The short answer to the question “are there risks with hedge funds?” is “yes.” With any type of investment, there are risks! The market is not foolproof, and there are dozens of cautionary tales for every possible type of investment. As for hedge funds specifically, the risks are incredibly varied. Because of the nature of any given hedge fund, which functions as a kind of investment portfolio and may be dealing with multiple types of investments at any given time, the risks associated are ever-changing and depend on individual hedge fund portfolios.
The main thing to remember about hedge fund risks is that the person delegated to control the fund, and to make investment decisions, should be a highly specialized and experienced money manager. Hedge fund management is not for amateurs. Hedge fund money managers must weigh their experience, knowledge, and study of the market against the goals of the investor, and must make sometimes difficult decisions. While hedge funds were initially developed as a method of reducing risk while seeking large profits, modern day hedge funds are often engaging in volatile markets. The higher the risk is, sometimes, the higher the gain is.
If the portfolio manager does end up taking “risks” by investing in a volatile market, things can be unpredictable and unsteady. This is where investors have to trust in the wisdom of their money manager. Recall that it is in the money manager’s best interests to make sound financial decisions so that they will make as much money as possible, along with the investor. Irresponsible or unskilled money managers will not have longevity in their profession, and will not be able to hold onto clients.
However, even the most responsible and thoughtful money manager with a great track record cannot predict every twist and turn of the market. What was considered a smart investment decision may ultimately fail to make profits. No one can predict the exact outcome of an investment, unfortunately, and there will be errors. If an investment does take a loss, the majority of investment partnerships will hold the money manager liable; many will not receive their performance fee, and there are often other safeguards put in place to make sure that the investor remains happy. Losing a great deal of money is always a possibility, when it comes to the world of investments, but a responsible investor who has done their research on their money manager will be prepared to weather the twists and turns of a tricky market.
Hedge funds are also generally designed to be long-term, and so an investor who sees little to no profit one year may see a substantial increase the next. The key is to remain in contact with your money manager, and yes, sometimes – if you feel they have acted irresponsibly – to perhaps take your business elsewhere. Do not make the mistake of thinking that hedge funds are “easy” money; hedge funds have been known to make people a lot of money very quickly, but that is not the case for everyone.