Chapter 16 CAIA Flashcards - Structure of the Hedge Fund Industry
Hedge Fund Definition
A hedge fund is an investment pool or investment vehicle that
(1) is privately organized in most jurisdictions;
(2) usually offers performance-based fees to its managers; and
(3) can usually apply leverage, invest in private securities, invest in real assets, actively trade derivative instruments, establish short positions, invest in structured products, and generally hold relatively concentrated positions.
Safe Harbour
In investments, a safe harbor denotes an area that is explicitly protected by one set of regulations from another set of regulations.
High Water Market
The high-water mark (HWM) is the highest NAV of the fund on which an incentive fee has been paid. Thus, the HWM is the highest NAV recorded on incentive fee computation dates but not necessarily the highest overall NAV.
Optimal Contracting
Optimal contracting between investors and hedge fund managers attempts to align the interests of both parties to the extent that the interests can be aligned cost-effectively, with marginal benefits that exceed marginal costs.
Managerial Co-Investing
Managerial coinvesting in this context is an agreement between fund managers and fund investors that the managers will invest their own money in the fund.
Excessive Conservatism
Excessive conservatism is inappropriately high risk aversion by the manager, since the manager’s total income and total wealth may be highly sensitive to fund performance.
Perverse Incentive
A perverse incentive is an incentive that motivates the receiver of the incentive to work in opposition to the interests of the provider of the incentive.
Pure Asset Gatherer
A pure asset gatherer is a manager focused primarily on increasing the AUM of the fund. A pure asset gatherer is likely to take very little risk in a portfolio and, like mutual fund managers, become a closet indexer.
Closet Indexer
A closet indexer is a manager who attempts to generate returns that mimic an index while claiming to be an active manager.
Managing Returns and Massaging Returns
The terms managing returns and massaging returns refer to efforts by managers to alter reported investment returns toward preferred targets through accounting decisions or investment changes. Consistent with this hypothesis, Agarwal and colleagues find that December returns for hedge funds were higher than other months by 1.5% and that, after controlling for risk, residual returns continued to be 0.4% higher. The authors conclude that hedge funds may be managing, or massaging, their reported returns. However, they cannot explain why returns were unusually low between June and October of each year.
Classification of Hedge fund Strategies
Macro and Managed Futures Funds
Event-Driven Hedge Funds
Relative Value Hedge Funds
Equity Hedge Funds
Funds of Hedge Funds
Macro & Managed Futures
Macro
Managed Futures
Event-Driven Hedge Funds
Activists
Merger Arbitrage
Distressed
Event Driven Multi Strategy
Relative Value Hedge Funds
Convertible Arbitrage
Volatility Arbitrage
Fixed-Income Arbitrage
Relative Value Multistrategy
Equity Hedge Funds
Long/Short
Market Neutral
Short Selling
Short Volatility Exposure
Short volatility exposure is any risk exposure that causes losses when underlying asset return volatilities increase.
Convergent Strategies
Convergent strategies profit when relative value spreads move tighter, meaning that two securities move toward relative values that are perceived to be more appropriate.
Relative Return Product
A relative return product is an investment with returns that are substantially driven by broad market returns and that should therefore be evaluated on the basis of how the investment’s return compares with broad market returns.
Fee Bias
Fee bias is when index returns overstate what a new investor can obtain in the hedge fund marketplace because the fees used to estimate index returns are lower than the typical fees that a new investor would pay.
Instant History Bias
Instant history bias or backfill bias occurs when an index contains histories of returns that predate the entry date of the corresponding funds into a database and thereby cause the index to disproportionately reflect the characteristics of funds that are added to a database.
Liquidation Bias
Liquidation Bias, which occurs when an index disproportionately reflects the characteristics of funds that are not near liquidation.
Participation Bias
Participation bias may occur for a successful hedge fund manager who closes a fund and stops reporting results because the fund no longer needs to attract new capital.
Synthetic Hedge Funds
Synthetic hedge funds attempt to mimic hedge fund returns using listed securities and mathematical models. These funds are designed to replicate the returns of successful hedge fund strategies but at a lower cost to investors as a result of lower fees.
