Fundamentals of Hedge Funds

September 14, 2021 67 0

Fundamentals of Hedge Funds, Exploring the core concepts, inner workings, calculations and activities in hedge funds.

WHY HEDGE FUNDS?

Hedge funds are one of the most profitable types of alternative assets.

However, they are not easy to comprehend.

Fund structures, investment strategies, provisions and fees, and other elements.

And unfortunately, it’s hard to find a course that covers the essentials of hedge funds.

So it becomes common for a student to:

Not be able to discern among the different investment strategies;
Not know if the provisions negotiated with an investor are helpful to the fund, or not at all;
Not know which people in a hedge fund perform which tasks;
Not master the different investment techniques, especially those with subtle differences (such as arbitrage plays);

So, how do we address this?

PUTTING THE “EDGE” IN HEDGE

TBD

THE PERFECT COURSE… FOR WHOM?

This course is, naturally, targeted at people who are interested in the functioning of hedge funds.

More specifically, it targets:

Aspiring (or current) asset management professionals, including traders that want to start their own fund;
Professionals in other areas of high finance that are considering hedge fund positions;
Professionals interested in the inner workings and processes of hedge funds;
Professionals interested in the performance and risk measures used in hedge funds;
Anyone looking to know more about hedge funds!

LET ME TELL YOU… EVERYTHING

Some people – including me – love to know what they’re getting in a package.

And by this, I mean, EVERYTHING that is in the package.

So, here is a list of everything that this course covers:

What makes a hedge fund, including being a class of alternative asset, being open-end instead of closed-end, charging a performance fee/incentive fee, and using exclusive techniques such as short selling, leverage or derivatives (like options, futures or ETFs);
Myths surrounding hedge funds, related to their secrecy, whether they hedge positions or not, their use of leverage, and their obscene returns;
Comparing hedge funds with mutual funds, in terms of structure, presence or absence of a performance fee, liquidity, and others;
Comparing hedge funds and other classes of alternative assets, in terms of structure, being open-end or closed-end funds, as well as expected allocator liquidity;
An overview of the key players in a fund, both internal and external;
The investment team, composed of traders, PMs, and analysts, and how they perform different tasks including idea generation, generating an investment thesis from an idea, and actually putting capital to work;
The fundraising and Investor Relations team, including activities such as fund marketing and selling a fund, negotiating provisions and agreements, and dealing with nervous or angry allocators that may want to redeem their capital;
The fund executives – usually CIO (Chief Investment Officer) or COO (Chief Operational Officer), that may be fund partners (usually GPs), or external, and what they focus on;
What prime brokerages (a.k.a. prime brokers or “primes”) perform, in terms of bridging hedge funds and financial marketings, including performing, clearing and settling trades, but also other services such as extending leverage or performing capital introductions;
Fund administrators and their functions, running operations and calculating performance metrics, among others, and fund custodians, taking custody of the assets – both for added investor protection;
Fund lawyers, which are usually essential to establish the fund’s legal entities and negotiate provisions with investors – both in a standardised LPA (Limited Partnership Agreement) but also custom provisions in side letters, as well as fund accountants, which usually perform spend analysis and investment analysis, creating third-party audited performance records, which are essential to investors;
An overview of the four main hedge fund strategies – equity, event-driven, macro and relative value/arbitrage;
Equity plays and how they work through the directional movement of equity prices, including quantitative approaches, long or short plays, and based on fundamental growth or fundamental value, in possible sectors or geographies;
The possible net market exposures of equity funds, which can be “net long”, market neutral or “net short”;
Event-driven plays, relying on either anticipating or causing a major change in a company’s lifetime;
How activist investing works, by owning a small share of a company and then presenting a plan for change to the board of shareholders;
How merger arbitrage works, by owning shares in two companies before a merger;
How private issue and Regulation D investments work, by owning private securities of a company that are usually less expensive than the public securities;
How distressed debt works, by investing in ailing companies and profiting from their recovery;
How macro plays work, by consolidating global tendencies in specific trades, usually in commodities or currencies;
How both systematic and discretionary macro plays are performed, including managed futures accounts, CTAs, or other formats;
How carry trades work, by performing yield arbitrage on a currency pair in order to obtain daily interest besides profiting from the price convergence;
How relative value (or arbitrage) plays work, by exploiting price discrepancies either for one single security, or in a pair of securities (where one is underpriced, and the other one is overpriced);
Other forms of hedge fund strategies, including multistrategy funds, which combine multiple strategies, which dilute both excess returns and losses, and Funds of Funds (FoFs), which have higher overhead, but can present investors with diversification and access to exclusive, high-performing managers;
Some measures of return calculations in a fund, including the nominal return, the annualized return (returns standardised for a yearly period), and compounding return, with different compounding rates;
Measures of returns adjusted for risk, including alpha, the Sharpe Ratio, the Sortino Ratio and the Treynor Ratio (which use different variations of risk, including standard deviation, downside deviation, or the market beta or undiversified risk);
Sources of risk in hedge funds, including the three main layers (market risk, secondary risk and idiosyncratic risk);
The six main types of market risks (equities, credit rates, interest rates, commodities, currencies, real estate);
Sources of risk unique to hedge funds including leverage, liquidity, position concentration, client concentration, counterparties, and more;
How leverage works (both borrowing leverage and notional leverage), as well as how to calculate levered risk;
How liquidity risk occurs, both by trading illiquid securities, but also by holding large positions (even in liquid instruments);
Some metrics and indicators for risk in hedge funds, including the famous (infamous?) VaR – Value at Risk, as well as its shortcomings, including lack of estimation outside the confidence level. Other measures of risk including standard deviation, downside deviation, largest loss and largest losing month, months to earn back losses or ratio of winning to losing months;