Why Investors Invest In Hedge Funds

Why entrustors Invest In Hedge aiming companysAbstractHedge cash fetch gained a lot of popularity in the last decade and ar iodinness of the fastest growing industries. The main aim of most dishearten strains is to reduce volatility and hazard. It also attempts to preserve peachy and deliver dictatorial deceases under all market conditions. Not all deflect inventorys atomic number 18 same and so it is important to know the difference surrounded by them. It differs in terms of its finds, enthronization rescues and volatility among the antithetical manipulate ancestry strategies. The strategies which are correlated to rectitude markets deliver consistent returns and have hapless risk objet dart the ones that are not go out be much volatile. Main objective of dip coin is to pull up stakes consistency in its returns for investor, lower portfolio volatility and preserve their capital coronations, which is the former wherefore investors much(preno minal) as pension origins, insurance companies, institutional investors and high net outlay mortals and families invest in circumvent bullion.This thesis reviews versatile issues relating to the enthronisation in turn off bullion, which have become popular with high net-worth individualists and institutional investors, as fountainhead as discuss their trial-and-error risk and return profiles. The concerns regarding the empirical measurements are highlighted, and meaningful analytical methods are proposed to reserve greater risk transparency in implementation reporting. It also discusses the development of the besiege store intentness in Asia.Asian hedging money have self-aggrandizing vastly in past few years. It is say to have bad nearly six times as many pecuniary resource while managing ten times are much in as sinks since 2000 according to Eureka manipulate. The manufacturing is estimated to consist oer 1100 cash in hand, and managing roughly $175 billion in assets. transnational managers are starting up their proclaim Asia- focus oned cash too. Allocators are more and more eyeing investment opportunities in Asia. Funds with a world(a) mandate are increasing their storage allocation to Asia.The paper presents an overview of put over finances, describing their development and characteristics. It also discussed the diverse issues related to the measurement of parry monetary computer storage carrying out, as well as examined alternate performance measures. This thesis ends with some remarks on the development of the fudge blood line assiduity in Asia.1. Introduction on that point has several description of escape monetary resource throughout the history. There isnt one particular reprove that defines what parry veraciousty really means. However, according to Chicago Board Options commuting (No Date), overreach bullion can be defined as A conservative strategy employd to limit investment loss by effecting a transaction that offsets an existing patch.Alfred Winslow Jones was the graduation person to create dip fund structure more than 50 years ago. The fund completed had following featureHe created skirts by investing in securities that was said to be undervalued and funded these positions by taking compendious-circuit positions in overvalued securities hence creating market-neutral position.He designed an incentive earnings compensation arrangement for fund mangers. They were paid a percentage of profit from the clients capital assets andHe so invested his sustain investment capital in the fund, to trifle sure that his capital and that of his investors were co-ordinated and in line so that it is not just an individual investment nevertheless a partnershipAlmost all modern table finances have above listed features in them, and are set up as limited partnerships with a lucrative incentive-fee structure. In most environ silver, managers also have a significant portion of their own capital invested in the partnerships. The term hedge fund has been generalized to describe investment strategies that range from the original market-neutral style of Jones to many other strategies and opportunistic situations, including orbicular/macro investing.There is a large variety of hedge fund investing strategies present today and therefore no touchstone way of life to classify hedge coin separately. Many data vendors and fund advisors set up their own major hedge fund styles according to their popularity. nether the classification by Credit Suisse, the categories of hedge bills with 9 separate styles and a fund-of-funds category(a) publication driven funds are the funds that take positions on corporate events when companies are undergoing re-structuring or mergers. For example, fund managers would buy bank debt or high yield corporate bonds of companies undergoing the re-organization which is oftentimes referred to as distressed securities. Another event- driven strategy is merger arbitrage where the funds take up the opportunity to invest just after a takeover has been announced. They obtain the shares of the target companies and then misfortunate these shares of the acquiring companies.(b) Global funds are categories of funds that invest in non-US dribbles and bonds with no specific strategy reference. This fund has the largest number of hedge funds and it take ons funds that specialize on the rising markets.(c) Global/ macro instruction funds are the funds that imprecate on macroeconomic analysis and invest in long and short position in array to capitalise on major risk factors and unforeseen markets such as currencies, interest rates, storehouse indices and commodities.