Are hedge funds suitable for retail investors and should advisers be able to sell them when the average person in the street has enough trouble grasping the nuances of the various types of long-only investment funds out there?Then, of course, there is the risk issue, which the FSA has focused on largely. Many advisers will remem- ber the fallout from the collapse of the Long Term Capi- tal Management hedge fund in 1998, which resulted in billions of dollars being written off and cost the jobs of the UBS chairman and three other board members. But long-only funds are not without risk and advisers will recollect the Peter Young fiasco at Deutsche Morgan Grenfell in the mid-1990s. FSA wholesale markets and institutions managing director Hector Sants says: “In relation to retail investment funds, we want to open a wider debate on three important issues. First, how we bring greater coherence to the current regime for retail investment products. “Second, should we seek to encourage or discourage wider access to hedge fund investment techniques by onshore providers? Third, should we consider lifting marketing restrictions on offshore unregulated collective investment schemes?” Hedge funds have certainly come into the mainstream in terms of the breadth of providers offering them, with many major retail houses, including New Star, Old Mutual and Gartmore, running successful alternative investment teams. Old Mutual Asset Managers head of marketing Simon Wilson believes hedge funds should be made available to the retail market, stressing that they are often very low risk compared with traditional long-only equity and bond mandates. “Hedge funds have low correlation with the equity and bond markets and have the ability to make money in both rising and falling markets. They are often very low-risk products which not everyone realises,” he says. Hargreaves Lansdown senior research analyst Meera Patel says hedge funds are a difficult area for advisers because many investors have not heard of them and even those who have will typically have a misinformed opinion, such as that they are very high risk or that they will always deliver positive returns, whether markets are falling or rising. Add in some of the parlance surrounding the different strategies used, such as merger arbitrage, convertible arbitrage or quantitative market neutral strategies, and clients are likely to be bamboozled. Patel says: “It is tricky for us to sell hedge funds because most of the public do not know what they are. People might like the sound of them but do not understand the different strategies. It is hard enough for them to get to grips with the different long-only funds. There should be a place for them in anyone’s portfolio because they can provide good diversification but a lot of the public think they are too high risk.” Jupiter fund of funds director John Chatfeild-Roberts, who runs the Jupiter Merlin absolute return portfolio, a fund of hedge funds, says another factor dampening investor enthusiasm is the fact that hedge funds currently have to be offshore and unregulated, which alters their tax treatment. Capital gains are charged as income tax, putting off some investors. He says: “A lot of people come up with the tax issue as an objection and the FSA would have to work with the Revenue to level the playing field with long-only funds.” Curiously, several hundred thousand risk-averse investors are already exposed to hedge funds, probably without knowing it. Many big life funds hold hedge funds in their asset mix, including the mammoth 73bn Prudential life fund that has been 2 per cent invested in hedge funds for more than three years. There is clearly a perception problem with hedge funds and much coverage of the products does tend to treat them as an asset class in their own right, when they are just vehicles that invest predominantly in equities and bonds, much like unit trusts and Oeics. Collins Stewart chief invest- ment officer for fund of funds business Kevin Boscher says their acceptance is inevitable as investors look for superior returns than cash and traditional long-only portfolios. He says: “As far as intermediaries are concerned, they will eventually be forced down this route. People need not be afraid of hedge funds. They are a way of investing, not an asset class of their own. I think the sector is set to grow.” Whether or not this is a good thing for hedge funds is debatable. Forsyth Partners head of alternative investments Tracy Pearson says hedge funds hold $1tn of investors’ money but there is a capacity issue surrounding being able to get into the fund you want before it closes. She recommends funds of hedge funds as an ideal way to get initial exposure to hedge funds, letting the experts pick the right funds with the added benefit of diversification. Chatfeild-Roberts says many single-manager funds will not be interested in taking retail money, particularly if it comes in small increments of, say, 2,000 to 3,000. Patel notes that several attempts at marketing retail funds of hedge funds have failed. The Henderson absolute return portfolio, an investment trust of hedge funds run by John Husselbee, was wound up after it failed to appeal to investors. Deutsche’s Xavex portfolio suffered a similar fate. Omam is the latest to try, offering what is in effect a managed account of hedge funds with an 80 per cent capital guarantee and low minimum investment of 5,000. How it fares might provide a useful barometer of the current state of consumer sentiment on hedge funds. Product innovation takes time to gain credence. The first retail corporate bond fund was launched by M&G in April 1994 and today they are a mainstay of retail investors. Perhaps, in 10 years, we will look back and wonder what all the fuss was about hedge funds.