Hedging Options » Hedge Funds

What Are Hedge Funds?

admin — Wed, 20 Jan 2010 19:11:56 +0000

Hedge funds can be described as pooled investment vehicles that use flexible strategies in order to generate returns while at the same time, preserving capital by hedging against market declines. Considered an alternative investment fund, a hedge fund trades and invests in various assets such as securities, currency, commodities and derivatives on behalf of its clients who are typically wealthy individuals.

Hedge funds are normally set up as limited partnerships where the fund manager is the general partner and the investors are the limited partners. They are loosely regulated which allows the fund managers to participate in the gains or losses of the money invested. These funds usually have large fees associated with them as fund managers habitually charge both a performance fee and an asset-based fee.

Hedge funds have greater flexibility than mutual funds in the investment policies they can incorporate and therefore are better able to hedge against downturns in the markets. In addition, mature hedge fund management firms structure their funds to include domestic and offshore investments. This provides the managers of hedge funds the distinct advantage of attracting capital worldwide.

Some of the investment methods hedge funds incorporate include short selling, arbitrage and leveraging. Short selling allows an investor to sell stock they do not own for the opportunity to profit when prices fall. Arbitrage allows for the simultaneous buying and selling of securities in different markets in order to profit from the difference in prices. Leveraging is the borrowing of money for investment purposes.

Hedge funds offer the sophisticated investor a diverse, alternative investment option.

Hedge Funds – Boon or Bane?

