Hedge fund

From Wikipedia, the free encyclopedia

This article or section deals primarily with United States and does not represent a worldwide view of the subject.
Please improve this article or discuss the issue on the talk page.

A hedge fund is a lightly regulated private investment fund. The term "Hedge Fund" is not a specific legal one but is used to differentiate lightly regulated funds which are (because of their lighter regulation) generally only open to a limited number of investors, each of whom must invest very large amounts on a "private placement" basis from retail investment funds, which are widely available to the general public and which tend to be referred to as Mutual Funds.

Because of the comparative absence of regulatory oversight Hedge Funds have a great deal of flexibility in terms of investment strategies they can adopt. Where Mutual Funds may be limited to being "long" the market by buying instruments such as bonds, equities or money market instruments, and may have a limited ability to enter into derivative contracts, hedge funds do not suffer such regulatory restrictions, and are limited only by the terms of the contracts governing the particular fund. Depending on their "investment guidelines" and the "style" of the fund, hedge funds may be long or short the market and may enter into futures, swaps and other derivative contracts. In this way, hedge funds are able to create more complex investment strategies which may, for example, profit in times of market volatility, or even in a falling market.

Because of usual limits on investor numbers of minimum investment amounts, Hedge funds are normally open only to professional, institutional or otherwise accredited investors.

Contents

[edit] Origins and definitions

The term hedged fund dates back to a fund founded by Alfred Winslow Jones in 1949. Jones's fund advisor, A.W. Jones was to sell short some stocks while buying others, thus some of the market risk was hedged. The term "hedge fund" (as opposed to "hedged fund") has today become the accepted vernacular though most such funds are not actually hedged in the literal sense. Before these terms gained wide financial acceptance, they were referred to as "investment pools", "investment syndicates", "investment partnerships" or "opportunity funds".

While Jones is often credited with founding the first hedge fund, it is noted that many investment operations that would in his time and today be considered hedge funds were in operation long before Jones. Such well known prior hedge fund operators included Jesse Livermore aka "Boy Plunger", who recounts his hedge fund experiences in his 1923 book Reminiscences of a Stock Operator and Bernard M. Baruch and Benjamin Graham, who both operated syndicates or investment partnerships throughout the 1920s.

While most of today's hedge funds still trade stocks both long and short, many do not trade stocks at all, instead focusing on commodity futures, emerging market debt, or other financial instruments.

For U.S.-based managers and investors, hedge funds are simply structured as limited partnerships or limited liability companies. The hedge fund manager is the general partner or manager and the investors are the limited partners or members respectively. The funds are pooled together in the partnership or company and the general partner or manager makes all the investment decisions based on the strategy it outlined in the offering documents.

In return for managing the investors' funds, the hedge fund manager will receive a management fee and a performance or incentive fee. The management fee is computed as a percentage of assets under management, and the incentive fee is computed as a percentage of the fund's profits.

A "high water mark" may be specified, under which the manager does not receive incentive fees unless the value of the fund exceeds the highest value it has achieved. The "high water mark" is intended to encourage fund managers to recoup losses, but is viewed by critics as encouraging laggard funds to close, to the detriment of investors.[citations needed]

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. Rules as to what period should be considered for the hurdle vary from fund to fund, but it most commonly covers the current fiscal year.

The fee structures of hedge funds vary, but fees are typically 20% of the profits of the fund plus 2% of assets under management. Certain highly regarded managers demand higher fees. In particular, Steven Cohen's SAC Capital Partners charges a 50% incentive fee (but no management fee) and Jim Simons' Renaissance Technologies Corp. charged a 5% management fee and a 44% incentive fee in its flagship Medallion Fund before returning all investors' capital and running solely on its employees' money.[citations needed]

Mature hedge fund management firms structure their funds to include both a domestic -- often U.S.-domiciled -- hedge fund and an offshore hedge fund. This allows hedge fund managers to attract capital from all over the world. Managers generally structure these funds in a Master-feeder relationship, with positions made 'pari passu'.

