Hedge Funds Flashcards
What are the types of Alternative Asset Funds? Define Hedge Funds
- Hedge funds
**2. Private Equity (invest in companies not publicly traded/listed)
**3. Real Asset Funds (ex. commodities and real estate)
Hedge Funds: pool together funds that aim to make high profits by using strategies like borrowing money, short selling, and trading a wide range of assets like stocks, bonds, and currencies.
* use derivative and hedging techniques to earn a risk free profit
Traditional Investing: Talk about Private Management (Private Wealth) and Investment Companies (Mutual Funds)
Private Management (Private Wealth):
- Clients contract/hire a management and advisory firm - to help manage their wealth
- They help develop a personal relationship with clients
- Usually customized, separate accounts for larger clients with high net worth (instead of pooling money with other investors, these clinets have their own account with (big!) money inside and have unique invetsmnet strategies tailored to that one individual)
Investment companies (Mutual Funds):
- Pooling of investment capital of several clients in an investment company
- Investment company offers a general solution for smaller (retail) clients
- New shares/units are issued representing proportional ownership of the fund
Mutual Fund Companies: Fees
Fill on the Blank:
In a Mutual Fund, there are annual management fees to compensate professional managers of the fund. Usually referred to as “?”
- vary from 0.25-1%
In addition, invetsors are often charged Loan Fees (?,?,?)
However, Mutual fund fees have been “?” due to the industry cosolidation and the “?” in ETFs
(?,?,?) list and describe the 3 differnet types of fees
MER (Management Expense Ratio),
Loan Fees:
- Front-End Load: A fee charged when you buy mutual fund shares.
-
Deferred Load (Back-End Load): A fee charged when you sell mutual fund shares, typically within a specific time frame.
- it typically decreases the longer you hold the fund
- Both: Some funds charge both a front-end and a deferred load, but this is less common
,Declining, growth
Wht is the Limited Partnership Structure?
One or more general partners run the business (and assume its legal obligations) and the remaining limited partners are liable for only the amount of their investment.
- these investors only contribute money to the business but do not run it
- they are only liable for the losses up to the amount that they invested
What consitutues up a Hedge Fund Portfolio?
- Often combines both a long and a short position in same trade/investment
- Uses of financial leverage to enhance return (ex. borrowing money from banks or reinvesting proceeds at a risk free rate)
- Better able to produce superior returns (alpha) than traditional investment structures, such as mutual funds
- Management fee plus performance fee is paid to the manager.
- Limitations as to type of investor allowed (ex. wealthy people who can also handle high risks)
- Limitations as to contributions/withdrawals (low liquidity for investors)
- Little or no regulation or transparency
Who are the Market Particpants?
- High net worth individuals
- Banks
- Endowments & Foundations
- Pension Funds
- Insurance Companies
These players engage in a major role in financial markets by buying, selling, or trading assets.
What are the 3 types of Hedge Funds?
Single Strategy Funds (Non-Directional & Directional):
- where one manager
- focuses on one strategy,
- such as long-short equity
Multi-Strategy Funds:
- where one manager
- employs several strategies,
- such as long-short equity and convertible arbitrage (capitalize on mispricing between a convertible bond and its underlying stock)
Fund of Hedge Funds: is alike an umbrella of HFs,
- where there is more than one manager,
- with each manager is running one of more funds.
- This type of fund of funds often has a higher fee structure, but the reason for it is that is provides huge diversification and higher alpha, as in theory it improves the efficient frontier, or the risk-return profile.
For Single Strategy Funds, what is Non-Directional & Directional
Non-Directional: Exploit temporary misalignments in relative valuation across sectors (example: Buy TD, Sell short Scotiabank)… always have a long & short side to a single trade
* Aim: is to exploit arbitrage opportunities
- Buy one type of security and sell one, usually at the same time
- strives to be market neutral (“hedged or “zero-beta”) - the returns are completely uncorrelated with the market’s return
Directional
* bets that one sector will outperform the other
Both strategies are alpha seekers
What are the 4 main common Single Stratgies used by Hedge Funds
+ which one is the least riskiest and the greatest risk?
- Relative Value: Least riskest
- Event Driven
- Opportunistic
- Global Macro: Greatest Risk
What are the 3 out of 5 Relative Value Strategies?
Convertible Arbitrage: Seeks to profit from disparities in relationship between prices for convertible bonds and underlying common stock.
- Example: Buy Air Canada 5% Convertible bonds and sell short Air Canada stock.
Equity Market-Neutral (EMN): limits the overall volatility of the fund by taking offsetting risk positions on the long and short side.
The fund tries to keep the total market value of long positions equal to the market value of the short positions (PM is continually rebalancing the portfolio
- Example: If $100 AUM, the fund would have $50mm long exposure and $50mm short exposure
Statistical Arbitrage (Market neutral)
- Quantitative systems seek out many temporary and modest misalignments in prices
- USUALLY referred to as a medium-frequency strategy where the trading period occurs over the course of a few hours to a few days.
What are the 2 Event Driven Strategies?
Merger (risk) arbitrage:
Merger arbitrage can only occur when a takeover or merger has been announced.
- Returns are dependent upon magnitude of spread on merger transactions, which relate to the likelihood of the deal closing.
- Take equity positions in companies that are the target of a merger or takeover attempt
Distressed Securities:
event-driven as it can only happen once a company has declared bankruptcy; has defaulted on loan or bond payments; or is about to default. Often these bonds fall in price more than is warranted by the company’s current financial position.
- When HFs invest in risky (high yield) bonds or other securities of distressed firms.
- When companies are in distress and are downgraded by the ratings agencies, often institutional investors are forced to sell as they can only hold a certain percentage of non-investment grade bonds in their portfolios.
What are the Opportunity Strategies? Explain the 3
Opportunistic strategies — these are usually short-term positions where HF managers see a temporary mispricing and try to exploit the perceived arbitrage opportunity.
Long-short equity:
Managers attempt to identify misvalued stocks and take long positions in undervalued ones and short positions in the overvalued ones
Emerging markets:
Broad class seeks to profit from improvements in developing countries.
Managed futures:
Using long and short positions in variety of futures contracts.
What is the Global Macro Strategy?
- Involve long or short positions in capital or derivative markets across the world.
- Portfolio positions reflect views on broad market conditions and major economic trends.
- Some argue that these are not true hedge fund strategies, as they tend to be very directional and there is no “hedge”. They are just leveraged bets on a macro event.
An Ex. of Global Macro event that has been the focus of many investment strategies is Brexit
Define Multi-Strategy Funds and Fund of Funds
Multi-Strategy Funds:
Hedge funds who focus on more than one strategy (but often related strategies), such as funds that specialize in risk arbitrage and distressed securities.
Fund of Funds:
Hedge funds who invest in a number of other funds in orders to achieve maximum diversification (lowest possible combined correlation)
Define Portable Alpha Strategies
Portfolio managers separate alpha from beta by investing in securities that are not in themarket indexfrom which their beta is derived.
- Alpha is the return achieved over and above the market return (beta) without taking on more risk (Or “excess risk-adjusted return”)
In simple terms, portable alpha is a strategy that involves investing in areas that have little to no correlation with the market.
