Introduction Flashcards
Hedge Funds are:
Absolute return funds. Return independently of market conditions. No benchmark, low beta. Focus on generating alpha.
Investment objectives of HF:
Focus on capital protection (low risk). Target SR close to 1 and then leverage up or down.
Investment policies of HF:
All instruments and markets. Allow short selling and leverage.
Who can invest in HF?
Only Institutional investors or High Net Worth individuals (absolutely no retail). Are usually very secretive about performance.
Typical fee for HFs:
1.5% management - 20% performance (approximately)
Are Hedge Funds liquid?
Not really, investors can’t just pull money in and out, strategies can go on for years.
Rule on Performance fee for HFs:
The High-Water Mark rule. Meaning managers don’t get performance fees simply by gaining money back. Only when they reach new levels of returns do they get performance fees.
Do HFs always aim for Beta=0?
No. Usually they are slightly overweight either in the short position or the long position. Actually what happens most frequently is that they are in the long position since they want to get market risk premium (expected returns on market).
Should you short a bubble?
Very hard to short a bubble since you can be short-squeezed, hard to understand if and when will it burst, and losses can go on for a very long time.
Explain Equity Long-Short
Long undervalued stocks and short overvalued stocks.
If you want to short an asset, what should you use? Why?
Should use futures. This is because they have a settlement date and/or price. Also, you will always be Margin Called
Characteristics of Equity Long-Short Portfolios:
Low risk (can be increased w/ leverage)
Returns uncorrelated w/ market performance
Equity Long-Shorts can be divided in:
Long Bias
Short Bias
Pure Market Neutral
Explain Global Macro
The aim of Global Macro strategies is to trade macroeconomic conditions and their impact on financial markets.
How do you put Global Macro in practice?
Establish directional positions in different asset classes and geographical regions
What is usually the major focus in Global Macro?
Interest rate positions
Explain Systematic Trading
Investment decisions are made by a system, often an algorithm. Basing themselves on technical patters, fundamental data, market anomalies…
Important in Systematic Trading:
Diversification. Avoids model misspecification or changing market patters
Explain Fixed Income Arbitrage
Point is to exploit inefficiencies between related fixed income securities while hedging for interest rate risk
Name common trades in Fixed Income Arbitrage
Yield Curve Arbitrage (2-10, 5-30)
Intermarket spreads (Bund vs Treasury Yield)
Name the Fixed Income Arbitrage positionings
Duration neutral
Long Bias
Short Bias
Explain Specialized Credit
Long undervalued credit and short overvalued credit
Explain Event-Driven
Trade Corporate events (M&A deals, buybacks, etc)
How do trade M&A deals
Usually by longing the target company and shorting the acquirer (basically betting that the acquirer will overpay).
Explain Volatility Arbitrage
Buy/sell options or convertible bonds while hedging for equity risk (this is done by shorting/buying the underlying)
Explain Funds of Funds (FoF)
Invest in other funds and combine.
Advantages of FoF
Diversification.
Specialization (each fund focuses on what they know best)
Disadvantages of FoF
Fees-on-Fees structure is expensive.
Explain Multi-Strategy
Try to hire the best possible people for each type of strategy.
Advantages of Multi-Strategy
Diversification without Fees-on-fees
Fast in shifting portfolio weights depending on market conditions
General assessment of HFs historical performance:
Outperform when it’s going down. Don’t catch up when it’s going up.
Why do Multi-Strategy funds tend to have good SRs
High diversification
Biases when assessing hedge funds performance
Back Fill Bias (only report if they’re successful)
Survivorship Bias
What is Back Fill Bias?
Only successful funds report their performance
What is Survivorship Bias? (in the context of HFs performance)
Many funds die, data only takes into account those that survive.
How can you generate alpha?
Have an active investment strategy (go beyond Beta and passive investment)
Risk control
Methods for Risk Control
Risk Limits VaR stops
Risk weightings
When Backtesting, the level of confidence depends on:
Stability of Backtest
Stability of further out-of-sample tests
Enumerate the Backtesting guidelines
- Compute daily returns
- Compute performance statistics
- Analyse Calendar performance of strategy
Enumerate performance statistics
Annualized return
Annualized standard deviation
Sharpe Ratio
Positive days/months
Skewness, Kurtosis and Distribution of Returns
Autocorrelations
Why are autocorrelations important
If returns are autocorrelated, we may be overestimating a strategies performance. Return may be driven by the autocorrelation instead of the strategy.
