Hedge Fund Reader

What are Hedge Funds?

For those who always believed that Hedge funds only meant investment vehicles that employed any type of hedging. The term "Hedge Fund" does not necessarily that as commonly understood. A good example would be a commodity trader who uses options to "hedge" a commodity position. Thus in the current understanding of things, 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.

These hedge funds can also be termed as "alternate investment vehicles" – as they are customized to the needs of sophisticated, high net worth private investors. These funds are usually structured as a limited partnership - having a general partner responsible for the investment activities and operation of the fund, and limited partners who are the investors fusing in capital but not participating in trading or operations of the fund. In essence, limited partners have limited liability, which means their exposure to loss is limited to their investment.

Key Strategy of Hedge Funds

Most of you guys who have been interested in the hedge funds industry and have tracked the sector would surely be mesmerized by the secrecy with which these funds operate. After witnessing the market return rather meager gains during 2005, there has been an increased caution and watchfulness resulting in close scrutiny of the current environment for new trading strategies.

According to our research and other market studies, one classic hedge fund strategy, which is known as the "paired trade," is gaining popularity among the pros. This strategy reportedly offers tremendous profit potential for professional traders. And this strategy is worth looking in this current hedge funds sector business environment.

According to industry analysts and experts, this strategy is gaining more prominence off late, because hedge funds have been struggling to generate the glamorous returns they need to justify charging their investors 20% of profit and a 2% management fee, as they commonly do.

There is an increased pressure on these funds to generate the sky high returns – otherwise there could be a sharp downturn in investor confidence in the investment vehicles. Specifically, since hedge funds mainly cater to the super rich segment, who only invest in this strategy to derive heightened returns despite risks. 

A paired trade is exactly what it means, "a pair of trades." An investor buys shares of a company that is doing well, while short selling another company - usually in the same sector or industry - that is struggling. By purchasing shares in one company, and selling borrowed shares short in another, hedge funds can make a greater return than if they just entered a single trade. This strategy or concept of "pairs trading" is one that long/short hedge funds have been employing for a while now.

The birth of hedge funds

The beginning of hedge funds traces back to the year 1948 when Alfred Jones, a graduated from Harvard while writing an article about current investment trends for was inspired to try his hand at managing money. He raised $100,000 and made an effort to try to minimize the risk in holding long-term stock positions. He did so by short selling other stocks. Jones further employed leverage in an effort to enhance the returns.

In the year 1966 another article in Fortune magazine highlighted an investment that had  outperformed the mutual funds saw the birth of the hedge fund industry. In a span of two years, there were close to 140 hedge funds in operation. The strategy to increase returns saw a changeover at this point. But unfortunately, this led to heavy losses in the year 1969-70, and was followed by a number of hedge fund closures in the following years.

The industry came alive again in 1986 when another hedge fund captured the interest of investor because of its outstanding performance. Soon investors started turning to hedge funds instead of mutual funds. Keeping in tune with the highs and the impeding lows of the industry, the late 1990s and early 2000s again saw a crash in the industry.

Today, inspite of the trouble seen in the last few years, the hedge fund industry is thriving. Currently there has been an increasing move towards regulating the functioning of the industry.

Protect yourself from hedge fund frauds

What can you do to protect yourself from hedge fund frauds? Well, quite a lot as long as you are willing to make the effort. A number of options are available for finding out the requisite information to ensure that your investment is safe. Armed with this information, you can truly make a ‘safe and profitable’ investment.

You can hire a sleuth who would find out the background of the hedge funds that you plan to invest in alongside with the history of the manager. These sleuths can save you from investing in the wrong hedge funds or trusting the wrong manager. In case you do not want to hire the services of a sleuth, you can even conduct a search on the internet as a lot of useful information is now accessible online. It is essential to verify the manager's credentials and the fund's claims.

Most investors feel that an investment in fund of funds is safe. In my opinion, nothing is safe any more. So don’t rest in peace, take the necessary measures to ensure that your money is safe. In fact even a hedge fund adviser could be giving you wrong information. It is imperative to research their background before you decide to trust them. Also, you should make an attempt to understand the strategy that they use to select safe and profitable investments.

EU Regulators Reject Hedge Fund Indices

The European Union financial market watchdogs - the Committee of European Securities Regulators - have reportedly rejected industry requests to allow pan-European Union funds to invest in hedge fund indices. The hedge funds indices are perceived as riskier than traditional assets such as stocks and bonds. Reuters reports:

"Given the complexities of hedge fund indices and the fact that they are still developing, CESR cannot recommend, at this stage, allowing hedge funds indices to be considered as financial indices for the eligibility of UCITS," CESR said in a statement.

Hedge Funds Acquire Stake in Alitalia

In spite of the strikes and rumors of bankruptcy regarding Alitalia, two investors have reportedly purchased big stakes in the carrier. This seems to be the trend as some hedge fund sources say it is part of the strategy to buy airlines seen as cheap in a bull market. Walter Capital Management and Newton Investment Management acquired a 12.4 percent stake in the Italy's biggest airline. Newton is reportedly a long-term investor and bought the stock in a recent issue as it is positive on the company's outlook. Reuters reports:

"Hedge funds bought when Alitalia staff went on strike and they bought BA in the summer when there were strikes (at airline caterer Gate Gourmet)," a hedge fund manager said. "Strikes are about working conditions and money and airline unions in most recent cases have lost ... That's generally good for the health of a airline."  The airline's 1 billion euro (690 million pound) rights issue late last year, coordinated by Deutsche Bank, did worry investors, given that it was more than the carrier's 800 million euros market capitalisation at that time, but not enough to sell the shares.

