Hedge Fund Industry

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  • 1.The Recent View of Hedge Fund Industry Hedge Fund Introduction According to Wikipedia, hedge funds are open-ended funds for speculating capital appreciation as limited partnershipsor corporationsby wide range of strategies. Hedge funds has only 1/3 volatility of S&P 500 between 1993- 2010. They have lower leverage 1.5- 2.5 compared with leverage 14.2 of investment banks. Hedge funds put fund managers money and investors money together and act on the same interest when making investments. They are private and have low transparency and not regulated by SEC. Even though some of them have extremely high return, they cannot marketing them self publicly. Instead, they have to raise capital privately. Hedge fund managers are a small group of individuals with special talent and have significant influence to the markets. They keep making high risk and return investments by learning mistakes under the pressure of investors expectation every year. They enjoy looking for information that are neglected by general public and utilize their resources efficiently for beating the markets. They invested in equity, fixed income, commodity, or currency market by a wide range of financial instruments, such as stocks, bonds, futures, forwards, options, swaps, and so on. Sectors and screening approach, and the degree of diversification also play significant roles in investment process. Reference on hedge fund history is in Appendixs Time Line.Cannell Capital& US Hedge Funds Cannell Capital is a multi- strategy hedge fund in San Francisco, and it offers both onshore funds to US investors and offshore funds to foreign investors or tax-exempt investors. In my opinion, it belongs to long/short fund because its core approach is to utilizing market neglect for earning profits in both long and short positions. Due to compliance consideration, material data about Cannell Capital are not available to public. According to Citis report, by March 2013, long/short hedge fund account for 17.8% asset under management and 32.3% of total number of hedge funds, and 6% year-to-date with leverage ratio only 1.8. This indicates that long/short hedge funds are the majority players in the industry, and long/short strategy has the highest return during Spring 2013. Between October 2012 and March 2013, the sharpe ratio of long/short strategy was only 0.15x, compared with 0.33x of CTA strategy and 0.35x of even driven strategy. Fixed income arbitrage strategy, convertible arbitrage, and distressed strategy have the highest level of return with the lowest risk between March 2012 and March 2013. Due to the characteristic of multi-strategy and time difference, all the above data cannot apply to evaluateCannell Capital. Hedge funds are actively managed, so they cannot be tracked accurately. Especially for multistrategy hedge funds, they have multi-characteristics for difference strategy at different degree.According to Wikipedia, in 2013, about 62% of hedge fund located in North America. $1.7 Trillion is managed by US hedge funds. According to Preqin Investors Survey about the time between 2010 and 2012, the hedge fund performance exceeds

2. investors expectation had decreased by 16%; the hedge fund performance meet expectation increased by 4%; and the hedge fund performance failed to meet expectation increased by 13%. Long/short equity and CTA strategies consisted of 56% of the hedge funds that fail to meet institutional investors expectation by December 2012. This indicates more hedge funds are no longer doing well because of talent dilution, or too many bad hedge funds enter the markets. However, there are still about 2/3 of the hedge funds meet investors satisfaction. I dont agree with talent dilution explanation. If a good hedge fund manager has enough special talent, hes funds will keep outperforming the markets. If a good hedge fund team went through a dangerous situation, they will learn from this experience and keep moving forward. Hedge fund professionals are all human, and human make mistakes. They are not perfect, so they may have bad performance when market is dropping significantly. However, if the market recover later, they will earn much higher return than average market. Their works are paid off; and their talent can fill the hole in history. Bloomerg Business Weeks shows that the HFRX Hedge Fund Index rose slightly after 2008 financial crisis; the net flows into hedge fund and funds of hedge funds recovery at a certain degree after the crisis. However, the net flows in 2012 dropped significantly. These are the proof about how bad hedge funds and the fair of the crisis pull down average performance. There is an argument about if the Alpha of hedge fund is diluted by increasing number of hedge funds and the fees are too high for investors. Now lets assume:$5 Million principle is invested by an investor with 2.0% management fee, 5.0% hurdle rate, and 20.0% incentive fee. According to