Hedge Funds Performance
Investment funds (hedge funds) are bundled investments in which portfolio managers pursue certain strategies on behalf of the fund investors. These are investment funds because they are bundled investment instruments in which several investors entrust their money to a manager and in which it is invested as part of a portfolio of publicly traded securities such as stocks, bonds or commodities.
There are two types of hedge fund investments: equity and bond investments. Investment funds primarily invest in stocks and bonds that deliver returns that replicate or try to beat the benchmark index.
Hedge funds can seek absolute returns or employ several more complex strategies, including short selling, leverage and derivatives, and seek returns in the range of 10% to 20%.
Measuring Hedge Funds Performance
To measure performance, the return of an investment fund is compared with the style of a particular index or benchmark. Most investment trusts invest in a wide range of shares, from large caps to small caps and penny stocks. The managers of these funds try to outperform their peers, whether they are investing in small caps, stocks or both. A less active manager could build a portfolio by following an index, then use shares and choose those that have the ability to increase or decrease or outweigh the stocks that are less attractive.
The aim of an investment fund is to beat an index on a modest scale, but the return must be favorable relative to the benchmark. For example, if the index falls by 10% in a year, while investment funds lose only 7%, the performance of the fund can be described as a success.
Investment funds are somewhere in the middle of the passive-active spectrum, where pure index investing is at its most extreme, while investment funds can also be semi-focused, actively seeking returns that are only longer than their peers “average returns. Hedge funds improve the returns of hedge funds, which in turn increases the returns for the hedge fund manager.
Hedge Funds Absolute Returns Performance
Hedge fund activity explains their popularity in bear markets, but their absolute return targets vary. One target could be described as an annualized return of 5% to 10% per year, and another as a percentage of the fund’s total assets. Hedge funds also do better in a bear market than they should if they hold a short position in hedges.
Investors need to understand, however, that hedge funds “promises of absolute returns mean that they are exempt. First, they generally do not register with the SEC and do not report their assets to the Securities and Exchange Commission.
This registration can be circumvented by limiting the number of investors and requiring accreditation, which means that income and asset standards must be respected. Moreover, hedge funds are forbidden to advertise or advertise a wider audience to raise funds, which adds to their mystique.
Liquidity is a key concern for hedge fund investors, and liquidity rules vary. Many funds have an initial phase after which investors can no longer withdraw their money. It is difficult to pull out of a fund at will, but the liquidity rules vary depending on the fund, fund type, asset class and even fund size.
Finally, hedge funds are more expensive because fees are performance-related and are usually calculated and maintained as a percentage of the fund’s total assets, not just as assets under management.
Most hedge funds are entrepreneurial organizations that have their own strategies and well-guarded secrets. However, the managers of many of these funds can say that they eat from their own kitchen and invest some of their own money in other investors “funds.
Arbitrage Hedge Funds Performance
Arbitrage is the exploitation of observable price inefficiencies and is considered risk-free. Arbitrage is the “exploitation” of the observable prices and inefficiency of a particular asset class or commodity.
Three trends in investment practice open up the possibility of arbitrage strategies for all types of applications. For example, electronic communication networks and foreign exchanges allow the use of exchange contracts between different exchange systems. In practice, arbitrage is more complicated, but consider a very simple example: a single six-month forward contract costs $14, and Acme shares are currently trading at $10. If you buy the shares and sell the futures contract at the same time, you can make a profit of 4% without taking any risks. Futures contracts are a way to buy and sell shares at a pre-determined price and to buy or sell them at a pre-determined price.
Moreover, arbitrage is harmful and self-defeating: if a strategy is too successful, it doubles and gradually disappears. While observable price inefficiencies are usually relatively low, pure arbitrage requires an investment that is usually leveraged. Historically, studies often show that few hedge funds are as successful as they used to be, and few are pure arbitrageurs.
These strategies try to capitalize on price differences, but they are not risk-free, and most so-called arbitrage strategies are better known as relative values.
