The hedge fund market crossed $3 trillion in assets at the close of 2014, according to Evestment’s Hedge Fund Asset Flows Report. These private funds, often incorporated in offshore jurisdictions as limited liability companies exempt from taxation, continue to attract investors seeking appealing absolute returns in a low interest rate world.

The results achieved by these funds and their managers remain, however, mysterious. The privacy that is attractive to these investors, many keeping their funds offshore as an accepted way to avoid taxes in their home jurisdictions, is a double-edged sword as there is little ability to hold the manager accountable.

Whose money is it?

With few mechanisms to independently assess the manager’s actions, managers sometimes behave as if the funds under their stewardship are theirs to use as they see fit. Understanding the way these funds work therefore becomes very important for investors considering investments in this arena.

Since these funds are typically structured as companies with a perpetual life, there is nothing to inhibit the manager from constantly seeking new money from new investors to pay redemption requests from previous investors, with no day of reckoning so long as the new money keeps coming in. Unhappy investors, having asserted themselves to be sophisticated enough to accept the risk associated with these private investments, have little recourse.

Apr-Jun 2015 Issue

Solon Group, Inc.