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An Introduction to Hedge Funds

I. Introduction

The term hedge fund usually refers to private investment vehicles that seek above-average returns through active portfolio management. Hedge funds tend to be skill-based investment strategies that attempt to obtain returns based on the unique skill or strategy of the trader. These returns are considered "absolute," as they do not depend on the relative long-term return of underlying traditional stock and bond markets.

Note: Stocks offer substantially greater liquidity and transparency than the alternative investment products noted and may be less costly to purchase.

Source: Hedge Funds: HFR Index; U.S. Stocks: S&P 500 Index and NASDAQ Index;
Intl. Stocks: MSCI World Index

Investors are attracted to hedge funds for a variety of reasons. This includes their potential to deliver positive returns under all market conditions, low correlation to traditional asset classes, and access to highly specialized strategies not typically available through traditional money management.

Hedge funds are largely unregulated by U.S. security laws and are strictly prohibited from advertising. As a result, hedge funds today are offered as private investment partnerships, generally with fewer than 100 affluent investors or institutional clients. Not all hedge funds are appropriate for all prospective investors: most hedge funds are available only to persons who meet specific financial requirements. Prior to investment, the law requires that the hedge fund determine the investor's suitability (i.e. is the hedge fund appropriate to the investor's risk tolerance, investment goals, and investment experience).

II. Benefits

A primary benefit of hedge funds is the low correlation many strategies have to traditional investments. While past performance is not indicative of future results, hedge fund strategies historically offer returns independent from the performance of stock and bond markets. In fact, they aim to diversify away from traditional "long-only" equity strategies and deliver positive returns under all market environments.

III. Risks

When considering alternative investments, including hedge funds, you should consider various risks including the fact that some products: often engage in leveraging and other speculative investment practices that may increase the risk of investment loss, can be illiquid, are not required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are not subject to the same regulatory requirements as mutual funds, often charge high fees, and in many cases the underlying investments are not transparent and are known only to the investment manager.

IV. How To Invest

With an estimated 6000 hedge funds managing in excess of $550 billion, most investors today are questioning where to begin. Many investors attempt to conduct their own due diligence and invest directly with specific managers, while others take advantage of professional hedge fund consultant firms to research, advise and monitor their investments.

Investing with a hedge fund manager involves a complex evaluation process. Identifying the best managers can be very difficult. Hedge fund managers are not required, and in many cases not allowed, to advertise or report performance data to any central authority. As a result, many of the top hedge fund managers are not listed in commercially available databases.

Hedge fund consultants can greatly assist in this process. Research specialists, with access to this data, screen the universe of hedge funds in search of high quality candidates for further analysis. They perform qualitative, on-site evaluations and review a manager's background, financial statements and corporate documentation in an attempt to identify a competitive advantage. This process often includes a quantitative review focused on the performance statistics related to volatility, consistency, and peer comparisons.

Consultants help investors define their investment profile and offer their clients a unique range of comprehensive hedge fund solutions. They then help clients monitor their investments to compare performance with their original investment parameters. They may advise a client to redirect their investment allocations as a result of changing market conditions, some asset classes outperforming others, or a change in the investor's objectives.

V. Conclusion

While there are risks involved, and hedge funds are not suitable for all investors, there is a compelling argument for the inclusion of hedge funds in a traditional investment portfolio. Many hedge funds can offer enhanced portfolio performance under various market conditions. It is hedge fund managers' flexibility and skill-based strategies that make this investment class inherently attractive. However, investors need to approach these investments with the necessary information to make an informed decision. Researching and evaluating hedge funds presents a host of challenges to even the most sophisticated investor. Through an appropriate allocation, hedge funds can be an attractive addition to a well-diversified portfolio designed to deliver positive returns while attempting to reduce volatility and risk.

Note: The NASDAQ, S&P 500 and MSCI indices are unmanaged and are generally representative of certain portions of the U.S. and international equity markets. These indices are mentioned for illustrative purposes only and are not indicative of any fund's performance. An investor cannot invest directly in an index. Moreover, indices do not reflect commissions or fees which might be charged to a similar fund and which might materially affect the performance data presented.

John Mauldin is the President of Millennium Wave Advisors, LLC (MWA) which is an investment advisory firm registered with multiple states. John Mauldin is a registered representative of Millennium Wave Securities, LLC, (MWS) an FINRA registered broker-dealer. MWS is also a Commodity Pool Operator (CPO) and a Commodity Trading Advisor (CTA) registered with the CFTC, as well as an Introducing Broker (IB). Millennium Wave Investments is a dba of MWA LLC and MWS LLC. Millennium Wave Investments cooperates in the consulting on and marketing of private investment offerings with other independent firms such as Altegris Investments; Absolute Return Partners, LLP; and Plexus Asset Management. Funds recommended by Mauldin may pay a portion of their fees to Altegris Investments who will share 1/3 of those fees with MWS and thus to Mauldin. For more information please see "How does it work" within this website. This website and any views expressed herein are provided for information purposes only and should not be construed in any way as an offer, an endorsement or inducement to invest with any CTA, fund or program mentioned. Before seeking any advisor's services or making an investment in a fund, investors must read and examine thoroughly the respective disclosure document or offering memorandum. Please read the information under the tab "Hedge Funds: Risks" for further risks associated with hedge funds.

Past performance is not indicative of future results. There is risk of loss when investing in managed futures or funds.
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