Look at Hedge Funds and EM Investment Funds - dummies

By David Stevenson

Crucially, hedge funds can offer UK investors exposure to sophisticated EM investments, including commodities, property, currencies and derivatives.

Hedge funds have become more and more active in EMs (emerging markets) over the last few decades, with a vast range of different strategies, including focusing on traditional shares (going long equities probably accounts for as much as 90 per cent of the funds in this space), event-driven investing (exploiting price inefficiencies following a merger, a bankruptcy, the release of an earnings report or other corporate event) and global macro and fixed-income arbitrage (in which investors make trades based on an analysis of trends in the global economy and exploit arbitrate opportunities in bonds, respectively).

The love of ‘growth’ stocks in countries as diverse as Brazil, India and Indonesia hasn’t stopped hedge funds employing innovative strategies such as:

  • Using leverage to increase return potential significantly.

  • Pushing trades out across asset classes based on a macro strategy; this strategy can help avoid potential liquidity traps that are quite common in smaller, less mature EMs.

  • Shorting to help to increase profits. Many EM equities can become fearsomely expensive, which opens up possibilities to sell the weaker companies. Managers can also draw on the growing range of derivatives that now exist to help protect the portfolio or to leverage it.

Many EMs and their government-appointed regulators don’t allow short-selling! Plus, some smaller countries have a distinct lack of futures or other derivative products with which to hedge risk.

Investing in the EMs has some unique risks, including a lack of transparency at the company level (which can make evaluating investment opportunities difficult). You also need to be careful about liquidity in some markets, especially when western investors all start to sell simultaneously during a market scare!