How the Sovereign fund and Freeway Managed fund invest in hedge funds

The Sovereign and Freeway Managed funds aim to achieve long-term growth, while spreading risk across a wide range of investments. Both invest mainly in both UK and overseas shares along with fixed interest investments* and property. They may also invest in alternative investments, money market instruments** and cash. They may achieve this by investing in one or more other funds.

An investment can be called an 'alternative investment' if it is anything other than one of the traditional investments, such as stocks and shares, fixed interest investments or cash. Hedge funds are a type of alternative investment we invest in.

What are hedge funds and why do we invest in them?

Hedge funds are similar to traditional funds in that investments are pooled and professionally managed; however, hedge funds generally have far more flexibility in where they invest so they tend to use more advanced and varied investment strategies. For example, they may hold “short positions”, they have greater scope for using derivatives for investment purposes and they may use leveraging. See below for explanations of some of these terms.

By using these varied investment strategies, hedge funds try to generate high returns, either with the aim of achieving growth regardless of how the markets are performing (this is known as an absolute return fund) or by aiming to outperform a benchmark (in a similar way to many traditional funds). By investing in hedge funds, therefore, we hope to improve the performance of the Sovereign and Freeway Managed funds in the future.

It is important to remember, however, that these aims are not guarantees; the value of the assets in a hedge fund will rise and fall just like a traditional fund, and it is possible to get back less than is invested. The varied investment strategies used may be riskier than the strategies used by traditional funds, so the risk that an investor could get back less than has been paid in can be greater.

Tell me more about these investment strategies and how they might impact risk

Short positions

Someone who borrows shares from a broker and then sells them on the open market is said to have a short position in the stock. The investor must eventually return the borrowed stock by buying it back from the open market. If the stock falls in price, the investor buys it for less than he or she sold it, and is able to make a profit. Conversely, if the value of the stock rises, the investor will make a loss.

This can be more risky than just buying and holding the shares in the hope that their value rises, because, theoretically, the potential loss is unlimited as the amount the shares could rise in value is unlimited. In reality, however, borrowers are generally required to cover any losses periodically, thereby reducing the risk.


Derivatives are a type of investment whose value is based on the price of another specified investment. In other words, it 'derives' its price from another asset. An example of a derivative is a ‘future’. This is a contract in which the buyer agrees to pay a set price for an asset, or to sell an asset for a set price, at a particular date in the future.

If the person or company selling the derivative (the counterparty) is unable or unwilling to fulfil the terms of that contract (eg they promised to buy an asset from the fund for a set price, but then did not have the money to buy that asset) the fund could lose money if the asset fell in value.


As well as investing money paid in by the investors, some funds borrow money from banks so that additional assets can be bought, a process called leveraging. If the fund’s assets rise in value, the leveraging will increase the fund's returns, as the fund was able to hold more assets by borrowing money to buy them. However, if the fund's assets fall in value, leveraging will have the opposite effect, and will increase the effect of any loss. This can mean that small movements in price result in large increases or decreases in the value of the fund.


All assets carry some liquidity risk. This is a risk that should a fund decide to sell an asset it may take a long time to find a buyer, or it may not be possible to find a buyer at all. If this happens, this could negatively impact the value of the fund. Some of the assets hedge funds invest in may not be bought and sold on a regulated market, and with this type of asset, liquidity risk is increased.

How might the investment in hedge funds affect the Sovereign and Freeway Managed funds' charges in the future?

As with all managed funds, investors in the Sovereign fund and Freeway Managed fund will pay an annual management charge which is deducted from the fund's value. Also deducted from the fund's value, will be the various costs the fund has to pay when it invests in its assets, such as dealing costs for buying and selling those assets, and the fund charges deducted from the funds it invests in. We call these "expenses".

Hedge funds have fund charges and, in the same way as we have described above, these will be deducted from Sovereign and Freeway Managed as part of their expenses. Hedge funds typically apply performance fees as part of their fund charges; these are a charge that a hedge fund will apply if the fund performs well. Performance fees can vary significantly, and this could have an impact on Sovereign fund and the Freeway Managed fund's expenses.

We provide an estimate of the Sovereign fund and Freeway Managed fund's expenses, which includes what we believe the impact of the performance fees will be in the foreseeable future. Currently, we estimate the expenses will be 0.6% per year (correct as of 01st September 2015). The actual expenses may be higher or lower than this; if the actual expenses are higher or we think our estimate for future expenses should be increased, we will let you know, probably in your next annual statement.

How much of the Sovereign fund has been invested in hedge funds over the last year and how has this affected the charges?

Over the last 12 months (up to 30th September 2016), the Sovereign fund has invested an average of 9.83% in hedge funds. Investing in these funds has meant that the Sovereign fund has paid additional costs of 0.26% over this same period. The total expenses have been 0.37%.

How much of the Freeway Managed fund has been invested in hedge funds over the last year and how has this affected the charges?

Over the last 12 months (up to 30th September 2016), the Freeway Managed fund has invested an average 10.27% in hedge funds. Investing in these funds has meant that the Freeway Managed fund has paid additional costs of 0.27% over this same period. The total expenses have been 0.38%.


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*Fixed interest investments are bought for an amount of money that will be returned on a specific future date. The investor receives a fixed rate of interest during this time. The rate of interest paid cannot change, but it is not the same as putting your money in a fixed rate cash account. Fixed rate investments can be traded on the stock market so their value, up until the end of the fixed rate period, can rise and fall in a similar way to the price of stocks and shares

**Money market instruments are short-term investments that provide a set return on maturity in exchange for investing funds for an agreed time period.