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Hedge Funds Reference – The Billion Dollar Site
Reference Section @ BillDoll.com – The Billion Dollar Site
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What are hedge funds? ..
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Main Sections @ The Billion Dollar Site
Related Sections @ BillDoll Reference
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Hedge Funds Reference
Hedge funds invest most of the money on the behalf of the super rich, and increasingly for other financial institutions, including pension funds.
Most hedge funds have a prohibitively high minimum investment
Since the investors in hedge funds are supposed to be quite sophisticated, the hedge fund market is relatively unregulated.
Some hedge fund strategies are extremely complex and sophisticated.
Most of the funds are domiciled offshore in locations like Cayman Islands or Bermuda for tax purposes.
There are about 10,000 hedge funds worldwide managing over 1 trillion $ in investment (Oct 2006 estimate: 1.3 trillion)
A typical hedge fund fee will be about 2% of the assets under management, and around 20% of the profits as performance fees!
The rewards from hedge funds can be exceptional. In 2005, the biggest earner in hedge funds, Dallas-based T Boone Pickens, made 1.5 billion $! Steve Cohen of SAC Capital reportedly made 1 billion $ in the same year. In the UK, Noam Gottesman of GLG Partners reportedly made about 150 million $ in 2005.
Investors poured over 340 billion US$ into hedge funds between 2001 and 2006.
The hedge funds that invest only in stocks are also called “long/short equities”
New York is the nerve centre of the hedge fund market and London is the second most important city for hedge funds.
The assets in UK hedge funds have grown four-fold since 2002, and is about 260 billion (2006 estimates).
In 1988, hedge funds held just 1% of the market. Today (2006) it is around 11%
The impact of the short-term trading strategies of hedge funds mean that their impact on the market is much larger than their total share of the market. By some estimates, over half the trading volume on the markets is due to hedge funds.
The main idea behind the (original) hedge funds was to invest in shares but at the same time, hedge bets by shorting others – making a bet that the share price will fall.
Many regulated investors such as mutual funds are allowed to be “long only”.
Shorting remains a widely used strategy in hedge funds but is increasingly only one of many.
There are over a thousand hedge funds investing exclusively in the emerging markets.
According to predictions, hedge fund assets would grow at an annualized rate of 15% between 2006 and 2008.
There is a feeling among investment industry professionals that hedge funds are “short” funds, which do not stay invested for a long duration.
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Some famous hedge funders:
Steve Cohen of SAC Jonathan Green of GLG Partners Arpad Busson of EIM
Other related organizations
Hedge Fund Research Centre (HFRI) – based in Chicago
Glossary
Alpha – The amount that a hedge fund can return over and above the standard market index. Beta – If a hedge fund makes only what the market makes on an average, then it is called a beta return Arbitrage – Is the process of spotting and profiting from difference in price of a single asset in different markets Shorting – In this process, an investor sells a borrowed share, in the hope that the price of the share will go down in future when he can buy it. The profit is the difference between the two. Leverage – The use of borrowed money to make a cash investment Private Equity – also sometimes called venture capital, this refers to an equity investment by one or a group of individuals acting in their private capacity
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More Hedge Fund Terms
A
Active Premium - A measure of the Investment’s annualized return minus the Benchmark’s annualized return. Additions – Frequency at which fund additions are accepted by the fund. Administrator – The offshore fund entity that manages the back office work and individual accounts for the fund. Alpha - Alpha is the measure of a fund's average performance independent of the market, (i.e. if the market return was zero.) For example, if a fund has an alpha of 2.0, and the market return was 0% for a given month, then the fund would, on average, return 2% for the month. ANALYST This is a job title given to junior staff who have been able to join the first rank of a hedge fund within the front office. It is also used to describe a staff member who has to gather any kind of financial information and find a use that can be profitable for the firm. AUM – Assets Under Management Average Annual Return or Average Rolling 12 Month Return -
The average of the rolling 12 month performance periods of the fund. For
example. If a fund begins in January 1997, and it is currently March 1998,
then there are four rolling 12 month periods for the fund. (The first is
January 1997 - December 1997, the next is February 1997 - January 1998, the
next is March 1997 - February 1998, and the last is April 1997 - March 1998.)
The average annual return is the average of the four rolling 12 month
periods. Average Monthly Gain – The average of the profitable months of the fund. Average Monthly Loss – The average of the negative months of the fund. Average Monthly Return - The average of all the monthly performance numbers of the fund. Average Number of Positions – The number of securities that a fund holds on any given day. Average Portfolio Turnover – The percentage of the portfolio that is bought and sold each year.
Alpha
Measures the value that an investment manager produces, by comparing the manager's performance to that of a risk-free investment (usually a Treasury bill). For example, if a fund had an alpha of 1.0 during a given month, it would have produced a return during that month that was one percentage point higher than the benchmark Treasury. Alpha can also be used as a measure of residual risk, relative to the market in which a fund participates.
Annual rate of return
The compounded gain or loss in a fund's net asset value during a calendar year.
Arbitrage investment strategy
An approach that aims at exploiting price differentials that exist as a result of market inefficiencies. Arbitrage plays typically involve purchasing a security in one market, while selling an instrument with similar performance characteristics in another market -- earning returns that far exceed the risk incurred.
Average annual return (annualized rate of return)
Cumulative gains and losses divided by the number of years of an investment's life, with compounding taken into account. The measure is used to compare returns on investments for periods ranging from partial to multiple years.
