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Hedging the bets

Hedge funds Helen Pow reports on the retailisation of funds of hedge funds.

But industry specialists say hedge funds are widely perceived by consumers and even advisers as extremely dangerous investments when in fact they are usually very low risk, designed to preserve capital. Regulation would potentially give advisers more business but until this misconception is put right, through thorough education, advisers are likely to shy away.

As it stands, it is technically possible to invest in a hedge fund or a single hedge fund but as they are unregulated, it tends to be difficult.

The minimum investments for funds can be £100,000 or more, so this is slightly off the radar of most investors.

Blackadders Financial Services director Keith Thomson says: “Retail investors can invest in hedge funds if they want to and have enough money to but, as limits of single hedge funds are £100,000 upwards, if they are diversifying, they must have a pretty huge portfolio.”

Companies are currently not allowed to market funds of hedge funds or single hedge funds in the UK and it is generally only very savvy investors who get wind of them and get involved.

But the FSA’s proposals to bring retail-oriented funds of hedge funds within its regulatory regime could give retail investors more access to the benefits that hedge funds can offer, while providing them with structural and operational safeguards.

FSA retail policy and asset management director Dan Waters says: “Asset management is a dynamic and innovative industry and we believe it is important that consumers can access the latest techniques to manage their own savings and investments.

“We think the time is right to permit access to a wider range of innovative strategies through authorised onshore vehicles. This will allow investors more choice and a better opportunity for risk diversification, while maintaining investor protection through our rules on the operation of the product.”

Schroders UK/Europe product development director Paul Truscott says: “It is a sensible move that proves the FSA is listening to what people are saying and are moving to change the rules.”

Hargreaves Lansdown head of research Mark Dampier says hedge funds are a very useful investment tool that should be available to retail investors.

He says: “Most hedge funds provide capital preservation and low volatility. Capital preservation is handy when clients are coming to retirement because, once people have accumulated money, in their 40s and 50s they want to preserve that money and protect it against potential downsides.”

Bestinvest director Justin Modray says funds of hedge funds are a low-risk way to access hedge funds. He says: “Funds of hedge funds spread the risk, so are often safer than ordinary hedge funds because they access a dozen or more funds.”

Regulation would also extend the range of products IFAs can offer their clients, potentially bringing in new business but essentially allowing them to give clients a better deal.

But many advisers are unaware of the role that hedge funds can play to reduce or manage risk. Thomson claims hedge funds are “misunderstood” and says this will hold back retail funds of hedge fund.

He says: “Most advisers will have to improve their knowledge of hedge funds, so they understand what they are recommending. Hedge funds are a mis-understood asset class.

“They can be good but have also been bad in the past, which is why they are often deemed to be higher risk than other investments, even though they are designed to reduce risk.

“IFAs need to understand the fund manager’s criteria and how the investment fits into a client’s portfolio. The average IFA is aware of what a hedge fund is but may not have enough knowledge to recommend them comfortably.”

Truscott says the industry’s perception of hedge funds, which he claims range from dangerous to down-right boring, is inaccurate.

He says there is a big difference between single-strategy hedge funds and funds of multi-strategy funds but many advisers lump them all into one group.

Advisers need to be educated on the ins and outs of hedge funds and the criteria and investment styles of different fund of hedge funds managers, and the onus is on providers, according to Truscott.

He says: “It is the providers’ responsibility to educate IFAs. It will take time for people to be comfortable. IFAs will have a look and once they feel comfortable and see that it is a good investment, they will start recommending funds of hedge funds.”

In terms of consumer awareness, Dampier says investment knowledge is pitiful and having a public that is savvy on hedge funds is a long way off.

He claims that certain investment disasters that have stuck in people’s minds have perpetuated hedge funds’ bad reputation.

He says: “If people have heard of hedge funds, they will probably consider them highly leveraged gambling but a lot of hedge funds are lower risk than most funds that IFAs sell.”

Modray believes this lack of awareness will make retail funds of hedge funds a slow burner. He says: “I do not think we will see people flooding in and buying them willy-nilly.”

He adds that funds of hedge funds will still have a high entry cost. He says: “Even though funds of hedge funds will be more easily marketed in the UK, they will still be difficult to invest in as the minimum investment will be about £10,000.”

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