Hedge funds promise very high returns, which makes them sound like a great option for retirement savings. After all, a long investment horizon and high returns equals a lot of golf money--and in a Roth IRA it's tax free. The good news is that the IRS does not expressly prohibit hedge funds in IRAs. The bad news is that high net worth requirements and large minimum investments may keep hedge funds out of reach for the average Roth IRA owner.
Hedge Funds Defined
Hedge funds are private investment funds that operate like mutual funds by pooling investors' money to provide greater buying power and diversification. That is where the resemblance ends, however. Hedge funds traditionally use aggressive investment tactics to beat the market. Managers make long term investments in stocks they feel will do well and bet against stocks they believes will perform poorly through the use of put options and short sales. In this way, fund managers "hedge their bets" and attempt to make money regardless of market conditions.
Net Worth Barriers
U.S. law requires that registered hedge fund managers make certain that investors meet one of two net worth classifications: the private investor class of $1.5 million in net worth or the qualified purchaser class, which must have at least $5 million net worth above and beyond the value of their home or any business property. Unregistered funds may go as low as $1 million in net worth. While it is not impossible for someone with a high net worth to have a Roth IRA, the Roth IRA income limits make it unlikely.
Minimum Investment Barriers
If you were insightful enough to contribute to a Roth IRA before amassing your fortune, or if you took advantage of the 2010 conversion limit suspension, you may still run into trouble. Most hedge funds require minimum investments of at least $500,000. Mutual funds made up of hedge funds do lower the minimum, but the total is still typically $25,000 or more. This is certainly possible with a Roth IRA, but may not allow for the diversification in investments you would like.
Other Considerations
Hedge funds are typically set up as limited liability corporations and may require a self-directed IRA or other specialized IRA agreement, depending on your IRA custodian. Hedge funds may also generate unrelated business taxable income, or UBTI, which is taxable regardless of whether or not you hold the fund in a Roth IRA. It is important to remember that hedge funds are not regulated by the U.S. Securities and Exchange Commission, leaving investors with fewer options in cases of fraud or fund company bankruptcy.
