Fiducitation: Hedge Funds
Author: Ray Ferrara
and Brian O’Keeffe
Date: February 14,
2002 © 2002 Fiducite.com, Inc.
Fiducitation: A
synthesis of public Internet resources on the topic, with a synopsis by
Fiducite.
Instructions: Use the Table of Contents to navigate the document. Each citation has up to four distinct parts: Annotation, Clip, Source, and Cached File. Our Annotation and Clip (text or graphic from source document) help you decide whether to view the document. The source document may be viewed by clicking on the Source URL or by opening the embedded Cached File. All information is attributed to its source.
The objectives of hedge funds are to create value through
positions that are not necessarily correlated with those of the traditional
equity and bond markets. Unlike traditional mutual funds – at least
non-derivative mutual funds whose portfolio values rise and fall with their
underlying holdings - hedge funds are designed to utilize both long and short
positions, puts, futures, and other devices on a variety of instruments such
that they can “generate portfolio performance regardless of the direction of
the capital markets”. As such, hedge
funds can be used to hedge losses under adverse market conditions as well as
amplify returns under certain other scenarios.
Additionally, the term hedge fund has also come to include a
legal connotation as well. Hedge funds are not typically regulated as strictly
as other forms of traditional investment, partially because they are fairly new
(the first hedge fund was devised by Alfred Winslow Jones in 1949) but also
because they have until now been confined to a fairly small target group of
fairly sophisticated investors. In the US for example, there are two primary
types of legal organizations for hedge funds: US-based and offshore:
·
A US-based hedge fund is
usually organized as a “private investment partnership”, a legal entity that
the Securities and Exchange Commission regulates less stringently than other
domestic investment vehicles. As private investment partnerships, they are
typically limited to 99 investors, at least 65% of whom must be accredited high
net worth individuals or institutional investors. (but in typical dynamic legal
fashion, there are new rulings and loopholes to apportion investor shares to
exceed even these maximums).
·
An offshore hedge fund is
organized in tax haven outside the US, and has no limits on the number of
investors. Some of these, however, abide by SEC requirements to enable
participation by US investors.
·
The other major
characteristic that distinguishes hedges funds is the hedging strategy they
employ. There are a number which have
been used to date – and more are being invented every year as new financial
instruments and placement terms appear. The first three citations below go over
the major types of strategies, while some of the later citations deal with some
newer variations. To quote from the first citation…
While
[all strategies] are all primarily focused on preserving capital and producing consistent
positive returns, there are significant differences in how the various
strategies try to achieve this. It is critical to understand the basis of the
underlying strategies and their differences in order to develop a coherent plan
to exploit the opportunity hedge funds offer investors to diversify their
portfolio and enhance returns. For example, long-biased equity and fixed income
strategies are impacted by the same market risk factors as traditional stock
and bond managers. Therefore, these strategies might be considered alternative
forms of active management within broader equity and fixed income portfolios.
Other strategies, such as equity market neutral and fixed income arbitrage, are
designed to remove exposure to underlying stock and bond markets and might be
considered diversifiers to a traditional portfolio. Other hedge fund strategies
attempt to exploit changes in market risk or market direction, and, therefore,
may do well during periods of market volatility. In short, analyzing the appropriateness
of a hedge fund should incorporate an understanding of the sources of return
for that strategy and recognizing the risk exposures underlying each
investment.
At present, there are about 4,000+ known hedge funds
worldwide, with a total investment capital in excess of $500M. Though this
still represents a fairly small fraction of the trillions in mutual funds – and
a smaller fraction still of the total traditional equity/bond market – there is
no denying that hedge funds are in a long and extended growth – a growth which
many feel will accelerate in the years ahead as the traditional capital markets
are faltering. Total investment capital in hedge funds has been growing at
about 20% per year for the last ten or so years, but at least one respected observer,
Ezra Zisk in the Journal of Alternative Investments, estimates that invested
capital may leapfrog to as high as $1.7 trillion by 2005 – a 35+% growth rate.
