Hedge Funds

Question 1

Hedge funds

Answer 1

Private pooled investments available to accredited investors
- Lightly regulated
- Managers have greater freedom
- Usually subject to high-water mark (performance fees payable when fund value exceeds prior value)
- Privately held

Question 2

Equity hedge fund strategies

Answer 2

Profit from long or short in publicly traded equities and derivatives

Question 3

[Equity strategy] Fundamental long/short

Answer 3

Long in undervalued securities while having short in portfolio of stocks or an index

Question 4

[Equity strategy] Fundamental growth

Answer 4

Fundamental analysis to find high-growth comanies

Question 5

[Equity strategy] Fundamental value

Answer 5

Buy shares believed to be undervalued and short overvalued stocks

Question 6

[Equity strategy] Market neutral

Answer 6

Fundamental analysis to hold undervalued equities long / overvalued equities to be sold short

Question 7

[Equity strategy] Short bias

Answer 7

Predominantly short positions in overvalued equities with negative market exposure overall

Question 8

Event-driven strategies

Answer 8

Corporate restructuring or acquisition that creates profit opportunities (long-biased)

Question 9

[Event-driven] Merger arbitrage

Answer 9

Buy shares of firm being acquired and sell short of firm making acquisition

Question 10

[Event-driven] Distressed/Restructuring

Answer 10

Buy shares when analysis shows potential recovery after restructuring

Question 11

[Event-driven] Activist shareholder

Answer 11

Buy enough shares to be able to influence company policy

Question 12

[Event-driven] Special situations

Answer 12

Buy shares when firms issue repurchasing securities, do spin-offs, sell assets ect

Question 13

Relative value strategies

Answer 13

Buying security and selling short a related security with goal of profiting when pricing discrepancy is solved

Question 14

[Relative value] Convertible arbitrage fixed income

Answer 14

Exploit discrepancy between convertible bonds and common stock

Question 15

[Relative value] Specific fixed income

Answer 15

Exploit pricing and quality differences

Question 16

Opportunistic strategies

Answer 16

Focus on macro events and commodity trading
Implemented using ETFs, derivatives, individual securities

Question 17

[Opportunistic] Macro strategies

Answer 17

Based on global economic trends and events
- Benefit from high volatility
- Smoother economic shocks reduce gains

Question 18

[Opportunistic] Managed futures

Answer 18

Trade commodity futures / financial futures

Question 19

Uniqueness of Hedge funds

Answer 19

• Less regulated and flexible mandates
• Higher cost - higher overall feels
• Lower liquidity including lockup periods, notice period, liquidity gate (restriction on redemption)

Question 20

Hedge fund structures

Answer 20

1) Commingled funds
2) Separately managed accounts

Question 21

Commingled funds

Answer 21

Master-feeder structure: Funds flow into master fund which makes investments
- Tax efficient
- Economies of scale
- Allows for global investors

Question 22

SMAs

Answer 22

• Customized portfolio
• Manager has no stake in fund (risk)
• Require more operational oversight

Question 23

Fund-of-funds

Answer 23

Investment company that invests in hedge funds - allows diversification among hedge fund strategies

Question 24

Hedge fund return sources

Answer 24

Market beta
Strategy beta = beta from specific sector exposure
Alpha = additional return delived by manager through security selection

Question 25

Hedge fund performance measurement

Answer 25

Usually higher than actual due to bias
- Survivorship bias: Funds might not be included until they reach certain threshold
- Selection bias: Index providers lack consistency in selection criteria
- Backfill bias: Historical index returns of adding fund returns to prior years