sky blue john
Well-Known Member
Seen as though we are trying to understand our owners motives I saw this that might help unravel the mess !!!
How hedge funds work
By Mickey Clark and Michael Clarke
UPDATED: 17:08, 27 March 2007
THE influence of hedge funds over the City has grown as quickly as investors' money has flowed into the funds over the past 15 years.
These funds now reportedly manage over £750bn of clients' money and their highly-paid managers can achieve remarkable returns.
Retail investors have so far been barred from investing in the funds, but that could change next year. But what are these funds and what makes them so different to normal collective investments? Read our report to find out.
What is a hedge fund?
Hedge funds are collective investments that aim to make money whether the market is moving up, down or sideways. Unlike unit trusts, Oeics or investment trusts, which tend to only grow when shares rise, hedge funds can make money when share prices are falling.
They do this using a range of complicated specialist techniques. The most commonly used is by going long or short on a share. Most private investors simply go long on a share, buying it in the hope that the price will rise.
Where an investor goes short, they believe that the equity will fall in value. There are two main ways that hedge funds can do this. The first is by 'shorting' the stock, where the investor 'borrows' a stock to sell it, with the hope that it will decrease in value so they can buy it back at a lower price and keep the difference.
For example, if an investor borrows 500 shares of X company at £10 each, they would then sell those shares for £5,000. If the price then falls to £8 per share, the investor would buy the shares back for £4,000, return them to the original owner and make a profit of £1,000.
Another way of taking advantage of falling share prices is by dealing in 'contracts for difference'. This allows the investor to make money on share price movements without actually buying the shares. A CFD on a company's shares will specify the price of the shares when the contract was started. The contract is an agreement to pay out cash on the difference between the starting share price and when the contract is closed.
However, hedge funds are not only restricted to equities. They will invest in anything that will make them a profit, including foreign currency, bonds or commodities. The return achieved by the fund is likely to be dependent on the skill of the manager rather than underlying economic conditions and that is why they are so well paid.
Can I invest in a hedge fund?
At the moment, hedge funds are only available to high wealth individuals who are prepared to invest around £500,000 or to professional investors, such as pension funds or insurance companies. Individual retail investors cannot buy directly into hedge funds as the City watchdog, the Financial Services Authority, is concerned about how the funds are operated and their risk. Plus, it is unclear whether the hedge fund operators would welcome dealing with a large number of small investors due to the costs involved.
However, the FSA will launch a consultation next year on whether it should increase the scope of funds it authorises to include funds of hedge funds. Retail investors still wouldn't be able to invest directly, but would be able to invest in an authorised collective investment scheme that would put money into hedge funds.
Currently, if investors want exposure to hedge funds they can purchase shares in the companies that operate funds, such as Man Group. It is also possible to buy into foreign funds over the internet, although investors cannot expect the same financial protection that they would receive in the UK.
By Mickey Clark and Michael Clarke
UPDATED: 17:08, 27 March 2007
THE influence of hedge funds over the City has grown as quickly as investors' money has flowed into the funds over the past 15 years.
These funds now reportedly manage over £750bn of clients' money and their highly-paid managers can achieve remarkable returns.
Retail investors have so far been barred from investing in the funds, but that could change next year. But what are these funds and what makes them so different to normal collective investments? Read our report to find out.
What is a hedge fund?
Hedge funds are collective investments that aim to make money whether the market is moving up, down or sideways. Unlike unit trusts, Oeics or investment trusts, which tend to only grow when shares rise, hedge funds can make money when share prices are falling.
They do this using a range of complicated specialist techniques. The most commonly used is by going long or short on a share. Most private investors simply go long on a share, buying it in the hope that the price will rise.
Where an investor goes short, they believe that the equity will fall in value. There are two main ways that hedge funds can do this. The first is by 'shorting' the stock, where the investor 'borrows' a stock to sell it, with the hope that it will decrease in value so they can buy it back at a lower price and keep the difference.
For example, if an investor borrows 500 shares of X company at £10 each, they would then sell those shares for £5,000. If the price then falls to £8 per share, the investor would buy the shares back for £4,000, return them to the original owner and make a profit of £1,000.
Another way of taking advantage of falling share prices is by dealing in 'contracts for difference'. This allows the investor to make money on share price movements without actually buying the shares. A CFD on a company's shares will specify the price of the shares when the contract was started. The contract is an agreement to pay out cash on the difference between the starting share price and when the contract is closed.
However, hedge funds are not only restricted to equities. They will invest in anything that will make them a profit, including foreign currency, bonds or commodities. The return achieved by the fund is likely to be dependent on the skill of the manager rather than underlying economic conditions and that is why they are so well paid.
Can I invest in a hedge fund?
At the moment, hedge funds are only available to high wealth individuals who are prepared to invest around £500,000 or to professional investors, such as pension funds or insurance companies. Individual retail investors cannot buy directly into hedge funds as the City watchdog, the Financial Services Authority, is concerned about how the funds are operated and their risk. Plus, it is unclear whether the hedge fund operators would welcome dealing with a large number of small investors due to the costs involved.
However, the FSA will launch a consultation next year on whether it should increase the scope of funds it authorises to include funds of hedge funds. Retail investors still wouldn't be able to invest directly, but would be able to invest in an authorised collective investment scheme that would put money into hedge funds.
Currently, if investors want exposure to hedge funds they can purchase shares in the companies that operate funds, such as Man Group. It is also possible to buy into foreign funds over the internet, although investors cannot expect the same financial protection that they would receive in the UK.
How risky are they?
Obviously, the level of risk depends on the strategy adopted by the manager, but they are generally regarded as being higher risk than a normal collective investment. The reason for this is many funds are 'leveraged', which means that they borrow money to add to their fund rather than just using investors' capital.
Because many funds use derivatives, where they bet against the future value of the an asset, rather than purchasing an asset directly, the funds are effectively borrowing the money. The result is that gains and losses are magnified, with some making huge profits, but if things go wrong the fund can go bust.
Also, because the performance of the fund is so dependent on the skills of the manager, picking the wrong one can prove costly.
Are they regulated?
The majority of hedge funds are domiciled offshore for tax reasons, but the UK-based managers are fully regulated by the FSA. The FSA polices the market against illegal activity such as insider trading and market manipulation. In March, Europe's largest hedge fund manager GLG and its former star trader Philippe Jabre were each fined £750,000 by the FSA for alleged insider dealing offences.
However, the FSA does not regulate the funds themselves and, as a result, the organisations have developed a reputation for secrecy. For example, firms don't have to disclose their investment strategies other than to clients, or reveal how they have performed. Also, if a fund goes bust, investors don't have any recourse for compensation. And as mentioned before, hedge funds are not currently among the collective investments authorised by the FSA.
How big is the hedge fund market?
It is believed that there are around 8,000 hedge funds operating globally, managing over £700bn of investors cash. The majority of funds are located in the US, but London is a growing, and important, market for the hedge fund world. It is hard to measure their impact on the financial markets, but it is estimated that these firms are responsible for around half of the daily turnover of London Stock Market shares.
It is also thought that they wield considerable power over mergers and acquisitions due to their tendancy to buy heavily into takeover targets. For example, it was believed that hedge funds played a key role in deciding the fate of the London Stock Exchange when several suitors were bidding for the company earlier this year.
The term first originated in the 1940s after alternative investor Alfred Winslow Jones created a fund that sold short some stocks, while normally investing in others.
Obviously, the level of risk depends on the strategy adopted by the manager, but they are generally regarded as being higher risk than a normal collective investment. The reason for this is many funds are 'leveraged', which means that they borrow money to add to their fund rather than just using investors' capital.
Because many funds use derivatives, where they bet against the future value of the an asset, rather than purchasing an asset directly, the funds are effectively borrowing the money. The result is that gains and losses are magnified, with some making huge profits, but if things go wrong the fund can go bust.
Also, because the performance of the fund is so dependent on the skills of the manager, picking the wrong one can prove costly.
Are they regulated?
The majority of hedge funds are domiciled offshore for tax reasons, but the UK-based managers are fully regulated by the FSA. The FSA polices the market against illegal activity such as insider trading and market manipulation. In March, Europe's largest hedge fund manager GLG and its former star trader Philippe Jabre were each fined £750,000 by the FSA for alleged insider dealing offences.
However, the FSA does not regulate the funds themselves and, as a result, the organisations have developed a reputation for secrecy. For example, firms don't have to disclose their investment strategies other than to clients, or reveal how they have performed. Also, if a fund goes bust, investors don't have any recourse for compensation. And as mentioned before, hedge funds are not currently among the collective investments authorised by the FSA.
How big is the hedge fund market?
It is believed that there are around 8,000 hedge funds operating globally, managing over £700bn of investors cash. The majority of funds are located in the US, but London is a growing, and important, market for the hedge fund world. It is hard to measure their impact on the financial markets, but it is estimated that these firms are responsible for around half of the daily turnover of London Stock Market shares.
It is also thought that they wield considerable power over mergers and acquisitions due to their tendancy to buy heavily into takeover targets. For example, it was believed that hedge funds played a key role in deciding the fate of the London Stock Exchange when several suitors were bidding for the company earlier this year.
The term first originated in the 1940s after alternative investor Alfred Winslow Jones created a fund that sold short some stocks, while normally investing in others.