New hedge-funds businesses at Citigroup

Citigroup has reportedly hired Steven Ciampi as managing director for its hedge funds and managed futures businesses in Europe and the Middle East. This is in line with the bank’s drive for product growth in those regions. Reuters reports:

Ciampi's role at Citigroup Alternative Investments also includes being head of product development and strategic initiatives for the hedge funds and managed futures division in Europe and the Mideast. Since 2001, Ciampi oversaw Citigroup's equity finance and prime brokerage unit in London, a unit that serves hedge funds.

Ciampi takes over as MD Citigroup

Steven Ciampi would be taking over as managing director, Citigroup for its hedge funds and managed futures businesses in Europe and the Middle East. This decision is a strategic move as the group is currently looking at increasing product growth in these regions. Reuters reports:

Since 2001, Ciampi oversaw Citigroup's equity finance and prime brokerage unit in London, a unit that serves hedge funds. Ciampi's role at Citigroup Alternative Investments also includes being head of product development and strategic initiatives for the hedge funds and managed futures division in Europe and the Mideast.

European Union funds request to invest in hedge fund indices rejected

Hedge funds are usually considered riskier than traditional investment tools like stocks and bonds. Keeping this in mind, the request to allow European Union funds to invest in hedge fund indices has been rejected by EU financial market watchdogs. This decision was taken after the Committee of European Securities Regulators, that are a group of market watchdogs from the 25 European Union member states, examined the new assets that could be included in cross-border funds known as UCITS.

Hedge fund indices are an average of returns from a group of hedge funds. These are used to attract traditional investors such as institutions.

The decision largely stems from the complexities of hedge fund indices and the fact that they are still developing. The committee might reconsider its stand towards the end of this year.

Hedge funds to see better regulation

With the increasing popularity of hedge funds, there has also been an increase in the number of fraud cases that have are being reported. A large number of hedge fund managers have been charged for defrauding investors.

Keeping this in view, the SEC has now introduced a new rule. Under this, most hedge fund managers would need to register with the agency. As a result, the SEC examiners would be able to inspect and overlook the functioning of most hedge funds. Further the managers would also have to abide by an array of regulations including accounting and disclosure requirements.

The rule essentially applies only to those funds that allow investors to redeem their stakes within two years of purchasing them. With this move, this largely unregulated sector would also see some regulatory action.

State-employee pension fund, NJ, to invest in hedge funds

The biggest advantage that hedge funds have is that they bring steady returns though these are not as high as those in the case of mutual funds. To leverage on the advantage of steady returns, state-employee pension fund, New Jersey, has reported that it would be investing in hedge funds. This would be the first investment ever into hedge funds by the state-employee pension fund.

This decision can be largely attributed to the attempt being made to improve returns and offset a deficit. According to sources from the organization, the deficit would be close to $30 billion.

The State Investment Council headed by Orin Kramer, would oversee the hedge fund assets. Consulting firms, Cliffwater L.L.C. and CRA RogersCasey, would assist the state in evaluating the choices available for hedge funds. The Philadelphia Inquirer reports:

State documents show that the pension fund will give a total of $300 million to four hedge-fund firms - Archipelago Partners L.P., AG Super Fund L.P., BGI Multi-Strategy Fund, and OZ Domestic Partners. New Jersey's $72 billion public pension fund, the eighth-largest in the United States, invested only in stocks and bonds until last year.

Complex financial instruments used for hedge funds can lead to trouble

Hedge funds investors, in the United Kingdom, are increasingly using complex financial instruments to diversify asset portfolios. On the basis of this trend, a warning was issued to banks and hedge funds over the dangers that come along with these financial instruments. Ft.com reports:

It has been repeatedly observed that esoteric products such as derivatives were creating fraud opportunities. This is further raising the risk of legal disputes and can lead to an increase in the number of mis-selling complaints.

Study on hedge funds by Edhec

Investors are gradually recognizing the benefits offered by hedge funds. This has further spurred the need for research and study in the field. Keeping this in view, a study has been carried out by Lionel Martellini and Volker Ziemann of the Edhec Risk and Asset Management Research Centre.

The study is titled, ‘The Benefits of Hedge Funds in Asset Liability Management’. This would be presented at the Edhec Hedge Fund Days in London from 14-16 February.

The study specifies that Hedge funds do not fall into a strategic asset class. This is because hedge funds are heterogeneous and cannot be modeled. Further, it also reports that an allocation of 20 per cent to hedge funds can reduce a fund’s probability of extreme loss by 50 per cent. Hedgeweek reports:

This study allows for the identification of hedge fund styles that enable the risk parameters of the stock and bond classes to be improved over the long-term.
Rather than identifying a hedge fund class, this approach therefore involves including hedge funds in fixed-income and equity management.

Walter Capital and Newton Investment acquire stake in Alitalia

In the hedge fund industry, it is a trend to buy airlines that are considered cheap in a bull market. In a recent move, Walter Capital Management and Newton Investment Management acquired a 12.4 per cent stake in Alitalia, Italy's biggest airline inspite of reports of strikes and chances of the airline declaring bankruptcy. Reuters UK reports:

Walter Capital, known in the hedge fund industry as a value investor with around $2 billion (1.1 billion pounds) under management, holds around 8.19 percent of Alitalia's stock and is the biggest shareholder after the Italian government, which holds 49.9 percent. Alitalia has posted a profit just once in the last decade.

