BOARD CERTIFICATION EXAM STUDY GUIDES Lower Extremity Trauma
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ME-P readers might believe the hedge fund industry is a small, exclusive club of elites, rich investors. But a new count by Preqin shows that it’s actually a large—and growing—sector of investing.
In fact, there may be more hedge funds globally (30,000+) than Burger King locations (18,700), and more more hedge fund managers than Taco Bell managers, per the FTE
Many doctors are surprised to learn of an alternative investment known as a hedge fund, pooled investment vehicle or private investment fund. Unlike mutual funds, they can be structured in many ways. However, these funds cannot be marketed or advertised, but they are far from illegal or illicit.
In fact, physicians were among the early investors in one the most successful hedge funds. Warren Buffett got his start in 1957 running the Buffett Partnership, a hedge fund not open to the public. His first appearance as a money manager was before a group of physicians in Omaha, Nebraska. Eleven decided to invest some money with him. A few then followed into Berkshire Hathaway Inc, now among the most highly valued companies in the world.
And, more recently, Scion Asset Management® LLC, is a private investment firm founded and led by my eloquent colleague Michael J. Burry, MD and featured in the movie, The Big Short. Other hedge fund mangers of note include: George Soros, Carl Icahn, Ken Griffin, David Tepper, John Paulson and Bill Ackman.
A hedge fund is a limited partnership of private investors whose money is managed by professional fund managers who use a wide range of strategies; including leveraging [debt] or trading of non-traditional assets [real-estate, collectible, commodities, cyrpto-currency, etc] to earn above-average returns. Hedge funds are considered a risky alternative investment and usually require a high minimum investment or net worth. This person is known as an “accredited investor” or “Regulation D” investor by the US Securities Exchange Commission and must have the following attributes:
A net worth, combined with spouse, of over $1 million, not including primary residence
An income of over $200,000 individually, or $300,000 with a spouse, in each of the past two years
The hurdle rate is part of the fund manager’s performance incentive compensation. Also known as a “benchmark,” it is the amount, expressed in percentage points an investor’s capital must appreciate before it becomes subject to a performance incentive fee. Podiatrists should view the hurdle rate as a form of protection or the fee arrangement.
The hurdle rate benchmarks a single year’s performance and may be considered mutually exclusive of any other year, or the hurdle rate may compound each year. The former case is more common. In the latter case, a portfolio manager failing to attain a hurdle rate in the first year will find the effective hurdle rate considerably higher during the second year.
Once a fund manager attains the hurdle rate, the investor’s capital account may be charged a performance incentive fee only on the performance above and beyond the hurdle rate. Alternatively, the account may be charged a performance fee for the entire level of performance, including the performance required to attain the hurdle rate. Other variations on the use of the hurdle rate exist, and are limited only by the contract signed between the fund manager and the investor. The hurdle rate is not generally a negotiating point, however.
Example: A fund charges a performance fee with a 6 percent hurdle rate, calculated in mutually exclusive manner. A podiatrist places $100,000 with the fund. The first year’s performance is 5 percent. The doctor therefore owes no performance fee during the first year because the portfolio manager did not attain the hurdle rate. During year two, the portfolio manager guides the fund to a 7 percent return. Because the hurdle rate is mutually exclusive of any other year, the portfolio manager has attained the 6 percent hurdle rate and is entitled to a performance fee.
High Water Mark
Some hedge funds feature a “high water mark” provision known as a ”loss-carry forward.” As with the hurdle rate, the high water mark is a form of protection. It is an amount equal to the greatest value of an investor’s capital account, adjusted for contributions and withdrawals. The high water mark ensures that the manager charges a performance incentive fee only on the amount of appreciation over and above the high water mark set at the time the performance fee was last charged. The current trend is for newer funds to feature this high water mark, while older, larger funds may not feature it.
Example: A fund charges a 20 percent performance fee with a high water mark but no hurdle rate. A podiatrist contributes $100,000 to the fund. During the first year, the hedge fund manager grows that capital account to $110,000 and charges a 20 percent performance fee, or $2,000. The ending capital account balance and high water mark is therefore $108,000. During year two, the account falls back to $100,000, but the high water mark remains $108,000. During year three, in order for the manager to charge a performance fee, the manager must grow the capital account to a level above $108,000.
Claw Back Provision
Rarely, a hedge fund may provide investors with a “claw back” provision. This term results in a refund to the investor of all or part of a previously charged performance fee if a certain level of performance is not attained in subsequent years. Such refunds in the face of poor or inadequate performance may not be legal in some states or under certain authorities.
ASSESSMENT
Managers of hedge funds, like colleague Dimitri Sogoloff MBA who is the CEO of Horton Point investment-technology firm, often aim to produce returns that are relatively uncorrelated with market indices and are consistent with investors’ desired level of risk.
