83. Hedge Fund

Merger Arbitrage Funds

• Commonly short the acquirer's stock
• Simultaneously purchase the stock of the firm being acquired

Equity Hedge Fund Strategies: Short Bias

• Focuses on profiting from short positions in overvalued equities
• These funds can hold long equity positions
• Typically maintains a net short exposure to the market

Fundamental Growth Strategy

• Seeks shares of companies with rapid revenue and earnings growth
• Aims for significant capital appreciation through investments in high-growth companies

Hedge Fund Strategies and Long Bias

• Convertible bond arbitrage aims to be market neutral to exploit mispricing
• Fundamental long/short strategies take long positions in undervalued companies and short stocks or an index
• Distressed/restructuring strategies tend to be long biased, investing in discounted debt of companies in or near bankruptcy

Hedge Fund Performance Evaluation

• Evaluated on a risk-adjusted return basis
• This is due to their strategies generating high risk-adjusted returns from market inefficiency or volatility
• Traditional benchmarks are difficult to apply
• Hedge fund indexes may overstate performance due to survivorship and backfill bias

Relative Value Hedge Fund Strategies

• Convertible arbitrage is a relative value strategy
• Market neutral is an equity hedge strategy
• Merger arbitrage is an event driven strategy

Separately Managed Accounts (SMA) for Hedge Fund Investment

• Least likely used for efficient capital allocation
• Benefits of an SMA include:
  • More customizable portfolio
  • Investor-specific investment mandates
  • Better transparency
  • Efficient capital allocation
  • Higher liquidity
  • Enhanced investor control
  • Lower fees
• Drawbacks of an SMA include:
  • Operational complexity
  • Higher governance oversight
  • Less manager incentive

Hedge Fund Redemption: Notice Period

• The time a fund has after receiving a redemption request to fulfill it
• Lockup period is the minimum time before an investor can redeem shares or make withdrawals

Selection Bias in Hedge Fund Index Creation

• Selection bias occurs when funds are inconsistently allocated to an index
• Removing a fund after it stops reporting introduces survivorship bias
• Including a fund only after successful performance introduces backfill bias

Hedge Fund Structures

• Typically structured as a limited partnership or limited liability company
• The general partner or managing member acts as the fund manager

Hedge Fund Terms: Side Letter

• A side letter addresses terms specific to an individual investor (not the fund in general)
• Can supersede the fund's offering documents
• The terms are generally stated in a private placement memorandum, partnership agreement, or the articles of incorporation

Hedge Fund Notice Period Defined

• The period following a request for redemption of shares
• It is the time within which the fund must fulfill the request

Hedge Fund Characteristics

• Hedge funds are privately held and available to qualified or accredited investors
• Hedge funds are lightly regulated and can pursue a wide variety of strategies.
• Risk can be higher because they use leverage and derivatives.

Hedge Fund Index Biases and Performance Overestimation

• Backfill bias and survivorship bias are most likely to overestimate performance
• Survivorship bias eliminates funds that no longer report
• Backfill bias includes new funds after successful performance

Hedge Fund Performance Comparison

• The fund with the highest coefficient of variation has the best risk-adjusted annual performance
• The coefficient of variation measures returns adjusted for the level of risk
• Standard deviation measures risk, and alpha is a measure of return