Specialist Investments

The most popular strategy. Managers buy (known as 'long') shares they think will rise in price and 'short' shares they think will fall in price. 'Shorting' means borrowing a share and then selling it in the hope you can buy it back in future at a lower price before you're due to return it to the lender. This is a popular way to make money from falling share prices.

The idea is that a good manager can make money whether the market is rising or falling. These funds still tend to have some market exposure, i.e. they have more long exposure than short, and returns will ultimately depend on how good the manager is at picking shares.

Some conventional unit trusts are starting to use long/short strategies to try and deliver absolute returns, with varying degrees of success.

Market neutral funds try to remove all market risk, so that overall market movements have no impact on the fund's performance (i.e. zero correlation). In practice it's hard to totally achieve this, but managers can get close enough to make it worthwhile.

In the case of stock markets, an equity neutral fund manager typically uses a long/short approach by 'pairing' shares in the same sectors. For example, suppose company A and company B are both high street retailers. The manager thinks A will perform better than B but is worried that the sector could be quite volatile. If he buys A and shorts B then he'll benefit if his hunch that A performs better than B is correct. However, shorting B will also protect him if the sector falls as a whole.

Other market neutral strategies include:

• Convertible Arbitrage - involves buying a convertible bond and shorting a share in the same company. If the share price rises the convertible increases in value while the short position protects from a falling share price.
• Hedged Arbitrage - involves buying shares that the manager believes will rise in price and shorting the stock market index. If the market falls as a whole the short position will make money, if the markets rises the manager hopes his chosen shares will make big gains.
• Fixed Income - involves buying one type of fixed income investment and shorting another with a similar redemption date. For example, if the manager prefers corporate bonds to gilts he'll buy bonds and short gilts, providing some protection from interest rate movements.

A very wide ranging strategy where managers aim to profit from global events and situations using any available type of investment. The risks can be high, as managers might be placing big bets on expected interest rate movements, economic events, political changes and government policies.

Managers often increase their exposure by borrowing and/or using 'derivatives', adding yet more risk to their bet. By using derivatives such as 'options' and 'futures' the manager can get exposure to a much greater amount of investment per £100 invested than normal, known as 'leverage'

The bets tend to be on a particular price moving in a certain direction (known as 'directional') or on a pair of assets where the manager expects the price of one to move relative to the other (known as 'relative value').

Perhaps the most famous global macro bet was when George Soros bet the UK would be forced out of the European Exchange Rate Mechanism (ERM) in 1992. He placed a relative value trade by shorting £10 billion of Sterling and buying German Deutschmarks and French Francs. Sterling fell relative to the other currencies, allowing Soros to buy back the original £10 billion stake for £9 billion, netting him a cool £1 billion profit.

The manager seeks out companies that are in big trouble, often on the verge of bankruptcy. Their aim is to re-structure and/or re-finance the company with a view to then selling it on at a profit. This could involve selling off some parts of the business to other companies.

To be successful a manager will need to understand why the business is on its knees and how it might be resuscitated. Alternatively, they might take the view that the business is probably doomed but that the assets are worth more than existing bondholders and debtors realise. They'll then try to buy bonds and bank debt on the cheap, making a profit when the business is eventually wound up or even more profit if they can actually save the business.

When one company acquires another, the shares of the company being bought usually trade a little below the agreed purchase price until the deal is complete, reflecting the risk that the deal will fall through. The manager aims to buy shares in companies being acquired (below the acquisition price) where he/she believes there's very little chance of the deal not completing, hence it's very likely they'll make a profit. Alternatively, if they believe the bid will fail they might short shares in the acquisition target.

If the acquiring company plans to swap some of its own shares with the other company to pay for the purchase, then managers usually short shares in the acquiring company and buy those in the company being acquired.

These are funds, normally investment trusts, that invest in a range of hedge funds. Their advantage is that they spread risk across several funds and, in the case of investment trusts, it's practical to invest a few thousand pounds.

Their downside is high charges, as you'll be paying both the fund of hedge fund manager and all the fees on the hedge funds held within the fund. The investment trust structure also adds extra risk. Because an investment trust is a company listed on the stock market, the value of the fund based on its share price may be different from the value of all the underlying investments. So even if the underlying hedge funds do actually deliver absolute returns, you could still lose money if the investment trust's share price falls relative to the investments held within. Of course, this could work to your advantage if the reverse happens, but the point is it adds risk to an investment whose main appeal should be consistent returns with less risk.

A few unit trusts (including Oeics) use long/short investment strategies to try and deliver absolute returns. In the past unit trusts had not been allowed to do this, but a rule change in April 2004 made this possible for funds willing to convert to 'UCITS III' status (basically an attempt to standardise fund rules across the EU).

The handful that do both long and short shares are usually more long than short, meaning they have a bias towards the market. During heavy market falls this means it's unlikely they'll deliver positive returns, something that's been evident in practice (with the odd exception).

The focus is on investing in privately owned companies that are not listed on any stock exchanges, very similar to the traditional venture capital industry (a bit like 'Dragon's Den' on a larger scale).

VCT managers tend to become actively involved in the running of the company, hoping they can build it up and sell out at a profit a few years later. It can often take the managers six to nine months just to purchase a company, due to all the research and checks involved. Because the private equity investment cycle can be quite long, investors in these VCTs should be prepared to sit tight for up to 10 years or more.

As private companies are not listed on a stock exchange there's no way to value the shares on a daily basis. They're usually valued periodically and quite conservatively, meaning their value can jump when the company is eventually listed or privately sold to someone else.

The focus is investing in companies listed on the Alternative Investment Market (AiM). Because these companies are listed on a stock market there's some prospect of selling shares if the VCT manager no longer wishes to hold a company, although this is not always easy.

The skills in managing an AiM VCT are more similar to running a conventional stock market fund and they're easier to value than private equity VCTs (using the quoted share prices of the underlying companies). It's common for AiM VCTs to have a technology bias, due to the nature of the companies that meet the qualifying investment criteria.

Generalist VCTs usually invest in a mix of private equity and AiM companies. It's important to check what the relative split is likely to be and the manager's experience of investing in private equity.

These VCTs invest in companies that have valuable assets backing their business, so if the business fails the VCT manager may still be able to reclaim some of their investment via the sale of the assets. Although VCT rules do not allow obvious asset backed trades such as hotels and property development, they do allow public houses, golf courses, garden centres and plant and equipment. In theory, this type of VCT should be less risky than the others.

These investment strategies are very narrow, typically focussing on areas such as technology, healthcare, wind power and music.

Given the specialist nature of these investment types, it's vital that the VCT manager has plenty of experience and expertise in the field they're investing. The potential risks can also vary widely, so make you have an understanding of these before investing.