Average monthly return
Cumulative gains and losses divided by the number of months of the investment's life, with compounding taken into account.
Average rate of return
The mean average of a fund's returns over a given number of periods. It is calculated by dividing the sum of the rates of return over those periods by the number of periods
Absolute return - A common term in the hedge fund
industry, absolute returns are synonymous with positive returns. Hedge funds target
absolute returns versus mutual funds which target returns relative to a
benchmark. Accredited Investor - A term used by provincial and
territorial securities regulatory bodies to define financially sophisticated
investors that can purchase hedge funds and other exempt securities for lower
minimums than other investors. Typically, individual accredited investors
must have a liquid net worth of $1 million or earn income of $200,000 in each
of the previous two years or earn a combined $300,000 income in conjunction
with their spouse. Active management - Investment strategy that actively
manages a portfolio with the objective of producing returns in excess of a
specified benchmark. Administrator - Processes subscriptions and redemptions
and calculates the value of the investors' holdings, either as a NAV or as a
partnership share ¾ and usually looks after other back-office needs such as
fund accounting and unitholder records. Alpha - Alpha (Α) is a measure of "excess
return" (a fund's performance over and above the market's rate of
return). As such, it represents the value-added return that can be attributed
to the hedge fund manager's actions rather than to the performance of the
market overall. Alternative asset class - A term commonly used to refer to
non-traditional assets (versus traditional assets like stocks, bonds and
cash) such as hedge funds, managed futures, real estate, private equity and
collectibles (such as art, coins, wine, etc). The diversification benefits of
adding alternative investments to traditional portfolios are due to the low
correlation of alternative investments to traditional investments. Alternative investment strategies (AIS) - Portfolio
management strategies that invest in alternative asset classes. Annualized return - Converts a rate of return to an annual
basis. Annualized Sharpe ratio - See Sharpe ratio. Annualized standard deviation - See Standard deviation. Arbitrage - Arbitrage is the market-neutral buying and
selling of a security to take advantage of price discrepancies in different
markets. However, the definition has broadened from the same security to
securities that have similarities ¾ for example, an arbitrageur might
construct a hedge by buying a company's convertible bond and shorting the
same firm's common stock. Asset allocation - An investment process whereby the total portfolio assets are divided among traditional assets (such as stocks, bonds and cash) and alternative assets (such as hedge funds, managed futures, real estate, private equity and collectibles) in an effort to reduce overall portfolio risk and improve risk-adjusted returns through portfolio diversification. This is achieved by adding lowly correlated assets together and is the basis of Modern Portfolio Theory.
ASSOCIATE This is a job title term for junior level members of any hedge fund or private equity fund. Back office or support people also use this term within their career direction despite not being in the front office.
Alpha Annual rate of return Arbitrage theories/strategies Annual return
Accredited Investors A term used by the Securities and Exchange Commission (SEC) under Regulation D to refer to investors who are financially sophisticated and have a reduced need for the protection provided by certain government filings. (Read More from U.S. Securities and Exchange Commission) Administrator A hedge fund administrator is generally an outside organization independent from the fund that services clients and investors and provides financial, tax and compliance reporting. The administrator calculates net asset values and manages money inflows and outflows. Alpha Measures risk-adjusted excess rate of return relative to a benchmark. It shows the return achieved over and above the return that results from the correlation between the fund in question and the market benchmark, in effect measuring the "skill" of the fund manager. (Read More from University of Massachusetts) Alternative Investments This term encompasses any non-traditional asset class. For example they include venture capital, private equity, hedge funds, managed futures and real estate. Arbitrage Refers to the exploitation of temporary price differences in securities that exist as a result of market inefficiencies. The same securities, or related asset, are bought on the market offering a lower price and sold on the market offering a higher price. (Read More from Wikipedia) Average Annual Return Cumulative gains and losses divided by the number of years of an investment's life, with compounding taken into account. The measure is used to compare returns on investments for periods ranging from partial to multiple years.
Alpha
B
Basis point - One-hundredth
of one percentage point, or 0.01 per cent. Therefore 1.0 per cent equals 100
basis points. Basis points are an easy way to state small differences in
yield. For example, a return of 6.0 per cent is 50 basis points greater than
a return of 5.5 per cent. Benchmark for Correlation Values – The benchmark that the fund has chosen to run correlation values such as alpha, beta, R and R squared. Benchmark for Graphing – The benchmark that the fund has chosen to graph itself against. Beta - Beta is the measure of a fund's volatility relative to the market. (Almost all fund managers correlate themselves to the S&P 500). A beta of greater than 1.0 indicates that the fund is more volatile than the market, and less than 1.0 is less volatile than the market. For example, if the market rises 1% and a fund has a beta greater than 2.5, the fund will rise, on average, 2.5%. For a fund with a beta of 0.4, if the market rises 1%, the fund will rise on average, 0.4%. The relationship is the same in a falling market. (Please note that funds can have a negative beta, meaning that on average they rise when the market falls and vice versa). To view the formula for Beta, please download the word document.
