Hedge Funds
Hedge funds are similar to mutual funds in 2 regards
They are a pooled investment vehicle (several investors entrust their money to a fund manager)
They invest in publicly traded securities
Unit trusts are open ended investments
Investment trusts are closed ended investments
Hedge Funds (or Long/Short)
They seek absolute returns. Use derivatives, short selling and also leverage (borrowing) to enhance the risk/rewards
These seek a positive return regardless of the performance of the market.
They are very popular in bear markets.
They may not outperform a mutual in a bull market.
These absolute returns vary but a goal might be 6-9% annualised return, regardless of market conditions
Hedge funds are likely to establish some (if not all) of their short exposure through broad equity market indices.
Hedge funds are generally not recognised with the SEC.
They have avoided registration by limiting the number of investors and requiring that their investors be accredited (which means they meet an certain
income or net worth standard)
Hedge funds are also prohibited from soliciting or advertising to a general audience (which lends to their mystery)
Hedge funds charge an annual fee (about 1-2% of assets managed)
And also keep about 20% of investment gains
Credit fund managers may decide to buy protection on credit indices to mitigate the risk that credit spreads will widen.
Debt fund managers often use C471IRS to reduce the duration mismatch between their assets and the funding provided by their prime broker.
Hedge fund managers are more likely to hedge out their currency exposure than long-only fund managers.
Closed Fund - they raise money by selling a specific number of units/shares
Multi-strat hedge funds use several strategies within the same pool of assets
1) Diversification helps to smooth returns, reduce volatility and decrease asset class and single strategy risk
These will rarely be the highest performing hedge funds over a short-time period because the diversification dilutes the returns of any highly profitable strategies.
Feeder Fund ---- feeds into a different fund.
How to calculate the NAV of a fund.
Carry - Interest (Paid or Received) on a position. The cost of "carrying" or holding the position
Segregated Mandate Funds
Money is managed as a single pool of funds from different sources ???
Net Asset Value
This is the price per share of the fund
Often abbreviated to NAV
Also known as book value (link this)
This is calculated by dividing the total value of all the securities in the portfolio (minus any liabilities) divided by the number of fund shares.
The best way to look at fund performance is to look at the annual total return.
Exchange Traded / Closed End Funds
For exchange traded funds this is fund's per share value
These trade like stocks and therefore their shares trade at market value which can be a value above (trading at a premium) or below (trading a discount) the NAV.
Management Fees
Performance Fees
Hedge funds normally charge a performance fee which is a share of any positive returns.
This performance fee is calculated as a percentage of the funds profits counting both realised and unrealised profits
Typically hedge funds charge 20% of the gross returns as a performance fee.
Strategies
Most hedge funds employ proprietary or well guarded strategies
Macro | chooses instruments whose price fluctuate based on the changes in economic policies. This strategy is very broad in scope and looks at market risk (or systematic risk) that is not security specific. Currency strategies, interest rate strategies and stock index strategies. Top-down bets on currencies, interest rates, commodities, etc Also known as "macro funds" |
Distressed | Securities of companies in distressed or defaulted situations trading at substantial discounts to par value. investing in companies that are re-organising |
Long Only | Also known as Index funds. Benchmark to a market index |
Equity Hedge | |
Event Driven | Takes ownership to force management changes or a restructuring of the balance sheet. This takes advantage of trade announcements and other one-time events. One example is merger arbitrage used in the event of an acquisition. Buying the stock of the target company, selling short the stock of the acquiring company. This is a type of equity long-short strategy. Its buys the convertible securities and takes a short position in the stocks that are expected to decrease in value |
Relative Value | Buying securities that are expected to appreciate and selling short securities that are expected to depreciate. For example buying a cooperate convertible bond and selling short the common stock. The idea is to make money from the bond's yield if the stock goes up, also make money from the short sell if the stock goes down |
Long Only | Also known as Index funds. Benchmark to a market index |
Long Only Hedge Fund | Do not benchmark to a market index. Also known as Alpha funds they are actively managed. |
Long Short | buying core stocks in a particular index. selling short the corresponding index futures (if the index goes down, the short will offset losses) |
Market Neutral | isolating pure returns. buying tesco's, selling short sainsburys (betting on Tescos out performning Sainsburys). it doesn't matter if market goes up or down |
Dedicated Short | Selling short securities that are overvalued (these are extremely risky as prices can increase indefinitely) |
Convertible Arbitrage | This is a type of equity long-short strategy. Its buys the convertible securities and takes a short position in the stocks that are expected to decrease in value |
Emerging Market | Equity and Fixed Income securities in emerging markets around the world |
Arbitrage | Pricing differences - considered risk free. There are very few pure arbitrage funds |
Asset Valuation
DFAA - Discount Factor Adjusted Approach
Sharpe (1964), Linner (1965) and others
The CAPM was an early attempt to Quantify the equilibrium adjustment for risk
Within the Capital Asset Pricing Model, risk was measured by the asset's beta and future expected cash flows were discounted at a risk-adjusted rate
Models that discount at a risk-adjusted rate within the category , the discount factor adjusted approach
CFAA - Cash Flow Adjusted Approach
Arrow (1964), Harrison and Kreps (1979), Hansen and Richard (1987)
Has a variety of different names: State Claims Valuation, Equivalent Martingale valuation, Stochastic discount factor valuation or risk-neutral valuation
Within this model the adjustment for risk is taken in some ways in the numerator of the valuation equation.
MCA - Market Comparables Approach
Thisi does not require the structure of a state claims framework.
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