Hedge funds and private equity investments have garnered a great deal of attention lately-often for the wrong reasons. Let me begin by saying there are a few fund managers and sponsors who are reputable and profitable. A precious few.
Most hedge funds and private equity funds are inherently perilous. The fees are unwieldy and the requirement to invest your money can lead to a disaster. The fees are usually 2% of your investment as a management fee. Then the fund manager takes 20% of any profit. The fund manager is also under a great deal of pressure to put your money to work. This causes some managers to reach on investments that may not be suitable.
In honor of the 12 Days of Christmas, I have listed below the 12 steps you should take before investing in a hedge fund or private equity deal.
First, determine the transparency of the fund. Can you inspect the financial records on a periodic basis? Can you speak with co-investors?
Second, find out whether the manager is investing his own money with yours.
Third, find out whether each investor is paying the same amount in fees. Some institutional investors negotiate smaller management fees.
Fourth, investigate the past performance of your manager. Ask to speak with former investors.
Fifth, ask to see audited financial statements from previous years. Make sure the auditor is reputable and independent. Even Bernie Madoff produced “audited” financial statements.
Sixth, thoroughly read the prospectus and offering memorandums.
Seventh, fully understand the redemption restrictions. In other words how long will your money be tied up and what do you have to do to redeem your investment if you want out.
Eighth, find out whether there is a comprehensive investment strategy and make sure you understand what that strategy is. The strategy should be clearly defined and narrowly focused with strict time horizons. Funds that describe their strategy as “opportunistic investing in deteriorated financial markets” or “commodity price fluctuation investing” and similar broadly stated objectives do not make for a “strategy.”
Ninth, find out whether the manager is investing through an affiliated broker/dealers.
Tenth, find out how the fund manager values investments that are not traded on an open market.
Eleventh, contact sec.gov and your local state securites office to find out whether there have been any regulatory actions against the manager.
Twelfth, contact an attorney or accountant that you trust to advise you and to ask the hard questions.