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


Macrochooses 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"
DistressedSecurities of companies in distressed or defaulted situations trading at substantial discounts to par value. investing in companies that are re-organising
Long OnlyAlso known as Index funds. Benchmark to a market index
Equity Hedge 
Event DrivenTakes 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 ValueBuying 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 OnlyAlso known as Index funds. Benchmark to a market index
Long Only Hedge FundDo not benchmark to a market index. Also known as Alpha funds they are actively managed.
Long Shortbuying core stocks in a particular index. selling short the corresponding index futures (if the index goes down, the short will offset losses)
Market Neutralisolating 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 ShortSelling short securities that are overvalued (these are extremely risky as prices can increase indefinitely)
Convertible ArbitrageThis 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 MarketEquity and Fixed Income securities in emerging markets around the world
ArbitragePricing 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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