Vorlesung Flashcards
The prudent man rule
The prudent man rule directs trustees “to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested.”
Mutual fund and broker difference to hedgefunds
Mutual fund: Pools money from many investors towards assets; daily pricing through the net asset value.
Difference to hedge fund: money is on the depot bank, not with the company.
Jones Hedgefund
Jones, father of hedge funds: wanted to leverage, but advertising for hedge funds was forbidden. No more than 99 investors, and no publication needed.
Own investment
Hedge fund benchmark
Hedgefunds do not care about benchmarks, they follow complete different strategies, To diversify the investors Portfolio.
Payment structure of a hedgefund
Payment of a hedge fund managers: 2.20. 2% initial fee and 20% performance fee.
Main Hedgefund classes
HFR strategy classifications: Equity hedge Event driven Micro + CTA Relative Value Specialty: Multimanager funds: fund of funds in reality: not as simple.
Beta of HF
HFRI annual investment returns are not correlated with the indices that much, however they are slightly correlated
What is institutionalization
Institutionalization of hedge funds: large part of their assets are not any more HNWIs, however institutional investors with expertise.
Name 4 types of funds
Four types of investment companies exist: mutual funds, exchange traded funds, close-end funds and unit investment trusts.
Liquid alternative funds
Futures vs. Options for hedging
futures are better than options because off call them options are not as liquid and they have no linear pay off. Additional question: is the contract volatile (liquidity premium). Protection gets more expensive if we buy the put options which are further out of the money.
Problem: Delta of Option changes with decline
Please do not forget: hedging always involves opportunity costs.
3 common features of hedgefunds (in the beginning)
They are three common features for the definition of hedge funds: first leverage, second short selling, third high-performance fees (2-20)
Common features of hedgefunds today
Today there is no universal definition of hedge funds, however there are some characteristics:
Leverage Shortselling High-performance fees, 2-20 Substantial capital investments by the manager itself Offshore structure or partnership structure Liquidity restrictions dynamic trading strategy Innovation from the whole industry
Describe services of a Prime Broker
Prime brokerage: services offered by investment banks to hedge funds
Global custody services (Safekeeping of assets, clearing, settlement)
Financing of leverage
Securities lending
Capital introduction
Consulting services
Additional services (risk analytics technology, office space,…)
What is the classification problem
Classification Problem: Mutual funds are defined by asset classes - Hedgefunds are defined by dynamic trading strategies
Methodology (Systematic vs. Discretionary/ Opportunistic)
sectors (Equity Hedge: Energy / Basic material vs. Technology Healthcare)
Regions (Global, emerging markets, Asia)
Frequency: Monthly indices / Daily
Type: single strategy vs. Fund of Funds
“style drift” of a Hedge Fund is very bad
Equity Hedge Equity market neutral
Equity Hedge Equity market neutral: Qualitative techniques of analyzing price data
Factor based: systematic analysis of common relationships between securities —> beta near 0 and a lot of leverage
Statistical arbitrage/trading: exploiting priced anomalies which may an occur as a function of expected mean reversion inherent insecurity prices; high-frequency trading; technical analysis; opportunistically to exploit new information
Characteristic: net equity market exposure no greater than 10% long or short
Equity Hedge fundamental growth
Equity Hedge Fundamental growth: assessment of the valuation characteristics on the underlying companies
which are expected to have prospects for a earnings growth and capital appreciation exceeding those of the broader equity market
Companies which are experiencing or expected to experience abnormally high levels of growth in earnings, profitability, sales or marketshare
Equity Hedge Fundamental Value
Equity Hedge Fundamental Value: trade evaluation metrics
by which the manager determines them to be inexpensive and undervalued when compared with relevant benchmarks
Focused on characteristics of the firms financial statements (absolute and relative)
Typically focus on equities which currently generate high cash flow, let’s trade at a discounted valuation multiples
Equity hedge Quantitative directional
Equity Hedge Quantitative directional: Factor based and statistical arbitrage/trading strategies
Typically maintain varying levels of net long or short equity market exposure over the various market cycles
Equity Hedge Short Bias
Equity Hedge Short bias: assessment of the valuation characteristics on the underlying companies with the goal of identifying overvalued companies
Maintain consistent short exposure —> expect to outperform traditional equity managers in declining equity markets