We also feel that this estimate is not unreasonable. While most hedge funds originally catered to high net worth
individuals, there is a growing a trend among institutional investors such as
endowment and pension managers to consider hedge funds as necessary ingredients
in their overall portfolios. While the
percentage of assets devoted to hedge funds versus other forms of investment
varies with the style of the manager, we have been seeing percentages as high
as 15% (from a progressive university endowment) to the 3-6% range as not
uncommon (for Calpers and similar pensions funds). And all this is despite the
bad press (i.e. Long Term Capital Management), the often-excessive fees, and
the non-transparent nature of hedge fund reporting. But as the number and types
of hedge funds increase – and more importantly, as fund managers grow in their
understanding of how to use the various types of hedge funds and to control the
risks and performance characteristics associated with them – we concur with
Ezra Zisk that we are on a rapidly growing upward trend. We are already
beginning to see promotions of “share
allotments” in hedge funds to the general investing public; and just as mutual
funds enabled stock ownership by the masses, we expect hedge funds – perhaps
initially as funds-of-funds - to eventually follow suit.
The really tough questions that face the hedge fund industry
going forward are what types of hedge fund strategies should be demanded,
designed, and then discarded or promoted. Like the pharmaceutical industry’s
arsenal of drugs, the types of hedge fund strategies and the behaviors and periods
they act over are constantly growing and interacting with each other. It is possible that some forms of hedging
strategy such as some arbitrage-based ones
– if overused – may become resistant and no longer able to produce
desired effects. To put these tough questions more broadly, where does the
correct balance of traditional investments versus hedge funds versus other
non-traditional investment lie for given investor risk/reward profiles? And how do you monitor and change these over
time to produce optimal results?
These questions have to be answered at both a macro level –
by regulatory agencies and hedge fund managers/designers – and at a micro level
by hedge fund investors. It is our belief that the next breakthrough in the
hedge funds industry will be in the area of multivariate predictive modeling.
As we begin to fully understand and mathematically model the behavior of hedge
funds and other investments against various market scenarios, we will be able
to better design the “best” mix of investment vehicles. We do not believe that
we will ever achieve the Holy Grail of Investing – a flexible, self-adjusting
investment strategy that generates positive returns under any and all market
scenarios. That is as elusive as the perpetual motion machine – it might work
except for friction (i.e. trading and position fees). But we do believe that a
lot of good work will be done in the near future on joining more sophisticated
scenario modeling systems with more sophisticated performance monitoring tools.
We will provide more in-depth information on this topic in a future
Fiducitation.
Differences
Between Hedge Funds and Mutual Funds or Other Investments
International
Hedge Fund Developments
Author:
An Introduction to Hedge Funds
Annotation: An excellent introductory article – the
first in a series from BARRA RogersCasey. The remainder of the series includes the role of hedge funds in a portfolio,
considerations in designing a hedge fund program, and the ongoing monitoring of
a hedge fund program.
Clip: What is a Hedge Fund?
“A hedge fund is an investment structure for managing
a private, loosely regulated investment pool that can invest in both cash
(physical securities) and derivative markets on a leveraged basis. Legally,
it may take the form of a limited partnership, corporation, trust or mutual
fund depending on where the fund is domiciled and the type of investors it
seeks to attract. The domicile or legal location of the hedge fund determines
the structure. Most U.S.-based hedge funds are structured as limited
partnerships while hedge funds outside the U.S., or “offshore” funds, are
typically structured as limited liability companies. As with more traditional
styles of management, investor funds are allocated either in a separate account
or, more typically, in a commingled fund. The hedge fund structure gives
investors access to hedge fund managers with specialized investment skills.
Unlike traditional asset managers, many hedge fund
managers try to create value primarily through positions uncorrelated with
systematic exposure to capital markets. Instead, they seek to generate
portfolio performance regardless of the direction of the capital markets.
Return opportunities come from two sources: an expanded universe of securities
from which to trade; and a wider array of trading strategies implemented
without the constraints of regulation common to most traditional products. For
example, hedge fund strategies may access financial and commodity markets and
may take long, short, spread, option and levered positions in any of these
markets. Therefore, hedge funds provide unique risk and return characteristics
that are not accessible by traditional asset management strategies. The hedge
fund structure encompasses a diverse set of strategies that attempt to create
value by exploiting specific arbitrage opportunities. Investment objectives
vary widely among hedge fund managers. Some hedge fund strategies, such as
market neutral, attempt to avoid systematic exposure to the capital markets and
are true diversifiers. Other hedge fund strategies, such as equity long/short,
are more sensitive to the same market factors as traditional stock strategies.”