admin — Sun, 17 Jan 2010 07:17:23 +0000

Anyone following the financial news has likely heard opinions right and left about what’s behind the current crisis. In addition to the usual suspects-Wall Street greed, lack of oversight, and predatory lending-you’ve doubtless seen fingers pointed at other culprits, such as short selling and hedge funds.
Let’s take a closer look at those last two subjects by answering these questions: What exactly are hedge funds? How do they work? Who is eligible to invest in them? And finally, why have these funds been grabbing headlines during the recent Wall Street crisis?
First, let’s examine what they are and where they came from.Hedging against risk
Back in 1949, Alfred W. Jones, a sociologist, author, and financial journalist, came up with a revolutionary idea for an investment fund. To hedge against potential losses for investors, Jones combined leverage and short-selling of securities. He was so successful at hedging the market, his fund outperformed the mutual funds of the day-and the term “hedge fund” was born.
Despite his success, hedge funds didn’t really get traction until the 1960s when wealthy entrepreneurs like Warren Buffet and George Soros got on board. Suddenly hedge fund became a Wall Street buzzword, and by some estimates, these funds currently manage close to $3 trillion in assets.
While Jones’s strategy focused on short selling and leverage, there are a variety of other methods today’s hedge fund managers use.Bigger risks, bigger rewards
Hedge funds are a bit like exotic mutual funds, but with bigger downside risks, and greater upside rewards. They’re similar to mutual funds in that hedge fund managers pool investors’ money and re-invest it in hopes of getting a positive return. But that’s where the similarity ends.
Unlike most security offerings, which are tightly monitored and regulated, hedge funds are not required to register with the Securities Exchange Commission (SEC) or to file periodic reports. Hedge fund managers aren’t even required to disclose what they’re doing with investors’ money. In fact, what they’re doing is investing in everything from stocks and futures to commodities and currencies, real estate, art, even website domain names – not to mention other risky investments. There’s no regulatory body overseeing hedge funds, so investors are virtually unprotected.
It’s an environment that attracts the wealthy in search of higher than average returns-investors who may even prefer the lack of government oversight. Hedge Fund managers have free rein to take risks tightly regulated mutual funds cannot. To do so, they use a variety of sophisticated investment strategies. Two of those strategies are short-selling and arbitrage.Short Selling is like placing a bet that the stock price will go down. The hedge fund manager borrows shares of stock he feels are about to slide and immediately sells them on the promise of returning the shares later. If the manager’s assumptions were correct, he can purchase the shares back at the lower price and keep the profit before returning the stock to the lender. Short selling on a massive scale upsets the balance and order of the market.Arbitrage takes place when you simultaneously purchase and sell the same investment to take advantage of inefficient markets. Here’s a simple example: A hedge fund manager buys securities in one country and immediately sells them in another, to take advantage of a lag in foreign exchange rate adjustments (and possibly different time zones). This risky technique requires careful monitoring of global currencies.Who’s eligible to play this high-stakes game?
Unlike mutual funds, hedge funds are small, private partnerships with stringent eligibility requirements. The widespread availability of hedge funds has changed a lot since Buffet and Soros first favored them, but one thing hasn’t changed. These funds are still for big hitters only-institutional or individual investors with deep pockets, wealthy enough to absorb heavy losses and savvy enough to understand the risks.
Typically, a pool of investors in a single hedge fund may be comprised of 100 “accredited investors” or an unlimited number of “qualified purchasers.” To join the ranks of qualified purchasers, you typically must meet these criteria:
An individual with investments worth at least $5 million including those held jointly with a spouse.
A family-held business with $5 million or more in investments.
A business with control of at least $25 million in investments.
A trust sponsored by qualified purchasers
The requirements to qualify as an accredited investor are similar, but typically apply only to individuals, not businesses or trusts:
An individual with a net worth in excess of $1 million-or that amount when combined with a spouse.
One who has had an individual income, excluding spouse’s income, of more than $200,000 in the previous two years with reasonable expectation for same in current calendar year.
A married couple with joint income of more than $300,000 in the previous two years and a reasonable expectation for the same in the current calendar year.Minimum investments:
The minimum investment is set by the General Partner (GP) and varies between funds, but $250,000 or $500,000 is the typical amount for a new fund. Minimums for established funds can run as high as $10,000,000. Generally the GP can waive the minimum if he wants to accommodate those investors that pledge to invest that amount over time.Hedge funds get in trouble
The strategies hedge funds use are designed to work to the investors’ advantage whether markets are rising or falling. In fact, these funds usually thrive in volatile markets because they can capitalize more fully on market opportunities using leverage, short-selling, options, futures, arbitrage and other strategies.
But now even hedge funds are struggling to hang on as they ride the financial roller coaster. Before the Wall Street meltdown and $700 billion bailout for financial institutions, hedge funds were already seeing their worst year on record. By the 2nd quarter of 2008, the average fund was down nearly 5 percent – a bitter pill to swallow when average annual returns on investment were often in the double digits.
No one can afford to be invested in an underperforming hedge fund right now – and half of the hedge funds in America are underperforming. Even billionaire Boone Pickens, founder of BP Capital LLC, who lost more than $1 billion of his own money in energy trades this year, reports that 15 percent of his hedge funds’ holders opted to cash out.
Most hedge funds set a quarter-end deadline for clients to request having their money returned. If the predictions are accurate and hedge fund investors want out en masse, it will push fund prices down far enough to force many smaller and poorly managed hedge funds out of business.
That won’t happen overnight, of course. The wave of closures would be gradual and most likely span a six month period. Experts predict the wave could kick off in November and December at the end of the typical 45- to 65-day waiting period, when fund managers must return investor money.
Many financial analysts predict the demise of as many as 2,000 smaller hedge funds between October 2008 and March 2009. Fear over a mass investor cash-out have become far more worrisome to hedge fund managers than the recent temporary worldwide bans on short-selling that hamstring trading strategies such as arbitrage.
Those bans were put in place in late September when, in an effort to quell market volatility, the SEC banned short-selling in 799 financial stocks and required hedge-fund managers to disclose their short positions.Disclosure? That was a first! Naturally there was immediate pushback, with some arguing that asking a hedge fund to reveal its inner-workings is like asking Coca-Cola or Colonel Sanders to reveal their formulae.
The expanded and extended no-short list now covers nearly one-fifth of regularly traded stocks listed on U.S. exchanges. The ban is expected to be in place until mid-October.
It remains to be seen how all of this shakes out and how the hedge fund industry will survive this major upheaval in the financial markets.

