It is highly recommended that an investor gets a clarified answer to all the questions about the deal terms, fund manager, and investment strategy. Below are some of the questions and their answers that you should know before investing in a hedge fund.

Do you understand the risks?

It is essential to understand that the returns are not guaranteed, just as with any other investment. It is considered that an investor who is willing to invest in hedge funds, is most likely aware of the risk involved. This all corresponds to how much an investor is willing to risk potentially reap outsized gains or to investor’s risk or return profile.

What is the fee structure?

Hedge funds can range from simple to complex. The standard fee structure of hedge funds is 2/20 model. In this model, the asset management fee is 2%, and the performance fee or carried interest is 20% of the investment profits. Fund structure can get more complicated. Investors should consider if there is a hurdle rate.

How are the assets valued?

Hedge funds may probably hold assets that are illiquid. As a result, as the underlying assets do not have a widely available daily opening and closing price, it may be difficult to value them, unlike stocks and bonds. In funds that participate in illiquid assets, it is critical to understand that there is some grey area in valuation.

Have you researched the firm and its management?

Investors are expected to do extensive research on the firm as well as the fund manager. You need to be assured that there are no SEC violations or pending infrastructures. FINRA’s brokercheck is one of the good resources for a quick search on the manager. Understanding the firm and the fund manager’s track record is important. Is the fund manager an emerging manager with a little track record or wether he is an established industry veteran, it is necessary to know what he is. There are pros and cons to both the situations. However, emerging managers have a lot to prove and also can be nimble by having to answer fewer stakeholders involved, and they probably will adjust their expectations accordingly.

Do you understand the strategic thesis of the funds?

Behind a systematic hedge fund opportunity, investors may not know the algorithms. However, the investors should have an understanding in regards to how these funds behave. Leave the quant trading to computers and the fund management to professionals. As an investor, your job is only to be well informed and aware of the trading characteristics and the tendencies that are inherently behind different hedge fund strategies.