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Trimester 4 > AI Articles Hedge Funds > Flashcards

AI Articles Hedge Funds Flashcards

1
Q

How are hedge funds organized?

A
  • they are usually limited partnerships (fund has to pay no taxes on investment returns, only the investor)
  • investors are limited partners
  • managers are general partners

–> similar to PE

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2
Q

commodity trading pools

A
  • regarded as part of the same investment universe as hedge funds
  • similar structure to hedge funds but are operated by commodity trading advisors (CTAs) –> they trade futures contracts traditionally, now the lines blurr
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3
Q

How are the returns of hedge funds different from mutual funds?

A
  • more than half of mutual funds have R^2 above 75%
  • half of hedge funds have R^2 below 25%
  • -> R^2 measured on the returns of 8 standard asset markets
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4
Q

R^2

A

R-squared is generally interpreted as the percentage of a fund or security’s movements that can be explained by movements in a benchmark index.

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5
Q

What are hedge funds and mutual funds exposed to?

A
  • mutual funds are strongly positively exposed to US stocks and bonds.
  • hedge funds have exposures in all asset markets and about 25% are negative exposures through short positions.
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6
Q

How do hedge funds leverage their bets?

A

By margining their position and short sales

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7
Q

What does margining a position mean?

A
  • it is position financing
  • -> if you take a position greater than the amount of cash in your account, interactive brokers may finance part of your position opening up to a certain limit (margin)
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8
Q

Which type of fee do mutual funds get and which do hedge fund managers get

A
  • mutual funds get symmetric payment. Gains lead to a gain for the manager and a loss of the fund leads to a loss for the manager.
  • hedge funds managers receive asymmetric fees. They receive positive incentives for gains but are not required to rebate (rückerstatten) fees to investors for losses.
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9
Q

What is the advantage of a Private Limited Partnership?

A
  • there is no double taxation
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10
Q

Why are there offshore funds?

A
  • to min. investors’ tax burden
  • min. managers tax burden on incentive fees. Deferred tax payment
  • for “non-US persons” and register in tax free jurisdictions
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11
Q

Two approaches to setting investment targets

A
  • relative returns

- absolute returns

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12
Q

Which returns are hedge funds styles usually based on?

A

On absolute return strategies. they are expected to deliver performance irrespective of market conditions

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13
Q

Two main approaches to achieve absolute return targets

A
  • Market Timing Approach (MT)
    long or short attempting to capture the rise and fall of the market
  • can have seemingly uncorrelated returns to the market over time but significant correlation over a short period of time
  • Non-Directional (ND) (low volatility)
    extraction of value from a set of diversified arbitrage opportunities
  • can approach zero correlation to market indices
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14
Q

What part of a traditionally-managed portfolio are hedge funds?

A

the purely active part

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15
Q

How are the active weights calculated?

A

h = w-b

h= active weight
w= portfolio weights
b = benchmark weights
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16
Q

Why is the theoretical h not achievable?

A

in practice short positions require margin cash. The h has a zero investment and thus no margin cash available.

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17
Q

Why might is be more attractive to hold a passive index plus a hedge fund?

A
  • due to specialization

- the hedge fund is pure information based trading with no capital investment.

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18
Q

Why is the incentive fee crucial for the success of a hedge fund?

A
  • a pay-for-profits compensation causes the manager’s aim to be absolute returns, not merely beating a benchmark
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19
Q

What is a pitfall of the asymmetric incentive fee structure?

A

there is no corresponding penalty for negative returns

- there is the possibility that managers will be tempted to take excessive risk, in pursuit of asymmetric incentive fees

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20
Q

high water mark

A

an absolute minimum level of performance over the life of an investment that must be reached before incentive fees are paid
–> ensures that a fund manager does not receive incentive fees for gains that merely recover losses in previous time periods

21
Q

hurdle rate

A

another minimum level of performance(typically the return of a risk-free investment) that must be achieved before profits are determined. Only for a single period.

22
Q

equalization

A

to treat both earlier and new investors into a hedge fund fairly, the adjustment for profit calculations is an accounting process called equalization

23
Q

classic long short position

A

choose two closely related securities, short the perceived overvalued one and long the undervalued one. This eliminates systematic risk in theory. But it is rarely completely market-neutral. Their typically is either a long bias or a short bias.

24
Q

Relative value strategy

A
  • is a market-neutral strategy

- takes advantage of perceived mispricing between related financial instruments.

