Week 4 - Hedgefunds Flashcards
1
Q
What is Dogs of the Dow?
A
- buy the 10 dow components with the highest yields: get more dividend income and hoping last year’s laggards outperform
- -> it outperformed the bear market of 2000 to 2002, and it beat the broader market in 2010, but lagged simply holding the dow between 2006 and 2009
- -> one shortcoming is that it does not put any weight on financial strength or apply any fundamental analysis with regard to the sustainability of the dividend
2
Q
What is GARP?
A
- an investment strategy that combines tenets of both growth and value investing by finding companies that show consistent earnings growth but don’t sell at overly high valuations
- PEG Ratio; price/earnings growth
- -> LOOK for stocks with a PEG ratio <1
- GARP seeks to avoid the disadvantages or pitfalls of pure growth and pure value stocks
- -> growth stocks can form a bubble by rising very high and crashing very fast while value stocks can go nowhere for a long time
- -> by finding a GARP middle ground, investors seek to enjoy rising prices w/o being vulnerable to a price crash
- GARP stocks can underperform growth stocks in a growth market and underperform value stocks in a value market
- However, GARP can outperform in mixed markets and over the long-term
3
Q
For the U.S stock market, what factors have researchers found to have had the greatest effect on expected stock returns?
A
- one month excess return (-)
- 12-month excess return (+)
- trading volume/market cap (-)
- earnings to price (+)
- BV of equity to price (+)
- return on equity (+)
- variability in cash flow to price (-)
4
Q
What have been the most statistically powerful and stable predictors of future stock returns in Canada?
A
- 12 month price momentum, one month reversals, and operating margin
- -> past winners continued to do well
- -> stock returns experience strong one-month mean reversion
- -> stock returns are positively related to firm profitability
- -> risk-based factors are negatively related to future stock returns
5
Q
What are some common investment mistakes?
A
- no plan (including exit plan), not being prepared
- chasing performance
- blindly following mechanical systems/softwares
- failing to adapt to changing
- trying to outsmart the market
- trading too much
- holding onto losses too long
- use too much margin/leverage
- overexposing a position
- waiting too long to start
- favouring short-term needs over long-term goals
- letting your emotions control you
- letting hindsight influence your trading
- overconfidence after a profit
- blaming others for your inability to make money
- media addiction
- expecting to get rich quick
- counting on luck
- paying too much in fees
6
Q
What are hedge funds?
A
- private investment vehicles open to a limited number of wealthy or professional investors
7
Q
What are characteristics of hedge funds?
A
- limited number of investors (accredited and qualified purchasers)
- minimum capital requirements are high –> typically $1 M in liquid requirements
- usually limited liquidity –> lockup period
- usually put some restrictions on when investors can withdraw their money
- often employ leverage and use of derivatives. Invest in a wide-range of strategies often not available in other investment vehicles
- manager fees are very high and often have a performance component
- unregulated
- not transparent
8
Q
Differences between hedge funds and mutual funds
A
- Transparency - mutual funds are regulated by a series of National Instruments adopted by provincial and territorial regulators. Hedge funds usually provide minimal information about portfolio composition and strategy to their investor only
- Investors - hedge funds typically are available only to accredited or sophisticated investors, in practice usually defined by the minimum net worth and income requirements.
- Investment Strategies - mutual funds lay out their general investment approach in their prospectus. Mutual funds limit use of short selling and leverage and their use of derivatives is highly restricted
- Liquidity - hedge funds often impose lock-up period. Many also employ redemption notices that require investors to provide notice weeks or months in advance of their desired redemption.
- Compensations structure: hedge funds differ in their fee structure. Whereas mutual funds assess management fees equal to a fixed percentage of assets, hedge funds charge a management fee plus a substantial incentive fee equal to a fraction of any investment profits beyond some benchmark
9
Q
Positions that Hedge Funds take
A
- mutual funds are subject to the Investment Company Act of 1940, required to disclose to the investing public info about the funds and investment objectives
- Hedge Funds are EXEMPT from the regulatory controls of the Investment Company Act
- DO NOT have to disclose their holdings, not even to their investors
- not usually 100% long
- often take some short positions and utilize leverage
- not always market-neutral; average HF beta w/ the market is ~0.3
10
Q
Famous hedge funds
A
- Soros fund management: bet $10 billion by shorting pounds and buying Marks
- LTCM blew-up: Russian debt crisis
- Amaranth blew up September 2006 after losing $6 billion on NG futures
- Renaissance Technologies Medallion Fund: Sharpe Ratio>20
- Man Group: fund you can invest in that invests in hedge funds
11
Q
Details in Hedge Fund Fees
A
- Standard 2/20: expense ratio of 2%, performance fee of 20% –> outperformance is shares 80/20
- performance fee is calculated net of a benchmark, e.g. LIBOR or the S&P500
- a high-water mark is often applied to the performance fee. Performance fees are levied only when the NAV exceeds the highest NAV previously achieved…e.g. NAV(0) = 100, NAV(1) = 120, NAV(2) = 110 –> no performance fee is payable at t=2 and none applies until NAV>120
- incentive fees are linked to higher performance: Ackermann report a Sharpe ratio increase of 0.15 moving from a fund with no performance fee to 20% performance fee
12
Q
Hedge Fund Historic Performance
A
- Do hedge funds deliver alpha? Evidence in literature is mixed, but the general consensus points to the existence of alpha among hedge funds
- No: Ackermann, McEnally and Ravenscroft (1999): HFs easily beat mutual funds but do not outperform market indexes
- Yes: estimates of HF alphas are around 3%-5% per annum. Jagannathan, Malakov, and Norikov: strong persistence in the HF performance
13
Q
A
Hedge funds limited losses during the financial crisis
14
Q
A
HF alpha has been on a downward trend
overtime, HF industry correlation w/ S&P500 increasing –> higher correlation; look more and more like index
smart beta; in between mutual funds/hedge funds
15
Q
What are the two main hedge fund styles?
A
- Discretionary: relies on a person’s judgement to determine trades
- Systematic: more rules-based and relies on quantitative models. I.e. quant black-box frequency trading
25
Q
Hedge Fund Returns = Short Put
A
- many common dynamic hedge fund strategies can be considered to be replicating option payoffs (e.g., selling out-of-money put options)
- shorting ‘out-of-money’ puts –> positive payoff if stock market goes up, option will finish out of money fifn’t go down much, if the market crash, will finish in the money and lose money