Convertible Bond Hedge Funds Performance
Convertible bonds are issued by companies that can be converted into ordinary shares at a lower price than bonds issued by the same company. The arbitrator of this strategy would think that the bonds are slightly cheaper, so the strategy tries to exploit the relative prices of the convertible bond and the stock. Since convertible bonds and stocks can be traded independently, the arbitrator loses, meaning that the position carries some risk. But the idea is to make money when stocks rise, and to lose when they fall because they are not as cheap as they used to be.
This event-oriented strategy is deployed in a number of different ways, such as mergers and acquisitions, acquisitions of other companies and asset sales. One example is merger arbitrage, which uses the case of a takeover announcement to include the purchase of the target company’s shares or to secure a purchase by short-term sale of shares in a acquiring company. The purchase price paid by the acquiring company to achieve its target will normally exceed the current trading price at the time of the announcement.
A merger arbitrator shall bet that the takeover will take place and that the share price of the target company will be higher than the purchase price paid by the acquiring company. But if the market rejects the deal, it can break through the stock market, pushing the price down by a temporary bump that crushes the target companies “shares and causes a loss of position. This is not only arbitrage, but also an investment strategy for hedge funds and private equity firms.
Another interesting type of event-driven fund is an activist fund that is predatory in nature. Another example is a hedge fund that invests in companies that have been reorganized or unfairly broken up. There are different types of event-driven strategies, but they are all different types of hedge funds.
This type takes up sizeable positions in small, flawed companies, and then uses property to force management changes or clean up the balance sheet.
Although macro funds are designed for larger investors, they analyze individual companies rather than being global. Large groups of hedge funds pursue both directional and tactical strategies. One example is the hedge fund universe, made famous by the likes of Goldman Sachs, Morgan Stanley, and other high-profile firms, which dominated newspaper headlines in the 1990 “s.
For example, long-and-short managers could hedge against the S & P 500 index and bet on a short-term decline in the price of a core stock like Apple, or buy a portfolio of core stocks with the same market capitalization as their short positions. If it fails, the vacancy offsets the losses of the core portfolio and limits the total loss.
This type of strategy is an example of how hedge funds can seek positive absolute returns even during bear markets. Market neutral strategies are certain types of longs and shorts that negate the impact of risk on general market movements and try to isolate the pure returns of individual stocks.
For example, a market-neutral manager could buy Lowe’s (a short-lived Home Depot) and bet that the former will outperform the latter. The stock could fall on the market or the share price could rise or fall with the markets, but short selling by Home Depot could give the position a net gain if Lowe does better than Home Depot and vice versa.
A special short strategy specializes in short selling – the sale of overvalued securities. This strategy is particularly risky because the losses on short selling – only the position is theoretically unlimited, as the stock can rise indefinitely.
Managers of these funds can review a company’s fundamentals and financial statements in search of red flags. Special short funds are often the first to foresee a collapse of companies, especially in the wake of financial crises such as the 2008 financial crisis. Investment funds and ETFs buy into portfolios of hedge funds, often targeting accredited investors with high investments – low-risk and low-return.
Zanthe Alexander Bentley is a finance veteran with over 25 years’ wealth management experience advising both family offices and institutions on their corporate finance requirements including capital raises (debt & equity), restructurings and M&A activities. He has significant experience in investment management and investment banking and spent nine years at UBS focused on convertible bond arbitrage and equity derivatives.
Prior to getting involved in Asset Management he expanded a small Spanish brokerage from a handful of staff in Barcelona to a diversified brokerage company with over 150 personnel spread across 9 countries, transacting deals from High Grade to High Yield Fixed Income and Loans; Structured Products through to exchanged traded equities.
After taking time to focus on family office activities in Asia, Zanthe-Alexander now leads an ambitious zero-leveraged fund providing exceptional growth and income to Sophisticated Investors.
Zanthe Alexander Bentley Twitter: https://twitter.com/BentleyZanthe