Novartis head asks regulators to keep a watch on hedge funds

Daniel Vasella, chairman and chief executive of Novartis, Europe's second-largest pharmaceuticals group, has asked regulators to keep a watch on hedge funds and the media. This direction stems from the growing concerns about the role that these can play during the speculation over the takeover plans of the company. MSN Money reports:

The apprehensions arise from the extreme volatility in the shares of Serono, the Swiss biotechnology group that is currently in play. There are two parties that can potentially take advantage of the situation, that is, the agents for the vendor, who can try to ramp up a share price by spreading rumors and the hedge funds.

What are Prime Brokerage Units?

If you are interested in the hedge funds industry and have been tracking it at some level, surely you must have come across the term ‘prime brokers’ or ‘prime brokerage units’. However, do you actually understand what these prime brokers are? What they do?

Well to draw out broad definition, we can say that prime brokers are possibly the most important short-term source of transaction flow for investment banks. A Prime Brokerage Unit is pivotal to the investments bank’s access to this transaction flow - A kind of a central node that facilitates hassle free transaction stream.

In their traditional role these Prime Brokerage Units have been known to offer a package of services in the securities transaction services. The bouquet of services offered by these broking units includes research, secured lending, trade execution, risk management, transaction processing, clearing, settlement and custody services to its ‘prime clients’ on structured fee basis. Historically, many of the services offered by the prime brokers were customized to the client and delivered manually by people within the units.

Hedge Funds: Technology Frontier

In one of the previous articles, we outlined and discussed the technology element in the hedge funds industry and how the prime brokers were responsible for solid technology integration in the sector. Also, we highlighted that for technology adoption to reach the next level; a lot would depend on how proactively hedge fund houses push the frontiers from the current scenario, where most of the technology needs of the sector are supplied by the prime brokers and other broking nodes.

This brings us to the inevitable question - At what stage of the growth curve will Hedge Funds establish their own technology platforms? Or a corollary of this would be - Should Hedge Funds continue to rely on Prime Brokerage Units for their technology support?

Although, hedge funds tend to be uncommunicative about their business and organizational strategy, the need to execute a lean administrative setup coupled with the responsibility for technology, including technology strategy, in all probability falls on the CFO or the COO at the larger Hedge Funds managers.

As most major Hedge Fund managers have number of funds, the mathematical complexity underlies the application of each investment strategy. With impending growth in size and increasing complexity, demand for a robust and appropriate technology platform and, subsequently, planning and implementation to accommodate migration would be critical.

It is a known fact that new financial products are the lifeblood of many hedge funds houses. Thus, technology is required to ensure that fund managers are able to deliver products efficiently and at the necessary scale for commercial viability. In essence, the function of technology could very well be the trump card in driving future growth in the sector. Now the critical question to be asked is – should such an important function be outsourced, even to Prime Brokerage Units?

China Looks at Hedge Funds

China's Banking Regulatory Commission has recently announced plans to form a special committee to find out how difficult will it be to regulate hedge funds. Based on it, it might be determined whether to allow hedge funds in the country or not. Oascentral reports:

Now, Jeffrey Tucker, founding partner of Fairfield Greenwich Group says it's just "a matter of time" before the Mainland welcomes the hedge funds, as there are signs China may be shattering its HF taboo, born of the belief that hedge funds were largely responsible for the Asian financial crisis a decade ago.

First Gulf Bank Launches Hedge Fund

Abu Dhabi-based First Gulf Bank has reportedly launched its first open-ended, macro-strategy hedge fund today - Al Saqer (The Falcon). The aim is to offer investors absolute return generation that too with low volatility and a low correlation to traditional asset classes, such as equities and bonds. The Hedge fund is not restricted to any one asset class, as the investment will include a variety of assets and use many different strategies. The focus will be consistent, absolute return, regardless of the direction of the local stock market. Ameinfo reports:

'We believe this Fund to be unique,' said Andre Sayegh, 'whereby we will reserve the right to invest in the booming property markets of Abu Dhabi and Dubai, and elsewhere for that matter.' 'We will invest according to available opportunities in all kinds of geographic locations, focusing primarily on the Gulf Co-operation Council states of the United Arab Emirates, Kuwait, Qatar, Bahrain, Oman and Saudi Arabia. Furthermore, because Al Saqer is a macro fund, we will apply whichever strategy we see fit as and when opportunities present themselves.'

ABN Amro Asset Management to Acquire IAM

ABN Amro Holding NV has reportedly agreed to acquire International Asset Management (IAM), a London and New York-based fund of hedge funds manager with around US $ 2.6 billion of assets under management. The deal is subject to regulatory approvals and is scheduled to close during the first quarter. Forbes reports:

ABN Amro Asset Management's existing fund of hedge funds operations, which have 1.4 bln usd of assets under management, will be combined with IAM. The combined business will have over 4.0 bln usd of assets under management.

Understanding hedge funds

'Hedge funds', the term is being increasingly used by investors. Investing in hedge funds is favored by sophisticated investors and a number of Swiss banks and other private banks. These investors understand the consequences of major stock corrections. An increasing number of pension funds and endowments allocate assets to hedge funds. 

In fact, the hedge fund industry is estimated to be a $1 trillion industry and it is growing at a rate of about 20 per cent per year. There are currently 8350 active hedge funds. These include a variety of investment strategies. A number of these strategies use leverage and derivatives while others are more conservative and employ little or no average.

