SEMINAR ON HEDGE

FUNDS

Speaker: Manish Pandey

39154
 WHAT IS HEDGING

Making an investment to reduce the risk of adverse
price movements in an asset. Normally, hedging
consists of taking an offsetting position in a related
security, such as a futures contract.
• Insurance policies
• Forward contracts
• Swaps
• Options
• Futures contracts
 HEDGE FUNDS

 There is no exact definition to the term hedge fund,
and perhaps remains undefined in securities laws
around the globe.

 The Securities Exchange Board of India (SEBI) made

an attempt to define hedge funds in a comprehensive
manner in a 2004 consultation paper .
 DEFINITION


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).
 HISTORY OF HEDGE
FUNDS

 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, followed by a
number of hedge fund closures during the bear market of 1973-74.

  In 2004, the Securities and Exchange Commission adopted changes

that require hedge fund managers and sponsors to register
as investment advisors.
 SIZE OF THE HEDGE
FUND MARKET

 Estimates of industry size vary widely due to the
lack of central statistics, the lack of a single definition
of hedge funds and the rapid growth of the industry.
 As a general indicator of scale, the industry may
have managed around $2.5 trillion at its peak in the
summer of 2008.
 Recent estimates find that hedge funds have more
than $2 trillion in AUM.
GROWTH OF HEDGE
FUNDS

 
HEDGE FUND AND
OTHER POOLED
INVESTMENT VEHICLES
 MUTUAL FUND

Similarities
 Differences

 Both entities issue units  Mutual funds are registered

or securities to investors with securities markets
regulator and are subject to
 Hold pools of securities the provisions of the relevant
to diversify investment, regulations.
 Have professional asset  Hedge funds are not required
to be registered and
manager and may, at
therefore, are not subject to
times, have similar similar regulatory provisions.
investment strategies.
VENTURE CAPITAL FUND
Similarities
 Differences

 Venture capital pools  Venture capital funds,

are similar to hedge invest in the start-up or
funds as they attract the early stages of a company.
same class of investors.  Unlike hedge fund advisors,
general partners of venture
capital funds often play an
active role in the companies
in which the funds invest.
 HEDGE FUNDS BY
STRATEGY TYPES

 Very high risk strategies
 High risk strategies
 Moderate risk strategies
 Variable risk strategies
 Low risk strategies
 VERY HIGH RISK STRATEGIES


 Emerging Markets
 Invests in equity or debt of emerging (less mature)
markets that tend to have higher inflation, volatile
growth and the potential for significant future
growth.
 Examples include Brazil, China, India, and Russia.
 Short selling is not permitted in many emerging
markets, and, therefore, effective hedging is often not
available.
 VERY HIGH RISK
STRATEGIES

 Short Selling
 In order to short sell, the manager borrows securities
from a prime broker and immediately sells them on
the market.
 The manager later repurchases these securities, ideally
at a lower price than he sold them for, and returns
them to the broker.
 Short selling managers typically target overvalued
stocks, characterized by prices they believe are too
high.
 HIGH RISK STRATEGIES

 Aggressive Growth
 A primarily equity-based strategy whereby the
manager invests in companies, with smaller or micro
capitalization stocks, characterized by low or no
dividends, but experiencing or expected to
experience strong growth in earnings per share.
 Managers employing this strategy generally hold
long position in stocks. This includes sector specialist
funds such as technology, banking, or biotechnology.
 HIGH RISK STRATEGIES

 Market Timing
 The manager attempts to predict the short-term
movements of various market segments and based
on those predictions, moves capital from one asset
class to another in order to capture market gains and
avoid market losses.
 Unpredictability of market movements and the
difficulty of timing entry and exit from markets add
to the volatility of this strategy.
 MODERATE RISK
STRATEGIES

 Special Situations
 The manager invests, both long and short, in stocks
and/or bonds which are expected to change in price
over 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

 Value
 A primarily equity-based strategy whereby the
manager invests in securities perceived to be selling
at deep discounts to their intrinsic or potential worth.
 Long-term holding, patience, and strong discipline
are often required, until the ultimate value is
recognized by the market. The manager can take
short positions in stocks he believes are overvalued.
 VARIABLE RISK
STRATEGIES

 Opportunistic
 Rather than consistently selecting securities
according to the same strategy, the manager's
investment theme changes from strategy to strategy
as opportunities arise to profit from events such as
 IPOs,
 sudden price changes often caused by an interim
earnings disappointment,
 hostile bids, and other event-driven opportunities.
 VARIABLE RISK
STRATEGIES

