Tag Archives: Joe Healey Hedgefund

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.

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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Hedge fund trends in 2012

3 Jan

Hedge fund trends tend to change over time – hence why they’re trends! Hedge funds themselves have a long and storied history of changing over time; think of the massive diversification into the internet with the Dot Com boom, and more recently, the newest regulations with the Dodd-Frank Act reshaping traditional hedge funds as we know them.

Recent hedge fund trends are all over the map (and there is no guarantee that these trends will continue), but here is a small selection:

  • Hedge funds in the early part of 2012 have shown a move toward global markets. The fact that hedge funds have a very large global presence, and that there is virtually no limit to what kind of investments can be made inside of a hedge fund portfolio, means that now is the perfect time to invest in emerging global markets.
  • The uber rich have been careful with their assets lately, seemingly looking to protect themselves against margin calls and looming finance changes. Many hedge funds have taken their assets out of funds in the form of cash. Hedge fund portfolios are still going strong, though, with 2012 seeing the best performance in the beginning of a year since 2006.
  • Managed futures are up, as are global macros!
  • Larger funds are seeing larger inflows. Small funds are still mostly experiencing redemptions, but not the kind of net inflows that larger funds are seeing. The number stands as funds with more than one billion dollars in assets receiving 78% of inflows.
  • Hedge funds that beat their ‘peers’ in 2011 had similar results in 2012 – at least thus far. 57% of those peer-beating funds saw net inflows in the first quarter.
  • The trend did seem to be that those hedge funds which saw positive results in 2011 continued to do so into 2012. The majority of large hedge funds saw net inflows in the first quarter of 2012, where 63% of mid-size funds with positive performance in 2011 saw net inflows into 2012.
  • There was a marked trend of investors who discovered their investments had under-performed shifting out of them and heading for seemingly greener pastures. This is usually the case (no investor typically has the patience to “hang around” an under performing fund), but the numbers were higher in the first quarter of 2012.

One of the biggest changes of 2011, leading into 2012, is the continued implementation of the government’s insider trading charges and other legal actions. Some funds have closed, many managers are under investigation, and some funds are doing poorly in general due to the continued investigation and allegations. While it is true that some funds have had a rough year so far, a good portion of funds are seeing decent to good profits on their invested assets. It remains to be seen if these positive trends will continue through the rest of 2012. It is evident to some that in the wake of the Dodd-Frank Act that regulation may begin to increase on hedge fund investments across the globe.

Regulations for hedge funds in other countries besides the U.S.?

15 Dec

Regulation of hedge funds does differ when taken outside of the boundaries of the United States. However, much of the regulation on hedge funds throughout the world does resemble the regulation in the US. In Europe, for example, the primary method is to regulate the financial advisors/managers of the funds. The managers are required to register with the FSA (the Financial Services Authority). Within the European Union, there have been some differences with regulation between different countries, but the hard and fast rule is that EU fund managers are required to register.

Recently, something called the Directive on Alternative Investment Fund Managers, or AIFMD, was passed by the EU to better monitor the activities of hedge fund managers. Countries within the EU are required to adopt the practices of AIFMD by 2013. It is quite an undertaking for every hedge fund manager within the European Countries to comply with the regulations in AIFMD, but AIFMD has made certain allowances to make the transition easier. For example, they have introduced a sort of passport that enables any hedge funds authorized in a country in the EU to operate throughout the entire EU.

Obviously Europe is not the only place aside from the United States that participates in hedge fund activities. An incredibly popular option for those abroad, and even for a portion of American citizens, is to run the hedge funds through offshore locations. This includes Bermuda, the British Islands, Dublin, the Cayman Islands, and many more locations. Any hedge fund that is run through an offshore location has to comply with the individual regulations there. Offshore hedge funds are quite different from other types of hedge funds; one example of this difference is the fact that the funds are valued as net asset value (NAV), not as account balances as with domestic funds.

In South Africa, registration with and approval from the Financial Services Board (FSB) is required for hedge fund managers. Also in South Africa, much emphasis is placed on local investment rather than international. In Singapore, hedge funds are less regulated and have fewer licensing requirements than other Asian hedge fund “hot spots,” such as Hong Kong. Singapore is a popular hedge fund location for this reason.

Recently, the Dodd-Frank Act was passed in the United States. This act has wide reaching implications and may change the nature of hedge funds throughout the world. Those international hedge funds that have more than twenty-five million dollars with fifteen or more American managers or investors must register with SEC. Managers who are registered with SEC are also required to file and keep information about managed assets up to date with the SEC as well.

This is only the beginning of overseas regulation for hedge funds. However, it illustrates that there is still a focus on regulating investment managers rather than the investments themselves. Hedge funds are popular globally, and there is a good amount of cross over investment from countries with financial hubs. Some seek to take advantage of the opportunities presented by offshore accounts, but new regulation may be changing some of that activity.