Source: http://www.hedgeworld.com/research/reports/viewer.cgi?doc_id=1061
Cached File: 
Hedge Fund Primer
Annotation:
This
area on the HedgeFund.net site provides some useful introductory information,
including definitions – and performance measures – of the different hedge fund
strategies.
Source: http://www.hedgefund.net/def.php3
Cached
File:
Harvard Business School Baker Library Guide to Hedge Funds
Annotation:
An on-line guide from HBS.
Clip:
- What
Are Hedge Funds?
- Hedge
Fund Facts and Terms
- Types
of Hedge Funds
- Who
are Hedge Fund Managers?
- Suggested
Resources Available at Baker Library or Via the Internet
- Associations
and Hedge Fund Trackers
- Other Relevant Publications
Source: http://www.library.hbs.edu/hedgefunds.htm
Cached
File:
A Primer on
Hedge Funds
Annotation:
This
more academically oriented primer from Duke University’s Fuqua Business School
covers some of the mathematical concepts behind various hedge fund strategies.
Clip: In this paper, we provide a rationale for how hedge
funds are organized and some insight on how hedge fund performance differs from
traditional mutual funds. Statistical differences among hedge fund styles are
used to supplement qualitative differences in the way hedge fund strategies are
described. Risk factors associated with different trading styles are discussed.
We give examples where standard linear statistical techniques are unlikely to
capture the risk of hedge fund investments where the returns are primarily
driven by non-linear dynamic strategies.
Source: http://faculty.fuqua.duke.edu/~dah7/primer.pdf
Cached
File:
Hedge Fund Industry Graphs
Annotation: These graphs shows market sizing and fund composition from the 1990s through Q3-2001. The graphs are from the archives of the Hedge Fund Industry Association, and originally produced by HFR.
Clip:
.
Source: http://www.thehfa.org/articles.cfm
Cached
File: 
An Introduction to Hedge Funds
Annotation:
This
article (also cited in the overview section) gives some statistics and
background on industry growth and sizing as of Q1, 2001.
Clip:
As evidenced below in Chart 1, the flow of global
capital to hedge funds has risen dramatically over the last decade. However,
capital allocated to hedge funds from all sources still pales in comparison to
the roughly $3.8 trillion allocated to more traditional strategies by
institutional investors alone. (4) [But] It is estimated that the assets managed by hedge funds
will increase from approximately $500 billion today (Q1 – 2001) to $1.7
trillion in 2005 and that at least half of this $1.7 trillion will come from
institutional investors.(5)
(4) P&I 1000, Pensions & Investments, January 22, 2001.
(5) Hedge Funds: An Industry Overview, Esra Zask, The Journal of Alternative Investments,
Winter 2000.
Source: http://www.hedgeworld.com/research/reports/viewer.cgi?doc_id=1061
Cached File: 
Advantages of Hedge Funds over Mutual Funds
Annotation:
A
concise but accurate article from the Magnum Fund site.
Clip: Hedge Funds Outperform Mutual Funds in Falling Equity Markets
|
|
S&P 500 |
VAN U.S. Hedge Fund Index |
Morningstar Average Equity Mutual
Fund |
|
1Q90 |
-3% |
2.20% |
-2.80% |
|
3Q90 |
-13.70% |
-3.70% |
-15.40% |
|
2Q91 |
-0.20% |
2.30% |
-0.90% |
|
1Q92 |
-2.50% |
5.00% |
-0.70% |
|
1Q94 |
-3.80% |
-0.80% |
-3.20% |
|
4Q94 |
-0.02% |
-1.20% |
-2.60% |
|
3Q98 |
-9.90% |
-6.10% |
-15.00% |
|
3Q99 |
-6.20% |
2.10% |
-3.20% |
|
2Q00 |
-2.70% |
0.30% |
-3.60% |
|
3Q00 |
-1.00% |
3.00% |
0.60% |
|
4Q00 |
-7.80% |
-2.40% |
-7.80% |
|
1Q01 |
-11.90% |
-1.10% |
-12.60% |
|
Total |
-62.72% |
-0.40% |
-67.20% |
During the last 13.25 years, the S&P 500 Index has had 12 negative
quarters, totaling a negative return of 62.72%. During those negative quarters,
the average U.S. equity mutual fund had a cumulative negative return of 67.2%,
while the average hedge fund had a cumulative negative return of only 0.40%,
displaying the ability of hedge funds to preserve capital in falling equity
markets.
