Hedge Fund Investment Strategies

download Hedge Fund Investment Strategies

of 40

  • date post

    14-Feb-2016
  • Category

    Documents

  • view

    20
  • download

    1

Embed Size (px)

description

Hedge Fund Investment Strategies. Hedge Fund Investment Strategies. - PowerPoint PPT Presentation

Transcript of Hedge Fund Investment Strategies

  • Hedge Fund Investment Strategies*L3: Hedge Fund Strategies

    L3: Hedge Fund Strategies

  • Hedge Fund Investment StrategiesHedge funds employ dynamic investment strategies designed to find unique opportunities in the market and then actively trade their portfolio investments (both long and short) in an effort to maintain high and diversified absolute returns (often using leverage to enhance returns)By contrast, most mutual funds only take long positions in securities and are less active in trading their portfolio investments (usually without leverage) as they attempt to create returns that track (and ideally outperform) the market There are four broad groups of hedge fund strategies: arbitrage, event-driven, equity-related and macro The first two groups in many cases attempt to achieve returns that are uncorrelated with general market movements, where managers try to find price discrepancies between related securities, using derivatives and active trading based on computer driven models and extensive research The second two groups are impacted by movements in the market, and they require intelligent anticipation of price changes in stocks, bonds, foreign exchange and physical commodities*L3: Hedge Fund Strategies

    L3: Hedge Fund Strategies

  • Four Categories*L3: Hedge Fund Strategies

    L3: Hedge Fund Strategies

  • Strategies are Diversified*L3: Hedge Fund Strategies

    L3: Hedge Fund Strategies

  • Equity-Based StrategiesEquity Long/ShortAlso known as equity hedge strategyIt is different from equity market-neutral strategy, where managers utually hold a number of long equity position and an equal, or close to equal, dollar amount of offsetting short equity position, so that the net exposure is close to zero (dollar neutrality).

    Non-Hedged EquityNo hedge involved, and investment is only long (not short)*L3: Hedge Fund Strategies

    L3: Hedge Fund Strategies

  • Equity Long/ShortA hedge fund manager that focuses on equity long/short investing starts with a fundamental analysis of individual companies, combined with research on risks and opportunities particular to a companys industry, country of incorporation, competitors and the overall macroeconomic environment in which the company operates This strategy attempts to shift the principal risk from market risk to manager risk, which requires skilled stock selection to generate alpha through a concurrent purchase and sale of similar securities in an attempt to exploit relative mispricings, while decreasing market riskManagers consider ways to reduce volatility by either diversifying or hedging positions across industries and regions and hedging undiversifiable market risk However, the overall risk in this strategy is determined by whether a manager is attempting to prioritize returns (by having more concentration and leverage) or low risk (by creating lower volatility through diversification, lower leverage and hedging)*L3: Hedge Fund Strategies

    L3: Hedge Fund Strategies

  • Buy on margin (page 133-138, Jaeger)Broker typically lend 50% of the value of stock to be purchasedVary across securitiesBrokers will not lend funds against risky stocksMargin requirement (margin=equity/assets) could be 5% or less for government securities. In the security business, the down payment is called the haircut.Suppose you have $100,000 in a brokerage account, and you want to buy $200,000 worth of IBM stock. So you borrow $100,000 from the broker, pledging the 2000 shares of stock as collateral. The broker charges an interest of 5% annually.What if IBM price goes up by 5% or down by 20% in a year?*L3: Hedge Fund Strategies

    L3: Hedge Fund Strategies

  • Short sellPage 139-146, Jaegers bookYou open an account with $100,000 and you sell short 1000 shares of Amazon.com at $100 each.What if the price goes down to $50/share or goes up to $120/share?Borrowing a stock is costlyAlso note that short selling creates a new interest-bearing assets Under what condition, short selling is most profitable? Boxing a short position (page 145-146)*L3: Hedge Fund Strategies

    L3: Hedge Fund Strategies

  • Diversification and hedgingBoth are ways to reduce riskDiversification, see chapter 7, JaegerHedging, see chapter 9, from page 146Shorting against the boxBasis risk

    *L3: Hedge Fund Strategies

    L3: Hedge Fund Strategies

  • Equity Long/Short*L3: Hedge Fund Strategies

    L3: Hedge Fund Strategies

  • Equity Long/Short*L3: Hedge Fund Strategies

    L3: Hedge Fund Strategies

  • More on Long-shortBenefits: (1) performance, (2) Interest rebate, (3) liquidity buffer interestCosts: (1) share borrowing costs, (2) margin costs on short position, (3) transaction costsThoughts from Jacobs & Levy (97, The Long and Short on Long-Short)Market-neutral long-short + long index futureMarket-neutral long-short HF is not an asset classL3: Hedge Fund Strategies*

