Hedge funds operate in private and release little information to the general public. Yet they’re known as one of the more exciting and interesting forms of collective investment. But how can you invest in hedge funds in the UK? And is it possible for a UK retail investor investing with little money to get exposure to the hedge fund asset class?
Before we begin, our explainer guide ’What is a hedge fund?’ explains what a hedge fund is, and how hedge funds differ from ordinary asset managers.
In summary, hedge funds are expensive collective investments, where the hedge fund manager can pursue any investment strategy with additional tools (such as derivatives and leverage).
In theory, this allows a hedge fund to target ‘absolute returns’, which means that they could produce a positive return during a fall in the overall stock market. However, dependent on the strategy (and the skill of the manager) this only occurs some of the time.
Hedge funds are high-risk investments because of the complex and aggressive strategies they pursue. Hedge fund managers are often remunerated via a ‘two and twenty’ management fee structure which means a 2% annual management charge on assets plus 20% of any surplus returns above a benchmark.
This incentivises hedge fund managers to follow high volatility strategies which maximise the chances of a large return above the benchmark. That same strategy can result in higher losses. As any investing book worth its salt would explain; those potential losses mean that hedge funds are very speculative, even if an individual fund has experienced a strong period of performance.
Some hedge funds have been known to ‘go to zero’ and others are shuttered after large withdrawal requests from institutional investors after a period of poor performance. The same cannot be said of investments that are suitable for the general investing public such as broadly diversified equity ETFs.
Who can invest in hedge funds
To directly invest in a hedge fund you must be qualified in two ways:
- You must be a sophisticated investor
- You must be able to afford a high minimum investment
Read the UK sophisticated investor definition to understand if you might tick the boxes for this classification.
Hedge funds only accept direct investment from sophisticated investors who are prepared to invest a large lump sum. Hedge funds are not always part of large investment groups and don’t have a huge team of staff to handle administration. It works in their interest to work with a small number of large investors, rather than a large pool of small investors.
Minimum deposit requirements of £500,000 are common and £5m is not unheard of.
How to invest in hedge funds as an ordinary investor
Despite the above, it is possible for adventurous investors who understand the risks to gain some exposure to the hedge fund asset class.
The only simple direct approach is to invest in ordinary mutual funds which attempt to replicate the trading strategies of a hedge fund.
A legally registered mutual fund, won’t be permitted to use leverage and therefore it is impossible for it to behave exactly like a hedge fund but this is the closest approximation available.
These funds are often known as absolute return funds. You can learn more about them from our quick guide to absolute return funds.
We’ve shortlisted the best UK stockbrokers below that you could use to buy absolute return funds:
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Capital is at risk
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Capital is at risk
You can also invest in the shares of publicly owned hedge fund managers. This provides indirect exposure to the financial success of the underlying hedge funds because when the hedge funds perform well, management fees will be high and therefore some of this will accrue to the owners of the asset manager.
Examples of asset management companies you can invest in include BlackRock and UBS.
The downside of this approach is that there are no publicly listed ‘pure’ hedge fund, asset managers. When buying the shares of BlackRock you are acquiring a $9 trillion dollar wealth management business, which will be relatively insensitive to the gains and losses of their hedge fund divisions.
How to research hedge funds
Under UK rules, hedge funds aren’t permitted to promote their funds directly to retail investors. This makes the marketplace more opaque for an investor performing research. Even getting clear information on how to invest in hedge funds is more difficult than it needs to be.
You won’t find active price comparison websites, providing information and comparing the returns of hedge funds and linking you through to a sign-up page.
Financial advisers who specialise in high finance, and private banks will be well trained to provide advice on hedge fund investments.
Our list of the top hedge funds in the UK might provide some names of the larger firms (in terms of assets under management) to begin with.
The best hedge fund books are also a great place to start in explaining the history of hedge funds, what you should be looking for and how they work on the inside.