Fundamental or technical
particular focus on the identification of overvalued companies —> expect to maintain in that short equity position over various market cycles
Macro Active trading (general)
Macro Active trading: Active trading methods
Typically with high-frequency position turn over all leverage
May employ both: discretionary and systematic macro with identifiable sub strategies
Process based on systematic, quantitative evaluation of macroeconomic variables
Portfolio positioning is predicated on convergence of differentials between markets (not necessarily highly correlated)
Fundamental relationships across geographic areas (inter- and intra asset classes)
Distinct from other macro strategies in that they characteristically emphasize rapid market response to new information + High volume of turnover in liquid but frequently volatile and unstable market positions
Macro Commodity
Macro commodity: systematic commodity based on mathematical, algorithmic and technical models
Trending or momentum characteristics —> highly liquid Instruments —> shorter holding period.
Expect to have greater than 35% of portfolio in dedicated commodity exposure
Discretionary commodity strategies are reliant on the fundamental evaluation of market data, relationships and influences
May trade actively in the developed and emerging markets (focusing on absolute and relative levels on equity markets, fixed income, currency, spreads trading)
Macro Currency / Discretionary Macro Currency
Macro currency: discretionary and systematic — mathematical, algorithmic and technical models
Little or no influence of individuals over portfolio positioning
Trending or momentum characteristics in highly liquid assets — short holding periods — some try to employ counter-trend models
Greater than 35% of portfolio dedicated to currency exposure
Discretionary currency strategies rely on fundamental evaluation of market data, relationships and influences
Investment process most heavily influenced by top-down analysis of macro economic variables
May try to trade actively in developed and emerging markets
Macro discretionary thematic
Macro discretionary thematic: relying on the evaluation of market data, relationships and influences — Group of portfolio managers
Top-down analysis of macro economic variables
Trade actively in developed and emerging markets
Positions typically are predicated on the evolution of investment themes the manager expect to materialize over the relevant time frame
Contain contrarian or volatility focused components
Macro systematic diversified
Macro systematic diversified: mathematical, algorithmic and technical models
Identify opportunities in markets exhibiting trending or momentum characteristics across individual instruments
Some strategies seek to employ countertrend models —> strategies benefit most from an environment characterized by a persistent, discernible trending behavior
No greater than 35% of portfolio in either dedicated currency or commodity exposures
Event driven Activist
Event driven Activists: obtain representation on the company’s board of directors
Impacting the firms policies or strategic directions
Advocate activities such as division or asset sales, corporate divestiture, dividend or share buyback, changes in management
Focused on equity companies which are engaged in the corporate transactions, security issuance/Repurchase, asset sales, division spinoffs or other catalysts
Greater than 50% of the portfolio in activist positions
Event driven credit arbitrage
Event driven credit arbitrage: opportunities in corporate fixed income secs
Senior or subordinate claims as well as bank debt and other outstanding obligations, structuring positions with little or no road credit market exposure
Limited exposure to government, silver rain, equity, combustible or other obligations —> main focus on fixed corporate obligations
Fundamental credit analysis to evaluate the likelihood of an improvement in the issuers creditworthiness
Difference to fixed income corporate strategies: involve more general Market Hedges, while Credit arbitrage in lieu of arbitrage positions with little or no net credit market exposure —> predicated on specific, anticipated idiosyncratic developments
Management typically involved with Company management
Event driven distressed/restructuring
Event driven distressed/restructuring: focused on corporate fixed income
Primarily trading at significant discounts to their value at issuance or obliged as a result of formal bankruptcy or financial market perception
Management typically in contact with company management or/and creditors
In contrast to special situations, distressed strategies employ primarily debt (greater than 60%) but also may maintain related Equity exposure
Event driven merger arbitrage
Event driven merger arbitrage: primarily announced transactions
Strategies typically have over 75% of positions in announced transactions
Event driven special situations
Event driven special situations: primarily focused on opportunities in equity.
