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- 1. WHAT IS HEDGING? Simplistic definition to get started: An investment made in order to reduce the risk, of adverse price movements in a security, by taking an offsetting position in a related security, such as an option or a short sale.
2. TRIVIA! The use of the term "hedge" in the US originally was coined by the agriculture industry. Farmers were the first "hedgers" by selling crops or cattle yet to be harvested at a price for future delivery. In doing so, they locked in a price today and were "not exposed" to future market fluctuations. In essence, they "hedged" their market exposure for the period of time it took them to harvest and deliver their product. 3. GOAL OF THE FUND The primary aim of most hedge funds is to Reduce volatility and risk while attempting to preserve capital, and deliver positive returns under all market conditions. 4. HISTORIC HEDGING Historically the hedging strategy centered around this logic: Equities on the "long side" outperformed up markets. At the same time, the equities on the "short side" did not create a drag on performance, and possibly even added to the portfolios return since there are always stocks that lose value, even in a bull market. In a market correction, the short portfolio would outperform the long portfolio, or at least "hedge" or reduce the slide in the long portfolios value. 5. ORGANISATIONAL STRUCTURE : HEDGE FUNDS 6. TYPES OF HEDGE FUNDS Long-Short Funds: Take both long and short positions in securities in hopes of using superior stock picking strategies to outperform the general market. Market-Neutral Funds: A sub-type of a long-short fund, however fund managers attempt to hedge against general market movements (thus the name "market neutral"). Event-Driven Funds: An attempt to capture gains from market events, such as mergers, natural disasters or political turmoil. Macro Funds: Take directional bets on the market as a whole, either long or short, based upon research and/or the fund's philosophy. 7. HOW IS HEDGE FUND DIFFERENT FROM MUTUAL FUNDS Hedge funds traditionally reserved for clients with initial minimum investment of $1 million. Mutual fund companies beginning to offer hedge fund products to wider client base There are 5 key differences between them based on: 1. Performance Evaluation 2. Level of regulatory control 3. Basis for Remuneration of Management 4. Portfolio Protection 5. Dependence on Markets 8. DIFFERENCES Performance Evaluation: Mutual funds are measured on relative performance compared to a relevant index or to other mutual funds in their sector Hedge funds are expected to deliver absolute returns under all circumstances, even when the relative indices are down Level of Regulation: Unlike hedge funds, mutual funds are highly regulated, restricting the use of short selling and derivatives. Makes it difficult to outperform market, or protect assets in downturn. 9. DIFFERENCES Remuneration for Management Mutual Fund managers are paid based on a % of AUM. Hedge funds pay managers performance- related incentive fees plus a fixed fee Portfolio Protection Mutual funds are not able to effectively protect portfolios against declining markets other than by going into cash or by shorting a limited amount of stock index futures Hedge funds are often able to protect against declining markets by using various hedging strategies, and can generate positive returns even in declining markets. 10. DIFFRENCES Dependence on Markets The future performance of mutual funds depends on the direction of the equity markets. The future performance of many hedge fund strategies tends to be highly predictable and not dependent on the direction of the equity markets. 11. FACTS ABOUT HEDGE FUND INDUSTRY Estimated to be a $2 trillion dollar industry, with about 10,000 active hedge funds. Includes a variety of investment strategies, some of which use leverage and derivatives while others are more conservative and employ little or no leverage. Most hedge funds are highly specialized, relying on the specific expertise of the manager or management team. not dependent on the direction of the bond or equity markets unlike conventional equity or mutual funds (unit trusts). Hedge fund managers are generally highly professional, disciplined and diligent. 12. TOP HEDGE FUNDS OF 2013 13. CONCLUSION Hedge funds have a definite place in portfolios for both return enhancement and diversification. They do have some drawbacks that should be seriously considered during the portfolio construction process, but carefully selected hedge funds, or even hedge- fund-like strategies, are a great addition to any portfolio.