Hedge funds can be rewarding for the brave
By Stephen Rothman • Bankrate.com

Some of the nation's largest banks have begun offering their wealthiest customers a chance to become even richer by taking a chance on hedge funds.
"This is where the action is,'' said George Van, chairman of Van Hedge Fund Advisers International, which monitors 2,700 funds here and abroad.
Hedge funds are about managing risk. By betting a stock will go up in value, and simultaneously betting that it will drop, hedge fund managers try to ensure that investors don't loose it all, explained David Harvey, founder of the Everest Partners L.P. hedge fund in Nashville, Tenn. That's what hedging is all about.
As with other investments sold by banks, cash in hedge funds is not guaranteed against loss by the FDIC or other government agencies.
Susan Weeks, a spokeswoman for $281 billion-asset Citicorp based in New York, said the bank only offers hedge funds to institutional investors or private bank investors who have $3 million or more in net worth available.

Only for the "very wealthy"
"We are talking about the very wealthy. The sophisticated investor," she said, adding the hedge fund opportunity is "risk tailored to the customer himself."
A spokeswoman for $320 billion-asset Bankers Trust New York Corp., which doesn't offer retail banking, takes the same position. Last year, Bankers Trust received the Micropal Off-Shore Fund Data Base of London's award for having the best performing fund in 1996.
Indeed, "These (funds) are not for the fainthearted because there is high risk in this class of investment,'' said Dennis Grabow, head of the Millennium Investment Corp., a Chicago-based hedge fund.
Harvey, considered a gray beard in an industry that took off only in 1993, believes hedge funds fail for two reasons. They accept more money than they can adequately manage or fail to screen investors for patience or intelligence.
"You don't want investors who are going to want their money back at the most inappropriate moment," said Harvey.

SEC doesn't say where to invest
The Security and Exchange Commission does not interfere in how or where a hedge fund invests.
Grabow has established a hedge fund based on his belief that at least 400 of the nation's banks will fail due to computer glitches that occur at the start of the year 2000. Most computers are programmed to read only the last two digits of the year and currently are unable to distinguish between 1900 and 2000.
The SEC, however, does have rules on who can participate as an investor.
An individual must have earned $250,000 during the last two years before applying for hedge fund membership or have a net worth of $1 million. A couple must have earned $300,000 or have a $1 million net worth, Van said.
That means a lot of people qualify. "Anyone who bought property in California 15 years ago would meet the net worth standard. Anyone living in New York City, including the garbage man, probably could meet the income test," Harvey said, but that doesn't mean they are "smart enough" to pick or handle hedge fund risks.

Reward matches the risk
Traditionally, hedge funds have been "the preserve of wealthy people who had money they could risk. The reward is great when they hit, but so is the risk" when they don't, said James Abbott, a partner in the 144-year-old law firm of Carter, Ledyard & Milburn which specializes in setting up domestic, foreign and offshore hedge funds.
In 1997, a year when the Standard and Poor's stock index showed a 33.4 percent profit, the best-performing hedge fund returned 46.9 percent, Van Hedge Funds reported. However the average hedge fund made only 20.9 percent.
In the old days, the SEC limited a hedge fund to no more than 99 persons who could invest up to $5 million. Recently, the SEC changed the rules to allow a pool of up to 500 investors who could put a total of $15 million into the fund.
"This has allowed a number of investment firms to flog (a hedge fund proposal) through a brokerage firm, as long as they make sure they don't sell it to mom and pop" who might lose their life savings, Abbott said.
Whether it's an individual, pension fund or insurance company, the question remains the same: "How much are you willing to risk for a greater return," said Abbott.
The hedge fund manager wants to win big, he said, because he gets 20 percent of the profits made off investors' money.

Manager gets 1 percent to pay expenses of fund
"The incentive for him is to make risky investments, but not so risky that he blows it," Abbott said, adding the manager also gets 1 percent of the money invested to pay for the fund's expenses.
So now that the risks are known, how is a hedge fund selected? For Duane Moyers, vice president of Investors Strategic Partners 1 Ltd. of Fort Worth, Texas, there are two key elements.
"You need to investigate the manager's style of investing and how much risk he is willing to take (with your money)," Moyers said, adding that he recommends that no individual put more than 20 percent of their net worth into a hedge fund.
"There have been some high profile disasters in the hedge fund arena over the last four or five years," Moyers said.
One occurred in 1995 when Morgan Stanley & Co.'s Global Opportunity Fund collapsed, wiping out the $120 million offshore investment by its 14 corporate and private investors.

One high profile disaster
They investors filed suit March 11 in New York Supreme Court charging Morgan Stanley International with fraud and misrepresentation. Investors allege they were induced to invest in what they were told was a low-risk investment with a goal of preservation of capital. They say it turned out to be quite something else.
In some cases, a hedge fund runs into trouble when managers use too much leverage in trying to maximize the return. For instance, if the fund takes in $100 million, the fund manager may go out and borrow $1 billion -- 10 times what he has in assets.
"If there is a dangerous downturn, the $100 million can get blown out of the market along with the investors," Moyers said, adding all it takes is one bad year to shut a fund down.
Today, Moyers said, "it's hard to find a hedge fund manager that has been around three years or longer," because a lot have guessed wrong on the market.
"Today the market is up. But when it heads down again, they will be writing more disaster stories about hedge funds," Moyers said, adding "there are a lot of mine fields out there to catch them."

-- Posted: March 26, 1998