Hedge Funds and Absolute Return

Hedge funds pursue strategies that guarantee a large absolute return and deserve a close investigation of the actual performance and risk of those strategies. Before starting dfferent question will raise such as;

a)      What are Hedge Funds?

b)      What are objectives?

                                      c)      How do they legally work?

                                      d)      How many are classified?

Hedge Funds:

 

Objective:

It offers play against the markets, using short selling, futures and other derivative products. However, funds are highly levaeraged; others are not. Some keep in hedging activities; others do not. Several focus on making macroeconomic gamble on commodities, curriencies, interest rates, and so on. Future funds belong to the world of hedge funds.

Legal requirement:

It has a limited partnership, limited liability Corporation (in the US). These structue allow the fund manager to take short (sell) and long (buy) positions in any asset, to use all kind of derivatives, and to levarage the fundwithout boundaries.

Initially, Hedge funds based in United States, most of them had organized limited partnership under sec 3(c)(7) of the investment Company Act of 1940, thus   getting excempotion from registration with the U.S. SEC regulations. While hedge funds remain under light regulatin throughout the world, some countries are pushing for tightr regulation; Germany has been the most verbal promoter.

Fee Structure:

The manager is remunerated through a base manegement fee based on the value of assets under management plus incentive fee. Base fee depend upon the performance of the fund.

 

Example:   Hedge Fund Fee

 

Base mangement fee: 1%, Incentive fee: 20%

Gross return: 40%       ; Risk-free rate: 5%

 

Solution:

 

Fee:1%+20% x (40%-5%)

Net return:40%-8%=32%

 

Classification:

Hedge funds have become quite worldwide, as evidenvced by the collection of global investments. These clasifcation are somewhat aribirary, and differ broadly across sources.

1.      Long/ short funds:

These are traditional hedge fund which taking short and long bets in common stocks. They have diverged short and long exposure throughout the world and oftenly maintain net positive or negative market exposures.

2.      Market neutral funds

They are form of long/short funds that attempt to be hedged against a general market movement. They take bets on valuation differences of individual securitires within some market segment. A market-neutral long-short portfolio is constructed so that the total value of the position held long equals the total value of the positions old short (dollar neutrality) and so that the total sensitivity of the short positions (beta neutrality). The long position would be in stocks considered undervalued, and the short position would be in stocks overvalued.

There has been a different types of arbitrage make use of complex securities with option like clauses, such as convertibles mortgage obligations. Among the vqarious technique used by various tecniques used by the market neutral funds are the following:

•          Equity long/ short
•          Fixed income arbitrage
•          Pairs trading
•          Warrant arbitrage
•          Mortgage arbitarage
•          Convertible bond arbitrage
•          Closed fund arbitarge
•          Staistical arbitarage

The above label “arbitrage,” “neutral”, these funds are not riskless because hedges can never be perfect. Loss can be incurred if the model is used imperfect, and it can be high because hedge funds tend to be highly leveraged.