Definition A Hedge Fund is an investment fund, a company or a private partnership that use derivatives and/or is allowed to go short and/or uses significant leverage through borrowing. Its manager has a significant personal stake in the fund and is free to operate in a variety of markets and investment styles. Industry participants estimate the number of hedge funds to more than 9,000, the majority of which are the result of private placements with specific investors, not publicly marketed. Most of hedge funds’ strategies limit investment capacity; they are only open to subscription for short periods of time, and are offered only to known investors. Some have high minimum investment levels – some as high as $10 million. Many impose entrance fees or sales charges. Redemption is usually quarterly with a notice period and in some cases with exit fees. These issues restrict the accessibility of hedge funds, particularly to smaller investors. The rationale The principal argument behind hedge fund investing is that great inefficiencies occur and will continue to occur, and therefore opportunities arise that enable investors to exploit mispriced securities without incurring excessive levels of risk. A key element is the talent of the manager to identify them and turn them into profits. Hedge funds aim to minimize directional market risk, while maintaining steady absolute returns. Hedge funds encompass a wide range of different investment objectives, strategies, styles, techniques and assets, offering a wide spectrum of risk/return profiles. The absolute return objective The approach of hedge fund managers is different from that of conventional long equity managers. Hedge funds aim to achieve steady absolute returns over time with low risk, rather than relative performance against a stated benchmark index, typically the goal of traditional buy/hold managers. For many investors this is a key difference : will you be happy that a fund has outperformed its index benchmark by 5% when the index is down 15% ? The manager’s interests are aligned with those of the investors Hedge fund managers are typically rewarded in the form of an annual management fee and through a performance-based fee. This is one of the distinguishing features of hedge funds. While annual fees are generally equivalent to 1-2% of assets, performance fees are typically in the region of 15-25% of a fund’s profits. Hurdle rates (typically 5% per annum) and high watermarks are often enforced to ensure fees are earned for absolute performance. A high watermark applies where accumulated losses need to be recouped before a performance fee will be paid. Although such fees may appear excessive, this type of remuneration has always been standard practice, luring high-quality talented investment professionals into the hedge fund sector and encouraging managers to generate maximum returns for investors. Hedge fund managers also tend to be investors in their own funds. The extent of their investment varies, but many managers commit a sizeable proportion of their own wealth to their fund, thereby further aligning their interests with those of investors. Different investment styles Despite the flexibility of not having an index benchmark, hedge funds generally adhere to an investment strategy detailed at the launch of the fund and which should be stable over time. Style drift is not well perceived by hedge funds allocators/investors. Although hedge funds have the freedom to invest in a wide variety of markets and instruments, most funds choose to specialize in specific asset classes, strategies or markets. An immense range of investments is available to hedge funds, including equities, currencies, interest rates and commodities. In general, all markets are available for their investments, including Europe, the US, Japan or the Emerging Markets. Investment instruments and techniques include cash, futures and options, derivatives, short selling, stock borrowing & lending and leverage. Hedge Fund Strategies A number of different investment strategies are employed by hedge funds. Although we define the four main investment styles here, it should be noted that there are no industry standard definitions and hedge fund managers will often use their own interpretations, subdividing further the categories we present. This should be taken into consideration when comparing portfolio descriptions from different managers. See the Investment Styles section for more details. Best implementation Investment in hedge funds is best implemented through a diversified portfolio. There are three ways to put this into practice :
With the first option unrealistic for most investors (primarily on the basis of due diligence), and the second requiring minimum size of asset, investment in a fund of hedge funds is the clear route for small to medium sized investors. In addition to the risk diversification advantages, the other main benefits of investing in funds of hedge funds, or multi-manager funds as they are often referred to, can be addressed under a few main headings :
Our core business is to select and monitor hedge funds as well as to manage alternative investment portfolios.
Do you want to know how 3A SA can help you in alternative investments? Please do not hesitate to contact us.
The SYZ & CO Group comprises several distinct entities, such as Banque SYZ & CO SA and 3A SA. |
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