Corporate transaction, security issuance/repurchase, asset sales, division spinoff or other catalysts
Focusing broadly on a wide spectrum of corporate lifecycle investing
Including, but not limited to distressed, bankruptcy and post bankruptcy security issuance, announced M&A, spinoffs, asset sales, etc.
Impacting an individual capital structure focusing primarily on situations identified via fundamental research —> likely to result in corporate transactions through catalyst
Primarily equity (greater than 60%) but also corporate debt exposure —> Post bankruptcy equity exposure & exit of restructuring proceedings
Relative value fixed income asset backed
Relative value fixed income asset-backed: realization of the spread between related instruments
One or multiple components of the spread is the fixed income instrument backed physical collateral or other financial obligations other than those of the specific Corporation
Attractive spread given the nature and quality of the collateral, the liquidity characteristics of the underlying instruments and on the issuance and trends in collateralized fix income instruments
Relative value fixed income convertible arbitrage
Relative value fixed income convertible arbitrage: realization of the spread between related instruments
One or multiple components of the spread is a convertible fixed income instrument
Isolate the attractive opportunities between the price of the convertible security and the price of a nonconvertible security
Characteristics sensitivity to credit quality of the issuer, volatility, interest rate and valuation of the issuer
Relative value fixed income corporate
Relative value fixed income corporate: realization of the spread between related instruments
One or multiple components of the spread is a corporate fixed income instrument
Isolate attractive opportunities between a variety of fixed income instruments, typically realizing an attractive spread between multiple corporate bonds or corporate and government bonds
Fixed income corporate typically involve more general market hedges with limited fixed income market exposure, while event driven credit arbitrage typically involve arbitrage positions with little or no net credit market exposure
Relative value fixed income sovereign
Relative value fixed income sovereign: one or multiple components of the spread is a sovereign fixed income instrument
Isolate attractive opportunities between a variety of fixed income instruments, typically realizing an attractive spread between multiple sovereign bonds or between corporate and government bonds
Quantitative and fundamental discretionary approaches — relative value arbitrage sub-strategies
Significant top-down macro influences
Typically minimum of 50% exposure to Global sovereign fixed income markets — typically lower net exposure and than similar strategies in macro multi strategy sub-strategy
Relative value volatility
Relative value volatility: trade volatility as an asset class Employing arbitrage, directional, market neutral or a mix strategy
Exposures can be long, short, neutral or variable
Include both listed and unlisted instruments
Isolate opportunities between the price of multiple options or instruments containing implicit optionailty
Characteristic sensitivity to volatility, interest rate and issuers equity
Relative value yield alternatives
Relative value yield alternatives: one or multiple components of the spread contain derivatives, equity, real estate, MLP or a combination.
Quantitatively driven to measure existing relationship between instruments
Isolate opportunities in the youth oriented securities
Yield alternative contain primarily in non-fixed income securities (in contrast to income arbitrage) and the investment thesis is more predicated on the yield realized then on price appreciation (in contrast to Equity hedge)
Problem with length of data
Length of data: unlike for equity and bond indices, there are no long-term time series for hedge funds
Problem with frequency of data
Frequency of data: monthly price and return data in database vendors
Deviation from normality
Deviation from normality: return distributions of hedge funds exhibit negative skewness and positive kurtosis
—> hedge funds generate extreme returns much more often than the normal distribution suggests
Instant history or backfilling bias
Instant history or backfilling bias: when the hedge funds report return information for the first time, Data vendors usually include the complete history of the database
Survivorship bias:
Survivorship bias: data vendors usually only include the returns of hedge funds currently reporting information (survivors) —> the main reason for high survivorship bias is the high attrition rate
Selection bias
Selection bias: a selection of hedge funds in the database is not necessarily representative for the complete universe of hedge funds
Markowitz modern portfolio theory
Markowitz: paper: modern portfolio theory, normative mean variance theory of portfolio management which shows what investors should do under certain assumptions.
