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March 15, 2004 at 07:00 PM
So, you’ve finally decided to take a serious look at hedge funds for your clients. But you feel bad for all your ‘B’ and ‘C’ clients, because most of them aren’t accredited and don’t have access to the same types of strategies you can offer your higher-net-worth clients. Not to worry–there are several interesting vehicles that allow the average non-accredited investor access to hedging strategies for as little as US$1,000, although it varies by product and distributor.
Segregated Hedge Funds
These are hedge funds that are guaranteed by an insurance company. They are similar to segregated mutual funds. Segregated funds are investment vehicles that are “segregated” from the insurance company’s assets and provide insurance benefits. They provide a guarantee of principal upon death or on maturity of the term of the fund. In addition, they can provide creditor proofing and bypass probate fees in an estate. So, this is a hedge fund with an insurance wrapper around it.
There is a cost to this guarantee, usually in the 1% range. Some offer less than a 100% guarantee; they might offer a 75% guarantee of your principal, so they’re a little less expensive. The term for the guarantee to kick in is usually 10 years, longer than a typical note structure. Some people argue that over a 10-year period, you should be able to make your principal back and think it’s a waste of money to pay for a 10-year guarantee.
The investment minimum on the segregated funds is usually US$1,000. You can redeem them usually weekly, but there may be a fee associated with selling it before the maturity date.
Closed-End Hedge Fund Trusts
A closed-end fund is a hedge fund that trades on an exchange, just as a stock would. These vehicles are filed with securities regulators and have a full prospectus. A closed-end fund is issued in the same way as a “new issue” for a stock. There are underwriters (banks/brokerages) who can offer the fund for sale to their clients through their investment adviser distribution network. The closed-end fund is made available for sale for a limited offering period, usually two to three months, at which point it is closed off to new investors.
Liquidity is an issue with closed-end trusts. Because it trades on an exchange as a stock would, in order to sell your shares you have to find a buyer for them. Remember, it’s not as widely traded as a blue chip stock. It’s usually a smaller offering, so they don’t issue as many shares as a regular company would if it was going public. If you want to sell your trust you have to find a buyer for it.
In addition to that, the shares on the exchange may trade at a discount to their actual net asset value. If you can wait, the trust usually will have an offer to buy back the shares once a year at the net asset value, rather than the share value on the exchange.
Because this type of offering is made under a full prospectus and registered with securities regulators, you don’t have to be an accredited investor to participate. Investment minimums are usually around US$1,000.
Hedge Funds Light: Mutual Fund Hedge Funds
These are hedge funds that file a full prospectus with the various regulators but aren’t real mutual funds in the traditional sense of the word. This is like a quasi-mixed hedge fund product with mutual fund characteristics. They don’t have all the restrictions of mutual funds, nor do they have all the freedom of hedge funds.
