AI Articles Hedge Funds Flashcards
How are hedge funds organized?
- they are usually limited partnerships (fund has to pay no taxes on investment returns, only the investor)
- investors are limited partners
- managers are general partners
–> similar to PE
commodity trading pools
- regarded as part of the same investment universe as hedge funds
- similar structure to hedge funds but are operated by commodity trading advisors (CTAs) –> they trade futures contracts traditionally, now the lines blurr
How are the returns of hedge funds different from mutual funds?
- more than half of mutual funds have R^2 above 75%
- half of hedge funds have R^2 below 25%
- -> R^2 measured on the returns of 8 standard asset markets
R^2
R-squared is generally interpreted as the percentage of a fund or security’s movements that can be explained by movements in a benchmark index.
What are hedge funds and mutual funds exposed to?
- mutual funds are strongly positively exposed to US stocks and bonds.
- hedge funds have exposures in all asset markets and about 25% are negative exposures through short positions.
How do hedge funds leverage their bets?
By margining their position and short sales
What does margining a position mean?
- it is position financing
- -> if you take a position greater than the amount of cash in your account, interactive brokers may finance part of your position opening up to a certain limit (margin)
Which type of fee do mutual funds get and which do hedge fund managers get
- mutual funds get symmetric payment. Gains lead to a gain for the manager and a loss of the fund leads to a loss for the manager.
- hedge funds managers receive asymmetric fees. They receive positive incentives for gains but are not required to rebate (rückerstatten) fees to investors for losses.
What is the advantage of a Private Limited Partnership?
- there is no double taxation
Why are there offshore funds?
- to min. investors’ tax burden
- min. managers tax burden on incentive fees. Deferred tax payment
- for “non-US persons” and register in tax free jurisdictions
Two approaches to setting investment targets
- relative returns
- absolute returns
Which returns are hedge funds styles usually based on?
On absolute return strategies. they are expected to deliver performance irrespective of market conditions
Two main approaches to achieve absolute return targets
- Market Timing Approach (MT)
long or short attempting to capture the rise and fall of the market - can have seemingly uncorrelated returns to the market over time but significant correlation over a short period of time
- Non-Directional (ND) (low volatility)
extraction of value from a set of diversified arbitrage opportunities - can approach zero correlation to market indices
What part of a traditionally-managed portfolio are hedge funds?
the purely active part
How are the active weights calculated?
h = w-b
h= active weight w= portfolio weights b = benchmark weights
Why is the theoretical h not achievable?
in practice short positions require margin cash. The h has a zero investment and thus no margin cash available.
Why might is be more attractive to hold a passive index plus a hedge fund?
- due to specialization
- the hedge fund is pure information based trading with no capital investment.
Why is the incentive fee crucial for the success of a hedge fund?
- a pay-for-profits compensation causes the manager’s aim to be absolute returns, not merely beating a benchmark
What is a pitfall of the asymmetric incentive fee structure?
there is no corresponding penalty for negative returns
- there is the possibility that managers will be tempted to take excessive risk, in pursuit of asymmetric incentive fees
high water mark
an absolute minimum level of performance over the life of an investment that must be reached before incentive fees are paid
–> ensures that a fund manager does not receive incentive fees for gains that merely recover losses in previous time periods
hurdle rate
another minimum level of performance(typically the return of a risk-free investment) that must be achieved before profits are determined. Only for a single period.
equalization
to treat both earlier and new investors into a hedge fund fairly, the adjustment for profit calculations is an accounting process called equalization
classic long short position
choose two closely related securities, short the perceived overvalued one and long the undervalued one. This eliminates systematic risk in theory. But it is rarely completely market-neutral. Their typically is either a long bias or a short bias.
Relative value strategy
- is a market-neutral strategy
- takes advantage of perceived mispricing between related financial instruments.