Beta
B Beta Measures the sensitivity of an investment, such as an investment fund, to fluctuations in the market, as represented by the relevant market benchmark. A Beta of one means the portfolio moves in tandem with the benchmark, a Beta of more than one means the fund gains (or loses) more than the index does, while a Beta of less than one means that the fund is less sensitive to market movements. (Read More from Investment FAQ)
Beta
C Call option - An option contract that gives its holder the
right (but not the obligation) to purchase a specified number of shares of
the underlying stock at the given strike price, on or before the expiration
date of the contract. Capacity - This term refers to the maximum size a fund can
grow to before liquidity and other problems arise. Capping - Hedge funds typically close or cap a fund to new
investment when they reach capacity. Capital gains - The difference between the buy and sell
price of an asset. You could have a capital gain or a capital loss, depending
on the price you paid and the price you sold at. For example, a capital gain
on stock ABC purchased for $150,000 and sold for $160,000 would be $10,000
and a capital loss on stock XYZ purchased for $100,000 and sold for $95,000
would be $5,000. Capital gains and capital losses receive favourable tax
treatment versus income tax gains and losses. CARR (compound annualized rate of return) - CARR
calculates the return of an investment on a per-year compounded basis. Carry trade - Investment position involving the borrowing
of funds or investments at a relatively low interest rate and the
simultaneous purchase of an offsetting position earning a higher yield. Category - Hedge funds styles and strategies fit into
three broad categories: Relative Value, Event-Driven and Opportunistic. Charts - Pictorial representations of specific stock
characteristics such as price and volume that technical analysts use to price
equities. Closed fund - A fund that is closed to new investment but
may be available on a secondary market. Closed-end fund - A type of fund that issues a set number
of shares and typically trades on a stock exchange with daily liquidity at
market price. Unlike more traditional open-end funds, transactions in shares
of closed-end funds are based on their market price as determined by the
forces of supply and demand in the marketplace. The market price of a
closed-end fund may be above (premium) or below (discount) the value of its
underlying portfolio (or net asset value). CDO transactions are debt that is repackaged into a more diversified basket of diversified debt. This is often put into first to default and second to default types, the two main kinds.
CONVERTIBLE ARBITRAGE Purchase convertible securities and short the underlying equities in order to profit from mispricing between the two.
CREDIT DERIVATIVES These are a group of fixed income or debt derivative products. They are popular with CB arbitrage hedge funds, and include CDS, CLN, CDO, FTD and STD transactions.
CREDIT DEFAULT SWAPS CDS are transactions using credit derivatives that are typically playing the credit spread below two corporate issuer names.
CREDIT LINKED NOTES CLN transactions are driven by investment banks in order to bring liquidity to weak corporate companies with weak balance sheets.
Calmar Ratio - This is a return/risk ratio. Return (numerator) is defined as the Compound Annualized Rate of Return over the last 3 years. Risk (denominator) is defined as the Maximum Drawdown over the last 3 years. If three years of data are not available, the available data is used. ABS is the Absolute Value. Compounded Annual Return – The compounded annual return is simply the compounded monthly return multiplied by the 12th power. Compounded Monthly Return – The compounded monthly return is the return that if compounded over the life of the fund would lead to the total return of the fund. For example, if a fund has 10 months of return equaling 100% as a total compounded return. The compounded monthly return would be 7.18%. Current Leverage – The amount of leverage currently used by the fund as a percentage of the fund. For example, if the fund has $1,000,000 and borrowing another $2,000,000, to bring the total dollars invested to $3,000,000, then the leverage used is 200%. Current Net Exposure – The exposure level of the fund to the market at the present time. It is calculated by subtracting the short percentage from the long percentage. For example, if a fund is 100% long and 25% short, then the net exposure is 75%.
Convertible arbitrage investment strategy
Capital structure arbitrage
D
DSC (deferred sales charge) Securities of companies in reorganization and/or bankruptcy, ranging from senior secured debt (low-risk) to common stock (high risk)The grade level is below the high yield level and is considered below D grade by ratings agencies
Downside Deviation - Similar to the loss standard deviation except the downside deviation considers only returns that fall below a defined Minimum Acceptable Return (MAR) rather then the arithmetic mean. For example, if the MAR is assumed to be 10%, the downside deviation would measure the variation of each period that falls below 10%. (The loss standard deviation, on the other hand, would take only losing periods, calculate an average return for the losing periods, and then measure the variation between each losing return and the losing return average).
Derivative
Debt
E
Early redemption policy EVENT-DRIVEN Investment strategy is follows events that are seen as special situations or opportunities to capitalize from price fluctuations
Event driven investment strategy
Emerging markets investing Emerging-markets investment strategy
Investing in stocks or bonds issued by companies and government entities in developing countries, usually in Latin America, Eastern Europe, Africa and Asia. Such funds typically employ a short- to medium-term holding period and experience high volatility.
Event-driven investment strategy
An approach that seeks to anticipate certain events, such as mergers or corporate restructurings. Such funds, which include risk-arbitrage vehicles and entities that buy distressed securities, typically employ medium-term holding periods and experience moderate volatility.
F
Fee-based accounts
FIXED INCOME ARBITRAGE Purchase bonds and short instruments that replicate bond. Strategy aims to profit from mispricing between the two sides.
FUND OF FUNDS Pooled capital is invested in a variety of funds diversifying risk across investment styles and return targets as well as offering investors ability to be part of funds with higher minimum investment amounts than they have
Fixed income investment strategy
An approach in which the manager invests primarily in bonds, annuities or preferred stock. The investments can be long positions, short sales or both. Such funds are often highly leveraged.
Fixed-income arbitrage investment strategy
An approach that aims to profit from pricing differentials or inefficiencies by purchasing a bond, annuity or preferred stock and simultaneously selling short a related security. Such funds are often highly leveraged.
