Hedge Funds, Private Equity Funds, ETFs and Mutual Funds in a Self Directed IRA

Hedge Funds, Private Equity Funds, ETFs and Mutual Funds in a Self Directed IRA

So you want to invest your IRA in a fund.  Many websites devoted to self directed IRAs talk about “alternatives.” It’s a broad term. In the mutual fund context, it has a very specific meaning. It refers to mutual funds that seek to mimic the sophisticated trading strategies of hedge funds, without many of the hedge fund features, like heavy fees, big investor minimum investments and with a lot less leverage. In the self directed IRA world, “alternatives” refers to non-traditional IRA investments like real estate, private investments, mortgages, tax liens, notes, and commodities. Forget what you know about self directed IRA for a minute. Consider some of the main features of “funds” you most often read about: ETFs, mutual funds, “alternative” mutual funds, hedge funds and private equity funds.

Hedge Funds and Private Equity Funds

Eligibility

Hedge funds and private equity funds are technically private offerings. As such, many clients are ineligible to invest in these, since SEC rules require that investors be accredited (typically $1 million of net worth not including your primary residence) or are otherwise “qualified” with at least $1.5 million of net worth. Further, some hedge funds only accept so called qualified purchasers, entities with $5 million or more in investments. Thus, if you’re reading about a prominent hedge fund manager and you want to invest, you are very likely out of luck.

Minimum Investment / Liquidity

Hedge funds and private equity funds often have initial lock-ups and it can be hard to redeem your holdings into cash (often once a year or quarterly depending on the fund). In addition, hedge funds and private equity funds often require high investment minimums, some starting out at $100 thousdand and up to $1 million. Having so much money locked (tied) up, with restrictions on how and when it can bet turned into cash, is often too cumbersome and represents too much of an individual’s  net worth.

Alternative Mutual Funds

Given the inability for most individuals to invest in hedge funds, many firms have launched a fairly recent innovation, “alternative” mutual funds. These funds mimic many of the strategies hedge funds trade, but with substantially lower (or no) wealth requirements. They often have large investment minimums, and thus are accessible via brokerage firms and investment advisors. Given “alternative” mutual funds tendency to trade frequently, they often incur much higher tax liabilities (like capital gains distributions). This issue of course does not effect IRA investors. In terms of fees, mutual funds do not charge performance fees, while hedge funds and private equity funds do. Most alternative investments charge some sort of management fee. A mutual fund expense ratio calculation includes management fees as well as other operational expenses. Expense ratios for alternative mutual funds tend to be higher than for traditional mutual funds, typically 1.5% or more.

Fees

The table below summarizes some of the relevant attributes of private equity funds, hedge funds and “alternative” mutual funds:

Funds table

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