Hedge funds are beginning to receive a higher profile in the Canadian investment industry. Here's an article that you can send to clients who are interested in learning more about hedge funds.

What is a Hedge Fund?
A hedge fund is similar to a mutual fund in that it is a collection of underlying securities in a single investment. Many hedge funds are similar to equity mutual funds in that they seek to grow capital, rather than return regular income like fixed-income investments, or provide regular interest payments like money market investments. Also like equity funds, hedge funds usually involve higher risk than fixed-income or cash investments. The big difference between hedge funds and mutual funds is the strategy that they can employ. Hedge funds can include short-sell positions. They can also use leveraging strategies, including the use of options, futures, commodities or borrowing to invest.

The term ‘hedge fund' is a generalization for a wide variety of funds that do not always include hedge positions. The reason investors use these funds in their portfolio is that hedge funds are designed to have a low correlation to the performance of stock markets – meaning simply, that their returns are not linked to any prevailing market conditions.

A Low-Profile Investment
In Canada today, there are about 50 hedge funds (Advisor's Edge, November 2001). In the United States, however, hedge funds are far more prolific. So why are hedge funds sight unseen to the average investor?

Hedge funds are considered a very specialized investment. Securities regulators currently do not require that investors receive a prospectus since hedge funds are considered an investment that is only sold to highly sophisticated investors. Most hedge funds require a high minimum investment, which generally starts above $100,000 in Canada, with some funds in the United States requiring a US$10,000,000 minimum. This low-profile investment could be heading for more of a spotlight as provincial securities commissions are considering dropping the minimum “sophisticated investor” requirements, making hedge funds more accessible. Some fund companies in Canada have already started launching RSP-eligible hedge funds.

Who Should Invest?
Many analysts believe that hedge funds can be considered a fourth asset class (besides equity, fixed-income and cash). They should be considered as part of the growth portion of an investor's well-diversified portfolio. In fact, analysts caution that investors looking to this investment option should first have a portfolio that has diversified investments across the other asset classes (equities, fixed-income and cash). Make no mistake, hedge funds do use strategies that incur higher risks than the most mutual funds, but they can offer the potential for capital protection in a market downturn.

Are They Right for You?
For more information about hedge funds and whether they are right for your portfolio, you should speak with your financial advisor.