How To Hedge Your Bets.(Giving Globally)(Global Investor)

Long the subject of mystique on Wall Street, hedge funds have gotten plenty of ink in recent years thanks to both their spectacular returns and equally spectacular debacles (think Long-Term Capital Management and, more recently, high-profile subprime victims like Bear Stearns's hedge funds). They are almost always defined in the extreme, as either legendary producers of superior investment returns, or vultures and potential destabilizers of the financial system.

The truth, of course, is somewhere in between -- an important point to make, now that hedge funds are coming to Main Street. A growing number of funds are looking to issue shares to the public through IPOs. Baskets of funds are being marketed through "fund of funds" vehicles. And hedge-fund techniques are increasingly being offered by more-traditional asset managers; one form is called a 130/30 equity fund -- i.e., a vehicle that can borrow money to leverage its bullish equity positions to 130 percent of its capital and, at the same time, sell stock that it does not own (short) to the tune of 30 percent based on its bearish calls.

Are hedge funds a smart bet for average retail investors? Maybe. In addition to their potentially high returns, hedge funds can be portfolio diversifiers, since they have access to a broad range of investment instruments. They are able to "leverage" to amplify the upside of their purchases, they can "short" not only stocks but also bonds and commodities to protect capital in the event of market downturns, and they can access sophisticated "derivative" products that can offer a more refined manner to express an investment view.

Yet Main Street investors should note the following before investing:

Hedge funds are not cheap. The fees typically amount to 2 percent of the invested capital and 20 percent of returns. This compares with a total of 0.5 to 1.5 percent for most actively managed mutual funds, and even less for index funds.

Not all hedge funds are created equal. For each superstar manager, there are hundreds of mediocre ones. Access to good managers is constrained by high minimums and wait lists of investors.

Most hedge funds expect you to "lock up" your money. By ensuring that investor capital is locked up for several quarters or years, hedge-fund managers are able to invest on the basis of potentially profitable long-term views. But this also limits the ability of investors to withdraw their capital.