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How to choose a hedge fund?

Hedge fund analysis? Why don't investors pick hedge funds in similar ways they are SUPPOSED to pick stocks? While chasing performance and what is currently "hot" are sadly prevalent traits throughout finance, it is interesting how differently many investors approach evaluating stocks to selecting hedge funds.

1. Buying a good stock during a drawdown has proven a great strategy over time. It's better known as deep value investing. Yet almost no-one invests in a TRULY skilled hedge fund in a drawdown. Existing investors redeem while new investors never even look because it fails the first cut - recent performance.

2. Who cares if a stock made 1,000% last year? What matters is the return in the future. Similarly pick a hedge fund for the future, its past performance made money for others, not you. Study the product, the process, the people; if you like it buy it.

3. Hundreds of stocks go out of business every year due to incompetence, embezzlement, out of date products or simply bad luck. This however does not invalidate investment in the stock market. Similarly many hedge funds disappear every year for similar reasons but this does not change the essential portfolio need for investors to diversify with well-run hedge funds.

4. Most investors spend too much time on due diligence BEFORE investing and not enough time AFTER investing. I do the opposite. Detecting frauds is easy; detecting true skill is harder. Ongoing due diligence is much more important than initial due diligence. If you come across an investment that looks interesting buy a small amount NOW. Already being in the portfolio increases your attention. Build the position as your ongoing due diligence continues. I pay much more attention to an investor who has real money in a fund than someone who is just thinking about it, even if the potential amount is far larger. A real investor has a vested interest in keeping trade secrets confidential.

If you want understanding of a hedge fund, invest a small amount THEN embark on proper due diligence. Rookie hedge fund investors and most funds of funds takes months or years to decide to invest and their "performance" reflects that.

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