There is always a risk that a hedge fund or a fund of hedge funds won't provide the return it seeks. And some hedge funds are, by definition, riskier than others because of the investments they make or the strategies they use.
Among the other potential problems that an investor must consider are lack of
liquidity
because of the restrictions on selling or transferring ownership and the lack of
secondary markets,
the possibility that figuring income or capital gains tax on certain transactions may be extremely complex, and the lack of information about the private investments the fund might make.
The fund is the manager
More than with most other fund investments, a hedge fund is a reflection of the investment style and strategies of the fund manager. Investors are relying on the manager's investment selection ability and financial acumen more than they would on a mutual fund manager's.
If that manager leaves or changes style, the hedge fund may no longer be aligned with its stated investment objectives. And investors may not be able to get out of the hedge fund, even if they want to, if it's still in the lock-up period.
Exit strategies may be irrelevant if the hedge fund closes its doors. In the hedge fund industry there is a reasonable risk that a fund will not be around in a few years. Some estimates put the average life of a hedge fund at around 3.5 years and other estimates are that more than 10% of hedge funds close each year. Investors in funds that are closing shop are likely to get only a portion of their initial investment back.