 Multi Strategy
 The manager typically utilizes many specific, pre-
determined investment strategies for e.g.
 Value
 Aggressive Growth, and
 Special Situations
 This style of investing allows the manager to
overweight or underweight different strategies to
best capitalize on current investment opportunities
 LOW RISK STRATEGIES

 Distressed Securities
 The manager invests in the debt and/or equity of
companies having financial difficulty.
 Such companies are generally in bankruptcy
reorganization or are emerging from bankruptcy or
appear likely to declare bankruptcy in the near
future. Because of their distressed situations, the
manager can buy such companies' securities at
deeply discounted prices.
 LOW RISK STRATEGIES

 Market Neutral - Securities Hedging
 The manager invests similar amounts of capital in
securities both long and short, generally in the same
sectors of the market, maintaining a portfolio with
low net market exposure.
 Due to the portfolio's low net market exposure,
performance is insulated from market volatility.
 LOW RISK STRATEGIES

 Market Neutral – Arbitrage
 The manager seeks to exploit specific inefficiencies in
the market by trading a carefully hedged portfolio of
offsetting long and short positions.
 By pairing individual long positions with related
short positions, market-level risk is greatly reduced,
resulting in a portfolio that bears a low correlation to
the market.
 STRATEGY MIX
 Strategy Mix
Macro
Others Multi-strategy
5%
4% 10%
Relative Value Long/short Equities
3% 44%
Arbitrage
3%
CTA/Managed Futures
7%
Distressed Debt Source: Eureka
hedge Report
5%
Event Driven Fixed Income
17% 2%
 EXAMPLE

 Suppose a hedge fund manager concludes on the basis of his analyses
that company X is undervalued and company Y is overvalued.
 The hedge fund then sells shares in company Y, even though it does
not own them: it goes short in Y.
 The hedge fund uses the proceeds of the sale of the shares Y to buy
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 it has to return the
shares to the institutional investor and only has to pay 80 .
 FEE STRUCTURE

 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% per annum
 PERFORMANCE FEES
 The performance fee is computed as a percentage of the
fund's profits, counting both paper profits and actual
realized trading profits.
 Typically, hedge funds charge 20% of gross returns as a
performance fee, but again the range is wide, with highly
regarded managers demanding higher fees.
 FEE STRUCTURE

 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 exceeds the
highest net asset value it has previously achieved.
 This measure is intended to link the manager's
interests more closely to those of investors and to
reduce the incentive for managers to seek volatile
trades
 EXAMPLE

 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 is
payable. If in the third year the NAV rises to 143, a
performance fee will be payable only on the 10%
return from 130 to 143 (which is 10%) rather than on
the full return from 120 to 143.
 FEE STRUCTURE

Hurdle rates
 Funds may also specify a 'hurdle', which signifies
that the fund will not charge a performance fee until
its annualized performance exceeds a benchmark
rate, such as USD 90-day T-bills or a fixed
percentage.
 Though logically appealing, this practice has
diminished as demand for hedge funds have
outstripped supply and hurdles are now rare.
 ASIAN HEDGE FUND
FEES

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 Source: Eurekahedge
2010 19.22 1.56 Report
REASONS FOR RAPID GROWTH
OF HEDGE FUND INDUSTRY


 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 fund
managers 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 investors
searched for absolute returns.
GROWTH OF THE ASIAN
HEDGE FUND INDUSTRY

 BENEFITS OF HEDGE
FUNDS

 Many hedge fund strategies have the ability to generate positive
returns in both rising and falling equity and bond markets.
 Inclusion of hedge funds in a balanced portfolio reduces overall
portfolio risk and volatility and increases returns.
 Huge variety of hedge fund investment styles – many uncorrelated
with each other – provides investors with a wide choice of hedge
fund strategies to meet their investment objectives.
 Academic research proves hedge funds have higher returns and
lower overall risk than traditional investment funds.
 Hedge funds provide an ideal long-term investment solution,
eliminating the need to correctly time entry and exit from markets.
 Adding hedge funds to an investment portfolio provides
diversification not otherwise available in traditional investing.
PERFORMANCE OF HEDGE
FUNDS AND EQUITIES

 HEDGE FUNDS IN
INDIA

 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
 HFG India Continuum Fund 
 

THANK YOU