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Investments > week 11 > Flashcards

week 11 Flashcards

1
Q

HEDGE FUND

 Transparency

A

usually set up as limited Liability Partnerships and provide minimal disclosure of strategy and portfolio composition

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2
Q

HEDGE FUND

Investors

A

No more than 100 “sophisticated” and wealthy investors

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3
Q

MUTUAL FUND

Investors

A

Number is not limited

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4
Q

MUTUAL FUND

Transparency

A

Regulations require public disclosure of strategy and portfolio composition

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5
Q

HEDGE FUND

Investment strategies

A

effectively partake in any investment strategy

can act opportunistically and empowered to invest in a wide range of investments

 Often use shorting, leverage, options

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6
Q

MUTUAL FUND

Investment strategies

A

Predictable, stable strategies, stated in prospectus

 Limited use of short selling leverage and use of derivatives is highly restricted

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7
Q

HEDGE FUND

 Liquidity

A

Have lock-up periods, require advance redemption notices

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8
Q

HEDGE FUND

Compensation structure:

A

Charge a Management fee between 1-2% of assets and an incentive fee of 20% of profits

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9
Q

MUTUAL FUND

Compensation structure:

A

management Fees are usually a fixed percentage of assets, typically 0.5% to 1.5%

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10
Q

MUTUAL FUND

Liquidity

A

Investments can be moved more easily into and out of a fund

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11
Q

Hedge fund strategies

directional

A

 Bets that one sector or another will outperform

other sectors of the market

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12
Q

Hedge fund strategies

non-directional

A

 Exploit temporary misalignments in in security valuations e.g. corp bonds are higher than treasury bonds, hedge fund would buy corporates and short sell treasury securities

 Buy one type of security and sell another

 Strives to be market neutral

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13
Q

Hedge fund strategies

Statistical Arbitrage

A

Uses quantitative systems that seek out many temporary and modest misalignments in prices among securities

involves trading in hundreds of securities a day with short holding periods (minutes or less)

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14
Q

Hedge fund strategies

Pairs trading

A

form of statistical arbitrage

Pair up similar companies whose returns are highly correlated but one is priced more aggressively

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15
Q

Hedge fund strategies

statistical arbitrage is associated with Data Mining

A

sorting through large amounts of historal data to uncover systematic patterns in returns that can be exploited by traders

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16
Q

Possible sources of superior performance of hedge funds

A

superior managers

Exposure to omitted risk factors with positive risk premiums

 Liquidity
Survivorship bias Changing factor loadings Tail events

17
Q

Liquidity and hedge fund performance

A

Hedge funds tend to hold more illiquid assets than other institutional investors

Unexpected declines in market liquidity are an important determinant of average hedge fund returns

Hedge funds report average returns in December that are substantially greater than their average returns in other months

 The December spike in returns is stronger for lower-liquidity funds, suggesting that illiquid assets are more generously valued in December

18
Q

Hedge fund performance

Backfill bias:

A

 Hedge funds report returns only if they choose to, and they may do so only when their prior performance is good

19
Q

Hedge fund performance

Survivorship bias

A

 unsuccessful funds cease operation and stop reporting returns and drop out of the database, leaving behidn only the successful funds

 Hedge fund attrition rates are more than double those for mutual funds

20
Q

hedge fund performance and changing factor loadings

A

Hedge funds are designed to be opportunistic and may frequently change their risk profiles (cf important assumption that portfolio manager manatains a stable risk profile over time)

 If risk is not constant, alphas will be biased in the standard linear index model

21
Q

tail events and hedge fund performance

A

Many hedge funds rack up fame through strategies that make money most of the time, but expose investors to rare but extreme losses

22
Q

Fee structure in hedge funds

High water mark

A

High water marks give managers an incentive to shut down poorly performing funds

 If a fund experiences losses, it may not be able to charge an incentive unless it recovers to its previous higher value

With deep losses, this may be too difficult so the fund closes

23
Q

Fee structure in Hedge funds

Funds of funds (feeder funds)

A

 Hedge funds that invest in one or more other funds, providing an opportunity to diversify across hedge funds

 Supposed to provide investors with ability to diveristy across funds and provide due diligence in screening funds for investment worthiness

24
Q

Fund of funds

hedge funds and fee structure

what do you need to pay?

A

Pay an incentive fee to each underlying fund that outperforms its benchmark even if the aggregate performance is poor

Diversification can hurt the investor in this case

25
Q

Fund of funds

hedge funds and fee structure

how should you spread risk

A

 Spread risk across several different funds, but

operate with considerable leverage

 If the various hedge funds in which these funds of funds invest have similar investment styles, diversification may be illusory

26
Q

Hedge fund strategies

Pairs trading

how can market neutral positoins be formed

A

by buying the relatively cheap firm and selling the expensive one.

27
Q

liquidity and hedge fund performance

typical alpha

A

typical alpha exhibited by hedge funds may be interpreted as an equilibrium liquidity premium rather than a sign of stock-picking ability

i.e. fair reward for providing liquidity to other investors

28
Q

liquidity and hedge fund performance

serial correlation

A

is a symptom of illiquid assets

29
Q

liquidity and hedge fund performance

serial correlation

implications?

A

thsi suggestion of smoothed prices has 2 important implications

  1. hedge funds are holding less liquid assets and their apparent alphas may be in fact liquidity premiums
  2. risk-adjusted performance measures are upward bias b/c any smoothing in the estimates of porftofilio value will reduce total volatility (increasing sharpe ratio) as well as covariances and tehrefore betas with systematic factors (increasing risk-adjusted alphas)
30
Q

positive serial correlation

A

positive returns are followed by positive than by negative returns

this is an indicator of less liquid markets b/c when prices are not available (since asset is not actively traded), the hedge fund estimates its value where firms smooth out their value estimates

31
Q

liquidity

hedge fund performance

Sadka’s studies show?

A

exposure to unexpected declines in market liquidity are an important determinant of average hedge fund returns

32
Q

liquidity and hedge fund performance

santa effect

A

Hedge funds report average returns in December that are substantially greater than their average returns in other months

33
Q

liquidity and hedge fund performance

why may returns be difficult to interpret?

A

hedge fund takes adv of illquid markets to manipulate returns by purposely misvaluing illiquid assets

34
Q

Hedge fund performance

changing factor loadings

Perfect market timing result

A

perfect market timinig (who engages in no security selection but moves funds from T-Bills into market portfolio only when the market will outperform bills)

results in a nonlinear characteristic line and hence greater sensitivity to the bull market

35
Q

Hedge fund performance

changing factor loadings

Funds that write options

A

have greater sensitivity to the market when it is falling than when it is rising

 Nonlinear characteristic lines suggest many hedge funds are implicit option writers

36
Q

Fee structure in Hedge funds

what is the typical hedge fund fee structure

A

management fee of 1% to 2% of assets plus an incentive fee equal to 20% of investment profits

Incentive fees are effectively call options on portfolios with a strike price X = current portfolio value x (1+benchmark return)

manager gets the fee is portolio rises sufficiently but nothing if it falls

37
Q

alike mutual funds, hedge funds

A

pool assets of several clients and manage the pooled assets on their behalf

38
Q

performance evaluation of hedge funds is complicated by

A

survivorship bias

potential instability of risk attributes

existence of liquidity premiums

unreliable market valuations if infrequently traded assets

esp difficult when the fund engages in option positions

Investments (12 decks)

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