Section 2 Flashcards
What is a common element of hedge funds?
The use of investment and risk-management skills to seek positive returns regardless of market direction. They often seek a return stream that is uncorrelated with equities and bond returns.
What is a hedge fund structured as / who is involved?
A corporation or partnership and is managed by an investment manager who is legally and financially separate from the fund and its assets.
Limited partners are the funds investors with no liability beyond their investments
General partner - serves as the manager of the partnership and has unlimited liability (though the typical form will be a limited liability company). Their role is to market and manage the fund, and perform any functions necessary in the normal course of business.
Prime brokers
Fund administrator
custodian bank
What is a prime broker in reference to a hedge fund?
Each fund has one or more prime brokers (usually an investment bank) to provide a range of investment services.
Including trade execution, settlement, leverage, portfolio software, client introductions, risk management, fund administration and custody
How do hedge funds and traditional asset managers differ in management style?
hedge funds are generally more active than conventional asset managers and use tools such as leverage, derivatives and short selling
How do hedge funds and traditional asset managers differ in investment policy
hedge funds are more flexible
How do hedge funds and traditional asset managers differ in return targets
for many hedge funds the target is absolute return with the aim of achieving this, regardless of market conditions; whereas conventional funds tend to target returns relative to a benchmark or index
How do hedge funds and traditional asset managers differ in fees?
hedge funds this will be based on funds under management and performance-related components whereas for more conventional funds it is simply based on funds under management
How do hedge funds and traditional asset managers differ in liquidity?
can be highly restricted allowing hedge funds to invest in highly illiquid markets compared to the highly liquid conventional funds.
Restrictive liquidity is useful for investors since it allows managers to hold losing investment positions during times of market stress and poor performance in anticipation of a turnaround. This may not be possible with conventional daily liquidity.
How do hedge funds and traditional asset managers differ in investor base?
For hedge funds, this usually comprises only high net worth individuals and institutional investors; whereas conventional funds are generally open to all.
What is a lock up period in a hedge fund
time in which investors can not withdraw funds these may be long for hedge funds - months or even longer
How do hedge funds and traditional asset managers differ in legal structure
hedge funds are generally less transparent
what categories do investors of hedge funds generally fall into?
- wealthy individuals
- institutional investors
- charities and endowments
- other hedge funds creating funds of hedge funds (risk diversification)
what is a key component of hedge funds in terms of fee structure
includes both a management fee and a performance fee
what is often needed before a hedge fund earns a performance fee?
a hurdle rate
what is a water mark in reference to hedge funds
Ingredient in the calculation of a fee - the idea that high water mark performance fees only accrue for the generation of NAV above previous predefined high points.
Therefore good returns after a very bad year may not generate performance fees until a certain earlier point is surpassed.
Most hedge funds have a high water mark
describe hedge fund strategies
opaque
how are hedge funds normally categorised?
According to their strategic objectives
what are relative value (market neutral) funds?
Attempt to produce return series that have no or low correlation with traditional markets such as equity.
Often highly quantitative in their portfolio construction process and often market themselves as an investment that can improve the overall risk/return structure of a portfolio of investments.
What strategy do relative value (market neutral) funds usually implement?
arbitrage strategies - where two related investments do not follow a prescribed relationship and the mispricing is then exploited.
not all funds that follow a relative value strategy will be ….a…..; however all …b…. funds will follow a …..c…..
a) market neutral
b) market neutral
c) relative value strategy
What is an event driven fund?
Seeks to make profitable investments by investing in a timely manner in securities that are presently affected by particular events. Such events include merger activity (sometimes called risk arbitrage) and corporate spins offs and restructuring
What is a long / short fund
Funds employing long/short strategies generally invest in equity securities, taking directional bets on either an individual security, sector or country level
What is tactical (or speculative) trading - aka directional strategies
Strategies that speculate on the direction of market prices and currencies, commodities, equities and/or bonds.
Managers may be systematic and rely on computer models based on technical analysis, or discretionary and take a less quantitative view.
This is the most volatile sector in terms of performance
What does a fund of hedge funds allow?
Small investors to access hedge funds
What are the benefits of investing in a fund of hedge funds?
