Seminar on Hedge Funds

8/8/2019 Seminar on Hedge Funds

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Speaker: ManishSpeaker: Manish PandeyPandey

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Making an investment to reduce the risk of adverseprice movements in an asset. Normally, hedgingconsists of taking an offsetting position in a relatedsecurity, such as a futures contract.

Insurance policies

Forward contracts

Swaps

Options

Futures contracts

WHAT IS HEDGING


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There is no exact definition to the term hedge fund,

and perhaps remains undefined in securities lawsaround the globe.

The Securities Exchange Board of India (SEBI) madean attempt to define hedge funds in a comprehensive

manner in a 2004 consultation paper .

HEDGE FUNDS


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Are organized as private investment partnerships or offshore investment

corporations;

Use a wide variety of trading strategies involving position-taking in a range

of markets;

Employ as assortment of trading techniques and instruments, often including

short-selling, derivatives and leverage;

Pay performance fees to their managers; and

Have an investor base comprising wealthy individuals and institutions and

relatively high minimum investment limit (set at US $100,000 or higher for most

funds).

DEFINITION


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The term hedge fund dates back to a fund founded by Alfred

Winslow Jones in 1949.

Jones is often credited with founding the first hedge fund.

By 1968, there were some 140 hedge funds in operation.

In an effort to maximize returns, many funds turned away from

Jones' strategy. These tactics led to heavy losses in 1969-70, followedby a number of hedge fund closures during the bear market of 1973-74.

In 2004, the Securities and Exchange Commission adopted changesthat require hedge fund managers and sponsors to registeras investment advisors.

HISTORY OF HEDGE

FUNDS


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Estimates of industry size vary widely due to the

lack of central statistics, the lack of a single definitionof hedge funds and the rapid growth of the industry.

As a general indicator of scale, the industry mayhave managed around $2.5 trillion at its peak in thesummer of 2008.

Recent estimates find that hedge funds have morethan $2 trillion in AUM.

SIZE OF THE HEDGE

FUND MARKET


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GROWTH OF HEDGE

FUNDS


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MUTUAL FUND

Similarities

Both entities issue unitsor securities to investors

Hold pools of securitiesto diversify investment,

Have professional assetmanager and may, attimes, have similarinvestment strategies.

Differences

Mutual funds areregistered with securitiesmarkets regulator and aresubject to the provisionsof the relevantregulations.

Hedge funds are notrequired to be registeredand therefore, are notsubject to similarregulatory provisions.


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VENTURE CAPITAL FUND

Venture capital poolsare similar to hedgefunds as they attract thesame class of investors.

Venture capital funds,invest in the start-up orearly stages of a company.

Unlike hedge fundadvisors, general partnersof venture capital fundsoften play an active role inthe companies in which thefunds invest.

Similarities Differences


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Very high risk strategies

High risk strategies

Moderate risk strategies

Variable risk strategies

Low risk strategies

HEDGE FUNDS BY

STRATEGY TYPES


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Emerging Markets

Invests in equity or debt of emerging (less mature)markets that tend to have higher inflation, volatilegrowth and the potential for significant futuregrowth.

Examples include Brazil, China, India, and Russia.

Short selling is not permitted in many emergingmarkets, and, therefore, effective hedging is often notavailable.

VERY HIGH RISK

STRATEGIES


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Short Selling

In order to short sell, the manager borrows securities

from a prime broker and immediately sells them onthe market.

The manager later repurchases these securities,ideally at a lower price than he sold them for, andreturns them to the broker.

Short selling managers typically target overvaluedstocks, characterized by prices they believe are toohigh.

VERY HIGH RISK

STRATEGIES


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Aggressive Growth

A primarily equity-based strategy whereby themanager invests in companies, with smaller or microcapitalization stocks, characterized by low or nodividends, but experiencing or expected toexperience strong growth in earnings per share.

Managers employing this strategy generally holdlong position in stocks. This includes sector specialistfunds such as technology, banking, or biotechnology.

HIGH RISK STRATEGIES


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Special Situations

The manager invests, both long and short, in stocksand/or bonds which are expected to change in priceover a short period of time due to an unusual event.

Examples of event-driven situations are mergers,hostile takeovers, reorganizations, or leveraged

buyouts.

MODERATE RISK

STRATEGIES


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Value

A primarily equity-based strategy whereby themanager invests in securities perceived to be sellingat deep discounts to their intrinsic or potentialworth.

Long-term holding, patience, and strong discipline

are often required, until the ultimate value isrecognized by the market. The manager can takeshort positions in stocks he believes are overvalued.

MODERATE RISK

STRATEGIES


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Opportunistic

Rather than consistently selecting securitiesaccording to the same strategy, the manager'sinvestment theme changes from strategy to strategyas opportunities arise to profit from events such as

IPOs,

sudden price changes often caused by an interimearnings disappointment,

hostile bids, and other event-driven opportunities.

VARIABLE RISK

STRATEGIES


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Multi Strategy

The manager typically utilizes many specific, pre-determined investment strategies for e.g.

Value

AggressiveGrowth, and

Special Situations

This style of investing allows the manager tooverweight or underweight different strategies tobest capitalize on current investment opportunities

VARIABLE RISK

STRATEGIES


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Distressed Securities

The manager invests in the debt and/or equity ofcompanies having financial difficulty.

Such companies are generally in bankruptcyreorganization or are emerging from bankruptcy orappear likely to declare bankruptcy in the near

future. Because of their distressed situations, themanager can buy such companies' securities atdeeply discounted prices.

