Hedge Funds For Dummies (For Dummies (Business & Personal Finance))

Title Page
Copyright Page
Table of Contents
Introduction
About This Book
Conventions Used in This Book
What You’re Not to Read
Foolish Assumptions
How This Book Is Organized
Part 1: What Is a Hedge Fund, Anyway?
Part 2: Looking at Alternative Investment Strategies
Part 3: Determining Whether Alternative Investments Are Right For You
Part 4: Special Considerations Regarding Hedge Funds
Part 5: The Part of Tens
Icons Used in This Book
Beyond the Book
Where to Go from Here
A Final Note
Part 1 What Is a Hedge Fund, Anyway?
Chapter 1 Hedge Funds: Alternative Assets and Alternative Strategies
Defining Hedge Funds
Defining Alternative Strategies
Absolute-return strategies
Directional strategies
Introducing Some Basic Concepts
Alternative, to what?
Generating alpha
Hedging is at the heart of it
Identifying hedge funds: The long explanation
Little to no regulatory oversight
Aggressive investment strategies
Manager bonuses for performance
Biased performance data
Pledging the secret society: Getting hedge fund information
Meeting the People in Your Hedge Fund Neighborhood
Managers: Hedging for you
Lawyers: Following the rules
Consultants: Studying funds and advising investors
Advising investors
Monitoring performance
Marketing fund managers
Paying Fees in a Hedge Fund
Managing management fees
Shelling out your percentage of performance fees
Chapter 2 Not Just a Sleeping Aid: Analyzing SEC Registration
Looking at Securities Laws
Reviewing Regulation D
Accredited investors
Financial criteria
Professional criteria
What’s in it for the funds?
Having fun with 40 act funds
Exchange-traded funds make alternative mainstream
Traditional mutual funds take up alternative lifestyles
Getting to Know the SEC’s Stance on Hedge Fund Regulation
Realizing that “registered” doesn’t mean “approved”
Addressing registration at the state level
Going Coastal: Avoiding the Registration Debate through Offshore Funds
Investing in a Fund without Registration
Contracting the manager’s terms
Covering yourself with due diligence
Chapter 3 How to Buy into a Hedge Fund
Using Consultants and Brokers
Marketing to and for Hedge Fund Managers
Investor, Come on Down: Pricing Funds
Calculating net asset value
Valuing illiquid securities
Managing side pockets
Purchasing Your Stake in the Fund
Fulfilling paperwork requirements
Working with brokers
Reporting to the taxman
Signing Your Name on the Bottom Line
Drawing up the contract
Addressing typical contract provisions
Finding room for negotiation
Chapter 4 Using Hedge-Fund Strategies without the Hedge Funds
A Diversified Portfolio Is a Hedged Portfolio
A slow-and-steady strategy works over the long run . . .
. . . But some investors want to hit a home run NOW
Reducing your diversification
Diversification into riskier assets
Exploring Your Expanding Asset Universe
Rounding up the usual asset alternatives
International stock
Foreign currencies
Commodities
Other assets you may not have considered
Your human capital
Residential real estate
Structuring a Hedge-Filled Portfolio
Recognizing natural hedges
Doing the math
Matching cash flows
Portfolio optimization
Utilizing Margin and Leverage in Your Accounts
Derivatives for leverage and hedging
Options
Futures
Short-selling as a hedging and leverage strategy
More leverage! Other sources of borrowed funds
Hedge Fund Strategies in Mutual Funds and ETFs
Bear funds
Inverse Funds
Leveraged Funds
Long-short mutual funds
Mutual fund of funds
Chapter 5 Hedging through Research and Asset Selection
First Things First: Examining Your Asset Options
Sticking to basics: Traditional asset classes
Taking stock in stocks
Any bonds today?
Surveying cash and equivalents
Going for some flavor: Alternative assets
Real estate
Commodities
Venture capital
Derivatives
Opting for an option play
Warrants and convertible bonds
Betting your future on futures
Forward (not backward!)
