chapter 26 3fb3 Flashcards
Q: What is the primary difference in accessibility between hedge funds and mutual funds?
A: Hedge funds are typically only available to accredited investors, while mutual funds are open to all investors.
Q: How do hedge funds and mutual funds differ in their investment strategies?
A: Hedge funds use aggressive strategies, such as short selling, leverage, and derivatives, while mutual funds generally focus on diversified, long-term investments.
Q: What is a key difference in fee structures between hedge funds and mutual funds?
A: Hedge funds charge a performance fee (e.g., “2 and 20” structure), whereas mutual funds charge management fees and may include front-end or back-end loads.
Q: What is a directional strategy used by hedge funds?
A: Directional strategies involve betting that some sectors or assets will outperform others, often relying on market trends and sector-specific information.
Q: What is a non-directional strategy used by hedge funds?
A: Non-directional strategies aim to exploit temporary misalignments in relative valuations by buying one type of security and selling another, striving to remain market neutral.
Convertible Arbitrage & Dedicated Short Bias
Convertible Arbitrage: Involves hedged investing in convertible securities, typically combining long positions in convertible bonds with short positions in stocks.
Dedicated Short Bias: Maintains a net short position, often in equities, focusing on profiting from declining asset prices rather than pure short exposure.
Emerging Markets & Market Neutral
Emerging Markets: Exploits market inefficiencies in emerging markets. Strategies are typically long-only, as short-selling may not be feasible in these regions.
Market Neutral: Uses long/short hedges, controlling for factors like industry, sector, and size. Aims to exploit inefficiencies while staying market neutral. Often involves leverage.
Event Driven & Fixed-Income Arbitrage
Event Driven: Focuses on profiting from situations like mergers and acquisitions (M&A), restructurings, bankruptcies, or reorganizations.
Fixed-Income Arbitrage: Seeks to profit from price anomalies in related interest rate securities.
Convertible Arbitrage & Global Macro
Convertible Arbitrage: Focuses on hedged investments in convertible securities, typically involving long convertible bonds and short stocks.
Global Macro: Involves taking long and short positions in capital or derivative markets globally, based on macroeconomic trends.
Long/Short Equity & Managed Futures
Long/Short Equity: Equity-oriented positions, either long or short, depending on market outlook. Not designed to be market neutral.
Managed Futures: Uses financial, currency, or commodity futures to capitalize on market trends.
Multi-Strategy & Funds of Funds
Multi-Strategy: Opportunistic selection of multiple strategies based on market conditions and outlook.
Funds of Funds: Allocates its cash across several other hedge funds, providing diversified exposure.
Statistical Arbitrage
Definition: Uses rapid-trading technology to identify and exploit misalignments in relative pricing.
Purpose: Achieves profits by diversifying across multiple small bets based on quantitative models.
High-Frequency Strategies
Dependent on: High-frequency trading and electronic news feeds.
Applications: Reacts quickly to market data and news to execute trades at high speeds
Cross-Market Arbitrage & Electronic Trading
Cross-Market Arbitrage: Identifies price differences across markets for the same or similar assets.
Electronic Trading: Includes market-making and “front running,” leveraging advanced algorithms for profitability.
Portable Alpha
A strategy that allows investors to separate alpha (excess return) from beta (market risk) and transfer it to a different asset class. This enables investors to profit from skilled active management in one area while maintaining exposure to a broader market through passive investments.
Steps of Portable Alpha Strategy contain:
Invest in a positive alpha position: Identify and invest in assets or strategies expected to outperform (generate alpha).
Hedge systematic risk: Use derivatives or other tools to eliminate exposure to market-wide risks, isolating alpha.
Establish desired market exposure: Achieve exposure in another asset class by investing in passive index funds or ETFs.
Key Insight of Portable Alpha:
Also called alpha transfer, this strategy allows investors to profit from areas of inefficiency (where alpha is achievable) and transfer those returns to complement broader market exposure in the asset class they prioritize.
Equity Market-Neutral Funds
These funds have uniformly low and statistically insignificant factor betas.
Goal: Achieve market-neutral returns by balancing long and short positions in equities.
Dedicated Short Bias Funds
These funds exhibit substantial negative betas on the market index.
Strategy: Primarily take short positions, betting that the market or specific stocks will decline.
Distressed-Firm Funds & Fixed-Income Arbitrage Funds
Distressed-firm funds: Have significant exposure to credit conditions and the market index, focusing on troubled companies.
Fixed-income arbitrage funds: Show positive exposure to the differential return between corporate bonds and T-bonds.
Standard Index Model - U.S. Equity Market as Benchmark
Estimated over a 5-year period ending in Dec 2018.
Betas tend to be considerably < 1, meaning the hedge funds are less volatile than the market.
Beta of short-bias index is large and negative, reflecting its inverse correlation with the market.
Hedge Fund Performance (Post-2010)
Average performance is below average.
Average alpha across indexes: slightly negative (-0.055% per month).
Average Sharpe ratio also negative, indicating that the average return is less than the risk-free rate.
Historical Hedge Fund Performance
Before 2010, hedge funds substantially outperformed passive indexes.
Performance has since declined, with hedge funds struggling to generate superior returns compared to market indexes.
Hedge Funds and Illiquid Assets
Hedge funds tend to hold more illiquid assets.
Aragon’s study suggests that part of the “alpha” they exhibit may actually be a liquidity premium, rather than an indication of stock-picking ability.
