What to look at when deciding what choice is right for your clients.

Should you put your well-heeled clients into unregistered or registered hedge funds? Or is it better to select a mutual fund that uses hedge-fund tactics and is managed by a registered investment company?

With unregistered hedge funds, only accredited investors-individuals with a net worth of at least $1 million or an annual income of at least $200,000 for the last two years-are permitted to invest. The minimum initial investment in a hedge fund typically ranges from $1 million to $5 million.

Unregistered hedge funds are not subject to many of the strict rules that govern their mutual fund counterparts when it comes to, for example, the nature of their investments and how much they can borrow. Hedge funds that have registered under the Investment Company Act of 1940 are subject to the same rules and investment restrictions as mutual funds. They are structured as closed-end funds, but are only available to well-healed investors.

Unregistered hedge funds generally do not have a board of directors. Nor do they have a standardized format of presenting performance results. Hedge fund investors usually pay an asset management fee and a performance fee of 20% or more of a hedge fund's annual profits. If there are no profits, no fee is paid. It also is harder to get out of an unregistered hedge fund.

Two Web sites that list the performance of unregistered hedge funds include www.hedgefund.com and www.hedgefund.net. Advisors can get information on registered hedge funds at www.hedgefunds.net/access.

Regardless of whether they are hedge funds or mutual funds using hedge fund strategies, these investments are designed to deliver returns that are not correlated with the equity market.

Lower volatility hedge funds may use the following investment tactics: merger arbitrage, convertible arbitrage, distressed securities investments, capital structure arbitrage and long/short market neutral investments. Aggressive hedge funds might be highly leveraged, engage in only short sales, make market-timing moves, invest in distressed securities or use global macroeconomic trends to invest.

A handful of mutual funds use some of these investment tactics, within limits. Such mutual funds with at least a three-year track record, according to Morningstar Inc, include: AXA Rosenberg Market Neutral, Calamos Market Neutral, Phoenix Market Neutral and Boston Partners Long/Short Fund. These funds grew at an average 6% annual rate over the past three years ending in September 2003. By contrast, the S&P 500 lost 10% annually over the same period.

Although these mutual funds performed well, analysts say that if your clients can afford it they might be better off in hedge funds, which have more investment flexibility. Over the past three years, hedge-fund-like mutual funds performed in line with the average return on unregistered hedge funds, according to Morningstar and Hedgefund.net data. But the data is distorted. It compared only seven mutual funds against data on more than 1,000 hedge funds. So random chance is a significant factor in these results, says Deborah Lee, an analyst with Hedgefund.net.

Jim Graves, director of HFN/Access, N.Y., which tracks registered hedge funds and is affiliated with Hedgefund.net, says there are only a few registered private-equity hedge funds with longer-term track records. Currently, there are about 55 funds in registration. For his current year-to-date ending in September, the average return on registered funds is slightly below the 6% return on the average fund of funds hedge fund, adds Graves.

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