Industry Analysis

Estimated to be a $1 trillion industry and growing at about 20% per year with approximately 8350 active hedge funds.
Includes a variety of investment strategies, some of which use leverage and derivatives while others are more conservative and employ little or no leverage. Many hedge fund strategies seek to reduce market risk specifically by shorting equities or through the use of derivatives.
Most hedge funds are highly specialized, relying on the specific expertise of the manager or management team.
Performance of many hedge fund strategies, particularly relative value strategies, is not dependent on the direction of the bond or equity markets -- unlike conventional equity or mutual funds (unit trusts), which are generally 100% exposed to market risk


Many hedge fund strategies, particularly arbitrage strategies, are limited as to how much capital they can successfully employ before returns diminish. As a result, many successful hedge fund managers limit the amount of capital they will accept.
Hedge fund managers are generally highly professional, disciplined and diligent.
Their returns over a sustained period of time have outperformed standard equity and bond indexes with less volatility and less risk of loss than equities.
Beyond the averages, there are some truly outstanding performers.
Investing in hedge funds tends to be favored by more sophisticated investors, including many Swiss and other private banks, that have lived through, and understand the consequences of, major stock market corrections.
An increasing number of endowments and pension funds allocate assets to hedge funds.

What is a hedge fund?

It’s 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.


There is no clear statutory or legal definition of a hedge fund in any of the relevant legislation.

–Pooled investment vehicle that are privately organised , administrated by professional investment managers, and not widely available to the public.

–Funds that utilise some form of short asset exposures or short selling to reduce risk or volatility, preserve capital or enhance retuns.


•Institutional and sophisticated investors are realising that hedge funds can and should form a key component of any investment portfolio if they are to achieve optimal returns.

•Its been referred to as a guard against the risk of loss and a “fund” as a reserve of money set aside for a certain purpose.

When Risk becomes more than return!

The primary aim of most hedge funds is to reduce volatility and risk while attempting to preserve capital and deliver positive returns under all market conditions.


Investors use hedging techniques to reduce their exposure to various risks. In financial markets hedging becomes more complicated than simply paying an insurance company a fee every year. Hedging against investment risk mean strategically using instruments in the market to offset of any adverse price movements. In other words, INVESTORS HEDGE ONE INVESTMENT BY MAKING ANOTHER.

Technically, to hedge you invest in two securities with negative correlations. Of course nothing is free, so you still have to pay for this type of insurance in one form or another.

Hedge Fund Performance

Performance depends on the nature of investment strategies employed, the risk/return profile and the effective execution of these strategies.

The primary aim of most hedge funds is to reduce volatility and risk while attempting to preserve capital and deliver positive returns under all market conditions.

Misconception:

The popular misconception is that all hedge funds are volatile -- that they all use global macro strategies and place large directional bets on stocks, currencies, bonds, commodities, and gold, while using lots of leverage. In reality, less than 5% of hedge funds are global macro funds. Most hedge funds use derivatives only for hedging or don't use derivatives at all, and many use no leverage.

Hedge Fund Strategy

A wide range of hedging strategies are available to hedge funds. For example:

•selling short - selling shares without owning them, hoping to buy them back at a future date at a lower price in the expectation that their price will drop.
•using arbitrage - seeking to exploit pricing inefficiencies between related securities - for example, can be long convertible bonds and short the underlying issuers equity.
•trading options or derivatives - contracts whose values are based on the performance of any underlying financial asset, index or other investment.
•investing in anticipation of a specific event - merger transaction, hostile takeover, spin-off, exiting of bankruptcy proceedings, etc.
•investing in deeply discounted securities - of companies about to enter or exit financial distress or bankruptcy, often below liquidation value.
•Many of the strategies used by hedge funds benefit from being non-correlated to the direction of equity markets

•There is about 14 distinct investment strategies:

–Aggressive Growth
–Distressed Securities
–Emerging Markets
–Income
–Macro
–Market Neutral-Arbitrage
–Market Neutral-Securities Hedging
–Market Timing
–Opportunistic
–Multi Strategy
–Short Selling
–Special Situation
–Value
–Fund-of-Fund

We shall discuss each strategy separately.

Why will you hedge?

–Say you own shares of TCS Corporation. Although you believe in this company for the long run, you are a little worried about some short-term loss in the TCS.To protect yourself from a fall in TCS, you can buy a put option (a derivative) on the company, which gives you the right to sell stocks at a specific price (strike price). This strategy is known as a married put. If your stock price tumbles below the strike price, these losses will be offset by gains in the put option.

News and Updates

With the industry still in its infancy and hedge funds under no formal obligation to disclose their results, gaining insight in the performance characteristics of the hedge funds is not straightforward. Here follows a couple of web sites that gives this information:

–www.hfr.com
–www.marhedge.com
–www.hedgeindex.com
–www.hennesseegroup.com
–www.vanhedge.com
–www.althedge.com
–www.hedgefund.net