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Trimester 4 > Hedge Funds 2 Performance, data and strategies > Flashcards

Hedge Funds 2 Performance, data and strategies Flashcards

1
Q

How much do hedge funds invest on behalf of institutional investors and wealthy individuals?

A

3 trillion USD

3000x1billion

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2
Q

Which type of returns do hedge funds try to deliver?

A

Absolute returns or alpha which are returns not explained by general market movements

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3
Q

What volatility is high for hedge funds?

A

Idiosyncratic volatility. Additionally, some risks may remain hidden until it’s too late.

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4
Q

Idiosyncratic volatility.

A

Idiosyncratic risk is a type of investment risk, uncertainties and potential problems that are endemic to an individual asset (like a particular company’s stock), or group of assets (like a particular sector’s stocks), or in some cases, a very specific asset class (like collateralized mortgage obligations). It is also referred to as a specific risk or unsystematic risk.

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5
Q

What is the Sharpe ratio?

A

expected return in excess of risk free rate, divided by the volatility of the excess return

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6
Q

another word for risk-averse investor

A

mean-variance investor

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7
Q

What does a risk-averse investor strive for in relation to the Sharpe ratio?

A

a maximization of the Sharpe ratio (maximization of the expected returns at a given level of risk)

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8
Q

What is Markowitz portfolio theory?

A

Modern Portfolio theory. So CAPM

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9
Q

What is the tangency portfolio?

A

The interception of the Capital Allocation Line and the efficient frontier- The tangency portfolio only contains risk assets (no risk free asset)

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10
Q

How can you get a portfolio on the Capital Allocation Line?

A

optimally get the tangency portfolio and combine it with the risk free rate

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11
Q

Considering CAMP why could hedge funds be interesting?

A

They usually do not have very high Sharpe ratios so they are under the efficient frontier. But they have a low correlation with existing asset classes, they may provide attractive diversification opportunities.

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12
Q

What could happen if you have a hedge fund in your portfolio?

A

If the hedge fund has a positive alpha, then the Capital Allocation line moves upwards and leads to a more attractive Sharpe ratio for the portfolio.

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13
Q

What implication would a negative alpha of a hedge fund have for you?

A

It would require a short position in the hedge fund

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14
Q

What strategies provide positive alphas relative to the market portfolio?

A

Overweighting small cap stocks
Overweighting value stocks
Overweighting stocks that had high returns over the past year (momentum)

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15
Q

What is overweight?

A

Overweight can also refer—in a looser sense—to an analyst’s opinion that a stock will outperform others in its sector or the market. In this sense, it is a buy recommendation, essentially. Conversely, when an analyst suggests underweighting an asset, they refer to it being less attractive to other investments.

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16
Q

What are value stocks?

A

Value stocks are classified as stocks that are currently trading below what they are really worth and will therefore provide a superior return.

17
Q

Is CAPM completely accurate?

A

No, empirically a large number of anomalies where reported (particularly in the equity market)

-> led to a range of multiple-factor models

18
Q

What is the Fama-French three factor model?

A

It introduces two new factors to the CAPM, which are SMB and HML.

19
Q

SMB (size factor)

A

SMB (small minus big)

return on a portfolio of small stocks minus the return on a portfolio of large stocks (small minus big)

20
Q

HML (value factor)

A

(high minus low)

return on a portfolio of high book-to-market value stocks minus the return on a portfolio of low book-to-market value stocks.

21
Q

What is the challenge for a professional money manager?

A

To outperform relative to the market portfolio and the factors of Fama-French so + SMB and HML

-> so provide positive alpha in a three-factor linear regression (this is harder than a positive alpha only with CAPM)

22
Q

What did Carhart introduce to evaluate mutual funds?

A

He introduced a 4-factor model to incorporate something that even Fama-French couldn’t explain.

23
Q

What is Carports fourth factor?

A

momentum (MOMt)

24
Q

MOM?

A

the return on a portfolio of past (one-year) winners minus the return on a portfolio of past losers

25
Q

How many databases are there for hedge funds?

A

Only five

26
Q

Survivorship bias

A

Older databases typically only contain information on hedge funds that are still alive. Working only with surviving funds creates a survival bias because the more successful funds are more likely to survive. Average returns tend to overestimate the true performance

27
Q

incubation bias

A

hedge funds may be added to a database after being around for a few years. This will only happen if the fund has been quite successful.

28
Q

backfill bias or instant history bias

A

If historical returns of funds that have just entered a database are backfilled this creates un upward bias.
This is because hedge fund managers register their funds when they are successful and have ‘nice’ historic returns

29
Q

Survivorship bias and incubation bias how much do they influence the return?

A

survivorship bias: 2.4%
incubation bias: 1.5%
(from 1994-2004)

30
Q

What is the Rsquared normally for a hedge fund?

A

half of hedge funds have Required below 25%

-> returns on hedge funds are not well-explained by traditional asset classes

31
Q

What are the two main approaches of hedge fund managers to achieve their absolute return targets?

A
  1. Directional (market timing, tactical trading)

2. Non-Directional (market neutral)

32
Q

Non-Directional (market neutral)

A

A market neutral strategy has a very low correlation to the overall
market and is typically long and short in comparable securities.
Includes long/short and relative value (arbitrage) funds.

33
Q

Directional strategies

A

Important directional strategies:

  • Global macro
  • Managed futures (CTAs)
34
Q

Example of a directional strategy?

A

Robertson’s Tiger Fund and Soros’ Quantum Fund

–> The Quantum Fund made north of 1 billion betting that the British Pound would drop out of the ERM in 1992

35
Q

Event-driven strategies

A

focus on debt or equity of firms that are in a particular stage of their life cycle

subcategories:

  • Merger arbitrage
  • Distressed securities
36
Q

Merger arbitrage

A

a typical trade here is to buy stock of the target company while shorting the stock of the acquirer

37
Q

Distressed securities

A

-focuses on firms in financial difficulty

38
Q

Relative value strategies

A

take advantage of perceived misplacing between related financial instruments

39
Q

Could it be a good idea to combine different hedge funds in one portfolio?

A

Yes. with different trading styles –> higher diversification

Trimester 4 (27 decks)

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