Fund of funds (multi-manager vehicle)
An investment vehicle whose holdings consist of shares in hedge funds and private-equity funds. Some of these multi-manager vehicles limit their holdings to specific managers or investment strategies, while others are more diversified. Investors in funds of funds are willing to pay two sets of fees, one to the fund-of-funds manager and another set of (usually higher) fees to the managers of the underlying funds
Fundamental analysis investment strategy
An approach that relies on valuing stocks by examining companies' financials and operations, including sales, earnings, growth potential, asset size and quality, indebtedness, management, products and competition.
Fixed income investment strategies Fund of funds
F Fund of Hedge Funds A fund of funds is a one that invests in other hedge funds. The fund of funds manager spends considerable time evaluating, identifying strategies and selecting the hedge funds to implement them. Fund of funds may control risk by achieving manager diversity. (Read More from Hedge Fund Center)
Fixed income arbitrage Fund codes
G
GLOBAL INTERNATIONAL Focuses on ex-USA global economic change. More stock-pickers in favoured markets so bottom-up-oriented and tend not to use index derivatives as much as macro funds.
GLOBAL MACRO Opportunistic, using leverage and derivatives to increase and enhance positions - the classic Soros type strategy with variable timelines from less than a month to over a year, profiting wherever an opening is spotted to create value.
General partner
Gap risk
General partner
The individual or firm that organizes and manages a limited partnership, such as a hedge fund. The general partner assumes unlimited legal responsibility for the liabilities of a partnership.
Global-macro investment strategy
An approach in which a fund manager seeks to anticipate broad trends in the worldwide economy. Based on those forecasts, the manager chooses investments from a wide variety of markets -- i.e. stocks, bonds, currencies & commodities. The approach typically involves a medium-term holding period and produces high volatility. Many of the largest hedge funds follow global-macro strategies. They are sometimes called "macro" or "global directional-investment" funds.
H
HIGH YIELD This is a term for high interest rate bonds that are below investment grade but not distressed. This bond rating level is typically starts at double BB and ends at D grade.
H
Hedging Hedge Fund High-net-worth sector High-water mark Hurdle rate
Hedge fund
A private investment vehicle whose manager receives a significant portion of its compensation from incentive fees tied to the fund's performance -- typically 20% of annual gains over a certain hurdle rate, along with a management fee equal to 1% of assets. The funds, often organized as limited partnerships, typically invest on behalf of high-net-worth individuals and institutions. Their primary objective is often to preserve investors' capital by taking positions whose returns are not closely correlated to those of the broader financial markets. Such vehicles may employ leverage, short sales, a variety of derivatives and other hedging techniques to reduce risk and increase returns. The classic hedge-fund concept, a long/short investment strategy sometimes referred to as the Jones Model, was developed by Alfred Winslow Jones in 1949.
High-water mark
A provision serving to ensure that a fund manager only collects incentive fees on the highest net asset value previously attained at the end of any prior fiscal year -- or gains representing actual profits for each investor. For example, if the value of an investor's contribution falls to, say, $750,000 from $1 million during the first year, and then rises to $1.25 million during the second year, the manager would only collect incentive fees from that investor on the $250,000 that represented actual profits in year-two.
Hurdle rate
The minimum return necessary for a fund manager to start collecting incentive fees. The hurdle is usually tied to a benchmark rate such as Libor or the one-year Treasury bill rate plus a spread. If, for example, the manager sets a hurdle rate equal to 5%, and the fund returns 15%, incentive fees would only apply to the 10% above the hurdle rate.
High Water Mark – The assurance that a fund only takes fees on profits unique to an individual investment. For example, a $1,000,000 investment is made in year 1 and the fund declines by 50%, leaving $500,000 in the fund. In year 2, the fund returns 100%, bring the investment value back to $1,000,000. If a fund has a high water mark, it will not take incentive fees on the return in year 2, since the investment has never grown. The fund will only take incentive fees if the investment grows above the initial level of $1,000,000. Highest 12 Month Return - The best or highest 12 month period of a fund's performance Highest Monthly Return - The best or highest monthly return of the fund. Hurdle Rate – The return above which a hedge fund manager begins taking incentive fees. For example, if a fund has a hurdle rate of 10%, and the fund returns 25% for the year, the fund will only take incentive fees on the 15% return above the hurdle rate.
H Hedge Fund Like mutual funds, hedge funds pool investors' money and invest those funds in financial instruments in an effort to make a positive return. However, hedge funds are subject to fewer regulatory controls, and as such, hedge funds can take both long and short positions, use arbitrage, buy and sell undervalued securities, trade options or bonds, and invest in almost any opportunity in any market where it foresees impressive gains at reduced risk. Just like there are many types of mutual funds, hedge fund strategies vary enormously and it is no more appropriate to group the performance of "hedge funds" than it is to group the perforamance of "mutual funds" -- rather, it is important to evalute each hedge fund on its own merits. The primary aim of most hedge funds is to reduce volatility and risk while attempting to preserve capital and deliver positive returns under all market conditions. (Read More from Magnum Funds) High Water Mark Principle whereby the manager of a hedge fund does not receive an incentive fee based on a percentage of the growth in the fund's value until any losses incurred in the previous year have been made up during the current year. As each investor may enter the fund at different times, the high water mark provision must be calculated individually for each investor.
Hurdle rate
I
Incentive fee
Incentive fee (performance fee)
The charge -- typically 20% -- that a fund manager assesses on gains earned during a given 12-month period. For example, if a fund posts a return that is 40% above its hurdle rate, the incentive fee would be 8% (20% of 40%) -- provided that the high-water mark does not come into play.