Hedge Funds Growth Open Doors To New Financing Options

admin — Tue, 22 Dec 2009 19:04:09 +0000

According to a recent study of financing options for hedge funds by Standard & Poor’s, the largest hedge fund families manage $10 billion, $20 billion, and even $30 billion today, and at least 100 individual funds have more than $1 billion in assets.
“Funds need to reach the multibillion level so they can access the broader range of funding,” explained Charles Davidson, director in Financial Services Ratings at Standard & Poor’s Ratings Services. Growth of assets size isn’t the way to attract even more assets. A track record that lenders and investors can evaluate is also important.
By now, many hedge funds have a performance history dating back eight to 10 years. The ability to post impressive profits over an extended period raises lenders’ and investors’ comfort level. Redemption restrictions that boost funds’ liquidity also help in obtaining financing.
These factors have enabled hedge funds to expand their financing beyond the traditional choices of collateralized loans through prime brokers, investors’ equity, and their own capital.
Bharat Book Bureau has released a report called “Hedge Funds and Prime Brokers”, the report explores the ever-changing and dynamic hedge fund-prime broker relationship through the use of a panel comprising of some of the world’s experts in investment, law and regulation.
According to the Bharat announcement, it examines how “unregulated hedge funds” are actually regulated already and why more “regulation” may not be required, it also explains just how these prime brokers are regulated in their hedge fund activities, as well as the trading and economic factors that drive the relationship.
The report also looks at the changing relationship between prime brokers and hedge funds, the relationship they have with hedge fund service providers, such as administrators, risk managers, directors, investors and regulators. The legal, regulatory and jurisdictional issues that affect the prime broker-hedge fund relationship, emphasizing relevant laws, listing and continuing obligation standards and agreements.
According to early estimates at the HFN Hedge Fund Aggregate Average was +1.40% in June 2007 and ended the first half of 2007 +7.86%.
The HFN Hedge Fund Aggregate Average is an equal weighted average of all single manager hedge funds and CTA/managed futures products in the HedgeFund database. The increase was the 11th positive month in a row for hedge funds. After trailing the prior three months, the Aggregate outperformed the S&P 500 Total Return which ended June -1.66% and +6.96% YTD. The HedgeFund database consists of over 7,400 current hedge fund, fund of funds, and CTA products.
Contrary to the previous three months, that on average produced positive results despite most major global equity markets falling during the month. What markets did supply in June was a sharp increase in volatility.

What are Hedge Funds and Starting Your Own Hedge Fund

admin — Wed, 09 Dec 2009 07:41:44 +0000

WHAT ARE HEDGE FUNDS?

www.turnkeyhedgefunds.com

In the securities world, the term “Hedge Fund” does not necessarily imply any use of “hedging” as commonly understood; for example where commodity traders use options to “hedge” a commodity position. Presently, in the securities world the term “hedge fund” refers to any type of Private Investment Company operating under certain exemptions from registration under the Securities Act of 1933 and the Investment Company Act of 1940. “Hedge Funds” are often referred to as “alternate investment vehicles” and are tailored to the needs of sophisticated, high net worth private investors. A Hedge Fund is generally structured as a limited partnership having a general partner responsible for the investment activities and day-to-day operation of the fund, and limited partners who are the investors supplying capital but not participating in trading or operations of the fund. The limited partners have limited liability. That is, their exposure to loss is limited to their investment. The General Partner has unlimited liability and is liable for the activities of the partnership. The General Partners principals limit their liability through the use of a corporation or limited liability company as the General Partner. (Of course, the principals cannot limit their liability from the application of the anti fraud provisions of the Federal Securities Laws.) All of the investors’ capital is pooled and is utilized by the General Partner or Investment Manager to implement its trading or investment strategy.