Source: http://www.magnum.com/hedgefunds/advantages.asp
Cached
File:
Why Hedge Funds Make Sense
Annotation:
A
fairly detailed white paper from Morgan Stanley’s Quantitative Group which
makes the case for how and why to invest in hedge funds, and how funds should
be balanced.
Clip: In this article, we analyze the performance and risk
characteristics of hedge funds. We evaluate the reasons why edge funds have
produced high levels of risk-adjusted return and alpha, and show how portfolios
of hedge funds can enhance strategic asset allocation for both pension funds
and endowments.
Source: http://www.thehfa.org/articles/1.pdf
Cached
File:
Hedge Funds: A Prudent
Diversification Strategy?
Clip: The objective of this web-based conference call was to
provide an opportunity for some of the leading thinkers in the institutional
investment management industry to share their thoughts and perspectives on
hedge fund investing.
Source: http://www.investorforce.com/aboutus/press_release/Hedge_Fund_Transcript_9-2001.pdf
Cached
File:
Author:
Apollo Fund (UK) Combines Hedge and Index Features
Clip: Sophisticated
investors large and small want good returns and minimal risk. Hedge funds offer
that up as a major selling point. But that’s not enough for many conservative,
institutional investors, who prefer investments that track an investment
benchmark. Apollo Advisors, with a soon-to-be launched offering, will try to
give investors the best of both worlds, the returns of a hedge fund coupled
with the investment risk of an index. Apollo is doing that by aggregating the
portfolios of managers in hedge funds of funds, and overlaying another
portfolio of securities that when combined with the hedge funds resemble a
broad market index. In a simple, long-only approach in place for a little over
a year, Apollo has been able to outperform the MSCI World Index by about 13%
but with a portfolio that resembles that very index, says Piotr Poloniecki,
chief executive of Apollo.
Source: http://www.hedgeworld.com/news/read_news.cgi?section=intl&story=intl5376.html
Cached File: 
Zurich Capital Markets raises $1.3B+
Annotation:
Following in Apollo’s footsteps, Zurich Capital Markets’ hedge fund
group is rolling out an institutional benchmark series.
Clip: Feb-06-2002
In what may be the fastest asset-growth story for any alternative investment
product, Zurich Capital Markets’ hedge fund group has already raised $1.3
billion for its Institutional Benchmark Series of funds, and appears to be
headed much higher, very soon.
Source: http://www.marhedge.com/
Cached File:
A Hedge Fund Designed to Please European Regulators
Annotation: An
interesting article from the Feb 2002 issue of Hedge Fund International.
Clip: A German
financier is hoping to set up an innovative scheme to introduce a new
distribution channel for hedge funds at home and internationally. René
Friedrich, who has been in fund marketing and equity sales since 1988 and has
advised European institutional investors on hedge fund selection, believes his
concept will address ongoing legal restrictions in some European countries.
If given the thumbs up by European regulators, his money market fund based on
hedge fund index certificates will benefit from low taxes and, as a low-risk
product, not face the distribution problems often still encountered by hedge
funds. “People are ready to put up with under 10 per cent return as long as
they get low volatility,” explained Friedrich. “So my idea was to create a cash
fund based on hedge fund certificates and construct everything in a way that it
would comply with legal requirements for cash funds or money market funds.”