Inception date
The day on which a fund starts trading.
Incentive Fee – The fee on new profits earned by the fund for the period. For example, if the initial investment was $1,000,000 and the fund returned 25% during the period (creating profits of $250,000) and the fund has an incentive fee of 20%, then the fund receives 20% of the $250,000 in profits, or $50,000. Inception Date – The date that the fund began trading.
I Incentive Fee The fee - typically 20% - that a fund manager charges on gains earned during a given 12 month period and collected either on a monthly or a quarterly basis. Inception Date The date in which the fund began trading.
Investment adviser
J
Jones model
Jensen Ratio - The Jensen Ratio, developed by Michael Jensen, quantifies the extent to which an investment has added value relative to a benchmark. The Jensen Alpha is equal to the Investment’s average return in excess of the risk free rate minus the Beta times the Benchmark’s average return in excess of the risk free rate.
Junk bonds
L
Large-cap securities Liability LONG-ONLY LEVERAGED A traditional equity fund structured like a hedge fund in that it will use leverage to maximize trading ability and will charge a performance fee for the manager.
LONG/SHORT Net exposure to market risk is reduced by having equal allocations on the long and short sides of the market
Lockup – Time period that initial investment cannot be redeemed from the fund. Longest Losing Streak – The number of consecutive months of negative performance. Lowest Monthly Return - The lowest or worst monthly return of the fund. Lowest 12 Month Return - The lowest or worst 12 month period of a fund's performance
Large cap securities
A May 6, 1997, "no-action letter" from the SEC to Lamp Technologies of Dallas indicating that an online hedge-fund database would not violate restrictions against marketing hedge funds. The landmark letter cleared the way for others to launch hedge-fund performance databases on the Internet, and expressed the SEC's opinion that such databases did not represent the type of general hedge-fund advertising that was prohibited under rule 502(c) of Regulation D under the Securities Act of 1933
Leverage
The borrowed money that an investor employs to increase buying power and increase its exposure to an investment. Users of leverage seek to increase their overall invested amounts in hopes that the returns on their positions will exceed their borrowing costs. The extent of a fund's leverage is stated either as a debt-to-equity ratio or as a percentage of the fund's total assets that are funded by debt. Example: If a fund has $1 million of equity capital and it borrows another $2 million to bring its total assets to $3 million, its leverage can be stated as "two times equity" or as 67% ($2 million divided by $3 million). Ratios of between two and five to one are common. Leverage can also come in the form of short sales, which involve borrowed securities
Limited partnership
Many hedge funds are structured as limited partnerships, which are business organizations managed by one or more general partners who are liable for the fund's debts and obligations. The investors in such a structure are limited partners who do not participate in day-to-day operations and are liable only to the extent of their investments.
Lock-up
The period of time -- often one year -- during which hedge-fund investors are initially prohibited from redeeming their shares. Long-biased investment strategy An approach taken by fund managers who tend to hold considerably more long positions than short positions.
Long-biased investment strategy
An approach taken by fund managers who tend to hold considerably more long positions than short positions.
Long/short investment strategy
An approach in which fund managers buy stocks whose prices they expect will increase and takes short positions in securities (usually in the same sector) whose prices they believes will decline. The strategy, also known as the Jones Model, is designed to generate profits during bullish periods in the overall stock market, while serving as a source of capital protection in a falling stock market.
M
M&A MARKET NEUTRAL The theory is to neutralise market risk at any one time, the reality is more a large reduction in market risk. This is done by building positions of opposite and equal size or utilizing derivatives to offset downside risk.
Managed futures Multi strategy
M Management Fee The fee charged by a hedge fund manager to cover operating expenses. Typically the fee ranges from an annual 1.0% to 2.0% of the investor's entire holdings in the fund, collected either on a monthly or a quarterly basis. Market Neutral An investment strategy that attempts to eliminate market risk and to be profitable in any market condition, typically by hedging. A portfolio is truly market neutral if it exhibits zero correlation with the unwanted source of risk. For example, the "market neutrality" of a US equities fund may be measured based on its correlation to a major US equities index such as the S&P 500. (Read More from Magnum Funds) Maximum Drawdown The cumulative percentage loss that a fund incurs from its peak net asset value to its lowest value, before regaining its peak net asset value. If one were to view a graph of a fund's net asset value over time, the maximum drawdown would by the greatest percentage drop "valley" between "peaks."
M
Management company Managed futures
A vehicle in which an investor gives a commodity trading advisor -- usually a manager or broker -- discretion or authority to buy and sell futures contracts, either unconditionally or with restrictions. A type of discretionary account
Management fee
The charge that a fund manager assesses to cover operating expenses. Investors are typically charged separately for costs incurred for outsourced services. The fee generally ranges from an annual 0.5% to 2% of an investor's entire holdings in the fund, and it is usually collected on a quarterly basis.
Market-neutral investment strategy
An approach that aims to preserve capital through any of several methods and under any market conditions. The most common followers of the market-neutral strategy are funds pursuing a long/short investment strategy. These seek to exploit market discrepancies by purchasing undervalued securities and taking an equal, short position in a different and overvalued security. Market-neutral funds typically employ long-term holding periods and experience moderate volatility.
Market timer
A hedge-fund manager that selects asset allocations in anticipation of movements in the broad market.
