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Funds allow entry into or exit out of the hedge fund at a limited num-
ber of times per year. Restricting flows to month-end, quarter-end, or year-
end greatly simplifies the tax-reporting burden on the hedge fund
administrator. Funds sometimes require investors to advise the manager in
advance of withdrawing funds. Some managers require 10 to 90 days' no-
tice to redeem hedge fund interests. These provisions, along with lockup
provisions, seek to make hedge fund investments more sticky (investors re-
main in a hedge fund for a longer period of time).
HEDGE FUND MYTHS
As mentioned earlier, the public perceives hedge funds as risky investments
appropriate for thrill-seeking investors. This myth and others persist de-
spite evidence to the contrary.
Hedge funds are sometimes called absolute return strategies. The
idea of absolute return is in contrast to traditional money management,
where returns are compared to a benchmark of returns on similar assets.
The return on a portfolio of stocks is compared to the S&P 500 or other
index, and a manager is judged not on whether the portfolio was prof-
itable but rather on how the portfolio return compared to the market re-
turn. In contrast, absolute return strategies can be expected to be
profitable regardless of what happens to any identifiable index. In the-
ory, the absolute return manager would be judged only on the size and
consistency of returns.
However, most hedge funds retain at least some correlation to stock
and bond returns. Academic studies have shown that the returns on
hedge funds can at least in part be explained by market returns and
other economic factors (credit spreads, volatility, and others). Further,
for hedge funds that follow a popular strategy, it is possible to bench-
mark an individual fund's return against peer fund returns. Finally,
hedge fund indexes now exist that provide reasonable benchmarks for
many hedge funds.
Another hedge fund myth involves assumptions about the life cycle of
hedge funds. Many investors refuse to invest in hedge funds that have less
than, for example, two years of performance in the belief that young funds
are more likely to fail. Other investors seek to invest in young funds be-
cause they believe that smaller, newer hedge funds provide higher returns
than large funds that have been in existence for many years. In addition,
there is a belief that hedge funds don't tend to survive longer than about
eight years.
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