Types of Hedge Fund Investors

The hedge fund provides a lower after-tax return but also a lower level of
volatility in the combined portfolio. Clearly, if the individual investor can
locate a hedge fund with returns higher than the investment alternatives,
this comparison looks more favorable still.
It is also clear that individual investors would prefer hedge funds that:
(1) have higher expected return; (2) have lower volatility; and (3) have
lower correlation to assets already in the portfolio. Similarly, if a hedge
fund could deliver some portion of its return as long-term capital gain, it
could create higher after-tax portfolio returns than hedge funds that pro-
vide a return taxed as ordinary income.
Semiaffluent Investors
There is currently much attention directed at those investors who margin-
ally qualify to invest in private hedge funds or would not qualify to invest
in a hedge fund sold as a private placement but could invest if the fund was
registered (see Chapter 7). This group is sometimes called semiaffluent or
nearly affluent.
Writers define this group differently. Some categorize individuals
with a net worth of between $1 million and $10 million as semiaffluent.
3
Others include investors with between $500,000 and $1 million in this
group.
4
J. P. Morgan also includes investors above $1 million in a group
called semiaffluent.
5
Regardless of how this group is defined, it includes
investors who historically have not had access to hedge funds. Due to
changing attitudes, changes in the risk profile of the hedge funds, and
new legal developments (notably the registered fund of fund), this group
represents a large, almost untapped market.
The appeal of marketing to this group of investors is: (1) it constitutes
many investors; (2) despite the more limited resources of individual in-
vestors, it constitutes a large potential pool of funds (by one account, semi-
affluent investors control between $6 trillion and $8 trillion in assets
6
); and
(3) this group has invested little in hedge funds to date.
The semiaffluent investors want to invest in hedge funds for the same
reasons that high-net-worth investors invest in hedge funds. Because many
hedge funds are less volatile than a broadly diversified portfolio of com-
mon stocks, these investors may invest in hedge funds to lower the risk of
their portfolios. With similar objectives, these investors may seek to lower
the volatility of their investment portfolios by diversifying into hedge
funds with low correlation to stock and bond returns. Finally, some semi-
affluent investors seek out hedge funds to increase the return on their in-
vestment assets.
As with any group, there are great differences between individuals who
Types of Hedge Fund Investors
39
ccc_mccrary_ch03_35-58.qxd 10/6/04 1:41 PM Page 39