In the last several years, private foundations have shown a demonstrated interest in alternative investments, especially hedge funds. Hedge funds, which are designed to “hedge” or mitigate the extreme ups and downs associated with frequent buying and selling, can be a beneficial addition to a foundation’s portfolio, but they come with some very important considerations.

When a foundation adds hedge fund investments to its portfolio, a range of issues are presented for consideration and management:

  • Prohibitions on the foundation’s financial transactions with insiders;
  • Limitations on the extent of the foundation’s permissible ownership interests in business enterprises;
  • The exercise of fiduciary obligations of business care and prudence;
  • Issues of liquidity ;and
  • Income tax considerations at funding and during foundation holding of hedge fund investments.

The rules governing these matters often are counterintuitive and may result in adverse consequences to the unwary foundation and its managers. This article outlines the key points to bear in mind when a foundation’s portfolio includes investments in hedge funds, especially those that are managed by foundation insiders.

Hedge funds can be a beneficial addition to a foundation's portfolio, but they come with some very important considerations.

While this article should help you identify potential trouble spots and provides general legal information about hedge fund investing, it is not a substitute for consultation with an attorney who is knowledgeable about the ever-changing laws that apply to private foundations and the operations of your particular organization.