Master-feeder fund
A common hedge-fund structure through which a manager sets up two separate vehicles -- one based in the U.S. and an offshore fund that is domiciled outside the U.S. -- which serve as the only investors for a third non-U.S. fund. The two smaller entities are known as feeder funds, while the large offshore vehicle acts as the master fund. The purpose of such an arrangement is to create a single investment vehicle for both U.S. and non-U.S. investors.
Merger arbitrage investment strategy
Trading the stocks of companies that have announced acquisitions or are the targets of acquisitions. Seeks to exploit deviations of market prices from proposed exchange formulas.
Mortgage-backed securities arbitrage investment strategy
An approach that seeks to exploit pricing differentials between various issues of mortgage-related bonds.
Multi strategy
An investment style that combines several different approaches. The term often applies to funds of funds
N
Naked long
NAV
O
Offering memorandum (O.M.)
Opportunistic Offshore fund
An investment vehicle that is domiciled outside the U.S. and has no limit on the number of non-U.S. investors it can take on. Although the fund's securities transactions occur on U.S. exchanges and are executed by a U.S. manager, or general partner, its administration and audits are conducted offshore -- usually in a tax haven like the Cayman Islands. Because it is administered outside the U.S., non-U.S. investors and such U.S. investors as pension funds and other tax-exempt entities aren't subject to U.S. taxes.
Opportunistic investment strategy
An approach that seeks to produce the greatest possible returns by making aggressive investments in the most-efficient products at a given time. Such funds typically hold their investments for five to 30 days, based on the momentum of the investments' values. They usually experience low volatility.
P
Pairs trading
PIPEs
Management Fee – The fees taken by the manager on the entire asset level of the investment. For example, if at the end of the period, the investment is valued at $1,000,000, and the management fee is 1%, then the fees would be $10,000. Master-Feeder Fund – A typical structure for a hedge fund. It involves a master trading vehicle that is domiciled offshore. The master fund has 2 investors: Another offshore fund, and a US (usually Delaware) Limited Partnership. These two funds are the feeder funds. Investors invest in the feeder funds, which in turn invest all the money in the Master fund, which is traded by the manager. Maximum Drawdown – The worst period of "peak to valley" performance for the fund, regardless of whether or not the drawdown consisted of consecutive months of negative performance. Minimum Investment – The minimum initial investment for the fund.
Peak to Valley Drawdown – The worst period of return of the fund. Percent Long – The percentage of the fund invested in long positions Percent Short – The percentage of the fund that is sold short. Profitable Percentage – The percentage of monthly returns that the fund made money. Pro-Forma - A monthly return that, for some reason, was not completed by the fund in the exact structure as it is now. Examples: 1. A fund manager who managers a master feeder structure does not have any money in the offshore fund, but since the offshore fund is simply an investor in the master fund, he reports the returns as pro-forma. 2. A fund manager runs managed accounts with the same exact strategy and fee structure as his new fund. He may list the performance of the managed accounts as pro forma, for while there was a real track record, it just was not in the fund structure. 3. A fund manager leaves his management company and brings the fund with him. He may report the performance under the old management company as pro-forma. 4. A fund of funds launches with 10 funds in the portfolio. It may report the historical results of the weighted funds as pro forma. Note: HedgeFund.net discourages the reporting of pro-forma results, as they oftentimes confuse investors because there are so many definitions of pro-forma results.
Pairs trading PARTNER This is a job title given to a hedge fund member who is an owner of the firm, not just an employee. As a partner of the firm, this owner may not only take a large bonus taken from the performance fee share of the firm, but also from the management fee share as well.
PIPEs Private Investment into Public Equities are direct buyer to seller transactions that are not public or "in the market". They often involved large blocks of stock, often by a long term investor or founding owner. As they are private, they are not announced and the profits that they generate, even when huge, are never disclosed.
PRINCIPAL This is a job title often given to a senior member of a hedge fund before becoming a partner. Within some European firms, it is the equal to a director job title.
PIPEs
Acronym for private investments in public entities. Investments typically made by funds following Regulation D investment strategy.
Prime broker
A large bank or securities firm that provides various administrative, back-office and financing services to hedge funds and other professional investors. Prime brokers can provide a wide variety of services, including trade reconciliation (clearing and settlement), custody services, risk management, margin financing, securities lending for the purpose of carrying out short sales, record keeping, and investor reporting. A prime brokerage relationship doesn't preclude hedge funds from carrying out trades with other brokers, or even employing others as prime brokers. To compete for business, some prime brokers act as incubators for funds, providing office space and services to help new fund managers get off the ground.
Private-equity fund
Entities that buy illiquid stakes in privately held companies, sometimes by participating in leveraged buyouts. Like hedge funds, the vehicles are structured as private investment partnerships in which only qualified investors may participate. Such funds typically charge a management fee of 1.5% to 2.5%, as well as an incentive fee of 25% to 30%. Most private-equity funds employ lock-up periods of five to ten years, longer than those of hedge funds
Private placement
Issues those are exempt from public-registration provisions in section 4-2 of the Securities Act of 1933. Hedge fund shares are generally offered as private placements, which are typically offered to only a few investors, rather than the general public. They must meet the following criteria:
The issuer must believe that the buyer is capable of evaluating the risks of the transaction. Buyers have access to the same information that would appear in the prospectus of a publicly offered issue. The issuer does not sell the securities to more than 35 parties in any 12-month period. The buyer does not intend to sell the securities immediately for a trading profit.