Hedge Funds are “Non-Public Offerings.” The private offering exemption prohibits Hedge Funds from making any public offering. Therefore, Hedge Funds are prohibited from general advertising and generally secure investors through word of mouth, consultants, registered representatives, brokers or investment advisors. Hedge Funds have investors that are either “accredited investors” or “qualified purchasers.” In general, the Federal Securities Laws define the terms “accredited investor” and “qualified purchaser” in terms of minimum asset and income threshold that must be met before they qualify to be investors in the Hedge Fund. Since the Hedge Fund generally limits investment to “accredited investors” or “qualified purchasers” both of whom are required to meet certain minimal asset and/or income thresholds, the Fund Manager or administrator must gather background information on potential investors to determine whether they meet the minimum requirements to be “accredited investors” or “qualified purchasers.” By making a non-public offering to certain kinds of investors, (accredited investors or qualified purchasers) the investment vehicle will be exempt from registration requirements of The Securities Act of 1933 pursuant to the safe harbour provisions of Rule 506 of Regulation D. Where the investment vehicle is limited to no more than 100 investors, and otherwise complies with the safe harbour provisions of Regulation D, such an investment entity is exempt from the extensive regulation pursuant to Section 3(c)1 of The Investment Company Act. Section 3(c)7 of The Investment Company Act offers a similar exemption to private investment companies with “qualified purchasers” as investors.

As an unregulated entity, the Hedge Fund Investment Manager is free to undertake greater risk on more volatile positions thereby exposing investors to potential substantial profit as well as substantial losses.

Typically, Hedge Funds provide for the payment of an Incentive Allocation or Performance Fee to the hedge Fund Manager/General Partner. Performance Fees range from 20% to 40% depending on the strategy employed by the Hedge Fund Manager. Typically, the Performance Fee provides for a “high water mark” structure which provides that incentive fees are paid only to the extent that the fund continues to meet or exceed the “high water mark.” Additionally, typical Hedge Funds include Management Fee of 1% to 2% of all assets under management.

Generally there are two kinds of Hedge Funds. On the one hand, there are the huge worldwide funds operated by charismatic managers such as George Soros. On the other hand, there are small boutique-styled Hedge Funds identified with a particular segment or investment strategy. The Fund Manager’s expertise, experience and background in recognizing investment opportunity will dictate that fund’s particular niche. For example, there are the “Biotech Hedge Funds” which are managed by experienced and highly qualified investment managers who may also hold advanced degrees in science and medicine. There are “Tech Hedge Funds” specializing in the technology sector managed by individuals having specialized experience trading in that sector. With the emergence of day trading and the availability of the trading technology, a number of floor traders and brokers are leaving the traditional brokerage and exchange venue to participate in the computer screen trading phenomena.

The boutique “Hedge Fund” typically relies on the particular skill and expertise of the Investment Manager or Trader. The highly specialized Investment Manager may utilize a “Sector” style of investing focusing on a particular industry or economic sector. Conversely, an Investment Manager utilizing a “Market Neutral” style will maintain a portfolio of securities which are generally ½ short and ½ long. Some Investment Managers utilize a “Value” investment style based upon assets, cash flow and book value; while other Investment Managers follow the “Emerging Markets” style and invest in emerging and foreign market equity and debt. “Trading” funds utilize an opportunistic investment style taking advantage of market trends, events and opportunities for short term profits. Each Fund Manager develops and uses a particular investment style that is unique to the experience, expertise and personality of its manager.

Unlike Hedge Funds, Mutual Funds raise money publicly; are highly regulated by the Securities and Exchange Commission, the Internal Revenue Service and other agencies; and offer investment diversification and are restricted from purchasing many types of derivative instruments, leveraging, short selling and other kinds of transactions.

Unlike the Mutual Fund Managers, the Hedge Fund Manager generally invests in the fund that they manage and participate in profits as well as risks with their investors. Unlike the Mutual Fund fee structure (which is determined on assets under management) the Hedge Fund Manager receives incentive allocations on performance.