Hedge funds that have filed for IPOs have done so outside the United States. Although widely reported as a "hedge-fund IPO" [1], the Fortress Investment Group LLC IPO filed November 8, 2006 is for the sale of the manager, not of the hedge funds it manages.[2]

[edit] Fund of Funds

Main article: Fund of funds

There is a special type of investment fund called a fund of funds (FoFs), which invests only in other investment funds (e.g., hedge funds) rather than trading assets directly. Because some U.S. funds of funds may be specially registered with the SEC, they can accept investments from individuals who are not accredited investors or "financially sophisticated individuals" (defined term by the SEC, which subjectively includes those individuals whose financial sophistication allows them to make investment decisions without the protection of registration under Section 5), and often have lower investment minimums (sometimes as low as $25,000).[citations needed]

Funds of funds carry an additional layer of fees, typically a 1% management fee and, optionally, a 10% incentive (performance) fee, in return for their due diligence on a selection of hedge fund managers. Besides lower mininum investment hurdles and diversification, some funds of funds also add value (or "justify" the extra layer of performance fee) by dynamic allocation to different hedge funds strategies, such as Long/Short Equities, Event Driven, Distressed Debt, Convertible Arbitrage, Statistical Arbitrage, Macro and Multi-Strategies.[citations needed]

Fund of Hedge Fund management companies either invest directly into the hedge funds by buying shares or offer investors access to managed accounts which mirror the performance of the hedge fund. Managed or segregated accounts have grown in popularity because they provide investors with daily risk reporting and help protect the assets if the hedge fund goes into liquidation.


[edit] Comparison to private equity funds

Hedge funds are similar to private equity funds, in many respects. Both are lightly regulated, private pools of capital that invest in securities and compensate their managers with a share of the fund's profits. Most hedge funds invest in very liquid assets, and permit investors to enter or leave the fund easily. Private equity funds invest primarily in very illiquid assets such as early-stage companies and so investors are "locked in" for the entire term of the fund. Hedge funds often invest in private equity companies' acquisition funds.[citations needed]

Between 2004 and February 2006, some U.S. hedge funds adopted 25 month lock-up rules expressly to exempt themselves from the SEC's new registration requirements. They now fall under the registration exemption drafted to exempt private equity funds.[citations needed]

[edit] Comparison to U.S. mutual funds

Like hedge funds, mutual funds are pools of investment capital. However, the two structures have several differences, including:

Additionally, mutual funds must have a prospectus available to anyone that requests them (either electronically or via US postal mail), and must disclose their asset allocation quarterly, while hedge funds do not have to abide by these terms. Hedge funds also frequently do not have daily liquidity, but rather "lock up" periods of time where the total returns are generated (net of fees) for their investors and then returned when the term ends, through a passthrough requiring CPAs and US Tax W-forms. Lots of people tolerate the nature of hedge funds over mutual funds because they usually generate higher total returns for their investors versus mutual funds.

Recently, however, the mutual fund industry has created products with features that have traditionally only been found in hedge funds.

Mutual funds have appeared which utilize some of the trading strategies noted above. Grizzly Short Fund (GRZZX), for example, is always net short, while Arbitrage Fund (ARBFX) specializes in merger arbitrage. Such funds are SEC regulated, but they offer hedge fund strategies and protection for mutual fund investors.

Also, a few mutual funds have introduced performanced-based fees, where the compensation to the manager is based on the performance of the fund. However, under Section 205(b) of the Investment Advisers Act of 1940, such compensation is limited to so-called "fulcrum fees".[3] Under these arrangements, fees can be performance-based so long as they increase and decrease symmetrically.

