Hedge Fund• Hedge fund is an investment fund open to a

limited range of investors that is permitted by regulators to undertake a wider range of investment and trading activities than other investment funds, and that, in general, pays a performance fee to its investment manager.

• Every hedge fund has its own investment strategy that determines the type of investments and the methods of investment it undertakes. Hedge funds, as a class, invest in a broad range of investments including shares, debt and commodities.

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• You have a strong belief that one company is undervalued, especially relative to its peers.

You have no opinion on the direction of the market but are concerned that you can be right and still lose capital if the market falls

Solution:

Buy the undervalued company and sell short an equivalent dollar amount of its overvalued competitor

Pesky Soda Company (NYSE: PES) $40.28

Coconut Cola Company (NYSE: NUT) $ 31.80

To create a portfolio balanced by dollar invested:

Buy 5,000 shares PES

Sell Short 6,300 NUT

Generate positive returns in both rising and falling equity and bond markets Vs.Generate results that are uncorrelated to equity and bond markets

TWO CONTRASTING DEFINITIONSTWO CONTRASTING DEFINITIONS

Accredited InvestorLock-inInfrequent RedemptionUse of Hedging Technique, "Knowledgeable” InvestorsVariety of investmentLeverageLiquidityFees

Beta represents the correlation of a funds returns to the return of the underlying market or index. (e.g. A rising tide raises all boats)

Alpha represents the increment over the underlying market return provided by the fund manager (e.g. the value added)

Generating Beta is relatively easy –Index Funds –and does not produce a premium fee.

Generating Alpha (beating the market) is harder

Strategies that consistently generate alpha have the higher fee structure

Most common hedge fund fee structure has two components:

A hedge fund manager will typically receive both a management fee and a performance fee (also known as an incentive fee) from the fund. A typical manager may charge fees of "2 and 20", which refers to a management fee of 2% of the fund's net asset value each year and a performance fee of 20% of the fund's profit.

A high-water mark (or "loss carryforward provision") is often applied to a performance fee calculation. This means that the manager receives performance fees only on increases in the Net Asset Value (NAV) of the fund in excess of the highest net asset value it has previously achieved.

Track RecordSignificant Investment by ManagerPricing Characteristics of StrategySize of FundConcentration Risk“Too Good to be True”Third Party InvolvementAuditorsAdministrators

Style: global macro, directional, event-driven, relative value (arbitrage), managed futures (CTA)

Market: equity, fixed income, commodity, currencyInstrument: long/short, futures, options, swaps

Exposure: directional, market neutral

Sector: emerging market, technology, healthcare etc.

Method: discretionary/qualitative (where the individual investments are selected by managers), systematic/quantitative (or "quant" - where the investments are selected according to numerical methods using a computerized system)

Diversification: multi-manager, multi-strategy, multi-fund, multi-market

It attempt to anticipate global macroeconomic events, generally using all markets and instruments to generate a return.

Discretionary macro - trading is carried out by investment managers selecting investments, instead of being generated by software.Systematic macro - trading is carried out using mathematical models, executed by software without any human intervention other than the initial programming of the software. Commodity Trading Advisors (CTA, Managed futures, Trading) - the fund trades in futures (or options) in commodity markets.Systematic diversified - the fund trades in diversified markets.Systematic currency - the fund trades in currency markets.Trend following - the fund attempts to profit from following long-term or short-term trends.Non-trend following (Counter trend) - the fund attempts to profit from anticipating reversals in such trends.Multi-strategy - the fund uses a combination of strategies.

Exploit pricing inefficiencies caused by anticipated specific corporate events.Distressed securities (Distressed debt) - specialized in companies trading at discounts to their value because of (potential) bankruptcy.Merger arbitrage (Risk arbitrage) - exploit pricing inefficiencies between merging companies.Special situations - specialized in restructuring companies or companies engaged in a corporate transaction.Multi-strategy - diversification through different styles to reduce risk.Credit arbitrage - specialized in corporate fixed income securities.Regulation D - specialized in private equities.Activist - take large positions in companies and use the ownership to be active in the management

Hedge funds are highly individual and it is hard to estimate the likely returns or risks.

Hedge funds’ low correlation with other assets tends to dissipate during stressful market events, making them much less useful for diversification than they may appear.

Hedge fund returns are reduced considerably by the high fee structures that are typically charged