Merrill Lynch creates a hedge fund for the man in the street

A new scheme lets the public invest in a way that used to be the preserve of the very wealthy. By David Budworth

YOU still have to be seriously wealthy to invest in hedge funds, but firms are continuing to devise schemes that enable ordinary investors to benefit from hedge-fund techniques. Last week, Merrill Lynch launched the most radical to date.

Steve Marriott of Bestinvest, a financial adviser, said: “Merrill Lynch UK Absolute Alpha appears to be the nearest you can get to a hedge fund in a unit trust without breaking the rules. We are expecting a lot of similar schemes in the near future.”

Hedge funds deploy a range of complicated investment strategies aimed at making a profit even if the value of shares or other assets fall. They can be less risky than mainstream equity or bond funds, providing positive returns year in, year out. But, as the high-profile collapse of Long Term Capital Management in the US seven years ago showed, they can lose billions overnight.

Despite the potential advantages, advisers are wary of recommending hedge funds because they are unregulated in Britain: the Financial Services Authority regulates hedge-fund managers, but does not oversee the schemes themselves.

Gay Huey Evans, the FSA’s director of markets and exchanges, said: “Generally, the feedback we receive does not indicate a great desire on the part of hedge funds or investment advisers to provide or sell them as retail products. Nor is there evidence of significant demand from retail investors.”

Nevertheless, they keep popping up, often based offshore. Most won’t give you the time of day unless you have at least £100,000 to invest.

But the new funds, such as Merrill Lynch UK Absolute Alpha, are fully regulated, listed in the UK and investment starts at as little as £250 a month. This has become possible after more flexible investment rules were introduced last year.

Baring Directional Bond, Credit Suisse Target Return, UBS Absolute Return Bond and DWS Ratebuster have already seized on the rules to adopt similar techniques to those used by hedge funds.

The funds are being targeted at risk-averse investors, many of whom are looking for an alternative to out-of-favour with-profits funds. They have been dubbed “absolute return funds” because they aim to deliver positive returns in all conditions.

But therein lies the danger. To produce profits in a falling market they have to use complex financial instruments such as derivatives, so that they can buy “put” options or sell futures contracts for later delivery at a hopefully lower price.

Derivatives are instruments used to bet on the future movement of bonds, interest rates, currencies and stock markets. They can be used to make a profit, even when a share or bond falls in value — a technique known as shorting.

The results can be volatile and heavily loss-making without carefully constructed safety nets. Few individual investors are likely to understand them.

Ros Altmann, an independent hedge-fund expert, said: “It is vital that you are confident that the managers have adequate risk controls in place and expertise to manage the short or down side. Shorting can be very dangerous to your capital if it goes wrong.”

Some advisers would rather wait and see whether the managers prove up to the job before committing money. Paul Ilott of Bates Investment Services said: “We are concerned about the relative lack of experience of some managers using these sorts of strategies. I would like to see longer track records before we entrust them with clients’ money.”

Even so, advisers say that absolute-return funds should not be dismissed. Christine Ross of SG Hambros, a private bank, said: “We are interested in the Merrill Lynch fund. However, it is only suitable for investors who can grasp how it works.”

The fund will be able to invest in derivatives, go short and move fully into cash. However, unlike a hedge fund, it will not be allowed to borrow to invest. The minimum investment is a £10,000 lump sum, or £250 a month.

Merrill Lynch creates a hedge fund for the man in the street - Your Money - Times Online