Most hedge funds are highly specialized and their performance relys on the expertise of the manager or the management team. Hedge fund managers are usually highly professional, disciplined and diligent.

The returns from hedge funds are usually consistent and have over a period of time outperformed standard equity and bond indexes. These have a much lower risk factor as compared to equities. Conventional equity or mutual funds are generally 100 per cent exposed to market risk and are affected by the direction of the bond or equity market. The performance of most hedge fund strategies, in particular relative value strategies, is not dependent on these. 

With a clear understanding of the advantages of hedge funds, most investors are seeking to capitalize on the benefits offered by these.

Benefits offered by hedge funds

Hedge funds are a lucrative investment tool and their popularity is gradually increasing. In fact a number of markets that did not allow hedge funds are opening for them. The question is, why are these becoming increasingly popular.

The first and foremost reason for this is that many hedge fund strategies have the ability to generate positive returns in both rising and falling equity and bond markets. Also, the inclusion of hedge funds in a balanced portfolio reduces overall portfolio risk and volatility. It also increases returns.

In case of hedge funds, investors have a wide choice in terms of the strategies that can be used to meet individual needs.

Over and above the rest of the benefits offered by hedge funds, research has indicated that these have higher returns and lower overall risk as compared to traditional investment funds.

China considering opening the market to hedge funds

It was recently announced by the Banking Regulatory Commission, China, that a special committee would be formed to look into hedge funds. This committee would determine how difficult would it be to regulate these funds if the country allowed them.

It has been indicated by sources that a number of signs were visible that the country would soon allow hedge funds. So far, the reason for hedge funds being a taboo in the country could be largely attributed to the belief that these were responsible for the Asian financial crisis a decade ago. Another misconception that investors in China had was that these funds ensure high returns because of the high risk factor.

It is now being recognized that hedge funds add liquidity and increase market efficiency. This move is also aimed to provide an impetus to the governments move towards greater market liberalization.

Hedge funds go bust, investors look at that as a healthy sign

A large number of hedge funds busted last year and the failure rate is expected to increase in the coming year. In spite of the facts in place, investors see this as a sign of health in the growing market.

Hedge Fund Research data estimated that approximately 5.7 per cent out of the existing 8,500 hedge funds closed in 2005. This number was estimated at 3.6 per cent of 7,500 in 2004. It has been further estimated, that this rate could rise to 10 per cent or higher in the next five years. This can also be attributed to the entry of more hedge funds in the market to meet the growing demand. The demand for these funds basically comes from institutional investors such as pension funds and insurance companies. Business Times reports:

Institutions looking for a way to preserve their capital and diversify away from traditional assets such as stocks and bonds, have piled into hedge funds since the 2000 equity bubble burst. Hedge funds are estimated to manage more than $1 trillion and analysts expect that number to double to $2 trillion within five years.

Playing it safe with hedge funds

If you are investing in hedge funds for the first time and do not have an understanding of the market, I would advise you to make use of the services of a consultant or else invest in fund of funds. A fund of funds distributes your investment over a larger portfolio of funds, thus minimizing the risk. Undoubtedly, we all make investments to make our money grow, not to lose it all. So why not play safe from the very beginning?

Understanding the demarcation between fund of funds and hedge funds

Any investment fund that is not a conventional investment fund, is termed as a hedge fund. Essentially, hedge funds use a strategy or a set of strategies other than investing long in bonds, equities, mutual funds, and money markets. On the other hand, a fund of funds is a combination of successful hedge funds and other pooled investment vehicles. As a result, in case of fund of funds, the investment is spread across different funds or investment vehicles. 

Hedge fund strategies are quite complicated and the returns and risk are varied. The returns and risks also depend on individual managers. In case of fund of funds, the process of selecting hedge funds is simplified as a number of funds are blended together to meet diverse needs of investors in terms of risks and returns. This makes the returns more consistent than in the case of individual funds.

Hedge funds are a lucrative alternative

Today hedge funds are a lucrative investment tool. This can be largely attributed to the fact that stock markets across the globe have reached excessive valuations. At this stage, experts predict future corrections. In this case, hedge funds are a viable alternative for investors as these assure consistency of returns rather than just magnitude of returns.

As an investor, you need to take your pick, is it just size that matters?

ABN AMRO and IAM join hands to capitalize on the increasing demand for hedge funds

ABN AMRO is buying the fund of hedge funds manager International Asset management(IAM). The move has been made to strengthen the formers own fund of hedge funds offering. IPE International reports:

The reason that spurred the decision is the increasing demand for hedge funds. Sources from ABN AMRO indicated that the best structure to run this operation and capitalize on the existing demand is by having a dedicated team. In terms of this, both the organizations have a similar approach.

Fortis Prime Funds Solutions plans to launch hedge funds

As a part of their expansion plans for the year, Fortis Prime Funds Solutions plans to launch hedge funds across the globe. These would be essentially launched in Asia, excluding Japan, Europe and in the US. Hedgeweek reports:

These hedge funds are being typically run by people such as former proprietary traders. The company also plans to increase hedge fund launches in newer regions like Australia.

What in the Heck are Hedge Fund Indexes?!?

