4.HF as Asset Class

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HEDGE FUNDS AS ANASSET CLASS

-Jeet R.Shah

M.Com , CFP CM


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Absolute return investment strategies and funds are commonly known as

hedge funds.

Jeet R.Shah2 www.veerconsultancy.com


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Overall Objectives of Alternative

Investments

Preservation of captial

Wealth accumulation/growth

Management of risk and volatility

Enhanced returns Low correlation/diversification

Access to strategies unavailable to traditional

managers

Jeet R.Shah

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www.veerconsultancy.com


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Traditional versus Hedge Funds

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Hedge Fund Strategy Characteristics

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Hedge Fund Strategy Characteristics

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HEDGE FUNDDISTINCTIONS


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1. Investment Strategies Traditional investment advisors are limited in their

investment options, whereas alternative investment advisorsare opportunistic.

Alternative investment managers can take larger positionsizes, invest across asset classes and security types, andemploy strategies whose returns generally come from the

exploitation of market inefficiencies, not market movements. Alternative investment strategies are also dynamic by

nature.

Fund managers can use leverage and sell securities short tovary market exposure actively.

Alternative investment returns are therefore a product ofhow the manager invests, not just where the managerinvests.

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2.Return Objectives The concept of absolute versus relative returns is

central to the alternative investment sector. Unlike traditional investment managers driven by

index weightings, nontraditional managers invest

for absolute returns, not returns relative to thebroad market.

Most of the returns from alternative investment

strategies come from the skill of the manager ratherthan the returns of an asset class.

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3. Minimum Investment Requirements

For the most part, due to the limited number of clients who

can be invested in a fund, the minimum investments steadilyincrease as the years go by.

A managers initial minimum may be as low as $250,000 or$500,000, but can quickly increase by a multiple. There is

no shortage of tier 1 investment managers who haveminimum requirements in excess of $10 million.

As institutions play an increasing role in the alternativeinvestment arena, fund managers often are induced to take

on as clients institutions rather than private individuals who,in most cases, allocate substantially smaller amounts.

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4. Coinvestment Opportunities Hedge fund managers tend to invest a significant

portion of their own capital in their partnerships,thereby reinforcing their commitment to their funds

performance.

This aspect differs greatly from the world oftraditional investment advisors where, for

regulatory reasons, managers often are

discouraged from purchasing their own proprietaryproduct.

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5. Liquidity Unlike managed accounts or mutual funds,

alternative investment vehicles may typicallyrequire a lock-up of 12 months before withdrawalsare permitted.

Some offshore funds offer liquidity as frequently asweekly, but certain onshore long-term investmentpools may require commitments of up to 4 years.

It is important to make sure that the funds liquidityconstraints are in keeping with industry norms forthe strategy employed.

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6. Access and Transparency The limited partnership format provides the manager

with flexibility to deliver returns that would not bepossible through other formats, but it also obscures aclients ability to monitor investment activities.

Furthermore, many managers are hesitant to allow

clients to second-guess their judgment in short-termincrements.

Without special considerations, it can be exceedinglydifficult to monitor whether a manager is diverging

from the stated strategy, inappropriately usingderivatives or leverage, or engaging in otherunacceptable behavior.

Jeet R.Shah

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Unique Return and Risk-Reduction

Opportunities of Hedge Fund Strategies

Hedge funds are not necessarily riskier than many

traditional stocks and bond investments. Hedge funds can add benefits to establish traditional

asset portfolios through:

1. Enhanced risk-adjusted returns

2. Diversification/low correlation to traditionalinvestments

3. Access to investment strategies cannot get elsewhere

4. Access to some of the top asset managers in the world

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IDENTIFICATION OF MANAGERS Because of restrictions on advertising, identifying potential

hedge funds with which to invest is challenging.

The most common way to select funds is to consult one ormore of several commercially available directories ordatabases.

The challenge then becomes one of narrowing the field to amanageable number that deserve further attention.