Q
Qualitative analysis
R
Redemption charge
R and R Squared - R and R Squared show if there is any correlation between the fund and the market. 1.0 is perfect correlation, 0.0 is absolutely no correlation and –1.0 is perfect negative correlation. The industry assumes that an R squared below 0.3 has no correlation to the market. Redemptions – Frequency at which fund redemptions are accepted by the fund. Reporting Agent – Any third party that analyses and verifies the monthly returns of a fund. Risk Free Rate for Sharpe Ratio: 5% Risk Free Rate for Sortino Ratio: 5%
R R-Squared Measures that represents the percentage of a fund's or of a security's movements that are explained by movements in a benchmark index. In other words, "How correlated is the movement of the fund to the movement of the index?" For fixed-income securities the benchmark is often the T-bill, and for equities the benchmark is often the S&P 500 index. A value of 1.0 indicates perfect correlation with the benchmark, while a value of 0.0 indicates no correlation with the benchmark. (Read More from Investopedia) Redemption Notice Period The required period of time prior to an intended redemption that a written request for redemption must be made. Many hedge funds require investors to give this advance notice for a planned redemption. Redemptions Partial or whole liquidation of interests in an investment fund. Relative Value Strategy This investment strategy exploits price differences of various financial instruments, which can be incorrectly valued relative to another financial instrument. Examples of Relative Value strategies are Fixed Income Arbitrage, Convertible Arbitrage and Equity Market Neutral.
Rolling 12 Month Sharpe Ratio - It is the same calculations as the above Sharpe ratio, except we use annual and rolling 12 month numbers. So, it's the Average Annual Return - the Annual risk free rate (5%) divided by the rolling 12 Month Standard Deviation.
R squared REGIONAL - EMERGING Focuses on less mature financial markets. The difficulty here is the inability to short sell in most emerging markets which forces managers to go to cash or change markets as long positions turn unprofitable.
REGIONAL - ESTABLISHED Focuses on opportunities in established markets such as USA, Europe and Japan.
RISK ARBITRAGE Manager simultaneously buys stock in a target company and sells stock in its acquirers. The trade depends on the takeover being completed. Reverse positions on takeover failure are also sometimes taken.
A measure of the degree to which a hedge fund's returns are correlated to the broader financial market. A figure of 1 would be a perfect correlation, while 0 would be no correlation and minus-1 would be a perfect inverse correlation. Any figure below 0.3 is considered non-correlated. The result is used to determine whether a hedge fund follows a market-neutral investment strategy. Sometimes referred to as "R."
Rate of return
The annual appreciation in the value of a fund or any other type of investment, stated as a percentage of the total amount invested. Sometimes referred to a simply the "return."
Redemption fee
A charge, intended to discourage withdrawals that a hedge-fund manager levies against investors when they cash in their shares in the fund before a specified date
Regulation D
A provision in the Securities Act of 1933 that allows privately placed transactions to take place without SEC registration and prohibits hedge funds from advertising themselves to the general public. It also outlines which parties qualify as company insiders.
Regulation D investment strategy
An approach in which the fund manager provides financing to publicly traded companies, usually in exchange for a privately placed convertible note issued at a discount. Also known as PIPES (private investments in public entities).
Relative-value investment strategy
A market-neutral investment strategy that seeks to identify investments whose values are attractive, compared to similar securities, when risk, liquidity and return are taken into account.
Risk arbitrage investment strategy
Purchasing stocks of companies that are likely takeover targets, while assuming short positions in the would-be acquiring companies. Risk arb players can employ an event-driven investment strategy or merger arbitrage investment strategy, seeking situations such as hostile takeovers, mergers and leveraged buyouts. Such funds typically experience moderate amounts of volatility.
Risk-free rate
The theoretical return on a risk-free investment, usually a U.S. security.
S
S&P (Standard and Poors)
S Sharpe Ratio Measures risk-adjusted performance of an investment asset, or a trading strategy. It characterizes how well the return of an asset compensates the investor for the risk taken. Fund managers commonly strive to achieve high Sharpe Ratios. (Read More from William F. Sharpe, Stanford University) Sortino Ratio A variation of the Sharpe Ratio that was developed to differentiate between good and bad volatility, using downside deviation instead of standard deviation. The Sortino ratio is the excess return over risk-free rate over the downside semi-variance, so it measures the return to "bad" volatility. This ratio allows investors to assess risk in a better manner than simply looking at excess returns to total volatility (i.e. Sharpe Ratio), since such a measure does not consider how often the price of the security rises as opposed to how often it falls. That is, the Sortino ratio does not penalize a fund for its upside volatility. (Read More from Hedge Fund Center) Standard Deviation Measures the volatility or deviation of returns around the portfolios mean-average return. The standard deviation is the amount of swing in performance that an investment can be expected to have from year to year. The further the variation from the average return, the higher the standard deviation. A standard deviation of zero would mean an investment has a return rate that never varies, like a bank account paying compound interest at a guaranteed rate. (Read More from Ric Edelman) Subscription In the fund business, subscription means the acquisition of fund units (shares). An investor is said to "subscribe" to the fund, and legal documents enabling the transaction are referred to as "subscription documents."
SECTOR Investment in particular economic sectors and/or industries. Focus can vary between large to micro cap and the approach can be fundamental, technical, opportunistic or bottom-down.
SHORT-SELLERS Thinking that the overvalued stocks will fall, a hedge fund borrows stock and sells it, hoping to buy it back at a lower price. Can be used to hedge long-only portfolios.
Sharpe ratio SPECIAL SITUATIONS This is often an opportunistic action based on an unexpected event or opportunity. News event driven actions can involve private placement transactions. These details are often not "in the market" and therefore not well known to any but the buyer and the seller.
