While hedge funds aren’t quite as prominent nowadays as they were in the past few decades, they can still deliver truly impressive results when managed well. In 2022, hedge fund returns declined by 2.4 percent on average due to factors ranging from high interest rates and inflation to the war in Ukraine. Even so, the four leading hedge fund strategies actually overperformed in the same period. The most successful of these, multi-strategy funds, recorded returns of 9.5 percent.
Hedge funds are no strangers to risk, but that shouldn’t extend to how you run one of these funds. Fortunately, investing in the right types of insurance can seriously mitigate the daily dangers your firm faces. Read on for our complete guide to the hedge fund insurance policies you need and how much you can expect to pay for them.
On the most basic level, a hedge fund is a pool of monies from multiple private investors. These people entrust control over their investments to professional fund managers using various strategies to get the most out of their clients’ money.
Hedge funds have the same overall goal as just about any other investment strategy: that is, maximizing ROI for everyone involved. The key difference between hedge funds and other investments is the methods hedge fund managers use to pursue these goals. In contrast to the more conservative investment management tactics used in mutual funds, hedge fund managers often use strategies like trading non-traditional assets and leveraging.
The incentives of investing in hedge funds are obvious—these funds can earn above-average returns when managed with care. But hedge funds are typically considered a high-risk, high-reward approach to financial planning when compared to other investment strategies. Furthermore, they often require a high net worth/minimum investment for participation. Because of this, hedge funds are typically targeted towards wealthy investors.
Some of the most prominent risks hedge funds face both on and off the market include:
While a handful of risks are closely associated with hedge funds, one stands above the rest: the chance that participants could lose a portion (or the entirety) of their investments. Fund managers have a high level of freedom when it comes to managing their clients’ investments, and hedge funds are not as heavily regulated as other types of funds. Taking all this into account, even allegedly “safe” hedge funds can be much riskier than you may expect.
Since hedge funds are less heavily regulated and held to different reporting standards than mutual funds, they come with an inherently higher risk of fraud. Compared to other investment professionals, hedge fund managers have more leeway to make their own decisions, including decisions that could be considered unethical.
In today’s financial news, it’s all too common to hear about hedge fund managers who have scammed their investors to make their funds look more successful than they are—or to finance their own lifestyles. To mitigate this risk, you’ll need to do your due diligence when searching for a manager for your fund (and have the right insurance policies in place).
Hedge fund managers don’t have to be blatantly immoral to make less-than-ideal decisions for the funds they’re in charge of. Problems related to a hedge fund’s procedures, policies, activities, and employees all fall into the category of “operational issues.”
Along with hedge fund-specific operational issues like mismanagement, it’s wise to be aware of the more general risks your firm faces. At the end of the day, hedge funds are simply another type of business. That means they’re just as susceptible to threats like cyberattacks, the deaths of key employees, and worker injuries as any other company.
Since hedge funds are nearly synonymous with risk, it only makes sense that these funds would need broad insurance coverage. Taking that into account, your hedge fund should seriously consider these insurance policies:
The executives at your hedge fund make countless high-stakes decisions in their line of work. If any one of these decisions goes wrong, your investors won’t be happy—and they might start considering legal action. But lawsuits are costly, and those costs are only going up.
That’s where directors and officers, or “D&O,” insurance comes in. This insurance can cover the defense costs your board members and managers will incur while defending against allegations of wrongdoing from shareholders or third parties. Additionally, it can help you pay for settlements, damages, and awards. Even if your partnership never gets sued, having D&O insurance is essential—without it, you’ll have a difficult time convincing top-shelf candidates to come on board.
Even small hedge funds include millions of dollars in funding, so it pays to be careful. Litigation from disgruntled clients is one potential headache hedge funds face, but the everyday risks of managing a hedge fund are also worth taking seriously. For these issues, you’ll need insurance coverage for your firm as a whole in the form of asset management protection insurance.
Like D&O insurance, an asset management protection policy can help in the event of legal matters. On top of that, these policies can help you deal with issues like dishonest employees and liabilities related to your employment practices.
“E&O” insurance may sound similar to “D&O” insurance, and these are both forms of professional liability insurance. But while these two types of insurance have superficial similarities, they are entirely different policies—and it’s in your firm’s best interest to have both.
The key difference between errors and omissions insurance and directors and officers insurance is whom these policies cover. As its name suggests, directors and officers insurance focuses on protecting high-level members of management. On the other hand, errors and omissions insurance covers the actual products and services your company provides. Since these policies don’t truly overlap, you’ll need both for full insurance coverage.
Like other companies, hedge funds should take life insurance seriously. Life insurance policies created with business needs in mind can include coverage for essential executives, help your succession plan work smoothly, and even provide access to cash value.
The digital nature of the modern economy all but ensures that hedge funds do much of their work on computers and smart devices. As a result, your hedge fund is likely susceptible to ransomware and other cybersecurity threats. Suppose your network goes down and your data is held ransom in one of these attacks. In that case, you’ll find it nearly impossible for your hedge fund to operate normally until the situation is resolved.
With cyber & data insurance, you’ll be covered for the direct and indirect costs associated with ransom events. Along with paying for actual ransom expenses, a comprehensive cyber insurance policy will help mitigate lost income and remediation costs incurred due to these situations. Plus, your cyber insurance could help you with notification costs—the expenses of letting people know their information could have been made publicly available.
Even white-collar workplaces, like the average hedge fund office, have their share of safety hazards. For example, say one of your employees gets injured at work. If that happens, you’ll need workers’ compensation insurance to help you pay for their medical expenses and lost wages.
If your hedge fund is US-based, you won’t truly have a choice when it comes to getting this form of coverage. As of 2023, 49 out of 50 states forced employers to offer workers’ comp for their employees.
Even if they aren’t charged with managing multimillion-dollar hedge funds, every business faces a certain amount of risk. To provide indemnity if your firm is faced with claims of injury or negligence, you need commercial general liability insurance. While these insurance policies are not technically mandated by law, a general liability insurance policy is usually a requirement to get a business license from your local government and to open an office.
Commercial general liability insurance isn’t the only form of liability insurance your hedge fund should have in place. An equally important policy is employment practices liability insurance, which protects you from damages and defense expenses from claims related to employment. These allegations can include (but are not limited to) discrimination, wrongful termination, workplace harassment, and retaliation.
Ransomware attacks and high-level misconduct are certainly threats hedge funds face, but not every hazard your firm might deal with is this dramatic. Other potential sources of loss include dishonest workers, lost or destroyed property, and credit card theft. Crime and fidelity insurance is another necessary step toward protecting your fund from these threats.
Finally, you’ll want to make sure you know how much you’re paying for the types of insurance listed above. The average monthly premiums for these policies are as follows:
There’s no denying that hedge funds still have a place in today’s economy. Despite the risks involved, a well-run hedge fund can deliver results for investors and executives alike. Of course, it’s impossible to eliminate the risks a hedge fund faces, both in terms of investment-specific threats and the mundane risks any business faces.
The good news is that buying the right insurance policies can make life far easier for you and your fellow execs. With D&O, E&O, asset management protection, and a few other insurance policies, you can focus on what really matters—successfully managing your fund.
Learn more about Hedge Fund Insurance today and speak with your dedicated risk advisor at Fullsteam.
