The ability to hedge against downturns may sound attractive to many investors, but hedge funds are not for everyone. In fact, hedge funds are for the few. The price of admittance is high. Generally, investors must be "accredited." That typically means a net worth of $1 million and annual income of over $200,000. Investment minimums typically run $500,000 to $1 million or more though some smaller, newer funds have investment minimums below $100,000.

Hedge funds are private investment limited partnerships that generally have 99 or fewer investors so they don't fall under the regulations of the Securities and Exchange Commission. (Some funds can take up to 500 investors, but the investors must have $5 million to invest.) The manager of the fund usually has a big stake in the fund and typically earns 20 percent of any profits, plus a one to two percent management fee. Beyond that, few hedge funds look alike. Much more than mutual funds, hedge funds reflect their managers, many of whom have been stars in the mutual fund industry.

If you think a hedge fund might be for you, be aware that not all hedge funds today "hedge" the market. Yes, there are classic hedge funds that simutaneously go short and long against the market. They may invest on margin or use levered bonds, put options, financial futures and other derivatives to hedge against market declines.

However, a new breed of aggressive hedge funds have emerged that place big bets on strategies intended to rack up large returns regardless of market conditions, for example, a risk-arbitrage hedge fund focuses on mergers and distressed companies. Other hedge funds bet on global currency or commodities or stocks and bonds. These funds can provide portfolio diversification since they aren't tied into the market.

Because these type of hedge funds don't hedge, their rewards can be huge, but so can the loses. One of the best-known hedge funds-actually a family of funds- is run by George Soros. His funds trade privately in Europe and are hot open to U.S. citizens or residents. During the huge market drop in late October, the Soros funds lost $2 billion. Another hedge fund lost all of its investors' money in the drop.  

A less risky and often less expensive alternative is to buy a hedge fund that invests in other hedge funds. Some specialize, while others buy a variety of different styles to provide diversification. Entrance fees are usually lower for these funds of funds-around $100,000 to $250,000. However, keep in mind that these funds add another layer of fees.

Liquidity is another issue investors should keep in mind. Investments are often "locked up" for at least a year, and you may have limited windows of opportunity for making redemptions.

Taxes are another important issue. Because the funds are limited partnerships, you are taxed pro rata on all net income regardless of whether you withdraw that income. Also, much of the return in the funds is short term, so you pay at your ordinary income tax rates instead of at capital gains rates. For investors in this type of fund, that typically means 39.6 percent, plus state and local taxes.

There are over 3,000 hedge funds today. Many of the newer ones are small and run out of the manager's home. By law, these funds can't advertise or market themselves, so they can be tough to find. Your financial advisor, if not directly familiar with hedge funds, should be able to put you in touch with hedge-fund consultants. Or you may find funds through word of mouth from hedge-fund investors you know.

January - 30- 1998