BUA651
Hedge Funds
• What is a hedge fund?
A hedge fund is an alternative investment vehicle which is different
from traditional investment funds in a number of ways. The
legislative requirements are less restrictive for hedge funds. This
allows hedge funds to use a number of financial instruments and
investment tactics which are off limits to traditional investment
funds. For instance, hedge funds are allowed to use high leverage
and can go short in a number of markets, e.g. stock, securities,
currency and commodities markets.
• What is "hedging"?
Hedging is another word for risk management. The fund managers
apply hedging techniques in order to mitigate a certain type of risk.
Types of risk hedged against include: market risk, inflation risk,
long exposure risk, interest rates and large sector weightings
(region, sector, company, currency). Hedging techniques include
raising cash and selling short as well as buying/selling options,
futures or commodity.
Hedge Fund Strategies
• Merger Arbitrage - an event-driven strategy in which
the arbitrageur takes a position of both companies
involved in a merger or acquisition, typically long the
stock of the company being acquired and short the
stock of the acquirer.
• Fixed Income Arbitrage - a strategy designed to
capture pricing disparities within fixed income markets
and related derivatives. Examples of where such
disparities may exist are yield curve anomalies,
volatility differences and the futures market versus the
underlying bonds.
• Global Macro - a broad strategy that invests (long or
short) across asset classes in anticipation of market
movements or trends in interest rates, currencies,
commodity prices and equity markets.
Hedge Fund Strategies
• Convertible Arbitrage - a strategy designed to take
advantage of pricing inefficiencies of the embedded
option in a convertible bond. Typically, the arbitrageur
would be long the convertible position and short the
underlying stock.
• Equity Market Neutral - a strategy designed to exploit
equity price inefficiencies through balanced long and
short positions that insulate the portfolio from overall
market risk.
• Long/Short - the most common hedge fund strategy in
which a manager takes long and short equity positions.
Depending on the mix of long and short positions the
portfolio may have a long bias or short bias.
Hedge Funds QA
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What are some ‘short sale’ intricacies?
When a broker facilitates the delivery of a client's short sale, the
client is charged a fee for this service, usually a standard
commission similar to that of purchasing a similar security. If the
short position begins to move against you (rise in price), money will
be removed from your cash account and moved to your margin
account. If short shares continue to rise in price, and you don't have
enough funds in your cash account to cover the position, you'll
begin to borrow on margin for this purpose. At that time, you'll also
begin to accrue margin interest charges. These will be computed
and charged the same as for a regular margin debit. When short
selling a stock that pays dividends and the ex-dividend date passes
while you are short the stock, the dividend will be deducted from
your account. It should also be noted that contrary to standard
finance theory, the short seller often does not enjoy the benefits of
the proceeds of the short sale to earn interest or reduce outstanding
margin amounts. The brokers generally do not pass this benefit on
to the retail client, unless the client is very large.
Hedge Funds QA
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Are all hedge funds aggressive risk takers?
No, a number of hedge funds, particularly in recent years as institutional
investors have entered the hedge fund investment business focusing
exclusively on generating stable, consistent returns by employing low risk
investment strategies.
What are hurdle rates?
The minimum investment return a fund must generate before it is eligible
to take a performance allocation or an incentive fee.
What are lock-up periods?
The amount of time during which assets cannot be removed from the
hedge fund.
Who typically invest in hedge funds?
Pension funds, insurance companies, fund of funds, endowments and
qualified clients.
http://www.hedgenordic.com/?pageid=47
http://www.commonfund.org/Commonfund/Help/Glossary.htm#pcm
Hedge Fund project – some
specifics
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1. This is a market-neutral paper portfolio exercise, for illustration of
investment and modern portfolio theory concepts. It is not to be
construed as investment advice of any sorts, I am not a financial
planner.
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2. Buying a Short ETF is a short and not a long, will you hedge it
with another short on the short side? Also a short ETF/Fund has a
higher expense ratio, remember you are the investment pro in the
making, you do not want a pro to do your work. No mutual funds in
the portfolio as well, except CE funds and only if there are no
comparable ETF’s – such as IRL or IFN
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3. You do not need equal number of securities on each side, strive
for beta neutrality, but you must have $ neutrality at the very least. If
you have a stock only long portfolio - about 16-20 stocks is
necessary for minimal diversification. If you have ETFs you can
have fewer on each side.
Hedge Fund project – some
specifics
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4. Shares are traded in 'round lots' , which are multiples of 100 (most
of the times). Anything else will incur higher trading costs or may
not be feasible. Minor deviations around total portfolio value are
expected and not a problem. Multiples of 10 are OK for this project.
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5. Beta-non stationarity' problem – betas are being calculated
differently by the different sites? Simple solution for now - use betas
from a single source - since different providers use varying
assumptions about how to calculate it. Cross-check the ETF betas
with those from my XL sheet, the website that has numbers closest
to mine is doing a better job, then go with them. You can read my
latest paper on ETF betas that discusses this.
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6. You cannot invest in indices – they are non-investible – an
instrument has to have a bid-ask for it to be tradeable, for example
^ATDOW is the Austria index (non-tradeable), use EWO to
trade/track it. The Euro such as ^DJEURO is an index – FXE is the
associated index. iShares.com, Yahoo ETF sites list ETF’s by type.
Hedge Fund project – some
specifics
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7. Fund expenses: The ultimate objective of this project is to
simulate real market conditions that impact investor bottom line.
When you calculate your net return at the end of semester a higher
ETF fee will eat into your gross return. So you make the call.
http://funds.reuters.com/lipper/retail/reuters/expenses.asp
http://finance.yahoo.com/q/pr?s=spy
http://www.ishares.com/fund_info/all_funds_profile.jhtml
8. Various market betas: Since you are a US investor keep it simple
at SP500 (SPY) as the relevant market...most other securities in your
portfolio have US market betas.
Hedge Fund project – some weblinks
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A good primer on ETF's
http://finance.yahoo.com/etf/education
http://www.ishares.com/learn/index.jhtml
http://amex.com/ (click on ETF's)
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About fund expenses:
http://quicktake.morningstar.com/DataDefs/FundNutsAndBolts.html
http://funds.reuters.com/lipper/retail/reuters/expenses.asp
Other ETF resources:
http://www.etfconnect.com/
http://www.etftopics.com/sitemap/
http://www.currencyshares.com/
http://etfscreen.com/
For the ETF correlation and beta matrices :
http://advancedportfoliosolutions.com/aps-research.html
http://www.sectorspdr.com/correlation/