While reading about the hedge fund industry, you might have come across the term ‘Hedge Fund Index’ many a times. Well to give you a brief idea about these, what we can say is that Indexes are just a compilation or averaging of all the Hedge Funds in a particular sector (much like an Energy Fund is for all the energy stocks)  Hedge Fund Indexes are often used as hedge fund performance measurement and benchmarking tools, which are useful as summary statistics for the universe of managers. These indexes offer a benchmark for strategy performance to the extent that they are investable, and to the extent that funds within a given strategy classification are also comparable.

Usually the indexes encompass all the funds in the FRM database and are equally weighted and rebalanced annually. The most important observation about indexes of hedge funds is that they exhibit considerably lower risk than traditional active managers and passive benchmarks. These indexes are a good way to track hedge fund sector as a whole and also compare a particular fund against the benchmark index.

Evolving Hedge Fund Industry

The hedge fund industry has underwent tremendous growth in the last decade, expanding by some estimates from about 300 funds in 1990 to over 3000 today. This segment has attained high visibility in the markets and also in the press, and is reported to command up to US $400 billion in capital before leverage.

Hedge funds, like other investments including real estate, commodities, venture capital, and private equity, are known to offer access to returns that are uncorrelated with traditional investments, and superior risk adjusted returns as well.

Also a growing trend among fund management companies is to introduce hedge fund like investment vehicle to large asset owners – so these asset owners can make strategic allocations to hedge funds. Capital markets analysts world over have outlined favorable outlook for hedge funds going forward, as hedge funds have the potential to attract investors who want to enhance strategic asset allocation for both pension funds and endowments funds.

Research shows that when structured as portfolios, hedge funds have the potential to provide a substantial improvement in the risk-reward matrix for the investor community.
To define hedge funds broadly it can be said that these are unregulated investment pools, generally with under 100 investors. These funds invest in any asset class as well as derivative securities and use long and short positions, as well as leverage.

What distinguishes hedge funds from other investment vehicles is their routine use of long or short positions to offset “market” risks and isolate arbitrage opportunities. Although, there are riders to these strategies as these are not without their specific risks.

Hedge Funds Drive Activist Bandwagon

During the last year – that is 2005- hedge funds and deep-pocketed individual investors have been urging management at many leading companies to buy back shares, increase dividends or take other steps to improve shareholder value. Even pressure tactics are being applied to force management to such ends. NYTime reports:

But while shareholder activism may be on the rise, it is still relatively rare among the 8,000-odd mutual funds in the United States. With $8.5 trillion in assets, mutual funds are a huge force in the market. Yet fund managers and industry experts say the funds are a meek presence in the boardroom because of cultural and structural factors.

Hedge Funds in China

China is expected to witness much more of a favorable business environment, which includes more openness, liquidity and interest from the investing public. This is going to be boon for the development of hedge funds over the next three years, according to a US expert. As of today, investing in hedge funds is forbidden due to concerns of its high risk and volatile nature. At the China Banking Regulatory Commission's annual meeting held in December 2005, Chairman Liu Mingkang reiterated the government's perception of hedge funds being one of the major forces behind the 1997-1998 Asian Financial Crisis.  Xinhuanet reports:

"Having discussed with the Chinese authorities, I believe that the consensus already seems to be developing that it is only a matter of time before hedge fund investing becomes a reality in China," said Jeffrey H Tucker, founding partner of the Fairfield Greenwich Group (FGG), a leading developer and investor in hedge funds.

Hedge funds: Treading the Retail Road

Hedge funds are now reportedly opening up to the not-so-rich of Europe. In Germany, investors can buy into a hedge fund from Deutsche Bank for as little as EUR 124 (HK$1,163), while in the UK, individuals are able to avoid restrictions on such investing by buying shares of funds that track hedge funds. The standard reports:

"There is going to be a gradual acceptance of hedge funds by the retail investor," said Marc Denogent, a vice president at Hedge Fund Research's investment management arm in Zurich, which oversees about US$4 billion in funds of hedge funds. "The regulatory difference between hedge funds and traditional funds is diminishing too."

Godden parts ways with Hedge Funds Research

According to recent reports, John Godden, Managing Director, Hedge Fund Researchs European asset management arm, has left the company. It is unclear who would take over, with reports suggesting that Swiss business chief Marc Denogent might step in.

It was an amicable split and it is likely that Godden would resurface at some point. Godden was set to share a platform at the National association of Pension Funds annual investment conference in Edinburgh alongside NAPFs Geoff Lindey, FSAs Dan Waters and Watson Wyatts Nick Watts in March, when this decision was taken.

One article I came across on this subject which provides a good overview is here.

Misconception about hedge funds

With the growing popularity of hedge funds, even the misconceptions about this investment category are increasing. A number of investors believe that all hedge funds are volatile and that they use global macro strategies and place large directional bets on stocks, currencies, bonds, commodities and gold, while also using a lot of leverage. In reality, less than 5 per cent of hedge funds are global macro funds. Most hedge funds use derivatives only for hedging or do not use derivatives at all, and many use no leverage at all.

Advantages offered by hedge funds over mutual funds

For an investor selecting the right investment might be a difficult task. Essentially an investor would only look at investing in a tool that would work to his advantage. The market is gradually turning to investing in hedge funds instead of mutual funds because of the advantages that the former offers.

Hedge funds are highly flexible in their investment options as compared to mutual funds. This can be attributed to the fact that these use financial instruments generally beyond the reach of mutual funds, which have SEC regulations and disclosure requirements that largely prevent them from using short selling, leverage, concentrated investments and derivatives. This flexibility that includes the use of hedging strategies to protect downside risk, gives hedge funds the ability to best manage investment risks. 