For example, the TFS Capital Small Cap Fund (TFSSX) has a management fee that behaves, within limits and symmetrically, similarly to a hedge fund "0 and 50" fee: A 0% management fee coupled with a 50% performance fee if the fund outperforms its benchmark index. However, the 125 bp base fee is reduced (but not below zero) by 50% of underperformance and increased (but not to more than 250 bp by 50% of outperformance. cool time dude [4]

[edit] Flows and levels

Assets under management of the hedge fund industry totaled $1.225 trillion at the end of the second quarter of 2006 according to the recently released data by Chicago-based Hedge Fund Research Inc. (HFR). This was up 19% on the previous year and nearly twice the total three years earlier. Because hedge funds typically use leverage/gearing or debt to invest, the positions they can take in the financial markets are larger than their assets under management. The number of hedge funds increased 10% during the past year to reach around 9,000 according to HFR. Research conducted by TowerGroup predicts that hedge fund assets will grow at an annualised rate of 15% between 2006 and 2008 while the actual number of hedge funds is likely to remain relatively flat.[citations needed]

At the end of 2004, 55% of the number of hedge funds, managing nearly two-thirds of total hedge fund assets, were registered offshore. The most popular offshore location was the Cayman Islands followed by British Virgin Islands and Bermuda. The U.S. was the most popular onshore location accounting for 34% of the number of funds and 24% of assets. EU countries were the next most popular location with 9% of the number of funds and 11% of assets. Asia accounted for the majority of the remaining assets. [citations needed]

Onshore locations are far more important in terms of the location of hedge fund managers. New York City and the Gold Coast area of Connecticut (particularly Stamford, Connecticut and Greenwich, Connecticut) together are the world's leading location for hedge fund managers with about twice as many hedge fund managers as the next largest centre, London. This is not surprising considering that the US is the source of the bulk of hedge fund investments. London is Europe’s leading centre for the management of hedge funds. At end-2005, three-quarters of European hedge fund investments, totalling $300bn, were managed within the UK, the vast majority from London. Assets managed out of London grew more than four-fold between 2002 and 2005 from $61bn to $225bn. Australia was the most important centre for the management of Asia-Pacific hedge funds. Managers located there accounted for around a quarter of the $115bn in Asia-Pacific hedge funds’ assets in 2005. [5]


[edit] Strategies

The bulk of hedge fund assets are invested in funds that employ "long / short" equity strategies. Other hedge funds use alternative strategies such as short bias, arbitrage, trading options or derivatives, using leverage, investing in seemingly undervalued securities, trading commodity and FX contracts, and attempting to take advantage of the spread between current market price and the ultimate purchase price in situations such as mergers. Many strategies acquire the risk of catastrophic losses as in the case of Long-Term Capital Management.[citations needed]

[edit] Equity Long Short

Equity long short is currently (3Q 2006) the most ubiquitous hedge fund strategy globally representing some 27% of North American hedge fund assets, 38% in Europe and 69% in Asia. Equity long short investing involves buying long equities that are expected to increase in value and selling short equities that are expected to decrease in value either in absolute terms or in relative terms.[citations needed]

Typically equity long short investing is based on what is termed 'bottom up' fundamental analysis of companies driving the decisions whether to hold a stock long or sell it short. There is usually also a 'top down' basis for risk managing the equity portfolio to diversify risk by geography, industry, sector and macroeconomic factors. With time various evolutions of this strategy have emerged.

The equity long short space is rich with variety. Within equity long short managers there are those who specialize in a value approach or a growth approach. Similarly there are a variety of trading styles where a manager may be a more frequent or dynamic trader or a more long term investor. There are managers who focus on certain industries and sectors or certain regions.

A special subset of equity long short manager is the so-called Market Neutral equity manager. Here, the long and short portfolios of the fund are balanced so that some form of market neutrality is achieved. This neutrality can be characterised with respect to the dollar exposure, which is the simplest metric, or it can be characterised with respect to beta-adjusted dollar exposure which balances the equity positions based on their sensitivity to the market as a whole. Depending on the managers' choice of benchmark(s), market neutrality can be imposed at the global portfolio level or it can more rigorously be imposed at the regional, industry or sector or market capitalization level resulting in a more tightly hedged portfolio.

Typical risk metrics for equity long short funds are gross and net exposures. Gross exposure equals long exposure plus the absolute value of short exposure. For example, for 100 USD of capital, if a fund is 150 USD long and 50 USD short, it means that gross exposure is 150 + 50 = 200 USD or 200%. Net exposure is long exposure less short exposure and in our example above would be 100 - 50 = 50 USD or 50%.

