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5 Things to Consider Before Adding a Hedge Fund Product

April 10, 2007
Related Topics: Benefit Design and Communication, Retirement/Pensions, Featured Article
Hedge funds leverage their investments by taking both long and short positions in the market, effectively allowing them to make bets against the stock market and perform well when the stock market falters. They are increasingly popular among employers as additions to retirement plans, but they’re not necessarily easy to explain, or manage. Here are five things to consider before adding hedge-like products to a 401(k) plan:

  • Think about your employees. Hedge funds are sexy vehicles and have made headlines for great performance during the past few years. But do your employees understand what they are? Even if you can explain how they work, will employees appreciate the fact that you have made them available? If your employees are highly educated, the answer to this question may be yes. But if not, it might not be worth the headaches in adding the fund.

  • Understand how the fund works. As with any investment option, it is the employer’s fiduciary duty to understand how the fund works before adding it to a 401(k) plan. Unlike equity funds, which often have similar goals and strategies, hedge-like mutual funds can vary greatly in their investment strategies. And employers must understand the process well before adding them to their 401(k) plans.

  • Find out about performance. The number of hedge-like funds on the market has exploded during the past few years, but not many have three- or five-year track records. Make sure to ask the managers how they benchmark their performance.

  • Figure out the fees. Hedge-like mutual funds can be pricier than average mutual funds. The average hedge-like mutual fund charges 2.07 percent in expenses, compared with 1.43 percent for the average U.S. stock fund, according to Morningstar. Funds of hedge-like funds, or those funds that invest in a pool of hedge-like funds, charge even higher fees. It’s up to the employer to figure out if the benefits of the investment strategy outweigh the costs that employees will have to pay to invest in these funds.

  • Devise an education strategy. Before adding a hedge-like mutual fund to a 401(k) plan, figure out how to explain the product to employees. Ask the investment provider or your plan administrator if they can help. These products are complicated, and a one-page brochure probably won’t do it.

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