[...]... in hedge funds, investors need a clear understanding of what a hedge fund is, what it is not, and how it works (See Table 1. 1.) 1 2 HEDGES ON HEDGE FUNDS TABLE 1. 1 Overall Objectives of Alternative Investments • • • • • • Preservation of captial Wealth accumulation/growth Management of risk and volatility Enhanced returns Low correlation/diversification Access to strategies unavailable to traditional... with at least a $5 million liquid net worth (See Table 1. 2.) Securities laws also regulate how hedge funds may obtain assets Hedge funds are not allowed to engage in any form of public solicitation of funds but can acquire funds only through means of completely private introductions or existing relationships The thinking behind TABLE 1. 2 Traditional versus Hedge Funds Traditional Performance objectives... Exploitation of macroeconomic trends One-way speculation on future movements Combine L/S equity and bonds to reduce market exposure and isolate performance while managing portfolio risk Exploit unrealized value Transaction and time-driven Exploit pricing inefficiences Neutralize L/S positions Minimize directional effect Focus Non Directional Directional Non Non (Non)/ Directional Seeks consistency... “retailization” of hedge funds, funds that formerly were available only to the world’s richest individuals Although hedge funds are not yet sold at the corner bank branch or ATM, that is not beyond the realm of possibility The industry continues to experience exponential growth with studies predicting $4 trillion in hedge fund assets by 2 010 —up from close to $800 billion in 2004 (See Figure P .1. ) Because hedge. .. according to ratio of funds and strategy Very high Medium to high Low Low Volatility Low No to negative Variable Low Low Correlationb 7 High 3 :1 to 5 :1 Low 2 :1 or less Low 2 :1 or less Variable 2 :1 5 :1 Low-moderate Relative Value/Market Neutral Event Driven Equity Hedge (L/S) Global Macro (Tactical) Fund of Hedge Funds Stock diversification and long term stabilization of returns Seeks preservation of capital... 19 50s 19 80s • 19 49: Alfred W Jones & Co investment model • 19 70s & 19 80s: gradual growth estimated at $40B: • George Soros • Barton Biggs • Warren Buffet • Michael Steinhardt STRONG GROWTH EXPLOSIVE GROWTH 2000 & Beyond 19 90s • Growth drivers: • Financial market conditions • Estimated 7,000+ hedge funds worldwide • Educated investor & media attention • Estimated $800B in assets • Increased supply of hedge. .. shows Unfortunately, most investors do not really understand hedge funds or how they differ from traditional stock and bond investments One of the common comments is that hedge funds are risky, a belief fueled by misconceptions and a lack of understanding in the area For instance, the very meaning of hedge implies reducing risk Hedge funds continue to spark the curiosity of investors, yet with that... speculative hedge T xiii xiv PREFACE A Number of Hedge Funds (Growth from 19 91 2003) 7,500* 7,000 6,000 5,000 4,000 3,000 2,000 1, 000 0 ’ 91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’ 01 ’02 ’03 B Hedge Fund Assets (Growth from 19 90–2003) 2003: 2003 – +$70B +$70B inflows* inflows* $700 $600 $700– $700$800B* $800B* $500 $400 $300 $200 $10 0 $0 ’90 ’ 91 ’92 ’93 ’94 ’95 ’96 ’97 ’98 ’99 ’00 ’ 01 ’02 ’03 FIGURE P .1 The... have never materialized T xxi Hedges on Hedge Funds CHAPTER 1 CHAPTER 1 The Hedge Fund Alternative SUCCESSFUL INVESTING REQUIRES KNOWLEDGE The first step in being a successful investor in hedge funds or other types of investments is getting in the driver’s seat and learning everything you can about timely opportunities and how they mesh with your objectives Cruising along, pursuing the same investment... subject of hedge fund marketing as part of its ongoing review of hedge funds; investors may see changes to these rules in the coming years Another significant defining attribute of hedge funds deals with the fees charged In contrast to traditional long-only investment managers, most hedge fund managers charge their clients an incentive fee in addition to a standard management fee The most common fee structure . Sector 14 3 CHAPTER 11 The Expansion of European Hedge Funds 15 1 CHAPTER 12 The Dynamic World of Asian Hedge Funds 16 7 CHAPTER 13 Hedge Fund Indices: In Search of a Benchmark 18 7 GLOSSARY 19 9 ABOUT. www.WileyFinance.com. ffirs _hedges. qxd 8/30/04 11 :53 AM Page ii Hedges on Hedge Funds How to Successfully Analyze and Select an Investment JAMES R. HEDGES IV John Wiley & Sons, Inc. ffirs _hedges. qxd 8/30/04 11 :53. 8 7 6 5 4 3 2 1 ffirs _hedges. qxd 8/30/04 11 :53 AM Page iv To Lundy, Evans, and Malone ffirs _hedges. qxd 8/30/04 11 :53 AM Page v ffirs _hedges. qxd 8/30/04 11 :53 AM Page vi Contents Foreword ix Preface