The market neutral definition typically admits a variation of plus to minus 10% in net exposure. [citation needed]

Equity Long/Short funds and-- to a lesser extent-- Equity Market Neutral funds can manage exposure through the use of derivatives such as options or futures on market indexes. Some managers refer to this technique as the provision of Portable Alpha.

[edit] Risk arbitrage

Main article: Risk arbitrage

One strategy is to buy shares of a company that has announced it is being purchased. When a merger or acquisition is announced, the target company (the one being acquired) and the acquirer (the one buying) disclose deal terms, or the premium that the acquirer will pay for the target. In almost all cases, the target's current share price is below the premium that will be paid for it at the completion of the merger, so arbitragers will buy the target company's now undervalued shares. This strategy is very risky; hence the name. There is no assurance the merger will be finalized and several factors such as regulatory approval, shareholder approval, and the possibility of other acquiring companies entering the picture account to this. As the announced merger's effective date gets closer and the more approval the merger gains, the closer the target's share price will get to the premium offered, so every detail of the merger process is very important.

When the acquiring company is offering to buy the target for cash and its own stock, the trader will short sell the stock of the acquiring company, the appropriate number of shares being decided by cash/stock ratio of the deal terms, in addition to buying the stock of the target in order to lock in the spread between the target's current price and the deal terms. This process is called "setting a spread".

The reversal of this process is called "unwinding a spread", and is the equivalent of exiting the position. There is also a risk arbitrage strategy of betting against the completion of a merger by selling the target short, and buying the acquirer's shares; traders engaged in this strategy are known as "Reversers".

Most of the early hedge funds employed this strategy. They became very popular as a way of seeing gains better than the investment grade bond market, while still having low risk.

However the side effect of this popularity was to dramatically increase the interest in all of the non-standard investment strategies, and soon other funds were being set up with new strategies aimed primarily at high growth. Although there is no hedging in these cases, the term is still used for these funds as well.

Some people break the hedge fund universe into seven broad classifications: (1) event driven, (2) fixed-income arbitrage, (3) global convertible bond arbitrage, (4) equity market-neutral, (5) long/short equity, (6) global macros, and (7) commodity trading.[citation needed]

[edit] Event driven strategies

Event driven strategies are unaffected by the general direction of markets or national policies. The events that drive event-driven funds are specific to enterprises -- chiefly mergers, takeovers, bankruptcies, and the issuance of securities.

Because of its concern with micro triggering events, this family of strategies is also sometimes called bottom up as opposed to top down.

Sometimes an event-driven hedge fund will focus upon one of those bottom-up strategies in particular, in which case it may be referred to as a risk arbitrage, a distressed securities, or a Regulation D fund, whichever name then applies.

But event-driven multi-strategy funds, as the term implies, can keep a finger in each of those pies. This provides diversification and evens out results over the business cycle, because while merger-oriented funds (i.e. risk arbitrageurs) and Regulation D funds (concerns with small-cap securities issuance) are busiest during times of boom, the distressed-securities strategy finds amplest opportunities during times of bust.

[edit] Regulatory Issues

Part of what gives hedge funds their competitive edge, and their cachet in the public imagination, is that they straddle multiple definitions and categories; some aspects of their dealings are well-regulated, others are unregulated or at best quasi-regulated.

[edit] Background on US regulatory issues

The typical investment company in the United States is required to be registered with the U.S. Securities and Exchange Commission (SEC). Mutual funds are the most common type of registered investment companies. Aside from registration and reporting requirements, investment companies are subject to strict limitations on short-selling and the use of leverage. There are other limitations and restrictions placed on investment company managers, including the prohibition on charging incentive or performance fees.

Although hedge funds fall within the statutory definition of an investment company, hedge funds elect to operate pursuant to exemptions from the registration requirements. The two major exemptions are set forth in Sections 3(c)1 and 3(c)7 of the Investment Company Act of 1940. Those exemptions are for funds with fewer than 100 investors (a "3(c)1 Fund") and funds where the investors are "qualified purchasers" (a "3(c)7 Fund"). [6] A qualified purchaser is an individual with over US$5,000,000 in investment assets. (Some institutional investors also qualify as accredited investors or qualified purchasers.) [7] A 3(c)1 Fund cannot have more than 100 investors, while a 3(c)7 Fund can have an unlimited number of investors. Both types of funds can charge performance or incentive fees.

