Problems with Collateral Fund Obligations

16 May

Although the hedge fund industry growth has been predominantly driven by high net worth individuals, private foundations and endowments, more institutional investors are finding this asset class attractive and portfolio enhancing. The future driver of hedge fund growth will be other institutional investors such as insurance companies, various pension funds, and banking institutions. Many institutional investors lack the investment mandate to gain exposure in alternative assets and below investment grade fixed income securities. Beyond legal restrictions (i.e. ERISA), institutional investors demand liquidity and transparency in their investments based on their fiduciary duty to act in accordance with the prudent investor rule that most institutional managers are governed by.

Concurrently, institutional investors seek capital preservation, enhanced risk-return opportunities and diversification benefits (i.e. low correlations). For a sophisticated investor, generating high absolute returns provides zero value if risk is increased commensurately. Any investor can achieve high returns by picking risky securities, but to generate more alpha (risk-adjusted returns) is extremely valuable for institutional investors. Therein lies the rift between hedge funds and traditional institutional investors.

Hedge funds customarily lack both transparency, based on their proprietary investment strategies, and liquidity, based on their lock-in periods; however, hedge funds provide precisely what institutional investment mangers’ portfolio objectives demand, capital preservation, higher alphas, and lower correlations. Furthermore, with the current financial markets in turmoil, all the value enhancing synergies that hedge funds provide to a diversified portfolio become increasingly important.

As unregulated investment partnerships, hedge funds have the financial flexibility and economic incentives to create innovative investment strategies which maximize risk-return tradeoffs. Additionally, hedge funds are able to furnish diversification benefits not based on the specific assets invested in but rather how the assets are invested in. The ability to short securities (idiosyncratic risk) and the market (systematic risk) and use derivatives to hedge away undesired risk is extremely value enhancing, especially in a market decline when other asset classes are falling. By mitigating liquidity and transparency issues between hedge funds and investors, capital flows will improve; however, understanding how the needs differ between both parties will create a more complementary solution.

Liquidity is a problem for investors due in part to the investment styles of hedge funds. For instance, a spread arbitrage would fail, if investors withdrew funds prior to the contraction and during a margin call. Likewise, distressed debt investments require substantial time for returns to materialize given the slow nature of the bankruptcy process. Conversely, the same bankruptcy process also creates inefficiencies in the market and the subsequent premiums for investors. Liquidity could easily be resolved by creating a secondary OTC market for tradable hedge fund securities.

Transparency is another issue hindering institutional investors from allocating more capital to alternative investments. However, it is very important to understand what investors need in terms of transparency. Although hedge funds may not want to divulge their positions and trading strategies, investors are only concerned with having access to information to understand, evaluate and verify the risk-adjusted performance of their investments. This is essential and an underlying principle of the prudent investor rule.

Planning to invest in Hedge funds?

15 Feb

For investors planning to invest in Hedge funds, one of the major concerns is regarding the fees that are associated with the hedge funds. This article is designed to help concerned  investors get their answers on the fees associated with hedge funds? After going through the information provided here, you will feel a bit more informed.

There are various fees involved in managing the hedge funds. In the majority of the financial markets across the globe, the following fees normally form a part of the hedge fund.

Withdrawal Fee

This is the fee that is charged by the hedge fund manager when the investor withdraws money from his/her hedge fund account. This fee has been introduced to discourage the investors from frequently withdrawing money from their hedge fund account. Such fees are applicable when the investor withdraws the money too soon or when the investor withdraws more money than the set limits.

Management Fee

This is the fee that goes to the fund manager who manages the hedge fund. The fee for the hedge fund manager is usually set between one percent and four percent of the total hedge fund value. This fee is usually paid to the fund manager in installments.

Performance Fee

In addition to the management fee, the hedge fund manager is also eligible for a performance fee. A certain percentage of the fund profits is set aside as the performance fee. This usually ranges from 18% to 20% of the total fund profits.

Hurdle rates

Hurdle rates are used  for computing the performance fees. Hurdle rates are calculated by comparing the fund performance with external standards. The external standard would include the standards established by the country’s apex financial regulatory institution. The fund manager would not receive a performance fee if the rate of fund return is less than the hurdle rate.

High water marks

This is another factor in addition to hurdle rates that goes in to determining the performance fees of the fund manager.

Brief history of hedge funds

5 Feb

Putting it in a nutshell, hedge funds are designed to handle a wide range of trading and investing activities. It must be mentioned, though, that hedge funds are open solely for certain types of investors. Generally speaking, investors can deposit and withdraw funds regularly, and this is only one of the advantages of these investment funds. In this article I will present you a short history of hedge funds, from the beginning until now.

The first hedge fund was founded back in 1949 by Mr. Alfred Jones. Jones had the idea of creating investment funds in 1948, when he was working as a journalist and he was writing an article about the main trends in investment forecasting. It was then when Alfred Jones reached the conclusion that he could develop a more efficient system for managing money. The term “hedged fund” refers to a specific investment strategy that involved purchasing assets whose price was believed to increase and afterwards selling the assets whose price was about to decrease. By doing so, Jones wanted to minimize the risks associated with the trading industry.

Despite the fact that hedge funds were blossoming, the unique strategy developed by Jones was brought to the public eye in 1966, in an article about the success of Alfred Jones and provided statistics regarding the benefits of hedge funds. After the article was published, more and more investors became interested in hedge funds. Nonetheless, it turned out that this strategy was not suitable for just any investor, and most of them simply stopped doing it. As expected, the number of hedge funds dropped significantly.

Hedge funds started to gain popularity again around the 1990s. Even though the strategy is basically the same, new hedging tools have emerged and made hedging safer. In addition, the concept of hedging has remained the same as well: hedge funds are still very exclusive clubs and, as stated above, they are designed only for certain types of investors that are specified by regulators.

Where can you get hedge funds?

25 Jan

Where can you get hedge funds?

Because hedge funds are not sold to the public or retail investors, the funds and their managers have historically not been subject to the same restrictions that govern other funds and investment fund managers with regard to how the fund may be structured and how strategies and techniques are employed. Regulations passed in the United States and Europe after the 2008 credit crisis are intended to increase government oversight of hedge funds and eliminate certain regulatory gaps.

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