It is preferable to invest with fund managers who are registered investment managers. You can find information about them on the SEC Web site (for both state or SEC registered). There is usually some due diligence done on them by regulators. You can, and you should review their filings (ADV 1, ADV II) prior to investing. It is also preferable to invest with managers who are either CFAs or have completed Series 65 certification (the investment adviser law exam). Both these emphasize various investing factors with investor interests as the primary concern (such as fiduciary responsibilities, portfolio concentration etc). Often, RIAs have one of these certifications. Contrast this with fund managers who are not RIAs. There is little or no information about them, and no due diligence done to verify their information.
Sometimes, we see people with a pedigree of a big name Wall Street firm that's launch a fund. Their ideas may be great, but if they lack significant and proven expertise in money management, they will be like a rookie quarterback trying to run a complex offense. If you still find such managers' offerings attractive, it is prudent to start small and let them prove themselves and their strategies.
Step 4: Choose Independence And Non-affiliation
It is desirable to invest in funds that have an independent and well-known custodian, and an independent accountant (third-party administrator). The fund manager and the offeree of the fund should not be affiliated with the custodian of the fund's assets. This simple step is important in protecting against possible frauds.
The fund's asset valuation is done on a periodic basis, usually monthly. It is best to opt for funds that use outside, experienced accountants for calculating net asset values. It is preferable to opt for a fund that is audited annually by independent auditors. For fund managers who are RIAs, an annual audit is usually a regulatory requirement. That is another reason to prefer funds offered by RIAs.
Step 5: Review Past Performance But Do Not Excessively Rely On It
It is important to review past performance and understand why the fund performed well or not well. Of course, past performance is no guarantee of future results, but it will give you insight into the fund's management philosophy. When you evaluate returns, it is important to look at time periods and compare them to peers. For example, if some one says, our fund is up 50%, ask him as of when - as of the first of the year? Or some other date? No cherry picking should be allowed. In short, review numbers carefully.
The five steps described above are a good starting point. There are further considerations - what are fees, what are redemption policies, has the fund manager invested a sizable portion of his own money in the fund (that is a plus), what are the minimums, how will the fund fit into to your client's total portfolio. If your client has mostly long exposure at present, adding long-short hedge funds can reduce net long exposure and volatility.
Above all, as a financial advisor, before you invest your clients' money in a hedge fund ask yourself a simple question - would I invest my own money in this fund under similar circumstances? The answer should be a resounding yes before you recommend the fund to your clients.
Manoj M. Nadkarni is the president of ChipInvestor Group LLC (CIG), a registered investment advisor based near Seattle. CIG offers technology sector-specific investment management for high-net-worth persons, financial advisors and institutions. Nadkarni graduated from the Massachusetts Institute of Technology with a master's degree in engineering, and holds a Series 65 license. He can be reached at [email protected] or at (800) 676-4045.