25
Q

Event Driven strategy

A
  • exploit perceived mispricing of security’s by anticipating events such as corporate mergers or bankruptcies, and their effects.
  • merger arbitrage is the investment in both companies (the acquirer and the takeover candidate) after a merger has been announced. Long the takeover candidate and short the acquirer.
26
Q

Tactical Trading

A
  • large variety of directional strategies

- -> e.g. global macro funds

27
Q

Does the risk in hedge funds come from the benchmark?

A

No

  • a hedge fund hedges away risk not related to its speculative strategy. The riskiness of a hedge fund depends upon its strategy.
  • in contrast to mutual funds where most of the risk comes form the benchmark, and a minority from the active portfolio strategy.
28
Q

What are the sources of risk in a hedge fund?

A
  • equity trading strategies may increase correlation with changes in particular industry sector or global regions
  • liquidity risk can occur of hedge funds specializing in emerging markets or distressed assets.
    credit risk:
  • default risk of leverage (repayment of interest)
  • default risk of debt securities for hedge funds that specialize in distressed securities
29
Q

Measuring hedge fund risk

A
  • variance based approach
  • value-at-risk approach (VAR)
  • -> often both are used
30
Q

variance of a portfolio return method

A
  • is the expected SD of the return from its mean
  • -> becomes less useful if returns differ sharply form a normal distribution. Portfolios that contain derivative securities are notable for their lack of normality
31
Q

VAR (value-at-risk) approach

A
  • is good to monitor hedge fund risk and guard against extreme events
  • defined as the maximum loss to be sustained within a given time period for a given level of probability
32
Q

Are hedge fund indices good for comparison

A

No

  • there are separate indices for different hedge fund strategies
  • the indices from different providers are not always comparable with one another
33
Q

self-selection bias/ backfill bias/ incubation/ instant history bias

A
  • choosing to report to a database by a hedge fund might be related to the fund’s performance
  • history of good performance may be backfilled into the database
34
Q

survivorship bias

A
  • when a database is created, it cannot reflect funds that are already defunct
  • funds that die or otherwise stop reporting are usually removed form an index and its associated database
  • some databases providers practice additional selection bias and will not include small or young hedge funds.

-> leads to an upward performance bias on an index

35
Q

performance shortfall with hedge funds

A
  • hedge funds that are included in aggregate performance data but that are closed to new investors
  • if closed hedge funds outperform other hedge funds, then the average measured returns will be higher than the average return available to new investors.
36
Q

Why might a hedge fund close?

A
  • larger-size funds incurs higher market impact costs in implementing trades, and this detracts from net returns
  • a large size makes it difficult for managers to find enough investment opportunities to generate superior returns
37
Q

Is there alpha in mutual funds

A

no, it is added value from hedge funds only

38
Q

Do large funds outperform small funds on average?

A

Yes

  • large funds have more access to leverage or are willing to take extra risk
  • managers of large funds may have greater skill than the average fund manager
  • managers of large funds have more resources and may be able to focus more on managing the funds instead of managing the business.
39
Q

Are value weighted indices more likely to be representative?

A

Yes, large funds are more likely to survive, also less backfilled data because they have been around for longer

40
Q

traditional long beta?

A

stocks, bonds and cash

41
Q

nontraditional beta?

A
  • trend-following exposure (momentum) and derivative based factors.

–> added value of hedge funds

42
Q

Do hedge funds really produce value?

A

Yes, they produce alpha. Adds value in bull and bear market.
In the future we don’t know how HF will perform because now money chases deals.

43
Q

institutionalization of the HF industry

A
  • institutional investors began increasing their allocation to hedge funds, responding to the bad performance in equity markets around 2000.
  • -> increased transparency..
44
Q

Why are HF increasingly multi strategy?

A

When HF grow they diversity to dampen the impact of economic cycles on their performance.

45
Q

selection bias

A

when the HFs in a database are not representative of the universe of HFs.

46
Q

liquidation bais

A
  • fact that hedge fund managers stop reporting returns to a database before the final liquidation value of a fund
47
Q

Do HF create systemic risk?

A
  • they can become the transmission mechanism of systemic risk
  • -> large losses from one or more HF can cause financial distress to banks and brokers
48
Q

How to reduce the hedge fund manager to make crazy risk investments?

A

minimize the call option feature embedded in the inventive contracts

Trimester 4 (27 decks)

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