Hedge Fund Structure

Convertible Arbitrage Moneyness (3 things)

1. Distressed - Stock price is very low and it is questionable if the issuer can service its debt 2. Bond-Like (Busted) - Stock price is not high enough for conversion to happen 3. Hybrid - Stock price is sufficiently high, where the equity option has value (MOST)

4 disadvantages of FOF

1. Double layer of fees 2. Possible exposure to netting risk 3. Lack of control with no ability to customize the portfolio 4. Limited transparency

4 advantages of FOF

1. Expertise and informational advantage 2. Immediate exposure and diversification 3. Possible to receive reduced (negotiated) fees from underlying hedge funds 4. Increased access to top HF managers

7 Pairs Trading Risks

1. Noise Traders 2. Fundamental Risk 3. Corporate Event Risk 4. Model Risk 5. Shortsale Risk 6. Liquidity Risk 7. Synchronization Risk

Distressed/Restructuring Returns are generated by 2 common strategies:

1. Pull-to-Par - based on fundamental valuation with the view that the target companies financials will improve due to a catalyst (i.e., changing economic situation or refinancing that lead to increase in asset values) 2. Negotiation - Use of leverage from covenants and the bankruptcy code to force a negotiation

5 Common Characteristics of Hedge Funds

1. Target positive absolute returns (opposed to relative return against a benchmark) 2. Accredited investors or institutions can participate 3. Can utilize a wide range of investment tools and instruments 4. Can go short or long 5. Can use leverage

Global Macro Strategy (4 things)

1. These funds employ a top-down approach 2. Concentrate on major market trends rather than on individual security opportunities 3. Can go long or short; Can invest in any asset class or derivatives 4. The most flexible mandate among major hedge fund styles

Pairs Trading

A strategy where an investor matches a long position in one stock with a short position in another stock, usually in the same sector The conventional practice has been to look for two stocks whose prices have historically have a high correlation

Activist

After buying large stakes in specific corporations, the managers seek to obtain representation of the company's board of directors in an effort to impact or change the company's policies or direction

1st Hedge Fund

Alfred Winslow Jones founded A.W. Jones & Co. in 1949 ("Hedged Fund") interesting in technical analysis Original amount of capital $100,000 He declined to register under the Securities Act of 1933 and the investment Advisors Act of 1940 because his funds were private. This means that he could never advertise them publicly

Long Bias

An Equity Directional investment style employing both long and short equity positions Funds will invest primarily in long positions in securities expected to appreciate in value while supplementing that with short positions of securities expected to fall in value

Statistical Arbitrage

An Equity Market Neutral investment style that attempts to take advantage of pricing discrepancies in the equity markets

Prime Brokers

Bundle package of serviced offered by investment banks and security firms to service hedge funds (e.g. capital introduction, custodian, lending, provide stocks, provides tech, etc.)

Distressed/Restructuring

Distressed Debt (or Securities) funds invest in debt (and equity) of companies that are in or near bankruptcy

first time the term hedge fund was used

In a 1966 Fortune article titled, "The Jones Nobody Keeps Up With" by Carol Loomis

"Accredited" Investors that can partake in hedge funds

Individual investors with a net worth over $1 million not including private residence Or an individual that has an annual income over $200K (or $330k jointly with a spouse) Some Hedge Funds are closed to outside money and others only accept money from institutional money managers (i.e., endowments)

Long/Short Funds

Long/short Funds employ both long and short equity positions switch back and forth between an overall net long or net short portfolio, depending on market conditions and opportunities

Merger Arbitrage

Trade after a merger or acquisition is announced so that a profit is made if the announced deal takes place If the merger succeeds, the arbitrageur captures the arbitrage spreads, but if it fails, they could suffer a substantial loss

Fund of Funds

a fund that invests in multiple underlying hedge funds investors achieve fund diversification across strategies, but pay an extra layer of fees

Hedge Funds

asset managers that utilize other investment strategies than those used by relative return long only managers differ from long only strategies in terms of investment objectives, manager's skill, and approach to risk (There is no clearcut legal or universally accepted definition of a hedge fund)

Convertible Arbitrage

attempt to exploit anomalies in the prices of convertible bonds and stock.

Fixed Income Arbitrage

attempt to identify overvalued and undervalued fixed income securities and profit from small price discrepancies while limiting interest rate risk

2&20

fee arrangement that is standard in the hedge fund industry and is also common in venture capital and private equity 2% of assets under management (annual fee charged) and incentive fee of 20% for profits made by the fund above a certain predefined benchmark

Equity Market Neutral

funds attempt to identify both overvalued and undervalued stocks while neutralizing the fund's exposure to market risk by combining long and short positions

Hedged Equity

funds attempt to identify overvalued and undervalued equities. Not typically structured to be market, sector, industry, or dollar neutral Can be heavily concentrated in a few companies and short positions could be a small percentage of the value of long positions

Short Bias (Bear Market)

funds invest in short positions and derivatives in order to profit from stocks that drop in price

Many Hedge Funds have _________ water mark and hurdle rate

high High Water Mark is the highest peak in value a hedge fund has reached. Managers must hit the water mark of last time before getting bonus Hurdle Rate is rate of return manager must beat over a set period before collecting bonus

Asset-Backed Securities

invests in securities backed by notes or receivables against assets other than real estate. Some examples are auto loans, credit cards and royalties.

Emerging Market Debt

invests primarily in fixed income securities in emerging markets. These areas include parts of Asia and the former Soviet Union, Eastern Europe, Latin America and Africa.

Fixed Income Directional

involves taking long and short positions in interest rate sensitive investments. The positions taken may not be market neutral. Returns generated by these strategies tend to have low correlation to equity markets.

Hedge funds intentionally adopt structures that are...

loosely regulated

Ed Thorp

pioneered the modern applications of probability theory, including the harnessing of very small correlations for reliable financial gain used high-level math to beat roulette, blackjack, etc.

Quant Funds

select securities based on quantitative analysis Typically, rely on proprietary computer based models to determine if an investment is worth investing in

Fixed Income Diversified

typically holds long positions, but may also invest on the short side, in debt securities. This includes government, corporate and other types of debt instruments, fixed income options and credit derivatives. Funds will attempt to profit from credit/yield opportunities