(d) Market neutral funds refer to hedge fund strategy that involves utilizing strategies such as long-short justness, stock tycoon arbitrage, convertible bond arbitrage and fixed income arbitrage. Long-short equity funds use the strategy of Jones by tak ing long positions in selective stocks and going short on other stocks to limit their exposure to the stock market. Stock index arbitrage funds trade on the dish out between index futures contracts and the underlying basket of equities.(e) Dedicated little preconceived opinionfunds are strategies that take more short positions than long positions and spend a penny returns by maintaining net short exposure in long and short equities. Detailed individual company re count typically forms the core alpha generation driver of dedicated short bias managers, and a focus on companies with weak cash flow generation is common. To affect the short sale, the manager borrows the stock from a counter-party and sells it in the market. short positions are sometimes implemented by selling forward. Risk management consists of offsetting long positions and stop-loss strategies.(f) transmutable bond arbitrage funds typically capitalize on the insert option in these bonds by purchasing them and sh orting the equities.(g) Fixed income arbitrage is a strategy that bets on the convergence of prices of bonds from the same issuer but with different maturities over time. This is the second largest grouping of hedge funds after the Global category.(h) utterly/long fund-, shorts focus on engineering short positions in stocks with or without matching long positions. They play on markets that have raised(a) too fast and on mean reversion strategies.Long funds take long equity positions with leverage. Emerging market funds that do not have short-selling opportunities also fall under this category.(i) Emerging Marketsfunds invest in currencies, debt instruments, equities and other instruments of countries with emerging or developing markets (typically heedful by GDP per capita). Such countries are considered to be in a transitional phase between developing and developed status. Examples of emerging markets include China, India, Latin America, much of Southeast Asia, parts of Eastern E urope, and parts of Africa. There are a number of sub-sectors, including arbitrage, credit and event driven, fixed income bias, and equity bias.(j) Fund of funds refer to funds that invests in a pocket billiards of hedge funds. They specialize in identifying fund managers with good performance and rely on their good industry relationships to gain entry into hedge funds with good track records.Table 1 excretes statistics about the various categories of hedge funds and past performance. The global/macro hedge funds provided the outmatch mean return over the diaphragm studied, while the event-driven funds had the worst ensample deflexion of returns. On a risk adjusted primer which is obtained by dividing the mean return by the standard deviation, the category of fund that ranks highest is the global/macro funds followed closely by event-driven funds. Hedge funds are not required to publicly disclose performance and holdings training unlike the registered insurance companies, w hich might be construed as solicitation materials. This is the reason why which makes it more difficult for investors to evaluate hedge fund managers. circuit card 1Jan 2000 Nov 2009CategoriesMean Return(%)Standard Deviation (%)Risk-Adjusted ReturnEvent driven8.665.441.60Global6.606.231.06Global / Macro12.286.072.02Market neutral2.0913.480.16Short/Long5.508.880.62Emerging Market9.2311.050.84Convertible Arbitrage6.988.340.84Dedicated Short Bias(1.95)16.40(0.12)Fixed Income Arbitrage3.666.810.54Source Credit Suisse/ Tremont hedge indexNotesThe mean returns are annually compounded returns over the period 2000 to November 2009,The annualized standard deviations were computed from of the standard deviation of monthly returns for each investment style.Risk-adjusted returns are obtained by dividing the mean return by the standard deviation.In 1990 the entire hedge fund industry was estimated at $20 billion. At the end of 2008, global hedge fund industry was estimated to be worth $1 one mi llion million with 8350 active funds. It has gained a lot of popularity in the last decade and is one of the fastest growing industries. While hedge funds are well established in US and Europe, they have also been growing speedily in Asia.Hedge funds have posted attractive returns. A seven year annualised return of 2.47% posted by Hedge Fund Research (HFR) from 2003 to 2009, high than the SP 1200 of 1.18%. Hedge funds are seen as cancel hedge to control downside risk because they employ investment strategies believed to generate returns that are uncorrelated to traditional asset classes. Hedge funds differ in strategies- a macro fund such as quantum fund more often than not take a directional view by betting in particular bond market or a currency movement. another(prenominal) funds specialise in corporate events such as mergers or bankruptcies. They also vary widely in investment strategies and the amount of pecuniary leverage.In the recent financial crisis, hedge funds have b een severely criticised in terms of their strategies and also for the fact that in 2008, they have had unwaveringly time fulfilling their absolute return targets. There have been other criticisms towards hedge fund regarding this particular crisis. Stromqvist (2009) writes that ever since the development of hedge fund industry there has always been discussions regarding the enjoyment of hedge funds in a financial crisis. The main focus of the criticism was on highly leveraged hedge funds and that they may have a large impact on price stability on both currencies and equities.In an article pen in The Times, Dillow (2008) observes that even though average return of hedge funds in 2008 has been poor, they have not been a serious source of