Warning Signs for Hedge Fund Investors

Investing in hedge funds is very different from investing in traditional investments like stocks or mutual funds.  In the following video, I point out five warning signs that hedge fund investors should look out for while investing in hedge funds.  This should not be considered financial advice, rather it is a few red flags that hedge fund investors should watch out for.

Video Transcript/Summary: The strategies and tips provided within this video module include:

1. Avoid one-man hedge fund shops.  If something happens to that one person, the hedge fund will surely suffer.
2. The hedge fund does not have an administration firm.
3. No ability or track record of raising capital.
4. No marketing materials.  A hedge fund is wasting your time if they haven’t taken time to compose their thoughts and strategy in easy-to-understand marketing materials that give you all the necessary information to make a well-informed decision on whether to invest in their fund.
5. There is no deep experience on the team.  Don’t settle for an inexperienced team.  

Hello, this is Richard Wilson. I’m coming to you from Nice, France today. I’m here recording some training videos for the hedge fund group. And today I want to talk to you about how I’ve been working with a single-family office from the United States and helping them develop criteria for identifying potential hedge fund managers to invest in.

So what I’d like to do is provide you with 5 kind of warning signs, very obvious things if you’ve been invested in hedge funds for a long time, but if you’re a family office or a wealth management firm or other type of investor, just to kind of give you a start in investing in hedge funds. There are some very basic things to look at while analyzing hedge fund managers. This is not financial advice but it is kind of just some basics on hedge fund education and now hedge fund businesses are formed.

The first thing is to avoid one-man hedge fund shops. That one person gets sick, God forbid if they died, their business is not going to be sustainable. You know multiple minds acting collectively with some organization is going to be more powerful than one person, even a team of just 2 or 3 people is better in my experience to invest in than just a one-person hedge fund.

The second thing is not having an administration firm. Since the Madoff scandal mini board of advisers of hedge funds all over the world have been forcing their hedge fund to have a third-party fund administration firm in place. As for many reasons it verifies the assets, it has some checks and balances while running the hedge fund and if you need someone who is not using the fund administration firm, you have to want to know why and wonder how serious they are about working with other types of investors like yourself.

The third thing is have no ability or track record of raising capital. If someone is at $5M or $10M or $30M on capital they may be worth looking at, maybe they’re just getting started, maybe they have an unrecognized talent on their team and a deep bench of experience on their team and you can be one of those first people to discover them. You can have huge amount of capacity in this voyage maybe very well. But many times the funds which have a lot of talent but are bad at raising capital may not survive long enough to really have a sustainable business. They don’t want to invest in a hedge fund and do all these due diligence and grow a great relationship with a hedge fund manager just to have them go out of business a year later.

So even if the hedge fund doesn’t have a lot of capital they should at least have some potential ways of raising capital and somebody on their team dedicated to raising capital, not the portfolio manager doing it 5 hours a week and not the idea that they’re going to build a track record for 5 years and then outsource it to a third-party marketer. It just doesn’t happen very often. Lots of times those hedge funds never make it.

The fourth thing is not having any marketing materials. The hedge fund manager meets with you and he hasn’t put all of his thoughts, his investment processes, risk management strategies, his past investment details, his term sheet. A service provider is all within a well-organized document and he really hasn’t invested in his business enough then he’s wasting your time. You should tell him to go back and come back to you when he has organized his thoughts within a one-pager and a PowerPoint pitch book. It’s very, very basic. So if somebody doesn’t have that they’re really not worth meeting with in most cases unless you’re doing somebody a favor just to give them some early kind of hedge fund startup advice.

And the final tip here on avoiding certain types of hedge fund managers is just the one who has no deep experience on the team. There are some teams out there that are focused on very niche areas like trading, orange juice contracts, or trading freight shipping contracts or on running a global map or a strategy focused only a few different parts of the world or focused on frontier markets specifically, maybe they specialize in 4 different countries specifically. So there’s very, very specialized people out there. There’s people that have 20 years or 30 years experience in one or two small niche areas. So don’t settle for a team that didn’t have a really experience on an area that’s directly connected to their scope of investments.

And again, it might seem overly obvious but many times hedge fund managers might have some fancy sounding model or their back testing might be amazing or they have this 3-year track record that’s amazing. But really I wouldn’t care what their 3 or 5-year track record is if they don’t have a unique position in the marketplace and don’t have a deep experience that leads them to have any competitive edge in the marketplace.

So I hope these 5 tips helped. I’ll just run through them again; avoid hedge fund managers, have a one-man shop that don’t have an administration firm, they don’t have the ability or track record of raising capital, funds that don’t have marketing materials and funds that don’t have a deep experience on their team that’s directly connected to what they’re investing in in their hedge fund.

This is Richard Wilson coming to you from Nice, France. Thanks for joining me and we’ll see you again next time.

Again, this video should not be taken as financial advice, please refer to your financial or legal adviser.  I do hope that hedge fund investors like family offices, institutional investors and high-net-worth individuals will keep these red flags in mind while investing in hedge funds.  

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