Hedge Funds Flashcards
(19 cards)
HF
Private pooled investment vehicle. Not an asset class but a variety of investment vehicle. Some HF focus on single asset class while others combine multiple asset class. Classified by strategy. MF managers are not required to invest in their own fund. But HF are usually established as limited partnership & LP’s usually ask managers to invest in it. Investment approach rather than underlying investment that distinguish hedge funds. They don’t hedge risky position against mkt move rather amplify the risk. Take more leverage but overall risk is lower. Seek to limit market exposure and returns from beta and primarily focus on generating idiosyncratic returns by identifying sources of unique return, or alpha. The primary source of hedge fund excess return is market inefficiencies (which may be short lived) and the skills of the manager in leveraging them.
Benchmarking performance
Can’t benchmark return with index return due to strategies used. Thus, many hedge funds evaluate their performance using an absolute return standard instead of tracking a benchmark
HF vs PE
HF typically have short time horizon & invest in more liquid asset classes. HF invest in public securities vs PE invest directly in private co & they don’t use leverage. Redeemable on periodic basis vs Require long term commitment. Investors fund at start of investment vs committed at start and funded over time. Mgt fee based on AUM vs Committed Capital
Equity HF strategies
Most use bottom up security specific approach. Fundamental long/short, Fundamental growth, Fundamental value, Short biased (just short overvalued equity with limited upside - negative correlation with other strategies. Generally, this approach doesn’t generate high return) & Mkt neutral (lowest positive correlation with mkt)
Event driven strategies
Seek to profit from defined events that are expected to change valuations such as acquisition or restructuring. Merger arbitrage, Distressed/restructuring (Instruct in FI securities of co that are either in or near bankruptcy. Sometimes purchase FI that are expected to be converted into equity called fulcrum security), Special situations (buy equity of co engaged in security issuance or repurchase, rescue finance, asset sale/spinoff), Activist
Relative value strategies
Seek to profit from pricing discrepancy between related sec based on unusual short-term relationship. Expectation is that short term discrepancy will be resolved over time. Convertible bond arbitrage (Can be sensitive to bankruptcy risks; however, they may be hedged away using either equity put options or CDS derivatives on the issuer), Fixed income (general) (Focus on the relative value within the fixed-income markets), Fixed income (asset backed, mortgage backed, and high yield), Multi-strategy (Rather than focusing on one type of trade (e.g., convertible arbitrage), a single basis for a trade (e.g., merger arbitrage), or a particular asset class (e.g., fixed income), this strategy instead looks for any available investment opportunities).
Opportunistic strategies
Funds that focus on macro events and commodity trading. Often use index ETF securities or derivatives in addition to individual securities. Macro strategies (top down approach, active moves by national authorities to smooth economic shocks shrink their investment sphere because they benefit profit from periods of higher volatility), Managed future funds (investment primarily in future mkt. Also called CTA because historically focused on comm futures. CTAs may include investment in commodity, equity, FI & Forex futures). Commodity focused managed future funds are unique compared to Macro because there is a constant price tension between suppliers & customers
Redemption fee
payable to fund itself rather than mgr
Soft lockup
Pay extra to redeem during lockup period
Primary drivers of return for HF
Mkt volatility & Mkt inefficiency
Private placement memorandum (or) Partnership agreement (or) Articles of incorporation
Lay out the legal and contractual relationship between the fund manager and the fund investor and create the operational framework for the fund.
Side letters
Address the specific legal, regulatory, tax, operational, and reporting requirements of an investor. Such side letters complement and can occasionally supersede the terms of the fund’s documents and are typically used when a HF investor requires concessions without changing the private placement memorandum, the partnership agreement, or the articles. Occasionally, specific rights are conferred to a particular investor, such as enhanced information rights.
Master feeder structure
A common HF form. Set up for optimum tax efficiency which consist of offshore & onshore feeder fund both feeding into a master fund. Investors in taxable jurisdictions do not avoid taxes by investing in offshore funds. Pooling funds from offshore and onshore funds creates economies of scale. Allows hedge funds to accept funding from global investors with relative ease. Many regional regulatory requirements can be avoided by such a structure.
Separately Managed Accounts
Investor creates his or her own investment vehicle and the underlying assets are held and registered in the name of the investor. However, the day-to-day management of the account is delegated to the hedge fund manager. Allows for a customizable portfolio, with investor-specific investment
mandates, better transparency, efficient capital allocation, and higher liquidity, over which the investor can exercise enhanced control while keeping the fees lower.
Fund of fund
Pool funds from investors and invest the proceeds in a diversified portfolio of hedge fund investments across a variety of hedge funds. Offer generally lower investment minimums, reduced lockup periods, and typically better exit liquidity with high fee
ETF
seek to replicate hedge fund investment style without directly investing in hedge funds themselves. Returns often fall short because these are publicly traded hence subject to regulations, do not impose restriction on redemption & can’t use leverage to same level.
Mkt Beta vs Strategy Beta vs Alpha
Broad market beta that can be realized using market index–based funds/ETFs vs Beta attributed to the investment strategy of the hedge fund applied across the broad market vs Manager-specific returns, due to the selection of specific positions
An investor wants to invest in a diversified hedge fund that minimizes the return correlation with the traditional asset classes but would prefer the fund to be more liquid and transparent while minimizing the leverage obtained by borrowing or shorting
Managed futures
Accredited retail investors can
invest in various types of hedge funds