Swaps
Custom products and private deals
Mezzanine financing
Payment-in-kind bonds
Tranches
Viaticals and Payments
Kicking the Tires: Fundamental Research
Top-down analysis
A microeconomic approach
A macroeconomic approach
Secular versus cyclical trends
Demographics
Bottom-up analysis
Focusing on finances: Accounting research
Gnawing on the numbers: Quantitative research
Reading the charts: Technical analysis
How a Hedge Fund Puts Research Findings to Work
The long story: Buying appreciating assets
Buying low, selling high
Trading for the short term
Holding for the long term
The short story: Selling depreciating assets
Protecting long positions
Investment shorts (unlike the shorts you can’t get rid of)
Fraud shorts (nope, not Capri pants)
Naked shorts (excuse the oxymoron)
Part 2 Looking at Alternative Strategies
Chapter 6 Calculating Investment Risk and Return
Market Efficiency and You, the Hedge Fund Investor
Why efficiency matters
Perusing profitable inefficiencies
Efficiency and the random walk
Using the Modern (Markowitz) Portfolio Theory (MPT)
So what’s risky?
Reviewing risk types in the MPT
Distributing risk
Hunting long-tail risk
Focusing on fat-tail risk
Determining the market rate of return
Beta: Ranking market return
Doing the beta math
Math’s great, but what does beta mean?
A different approach with alternative beta
Alpha: Return beyond standard deviation
The Arbitrage Pricing Theory (APT): Expanding the MPT
Discovering How Interest Rates Affect the Investment Climate
Seeing what goes into an interest rate
Compensation for the use of the money
Risk of repayment
Inflation
Deflation
Relating interest rates and hedge funds
Witnessing the power of compound interest
Investing Irrationally: Behavioral Finance
Examining the principles of behavioral finance
Using quick and easy rules: Heuristics
Harnessing the power of presentation: Framing
Battling inefficiency: Pricing anomalies
Applying behavioral finance to hedge funds
Chapter 7 Buying Low, Selling High: Using Arbitrage in Hedge Funds
Putting Arbitrage to Good Use
Understanding arbitrage and market efficiency
Factoring transaction costs into arbitrage
Pitting true arbitrage versus risk arbitrage
Cracking Open the Arbitrageur’s Toolbox
Drawing upon derivatives
Using leverage
Short-selling
Synthetic securities
Flipping through the Rolodex of Arbitrage Types
Capital structure arbitrage
Convertible arbitrage
Fixed-income arbitrage
Index arbitrage
Liquidation arbitrage
Merger arbitrage
Option arbitrage
Pairs trading
Scalping
Statistical arbitrage
Warrant arbitrage
Chapter 8 Short-Selling, Leveraging, and Other Equity Strategies
Short-Selling versus Leveraging: A Brief Overview
Strutting in the Equity Style Show
Trying on a large cap
Fitting for a small cap
Investing according to growth and GARP
Swooping in on lowly equities with value investing
Keeping options open for special-style situations
Market Neutrality: Taking the Market out of Hedge Fund Performance
Being beta neutral
Establishing dollar neutrality
Staying sector neutral
Rebalancing a Portfolio
Long-Short Funds
Making Market Calls
Investing with event-driven bets
Taking advantage of market timing
Putting the Power of Leverage to Use
Buying on margin
Gaining return with other forms of borrowing
Chapter 9 Observing How Hedge Funds Profit from the Corporate Life Cycle
Examining the Corporate Structure (And How Hedge Funds Enter the Picture)
Observing the relationship between owners and managers
Pitting business skills versus investment skills
Management decisions versus investment decisions
Hedge funds as business managers
From to Ventures to Vultures: Participating in Corporate Life Cycles
Identifying venture capital and private equity as hedge fund investments
Project finance: Are hedge funds replacing banks?