The strong results shown by hedge funds can also be linked to performance incentives offered to fund managers. Unlike many mutual fund managers, hedge fund managers usually heavily invest in a significant portion of the funds that they run. As a result, they share the rewards as well as the risks with the investors. 'Investors fees' remunerate hedge fund managers only when the returns are positive, whereas mutual funds pay their financial managers according to the volume of assets managed, regardless of performance. This incentive structure tends to attract many of Wall Streets best practitioners and other financial experts to the hedge fund industry.

In the last decade, the number of hedge funds has risen by about 20 per cent per year and the rate of growth in hedge fund assets has been even more rapid. While the number and size of hedge funds are small relative to mutual funds, their growth reflects the importance of this alternative investment category for institutional investors and wealthy individual investors.

New policy to protect hedge fund managers and directors

National Union Fire Insurance Company, a part of the American International Group, has recently introduced a new policy to protect hedge fund managers and directors against liability exposures and litigation. National Unions expertise in providing financial institutions with risk management solutions, places it in a unique position to serve the hedge fund market. 

It has been estimated that less than 30 per cent of hedge funds are protected by the type of coverage offered through the policy. The policy covers directors and officers liability, partnership liability, managing member liability and professional liability insurance specifically tailored for hedge funds.

As reported by the Hedge Fund Association, hedge fund assets have grown at an average rate of 20 per cent each year over the last five years and represent a $875 billion industry. Ongoing growth combined with a number of recent high profile fraud cases involving hedge funds has led to greater industry wide scrutiny of hedge fund managers. Moreover in February 2006, majority of hedge fund managers would be required to register as investment advisors with the Securities and Exchange Commission.

Hedge funds returns brighten up in 2005

In the year 2005, hedge funds ended with respectable gains, beating the broader stock market indexes and making good on promises to make money inspite of a number of investment pools failing. According to research carried out by the Hedge Fund Research, Chicago the average hedge fund returned 9.18 per cent last year. In 2004, the average fund had returned 9.03 per cent. Other companies that track the performance of hedge funds, including CSFB/Tremont, will also be releasing their research data soon. 

While hedge funds gains are nowhere near the double digit returns that made the $1.1 trillion industry famous in the 1990s, the funds did manage to beat the broader stock market where the Standard & Poor's 500 index returned 3 per cent in 2005.

The only funds to lose money last year were those specializing in convertible arbitrage deals. They lost 1.61 per cent according to HFR. However during the year, these types of funds had found their footing, paring even higher losses during the spring when the rating agencies downgraded the debt of General Motors.

The year also saw a string of frauds in the industry, including the collapse of the Bayou Group.

Looking at the dismal state in 2004, a number of managers quit hedge funds to return to mutual funds in 2005. Yet, the industry managed to reaffirm its reputation and made money towards the end of the year.

The gains in the industry have come at a time when pension funds are still eager to pour money into the industry, assets have doubled to more than $1 trillion in the last five years and only a few weeks before a new rule will require many of the worlds hedge funds to register with US financial regulators.  With US regulations expected to step in, it is expected that the functioning of the industry would improve.

Read more at The Standard. 

Extensive Technology Usage by Hedge Funds

With Hedge Funds growing at a break neck pace, the fund houses have ensured that they maintained relatively lean administrative structures as compared to other financial investment houses. This has been achieved mainly on the basis of the extensive usage of third party technology, which has been deployed to make fund management, operational and administrative processes more efficient.

In the hedge funds sector, technology has been extensively deployed in order to connect Hedge Fund managers with Prime Brokers and other Brokers through whom transactions are executed and services for the management of the transaction’s life cycle are offered.

The key role in such extensive utilization of technology in the sector has been played by the Prime Brokers, who have ensured that technology has not been used for technology’s sake by Hedge Funds. Prime Brokers are known to extend use of their own technology to the Hedge Funds in order to provide the scale, connectivity and range of access to the Prime Brokerage Unit’s services.

To define what Prime Brokers are, it can be said that these are business units of major investment banks that source transaction flow. Prime Brokerage Units are projected to generate about US$ 5 billion in revenues for their investment banking groups during 2006. And Hedge Funds are forecast to account for an average of 35% of daily transactions volumes through the major exchanges in Europe.

It is being reported that many of the hedge funds are reaching the scale of growth and complexity, which would eventually warrant that they consider recruiting their own Chief Technology Officer. But still a lot of the momentum would depend on whether the Prime Brokers will continue to supply much of the technology.

Basic facts about Hedge Funds

If you intend to invest in hedge funds, there are certain basic facts that you should know. The hedge fund industry is growing at a rate of about 20 per cent per year, with approximately 8350 active hedge funds. Most hedge funds are highly specialized, relying on the specific expertise of the manager or the management team. Performance of many hedge fund strategies, particularly in case of relative value strategies, is not dependent on the direction of the bond or the equity markets. On the other hand, conventional equity or mutual funds are generally 100 per cent exposed to market risk. The returns from hedge funds over a sustained period of time have outperformed standard equity and bond indexes with less volatility and a lesser risk of loss. In fact, it has been noticed that investing in hedge funds tends to be favored by the seasoned investors, including Swiss and other private banks. Also, many endowments and pension funds allocate assets to hedge funds.

SEC intends taking action against Perry Capital

The Securities and Exchange Commission has notified Perry Capital, a large hedge fund company, that it intends to take action against the firm. The commission has accused the firm of violating disclosure rules when it used an unusual trading technique last year to try to influence a takeover battle.