unbalance in the wider financial system.Regardless of the recent financial crisis, hedge funds still generate a growing number of interests all some the world. Due to their private nature, it is difficult to obtain information about the trading operations of individual hedge funds and reliable summary statistics about the industry as a whole.It is a common belief that investing in hedge funds can have superior returns. Many advantage stories have emerged in the past and the most popular of which is the George Soros story. In kinsfolk of 1992, he risked $10 billion on a singlecurrencyspeculation when he shorted the British pound, which gave him an international fame. He was right, and in a single day he successfully generated a profit of $1 billion ultimately, it was reported that his profit on the transaction almost reached $2 billion. Therefore, he is famously known as the the man who broke the money box of England.The greates investor George Soros,http//www.investopedia.com/university/greatest/georgesoros.asp 16-12-09As seen in Table 1, the hedge funds as a group can generate positive returns. For example, over the period 1990-1997, all the hedge funds had positive absolute returns. Global/Macro funds obtained mean r eturns of 28.1% p.a. with a standard deviation that is comparable to equity funds.Traditional asset allocation makes the most of the use of equities, bonds, real nation and private equity to invest in a portfolio that maximizes returns and minimizes the portfolio risk. Therefore, in an investment portfolio hedge funds can play a vital role in maximising returns. Moreover, in a bear market, many investment and fund mangers find it dull to just beat the market index, which may have negative returns. They generally prefer to go short or avoid long positions to have positive returns. Choosing an appropriate hedge fund to invest increases the possibility of obtaining positive absolute returns.It is also generally believed that hedge funds have returns that are generally uncorrelated with the traditional asset classes. In fact, hedge funds may even have a lower risk profile. For example, Morgan Stanley Dean Witter (2000) reported that hedge funds adjoin a low correlation with traditiona l asset classes, suggesting that hedge funds should play an important role in strategic asset allocation.The do to the question Why invest in Hedge funds? solely is to make money. The common analogy in all hedge funds strategies and the underlying rationale for investing in hedge funds is the search for absolute returns. This is sometimes called alpha. Alpha is the extra return a adept manager can produce over and above the market return (or beta). Whereas many conventional fund managers aim simply to outperform their chosen benchmark index, hedge fund managers seek to produce positive gains in all market conditions.http//www.fleetstreetinvest.co.uk/shares/trend-investing/hedge-fund-investing-00128.htmlResearch QuestionBy using quantifiable study, I will try to answer the following questionsWhy investors invest in hedge funds?To answer this question I will be looking at the return, risk and performance associated with investing in hedge fund and how the fund mangers. By looking at the annualised return, standard deviation and risk adjusted returns of different styles of hedge funds their performance can be measured.What are the issues relating the investment in terms of risk, return and performance measurement?Although hedge funds are popular in terms of an investment vehicle, there are various issues. The issues related are its salute/ management fee structures, collection of data, survivorship bias and selection bias. discordant performance measure techniques are available for hedge funds too. I will be looking at some of the performance measurement approaches.PurposeThere are several purpose for this paper. First is to give an overview of hedge fund as an investment vehicle with a short description of different characteristics and styles of hedge funds. Second is to describe why hedge funds are attractive for investors and fund managers by presenting different theories where risk and returns of hedge funds are investigated in order to evaluate the per formance measures. Third purpose is to investigate the issues related to the investment in hedge funds where several sets of issues are evaluated and various performance measures are identified. writings REVIEWThere is no one particular definition of hedge fund as mentioned earlier. According to the Investment Company Act 1940 of the US, hedge funds were defined by their low degree of regulatory controls. In comparison to mutual funds, hedge funds were seen to have higher level of risk. This led to a 100-investor limit as well as wealthiness requirement of the investors. Fung and Hsieh (1999) claim that another reason for 100-investor limit is the use of leverage and short selling in hedge funds. The limit restrictions were later abandon and wealth requirement lowered.Many definitions of hedge funds have been cited-most of them chiefly based on its characteristics. Some of them areInvestment companies that by their require can buy on margin, sell short, hold warrants, convertibl e securities and commodities and other than engage in aggressive trading tactics in order to profit from forcasting market swings.- Polhman, Ang and Hollinger (1978)A mutual fund that employs leverage and uses various techniques of hedging- Soros (1987)hedge funds are vehicles that allow private investors to pool assets to be invested by a fund manager. Unlike mutual funds, hedge funds are comm just structured as private partnerships and thus topic to solo minimal SEC regulation. Moreover, because hedge funds are only lightly regulated their managers can pursue investment strategies involving, for example, heavy use if derivatives, short sales and leverage.