1.10 Hedge Funds, LPs & Structured Products
This chapter covers the private and customized investments that sit outside ordinary stocks, bonds and mutual funds: limited partnerships, hedge funds, and structured products including ETNs. Each one gives up liquidity or regulatory protection in return for something else, such as tax deductions, flexible strategies or principal protection. On the exam and with clients, the skill is matching each product to the investor who can bear its risks.
What each topic covers
DPPs & Limited Partnerships explains that a direct participation program passes income, gains and losses through to its owners, and that the loss pass-through is its defining feature because it can produce a tax deduction. A limited partnership has general partners, who run the business with unlimited liability, and limited partners, who fund it and can lose only what they invest. The lesson also covers the certificate and agreement of limited partnership, the subscription agreement used to judge suitability, Regulation D private placements versus registered public offerings, the liquidation order (secured creditors, unsecured creditors, limited partners, then general partners), and how a real estate limited partnership differs from a REIT.
Hedge Fund Eligibility & Fees shows how hedge funds pool money like mutual funds but face far less regulation, so they can use heavy leverage, short selling and speculative assets. Most require a $1 million minimum and accredited investors under Regulation D, while a fund of hedge funds often starts around $25,000 and does not require accreditation, though it adds a second layer of fees. The common “2 and 20” structure charges 2% of assets under management plus 20% of the gains. The lesson also explains SPACs, or blank check companies, which have no defined business at the offering and usually must acquire or merge within two years or less, and blind pools, which are typically more open about the industries they target.
Structured Products & ETNs defines a structured product as a customized investment that typically combines a debt component with a derivative component. The worked example splits a $200,000 investment into a $164,000 zero coupon bond that matures at $200,000 and a $36,000 Nasdaq-100 call, so the investor gets principal back after four years plus any option gains. These products carry credit risk because the issuer can default, and most carry significant liquidity risk because no public secondary market exists. Exchange traded notes are the exception: they trade on exchanges and generally have little or no marketability problem.
Alternative Risk & Investor Profile ties each product to the investor it fits. A sophisticated investor can withstand large losses, typically because of high net worth. Limited partnerships suit wealthier investors who tolerate illiquidity and can use the deductions, but should not be bought only for tax benefits. Hedge funds, with lock-up periods such as one full year, suit aggressive investors, and structured products suit sophisticated or institutional ones. The lesson also covers venture capital funds, whose advisors are exempt reporting advisors that file financials regardless of AUM, and commodity pools, which a commodity pool operator manages, the CFTC regulates, and NFA rules apply to.