Hedge Funds Suitable for Retail Essay

Excerpt from Essay :

The investors have responsibility to invest based on the social needs. The retail investor, can for example is thus a person who buys socially responsible unit trusts or mutual funds. Actually the investment that is being touted as responsible investment is the work of socially beneficial institution like pension funds, and some charitable foundations. Normally the institutional investors do not enter the socially responsible investment scenario. Of late however the new approaches to fund investment by the institutions have bordered on social concerns. The issues of institutional investment are more complicated and diverse than the retail funds. (Sparkes, 2002, p. 117)

There are many other investment opportunities available to the retail investor without incurring the risk but at the same time gaining efficiency in value without hedging. The retail investors thus are better off in those segments and hedging must not be opened to them. There are ample other investment portfolios that offer similar returns without so much risk. The cost of operation, entry cost and exit costs are also less.

Retail Investors & Markets

There are many types of securities that are traded in the market and can be used for hedging. One is the fixed income securities, although these are relatively risk free, and provide a predictable future return. These are not exactly hedging funds. Most retail investors prefer this to the greater risk bearing mutual fund or hedge funds. The values of these securities however can rise or fall and the value being subject to change, there is nevertheless a small element of risk. This thus is safe in the short-term investment considerations. Other non-risky investments are the money market deposit accounts in depository institutions because these are assured by the 'Federal Deposit Insurance Corporation.' Thus deposits with any commercial bank, Mutual savings bank will be covered. (Nowak, 1993, p. 108)

The disadvantage is that the interest for the investment is fixed. However the investor is assured that the interest and the principal is safe. On the other hand the stock and bond markets are very volatile and very risky. This applies to the commodity and the FOREX market too. Hedging is a feature of these markets. In the investments in the safe side, the investor need to know only elementary things like the rate of return and the interest rates and the offers by the banking institution in which the retail investor invests. On the other hand the investor in the hedge funds has to be learned in many market operations and require deep knowledge and training in the process of forecast, and what is called fundamental analysis. (Nowak, 1993, p. 108)

Thus the investors have to be very knowledgeable about the positions of hedge funds at all times in the financial markets and the investor ought to be through with the positions that affect all the financial prices. And knowing positions of hedge funds, as well as those of other market participants, is necessary for the investors. But there is a scarcity of actual data on market positions and it requires a lot of knowledge to understand the nuances of the hedge funds' stay in various markets. This some researchers have argued can be seen from some index like the aggregate returns and the net asset values of individual hedge funds. (Brouwer, 2001, p. 15) One of the most common hedging instruments for the retail investor was the mutual funds which were passively managed and low-cost market index funds. It is stated that as an instrument the mutual fund has taken a blow with the depression making most investors go abroad to other markets. (Bogle, 1999, p. 107) Thus the stability factor must also be considered. It is thus shown that hedging has the highest risk in the investment operations and the retail investor will be open to these.

The Arguments

The hedger stands to gain if the assumption made was correct and shall sustain loss if the assumption was wrong. The question is if retail trading in this is good? The answer can be found if it is explored who could be the retail investor. Setting aside the fact that institutional investments and individual investments are different and considering them as the same entity, the only difference we can see is the risk bearing capacity. The institutional investment has capital back up and the reverses can be sustained. On the other hand the individuals and groups of individuals who buy small lots and speculate with greater margins will end up in penury at a small change in the volatile market overnight. For investors in the retail segment therefore there must be the enforcement of the regulation regarding the net worth guidelines, where the investor cannot trade without an asset that is shown as a backup to a prefixed amount. (Barnes, 2007)

Regarding regulation, the Securities Exchange Commission -- SEC in 2007 was of the opinion that hedge funds will generate better diversification benefits. The retail hedge is put under severe restrictions to protect the investor and these funds managers are expected to apprise the investors about the risks on a daily basis. They are also to be audited by securities regulators. While the Global Investment Performance Standards -- GIPS exist as guidelines for mutual funds, there is yet to become a proper standard for hedging. So far only institutional investors have used the hedge fund investments because they can benefit from the diversification of funds from the underlying fixed assets. (Barnes, 2007) to retail such a risky thing to an unprotected investor who cannot appreciate the nuances of the risk and the dangers inherent is bad policy.


Therefore taking into consideration that hedge funds have more inherent risks with short selling, trading in derivative instruments and is suited more to the bear markets, the determination of which is a very specialized affair, and the investment is a risk based on market fluctuations and premises based on the future, the retail investment is not advantageous. The retail investor has other instruments that avoid incurring the risk but at the same time these portfolios that offer similar returns. Hedging is beneficial to the institutional investors on account of diversification of funds from the underlying fixed assets. They have less chance of instability with market reversals. It is opposite in the case of the retail investor. Hence retain investing in hedge funds is not advisable.


Barnes, Ryan. 2007. Hedge Funds Go Retail. Investopiedia Online,

http://www.investopedia.com/articles/mutualfund/07/mutual_fund_retail.asp#axzz1naDnVsEo accessed 4 March 2012.

Bogle, John C. 1999. Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor. Wiley: New York.

Brouwer, Gordon De. 2001. Hedge Funds in Emerging Markets. Cambridge University Press: Cambridge, England.

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