    L3: Hedge Fund Strategies

  • Macro StrategiesGlobal macroMake leverage bets on anticipated price movements in stock and bond markets, interest rates, foreign exchange, and physical commodities.Also known as global asset allocators

    Emerging marketSecurities of companies and sovereign bonds*L3: Hedge Fund Strategies

    L3: Hedge Fund Strategies

  • Global MacroA macro focused hedge fund makes leveraged bets on anticipated price movements in stock and bond markets, interest rates, foreign exchange and physical commoditiesThis strategy also takes positions in financial derivatives such as forwards, options and swaps on assets such as stocks, bonds, commodities, loans, and real estate and on indexes that are focused on interest rates, stock and bond markets, exchange rates, and instruments that relate to inflation A macro-focused fund considers economic forecasts, analysis about global flow of funds, interest rate trends, political changes, relations between governments, individual country political and economic policies and other broad systemic considerations A well-known practitioner of a global macro investment is George Soros, who sold short more than $10 billion of pound sterling in 1992, successfully profiting from the Bank of Englands reluctance to either raise its interest rates to levels comparable to rates in other European countries or to float its currency*L3: Hedge Fund Strategies

    L3: Hedge Fund Strategies

  • Two types of global Asset allocatorsDiscretionary managersRely on some blend of fundamental analysis and technical analysis to form a reasonable investment judgmentGrowth variablesInformation variablesInterest ratesTrade flow and capital flowsEquity valuation variables: P/E, price to cash flow, business value, etcSystemic managersFollow definite rules for putting on and taking off positionsPage 237 (JAEGER)*L3: Hedge Fund Strategies

    L3: Hedge Fund Strategies

  • Emerging MarketsAn emerging market focused hedge fund invests most of its funds in either the securities of companies in developing (emerging) countries or the sovereign debt of these countriesEmerging markets is a term used to describe a countrys social or business activity that is characterized by rapid growth and industrialization Typically investors demand greater returns because of incremental risks

    *L3: Hedge Fund Strategies

    L3: Hedge Fund Strategies

  • Arbitrage StrategiesFixed income-based arbitrageConvertible arbitrageRelative value arbitrage

    *L3: Hedge Fund Strategies

    L3: Hedge Fund Strategies

  • Fixed Income ArbitrageFixed income arbitrage funds attempt to exploit pricing inefficiencies in fixed income markets by combining long/short positions of various fixed income securitiesFor example, historically, because of the limited liquidity of the Italian bond futures market, the currency-hedged returns from this market in the short term were lower than the short-term returns in the very liquid U.S. Treasury bond marketHowever, over a longer period of time, the hedged returns became nearly identical Fixed income arbitrageurs benefitted from the eventual convergence of hedged yields between currency-hedged Italian bond futures and U.S. Treasury bonds by shorting relatively expensive U.S. Treasury bonds and purchasing relatively cheap Italian bond futures*L3: Hedge Fund Strategies

    L3: Hedge Fund Strategies

  • Fixed Income ArbitrageAnother example involves 30-year on-the-run and off-the-run U.S. Treasury bonds Liquidity discrepancies between the most recently issued 30-year Treasury bonds (called on-the-run bonds) and 29.75 year Treasury bonds that were originally issued one quarter earlier (called off-the-run bonds) sometimes causes a slight difference in pricing between the two bonds This can be exploited by buying cheaper off-the-run bonds and shorting the more expensive on-the-run bonds Since the price of the two bonds should converge within three months (both bonds becoming off-the-run bonds), this trading position should create a profit for the arbitrageur

    *L3: Hedge Fund Strategies

    L3: Hedge Fund Strategies

  • Convertible ArbitrageA convertible bond can be thought of as a fixed-income security that has an embedded equity call option The convertible investor has the right, but not the obligation to convert (exchange) the bond into a predetermined number of common shares The investor will presumably convert sometime at or before the maturity of the bond if the value of the common shares exceeds the cash redemption value of the bond The convertible therefore has both debt and equity characteristics and, as a result, provides an asymmetrical risk and return profile Until the investor converts the bond into common shares of the issuer, the issuer is obligated to pay a fixed coupon to the investor and repay the bond at maturity if c