In order to comply with 3(c)(1) or 3(c)(7), hedge funds are sold via private placement under the Securities Act of 1933. Thus interests in a hedge fund cannot be offered or advertised to the general public, and are normally offered under Regulation D. Although it is possible to have non-accredited investors in a hedge fund, the exemptions under the Investment Company Act, combined with the restrictions contained in Regulation D, effectively require hedge funds to be offered solely to accredited investors. [8]. An accredited investor is an individual with a minimum net worth of US$1,000,000 or, alternatively, a minimum income of US$200,000 in each of the last two years and a reasonable expectation of reaching the same income level in the current year.

The regulatory landscape for Investment Advisors is changing, and there have been attempts to register hedge fund investment managers. There are numerous issues surrounding these proposed requirements. One issue of importance to hedge fund managers is the requirement that a client who is charged an incentive fee must be a "qualified client" under Advisers Act Rule 205-3. To be a qualified client, an individual must have US$750,000 in assets invested with the adviser or a net worth in excess of US$1.5 million, or be one of certain high-level employees of the investment adviser. [9]

For the funds, the tradeoff of operating under these exemptions is that they have fewer investors to sell to, but they have few government-imposed restrictions on their investment strategies. The presumption is that hedge funds are pursuing more risky strategies, which may or may not be true depending on the fund, and that the ability to invest in these funds should be restricted to wealthier investors who are presumed to be more sophisticated and who have the financial reserves to absorb a possible loss. [citations needed]

[edit] Recent US regulatory developments

In December 2004, the SEC issued a rule change that required most hedge fund advisers to register with the SEC by February 1, 2006, as investment advisers under the Investment Advisers Act.[10] The requirement, with minor exceptions, applied to firms managing in excess of US$25,000,000 with over 15 investors. The SEC stated that it was adopting a "risk-based approach" to monitoring hedge funds as part of its evolving regulatory regimen for the burgeoning industry.[11] The rule change was challenged in court by a hedge fund manager, and in June 2006, the U.S. Court of Appeals for the District of Columbia overturned it and sent it back to the agency to be reviewed. See Goldstein v. SEC.

Although the SEC is currently examining how it can address the Goldstein decision, commentators have stated that the SEC currently has neither the staff nor expertise to comprehensively monitor the estimated 8,000 U.S. and international hedge funds. See New Hedge Fund Advisor Rule. One of the Commissioners, Roel Campos, has said that the SEC is forming internal teams that will identify and evaluate irregular trading patterns or other phenomena that may threaten individual investors, the stability of the industry, or the financial world. "It's pretty clear that we will not be knocking on [hedge fund] doors very often," Campos told several hundred hedge fund managers, industry lawyers and others. And even if it did, "the SEC will never have the degree of knowledge or background that you do."[citation needed]

[edit] Recent UK regulatory developments

In recent years, HM Revenue and Customs, formerly Inland Revenue, has adopted interpretations of the tax laws that seem likely to keep many funds offshore. One change was in June 2005, The United Kingdom's Financial Services Authority published two discussion papers about hedge funds -- one concerning systemic risks, the other on consumer protection. Due to the same concerns, later in the year the FSA created an internal team to supervise the management of 25 particularly high-impact hedge funds doing business within the UK. [citations needed]

Another regulatory body, the Takeover Panel, is reportedly concerned about the use by hedge funds of instruments known as contracts for difference, which it worries may have opaque effects on mergers and acquisitions.[citation needed]

[edit] Privacy issues

As private, lightly regulated partnerships, hedge funds do not have to disclose their activities to third parties. This is in contrast to a fully regulated mutual fund (or unit trust) which will typically have to meet regulatory requirements for disclosure. The hedge funds are typically domiciled in an offshore jurisdiction, such as Bermuda, Cayman Islands, British Virgin Islands, where regulation of investment funds permits wider powers of investment (the Cayman Islands have been estimated to be home to about 75% of world’s hedge funds, with nearly half the industry's estimated $1.225 trillion AUM[1]). Hedge funds have to file accounts and conduct their business in compliance with the less stringent requirements of these offshore centres. Investors in hedge funds enjoy a higher level of disclosure than investors in mutual funds including detailed discussions of risks assumed, significant positions, and investors usually have direct access to the investment advisors of the funds. This high level of disclosure is not available to non-investors, hence the notion of privacy attached to hedge funds.

