Alternative managers are hedge funds and private equity funds. Because there are special issues associated with such managers, I've added a few paragraphs about working with each.
Prophesy as much as you like, but always hedge.
—Oliver Wendell Holmes
As Gertrude Stein might say, a manager is a manager is a manager. But a hedge fund manager is a manager only more so—a manager on steroids, if you will. The earlier precautions about managers in general go for hedge fund managers, but they are all even more critical. Long-only managers can underperform, sometimes substantially, but they rarely blow up and lose all an investor's capital. Hedge funds do this quite regularly.
The fundamental concern about hedge funds is that the assets managed by hedge fund managers are not held in custody in the usual sense of the word. Custody issues are discussed in Chapter 22, but in brief, when an investor engages a long-only manager, the manager never actually gains control of the investor's cash or securities. Cash and securities remain in the hands of a bank or brokerage firm that is acting as the asset custodian for the investor. The portfolio manager has, in reality or in effect, a limited power of attorney to direct the investments in the account. The manager can cause the account to sell GE and buy Microsoft. But the GE stock doesn't leave the custodian's hands until the proceeds from its sale arrive, and the funds required to buy Microsoft don't ...