Managing my financial journey
Managing my financial journey

Start this free course now. Just create an account and sign in. Enrol and complete the course for a free statement of participation or digital badge if available.

2.2.4 Hedge funds – are they market manipulators?

Hedge funds have attracted considerable attention and, on occasion, criticism in recent years – but what are they, and how are they different from other types of investment funds? The term relates to an array of funds with a variety of structures and investment strategies. However, there are some common features:

  • some are targeted at wealthy individuals (those of ‘high net worth’) who may be prepared to take greater risks with their investments than ‘ordinary’ investors
  • the managers of hedge funds charge high fees for their services, often linked to the performance of their funds
  • the funds tend to adopt riskier investment strategies than ‘ordinary’ investment funds, often building up their positions by borrowing money from the wholesale markets to finance their investments.

The main criticism levied at the hedge funds is that there is evidence that they target firms they perceive to be in difficulties and engage in strategies to profit from a fall in their share prices. They do this by ‘short-selling’ – entering into agreements to sell shares they do not possess for settlement at a future date. The intention is that between the transaction date and the settlement date, the market price of the shares in question will fall, enabling the hedge fund to buy them at the lower market prices to deliver them as required under the terms of the original transaction. The profits arise from having originally sold the shares at a higher price than the one at which they were ultimately acquired for delivery to the customer. If this strategy pays off, it is often to the disadvantage of the affected firms, who may find that their share price has been driven downwards – or, at worst, that the fall in the price has provoked panic selling by other investors, thereby jeopardising the firm’s existence. Hedge funds were widely criticised for their role in pushing down bank share prices during the 2007/08 financial crisis.

Ironically, the term ‘hedge’ is widely used in the financial markets to describe a method for reducing risk. Hedge funds, by contrast, are widely viewed as seeking to increase risk in the search for higher investment returns.

However, to be fair, there is a huge variation of styles and risk profiles within the hedge fund sector. Consequently, recent years have seen the rise of the ‘fund of hedge funds’ (FOHF): investors buy into a FOHF and leave the manager of the FOHF to use their skill and judgement to decide which hedge funds to buy into. This can provide greater investment diversification and thus help to reduce the overall risk to the investor.

Take your learning further

Making the decision to study can be a big step, which is why you'll want a trusted University. The Open University has 50 years’ experience delivering flexible learning and 170,000 students are studying with us right now. Take a look at all Open University courses.

If you are new to University-level study, we offer two introductory routes to our qualifications. You could either choose to start with an Access module, or a module which allows you to count your previous learning towards an Open University qualification. Read our guide on Where to take your learning next for more information.

Not ready for formal University study? Then browse over 1000 free courses on OpenLearn and sign up to our newsletter to hear about new free courses as they are released.

Every year, thousands of students decide to study with The Open University. With over 120 qualifications, we’ve got the right course for you.

Request an Open University prospectus371