Wealthy 'moving to hedge funds

Date: Thursday, October 25, 2007
Author: BBC News

The world's wealthiest private investors are planning to put more money into alternative investments over the next three years, a report says.

The study said the global rich are increasingly attracted by private equity schemes and hedge funds as they offer more stable returns than shares.

Its findings come after recent global stock market volatility.

The report by Barclays Wealth questioned 790 wealthy individuals from around the world.

Hedge fund mystery

It found that only 48% of respondents planned to buy further investments in stocks over the next three years, down from 64% over the past 36 months.

This comes following recent turbulence on the worldwide stock markets, sparked by record loan defaults in the US sub-prime mortgage market and a resulting shortfall in global credit.

By contrast, 15% of respondents said they planned to invest in private equity funds, up from 11% over the past three years; while 21% said they expected to invest in hedge funds, up from 20%.

The report added that despite the increase in popularity of such alternative investments, just 27% of respondents said they understood how hedge funds worked, while only 36% said they knew how private equity schemes operated.

Private money

Instead of going to the stock market and selling shares, private equity companies raise cash from private sources, pooling groups of smaller wealthier investors, or borrowing money from banks.

This money is used to buy and sell companies.

If there is a capital gain from the sale of the business, it is returned to investors with private equity managers taking a cut.

Hedge funds use more complicated financial methods to make money from their investments.

One of their most typical tactics is to acquire a stock that appears undervalued - either outright or by buying a call option that gives the fund the right to buy the stock at today's price even if the market price goes up.

To reduce the risk of such a directional bet, a hedge fund might also buy a put option which gives it the right to sell the stock at the current price, even if there is an unexpected fall in its market value.

Roughly speaking, if the stock falls in value the fund will lose what it paid for its options, but no more.

If the value of the stock is rising, it will start to make money once these option premiums have been covered.