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Sapienza Università di Roma

Sapienza Università di Roma. International Banking Lecture Five Hedge Funds Prof. G. Vento. Agenda. Introduction to hedge funds Hedge Funds Characteristics Investment Strategies Adoptable by Hedge Funds Legal aspects The Risks Investing in a Hedge Fund

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Sapienza Università di Roma

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  1. Sapienza Università di Roma International Banking Lecture Five Hedge Funds Prof. G. Vento

  2. Agenda • Introduction to hedge funds • Hedge Funds Characteristics • Investment Strategies Adoptable by Hedge Funds • Legal aspects • The Risks Investing in a Hedge Fund • Hedge Funds in the world and in Italy Prof. G.Vento - March 2013

  3. HedgeFunds: Anintroduction • A hedge funds is an investment fund open to a limited range of investors that is permitted by regulators to undertake a wider range of activities than other investment funds. • Hedge funds pay a performance fee to its investment manager. • Hedge funds as a class invest in a broad range of investments extending over shares, debt, commodities, etc. • They use a variety of methods, most notably short selling, in order to increase return. Prof. G.Vento - March 2013

  4. Some Definition of Hedge Funds • “ A mutual fund that use the leverage and different hedging technique”(George Soros) • “A limited partnership, which the general partner is paid in relationship at the profits of the fund”(Michael Steinhardt) • “A limited partnership or a Off-shore investment corporation…”(Republic of New York Securities hedge fund Selection and Evaluation Group) Prof. G.Vento - March 2013

  5. Hedge Funds Characteristics • Hedge funds were little known before the late 1980s. The first funds were started by traders with significant experience in trading for mutual funds, currency desks, or proprietary trading firms. • They are typically open to a limited range of professional or wealthy investors. • Hedge funds experienced dramatic growth during the 1990s, increasing in number from fewer than 2,000 in the late 1980s to over 8,000 in recent years. • HFs have managed around $2.5 trillion at its peak in the summer 2008. Prof. G.Vento - March 2013

  6. Investment Strategies Adoptable by Hedge Funds • There are different investment strategies, highly heterogeneous: • Hedging: the original nature of these funds was to cover or protect against the risk associated with the investments done, exploiting, at the same time, the opportunities offered by the market. • Short selling: the selling of securities of which are not currently available. • Leverage: Hedge funds may borrow the fund necessary to invest in new securities. Prof. G.Vento - March 2013

  7. Fees in a HedgeFund A hedge fund manager will typically receive both a management fee and a performance fee. • Performance fee: it represents the most significative part of the remuneration of the fund manager (usually 20% of the profits exceeding the benchmark to defined in the contract). • fixed management fee(usually 1-2% of the fund’s net asset value each year). • High performance fees align the interest of the manager and investor more closely than flat fees do. Prof. G.Vento - March 2013

  8. Legal Aspects 1/3 • Differences between Hedge Funds Onshore(typology of contract: Limited Partnership) and Hedge Funds Offshore (typology of contract Investment Corporation). • The first are funds originated in the USA or in the origin’s countries; the seconds are funds originated in tax heaven countries. Prof. G.Vento - March 2013

  9. Legal aspects 2/3 Structure of a Limited Partnership Source: Joseph G. Nicholas, Investire negli Hedge Funds. Strategia per i nuovi mercati, Egea, Milano, 2000 Prof. G.Vento - March 2013

  10. Legal Aspects 3/3 Structure of a Offshore Investment Corporation Source: Joseph G. Nicholas, Investire negli Hedge Funds. Strategia per i nuovi mercati, Egea, Milano, 2000 Prof. G.Vento - March 2013

  11. Organization of a Hedge Fund • Fund Manager: he is the person or the group that design the investment strategies (in U.S. is said General Partner). • Fund Administrator: only in the offshore funds. • Custodian: it is the bank that owns the fund’s assets and control the capital flows. • Broker: it performs the transactions disposed by the fund manager. • Sponsor: it’s a optional role, that keep the relationship with the clientele. Prof. G.Vento - March 2013

