Now that hedge funds are getting crowded with institutions and smaller investors, the ultra-wealthy are getting crowded out.Not only have funds emerged that have initial investments as low as $25,000, but two of those new funds successfully raised initial capital through public sales of stock in early 2006.

Although exact ownership percentages of the entire market are as opaque as the average black-box trading strategy, the early participation of family-office-type clients means that they still own most of the $1.2 trillion in hedge fund assets. Trying to keep ahead of the competition, the ultra-wealthy are turning to new strategies to keep the edge.

Those strategies include forming networks to seek out under-the-radar managers, garnering institutional pricing and getting skilled at finding the next hot strategies, according to a leading hedge fund information source, MarHedge. "It's a scary sign of the times that the little guy on the street is getting into hedge funds," said Glenn Frank, CPA/PFS, CFP, of Wachovia Wealth Management, in Waltham, Mass. "And the top quartile of performers is so popular they're not open even to affluent investors."

Another way that some advisors to the wealthy keep an edge on the hedge market is to create in-house funds. Not only are the firm-specific funds exclusive only to clients, but strategies can be tailored and costs can be slashed. Frank's firm started on that tack early, offering a commodity fund to clients for over 10 years.

Hedge funds can typically charge an annual fee of between 1 and 3.5 percent, and retain 20 percent of profits. "We don't view this as a separate profit center, and charge just

75 basis points and no carry charges," said Frank. "But this is not as uncommon as when we started, so we're asking whether we need to innovate, or whether we just do it better because we've done it longer."

New money managers, and old

Staying with the crème de la crème is an ongoing strategy for others. Firms that got into the top managers when they were still available are keeping their spaces. Multi-family-office firm Cymric uses hedge funds for larger accounts held by their nine families with $300 million.

"We've reached as much as we want to have in the two we are using," said Thomas J. Barrett, CPA/PFS, CFA, chief financial and chief investment officer of the Costa Mesa, Calif.-based firm.

Accessing new managers poses a challenge.

Many family offices have longstanding relationships with current managers, and aren't actively in the marketplace seeking new ones. That, combined with the fact of the top managers being closed to new investors, drives new money to seek new managers. "Usually our clients are too conservative for managers with shorter than five-year track records that show 15 percent to 20 percent returns," Barrett said.

The industry has changed to accommodate the new investors. Hedge funds have both gone upscale by hiring special marketing staffs to target institutions, and downscale by packaging funds in $25,000 amounts for smaller investors. The top-performing long/short mutual fund Diamond Hill even welcomes smaller amounts of $10,000. Investors who consider commodities to be equivalent alternatives can buy shares in the ever-increasing number of exchange-traded funds that track commodity indexes.

Barrett tracks these new issues as part of his job as CIO. "But if these things start to have a marketable feel to them, it takes away a lot of the advantage," he said. "That strips out the reason why the wealthy are in hedge funds anyway."

Staying diversified is still the hedge of first choice for many advisors to the very wealthy. In some cases, that means the use of alternatives to plain-vanilla stocks and bonds. "We're using commodities lately, but the money is coming out of TIPS, so it's still an inflation hedge," said Barrett. "Besides, clients were questioning why they were in bonds when the gain in the coupon was lost in the fluctuating principal value."

Get broad diversification, keep costs low, keep tax efficiency high, and that's the proper hedge. "Especially for clients on the low end of the family office size, hedging doesn't always mean using hedge funds," said Wachovia's Frank. "Our job is to get clients from point A to point B, but not necessarily provide an exciting ride or cocktail chatter."

In addition to newer managers, some family offices are spreading out into private equity and venture capital. With returns from each ticking back up after the tech bubble burst, the early 2006 returns of 22.8 percent and 19.8 percent, respectively, might begin to turn some heads.

CPAs in family offices are less likely to leave behind their skepticism to rush into the new twists. "Clients are more discerning these days, and do know about alternative investments," said Frank. "But they still don't want cachet - they want results."

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