What is a hedge fund?
Hedge funds are investment vehicles that take big bets on a wide range of assets and specialise in sophisticated investment techniques. Some of these funds have made huge amounts of money for their investors in recent years. They are meant to perform well in falling as well as rising markets.
Who runs them?
A lot of hedge funds are run by former bankers or traditional investment managers who set up their own funds. They can make a lot of money out of them by charging high fees, typically a 2 per cent management fee as well as 20 per cent of the profits.
Who invests in them?
Because they are unregulated and risky, the managers will only accept investment from wealthy, sophisticated investors.
Some banks, pension funds, and companies also invest.
Why are they losing money?
Some hedge funds have been caught out by betting the wrong way on recent market movements. Some of them have also made losses by buying the complex packages of debt that contain many of the U.S. mortgage loans now turning sour.
Should we care?
By some measures hedge funds account for a third of stocks traded on the London Stock Exchange and a fifth of those in New York.
They are also the most lucrative customers of leading investment banks. They are an integral part of the financial system and problems with hedge funds can have a big knock-on effect.
Why are there so many of them?
There are several thousand hedge funds in existence accounting for trillions of dollars of investments. They have enjoyed a surge in popularity in recent years as investors have tried to diversify their assets and increase their returns.
Why are they not regulated?
Regulators have largely left them alone as long as they are not sold to retail investors.
In Britain, managers are required to register with the Financial Services Authority, the chief City regulator, but not in the U.S.
What happens if one goes bust?
There have been several high-profile hedge fund collapses in recent years. When Long-Term Capital Management failed in 1998, its losses were so big, it threatened the stability of the U.S. financial system. Regulators organised a bail-out to prevent a knock-on effect. However, last year Amaranth, another U.S. hedge fund, lost $6.5 billion in a month in the natural gas market. It was not bailed out by regulators and instead closed with investors losing out. — ©Guardian Newspapers Limited, 2007