CAPM
William F.sharpe: CAPM; positive general equilibrium theory for the pricing of financial assets
Risk
Risk: measurable uncertainty; uncertainty: unmeasurable one
Markowitz optimal portfolio
Markowitz optimal portfolio call set of portfolios with: 1. Maximum expected return for varying levels of risk and 2. Minimal risk for varying levels of expected return. This set of portfolios is known as the Efficient frontier
How to select an optimal portfolio
How Can investors select an optimal portfolio: determine the efficient frontier and select portfolio with the desired target return E. The purpose of this is to determine the optimal portfolio weights W* (mathematically: minimize portfolio variance with constraints: C1 : target return equals E. C2: some of weight equals one, which means 100% is invested
Creating CML
When a risk-free investment is available in addition to risky assets, the shape of the frontier changes dramatically. It become the line. Therefore all investors prefer portfolios which are a combination of the risk-free asset in the portfolio M (two fund separation). This line is called the capital market line (CML).
Efficient frontier
Efficient frontier: There must be one portfolio that is the efficient combination of all available securities, because if 2 securities have the same return for different amounts of risk than the one with the greater risk will be avoided by risk-averse investors
Difference in risk between SML and CML:
Difference in risk between SML and CML: the CML uses the standard deviation of the returns on the market portfolio as the risk measure where as the CAPM uses the covariance of the returns on the security with those on the market portfolio as the risk measure.
Key conclusion of the CAPM is that portfolio of all assets, held in proportion of their outstanding market values, is an extremely attractive investment choice.
Market neutral
Statistical definition: the portfolio is market neutral, if the beta of the factor model used are zero
Asset based style factor model Expansion
Asset-based style factor model
Risk of Hedge fund depends on style → non-linear ⇒ Option like returns (Fungh/hsieh 2001)
Additional risk/return characteristics: Spread, volatility, option based, rule based factors
Mitchell/Polvino (2001): 1: Merger arbitrage are uncorrelated in flat or appreciating markets, but positively correlated with depreciating markets & 2. Returns are similar to an option strategy, which sells uncovered index put options
Cash merger
Cash merger: Offer of cash for company assets
Strategy: Buy company stocks below public M&A price and sell it for M&A price. Additionally take offered dividends. Opportunity cost of capital: Capital frozen until final merger
Main risk: Deal failure
Stock Merger
Stock merger: Company offers stocks to buyout target
Strategy: Buy targets stocks and short the aquirers stock. Profit is difference between price of the acquirer and target company. Dividends of the target (but pay dividends of aquirer) + Interest income on the proceeds of the short sale
Main risk: Deal Failure
Problem in HF and CAPM/3factor model
Merger Arbitrage option strategy
Dangers for MA
CAPM/3-factor Fama-French Model DO NOT capture risk of merger arbitrage —> excess return is not necessarily alpha but the risk premium not captured by the linear factor models (—> missing risk factor/non linear relation?)