A byproduct of this privacy and the lack of regulation is that there are no official hedge fund statistics. An industry consulting group, HFR (hfr.com), reported at the end of the second quarter 2003 there are 5660 hedge funds world wide managing $665 billion. To put that in perspective, at the same time the US mutual fund sector held assets of $7.818 trillion (according to the Investment Company Institute). [citations needed]

The combination of privacy and rich investors means that hedge funds are a target for criticism whenever markets move against some group's interests. For example, hedge funds were widely blamed for the speculative run-up in the bond market that preceded the global bond crisis of 1994, although the major players in the bond spree were actually large commercial and investment banks. [citation needed]

[edit] Criticism

[edit] Questionable propriety

The U.S. Senate Judiciary Committee began an investigation into the propriety of Hedge Funds on June 28, 2006. The hearings have been recently reported on by CNBC, Bloomberg, and Marketwatch after a New York Times article exposed an investigation by Gary Aguirre, an investigating attorney, who was recently fired by the SEC. [12] [13]

[edit] Systemic risk

Hedge funds came under heightened scrutiny as a result of the failure of Long-Term Capital Management (LTCM) in 1998, which necessitated a bailout coordinated by the U.S. Federal Reserve. Critics have charged that hedge funds pose systemic risks highlighted by the LTCM disaster.

The ECB (European Central Bank) has issued a warning on hedge fund risk for financial stability and systematic risk:

"... the increasingly similar positioning of individual hedge funds within broad hedge fund investment strategies is another major risk for financial stability which warrants close monitoring despite the essential lack of any possible remedies. This risk is further magnified by evidence that broad hedge fund investment strategies have also become increasingly correlated, thereby further increasing the potential adverse effects of disorderly exits from crowded trades." ECB Financial Stability Review June 2006, p. 142

The Times wrote about this review:

"In one of the starkest warnings yet from an official institution over the role of the burgeoning but secretive industry, the ECB sounded a note of alarm over the possible repercussions from any collapse of a hedge fund, or group of funds." Gary Duncan, Economics Editor, June 02, 2006

However, the ECB statement itself has been criticized by a part of the financial research community, some of their arguments can be found in this paper [14].

[edit] Poor performance

Critics also maintain that hedge fund performance has suffered as aggregate asset sizes have climbed.

In 2005, Princeton University professor and noted financial theorist Burton G. Malkiel published a paper maintaining that hedge funds systematically underperform the market averages[15]. Malkiel contended that hedge fund indexes, particularly prior to 1995, were often statistically faulty and overstated hedge fund performance. Hedge funds, however, contested Malkiel's findings.[16]

Recent evidence suggests the myth of good performance in all markets is somewhat shaky even for fund of hedge funds. (Source:[17]).

Hedge funds may also simply bet wrong, with a high degree of leverage. In September 2006, the US fund Amaranth Advisors' natural gas trader lost roughly $6 billion of the firm's $9 billion assets on a series of ill-timed trades.

[edit] Hedge Fund Fees

Hedge funds typically charge two levels of fees. There is a management fee which typically ranges from 1.5% to 2.0% although there are funds that charge less, from 0.5% to 1.0%, and funds that charge as much as 5.0%. The fees are charged on the size of the capital invested, that is on the equity contribution of the investor or the gross asset value (GAV) of the shares owned by the investor.

There is also almost always a performance fee being a percentage of profits. The structuring of the management fee can vary, as can the proportion. Typically, hedge funds charge between 10% - 25% of gross returns in performance fees.