Source: http://www.portfolioint.co.uk/archive/article.asp?id=900&a=35&m=52&y=2002
Cached File:
HEDGEWORLD FUNDSELECT PLATFORM FOR OFFSHORE HIGH-NET-WORTH INVESTORS AND ADVISERS
Clip:
HedgeWorld FundSelect is the first
global no-transaction fee marketplace for high-net-worth investors and advisers
to research, select and invest in single and multi-manager hedge funds through
a web-enabled platform assisted by offline account representatives. The first phase of the HedgeWorld FundSelect
rollout focuses on the needs of non-US high-net-worth investors and
advisers. The second phase, scheduled
for release in the first quarter of 2002, will focus on US high-net-worth
investors and advisers. In a subsequent
phase, the platform will be made available to institutional investors,
including multi-manager funds, family offices and foundations and endowments.
Source: http://www.hedgeworld.com/news/download/press_release_fs.doc
Cached File: 
Author:
The Hedge Fund Association
Annotation: This
association has attracted about 30-odd members since its spin-off from an
earlier fund association in 1997.
Clip: The Hedge
Fund Association is an international not-for-profit association of hedge fund
managers, service providers, and investors formed to unite the hedge fund
industry and add to the increasing awareness of the advantages and
opportunities in hedge funds.
Source: http://www.thehfa.org/
Cached File:
Van Hedge Fund Advisors International
Annotation: VAN is
perhaps the industry’s most comprehensive hedge fund website with data on over
4,000 hedge funds. The other web sites cited after it are also substantial
information sources.
Clip: This
website represents our effort to provide you as much useful hedge fund
information as possible - from basics, such as definitions of hedge
funds and hedge fund strategies, through empirical evidence as to the
desirability (and limitations) of hedge funds, including updated
performance of individual managers.
Source: http://www.vanhedge.com/
Cached File:
HedgeFund.net
Clip: HedgeFund.net
is a free listing of hedge fund information and performance that currently
encompasses 31 different strategies. Our growing membership includes over 2,000
of the world's most talented hedge fund managers and more than 15,000 sophisticated
investors.
Source: http://www.hedgefund.net/
Cached File: 
MAR – the global source for alternative investment information
Annotation: This UK-based
firm provides newsletters, conferences, and directories for the global
alternative investment community. In
the near term, they are sponsoring the 7th annual European
Conference on Hedge Fund Investments on February 25-27 in Geneva.
Clip: Managed Account Reports Inc publishes a wide
range of newsletters and directories covering the global alternative investment
marketplace. To see more information about the individual publications, simply
select the appropriate link…
Source: http://www.marhedge.com/
Cached File:
Hedge Funds Research (HFR)
Annotation: Hedge Funds
Research is one of the more established marketing and consulting firms in the
hedge funds industry. It also maintains a very extensive database.
Clip: The
HFR Database is recognized as the most comprehensive source of information on
hedge funds and alternative investment managers in the industry. Hedge Fund
Research provides a data service for its clients to effectively analyze
investment opportunities. The HFR Hedge Fund Database allows users to identify
alternative investment managers based on several key factors, such as risk
tolerance, geographic location, liquidity and investment sectors, among others.
The research staff continues to build this product to educate our clients and
to assist them in decision making.
Source: http://www.hfr.com/products.html
Regulatory Guidance and Best Practices for Hedge Funds
Annotation: This is a web
directory from the Managed Funds Association – a US-based association of fund
management professionals.
Source: http://www.mfainfo.org/washington/hedgefunds/hedgefunds.html
The Hedge Funds Consistency Index Newsletter
Annotation:
This subscription newsletter ranks and profiles the most
consistently performing hedge funds on a risk-adjusted basis.
Source: http://www.hedgefund-index.com/
Cached File:
Hedge Funds Review Magazine
Annotation: This is a new
UK-based magazine covers the hedge fund industry.
Clip: Each issue contains a profile of a hedge fund management
firm looking at the highs and lows of their trading; a comment piece written by
the industry for the industry; statistical analysis of the markets and the
funds and news stories, covering everything that is happening in this exciting
sector.
Source: http://www.hedgefundsreview.com/about.asp
Cached File:
Hedge Funds International
Annotation: This UK-based
monthly magazine, part of Portfolio International, also covers the hedge fund
industry and maintains on-line article archives.
Source: http://www.portfolioint.co.uk/archive/backissues.asp?m=52
Cached File: