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Last Updated: Thursday, 27 May, 2004, 08:03 GMT 09:03 UK
Investors learn to hedge their bets
By Matthew Davies
BBC World Service business reporter

Stock market graph
Hedge funds can make money even when markets fall
Hedge funds conjure up the idea of enormously powerful financiers taking huge bets on the markets.

Traditionally backed by super-wealthy individuals, hedge funds are investment firms which specialise in complex, sometimes risky, but potentially lucrative trades of a kind that most regular investors steer well clear of.

Though not for the faint-hearted, they have become increasingly popular in the UK, attracting money even from some pension funds.

Hedge funds first came to prominence in 1992 when George Soros used the vast resources under his control to play the market.

The end result was that the British pound fell out of the European Exchange Rate Mechanism.

Six years later, when leading US hedge fund Long Term Capital Management collapsed, there were fears that fund managers were so influential, and so reckless, that they could destabilise the world economy.

Health warning

Sir John Banham, chairman of British leisure company Whitbread, says investors considering hedge funds need to be cautious.

George Soros
Financier George Soros put hedge funds on the map
"They believe wrongly that it's a risk-free bet. It isn't," he said.

"Forty per cent of hedge funds fail in any one year, and some of the biggest ones have had the biggest failures.

"Any pension fund trustee who recommends putting their pensioners' funds into a hedge fund, and who has not read the history of Long Term Capital Management, in my view, is guilty of professional negligence."

Unfair image

Anthony Brooke, a director at Fauchier Partners, a London-based specialist fund management firm which exclusively invests in hedge funds, believes such warnings are overstated.

Fewer hedge funds have had problems over the past five years than ordinary shares.
Anthony Brooke, Fauchier Partners
He feels that the cataclysmic image the hedge fund industry suffers from in some quarters is unfair.

"It's like thinking that the only sorts of shares are shares like Marconi or Enron, where things have gone disastrously wrong," he says.

"You're therefore painting all shares to have the same quality, and as we know that is absolutely not true.

"A very, very small number of them have had problems, but I think one could argue that fewer hedge funds have had problems over the past five years than ordinary shares.

In fashion

In recent years, hedge funds have started to proliferate.

The catalyst for their renewed popularity was a steep fall in the stock market four years ago.

Investors lost faith for a while in ordinary stock market investments and started to look for alternative strategies.

Hedge funds - which, thanks to their aggressive trading strategies can make money even when markets are falling - quickly caught their eye.

Now, a new generation of hedge fund managers have come up with exotic ways to look after other peoples' money.

They range from investments in fine art to complex financial strategies.

Some hedge funds specialise in commodities such as crops and metals. Others try to make money out of arbitrage - spotting that an investment can be worth more if it is bought in one market place and sold in another.

Almost all hedge funds are based in offshore centres, where regulation and supervision is light.

Walking the walk

But hedge fund managers argue that investors can take comfort from an important fact: If the fund loses money, so will the manager, because he or she almost always invests in his or her own fund.

"The first question that a lot of investors are asking is how much of your wealth is in your own funds?" says one fund manager.

"It's insurance for them that we are going to try and work the best, because our own money is involved."

Hedge funds are very much in vogue in the investment world.

Some might say dot.coms were the last big fashion, and they ended in tears.

Hedge funds, however, have as many fans as critics.

And it's increasingly likely that at least part of your pension pot, if you have one, will be invested in a hedge fund.

Rail pension buys into hedge fund
06 Apr 04 |  Business
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