Hedge Fund Investing for Everyone

Masterworks
October 12, 2021

Isn’t it time for alternative investing to be accessible? Here’s a look at hedge fund investing for everyone.

If hedge funds sound about as mysterious and well-to-do as fox hunting or cotillion balls, the concept is certainly popular: according to Barclays, the total number of hedge fund assets under management for hedge funds jumped by 2335%.

Given that the 2018 Preqin Global Hedge Fund Report valued the hedge fund industry at more than $3.2 trillion, it should come as no surprise that hedge funds have long been viewed as the purview of people who qualify for the phrase “high-net-worth”.

These days, though, there are ways for investors without the last name Bezos or Gates to get started with hedge funds. Here’s a look at hedge fund investing for everyone.






What are Hedge Funds?

A hedge fund is a type of alternative investment designed to protect portfolios from market volatility. More specifically, a hedge fund pools investors’ money and invests it to make a positive return, kind of like a mutual fund. The difference is that hedge funds have much more flexible investment strategies than mutual funds. In fact, every hedge fund is structured to take advantage of certain identifiable market opportunities.

Hedge funds get their name from their original structure. As initially conceived, hedge funds were structured to hold long and short stocks, which meant the positions were “hedged” to reduce risk. That meant that investors earned money regardless of whether the market soared or sunk. Hedge funds now use a variety of pooled capital arrangements, but the original name stuck.

Hedge funds are always run by a hedge fund manager, who oversees the fund’s day-to-day activities on behalf of its investors to help those investors achieve their financial goals. A hedge fund’s reputation rests squarely on the reputation, skill, and investment style of its manager.

How Do They Work?

Broadly speaking, hedge funds work like mutual funds in that they are managed portfolios that pool investments from a group of investors and then invest the pooled funds to try to earn positive returns. After that, though, the similarities end.

Mutual funds offer a variety of options for retail and institutional investors. Hedge funds exclusively target accredited investors, which means high-net-worth individuals meeting qualifying criteria or institutional investors comprised of investors who are accredited in their own right.

Unlike mutual funds, hedge funds are distinguished by market neutrality, which means they earn money regardless of how the market performs. In this regard, hedge funds are more like classic investors.

They also have far greater liberty in choosing their investment strategies than mutual funds, including hedging. Ultimately, a hedge fund’s tactics are only limited by its mandate, which means it can basically invest in anything. Mutual funds are limited to stocks and bonds and are usually long-only.

What is an Accredited Investor?

An accredited investor isn’t something hedge funds made up out of preference. It’s a legal term defined by the Securities and Exchange Commission to ascertain who is eligible for participation in private capital markets.

Under federal securities law, an accredited investor is anyone who meets any of the following criteria:

  • Earned income exceeding $200,000 in each of the prior two years and expects to earn the same in coming years, or exceeding $300,000 together with a spouse or spouse equivalent
  • Has a net worth of $1 million or more excluding their primary residence, alone or with a spouse or spouse equivalent
  • Holds in good standing a Series 7, 65, or 82 license

An accredited investor may also be an institutional investor. In that case, the investor must be one of the following:

  • A trust with total assets of more than $5 million not explicitly formed for the purpose of investing, whose purchase is directed by a sophisticated person
  • An entity with total assets of more than $5 million not explicitly formed for the purpose of investing
  • Any entity in which all equity owners are accredited investors

In this context, a sophisticated person doesn’t mean good taste in jewelry—it means you must have sufficient knowledge of business and finance to make an educated evaluation of the risks and merits of an investment.






Investment Strategies

The SEC limits hedge fund access to accredited investors as a means of ensuring that those who use hedge funds fully understand the risks and have sufficient assets to successfully navigate the ebbs and flows of the investment. That’s important, because hedge funds have less regulation in exchange for greater strategic leeway.

Again, a hedge fund’s strategies are only truly limited by its mandate. Realistically, hedge funds specialize in a specific form of investing based on the knowledge, background, and skillset of the manager.

For example, the strategy that hedge funds get their name from is long/short equity, which involves a simple premise: research turns up winners and losers, and the fund bets on both. In technical terms, the fund takes long positions on winners as collateral so that it can finance short-term positions on losers. This reduces overall risk (hedging risk) since the shorts offset the fund’s long-term market exposure.

These days, though, hedge funds use a host of strategies. Renaissance Technologies, for example, relies on quantitative trading, which is a technique using mathematical modeling and statistics with large data sets. RenTech uses technology to make automated trading decisions based on mathematical modeling and may be considered black box since the internal workings are both proprietary and obscure.

In other words, the world is more or less a hedge fund’s oyster. That’s good news for investors, since managers can use pretty much any strategy or asset they like to generate positive returns even if the market takes a nosedive.

What You Need to Get Started with Hedge Funds

With all of that in mind, let’s talk about how the average investor can get involved in hedge funds.

Legally, hedge funds have to work with accredited investors. For the average investor, the road to a hedge fund involves working with a broker who is an accredited investor and has a relationship with the hedge fund. That involves doing your homework on both the broker and the fund they work with to make sure you understand their strategies and that their strategies are aligned with your preferred investment techniques.

It’s also important to work with an expert so that you can fully understand what you’re getting into. Again, that’s why hedge funds market exclusively to accredited investors—it automatically means they’re working with people who know what they’re getting into and have the funds to enter the market.

Ready to Try Your Hand at Alternative Investing?

Here at Masterworks, we believe alternative investing should be open to everyone, from hedge funds to our personal favorite, fine art. That’s why we offer a unique crowdfunded approach to blue-chip art while giving ordinary investors access to finance and art experts.

Our research team works with Citi Bank, Bank of America, and others to identify artist markets with the best potential risk-adjusted returns, then handles the auction process. Then, we file an offering circular with the SEC, and our members can purchase shares. Then, when it’s time to sell, we handle the auction process and you collect your proceeds. Sound good? Then let’s talk.







Masterworks
Masterworks is a fintech company democratizing the art market. Our investors are able to fractionally invest in $1mn+ works of art by some of the world's most famous and sought-after artists.