Not for everyone

Most of us invest in normal investment funds. These buy stocks, bonds and other products that are widely available to the public. We pay someone to look after our money and keep track of the markets for us. It's a quick and simple process to get our money back.

Investors in hedge funds, private equity or buyout funds allow their managers to use riskier methods and a wider range of techniques to earn money.

Investors have to commit their money for a longer time, and the minimum investment might be millions of dollars. These funds generally make investments that other funds are unable to due to regulation and lower appetite for risk.

For these reasons, financial regulators generally require investors to have a higher level of investment knowledge and experience before they are allowed to put their money in hedge funds.

There are some hedge funds available to the Hong Kong public, but they still require that investors prove they have the experience needed.

Hedge funds are infamous in Asia. During the 1997 financial crisis, they played a big role in the collapse of currencies such as the Thai baht.

Although they did nothing illegal, they profited from a situation that caused many others to lose money. Since then they have struggled to clear their name in public opinion.

In Hong Kong, the Cantonese nickname for hedge fund means 'crocodile'.

How they do it

Hedge funds may invest in stocks and bonds like other funds do, but they can profit when the market is going up or down by using short position techniques.

They also use leverage, which means they make investments with borrowed money.

Private equity funds and hedge funds often make similar investments, but the name 'private equity' implies what they really specialise in. Private equity means investments that are not listed and traded on exchanges.

A private equity fund may find a sweets manufacturer that has found a new market and wants to expand so it can dominate that market. However, the company may be family-owned, and the family does not have the money or the management experience to expand.

A private equity firm will provide the money in exchange for a stake in the company, and it will provide a sweets-making expert to help the business grow.

Eventually, the private equity firm will sell its stake in the company, hopefully at a big profit.

Buyout funds do similar deals, but they are often involved in buying companies that are in trouble.

A buyout fund will find a company that owes money, or is falling behind the rest of its competitors.

They might buy a company and pick it apart, laying off workers and abandoning parts of the business that don't make money. The fund will then take the profitable parts of the business, rebuild them and resell them at a profit.

Buyout funds sometimes have a bad reputation for focussing on the money that can be made, and not a company's history, employees or reputation.

They say they rescue the profitable parts of a business from drowning with the unprofitable parts, but others may accuse them of wrecking businesses altogether.

All three types of funds bring large amounts of money to the market. The money they have injected into mainland and Hong Kong markets has helped drive stock markets to their current highs.

It is often said that they make markets and companies more efficient because they force companies to focus on profits.

BUSINESS TALK

Investment fund : A firm that pools money from many investors and charges a fee to invest the money in markets or companies.

Hedge funds : An investment fund where investors allow fund managers to use higher risk investment techniques to generate higher returns, using short positions and leverage. Hedge funds charge much higher management fees than other funds as their managers are expected to see profitable opportunities before the public notices them.

Buyout/private equity funds : Investment funds that buy large stakes in companies in order to get control of the company and make it operate more efficiently. Sometimes this involves selling parts of the company, cutting its workforce and operating costs, or changing the way it is managed.

Short position : This is done by borrowing something and selling it with the expectation that its value will fall. The investor then buys the same item back at a cheaper price, making a profit after repaying the lender.

Leverage : Borrowing money and investing it in something that will generate profits that are higher than the cost of borrowing. This is a risky investment strategy, because the investor can lose his own money as well as the money he has borrowed, which he must still repay.