Hedge funds have been attracting inflows from yield-hungry investors eager for seemingly guaranteed superior returns. But there are a few things that investors should know before giving hedge funds a try, said Niall Gannon, director of wealth management at Gannon Group at Morgan Stanley Smith Barney.
“Investors shouldn’t rely on trust,” Gannon told CNBC.
“They should understand the raw drivers of performance and how that arithmetic relates to them.”
Higher federal and state taxes, Medicare investment surtaxes and hedge fund fees rob investors of the majority of a fund’s return, said Gannon.
“If you look at a hedge fund’s fee and taxation structure, even if the hedge fund can return 16 percent on a gross basis, the investor will lose 5 percent on fees and another 5.5 on taxes,” he said. “That is a bad risk-reward scenario in our opinion.”
Instead, investors should consider low-turnover, low-fee equity strategies combined with municipal bonds in order to obtain better results, advised Gannon.
“If the manager’s focused on net returns and control turnover and taxes, the investor will pay less fees and taxes, they’ll have transparency,” he said. “That’s the litmus test they should demand.”
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No immediate information was available for Gannon or his firm.