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Last Updated: Wednesday, 1 March 2006, 15:44 GMT
What is a hedge fund?
David Mills
David Mills' investments are attracting attention
As interest grows in the investments of David Mills, husband of Culture Secretary Tessa Jowell, hedge funds are now firmly in the headlines.

Their popularity among both rich investors and institutions has grown sharply in recent years.

But few outside the investment community know much about how they work, or what their benefits are.

The kind of fund in which Mr Mills invested 400,000 use financial derivatives, often in leveraged bets.

At a basic level, this could take the form of acquiring a stock that appears undervalued - either outright or by buying a call option that gives the fund the right to buy the stock at today's price even if the market price goes up.

To reduce the risk of such a directional bet, a hedge fund might also buy a put option which gives it the right to sell the stock at the current price, even if there is an unexpected fall in its market value.

Roughly speaking, if the stock falls in value the fund will lose what it paid for its options, but no more. If the value of the stock is rising, it will start to make money once these option premiums have been covered.

Such practices differ notably from those widely used by large companies, which use derivatives - such as futures, options, swaps or tailored financial products - as a means of offsetting risks such as fluctuations in currency values.

Hedge funds look for investments that will provide returns from declining markets as well as rising ones, and they often bundle their investments in complex combinations of positions to provide high returns.

Typically, investments in hedge funds are for a minimum of one year.


Normally, hedge fund investors who are looking to seek better returns have the wherewithal to fund those investments directly
Neil McKinnon, ECU Group

In the case of David Mills, an international lawyer, he and Ms Jowell say they took out a 400,000 mortgage on their house to buy into a Guernsey-based hedge fund.

The loan was reportedly paid off only weeks later with money from another fund.

But according to Neil McKinnon, hedge fund manager and chief economist of ECU Group, it was unusual for high net worth individuals to take out short-term mortgages to invest in hedge funds.

"Normally, hedge fund investors who are looking to seek better investment returns have the wherewithal to fund those investments directly without recourse to bank loans or indeed mortgage loans," he told the BBC's Today programme.

"Normally, the eligibility criteria for hedge funds are quite stiff, [including] minimum investment requirements and normal client suitability criteria."

Italian prosecutors have alleged that there is a connection between the loan secured on the house which Mr Mills and Ms Jowell jointly own, and a 344,000 payment received by Mr Mills.

They also maintain the money came from Italy's Prime Minister Silvio Berlusconi.

But Mr Mills says both suggestions are wrong.

For her part, Ms Jowell, whose alleged involvement is being investigated by Cabinet Secretary Gus O'Donnell, denies wrongdoing and is said to have Tony Blair's backing.

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19 Feb 06 |  Europe

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