While hedging may reduce some risks overall, they cannot all be eliminated. According to a report by the Hennessee Group, hedge funds were approximately one-third less volatile between 1993 and 2010.
For a podiatrist who already holds mutual funds and/or individual stocks and bonds, a hedge fund may provide diversification and reduce overall portfolio risk. Consider investing in them with care.
2. Burry, Michael, J: Hedge Funds [Wall Street Personified]. In, Marcinko, DE and Hetico, HR: Comprehensive Financial Planning Strategies for Doctors and Advisors [Best Practices from Leading Consultants and Certified Medical Planners™] Productivity Press, New York, 2017.
3. Marcinko, DE and Hetico, HR: Risk Management, Liability Insurance, and Asset Protection Strategies for Doctors and Advisors [Best Practices from Leading Consultants and Certified Medical Planners™]. Productivity Press, New York, 2015.
4. Marcinko, DE: Dictionary of Health Economics and Finance. Springer Publishing Company, NY 2006
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A hedge fund is a limited partnership of private investors whose money is pooled and managed by professional fund managers. These managers use a wide range of strategies, including leverage (borrowed money) and the trading of nontraditional assets, to earn above-average investment returns. A hedge fund investment is often considered a risky, alternative investment choice and usually requires a high minimum investment or net worth. Hedge funds typically target wealthy investors.
My medical practice has a small self-directed pension plan with profit sharing features.
QUESTION: Can my medical practice’s retirement plan invest in a hedge fund?
Such a pension fund falls under a category called self-directed “plan” assets.
Among the rules are that each participant in the plan counts toward the 100 investor maximum under which most hedge funds operate, that each plan participant be a fully accredited investor, and that the hedge fund keep investments such as pension plans and other funds covered under ERISA to less than 25 percent of total assets under management.
A hedge fund is a limited partnership of private investors whose money is pooled and managed by professional fund managers. These managers use a wide range of strategies, including leverage (borrowed money) and the trading of nontraditional assets, to earn above-average investment returns. A hedge fund investment is often considered a risky, alternative investment choice and usually requires a high minimum investment or net worth. Hedge funds typically target wealthy investors.
QUESTION:Can I invest my Individual Retirement Account [IRA] in a Hedge Fund?
This is up to the manager, but there is no legal restriction on a hedge fund accepting individual retirement account (IRA) assets. IRA accounts are not well suited for funds that make extensive use of leverage, however. In such cases, the fund is likely to generate significant amounts of unrelated business taxable income (UBTI) – profits of the fund attributable to the use of leverage. The holder of an IRA account must pay taxes on UBTI, even if the UBTI was generated in an IRA account.
But, today’s hedge funds may or may not use leverage. Many hedge funds are not hedged at all, but rather are just specialized versions of regular long stock portfolios. If such funds do not use much leverage, IRA investors will not encounter much difficulty with UBTI and should not hesitate in considering these funds.
In considering whether to accept IRA money, hedge fund managers must consider several factors. If the only type of retirement money accepted by the hedge funds is IRA money, then the manager has no limit on how much retirement money the fund can accept. If, however, there are other types of retirement money invested in the fund, such as pension funds, IRA money will be counted towards a total of 25 percent of fund assets that can be invested in retirement accounts before the fund becomes subject to the Employment Retirement Income Security Act of 1974 (ERISA). Funds subject to ERISA regulations face a heavy administrative burden and more restrictions than most fund managers like.
Finally, IRA distributions from a hedge fund are subject to the standard 20 percent withholding unless the funds are directly rolled over to other qualified plans.
Posted on June 11, 2024 by Dr. David Edward Marcinko MBA MEd CMP™
By Staff Reporters
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A security, most simply, is a financial instrument traded for profit. They form the basis of investment contracts for thinks like equities, debt, and derivatives.
The SEC points to the Howey Test to determine if an asset can be classed as a security. This test has four prongs, all of which need to be passed to be determined a security: [1] An investment of money [2] in a common enterprise [3] with expectations of a profit [4] to be derived from the efforts of others.
In the US, if an asset is deemed to be a security it needs to be registered with the SEC. For example, an initial public offering (IPO) of a stock newly listed on the stock exchange represents the first offering of its freshly registered securities. Securities need to be registered as it gives the issuing company the relevant shareholder information to pay dividends and provide relevant stock-related information. It also helps reduce fraud by keeping on record the legitimate owner of the security.
According to the SEC, an unregistered security is simply one that hasn’t been rubber-stamped by the regulator.
Unregistered securities have been the subject of several scams, with the SEC saying their hallmarks include the promise of high yields with no risk, aggressive sales tactics, and are backed by unqualified investment professionals. As such, their use is limited.
Only accredited investors, defined as those with a net worth higher than $1 million or an annual income exceeding $200,000, can trade unregistered securities, essentially locking out most retail investors. The threshold is seen as a gauge of financial sophistication and suggests a buffer for eligible investors against potential losses.
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