Perrys has received a Wells notice that describes the SECs complaint. Before a case is brought, Perry has the right to argue its case to the agency.

The case stems from a complex hedging technique that Perry used to buy a voting stake in a company without holding the same economic interest in the company. SEC has alleged that Perry used a complex hedging technique to try to influence the outcome of a takeover battle for King Pharmaceuticals, a generic drug maker, waged by a larger rival, Mylan laboratories. The firm appeared tohave set up a sophisticated swap trade with Bear Stearns and Goldman Sachs so that it controlled about 10 per cent of Mylan's votes with limited or no exposure to fluctuations in Mylan's share price. The New York Times reports:

The maneuver made Perry the largest, if indirect, shareholder of Mylan, and could have helped ensure that Mylan would receive enough shareholder votes to approve the deal for King at a time when the next biggest shareholder of Mylan, Carl C Icahn, was trying to block the merger. If the deal had been completed, Perry stood to make more than $28 million, based on figures in an SEC filing.

SEC pushing for registration of Hedge Fund Managers

The Securities and Exchange Commission (SEC) staff has reportedly recommended that hedge-fund advisors register with federal authorities. Such a move would give regulators better insight into the largely unregulated US $600 billion hedge-fund industry. Although the staff report stops short of hinting at registration of hedge funds as an entity, there is bound to be industry rebound in terms of reaction and fund performance. Even if the registration bit doesn’t come out as feared, this is likely to impact the investor confidence and leave a dent in the new investment pouring into the hedge funds sector. So more than the issue at hand the propaganda around it is likely to cause more damage.

According to the estimates of the SEC staff, there are between 6,000 and 7,000 hedge funds in the United States, and only about one-third of hedge-fund advisers now register with the SEC voluntarily. The likely motive behind the drive for the SEC is to gain deeper insights into the strategies deployed by the hedge fund managers.

Hedge Fund Investors could have avoided losing money invested in HMC with research

In most cases, it is not easy for investors to gather information about the inner working of hedge funds. At the same time, a little research can save an investor from losing money. In case of the investors in one of the recent hedge fund collapse, HMC International Fund of Montvale, N.J., enough information was available on the internet to warn of the impeding danger. Business Week Online reports:

Bret Grebow, HMC, left a trail of legal problems that included a property lien, an arrest on charges of possessing drug paraphernalia, and failure to repay a loan taken from a former employer. Grebow and co-manager Robert Massimi, HMC now face Securities & Exchange Commission charges of securities fraud and misappropriation of more than $5.2 million of the $12.9 million invested in HMC.

Hedge funds accessible for medium income investors in Europe

According to recent reports, hedge funds in Europe would now be available for people falling in the medium income strata as well. In Germany, investors can purchase hedge funds from Deutsche Bank AG for as little as 124 euros, that is $150. Regulators in UK and Spain are also considering opening the industry to more individual investment.

Investors need to know that hedge funds usually tend to take larger bets than conventional funds and aim to make money even in falling markets. According to Chicago based Hedge Fund Research Inc., hedge funds worldwide have more than doubled their assets since 2000 to about $1.1 trillion. Also, for Europeans, hedge fund investments may lift returns. Over a period of five years, ending last November, the CSFB Tremont Hedge Fund Index advanced 48 per cent, compared with a 2.4 per cent return for the MSCI World Index during the same period.

At the same time, investors need to exercise caution as these funds can be risky. The Bailey Coates Cromwell Fund, London, that had about $1.3 billion at its peak, closed in June after losing 20 per cent of its value.

It is advisable for new investors to study the market in detail before capitalizing on the opportunity now available to invest in hedge funds. New investors

At the same time, caution has to be exercised, as these funds can also be risky. The London-based Bailey Coates Cromwell fund, which had about $1.3 billion at its peak, closed in June after losing 20 percent of its value.

Hedge Funds Moved Up 9.2% in 2005

During 2005, Hedge funds, the loosely regulated partnerships that generally cater to the wealthy investors and institutions, moved by 9.2 percent on average. The performance was helped by the stock-market rally in the second half, according to Hedge Fund Research Inc. Bloomberg reports:

Performance had been mixed early in the year, but they finished on par with last year after a strong second half,'' said Josh Rosenberg, president of Hedge Fund Research, in an interview yesterday. The Standard & Poor's 500 Index rose 5.8 percent, including dividends, during the last six months of 2005.

Giordano pleads guilty for hedge fund fraud

In connection with a hedge fund fraud and stock manipulation scheme, Anthony Giordano, 29, of Boca Raton, pled guilty to federal securities and wire fraud charges. For the securities fraud charges, Giordano faces a maximum term of imprisonment of twenty years, and a fine upto $5,000. Law Fuel.com reports:

The defendant pled guilty in front of the Chief United States District Court Judge William J Zolch. The sentencing is scheduled for March 20, 2006.

Hedge funds drive Bullion to higher levels

With hedge funds investing heavily into the premium metal ‘Gold’ – the bullion prices have skyrocketed for the fifth consecutive year. Industry experts opine that this trend of bullion buying by hedge funds is expected to continue through 2006 as well. And led by this trend is the forecast of bullion prices reaching further north. For a sixth year in a row in 2006, the loosely regulated hedge funds are all set to buy the metal to diversify from stocks, bonds and currencies. According to median forecast of 29 analysts (including traders and investors surveyed by Bloomberg News), the price of bullion is likely to shoot up by about 18 percent, to average about US $525 an ounce, up from US $445 last year. Chicago Tribune reports:

Hedge funds and other speculators more than tripled their net long positions, or bets prices will rise, in New York gold futures in the past five months. Inflation, the U.S. budget and current account deficits, and the dollar led investors to buy gold. Investors are buying gold because it's outperforming stocks and bonds. Gold rose 90 percent in five years, while the Standard & Poor's 500 index returned 2.7 percent with dividends reinvested.

