Hedge Funds and Private Equity

Question 1

Hedge Funds

Answer 1

Short and long positions in shares

• Short: selling position
• Long: buying position
• Market neutral
• Often involves derivative trading

Hedge fund: absolute returns
Conventional investment: relative return (to benchmark)
Jones’ performance fee 20%

Who invests?
- Accredited investors: wealthy or professional enough so that regulator protection not needed; wealthy individuals, institutions and UCITS

Question 2

Hedge funds regulations

Answer 2

Conventional funds:

• protect investors
• restricted list of investible assets e.g pension funds
• Close regulation by regulators and stock exchanges

Hedge funds:

• Investors are usually rich individuals and professionals; can protect themselves
• Free to invest in wide range of markets and assets
• Lightly regulated
• Authorities are introducing regulation

Question 3

Hedge funds: gates and lockups

Answer 3

Purpose

• Prevent the manager having to liquidate funds at a time when prices are not favourable for redemption; prevent run of funds
• Why clients want to withdraw at unfavourable times? demand for liquidity, myopic clients, lack of confidence
• Negative consequence of untimely withdraw; liquidate while asset price is low
• Lock up: cannot withdraw for given period
• Gate: cap on amount that can be withdrawn in at one time

Question 4

Hedge funds: side pocket

Answer 4

Special account for difficult to value or illiquid assets

An investor who withdraws cannot redeem any assets in the side pocket until fund managers liquidate it

Question 5

Fund managers

Answer 5

• Individuals or investment companies
• Freedom to invest
• When raising money, inform investors
• Alpha, performance measure - Return in excess of benchmark
• Often in financial havens
• Geographically close to financial centres

Fees

• annual fee 1-2% of net asset value of a fund
• Incentive fee 20-50%

Question 6

The UCITS III

Answer 6

Allow collective investment scheme to operate freely in the EU, on the authority of a single member state

• collective investment scheme: allow investment alongside other investors
• Host member state is responsible for regulating fund
• The fund can operate in any member state without further regulation
• Allow small investors to participate
• Phase I and II are for long only strategies
• Phase III allow UCITS compliant funds to use derivatives; allow short selling and hedge fund strategies, only some hedge funds to access retail non-professional market, attract hedge funds to register in EU

Question 7

Primary Broker Service

Answer 7

• Provided by investment banks
• Include; broker, lend securities, clearing and settlement, custody services
• Income - commissions from services, spreads from financing

Question 8

Private Equity

Answer 8

Medium to long term finance invested in companies not quoted on stock exchange
- private equity to refer to investment in established private companies, VC refers to investment in early stage and high growth companies

Question 9

Private equity funds

Answer 9

General partner 
- Fund contributor 
- Manage the fund 
- Arrival fee 
- Carried interest of capital gain 
Limited partners
- fund contribution 
- capital gain 
Capital gain realised at fund liquidation

Question 10

Business Angels

Answer 10

• Wealthy individuals also provide their own money to be used as capital in new business ventures
• Substantial business and entrepreneurial experience
• Invest between 10k-250k
• Investment syndicate; private network, formal network
• Hands on strategy: management

Question 11

Venture Capital

Answer 11

-Formally organised venture capital funds
-Make medium to long term investment
-Companies are new, innovative often high tech, very risky
- Debt and equity finance
-Low liquidity
-Return on investment 5-7 years
Supports at different stages; seed corn, start-ups, early stages

Expansion stage
Management buyout 
Management buy in 
Leverage buy out 
Public to private 
Exit: sell the investee company and invest the reward