Introduction to Hedger Funds, Hedge Fund Returns and Asset Alloation Flashcards
What is safe harbor exemption of the Investments Act of 1940?
Exemption from filing, disclosure, record keeping and various reporting requirements mutual funds must adhere to.
Hedge funds fall within the safe harbor exemptions.
FDRR
Who are considered wealthy individualas:
Who is an accredited investor
Who is a qualified purchaser in a hedge fund?
They are accredited investors and qualified purchasers.
Accreditor investor:
Investor has net worth > $1m, or annual income of $200k for each of last 2 years, $300k in the case of husband and wife.
Qualified Purchaser
Individual investor with net worth greater than $5m, Institutional investor with net worth greater than $25m
Who are the primary investors in hedge funds?
- Wealthy individuals,
- pension funds,
- foundations and
- endowments
What are the key elements that differentiate hedge funds from traditional investments?
They are differentiated by their Regulatory structures, Compenation Strctures and Trading Structures.
- Regulatory Structures; Privately organized and generally unlisted, hence not heavily regulated
- Compensation Structures: Offer managers performance-based fees
- Trading Structures: Invest in private securities, real estate, derivatives and strctured products. They use leverage, derivatives, short sell securities, and take concentrated positions
What are the 5 calssifications of hedge fund strategies?
- Futures Funds (Global Macro and Managed Futures)
- Event Driven Hedge Funds
- Relative Value (Arbitrage ) Hedge Funds
- Long/ Short Equity Hedge Funds
- Fund of Funds
The first 4 are single manager funds, 5th invest in a diverse group of single manager funds.
FE R(a) EF
What are the 2 Hedge Fund fees
- Management fees;
- Carried Interest, Performance fees, Incentive fees or Profit -sharing fees
” 2 and 20” is the most common
High water mark
Maximum previously observed NAV, Incentive may only be paid if the NAV is above the previous maiximum
Hurdle Rate
Incentive fee will only be paid if the fund return exceeds a set threshold return (Net Return or Return net of management fee)
What are techniques used to align inerests between managers and investors?
What is meant by the following?
- Excesssive conservatism;
- Perverse inventive
- assymetric incentive fee
O&M
Optimal contracting and managerial co-investing
- Excessive conservatism: Involves managers being extremely risk averse;
- Perverse incentive: Managers prusue more risky incentives;
- Asymetric incentive fees: Managers receive some investment gains without compensating investors for loss lkein the ‘40 Act mutual funds
What are the 2 ways of viewing incentive fees, explain each
A O
- The annuity view demonstrates management’s incentive to earn large returns over a long period of time.
- The option view demonstrates how increasing the volatility will increase the present value of future management fees. Performance fees are considered a free call option (i.e. an incentive fee opton) granted to the fund manager on an annual basis. Increasing volatility increases the value of a call opton, this means that the manager is motivated to take too much risk.
Pure Asset gatherers
Managers whose primary focus is to increase AUM. Their returns are highly correlated with index returns
Closet indexers
They charge high management fees, but actually are passive investors
What is meant by lock-in-effect?
Managers taking less risk when the NAV is far in the money, in line with the option view of hedge fund fees.
What is the formula for incentive fee call option value?
i x 40% x (price of underlying asset) x sigma x square root of T.
Why the long term growth rate of hedge funds?
Their favorable investment attributes viz.
- Low correlation with traditional investments;
- Ability of funds to hold both long and short positions;
- Potential for large returns than what traditional investments provide.
Higher kurtosis indicates
Leptokuritc (leap) distribution, fatter tail
What are the 4 broad categories of hedge fund strategies?
- Directional
- Event risk
- Absolute Return
- Diversified
DEAD
Directional and Non-directional (Absolute) Return are the 2 major strategies
Directional strategy
Any trading or investment strategy that entails taking a net long or short position in a market. It is betting on the direction the overall market is going to move in. A trader who is net long will benefit from a rise in the market.
Event risk hedge fund strategy
Take position based on some event that has happened or is likely to happen
Absolute Return Hedge Fund Strategy
Sometimes called a “non-directional fund,” an absolute-return fund is designed to generate a steady return no matter what the market is doing.
Absolute-return strategy is most appropriate for a conservative investor who wants low risk and is willing to give up some return in exchange. Hedge fund managers can use many different investment tools within an absolute-return strategy.
Diversified strategy
Diversify across different investment themes
What are the different hedger fund types?
- Single manager funds, it does not contain other hedge funds.
- Fund of Funds
When classified by trading strategies, CAIA classifies them into 5 groups, viz:
- Macro and Managed Futures;
- Evetn driven;
- Relative value;
- Equity
- Funds of Funds
MereF
In relation to hedge fund indices:
- Name the 3 well-known hedge fund databases
- What is meant by Fee bias;
- What is meant by the investability of an index;
- TASS (Trading Advisor Selection Ssytem): HFR, CISDM (Centre for international Securities and Derivatives Market)
- Fee bias: The returns that NEW investors are going to make are going to be lower than whar the index indicates;
- Investability of an index is a measure of whether an investor can earn the same return as the index. If the index contains closed end funds, the investor cannot. Closed end funds constitute a large portion of the hedge funds universe.