IF markets are flat or appreciating: generating alpha (in excess of beta & r)
However, if markets DECLINE, Beta increases to 0.5 —> High positive correlation between the returns (negative)
Merger arbitrage is similar to a strategy writing uncovered index put options
Mergers are often canceled or postponed when equity markets fall
Hedge ratio
Portfolio Value / Contract Value
Future Value
Value per point * Actual index value
ROE
Profit margin * asset turnover * financial leverage
(Net income / average equity) =
(net income / net sales) * (net sales / average assets) * (average assets / average equity)
FCFF
Free Cashflow to the firm
EBIT(1-t) + D&A - Capex - ∆WC +- Adj
EBIT
Earnings before interest and taxes
Rev - COGS - SG&A - R&D - Others
D&A
Depreciation and Amortization
Capex
Capital expenditures
∆WC
Change in working capital
∆Current assets - ∆Current liabilities
COGS
Cost of good sold
SG&A
Selling, General & Administrative
WACC
r(1-t) * [MV(D) / MV(D) + MV(E)] + r * [MV(E) / MV(D) + MV(E)]
CAPM
i = rf + beta(rm - rf)
Present Value of a company
- : Calculate FCFF
- : Calculate WACC
- : Calculate Present Value of Firm
PV = (FCFF / 1+WACC) + (FCFF2 / 1+WACC^2) …..
= SUM(FCFF / 1+WACC) + TV
TV = (FCFF / WACC-g) / 1+WACC^T
- : PV - MV(D) +- Adj.
- : Value of 1 share = PV(E) / Number of shares outstanding
Differences of Liquid alternatives to Hedgefunds
Ownership: Mutual Fund – Private/Offshore Corp
Regulation:
UCITS/Inv. Comp. Act of 1940 – AIFMD/Sec. Act of 1933
Daily Liquidity/Daily rebalancing possible: Yes – No
Investor qualification: None – Accredited Investor
Investment Minimum: Low – High
Transparency:
Sales prospectus – Private placement/Subscription doc.
No Marketing allowed
Custody of assets:
Commercial Bank – Brokerage Firm/Prime Broker
Illiquidity Premium: No – Yes
Restrictions on leverage: yes – no
Hedge Ratio
Portfolio / Value of Future = Number of needed futures
Value of future:
Contract Value = Value of 1 point * Price of underlying
Small Caps
Stocks with small market capitalizations
Large caps
Stocks with high market capitalizations
Value Stocks
High book to market ratio
Growth stocks
Low book to market ratio
Selection bias
Selection bias: Hedge funds in the observable portfolio are not representative of the universe of hedge funds
—> Probably means, that a vendors database may not provide the true picture of the performance of all funds available for investment
Instant history bias:
Instant history bias: Database vendors backfill a hedge funds performance when they add a new fund into their database
Survivorship bias:
Survivorship bias: Funds dropped out of database, because of performance(!) reasons —> Upward bias
Market portfolio of hedgefunds
Market portfolio of hedgefunds is not practical —> Hedgefunds minimum investment way to high
Use fund of funds —> does not contain survivorship, instant history & selection bias (they are a good proxy for the hedgefund universe –> Tells us how much the management of a hedgefund portfolio costs)
Downward bias of fund of funds
They have to hold cash (redemptions) which is in the performance
do not contain survivorship, instant history & selection bias
Lookback straddle:
Lookback straddle: Straddle of Lookback put & call —> Buy/sell at minimum and buy back at maximum —> Shows the maximal possible return
PMTS:
PMTS: Primitive Market timing strategy: Enter trade in anticipation of a price move
Long standard straddle
PTFS:
PTFS: Primitive Trend Following strategy: Trade after certain price moves
Long lookback straddle
2 Main characteristics of CTAs in a portfolio
Trend followers, although they have systematic risk(1), can reduce the volatility of a typical stock/bond portfolio during extreme market downturns(2).
Asset based hedge fund style factor:
Asset based hedge fund style factor: Asset-based style factors link returns of hedge fund strategies to observed market prices
They provide an explicit description of how various styles of hedge funds add to portfolio diversification rather than relying on peer Group averages of historical hedge funds returns.
Managers with the same strategy can differ in:
Managers with the same strategy can differ in:
Leverage —> differences in their beta
Trade execution —> differences in their alpha
Choice of securities —> differences in alpha and beta
Hedgefund strategy has 3 elements:
Hedgefund strategy has 3 elements:
Strategy: How long and shorts are combined
Location: To which assets is the strategy applied
Style: How are the positions leveraged and managed