Spin-off Purchase basket of stocks and sell short stock index futures contract, or reverse
Sharpe ratio
A measure of how well a fund is rewarded for the risk it incurs. The higher the ratio, the better the return per unit of risk taken. It is calculated by subtracting the risk-free rate from the fund's annualized average return, and dividing the result by the fund's annualized standard deviation. A Sharpe ratio of 1:1 indicates that the rate of return is proportional to the risk assumed in seeking that reward. Developed by Prof. William R. Sharpe of Stanford University.
Short-biased investment strategy
An approach that relies on short sales. Such funds tend to hold larger short positions than long positions.
Soft dollars
Credits that can be used to pay for research and other services that brokerage firms provide to hedge funds and other investor clients in return for their business. Those credits are accumulated through soft-dollar brokers, which channel trades to multiple securities brokers.
Sortino ratio
Also called the "upside potential ratio." Similar to the Sharpe ratio, it was developed by the Pension Research Institute to determine the amount of "good" volatility that a fund's investment portfolio possesses -- that is, it seeks to define the amount by which the investment pool's value may increase, based on expected pricing fluctuations.
Special situations investment strategy
An event-driven investment strategy in which the manager seeks to take advantage of unique corporate situations that provides the potential for investment gains.
Standard deviation
For an investment portfolio, it measures the variation of returns around the portfolios mean-average return. In other words, it expresses an investment's historical volatility. The further the variation from the average return, the higher the standard deviation.
Statistical arbitrage investment strategy
A market-neutral investment strategy that seeks to simultaneously profit and limit risk by exploiting pricing inefficiencies identified by mathematical models. The strategy often involves short-term bets that prices will trend toward their historical norms.
Sortino Ratio – The Sortino Ratio is similar to the Sharpe Ratio, except that instead of using standard deviation as the denominator, it uses Downside Deviation. The Sortino Ratio was developed to differentiate between “good” and “bad” volatility in the Sharpe Ratio. If a fund is volatile to the upside (which is generally a good thing) its Sharpe ratio would still be low. To quote the Sortino web site: “A comparable downside risk ratio that has come to be called the Sortino ratio has for the numerator the difference between the return on the portfolio and the MAR. The denominator for the Sharpe ratio is standard deviation, and for the Sortino ratio it is downside deviation." The MAR is the Minimum Acceptable Return (We are using 5%). Sterling Ratio - This is a return/risk ratio. Return (numerator) is defined as the Compound Annualized Rate of Return over the last 3 years. Risk (denominator) is defined as the Average Yearly Maximum Drawdown over the last 3 years less an arbitrary 10%. To calculate this average yearly drawdown, the latest 3 years (36 months) is divided into 3 separate 12-month periods and the maximum drawdown is calculated for each. Then these 3 drawdowns are averaged to produce the Average Yearly Maximum Drawdown for the 3 year period. If three years of data are not available, the available data is used.
Standard Deviation or Average Standard Deviation - The Standard Deviation of monthly returns. If you need a definition of standard deviation, please download the word document. Rolling 12 Month Standard Deviation - Standard Deviation of Rolling 12 Month Returns. Sharpe Ratio or Annualized Sharpe Ratio - Here are two ways of stating the same thing: The average monthly return minus the monthly risk free rate (we use 0.41%) divided by the Standard Deviation. We take that number and multiply it by the square root of 12 to annualize it. [(Average Monthly Return - Risk Free Rate (0.41%) / Standard Deviation] *12 to the 1/2 power.
T
Technical analysis (technicals)
Total Return Since Inception - The total Cumulative return for the fund since inception Treynor Ratio - The Treynor Ratio, developed by Jack Treynor, is similar to the Sharpe Ratio, except that it uses Beta as the volatility measurement. Return (numerator) is defined as the incremental average return of an investment over the risk free rate. Risk (denominator) is defined as the Beta of the investment returns relative to a benchmark. Typical Leverage – The amount of leverage typically used by the fund as a percentage of the fund. For example, if the fund has $1,000,000 and borrowing another $2,000,000, to bring the total dollars invested to $3,000,000, then the leverage used is 200%. Typical Net Exposure – The exposure level of the fund to the market that the fund attempts to maintain over time. It is calculated by subtracting the short percentage from the long percentage. For example, if a fund is 100% long and 25% short, then the net exposure is 75%.
Top down investing Top-down investment strategy
An approach that seeks to assess the influence of various macro-and micro-economic factors before identifying individual investments.
Unlisted security
Valuation
VALUE INVESTING An investment style which favors good stocks at great prices over great stocks at good prices. Utilizes such valuation measures as price to book ratio, price/earnings ratio and yield.
V Volatility arbitrage In "vol" trading, managers buy options and short the underlying stock, keeping in mind the delta or the correlation between moves in the option price and the stock price. Conversely, traders can earn a premium by selling the option and buying the stock. The strategy is driven by differences between the option's implied volatility, and a forecast of the underlier's future realized volatility
Valuation Value investment strategy
An approach that involves purchases of stocks that the manager deems to be priced below their intrinsic values, or are out of favor with the market but are still fundamentally solid. Such funds typically employ long-term holding periods and experience low volatility.
Venture capital
Money given to corporate start-ups and other new high-risk enterprises by investors who seek above-average returns and are willing to take illiquid positions.
Volatility
The likelihood that an instrument's value will change over a given period of time, usually measured as beta.
W
White label
Y
Yield
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