By Noah Rosenfarb (New York)
1. Hedge funds require accredited investor status.
This status is obtained by any natural person whose individual net worth, or joint net worth with that person's spouse, at the time of his purchase exceeds $1,000,000. Also, one can be an accredited investor if they had individual income in excess of $200,000 in each of the two most recent years or joint income with that person’s spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year.
Any trust with total assets in excess of $5,000,000, not formed for the specific purpose of acquiring the securities offered, whose purchase of the securities is directed by a person who has such knowledge and experience in financial and business matters that he is capable of evaluating the merits and risks of the prospective investment is also an accredited investor.
2. Understand any limitations on your clients’ rights to redeem shares.
Hedge funds typically limit opportunities to redeem, or cash in, your shares (e.g., to four times a year), and often impose a "lock-up" period of one year or more, during which you cannot cash in your shares.
3. Understand how a fund's assets are valued.
Funds of hedge funds and hedge funds may invest in highly illiquid securities that may be difficult to value. Moreover, many hedge funds give themselves significant discretion in valuing securities. You should understand a fund's valuation process and know the extent to which a fund's securities are valued by independent sources.
4. Don’t confuse Private Equity fund investments with hedge funds.
Private equity investment funds “look” similar to hedge funds – investors must be accredited and owners generally receive a Form K-1 detailing income and capital gains. However, private equity fund capital and investment structure is very different. More importantly, the value listed for a fund on a brokerage statement may be very different than the actual value of the underlying assets due to conservative accounting policies followed by many funds.
5. Recognize the tax ramifications.
Investors generally receive Form K-1 on or near the tax filing deadlines. As a result of the added complexity, there may be additional costs for tax return preparation. Also, know the tax treatment for earnings and the distribution rights, if any, to pay the resulting tax.
Noah B. Rosenfarb, CPA is Managing Director at Freedom Divorce Advisors where he provides sophisticated tax and financial advice to affluent divorced women. Mr. Rosenfarb integrates life planning with financial planning to ensure clients experience the maximum benefits of affluence post-divorce. His holistic approach increases the probability of leading a life that is filled with prosperity – the kind that is measured more by personal happiness than merely by currency.
Reprint with permission.