Alternative Investments: 1

Question 1

What are hedge funds?

Answer 1

They are alternative investment vehicles available to certain types of investors.

Question 2

Trying to hedge the market

Answer 2

• Long and short positions in traditional securities (trying to produce a zero beta portfolio = zero systematic risk).
• Investing in more complex, sophisticated and more risky investments, asset classes and techniques.

Question 3

Hedge Funds and Investors

Answer 3

Accredited investors:

• banks and wealth management firms
• long term institutional investors
• small business investment companies

High net worth investors
Lightly regulate investors

Question 4

Fund of hedge funds vs Listed Funds

Answer 4

Hedge Funds

• spreading the financial risk via diversification
• fund of hedge fund are selective in order to generate higher relative returns
• for unlisted funds, financial statements are less transparent

Listed Funds

• shares of liquid
• dealings are more transparent

Question 5

What are gates, lockups and side pockets?

Answer 5

They are used to prevent the manager having to liquidate funds at a time when prices are not favorable for redemption and hence to prevent a run on funds.

Question 6

Lock-up period

Answer 6

Money invested in hedge funds can be locked up for a certain period. Hence, money cannot be withdrawn by HF investors during this period.

Question 7

Gates

Answer 7

Setting upper bounds on the proportion of the amount HF investors are allowed to withdraw at any time.

Question 8

Side pocket

Answer 8

Enables a fund manager to separate a difficult to value or liquidate from all other investment, and hence investors who withdraw money from the fund cannot redeem any investment which has been placed in a side pocket.

Question 9

Offshore

Answer 9

A signification proportion of hedge funds are registered in offshore financial centers in different locations.

Question 10

Hedge Fund Strategies

Answer 10

• Arbitrage
• Fixed income arbitrage
• Convertible bond arbitrage
• Long/short strategy
• Market neutral
• Event driven
• Global macro
• Activist strategy
• Multi strategy
• Fundamental growth/value

Question 11

Fund Mangers, Performance Fees, Undue Risk

Answer 11

• Fund mangers should state to investors the types strategies they intend to follow.
• Performance fees are often very (as high as 50%)
• Hedge funds often take very high risks by investing in complex financial products and by adopting risky strategies.

Question 12

Leverage

Answer 12

Leverage or gearing is a method that involves the use of borrowed funds for purchasing an asset.
Investors expect the net income from the asset to exceed the corresponding borrowing cost.
Hedge fund only have to deposit a small proportion of the underlying exposure as margin.