* Assessing the suitability for individuals

When assessing the suitability of hedge funds for individuals, an assumption about taxes must be part of the consideration. Hedge funds by their very nature are tax-inefficient investments. Because of their opportunistic nature, most hedge funds tend to turn over their positions well before they become long-term for tax purposes. Shorting is also tax-inefficient because it always results in short-term gains or losses, regardless of how long a fund holds the position.

The criteria for determining whether a hedge fund would be appropriate for a wealthy investor really come down to a few critical factors. Firstly, after accounting for fees and taxes, what does the investors get to keep? Hedge funds, unlike individual stocks, bear hefty management fees (typically 2%) and carried interest (usually 20%).

Secondly, can the investor get the same risk-return profile through a traditional investment vehicle? Hedge funds, especially long/short equity funds, are not a separate asset class but rather an alternative approach to investing in a traditional asset class. So when considering investing in hedge funds, the investor also needs to be aware of the traditional investment options.

Because hedge funds are largely unregulated investments, there is a certain degree of business risk on the part of the underlying manager. This risk can be mitigated by proper manager research, but it can never be completely eliminated. There is no need to engage in this risk if it is possible to get a similar risk/reward tradeoff in a traditional investment vehicle.

The decision to include hedge funds in the portfolio of wealthy individuals is ultimately determined by their individual circumstances. Hedge funds only become appropriate when the risk/return tradeoff is unavailable through traditional investment options.

see detail: Are hedge funds suitable for individual investors?