Hedge Funds Flashcards
What is a hedge fund?
Alternative Investment
Aim to deliver absolute returns
Use a variety of investment stratergies
Where are hedge funds located? Why?
Offshore
Tax Benefits & Lax Reporting
Who regulates HFs in the UK?
The FCA
Despite being offshore / unauthorised
Who are hedge funds aimed at? Why?
UHNWI & Institutions
High minimum investment
What restrictions are HFs subject to?
Short Selling
Credit Default Swaps
How are HFs regulated re: Short Selling
1) Disclose positions >0.2%
2) Limited ability during market turmoil
3) Banned from Naked Shorting
Short selling not permitted during COVID
What to HFs aim to deliver?
Absolute Returns
Regardless of market conditions
What fees do HFs charge?
Management (1.5%-2%)
Incentive / Performance
Give 3 Points about HF incentive fees?
1) Pay out after reaching a certain level
2) cannot be paid until a high watermark NAV is met
3) Losses must be recouped before it is paid
How are managers renumerated?
1) Fixed Fee - % of AUM
2) Performance Fee
What jurisdictions are HFs domiciled in?
- Cayman Islands
- Bahamas
- Bermudas
What are the three types of Hedge Fund Strategy?
1) Arbitrage / Non-Directional
2) Event Driven
3) Directional
What are non-directional funds?
Aim to deliver a positive return in all markets - exploit mispricings
Eliminate Market Risk - Performance is down to managers skill
What is an event driven fund?
Seeks to exploit mispricing following events e.g.
1) Corporate Actions
2) Mergers
3) Bankruptcy
Tend to be short term funds (apart from distressed)
What is a directional fund
Takes a view on direction of market or asset class.
What two categories of directional funds are there?
1) Equity Hedge
2) Tactical Trading
What are the 3 event driven funds?
1) Special Situations
2) Merger Arbitrage
3) Distressed Companies
What are the 6 non-directional funds?
1) Equity Market Neutral
2) Convertible Arbitrage
3) Statistical Arbitrage
4) Fixed Income Arbitrage
5) Relative Value
6) Volatility Arbitrage
What are the 4 equity hedge directional stratergies
1) Long/Short
2) Short Only
3) Emerging Markets
4) Private Placements
What are the 2 tactical trading stratergies
1) Global Macro
2) Systematic Stratergies
How does relative value work?
- Focuses on two assets and the spread between them
- Buy or sell the spread using instruments like swaps
- If spread is to widen you would sell
How does fixed income arbitrage work?
Exploit inefficiencies in:
1) Yield Curves
2) Spreads
3) Pricing
Can purchase different durations from the same issuer
(if yield is rising at long end of issuer curve -> buy short sell long duration)
What is an equity market neutral strategy?
1) Pick two correlated assets (pairs trading)
2) Go Long / Short to create a balanced beta
3) High risk of betas changing
What is convertible arbitrage?
1) Long convertible
2) Short Issuer equity
3) Exploit mispricings
Criticisms / Risks of Convertible Arbitrage:
1) Riskier than orignally assumed
2) Long and Short can move against you
3) Lost popularity during ultra low rate environment
With rate uncertainty - it’s more prevalent
What is statistical arbitrage?
- Use statistics to generate signals to trade
- Belief of mean reversion (hard to say when mean will revert)
- Uses momentum investing
What is volatility arbitrage?
- Using options to trade implied vs forecasted volatility
- If you beleive volatility is overstated sell a call option
- Profit from changes in option pricing
What is a special situations fund?
- Attempt to profit from mispricing following:
- Corporate Actions
- Takeovers
- Bankruptcies
- Valuations are out of line / inaccurate
What is Merger Arbitrage?
Profit from spreads changing following merger announcements
- Buy target
- Sell acquirer
- Low risk unless merger fails
What is a distressed companies fund?
Firm facing bankruptcy assets’ will trade cheap
1000bps over base rate
CCC rated
Fund takes the view that company will survive and can buy assets cheap
Only long term event driven strategy.
What is Long / Short directional?
- Identify intrinsic price
- Identify mispricing (long and short)
- Will be net long / net short
- Outperform in bear market
- underperform in rapidly rising markets
What is a short only fund?
- Due diligence to find overpricing / problems
- Permanent pessimists
- Work as a hedge in bear market
- Rare now as markets are upward trending
What is an emerging markets hedge fund?
- Uses equity, debt, commodities & special sits
- Targets high growth areas like BRICs
- Record of outperforming developed markets
- Growth worse in recent times
- Higher risk e.g. Russia
What is a private placement hedge fund?
Invest in securities which do not require a full prospectus
Issued direct to investors (not public)
What is a global macro hedge fund?
- Popularised by George Soros
- Large best on macro e.g. FX or Index
- Combine research with technical analysis
What is a systematic directional hedge-fund?
- Use maths / models to generate signals
- Ride Trends
- Use intermarket tactics (e.g. JPY / AUD pair relationship)
- Blackbox funds - use Propreiatary systems that are not disclosed to the public
Benefits of Fund of Fund HF
- Smaller investors get access
- Manager Knowledge
- Access to closed funds
- Diversification
Limitations of Fund of Fund HF?
- Double Fee - hard to make profit
- No communication with HF manager
- Diversification can be counter-productive
- Less visibility of underlying
