Hedge Fund Glossary

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

Beta

Gauges the risk of a fund by measuring the volatility of its past returns in relation to the returns of a
benchmark, such as the S&P 500 index. A fund with a beta of 0.7 has experienced gains and losses that are
70% of the benchmark's changes. A beta of 1.3 means the total return is likely to move up or down 30%
more than the index. A fund with a 1.0 beta is expected to move in sync with the index.

Bottom-up investment strategy

An approach that seeks to identify investments that will produce strong returns, before assessing the
influence that economic factor will have on those assets

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Closed fund

A hedge fund or open-end mutual fund that has at least temporarily stopped accepting capital from
investors, usually due to rapid asset growth. Not to be confused with a closed-end fund.

Compounded monthly return

The average monthly increase that, when compounding is taken into account, would have produced a fund's
total return over any period of time. For example, if a fund had a one-year return of 20%, its compounded
monthly return would be 1.53% -- the amount it would have needed to gain in each of 12 months to achieve
that full-year result.

Convertible arbitrage investment strategy

A conservative, market-neutral approach that aims to profit from pricing differences or inefficiencies
between the values of convertible bonds and common stock issued by the same company. Managers of such
funds generally purchase undervalued convertible bonds and short-sell the same issuers' stock. The
approach typically involves a medium-term holding period and results in low volatility.

Derivative

A financial instrument whose performance is linked to a specific security, index or financial instrument.
Typically, derivatives are used to transfer risk or negotiate the future sale or delivery of an investment.
Derivative instruments come in four basic forms: forward contracts, futures contracts, swaps and options.

Distressed securities investment strategy

Purchasing deeply discounted securities that were issued by troubled or bankrupts companies. Also, short-
selling the stocks of those corporations. Such funds are usually able to achieve low correlations to the
broader financial markets. The approach generally involves a medium- to long-term holding period.

Drawdown

The percentage loss that a fund incurs from its peak net asset value to its lowest value. The maximum
drawdown over a significant period is sometimes employed as a means of measuring the risk of a vehicle.
Usually expressed as a percentage decline in net asset value.

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.

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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.

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.

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.

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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.

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.

Jensen's Alpha

A risk-adjusted performance measure that represents the average return on a portfolio over and above that
predicted by the capital asset pricing model (CAPM), given the portfolio's beta and the average market
return. This is the portfolio's alpha. In fact, the concept is sometimes referred to as "Jensen's alpha."

Kurtosis

In probability theory and statistics, kurtosis (from the Greek word kurtos, meaning bulging) is a measure of
the "peakedness" of the probability distribution of a real-valued random variable. Higher kurtosis means
more of the variance is due to infrequent extreme deviations, as opposed to frequent modestly-sized
deviations.

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Lamp letter

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/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.

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

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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

Net Asset Value

A mutual fund's price per share or exchange-traded fund's per-share value. In both cases, the per-share
dollar amount of the fund is derived by dividing the total value of all the securities in its portfolio, less any
liabilities, by the number of fund shares outstanding. In terms of corporate valuations, the value of assets
less liabilities equals net asset value, or "book value".

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 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.

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

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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.

Qualified purchaser

To be a qualified purchaser you must meet either of the following criteria:

a) Individuals who own $5 million in investments, which include securities, financial contracts entered into
for investment purposes, cash, cash equivalents held for investment purposes, real estate held for
investment purposes, CDs, bankers acceptances and other similar bank instruments held for investment
purposes. Investments do not include real estate held for personal purposes, jewelry, art, antiques, and
other collectibles. Debt used to acquire the investments is excluded from the value of the investments;
b) Institutional investors who own $25 million in investments;
c) A family owned company that owns $5 million in investments;
d) For trusts with less than $25 million, a trust where the trustee and each person who contributes assets to
the trust is a Qualified Purchaser; e) A "Qualified Institutional Buyer" under Rule 144A of the 33 Act, except
that "dealers" under Rule 144 must meet the $25 million standard of the 1940 Act, rather than the $10
million standard of Rule 144A. Rule 144A generally defines a "Qualified Institutional Buyer" as institutions,
including registered Investment Companies, that own and invest on a discretionary basis $100 million of
securities that are affiliated with the institution, banks that own and invest on a discretionary basis $100
million in QIB securities and have an audited net worth of $25 million, and certain registered dealers;
f) A company owned beneficially only by Qualified Purchasers; however, a company will not be deemed to
be a qualified purchaser if it was formed for the specific purposes of acquiring the securities offered by a
3(c)(7) fund.

For a complete definition of Qualified Purchaser, please see Title 15 U.S.C. Chapter 2D, Sub Chapter I,
Section 80a-2(a)(51), which is publicly available at www.gpoaccess.gov/uscode/browse.html

R-squared

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."

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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.

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.

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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.

Top-down investment strategy

An approach that seeks to assess the influence of various macro-and micro-economic factors before
identifying individual investments.

Traynor ratio

A measure of the excess return per unit or risk, where the excess return is defined as the difference
between the portfolio's return and the risk-free rate of return over the same period.

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.

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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.

Warrent Arbitrage

Developed as a result of the experience gained whilst working and trading on the Japanese Warrants desk
and having fine-tuned the software for the Japanese market, other markets, in particular the European
markets, have been incorporated. The application combines a blend of traditional option pricing calculators
together with practical fine tuning to identify warrant price anomalies on a volatility basis, or where warrant
prices have broken their historic relationships with the underlying stock price.

At the heart of the system is empirical regression and volatility crossover analysis, providing real-time
pricing and graphical capabilities to view particular issues, or the market by sector, maturity, SE or a
combination (SE = stock price / exercise price). Other features include interactive Premium/SE and Implied
Volatility/Historic Volatility graphics, what-if-scenarios and a variety of reports to track the warrant universe.
Whilst the basis for creative warrant trading strategies, the system can dramatically enhance client comfort
levels with graphical awareness of optimal warrant/stock purchases and by confirming fundamentals.

Zero-Coupon Bond

A Zero coupon bond (also known as a discount bond) is a bond bought at a price lower than its face value,
with the face value repaid at the time of maturity. It does not make periodic interest payments, or so-called
"coupons," hence the term zero-coupon bond. Investors earn interest via the difference between the
discounted price of the bond and its par (or redemption) value. Examples of zero-coupon bonds include U.S.
Treasury bills, U.S. savings bonds, and long-term zero-coupon bonds.In contrast, an investor who has a
regular bond receives income from coupon payments, which are usually made semi-annually. The investor
also receives the principal or face value of the investment when the bond matures.

Some zero coupon bonds are inflation indexed, so the amount of money that will be paid to the bond holder
is calculated to have a set amount of purchasing power rather than a set amount of money, but the majority
of zero coupon bonds pay a set amount of money known as the face value of the bond. Zero coupon bonds
may be long or short term investments. Long-term zero coupon maturity dates typically start at ten to
fifteen years. The bonds can be held until maturity or sold on secondary bond markets. Short-term zero
coupon bonds generally have maturities of less than one year and are called bills. The U.S. Treasury bill
market is the most active and liquid debt market in the world.

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