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Hedge Fund

Hedge Fund

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Published by: kishorepatil8887 on Mar 31, 2010
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01/14/2011

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Hedge fund
 
A
hedge fund
is aninvestment fundstructured to avoid directregulationandtaxationin major  countries and which charges a performance feebased on the increase of the value of the fund'sassets. Theassetsof a hedge fund will usually be managed by aninvestment management firm   based in a major financial centre. As a hedge fund is largely unregulated, its investment manager is able to deploy a wider range of investment strategies and tactics than it could for a regulatedfund, and investing in a hedge fund is therefore considered to carry more risk.As a hedge fund's investment activities are limited only by the contracts governing the particular fund, it can make greater use of complex investment strategies such asshort selling, entering intofutures,swapsand other derivativecontracts andleverage. A hedge fund will often seek to generate returns that are not closely correlated to those of the broader financial markets byhedgingits investments against adverse moves in those markets.For the purposes of consumer protection, in most countries hedge funds are prohibited frommarketingto investors who are not professional investors or individuals with sufficient privatewealth, unlike retail funds. They therefore have littleincentiveto release information to thegeneral publicvoluntarily and have acquired a reputation for secrecy. Since hedge fund assets can run into many billions of dollars and will usually be multiplied byleverage, their sway over markets, whether they succeed or fail, is potentially substantial andthere is a continuingdebateover whether they should be more thoroughly regulated.
Fees
Usually the hedge fund manager will receive both a management fee and a performance fee. Aswith other investment funds, the management fee is computed as a percentage of assets under management. Management fees typically range from 1.5% to 4.0%.
[
edit] Performance fees
Performance fees, which give a share of positive returns to the manager, are one of the definingcharacteristics of hedge funds. The performance fee is computed as a percentage of the fund's profits, counting both unrealized profits and actual realized trading profits. Performance feesexist because investors are usually willing to pay managers more generously when the investors
 
have themselves made money. For managers who perform well the performance fee is extremelylucrative.Typically, hedge funds charge 20% of gross returns as a performance fee, but again the range iswide, with highly regarded managers demanding higher fees. In particular,Steven Cohen'sSAC Capital Partnerscharges a 50% incentive fee (but no management fee) andJim Simons' Renaissance TechnologiesCorp. charged a 5% management fee and a 44% incentive fee in itsflagship Medallion Fund before returning all investors' capital and running solely on itsemployees' money.
[
citations needed 
]
 Managers argue that performance fees help to align the interests of manager and investor better than flat fees that are payable even when performance is poor. However, performance fees have been criticized by many people including notable investor Warren Buffettfor giving managersan incentive to take risk, possibly excessive risk, as opposed to high long-term returns. In anattempt to control these problems, fees are usually limited by high water marks and sometimes by hurdle rates.
[
edit] High water marks
A "High water mark" is often used.
[1]
This means that the manager does not receive incentivefees unless the value of the fund exceeds the highest net asset value it has previously achieved.For example, if a fund was launched at a net asset value (NAV) of 100 and rose to 130 in its firstyear, a performance fee would be payable on the 30% return. If the next year it dropped to 120,no fee is payable. If in the third year the NAV rises to 143, a performance fee will be payableonly on the 10% return from 130 to 143 rather than on the full return from 120 to 143.This measure is intended to link the manager's interests more closely to those of investors and toreduce the incentive for managers to seek volatile trades. If a high water mark is not used, a fundthat ends alternate years at 100 and 110 would generate performance fee every other year,enriching the manager but not the investors. However, this mechanism does not providecomplete protection to investors: a manager who has lost money may simply decide to close thefund and start again with a clean slate -- provided that he can persuade investors to trust him withtheir money. A high water mark is sometimes referred to as a "Loss Carryforward Provision."Poorly performing funds frequently close down rather than work without fees, as would berequired by their high water mark policies.
[2]
 
[
edit] Hurdle rates
Some funds also specify a 'hurdle', which signifies that the fund will not charge a performancefee until its annualized performance exceeds a benchmark rate, such asT-billsor a fixed percentage, over some period. This links performance fees to the ability of the manager to do better than the investor would have done if he had put the money in a bank account.Though logically appealing, this practice has diminished as demand for hedge funds hasoutstripped supply and hurdles are now rare.
[
citations needed 
]
 
 
[
edit ] Strategies
Hedge funds do not constitute a homogeneous asset class. The bulk of hedge funds describethemselves as long / short equity, perhaps because this is the least specific of the availabledescriptions, but many different approaches are used taking different exposures, exploitingdifferent market opportunities, using different techniques and different instruments:
y
 
Global macro seeking assets that are mispriced relative to global alternatives.
y
 
A
rbitrage seeking related assets that have deviated from some anticipated relationship.
o
 
C
onvertible arbitrage between a convertible bond and equity.
o
 
F
ixed income arbitrage between related bonds.
o
 
R
isk arbitrage between securities whose prices appear to imply different probabilitiesfor an event.
o
 
S
tatistical arbitrage(or '
S
tat
A
rb')  between securities that have deviated from somestatistically estimated relationship.
o
 
D
erivative arbitrage between a derivative security and the underlying security.
y
 
L
ong / short equity generic term covering all hedged investment in equities.
o
 
S
hort bias emphasizing or investing solely short.
o
 
E
quity market neutral maintaining a close balance between long and short positions.
y
 
E
vent driven  specialized in the analysis of a particular kind of event
o
 
D
istressed securities companies that are or may become bankrupt
o
 
R
egulation
D
 distressed companies issuing securities
o
 
M
erger arbitrage- between an acquiring public company and a target public company
y
 
O
ther
o
 
E
merging markets 
o
 
F
und of hedge funds 
o
 
uantitative 
[
edit ] Hedge fund risk 
Investing in a hedge fund is considered to be ariskier proposition than investing in aregulated fund, despite the traditional notion of a "hedge" being a means of reducing the risk of a bet or  investment. The following are some of the primary reasons for the increased risk:
Leverage
- in addition to money put into the fund by investors, a hedge fund will typicallyborrowmoney, with certain funds borrowing sums many times greater than the initialinvestment. Where a hedge fund has borrowed $9 for every $1 invested, a loss of only 10% of the value of the investments of the hedge fund will wipe out 100% of the value of the investor'sstake in the fund, once thecreditorshave called in their loans.
A
t the beginning of 1998, shortlybefore its collapse,
L
ong Term
C
apital
M
anagementhad borrowed over $26 for each $1invested.
Short selling
- due to the nature of short selling, the losses that can be incurred on a losing betare theoretically limitless, unless theshortposition directlyhedgesa correspondinglong 

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