At this point, investors can apply set criteria and come upwith a list of items to investigate in greater detail.

However, it is critical to keep in mind that these resourcesare useful only as a starting point because of severallimitations to the kind of data they contain and the qualityof that data.

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IDENTIFICATION OF MANAGERS The principal flaw of databases is that they tend to offer

little more than purely quantitative and historicalinformation.

More specifically, data integrity can be problematic due tothe different sources these databases rely on to get theirinformation. For instance, a comparison of the leading

hedge fund databases will uncover substantial disparities inmanagers historical performances. Last, many managersare reluctant to allow information about their funds to bepublished.

According to SEC officials, publication of such information,even by an unaffiliated firm, may constitute unlawfuladvertisement.

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IDENTIFICATION OF MANAGERS The result is that some of the best firms remain

unlisted and essentially invisible to the generalpublic; thus they can be accessed only (if they areeven open to additional funds) through a directintroduction.

Nevertheless, with these limitations in mind, theprocess of identifying managers essentiallyinvolves developing a set of screening criteria to

apply to a broad universe of funds contained in adirectory or database.

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EVALUATION OF MANAGERS The four main elements of a successful evaluation

process are:1. Collection and analysis of partnership documents

2. Quantitative analysis of returns

3. Background and reference checks

4. On-site interviews

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EVALUATION OF MANAGERS1.Analysis of Disclosures

The limited partnership structure of most hedge fundsprovides investment flexibility, but also poses significantchallenges to the due diligence process.

It is crucial for family office professionals to develop

the unique tools necessary for evaluating funds basedon their investment strategies , personnel, and generalbusiness plans

If the family office chooses not to develop this expertise

in-house, engaging an alternative investmentprofessional should be considered the price of entry tothese investments.

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EVALUATION OF MANAGERS2.Quantitative Analysis

Sophisticated computer programs often are used in the managerevaluation process.

Analysis of the returns provides data that can be used to comparevarious strategies and managers based on risk/return measures aswell as the correlation of returns.

However, quantitative analysis should not be used as a crutch inplace of sound qualitative analysis.

The simplicity of transforming art into science provides investors witha false sense of security. Further, the utility of statistical analysis iscompletely dependent on the extrapolation of trends, and relying

solely on this type of analysis is not prudent. Understanding the strategy and the people employing it is of far

greater value when assessing the investment risk involved.

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EVALUATION OF MANAGERS3.Background Checks

Most managers will provide a list of professional and clientreferences when asked.

Of course, investment managers will provide only the names ofreferences who will speak positively of them.

Reference checks can be helpful, but often it is necessary to go

further. It may be more valuable to tap into a network ofinformation resources that includes other investment managers,consultants, brokers, bankers, auditors, attorneys, and investors.

Another helpful tool can be the selective use of professional privateinvestigators.

Market investigators can search for criminal or civil complaints andfinancial or personal problems that could interfere with the bestinterests of the investors.

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EVALUATION OF MANAGERS4.Interviews

Manager interviews are an essential part of theevaluation process.

By devoting the necessary resources (time and

money) to visit managers onsite, one can identifyproblems and opportunities early and act

decisively.

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ONGOING MONITORING Once some investors decide to hire a manager, they

pay little attention to ongoing due diligence. Simply tracking the managers performance is not

sufficient.

One should not underestimate the importance ofmaintaining regular contact with the managers as wellas their peers, competitors, service providers, brokers,and other investors.

A commitment to information gathering will betterposition an investor to monitor managers exposures,leverage, and diversification.

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INVESTING THROUGH A FUND OF

HEDGE FUNDS

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IDENTIFICATION OF MANAGE Two Primary

Approaches to Investing in Hedge Funds

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Advantages of FOHF investing1. Professional management in the identification,

evaluation, selection and monitoring process, as justoutlined

2. Access to funds with as low capital as USD25,000

3. Diversification among selected strategies andmanagers

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Dhanyawaad

Jeet R.Shah

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Documents

4.HF as Asset Class