- Bodie, Kane and Marcus (2008).Murguia and Umemoto (2004) claims that the reason why there is no proper definition of hegdge funds is because they are not classified by the different asset classes but by the type of strategies employed by the fund mangers is what classifies them. Such strategies range from very aggressive to co nservative, which is the reason why there is no clear definition.Several studies have been carried out about hedge funds performance and risk issues. Fung and Hsieh (1997a) extend Sharpe (1992) style analysis and solve that there are more modify hedge fund strategies and suggested that hedge fund strategies are more dynamic. The literatures also conclude that option-based factors can rear the power of explaining hedge fund returns. Brown, Goetzmann and Ibbotson (1999) examine the performance of offshore hedge funds and attribute fund performance to style effects alternatively than managerial skills.Brown, Goetzmann and Liang (2003) tack together, in a study using the TASS database, that fund of hedge funds reduce by a third the standard deviation of monthly hedge fund returns, as well as significantly reduce the value at risk of hedge fund investment. Hence, fund of hedge funds can also provide significant variegation potential. A well-diversified fund of hedge fund manager can therefore take advantage of market-specific risks while maintaining low correlations to stock, bond, and currency markets. As a result of which the fund of hedge fund manager can provide superior returns and generate alpha which reflects managerial skills. More generally, since fund of hedge funds deliver more consistent returns with lower volatility than individual hedge funds, they are considered to be ideal for diversifying traditional portfolios. During 19932001, fund of hedge funds outperformed the SP 500 index on a risk-adjusted basis (Gregoriou, 2003a).Koh, Koh, lee and Phoon(2004) state that traditional asset allocation optimizes the use of equities, bonds, real nation and private equity to invest in a portfolio that maximizes returns and minimizes the portfolio risk. Thus, hedge funds become vital in enhancing returns in an investment portfolio.Following the growth in hedge fund industry, fund-of-hedge funds (FOF) have become more and more popular. Liang (2003) states th at FOF mixes various strategies and asset classes together and creates more stable semipermanent investment returns than any of the individual funds. It invests in underlying hedge funds and diversifies the fund specific risks and relieves burdens on investor to select and monitor managers, and providing asset allocation in dynamic market environments. Fund-of-funds require less initial investment as compare to hedge funds and therefore are more affordable for small investors. To participate in the investment, small investors may be willing to pay extra fees as it might be the only way for them.Previous studies in this area by Brown, Goetzmann and Liang (2002) conclude that trust hedge funds with fund-of-funds not only causes the double counting but also hides the difference in fee structures between hedge funds and fund-of-funds. Liang (2003) state that a hedge funds charges a management fee and incentive fee while a fund-of-funds not only charges these fees at a fund-of-fund leve l but also passes hedge fund level fees in the form of after fee returns to the fund-of-fund investors whether or not the fund-of-funds make a profit.Brown, Goetzmann and Liang (2002) examine this issue and propose an alternative fee which provide a better incentive for fund-of-fund managers and reduce the cost for investors under the period fee structure, which is that the fund-of-fund managers absorb the underlying hedge fund fees and establish their own incentive fees at the fund-of-fund level. Liang (2003) conclude that because of the above issues fund-of-funds need to be separate from hedge funds in academic studies and address the difference in performance, risk and fee structures.However, the FOF mangers can add value to the portfolio through selection, tress and continuous monitoring of the portfolio. They provide professional services and have entree to the information that are expensive and difficult to obtain otherwise. The FOF mangers quite often use different invest ment strategies and styles through a diversified portfolio of individual fund managers. Considering these advantages for an investor, investing in fund of hedge funds is not cheap. The cost can be as high as the cost of buying a building, according to Koh, Koh, Lee and Phoon (2004). This structure allows for more diversified portfolio and much reduced risk at the fund level which comes at a price. More diversified the portfolio is it is more likely that it will father more incentive fees.Therefore, there are many persuasive reasons why investing in hedge funds are considered as alternative investments. Some uninformed investors may be misled about the risks and returns on hedge funds as it relies heavily on statistical compilation from the database vendors which is modify with data bias such as survivorship bias and selection bias.Fung and Hsieh (2001a) found that estimates of survivorship biases differed across two commonly used databases, HFR and TASS. The survivorship bias was much higher in TASS than that in HFR. They estimated that survivorship bias would over-report hedge fund mean returns by about 1.5% to 3% per annum.Brooks and Kat (2001) stated that around 30% of newly established funds do not survive the first three years, primarily due to poor performance. Thus, not including defunct funds is likely to lead to over-estimation of the returns and profile of hedge fund industry.