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The Little Book of Alternative Investments: Reaping Rewards by Daring to be Different by Phil DeMuth, Ben Stein

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Chapter Eight

So Why Invest in Hedge Funds?

Okay, We Lied

If all of the previous so-called myths are valid reasons to be wary of investing in hedge funds, there must be some pretty good arguments on the other side to explain why professional investors stand by them. Pensions, institutions, endowments, and tax-exempt organizations use hedge funds for anywhere from 10 to 25 percent (depending on which study you read) of their investment allocation, while retail investors like us—who also would like to make a dollar if we could—have close to zero percent in the game. What’s an investor to do?

Final Answer

Okay, we’re going to tell you.

But before we do, we have to come clean. First, we admit that hedge funds in aggregate are probably not going to “beat the market.” Any given year, some funds will beat the stock market by a spectacular amount. Over time, however, many funds may not.

Second, let’s accept that we are not going to be able to gain access to these strategies for the same price as a Vanguard index fund. These are specialized approaches requiring more brainpower to work and more expense to operate, and we are going to have to pay for them.

Third, let’s grant that hedge funds have a moderate correlation to regular market indexes. They are not an insurance policy with a guarantee to save us when the market is down.

Hark back to the thrilling days of yesteryear. Remember the credit crisis, when the S&P 500 lost 37 percent of its value in 2008? We do. We still wear the lash ...

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