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Hedge Funds

Hedge funds are aiming for positve absolute return at all times and use sophisticated derivatives to try to achieve it. Can something that sounds so risky be a safe haven?

hedge funds

A hedge fund is a portfolio of investments that are pooled and professionally managed. Historically they were mostly set up as private entities with a limited number of high-worth investors who had commit to leave a large amount of money in for set time. Now, however, they are widely available to the general public and can be found in managed funds and make up part of a low to medium risk portfolio.

'Hedging' and Reducing Risk

The term ‘hedging’ is the practice of attempting to reduce risk. It is a strategy employed in the futures, options and warrants markets to reduce risk by making a transaction in one market to protect against a loss in another. Traditionally a commodity producer (say, a cocoa grower) would agree to sell his goods at a stated price at a stated time in the future, and the user of the commodity (say, a chocolate manufacturer) would agree to buy them. By agreeing on a price, quantity and delivery date, they introduce certainty into their operations and reduce risk. For the producer, the risk would be that prices drop, and for the processor that they would rise.

In the financial markets, options and warrants can be used to hedge a portfolio position. In the case where shares have been sold, for example, the purchase of equivalent call options (the option to buy shares) means that if the shares rise in price, a corresponding rise in the value of the option will offset the notional loss expected on the underlying shares.

Not All Hedge Funds are the Same.

Hedge funds are not all the same. They can have vastly different strategies and risk profiles so it is important to fully understand them before investing. They are also known for having relatively high costs, although these are coming down as more funds become more widely available. Hedge funds are also known as ‘absolute return’ funds because their fundamental aim is to always stay ‘above water’. Regardless of market conditions, the fund manager is targeted on their absolute gains and losses as opposed to their gains and losses relative to other fund managers. For example, if you invested £100,000 in a hedge fund,  you would hope that your money would never go below the amount you initially invested. However, there are NO guarantees, but on balance you should see less movement in a hedge fund than in, say, a standard stocks and shares tracker.

We strongly recommend that you take advice before investing in a hedge fund. If you would like to speak to an LGBT-friendly adviser about this or any other matter, please enter your postcode under the map on your right, to find an adviser near you.

Additional Reading

  • Stocks & Shares

    Stocks and Shares can form a valuable part of your financial portfolio, we recommend you take advice before investing. Read our guide to find out more.
  • Risk Tolerance

    Knowing your risk tolerance is essential for financial planning. Read our guide to find out more.
  • Exchange Traded Funds

    So what are ETFs? These are funds that track an index, but can be traded like stocks. But beware - make sure you understand the risks.
  • Risk Tolerance

    What is financial risk tolerance? In short your capacity to accept or absorb the risk that you undertake with an investment - get sound advice from us first!
  • Market Update 18 January 2013 - what would Churchill say?

    Why are share prices so healthy? Have we really turned a corner?

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