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.
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.
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.