Sometimes the performance fees are levied only after a performance target has been met. This is called the Hurdle or Hurdle Rate. Typical hurdle rates are a fixed 5% - 8% or a variable rate linked to short term interest rates for example 3 month USD LIBOR. This practice has diminished as demand for hedge funds has outstripped supply. The typical hurdle is currently 0% i.e no hurdle.

Performance fees have been accused of introducing perverse behavior on the part of hedge fund managers in that they are not penalized for negative or poor performance. The High Watermark mechanism in part addresses this problem. Under a high watermark system, performance fees only apply to net new profits for each individual investor. That is, if a fund has risen say 30% and performance fees are 20% of returns, then performance fees are 20% of 30% which is 6%. If the fund then drops 10%, no performance fees are due to the hedge fund manager. Further, until the 10% loss is fully recovered, no performance fees will accrue to the hedge fund manager. Only when the loss is fully recovered, hence the concept of high watermark, will performance fees apply and then only to the performance calculated from the high watermark.

[edit] High fees

Criticism was also heaped upon hedge funds by investigative journalist Gary Weiss, in his caustic 2006 book Wall Street Versus America. The book contends that hedge funds have evolved into little more than high-fee mutual funds.

Performance-based management fees have been criticised by people including investor Warren Buffett for rewarding managers for high variability, rather than high long-term returns. A fund that may gain $100M in one year and lose $100M in the next year may pay its managers a performance fee of $30M or more for the profitable year, although the nominal return is zero, and the real return after fees is negative.

This article or section may contain original research or unverified claims.
 Please help Wikipedia by adding references. See the talk page for details.

An illustration::

The typical hedge fund charges what is known in the industry as 2 and 20 by which is meant that management fees are 2% per annum and performance fees are 20% of whatever returns are generated. All these fees apply to gross asset values and gross performance.

Assume that a hedge fund returns 15% in a year net of all fees. This means that the gross returns must add back the 2% management fee and adjust for the 20% share of gross returns that accrue to the hedge fund manager.

Gross returns are therefore (15% + 2%) / (100% - 20%) = 21.25%.
Total fees to the hedge fund manager are therefore 21.25% - 15.00% = 6.25%
Net returns to the investor = 15%

Thus of the gross returns generated by the hedge fund manager, some 30% of the returns are retained as fees and 70% paid to the investor. While the precise quanta of fee shares will depend on the precise fee terms of each fund and the level of gross returns generated, the numbers above are within the realm of contemplation.

[edit] Hedge fund data

[edit] Top earners

Institutional Investor magazine annually ranks top-earning hedge fund managers. Earnings from a hedge fund are simply 100% of the capital gains on the manager's own equity stake in the fund plus 20% to 50% (depending on policy) of the gains on the other investors' capital.

The 2004 top earner was Edward Lampert of ESL Investments Inc. who earned $1.02 billion during the year (PR Newswire link).

The 2005 top earner was James Harris Simons with an earning of $1.5 billion according to Alpha magazine.[2] However, Trader Monthly reported that Simons only earned about $1 billion and that the top earner was instead T. Boone Pickens with an estimated earning of over $1.5 billion during the year.[3]

The full top 10 list of hedge fund earners according to Trader Monthly includes:

[edit] Notable hedge fund management companies

Sometimes also known as alternative investment management companies.