- Diversification
- Access to hedge funds
- Access to expertise
what are downsides to a fund of hedge funds?
two layers of costs payable
what is private equity?
Capital that is not quoted on a public exchange
traditionally what do private equity firms do?
Traditionally provide capital for start-up companies and existing firms (buy-outs), and have assisted companies that have been unable to raise capital in any other way.
Provide capital for management buy-outs or for straightforward leveraged buy outs. These tend to be profitable companies with strong cash flows
How are private equity funds structured?
As partnerships
Investors are limited partners who co-invest with the investment managers (the general partners).
How to private equity funds get diversification
invest in a range of projects
Who are typical investors of private equity funds?
High net worth individuals, pension funds, endowments, foundations, insurance companies, sovereign wealth funds and investment banks
In private equity what may investors need to commit but when may this be used?
Commit funds upwards for a ten year horizon but this is only drawn down as required for actual investing
When are investments normally made in a private equity fund?
Typically these investments are made over the first five years or so (the investing period) and will be realised over the subsequent five years (the harvesting period)
What may occur in a private equity fund if not all investments have been liquidated
There may be an extension period
however investors can sell their investments in the secondary market.
What is the tax structure of a PE fund?
The limited partnership structure is tax transparent, so there is a full flow-through of any gains to underlying investors i.e. there is no tax leakage.
what are costs of a PE fund
management fee around 1-2% of committed capital plus 20% of carried interest - this refers to investment returns generated often in excess of a previously agreed rate of return (the hurdle rate)
when will funds from a PE firm be released?
only after successfully exiting an investment which may take years
What strategy do most PE funds employ?
A value-added active strategy
nature of this will depend on where the purchased company is in its life cycle. Each stage of a company’s life cycle possesses a certain risk profile, requiring specific skills from the general partner
what are the three main financing stages in a company’s life cycle?
1) Venture capital
2) growth capital
3) Buy-out investments
What is venture capital
Investment made in young companies with very little revenue. It may be considered a highly entrepreneurial phase with a high chance of either total loss or high return.
In practice one or two major successes drive the performance of the entire private equity fund
What is growth capital
equity investment, often minority in nature, in relatively mature companies seeking to expand or restructure operations. This will not involve a change of control
What is buy-out investments
Involve taking a stake in a private company, with the investors exercising direct influence on the company.
The acquisition often involves mature well-established companies with strong market positions, usually with the intent of using the company as a tool to acquire further business.
The private equity firm’s manager will support the company’s management in its acquisition plan, seeking funding, and negotiating with third parties. The plan may include cost restructuring and the sale of non-core assets
what are the three types of private equity investments?
Primary, secondary and co
what is a primary private equity investment?
Newly constructed, closed-end private equity partnerships. Following due-diligence on the general partners, limited partners commit an amount to the new fund.
Capital is called as investment opportunities arise
What is secondary private equity investments
Existing limited partner private equity interest available on the secondary market.
Investors enjoy shorter investment periods and accelerated returns on investment capital.
Also, as they compromise existing assets, the risk of investing blind in a pool of assets (which may not yet have been purchased) is significantly reduced.
Hopefully large write-offs and losses from early investing are avoided
What is co-investments in private equity?
Direct investments by a limited partner in a company alongside a private equity fund
these occur when the general partners want to acquire an investment (possibly a stake in a company) larger than is allowed by the diversification rules set by the limited partnership agreement.
Co-investment allow the limited partners to increase their exposure to a particular opportunity through the fund and direct investment
How are co-investments usually offered?
On a no-fee, no-carry basis
what are pros of private equity
- Partners hope to have information advantage over other investors with their extensive due diligence
- Active involvement of partners aims to create operational value
- No exposure to daily stock market volatility private equity can allow companies to take a longer-term view for executing strategy and restructuring.
- Diversification of portfolio is also enhanced as private equity returns have a low correlation to public equity and bond markets
what are downsides to private equity
- Illiquid
- illiquidity makes measuring performance more difficult than for other funds
- difficult to calculate time weighted returns
what two measures are used to assess PE firms?
Investment multiples and internal rate of return