BlackRock, between 1997 and 2011, the spread of hedge fund performance is between -18.1% and 24.3%. By doing research, we pick a good manager with 24.3% annual return: Beginning AUM ($)5,000,000Ending AUM ($)6,215,000Return % Profit ($) Management Fee % Management Fee ($) Profit after Management Fee($) Hurdel Rate %24.3% 1,215,000 2.0% 124,300 1,090,700 5.0%Profit for Hurdle Rate250,000Profit after Hurdle Rate ($)840,700Incentive Fee % Incentive Fee ($) Investor's Return % Investor's Profit ($)20.0% 168,140 18.5% 922,560 3. As can be seen from the above calculation, investor still have 18.5% return after paying all the fees. But in reality, some hedge fund may not apply hurdle rate for inventive fee calculation; the fees may changes according to negociation; and some hedge fund performs much better than a 24.3% return in a particular year or even only a quarter. Each individual case has its own calculation for their situation. There is no right or wrong answer for this argument.Hedge Funds in China According to Lehman, Lee & Xu Law Office, hedge fund is not recognized officially for almost a decade in Mainland of China by November 2012 under the Securities Law of Peoples Republic of China. Sunshine Fund, a closed- end fund, is a representation of Chinese regulated hedge funds with absolute return strategy and short selling limitation. It has higher return and fewer restrictions on asset allocation compared to mutual funds; and it has more transparency compared to private offered funds. According to Bloomberg, Zhao Danyang established this fund in February 2004. The funds AUM had reached $22 Billion by the time of 2nd Feb, 2012; and it is only 3% of the total AUM of trust funds in China. Sunshine Fund charges similar fees as hedge fund to high-net-worth clients in China. These millionaires own $2.7 Trillion wealth of Chinese capital, which is 1.27 times of 2012 global hedge fund AUM. They are willing to pay higher fees for Sunshine Funds for avoiding poor performance of stock markets. Generally speaking, rich Chinese have no much knowledge about hedge funds; and they always like to invest in real assets. Clifford Change Publications & News claims that privately offered Chinese National Peoples Congress released funds provisions in July 2012, and this indicates the potential development opportunity of Chinese hedge fund. In 1st June, 2013, hedge funds in mainland China is recognized under the adjustment of Securities Investment Funds Law according to Risk.net. Even though this is huge change of fund industry, the short selling strategy still need time to be approved by regulators. Average knowledge of Chinese investors have not enough knowledge about hedge fund; and it takes time for mainland hedge fund development. For hedge fund industry in Shanghai of China, qualified Chinese investors may allowed to invest in international hedge funds due to the effort of Shanghai Municipal Government Office according to COOConnect News. China Offshore News states that Hong Kong is to going to perform tax reform as a special administration region of China. This will create more benefits for private offshore equity funds on tax exemption aspect. About 80% hedge funds are not domiciled in Hong Kong currently. According to Hong Kong Securities and Futures Commission, between 2010 and 2012, SFC-Licensed hedge fund managers increased by 26%; and AUM expended by 38%. 33% of them apply traditional long/short strategy; while 31% of them apply multi-strategy. 65% of AUM is invested in Asia Pacific markets.Summary Generally speaking, hedge fund industry is vary depends on difference market movements. The key point is how risk-loving you are or how risk-averse you are. Fee structure and fund manager picking are the core considerations for investors. We cant predict future and no one can beat the market forever. What we can do is to follow our strategies and make the most 4. reasonable decisions. Good hedge funds are special market participants in the market for small group of wealthy and extremely intelligent people. If you can find them at the right time, they will definitely offer you exciting returns. Is has been existed for about 90 years original from US, and it will expand into China and other emerging markets at a larger degree in future. China mainland, Shanghai, and Hong Kongs hedge fund development has a long way to go due to regulations, market conditions, and customer preference. The problem is not about investors wealth and hedge funds ability, it is about how to balance all market participants for mutual benefits under a reasonable agreement.AppendixHedge Fund History Time Line: 1920s: 1st hedge fund, Graham-Newman Partnership, by Benjamin Graham and Jerry Newman 1949: Hedge Fund named by financial journalist Alfred W. Jones 1968: Hedge funds numbers reached 200 1969- 1970: 1st fund of funds; many long/short funds closed because of recession 1973- 1974: Many long/short funds closed because of stock market crash 1990s: More hedge funds are c