[edit] Top 30 Funds of funds

Ranked by December 2005 Assets Under Management

  • UBS Global Asset Management (GAM) (London, UK and Stamford, CT) $45.0 billion ([18])
  • Man Investments (London, UK and Pfaffikon, Switzerland) $35.6 billion ([19])
  • Union Bancaire Privée (UBP) (Geneva, Switzerland) $20.8 billion ([20])
  • HSBC Private Bank (Suisse) / HSBS Republic Investments (London, UK) $20.2 billion ([21])
  • Permal Asset Management (New York, NY) $18.8 billion ([22])
  • Société Générale (Paris, France) $15.9 billion ([23])
  • Quellos Capital Management (Seattle, WA) $15.0 billion ([www.quellos.com])
  • Ivy Asset Management (Jericho, NY) $14.9 billion ([24])
  • Grosvenor Capital Management (Chicago, IL) $14.7 billion ([25])
  • Goldman Sachs Hedge Fund Strategies (Princeton, NJ) $14.2 billion ([26])
  • Financial Risk Management (FRM) (London, UK) $ 13.3 billion ([27])
  • Pictet & Cie. (Geneva, Switzerland) $13.0 billion ([28])
  • Crédit Agricole Alternative Investment Products Group (Paris, France) $11.8 billion ([29])
  • Notz Stucki & Cie. (Geneva, Switzerland) $10.7 billion ([30])
  • Blackstone Alternative Asset Management (New York, NY) $9.3 billion ([31])
  • Arden Asset Management (New York, NY) $9.2 billion ([32])
  • Pacific Alternative Asset Management Co. (PAAMCO) (Irvine, CA) $8.9 billion]] ([33])
  • J.P. Morgan Alternative Asset Management (New York, NY) $8.8 billion ([34])
  • Mesirow Advanced Strategies (Chicago, IL) $8.2 billion ([35])
  • Tremont Capital Management (Rye, NY) $8.2 billion ([36])
  • CSFB Alternative Capital (New York, NY) $7.9 billion ([37])
  • AIG Global Investment Group (New York, NY) $6.7 billion ([38])
  • Harris Alternatives (Chicago, IL) $6.7 billion ([39])
  • DB Absolute Return Strategies (New York, NY) $6.6 billion ([40])
  • RBS Asset Management (London, UK) $6.5 billion ([41])
  • Lehman Brothers Alternative Investment Management (New York, NY) $6.2 billion ([42])
  • EIM (Nyon, Switzerland) $6.0 billion ([43])
  • Gottex Fund Management (Lausanne, Switzerland) $5.1 billion ([44])
  • Morgan Stanley Alternative Investment Partners (West Conshohocken, PA) $5.1 billion ([45])

InvestmentSeek.com has a listing of most fund of funds managers with their links ([46])

[edit] Managed Account Platforms

[edit] Hedge fund strategies

[edit] Terminology

[edit] References

  1. ^ Institutional Investor, 15 May 2006, Article Link, although statistics in the Hedge Fund industry are notoriously speculative
  2. ^ $363M is average pay for top hedge fund managers. Institutional Investor, Alpha magazine (USA TODAY article, 26 May 2005). Retrieved on May 27, 2006.
  3. ^ Traders Monthly. Top Hedge Fund Earners of 2005.

4. Hedge Fund Amaranth wiped out by unhedged gas position losing $5+ billion

5. "Hedge" Fund Amaranth to Close After loss of $6.5 of 9 billion on Unhedged Gas Bet

[edit] Further reading

  • Ineichen, Alexander M., Absolute Returns - Risk and Opportunities of Hedge Fund Investing, New York: John Wiley & Sons, 2003. ISBN 0-471-25120-8
  • Ineichen, Alexander M., Asymmetric Returns - The Future of Active Asset Management, New York: John Wiley & Sons, 2006, forthcoming. ISBN 0-470-04266-4
  • Weiss, Gary, Wall Street Versus America: The Rampant Greed and Dishonesty That Imperil Your Investments, New York: Portfolio, 2006. Argues that hedge funds tend to underperform market indexes and are excessively hyped by the media. ISBN 1-59184-094-5
  • Hedge Fund Flameout

[edit] External links


[edit] Trade associations

[edit] Indices

[edit] Hedge fund research


Investment management

Collective investment schemes:  Common contractual funds • Fonds commun de placements • Investment trusts • Hedge funds • Unit trusts • Mutual funds • ICVC • SICAV • Unit Investment Trusts • Exchange-traded funds • Offshore fund • Unitised insurance fund

Styles and theory:  Active management • Passive management • Index fund • Efficient market hypothesis • Socially responsible investing • Net asset value

Related Topics: List of asset management firms • Umbrella fund • Fund of funds • UCITS


General areas of finance
Financial markets • Investment management • Financial institutions • Personal finance • Public finance • Mathematical finance • Financial economics • Experimental finance • Computational finance
Retrieved from "http://en.wikipedia.org../../../h/e/d/Hedge_fund.html"