BOC to Offer Hedge Funds

Bank of China (BOC) has reportedly outlined plans to introduce hedge funds into the market in order to speed up its forthcoming Hong Kong listing. The Chinese bank is yet to submit its Initial Public Offering (IPO) application to the Stock Exchange of Hong Kong. Tmcnet reports:

Although the third-largest Chinese lender once refused to talk with hedge funds, it has recently nodded Oaktree Capital Management and Och-Ziff Capital Management, said an insider familiar with the affair. BOC have required the two hedge funds not to sell the stake bought within three years, said local reports.

Concerns over Hedge Funds Sustainability

Although there is a halo around the hugely popular and loosely regulated investment strategy called the hedge funds, industry skeptics give a warning signal and urge to tread with caution. The pertinent question that everyone seems to be asking nowadays is that are hedge funds the next big thing in mass investing? Will it actually break the barrier of being the investment vehicle of the super rich and go fully retail? And if so, will hedge funds suffer the same fate as the last big thing in mass investing — mutual funds?

This is one big concern that has emerged from all corners of the industry. Back in the 1990s, the mutual-fund industry doubled – with millions of new investors pumping in money in expectation of excellent performance. However, as of today, according to the Investment Company Institute, there are about 8,000 United States mutual funds, with about US $ 8.5 trillion in assets. Yet it is being reported that majority of the mutual funds under-perform vis-à-vis the market indices. Thus in spite of all the good will and expectation, there is the undercurrent of uncertainty for hedge funds.

Hedge Funds Era: Emerging Horizons

The last few years, or at least the last year, could be termed as the year of hedge funds in context of the investments. Hedge funds – the largely unregulated brackets of private capital, which were once generally available only to institutions and the super-duper rich, proliferated into at least the segment of large retail investors. Well at least a portion of this statement can be deemed to be correct, if not all. The increasing popularity of the hedge funds as investments was only rivaled by the scandal articles published about it.

Traditionally, the hedge-fund managers were known to be wary of media attention and avoided disclosure of any sort to the prying media eyes. These Garbos of the asset management world preferred to be left alone by all and sundry, including the media, the public, and above all, by the Securities and Exchange Commission.

However, in recent years, especially in 2005, these very hedge fund managers have thrown their weight around and claimed their stake as the brains behind one of the most mesmerizing investment strategies. Some of the aggressive hedge-fund managers are shaking-up management and pushing restructurings at leading blue-chip companies such as Time Warner and McDonald's.

While other hedge funds managers did something totally different - not content with manipulating with the stocks and investments, went on to leading positions at well-known companies. A good example is Edward S. Lampert who has done it at Sears.

By some estimates, the hedge-fund industry has nearly doubled in the last four years; there are now an estimated US $ 1 trillion in assets across 8,000 funds. Leading institutions such as university endowment funds and state employee pension funds are dumping money into hedge funds. Further as a tip off for the future, hedge funds are going retail big time - with investment banks having rolled out funds, which let big retail investors taste the once unaffordable investment option.

Hedge Funds Slowing Down

According to latest figures, the high ride and allure of hedge funds has somewhat faded. The is shown by figures that indicate that the amount of money invested in them halved over the past year as returns fell below 7 percent. The year of 2004 was a record year, with never seen before figures, but investors got 4- 5 percent after performance fees and put the brakes on. telegraph  reports:

Oliver Schupp, the head of investment bank Credit Suisse's hedge fund index, said around $60billion-$65billion had been invested internationally in hedge funds during the past year, compared with more than $120billion in 2004.

Hedge Funds Index Posts Meager Gains

If you have been nurturing the notion that hedge funds world over are minting money, then you need a reality check. A look at the Standard & Poor's hedge fund index figures will surely prove to be an eye opener. The index posted gains of just over 2.4 percent in 2005. This is not the only year when the actual performance of the hedge funds was far below the mythical levels. Even in 2004, the hedge funds index posted lackluster figures, with meager gains of 3.6 percent. A comparison with the S&P 500 index reveals that the hedge funds index performance was about half of the S&P 500. usnews reports:

That track record hasn't hurt the earnings of the average hedge fund manager, who took home about $1.2 million in 2004. But with the number of hedge funds--thinly regulated investment pools for the well-to-do--having mushroomed from a few hundred to more than 8,000 worldwide, with combined assets now around the $1 trillion mark, many investors are finding that storied hedge fund edge elusive.

Phillip Goldstein’s Suit against SEC Rule on Hedge Funds

Phillip Goldstein is leading a closely watched effort to prevent the Securities and Exchange Commission from extensively expanding regulation of the trillion-dollar hedge-fund industry. He is reportedly contesting to overturn a new rule that would force hedge funds managing more than $25 million to be registered with the agency by February 1 2006 and undergo periodic audits. Latimes reports:

The SEC says it must get a handle on the freewheeling investment pools that are mushrooming in popularity among pension funds, endowments and wealthy individuals. The agency points to a spate of recent hedge-fund frauds, as well as the collective force the funds have on financial markets.