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Not Rich Enough to Invest in Hedge Funds? Some Alternative Investments You Can Afford

Hedge funds and private equity firms require huge pockets to join the party. But hedge fund alternatives are available to investors who can stomach the risk in search of beefier returns.

Hedge fund alternatives like the GURU ETF can give investors beefier returns without the big barriers to entry.Whispered in the shadows of your office or your in-laws’ dining room may be talk of investing in “alternative” funds. Words like “hedge fund” or “private equity” may be thrown around haphazardly with boasts of high returns, low risk, and a lack of correlation to the overall stock market.

You’re probably curious to know more, and better yet, how to invest in these seemingly lucrative alternative vehicles. As with anything that’s too good to be true, there’s a catch.

Who can invest in hedge funds and private equity?

Hedge funds are like mutual funds on steroids; they have (much) higher requirements for investing, (much) higher management fees, but they can invest in just about anything. Private equity is simply a term for investments in non-public companies.

Both hedge funds and private equity firms are usually invitation-only investment companies that, by law, require you to meet certain minimum standards. You have to have earned $200K or more for the last two years with expectations of earning the same for year three, or a minimum net worth of $1 million.

Furthermore, most alternative funds will require a minimum investment amount averaging $250K and a lockout period of at least a year where you cannot withdraw money without incurring a fee. Even for those of you who do qualify for a hedge fund or private equity company, the management fees you’ll pay are enormous. Typical hedge fund fees are set up as “2 and 20″; meaning that 2 percent of the total assets under management are charged a yearly upkeep fee, while 20 percent of all gains are paid out as bonus to the fund manager.

Alternatives to hedge funds and private equity

If you want access to the world of alternative investments but don’t meet the stringent qualifications, there are other vehicles you can use. There proliferation of exchange-traded funds (ETFs) has resulted in indexes that follow everything from gold to soybean futures to, that’s right, hedge funds and private equity groups.

Exchange-traded funds

ProShares Global Private Equity ETF (PEX) tracks around 30 private equity companies and gives you access to something once limited to millionaires. For those of you that want to track hedge funds, you could try the Global X Top Guru Holdings ETF (GURU) which buys the top 75 stocks selected by top hedge fund managers.

Master limited partnerships

If you want something that generates a bit more income, you could try a Master Limited Partnership (MLP). These investments have the liquidity associated with stocks, but the tax benefits of a Limited Partnership. These companies are defined as earning 90 percent or more of its income through activities in natural resources, real estate, or commodities. MLPs generally offer high dividend yields and attracts investors interesting in generating a stable income base as well as capital appreciation.

Direct investments

For those of you who want a more direct form of ownership, you could consider becoming a Limited Partner in a startup company, an oil and gas partnership, or a real estate investment company. You’ll need to have the contacts to get introduced to an opportunity like this and — hopefully it goes without saying — this is perhaps the riskiest (but also most rewarding) kind of investment you can make.

In this scenario, you would be a direct investor in the company itself earning a steady income from its activities. These types of investments are similar to hedge funds and private equity companies in the sense that they are not liquid and require a commitment to keep capital invested for a number of years for the project to pay off. They are also not subject to the same kinds of regulation that’s attached to publicly traded stocks, so investors will need to take extra precaution when considering becoming a partner in any of these types of investment companies.

While the allure of hedge funds and private equity firms are unlikely to lose their luster anytime soon, anyone can use these alternative paths to mimic their performance. Alternative investing is popular, but you shouldn’t engage in it unless it makes sense for your overall investment goals. In the right portfolio, alternative investments can be a tremendous boon, but a huge liability for someone who can’t risk tying up capital for extended periods of time.

About Daniel Cross

Daniel Cross has been in the industry as an investment writer and financial advisor since 2005. He holds the Chartered Financial Consultant designation (ChFC) as well as Series 7 and Series 66 licenses, and has embarked on the arduous journey of obtaining the coveted CFA designation. Daniel lives in Florida with his wife, daughter, and pet Tortoise ironically named Turbo.

Comments

  1. Hi Daniel,
    Thanks for the article. Wanted to ask your opinion regarding managed accounts. I have put some money aside at a local bank and wanted to invest it instead of having to sit in a savings account.
    Do you suggest I open a managed account and invest it, so hopefully I see it grow? Or do you suggest leaving it in the savings account since market always fluctuates?
    Appreciate the feedback!

    • Daniel Cross says:

      If you’re looking for a return of any kind, a savings account is the last place your money should be — just short of keeping it under your bed anyways. In regards to managed accounts, it’s certainly a better option than the savings account if you’re trying to grow it. That being said, keep an eye on the fees associated with the account before committing to anything. Managed accounts are designed as a collection of various investments tailor made for you and managed by an investment professional. Make sure it’s worth your while to do that as opposed to just investing in some mutual funds yourself.

  2. Here’s the thing about managed accounts, most of them are really not worth the money, especially if you can’t afford the high net worth managers.

    What will they do? They will help put together a risk profile to generate an allocation for you (x% in US large cap, x% in US mid caps, x% foreign, x% bonds). Then they will stick your money in their company’s mutual funds that fit that allocation. They will charge you an account management fee and get the fees from all the mutual funds. It’s not like they are looking at your account regularly, moving money around, and asking how can we make Joe Schmo more money this month. They will probably only reallocate your money once a year. All you are doing is paying someone to do the minimal homework.

    Why not cut out the middle man and do it your self? This website provides more unbiased info on the subjects of asset allocation, risk management, and mutual fun investing than you would ever need. So why pay some guy with a communications degree and no idea what he is doing a bunch of money to do what you can do in an evening for free. Unless you have enough money ($500k+) to get on with a small investment firm that actually cares about you and know what they are doing, just do it yourself.