Sleuthing Tips for Prospective Hedge Funds

Wall

Street Journal

The recent fraud allegations and mismanagementof hedge fund Bayouhave brought greater attention tothe risks involved in this mostly unregulatedinvestment vehicle. Because hedgefunds do not disclose information very easily,physician-investors have to put on theirsleuthing caps to perform the backgroundresearch themselves, according to the . Although professionalfirms can provide the service for you, thecosts usually range from $1000 for a basicmanager check to more than $10,000 for multiple managers. Do-it-yourself factcheckers should consider the following guidelines when researching a prospectivehedge fund management firm:

• Ask to see a firm's audits for the past 3 years.
• Check that a firm's promotional materials are true.
• Verify all references—past employers, colleges, and investors—and be waryof any discrepancy.
• Do not commit money for at least 3 to 6 months and after several meetingsat the firm's office.
• Compare the firm's returns against competitive hedge funds through fundadministrators and hedge fund databases.li>Understand specifics involving trades, brokerages, and securities reports andprices. Be cautious of hedge funds that use their own brokerage firm.
• Beware of side letters, which give preference to certain investors, and carveouts,a means to exclude investments from performance numbers.