LOW RISK STRATEGIES


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Market Neutral - Securities Hedging

The manager invests similar amounts of capital insecurities both long and short, generally in the samesectors of the market, maintaining a portfolio withlow net market exposure.

Due to the portfolio's low net market exposure,

performance is insulated from market volatility.

LOW RISK STRATEGIES


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Market Neutral Arbitrage

The manager seeks to exploit specific inefficiencies inthe market by trading a carefully hedged portfolio ofoffsetting long and short positions.

By pairing individual long positions with relatedshort positions, market-level risk is greatly reduced,

resulting in a portfolio that bears a low correlation tothe market.

LOW RISK STRATEGIES


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Long/shortEquities

44%

Fixed Income2%

Event Driven17%

Distressed Debt5%

CTA/ManagedFutures

7%

Arbitrage3%

RelativeValue

3%

Others

4%

Multi-strategy10%

Macro5%

Strategy Mix

Source: Eurekahedge Report

STRA

TEGY

MIX


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Suppose a hedge fund manager concludes on the basis of his

analyses that company X is undervalued and company Y isovervalued.

The hedge fund then sells shares in company Y, even though itdoes not own them: it goes short in Y.

The hedge fund uses the proceeds of the sale of the shares Y tobuy shares in company X: it goes long in X.

the hedge fund gains in two ways: X is undervalued and will

therefore gradually increase in value. The hedge fund also gains on the holding in Y. This company

was overvalued and has now fallen in value, say from 100 to 80.When the hedge fund sold the shares Y, it received 100. Now ithas to return the shares to the institutional investor and only hasto pay 80 .

EXA

MPLE


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MANAGEMENT FEE

As with other investment funds, the management fee is

calculated as a percentage of the fund's net asset value.Management fees typically range from 1% to 4% perannum

PERFORMANCE FEES

The performance fee is computed as a percentage of the

fund's profits, counting both paper profits and actualrealized trading profits.

Typically, hedge funds charge 20% of gross returns as aperformance fee, but again the range is wide, with highlyregarded managers demanding higher fees.

FEE STRUCTURE


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Performance fees are usually limited by high water

marks and sometimes by hurdle rates.

High water marks This means that the manager does not receive

incentive fees unless the value of the fund exceedsthe highest net asset value it has previouslyachieved.

This measure is intended to link the manager'sinterests more closely to those of investors and toreduce the incentive for managers to seek volatiletrades

FEE STRUCTURE


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For example, if a fund was launched at a net asset

value (NAV) of 100 and rose to 130 in its first year, a

performance fee would be payable on the 30%return. If the next year it dropped to 120, no fee ispayable. If in the third year the NAV rises to 143, aperformance fee will be payable only on the 10%

return from 130 to 143 (which is 10%) rather than onthe full return from 120 to 143.

EXA

MPLE


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Hurdle rates

Funds may also specify a 'hurdle', which signifiesthat the fund will not charge a performance fee untilits annualized performance exceeds a benchmarkrate, such as USD 90-day T-bills or a fixedpercentage.

Though logically appealing, this practice hasdiminished as demand for hedge funds haveoutstripped supply and hurdles are now rare.

FEE ST

RUCT

URE


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Year Performance Fees (%) Management Fees(%)

2000 19.48 1.49

2001 19.75 1.47

2002 19.82 1.54

2003 18.61 1.47

2004 19.75 1.58

2005 19.42 1.73

2006 18.68 1.62

2007 19.08 1.84

2008 18.86 1.68

2009 17.94 1.66

2010 19.22 1.56

ASIAN HEDGE FUND

FEES

Source: Eurekahedge

Report


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While high net worth individuals remain the main

source of capital, hedge funds are becoming more

popular among retail investors. The unprecedented bull run in the equities market

swelled investment portfolios, this lead both fundmanagers and investors to become more keenly

aware of the need for diversification. The decline in the stock markets worldwide

provided fresh impetus for hedge funds as investorssearched for absolute returns.

REASONS FORRAPID GROWTHOF HEDGE FUNDINDUSTRY


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Many hedge fund strategies have the ability to generate

positive returns in both rising and falling equity and bondmarkets.

Inclusion of hedge funds in a balanced portfolio reduces overallportfolio risk and volatility and increases returns. Huge variety of hedge fund investment styles many

uncorrelated with each other provides investors with a widechoice of hedge fund strategies to meet their investmentobjectives.

Academic research proves hedge funds have higher returns andlower overall risk than traditional investment funds.

Hedge funds provide an ideal long-term investmentsolution, eliminating the need to correctly time entry and exitfrom markets.

Adding hedge funds to an investment portfolio providesdiversification not otherwise available in traditional investing.

BENEFITSOF HEDGEFUNDS


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PERFORMANCE OF HEDGE

FUNDSAND EQUITIES


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Investment in hedge funds in India has been gaining momentum

post 2001-2002. Financial experts opine that India has tremendous potential for

attracting global investments in hedge funds.

The hedge funds operating in India are:

Indea Capital Pte Ltd. Naissance Jaipur (India) Fund India Capital Fund. Monsoon Capital Equity Value

Fund India Deep Value Fund Vasishta South Asia Fund Limited Absolute India Fund (AIF) Atyant Capital Fair Value Karma Capital Management, LLC Passport India Fund Atlantis India Opportunities Fund HFGIndia Continuum Fund

HEDGE FUNDSININDIA


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Seminar on Hedge Funds

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