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FINC3017 - IPM FINAL > TOPIC 10 - HEDGE FUNDS > Flashcards

TOPIC 10 - HEDGE FUNDS Flashcards

1
Q

Directional funds take a stance on

A

the performance of broad market sectors.

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2
Q

Nondirectional funds establish

A

market-netural positions on relative mispricing. However, even these hedged positions still present idiosyncratic risk.

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3
Q

Statistical arbitrage is the use of quantitative systems to

A

uncover many perceived misalignments in relative pricing and ensure profits by averaging over all of these small bets.

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4
Q

Portable alpha is a strategy in which one invests in positive-alpha positions, then

A

hedges the systematic risk of that investment and finally establishes market exposure where desired by using passive indexes or futures contracts

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5
Q

Performance evaluation of hedge funds is complicated by what 4 things?

A

1) survivorship bias,
2) potential instability of risk attributes,
3) the existence of liquidity premiums
4) unreliable market valuations of infrequently traded assets.

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6
Q

what makes performance evaluation super tricky?

A

when the fund engages in option positions. Tail events make it hard to assess the true performance of positions involving options without extremely long histories of returns.

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7
Q

Hedge funds typically charge investors both a management fee and

A

an incentive fee equal to a percentage of profits beyond some threshold value.

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8
Q

The incentive fee charged by hedge funds is akin to

A

a call on the portfolio. Funds of hedge funds pay the incentive fee to each underlying fund that beats its hurdle rate even if the overall performance of the portfolio is poor

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9
Q

transparency for hedge funds vs mutual funds

A

hedge funds - minimal disclosure of strategy and portfolio composition (good and bad)
vs mutual funds way more transparent due to regulation

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10
Q

investment strategies - hedge fund vs mutual fund

A

hedge: v flexible, use shorting leverage options
mutual: predictable, stables strategy, can’t chop and change as much

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11
Q

liquidity of hedge funds vs mutual funds

A

hedge: often have lock up periods
mutual: investments can be moved in and out of fund more easily

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12
Q

compensation of hedge vs mutual funds

A

hedge: management fee of 1-2% of assets + incentive fee (can be large!)
mutual: usually fixed % of assets (0.5%-1.25%)

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13
Q

hedge fund directional strategies

A

bets one sector or another will outperform sectors of the market

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14
Q

hedge fund non-directional strategies

A

exploits temporary misalignments in relative pricing

  • often involves long position in 1 security hedged with a short position in a related security
  • strives to be market neutral
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15
Q

3 steps of portable alpha strategy

A

1) invest in positive alpha positions
2) hedge the systematic risk of that investment
3) establish market exposure where you want it by using passive indexes

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16
Q

In simple terms, portable alpha is a strategy that involves investing in areas that have little to no correlation with the market. Portfolio managers separate alpha from beta by

A

investing in securities that are not in the market index from which their beta is derived. Alpha is the return on investment achieved over and above the market return—beta—without taking on more risk.

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17
Q

style analysis for equity market neutral funds

A

Uniformly low and statistically insignificant factor betas

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18
Q

style analysis for dedicated short bias exhibit

A

substantial negative betas on the market index

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19
Q

style analysis for distressed firm funds

A

have significant exposure to credit conditions as well as the market index

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20
Q

fixed index income arbitrage funds style analysis show

A

positive exposure to the differential return on corporate vs treasury bonds

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21
Q

Equity market neutral funds commonly use

A

long/short hedges.

Typically controls for industry, sector size and establishes market neutral positions designed to exploit some market inefficiency. Commonly involves leverage.

22
Q

dedicated short bias funds have what position in equities?

A

net short position usually in equities as opposed to pure short exposure

23
Q

fixed income arbitrage

A

attempts to profit from price anomalies in related interest rate securities.

24
Q

In a short-hedged position, the entity is seeking to

A

sell a commodity in the future at a specified price.

25
Q

The company seeking to buy the commodity takes

A

the opposite position on the contract known as the long-hedged position.