Borrowing
Lending
Gaining return from company mergers and acquisitions
Leveraged (management) buyouts
Buyout funds
Bridge lending
Merger arbitrage
Investing in troubled and dying companies with vulture funds
Hostile takeovers
Liquidation arbitrage
Activist investing
Proxy battles
Chapter 10 Macro Funds: Looking for Global Trends
Fathoming Macroeconomics
Focusing on fiscal policy
Making moves with monetary policy
Governments with too much money
Governments with too little money
Money is more than currency
Non-currency money and interest rates
Taking Special Issues for Macro Funds into Consideration
Diversified, yes. Riskless, no.
Global financial expertise
Subadvisers
The multinational conundrum
Widening or Narrowing Your Macro Scope
Coming to terms with currencies
Trading currencies
Exchange rate regimes
Determining exchange rates
Interest-rate parity
Purchasing-power parity
The International Fisher Effect
Contemplating commodities
Financing
Speculating
Part 3 Determining Whether Alternative Investments Are Right for You
Chapter 11 Fitting Alternatives into a Portfolio
Assaying Asset Allocations
Matching goals to money
Chasing return versus allocating assets
Using Hedge Funds as an Asset Class
How hedge funds are assets
Absolute return funds
Directional funds
Diversification, risk, and return: How the asset pros and cons play out
Viewing a Hedge Fund as an Overlay
Considering the overlay pros and cons
Investment reporting: An overlay example
Mixing and Matching Your Funds
Looking for excess capital under the couch cushions
Taking different funds to the dressing room
Absolute return funds or directional funds?
What type of investment strategy?
Working without transparency
How much disclosure do you need?
How much disclosure can you demand?
Chapter 12 Examining How Hedge Funds Are Structured
Exploring the Uneven Relationships between Fund Partners
General partners: Controlling the fund
Limited partners: Investing in the fund
Only Accredited or Qualified Investors Need Apply
Which kind of investor are you?
Accredited investor
Why do hedge fund investors need to be accredited?
Do funds really check up on you?
Do I have alternatives if I don’t qualify?
Using hedge fund strategies within a small portfolio
Finding ETFs and mutual funds that use hedge fund strategies
Following the Cash Flow within a Hedge Fund
Waiting for withdrawals and distributions
Regular payment distributions
Extraordinary distributions
A liquidation with no sale: Closing the fund
Fee, Fi, Fo, Cha-Ching! Paying the Fees Associated with Hedge Funds
Management fees
Sales charges
Performance fees
Redemption fees
Commissions
Dealing with the Hedge Fund Manager
Making time for meetings
Communicating with the written word
Seeking Alternatives to Hedge Funds
Making mutual funds and ETFs work for you
Profiting from pooled accounts
Entering individually managed accounts
Individual money manager
Brokerage discretionary account
Family offices
Chapter 13 But Will You Make Money? Evaluating Hedge Fund Performance
Measuring a Hedge Fund’s Risk and Return
Reviewing the return
Time-weighted returns
Dollar-weighted returns
Gross of fees
Net of fees
Sizing up the risk
Standard deviation
Beta
Peak-to-trough ranges
Stress tests
Value at risk
Benchmarks for Evaluating a Fund’s Risk and Return
Looking into indexes
Market-capitalization-weighted index
Price-weighted index
Differing results for different indexes
Picking over peer rankings
Standardizing performance calculation: Global Investment Performance Standards
Putting Risk and Return into Context with Academic Measures
Sharpe measure
Treynor measure
Jensen’s alpha
The appraisal ratio
Serving Yourself with a Reality Check on Hedge Fund Returns
Risk and return tradeoff
Survivor bias
Performance persistence
Style persistence
Hiring a Reporting Service to Track Hedge Fund Performance
Backstop BarclayHedge
eVestment
Hedge Fund Research
Morningstar
Refinitiv
Van
Chapter 14 You Want Your Money When? Balancing Time and Liquidity
Considering Your Cash Needs
Like Dollars through the Hourglass: Determining Your Time Horizon
Taking stock of temporary funds
Fathoming matched assets and liability
Peeking into permanent funds
Poring Over Your Principal Needs
Handling Liquidity After You Make Your Initial Investment
Taking advantage of additional investments
Knowing when (and how) you can withdraw funds
Receiving distributions
Income
Returns of capital
Moving on after disbandment
Chapter 15 Taxes, Responsibilities, Transparency, and Other Investment Considerations
Taxing You, the Hedge Fund Investor (Hey, It’s Better than Death!)
