Personal Finance: The place for adventure capital

Hedge funds are high risk but can offer gains in markets that are falling as well as rising

WILL HEDGE funds be the next big thing in retail investment? Seen as high-risk, they offer the prospect of gains in markets which are rising, going sideways, or falling.

Investing in a hedge fund is not for the unwary. Alan Pace, director of international prime brokerage at Lehman Bros, the US investment bank, warns: "There is no exact definition of what counts as a hedge fund and investors should do careful research or take qualified advice before investing. Hedge fund managers can embrace different investment strategies. Also, some have been around for years, others have short track records."

This diversity can partly be explained by the way hedge funds first developed. They were based in offshore tax havens, usually constituted as private investment partnerships, in which managers had a lot of their own money.

Today, there is an estimated 3,500 hedge funds around the world, controlling up to pounds 245bn in assets, with most of this coming from the rich. But providers like Global Asset Management and Fraternity Fund Management have made hedge investments affordable by setting minimum investment levels of between pounds 10,000 and pounds 15,000.

A distinction between hedge funds and most equity investment is the basis on which they calculate returns. Most pooled equity funds are like unit trusts that measure performance relative to a bench mark like the FTSE All Share Index. By contrast, hedge fund managers look for an absolute return. As hedge funds are unregulated they can hold any assets the manager wants to buy, and can "sell short" as well as "buy long".

Nicola Meaden, of Tass, a City firm which researches hedge funds says: "A conventional equity unit trust will 'buy long', buying shares in the hope that they will go up in value. But they are not allowed to 'sell short', against a fall in value."

Selling short depends on a fund manager being able to "borrow" shares for a fee then re-selling them to a third party. Once the share price falls, the manager buys the shares back and returns them to the original lender.

This can be high risk, hence the reason why regulated fund managers are not allowed to do it. But it means that hedge funds can make money while a market is falling and rising.

There is no limit hedge funds can borrow against the assets they own. This explains why some of them have failed badly by managing to lose all of their investor's money.

The dominant styles of hedge fund management are event-driven, global macro, equity hedge and market-neutral. Event-driven funds are common in the US and are now being exported to Europe. They look for profit in so-called "merger arbitrage" and when a firm tries to takeover another they go short on the creditor's shares, while buying up their victim's. Takeovers cost money, but suggest that the victim's shares are undervalued.

They also may buy "distressed stock" - shares in bankrupt firms that still trade in the hope of making a recovery.

Global macro funds may be active in any asset class, Meaden says: "The Soros funds fall into this category, and typically funds like this will do a lot of research on their chosen asset class. Bets on interest rates and currency values are common."

Equity hedge funds are run by stock pickers - managers who research particular shares or sectors thinking they can beat the market.

Market-neutral funds hold two or more assets whose risk and return values offset each other. "These tend to be quantitative and often make money from identifying price anomalies or inefficiencies in a market," Meaden says.

Managers may try to "equalise" the risk of a market falling or rising, by selling short and buying long. Another small category is "short sellers" which carry portfolios heavily weighted to going short, or selling against an expected decline in the value of a share category or an index like the FTSE All Share.

Hedge funds are not presently authorised in the UK by the Financial Services Authority, the City's top regulator. They are not permitted to advertise or sell direct to the public. Buyers must find a stockbroker or independent financial adviser who will deal in them, but not all of them do.

Christopher Cottrell, Managing Director of mutual funds at GAM, says this is a pity as "we take the view hedging is about reducing not amplifying risk. We run developed hedge funds as part of a portfolio management service for private clients. if these funds were properly regulated it would help to get rid of cowboys."

The most accessible hedge funds for those with limited means are "fund of funds", like GAM's Diversity Fund. Started in 1989, it controls assets of more than $1.1bn and has grown by 14.95 per cent per year compound since its launch.

