UK hedge funds are different from a normal type of investment fund in that investments are made across a much wider group than is traditional. A traditional investment fund will usually mean taking a long position in a stock or bond, which means that the holder will profit if the price increases.
UK Hedge funds still invest in stocks and commodities, but will try to hedge some of the risks involved. One way they will do this is by short selling an asset. The assets that are sold are generally borrowed from a lender. The idea is that the price of the asset will decline allowing the hedge fund to buy it back at a cheaper rate, before returning it to the lender. The difference made between the prices of the asset is profit for the UK hedge funds. The risks taken are that the assets will rise in value, and the hedge fund will make a loss buying them back. There may also a fee for borrowing of the assets.
UK Hedge funds are typically invested in by the wealthy. The criteria laid down by regulators are a lot less strict than most investment funds. They allow the practice of short selling, and lay down the terms and conditions by which money can be removed from the fund by individual investors.
The fund is run by an investment manager who will decide which assets will best meet the needs of the fund. The manager receives a performance fee which is dependent on the increase of the funds value. It is calculated using the net asset value, and a typical performance fee might be 20% of the increase in value.
If a fund declines below the highest net asset value, then the investment manager doesn’t receive a fee. The manager will not receive a performance fee until the fund rises back above the level of the highest net asset value. This level may also be called the high water mark. The investor may still be responsible for a management fee, and this is applicable regardless if the UK hedge funds have made a profit or not.
UK Hedge funds generate a lot of business, and may be responsible for as much as half of all the shares bought and sold on the London stock exchange. In addition to short selling, they also search out investment opportunities in bankrupt companies or ones that are merging. A UK hedge funds performance is largely dependent on the manager’s skill. It is not uncommon for the UK hedge funds to be closed to new investors as the best managers have created very desirable funds.