  12. The Documents 1/2 There are minimum 3 documents to be produced in order to entry in a hedge fund: • Offering document: it includes general information, such as: typology of securities in the hedge fund, the goals and the policies of the investment, the experience of the fund manager, the commissions, the minimum amount of the investment, the risk of the investment, etc. The offering documents provides by offshore funds usually have a lower transparency standard than those of onshore funds. Prof. G.Vento - March 2013

  13. The Documents 2/2 2.Partnership agreement: it’s the contract stipulated by the investor, through witch he acquires the condition of limited partner. This document highlights the rights and duties of the different shareholders. In case of offshore funds, this contract is not included, because they assume the form of Joint stock companies and the capital is divided in stocks. 3. Underwriting agreement: it is the instrument through which the investor can become shareholder of the limited partnership. This document is also required in case of offshore funds. Prof. G.Vento - March 2013

  14. The Prime Brokerage • It is a particular and innovative role created thanks to the development of the hedge funds. • The prime broker is a corporation that offers services of clearing and custody which goes beyond the services offered by a usual depository bank.. • By the time, there is only one financial intermediary which offers services of clearing & settlement, custody, as well as performs transactions. It’s possible to distinguish 3 roles: • prime broker o clearing firm; • executing broker; • the customer, typically a hedge fund. Prof. G.Vento - March 2013

  15. The Risks Investing in a Hedge Fund 1/2 • It is often said that the hedge funds are most hazardous that the traditional funds. This is because the hedge funds to use speculative strategies. • It is possible to identify different typologies of risk, such as: • wrong investment; • the fund obtains a performance lower than expected; • value decrease in the portfolio managed by the fund; • leverage; • frauds; • low transparency. Prof. G.Vento - March 2013

  16. The Risks Investing in a Hedge Fund 2/2 • A strong assessment of the risks in the investment strategy is based on some fundamental steps, that include the study of: • people, • process, • portfolio construction, • performance, • partnership details. Prof. G.Vento - March 2013

  17. DifferencebetweenHedgeFund and Open-Ended Mutual Funds 1/2 Legal differences: • The market. The open-ended mutual funds are addressed to the generalized public savings, whereas the hedge funds make reserved offers. • Regulation and disclosure: in U.S. the hedge funds are exempted from SEC registration; this is a significative advantage compared to the open-ended mutual funds, which are highly regulated. • Fees: a mutual fund manager usually receives a flat fee, whereas a hedge fund manager obtain about 20% of the profit. In the second case the manager is more motivated to better manage the portfolio. Prof. G.Vento - March 2013

  18. Differencebetweenhedgefund and open-endend mutual funds 2/2 • The open-ended mutual funds are more liquid and flexible that the hedge funds. Operative Differences: • The open-ended mutual funds assume a long term position. The hedge fund, on the other hand, are characterized for long and short positions and for the use of different cover techniques. • The hedge funds have an higher flexibility and freedom compared to the open-ended mutual funds. • Limited leverage in the open-ended mutual funds. • Performance measurement frequency. Daily performance assessment for the open-ended funds and monthly assessment for the hedge fund. Prof. G.Vento - March 2013

  19. Fund’s Value • The fund’s value is calculated through the net asset value (NAV). Given the complexity of calculation, usually the hedge funds calculate the NAV monthly. • Hedge funds are not forced to fulfill any reporting standard. Thus, the only guarantee for the investor is to asks to the prime broker the monthly statement of the fund’s operations. • Lock up: the investment cannot be withdrawn before a certain period. Prof. G.Vento - March 2013

  20. Portfolio Effects of Hedge Fund Investments • Hedge funds typically have a slightly lower return and a significantly lower volatility than traditional investment funds. • When the risk of an investment falls faster that the return, the investment can provide a higher return for each unit of risk incurred. • This means that most hedge funds offer a risk/reward relationship that is significantly more attractive than most stock market investments. Prof. G.Vento - March 2013

  21. The Hedge Funds in the World Souce: Black, K., Managing a Hedge Fund, McGraw-Hill, 2004 Prof. G.Vento - March 2013

  22. The Hedge Funds in Italy • SGR (Sociatà di gestione del risparmio) can create hedge funds in Italy • Bank of Italy’s Rule 20/09/1999 • Max 200 investors; minimum € 500,000. Prof. G.Vento - March 2013

  23. Next Lecture The Sovereign Wealth Funds (SWFs) Prof. G.Vento - March 2013

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