Arts and Entertainment
'A voice untroubled by time': Kate Bush
musicReview: A preamble, then a coup de théâtre - and suddenly the long wait felt worth it
Life and Style
Cooked up: reducing dietary animal fat might not be as healthy as government advice has led millions of people to believe
healthA look at how governments started advising incorrectly on diets
News
peopleJustin Bieber accuses papparrazzi of acting 'recklessly' after car crash
Life and Style
tech
PROMOTED VIDEO
Have you tried new the Independent Digital Edition apps?
Life and Style
ebooksA superb mix of recipes serving up the freshest of local produce in a delicious range of styles
Life and Style
ebooksFrom the lifespan of a slug to the distance to the Sun: answers to 500 questions from readers
News
people
Voices
voices
Sport
Roger Federer is greeted by Michael Jordan following his victory over Marinko Matosevic
tennisRoger Federer gets Michael Jordan's applause following tweener shot in win over Marinko Matosevic
Arts and Entertainment
Oppressive atmosphere: the cast of 'Tyrant'
tvIntroducing Tyrant, one of the most hotly anticipated dramas of the year
News
i100
News
Ukrainian Leonid Stadnik, 37, 2.59 meter (8,5 feet) tall, the world's tallest living man, waves as he poses for the media by the Chevrolet Tacuma car presented to him by President of Ukraine Viktor Yushchenko in Kiev on March 24, 2008.
newsPeasant farmer towered at almost 8'5'' - but shunned the limelight
News
Walter Matthau and Jack Lemmon in ‘The Front Page’, using an old tech typewriter
media
Life and Style
Could a robot sheepdog find itself working at Skipton Auction Mart?
techModel would allow robots to be programmed to control crowds and save people from burning buildings
News
i100
Arts and Entertainment
Suha Arraf’s film ‘Villa Touma’ (left) is set in Ramallah and all the actresses are Palestinian
film
Sport
Angel Di Maria poses with Louis van Gaal after signing for Manchester United
sportWinger arrives from Real Madrid and could make debut on Saturday
Arts and Entertainment
Kingston Road in Stockton is being filmed for the second series of Benefits Street
arts + entsFilming for Channel 4 has begun despite local complaints
Arts and Entertainment
Hooked on classical: cellist Rachael Lander began drinking to combat panic attacks
musicThe cellist Rachael Lander’s career was almost destroyed by alcohol she drank to fight stage fright. Now she’s playing with Elbow...
Independent
Travel Shop
the manor
Up to 70% off luxury travel
on city breaks Find out more
santorini
Up to 70% off luxury travel
on chic beach resorts Find out more
sardina foodie
Up to 70% off luxury travel
on country retreats Find out more
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs General

    Organisational Change/ Transition Project Manager

    £500 - £550 Per Day: Clearwater People Solutions Ltd: Our client are currently...

    Head of IT (Not-for-Profit sector) - East Sussex

    £45000 - £50000 per annum + 5 weeks holiday & benefits: Ashdown Group: Head of...

    Accountacy Tutor

    £100 - £120 per day: Randstad Education Bristol: Randstad Education is looking...

    Generalist HR Administrator, Tunbridge Wells, Kent - £28,000.

    £25000 - £28000 per annum: Ashdown Group: Generalist HR Administrator - Tunbri...

    Day In a Page

    Kate Bush, Hammersmith Apollo music review: A preamble, then a coup de théâtre - and suddenly the long wait felt worth it

    Kate Bush shows a voice untroubled by time

    A preamble, then a coup de théâtre - and suddenly the long wait felt worth it
    Robot sheepdog technology could be used to save people from burning buildings

    The science of herding is cracked

    Mathematical model would allow robots to be programmed to control crowds and save people from burning buildings
    Tyrant: Is the world ready for a Middle Eastern 'Dallas'?

    This tyrant doesn’t rule

    It’s billed as a Middle Eastern ‘Dallas’, so why does Fox’s new drama have a white British star?
    Rachael Lander interview: From strung out to playing strings

    From strung out to playing strings

    Award-winning cellist Rachael Lander’s career was almost destroyed by the alcohol she drank to fight stage fright. Now she’s playing with Elbow and Ellie Goulding
    The science of saturated fat: A big fat surprise about nutrition?

    A big fat surprise about nutrition?

    The science linking saturated fats to heart disease and other health issues has never been sound. Nina Teicholz looks at how governments started advising incorrectly on diets
    Emmys 2014 review: Can they genuinely compete with the Oscars

    Can they genuinely compete with the Oscars?

    The recent Emmy Awards are certainly glamorous, but they can't beat their movie cousins
    On the road to nowhere: A Routemaster trip to remember

    On the road to nowhere

    A Routemaster trip to remember
    Hotel India: Mumbai's Taj Mahal Palace leaves its darker days behind

    Hotel India

    Mumbai's Taj Mahal Palace leaves its darker days behind
    10 best pencil cases

    Back to school: 10 best pencil cases

    Whether it’s their first day at school, uni or a new project, treat the student in your life to some smart stationery
    Arsenal vs Besiktas Champions League qualifier: Gunners know battle with Turks is a season-defining fixture

    Arsenal know battle with Besiktas is a season-defining fixture

    Arsene Wenger admits his below-strength side will have to improve on last week’s show to pass tough test
    Pete Jenson: Athletic Bilbao’s locals-only transfer policy shows success does not need to be bought

    Pete Jenson: A Different League

    Athletic Bilbao’s locals-only transfer policy shows success does not need to be bought
    This guitar riff has been voted greatest of all time

    The Greatest Guitar Riff of all time

    Whole Lotta Votes from Radio 2 listeners
    Britain’s superstar ballerina

    Britain’s superstar ballerina

    Alicia Markova danced... every night of the week and twice on Saturdays
    Berlin's Furrie invasion

    Berlin's Furrie invasion

    2000 fans attended Eurofeurence
    ‘It was a tidal wave of terror’

    ‘It was a tidal wave of terror’

    Driven to the edge by postpartum psychosis