26
Q

hedge funds tend to hold more or less illiquid assets than other institutional investors

A

more illiquid assets

27
Q

Aragon’s study suggests that part of any “alpha” exhibited by hedge funds may in fact be an XXXX rather than a sign of stock-picking ability

A

equilibrium liquidity premium

28
Q

backfill bias in hedge funds arises bc

A

hedge funds report returns to database publishers only if they choose! prior performance of funds eventually included in the sample may not be representative of typical performance

29
Q

survivorship bias arises when

A

unsuccessful funds that cease operation stop reporting returns and leave a database leaving behind only the successful funds

30
Q

Incentive fees in hedge funds are effectively call options, where the manager gets

A

the fee if the portfolio value rises sufficiently, but loses nothing if it falls –>
Strike price = current portfolio value × (1 + benchmark return)

31
Q

High water mark is the previous value of a portfolio that must be reattained before

A

a hedge fund can charge incentive fees - o Give managers an incentive to shut down funds that have performed poorly

32
Q

what are funds of funds?

A

investment funds that invest in other funds rather than investing directly in securities (stocks or bonds)

33
Q

With all market risk hedged away, the standard deviation of the monthly
return of the hedged portfolio is equal to

A

the standard deviation of the residuals. The standard deviation of the residuals for the stock is the volatility that cannot be hedged away. For a market-neutral (zero-beta) position, this is also the total
standard deviation.

34
Q

The expected rate of return of the market-neutral position is equal to

A

the riskfree rate plus the alpha

if you’re market neutral you’ve hedged away all the risk

35
Q

expected return of the market-neutral position is equal to the

A

riskfree rate plus the alpha

36
Q

Why does the misestimation of beta matter so much more for the 100-stock portfolio
than it does for the 1-stock portfolio?

A

The market exposure from improper hedging is far more important in contributing to total volatility (and risk of losses) in the case of the 100-stock portfolio because the idiosyncratic risk of the diversified portfolio is so small in this case.
When idiosyncratic risk is minimal, the market risk that results from underestimating
beta has a much greater proportional impact on the total risk of the portfolio.

37
Q

READING Illiquid assets
in Asset management: After taking into account biases induced by infrequent trading and selection, it is LIKELY OR UNLIKELY that illiquid asset classes have higher risk adjusted returns that traditional liquid stock and bond markets

A

unlikely that illiquid asset classes have higher risk-adjusted returns than traditional liquid stock and bond markets

38
Q

READING Illiquid assets
in Asset management:

whilst it’s unlikely that illiquid asset classes have higher risk adjusted returns than traditional illiquid stock & bond markets, there are still

A

significant illiquidity premiums within asset classes. Portfolio choice models incorporating illiquidity risk recommend that investors should retain only modest holdings of illiquid assets and demand high risk premiums for investing in them

39
Q

Convertible arbitrage - hedge fund style

A

hedged investing in convertible securities, typically long convertible bonds and short stock

40
Q

dedicated short bias - hedge fund style

A

net short position, usually in equities as opposed to pure short exposure

41
Q

emerging markets - hedge fund style

A

goal is to exploit market inefficiencies in emerging markets. Typically long-only bc short-selling ins’t feasible in many of these markets

42
Q

equity market neutral - hedge fund style

A

commonly uses long/short hedges. Typically controls for industry, secotr, size adn other exposures and establishes market-neutral positions designed to exploit some market inefficiency

43
Q

equity market neutral strategy commonly involves what? ( - hedge fund style )

A

leverage!!

44
Q

event driven - hedge fund style

A

attempts to profit from situations like M&A, restructuring, bankruptcy or reorganisation

45
Q

fixed-income arbitrage - hedge fund style

A

attempts to profit from price anomalies in related interest rate securities, incl, interest rate swap arbitrage, US vs non-US gov bond arbitrage, yield curve arbitrage and mortgage backed arbitrage

46
Q

Global macro - hedge fund style

A

involves long and short positions in capital or derivative markets across the world. Portfolio positions reflect views on broad market conditions and major economic trends

47
Q

Long/short equity hedge - hedge fund style

A

equity oriented positions on either side of the market (ie long or short) depending on out-look

48
Q

are long/short equity hedges meant to be market neutral?

A

no, may est a concentrated focus regionally or on a specific sector, can also use derivatives to hedge positions

49
Q

managed futures - - hedge fund style

A

uses financial currency or commodity futures, may make use of technical trading rules or a less structured judgmental approach

50
Q

multistrategy - hedge fund style

A

opportunistic choice of strategy depending on outlook

51
Q

fund of funds - hedge fund style

A

fund allocates its cash to several other hedge funds to be managed

FINC3017 - IPM FINAL (12 decks)

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