Important questions related to any

investment?
• Who
• When
• Where
• Why
• Whom
• How
• How much
• ?????????????????????????????????????
 How do you handling or
assessing risk?
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 Hedge funds
Learning outcome
1. Identifying the probable risk associated with
investments
2. Developing expertise to get better returns in all
market situations
 Introduction
• Hedge means minimizing risk. But how?
• Hedge funds may invest in all markets globally
and can have exposure to equities, fixed
income, commodities, credit, currencies and
derivatives. But why?
 Features
• Absolute returns
• Skill based investing
• Minimum investment levels
• Liquidity and capacity
• Performance fees
 Concept
• Pooled Investment Company/vehicle
• An investment made in order to
– reduce the risk/volatility
– of adverse price movements in a security,
– by taking an offsetting position in a related
security, such as an option or a short sale.
 What is a hedge fund?
• Hedge Fund- A fund that 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.
– Can invest in markets such as equities, bonds, OTC
products, fixed income, commodities, credit,
currencies and derivatives.
 Characteristics of Hedge Funds
• Organized as private investment partnerships
• Fluctuate extremely in terms of investment returns.
• Utilize different investment styles and strategies
• Portfolio diversification
• Deliver non-market correlated returns.
• Consistency of returns and capital preservation
rather than magnitude of returns.
Hedge Funds vs Other traditional asset
classes
• Criteria • Mutual funds
– Absolute Returns • Private equity
– Skill Based investing • Venture capital funds
– Minimum investment
levels
• Commodity pools
– Liquidity and capacity
– Performance Fees
 Principles of Hedge Funds
• 1. Correlation among stocks
• 2. Sensitivity of stock with other
Differences Between Hedge funds and
Mutual Funds
Basis for comparison Hedge fund Mutual fund
A trust, where savings of
The hedge fund is a portfolio
several investors are pooled
of investments, in which few
together to purchase a
Meaning qualified wealthy investors
diversified basket of securities
pool their money to buy
at low cost, is known as
assets.
Mutual fund.
Return Absolute Relative
Comparatively less
Management Aggressively managed.
aggressively managed.
Owners Few Thousands
Pension fund, endowment
Investor type fund, high net worth Retail investors
individuals.
Regulation Less regulation Strictly regulated by SEBI
Based on the percentage of
Fees Performance based.
assets managed.
Hedge Funds vs Other traditional asset classes
Investment Class Hedge Funds Traditional Investment
Strategies Long and Short Long Only
Performance Absolute Benchmark
Measurement
Positive Returns Independent of behaviour Conditional on rising
of traditional markets markets
Technique Leverage/deleverage Limited use of
leverage/deleverage
Managers own Invested Not invested
investment
Risk Absolute Risk Tracking error
Fees Management and Incentive Management Fee only
Fee
Transparency Often very low Public Information
Distribution
Correlation Low High
between
manager
 Hedge Fund Strategies
• Emerging Markets
– Invest in emerging markets
– Emerging markets offer less options for short selling, so
these are mostly long biased and employ growth or value
approach to investing in equities.
– Expected Volatility: High
• Convertible arbitrage
– Make profit from arbitrage of convertible securities.
– Make money from mispricing and volatility.
– Usually buy a convertible bond, and takes short position in
underlying equity.
 Hedge Fund Strategies
• Long-short equity
– Base strategy of the initial hedge funds formations by
Jones.
– Hedging portfolio of longs by portfolio of shorts.
– Main focus on the stock picking opportunities.
• Global Macro
– Invest in developed as well as developing countries.
– Enough flexibility can invest in any security in any
market where there is an opportunity.
– These can be illiquid & carry a high risk due to
correlation of emerging economies.
– Expected Volatility: Very High
 Hedge Fund Strategies
• Event driven
– Focus on events of corporate life cycle like merger and
acquisitions, buy-backs, demerger and spin-offs.
• Merger/Risk Arbitrage
– Focus on the companies which are going through any
merger or takeover (focus on both companies)
– The risk is deal risk rather than market risk.
• Distressed Securities
– Buying the bonds or securities of companies facing or
approaching bankruptcy or restructuring.
– Tries to benefit from the price movement of these
securities.
– Expected Volatility: Low- Moderate
 Hedge Fund Strategies
• Equity Market Neutral
– Market timing rather than stock picking
– Taking long and short position in the undervalued and
overvalued securities.
– Has low volatility.
• Aggressive Strategy
– Invests in equities expected to experience acceleration in
growth of earnings per share.
– Generally high P/E ratios, low or no dividends
– Often smaller and micro cap stocks which are expected to
experience rapid growth.
– Hedges by shorting equities where earnings
disappointment is expected or by shorting stock indexes.
– Tends to be "long-biased."
– Expected Volatility: High
 Hedge Fund Strategies
• Fund of Funds:
– Mixes and matches hedge funds and other pooled investment
vehicles.
– More stable long-term investment return than any of the individual
funds.
– Returns, risk, and volatility can be controlled by the mix of underlying
strategies and funds.
– Volatility depends on the mix and ratio of strategies employed.
– Expected Volatility: Low - Moderate
• Opportunistic :
– Investment theme changes from strategy to strategy as opportunities
arise to profit from events
– May utilize several of these investing styles at a given time and is not
restricted to any particular investment approach or asset class.
– Expected Volatility: Variable
 Hedge Fund Strategies
• Multi Strategy:
– Investment approach is diversified by employing various
strategies simultaneously to realize short- and long-term
gains.
– Trend following and various diversified technical strategies.
– Expected Volatility: Variable
• Short Selling:
– Sells securities short in anticipation of being able to rebuy
them at a future date at a lower price .
– Manager’s assessment of the overvaluation of the
securities, or the market, or in anticipation of earnings
disappointments often due to accounting irregularities, new
competition, change of management, etc.
– Expected Volatility: Very High
 Hedge Fund Strategies
• Value
– Invests in securities perceived to be selling at deep
discounts to their intrinsic or potential worth.
– Such securities may be out of favour or underfollowed by
analysts.
– Long-term holding, patience, and strong discipline are
often required until the ultimate value is recognized by the
market.
– Expected Volatility: Low – Moderate
• Fixed Income Arbitrage