Making sense of capital-gains taxes
Taxing ordinary income
Exercising your right to be exempt
Identifying qualified plans
Getting the gist of foundations and endowments
Figuring Out Your Fiduciary Responsibility
Coming to terms with common law
Tackling trust law
Uniform Management of Institutional Funds Act (UMIFA)
Employee Retirement Income Security Act (ERISA) of 1972
Transparency in Hedge Funds: Rare but There
Appraising positions
Interpreting risk
Avoiding window dressing
Considering the Environment, Society, and Governance
Part 4 Special Considerations Regarding Hedge Funds
Chapter 16 Hooking onto Other Types of Hedge Funds
Multi-Strategy Funds: Pursuing a Range of Investment Strategies
Determining the strategies
Dividing in-house responsibilities
Scoping the pitfalls of working with a broad portfolio
Funds of Funds: Investing in a Variety of Hedge Funds
Surveying fund of funds types
Multi-strategy funds of funds
Multi-manager funds of funds
Highlighting the advantages of funds of funds
Acknowledging the problems with funds of funds
Multiple funds, multiple fees
Graduated performance fees
Negotiating with the hedge fund manager
Advancing to funds of funds of funds (I’m not making this up!)
Hedge Funds by Any Other Name
Entering Mutual Funds That Hedge
Chapter 17 Hiring a Consultant to Help You with Hedge Funds
Who Consultants Work For
What Do Consultants Do (Besides Consult)?
Analyzing performance
Determining your investment objectives
Putting a hedge fund manger under the microscope
Optimizing your portfolio
Managing a Request for Proposal (RFP)
Consultants and funds of funds
Hunting for the Hedge Fund Grail: A Qualified Consultant
Following recommendations and referrals
Performing another round of due diligence
Managing Conflicts of Interest
Compensating Consultants for Their Services
Hard-dollar consultants
A la carte consulting
Retainers
Soft-dollar consultants
Hedge Funds Pay the Consultants, Too
Chapter 18 Doing Due Diligence on a Hedge Fund
Why Do Due Diligence?
Becoming Your Own Magnum, I.I.: Investment Investigator
First things first: Knowing what to ask
Interviewing the hedge fund manager
Poring over fund literature
Picking up the phone
Searching Internet databases
Seeking help from service providers
More assistance with due diligence
What Are You Gonna Do When the Hedge Fund Does Due Diligence on YOU!
Knowing the Limits of Due Diligence
Part 5 The Part of Tens
Chapter 19 Ten (Plus One) Big Myths about Hedge Funds
A Hedge Fund Is Like a Mutual Fund with Better Returns
Hedge Funds Are Asset Classes That Should Be in Diversified Portfolios
Alpha Is Real and Easy to Find
A Fund That Identifies an Exotic and Effective Strategy Is Set Forever
Hedge Funds Are Risky
Hedge Funds Hedge Risk
The Hedge Fund Industry Is Secretive and Mysterious
The Hedge Fund Industry Loves Exotic Securities
Hedge Funds Are Sure-Fire Ways to Make Money
Hedge Funds Are Only for the “Big Guys”
All Hedge Fund Managers Are Brilliant
Chapter 20 Ten Good Reasons to Invest in a Hedge Fund
Helping You Reduce Risk
Helping You Weather Market Conditions
Increasing Your Total Diversification
Increasing Your Absolute Return
Increasing Returns for Tax-Exempt Investors
Helping Smooth Out Returns
Giving You Access to Broad Asset Categories
Exploiting Market Inefficiencies Quickly
Fund Managers Tend to Be the Savviest Investors on the Street
Incentives for Hedge Fund Managers Are Aligned with Your Needs
Index
EULA