Investment options through Hedge Fund

By

Nirmoy Dey

Geo George

Megha C R

Ashim Mandal

Meenu Maria

Tanveer Ahmed

Vinoth K.

• "Today, if asked to define a hedge fund, I suspect most folks would characterize it as a highly speculative vehicle for unwitting fat cats and careless financial institutions to lose their shirts.“

– Mario Gabelli, hedge fund manager

What is hedge fund?

• Hedge funds are private investment funds used primarily by wealthy individuals and institutions to accomplish aggressive investing goals.  

• A hedge fund is a fund that can take both long and short positions, use arbitrage, buy and sell undervalued securities, trade options or bonds, and invest in almost any opportunity in any market where it foresees impressive gains at reduced risk.

• 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.

Evolution of Hedge Fund

• Alfred Winslow Jones is credited with creating the first hedge fund in the year 1949 when he combined a leveraged long stock position with a portfolio of short stock positions.

• Investors in Jones' relatively unknown fund enjoyed large returns and outperformed all other mutual funds of that era.

• This style of investment management exploded in

popularity in the late twentieth century with the arrival of derivatives.

Key Characteristics of Hedge Funds

• Hedge funds utilize a variety of financial instruments to reduce risk, enhance returns and minimize the correlation with equity and bond markets. Many hedge funds are flexible in their investment options (can use short selling, leverage, derivatives such as puts, calls, options, futures, etc.).

• Hedge funds vary enormously in terms of investment returns, volatility and risk• Many hedge funds have the ability to deliver non-market correlated returns. • Many hedge funds have as an objective consistency of returns and capital

preservation rather than magnitude of returns. • Most hedge funds are managed by experienced investment professionals who are

generally disciplined and diligent. • Pension funds, endowments, insurance companies, private banks and high net worth

individuals and families invest in hedge funds to minimize overall portfolio volatility and enhance returns.

• Most hedge fund managers are highly specialized and trade only within their area of expertise and competitive advantage.

• Hedge funds benefit by heavily weighting hedge fund managers’ remuneration towards performance incentives, thus attracting the best brains in the investment business. In addition, hedge fund managers usually have their own money invested in their fund.

Features of hedge fund

• Minimum investment amount is very high such as $250000 to $10 million

• Exempt from many rules and governance which are related to Mutual fund, pension funds and insurance companies

• Maximum no of investors per fund is 100• Investors in a hedge fund pay a management fee in

between 1 and 2 percent• Hedge funds also collect a percentage of the profits, usually

20 percent

Benefits of Hedge Funds

• 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. • 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.

How hedge fund is ditributed?

Hedge funds Vs Mutual funds

• Most mutual funds invest in a predefined style , performance compared with some sector or index and relative performance is considered

• Mutual funds make only buy sell decisions

• Profit in bull market, loss in bear market

• In contrast hedge fund seeks absolute returns irrespective of index performance

• hedge fund engages in more aggressive strategies and positions, such as short selling, trading in derivative instruments like options and using leverages (borrowing) to enhance the risk/reward profile.

• Profit in both bull and bear market

Similarity :(1) they are pooled investment vehicles (i.e. several investors

entrust their money to a manager) and (2) they invest in publicly traded securities.

Differences:

Parameters for hedge fund strategy

1. Investment returns,

2. Volatility, and

3. Risk

Strategies Adopted By Hedge Fund

• Equity Market Neutral:

Minimizes inherent securities market risks by combining an array of long and short sales within the same industry, market, country, etc. that offset one another against the market.

It creates a hedge against market factors.

• Convertible Arbitrage:

Strategy that involves purchasing a portfolio of convertible securities, generally convertible bonds.

Hedging a portion of the equity risk by selling short the underlying common stock. When a stock declines, the associated convertible bond will decline less, because it is

protected by its value as a fixed-income instrument and it pays interest periodically.

• Fixed-Income arbitrage: Assumes opposing positions in the market to take advantage of small price

discrepancies while limiting interest rate risk Profit from principal appreciation and interest income. Most common fixed-income arbitrage strategy is swap-spread arbitrage.

• Managed Futures: Investments depending on the manager's view of the economic or market

outlook. Managers profit from large up and down movements using both long and short

positions, resulting in returns similar to that of a straddle. Straddle is composed of buying a put and call option on the same investment &

the gain is directly related to the volatility of the investment. The more investments fluctuates, the higher the return and vice versa.

• Dedicated Shorts: Sells securities short in anticipation of being able to re-buy them at a future

date at a lower price. Managers asses investment options based on his or her opinion of the

overvaluation of securities, the market. Used as a hedge to offset long-only portfolios and by those who feel the market

is approaching a bearish cycle.

• Global Macro: This does not focus on individual companies but rather focus primarily on profiting

from shifts in global trends. A fund may be long or short in various international stock indexes and currencies,

and at the same time attempting to take advantage of assets that are miss-priced relative to global alternatives.

Example of emerging market strategy whereby a hedge fund invests in developing countries with less mature financial markets, usually in equities.

• Event Driven: Also known as “Special Situation” or “Special Opportunity” strategies. Invest in companies that are expecting a large impact on the price of the stock over

a short period of time. Tries to capitalize on the changing prices of stocks caused by events such as

corporate restructuring, stock buybacks, bond upgrades, expected earnings surprises, and any other reason a company's stock price may change.

E.g. “distressed securities” – A hedge fund would wait for an impending reorganization or bankruptcy of a company.

“Risk (Merger) Arbitrage ”-the hedge fund simultaneously buys a company that is being acquired and sells the short the stock of the acquirer.

The investment philosophy of “Fair Value Capital” in Indian market is Event Driven.

Hedge Funds in India

• HFG India Continuum Fund - focused on India’s aerospace, defense, homeland security and other strategic sectors, New York based firm

• Avatar Investment Management - Headquartered in Mauritius, the funds are focussed on the Indian public and private equity markets

• India Deep Value Fund –Focussed on Indian capital and real estate markets

• Fair value - Fair Value Capital is a highly specialized and exclusive Investment Advisory Firm focused on Deep Value Investment opportunities primarily in Indian equity markets

• Indea Capital Pte Ltd  - a Singapore based investment advisor• India Capital Fund - Mauritius based• Monsoon Capital Equity Value Fund - Mauritius based• Karma Capital Management, LLC• Atyant Capital • Atlantis India Opportunities Fund

Some facts about Indian Hedge Funds

• India-focused hedge funds ranked among world's top performers

• The Eurekahedge Indian Hedge Fund Index returned over 5% in the first eight months of 2010 vis-à-vis 2% gains by benchmark Sensex in the same period.

• The $15bn FoHF portfolio of London-based hedge fund giant Man Group, for example, is 10-15% exposed to emerging markets and 1% exposed to India.

• Indian hedge fund industry has grown 30% this year while India focused hedge funds have increased 7% in September alone

Thank You