Investment Partnerships and Hedge Funds

Private investment partnerships represent an alternative to mutual funds.  Partnerships and mutual funds are both actively managed pots of pooled money, usually employing some well-defined investment strategy.  But there are significant differences between the two with advantages and disadvantages.   Partnerships and hedge funds can invest in a much wider assortment of investments, including all the latest derivative instruments like credit default swaps, collateralized debt obligations (many of which have lost their luster in the sub-prime mortgage meltdown).  They can also sell securities short, which allows them to engage in strategies like convertible arbitrage.  And they can leverage their returns by borrowing money so they have more capital to invest than just what the partners have contributed.  These features offer the possibility of exceptional returns but at greater risk.

Since the managers of these funds typically take a percentage of the profits as well as a percentage of the assets under management, they stand to make a lot of money if they are successful.  Some argue that since money talks, this compensation structure attracts the best and brightest on Wall Street.  That has not kept some funds from losing most of their investor's money in the recent past.

Partnerships and hedge funds typically have sizable minimums, and investors may also have to meet minimum net worth requirements.  The minimums have come down as the fund have proliferated but are still measured in tens of thousands of dollars (used to be hundreds of thousands or even millions). 

Another drawback to these funds is that they are not liquid.  In many cases investors can only invest or withdraw funds at the end of a quarter.  That means if some negative news breaks in January, changing your investment outlook, you have to wait until March to get your money out, and you are relying on the fund manager to cope with the bad news until then.