protections are placed on your investment and what your rights are as an investor. In addition, you may wish to read FINRA's investor alert, which describes some of the high costs and risks of investing in funds of hedge funds.

What protections do I have if I purchase a hedge fund?

Hedge fund investors do not receive all of the federal and state law protections that commonly apply to most registered investments. For example, you won't get the same level of disclosures from a hedge fund that you'll get from registered investments. Without the disclosures that the securities laws require for most registered investments, it can be quite difficult to verify representations you may receive from a hedge fund. You should also be aware that, while the SEC may conduct examinations of any hedge fund manager that is registered as an investment adviser under the Investment Advisers Act, the SEC and other securities regulators generally have limited ability to check routinely on hedge fund activities.

The SEC can take action against a hedge fund that defrauds investors, and has brought a number of fraud cases involving hedge funds. Commonly in these cases, hedge fund advisers misrepresented their experience and the fund's track record. Other cases were classic "Ponzi schemes," where early investors were paid off to make the scheme look legitimate. In some of the cases brought by the SEC, the hedge funds sent phony account statements to investors to camouflage the fact that their money had been stolen. That's why it is extremely important to thoroughly check out every aspect of any hedge fund you might consider as an investment.

What should I do if I have a complaint about a hedge fund or a fund of hedge funds?

If you encounter a problem with your hedge fund or fund of hedge funds, contact and experienced securities attorney immediately.

With extensive courtroom, arbitration and mediation experience and an in-depth understanding of securities law, our firm provides all of our clients with the personal service they deserve. Handling cases worth $25,000 or more, we represent clients throughout Florida and across the United States, as well as for foreign individuals that invested in U.S. banks or brokerage firms. Contact us to arrange your free initial consultation.