Beruflich Dokumente
Kultur Dokumente
by Alexander M. Ineichen
John Wiley & Sons 2002
514 pages
Focus
Leadership & Mgt.
Strategy
Take-Aways
Sociologist Alfred Winslow Jones set up the rst hedge fund in 1949.
Warren Buffett set up a fund that ts todays perception of a hedge fund in the 1950s.
Absolute return money managers play both the long and short side of the market.
Corporate Finance
Human Resources
Good hedge fund managers specialize. Analyzing their motivation and performance
is difcult.
Markets are never completely efcient, and active managers can beat them sometimes.
Arbitrage traders take offsetting positions in related instruments whose performance
is fairly predictable.
Market neutral strategies are a form of arbitrage that seeks to exploit market
inefciencies by holding roughly equivalent long and short positions.
Personal Finance
Rating
Overall
(10 is best)
Applicability
Innovation
Style
To purchase individual Abstracts, personal subscriptions or corporate solutions, visit our Web site at www.getAbstract.com
or call us at our U.S. ofce (954-359-4070) or Switzerland ofce (+41-41-367-5151). getAbstract is an Internet-based knowledge rating
service and publisher of book Abstracts. getAbstract maintains complete editorial responsibility for all parts of this Abstract. The respective
copyrights of authors and publishers are acknowledged. All rights reserved. No part of this abstract may be reproduced or transmitted
in any form or by any means, electronic, photocopying, or otherwise, without prior written permission of getAbstract Ltd (Switzerland).
Relevance
What You Will Learn
In this Abstract, you will learn: 1) The history and track record of hedge funds; 2)
All of the basic investment questions about hedge funds; and 3) Numerous possible
answers to each one.
Recommendation
Hedge funds burst into the headlines in the early 1990s, when George Soros became a
household name at least in Europe, where many people blamed him and his
hedge fund for wrecking the European exchange rate mechanism. Similarly, a U.S.
hedge fund called Long Term Capital Management (LTCM) began with an aura of
investing invincibility, only to fail dramatically. Hedge fund investing is sometimes,
but not always, high risk and high return. Once limited to a privileged elite group
of investors, hedge funds are now opening their rosters to less sophisticated, less
wealthy speculators. But hedge funds are not just like any other funds, and anyone
contemplating an investment needs a solid, comprehensive guide, such as this book.
Author Alexander M. Ineichen, neither a salesman nor an alarmist, pulls no punches
when discussing the risks of hedge funds. He is quite straightforward about the
sometimes astonishing success of some hedge fund managers, but careful to point out
the common misconceptions about them. Without hedging our bets, getAbstract.com
nds this book a valuable addition to every investors library.
Abstract
A Half Century of Hedge Fund History
The rst hedge fund made its debut in 1949, when sociologist Alfred Winslow Jones
started a general partnership, later changed to a limited partnership, to trade equities. In his
stock trades, Jones sometimes went long and sometimes sold short. Short sellers borrow a
stock and sell it, expecting to buy it back at a lower price and then return it to the lender.
Traders who go long expect the price to go up; those who sell short expect the price to
fall. Joness ability to prot both ways was extraordinary. Other hedge funds followed.
Dont lose money.
If you dont know
the facts, dont
play. I just wait
until there is
money around the
corner, and all I
have to do is go
over there and pick
it up.
In 1956, Warren Buffett established a partnership which resembled a hedge fund in most
ways; the difference was that Buffett did not sell short. From 1956 to 1969, his returns
were 29.5% compounded. Buffetts compensation depended on the funds performance.
His investors received a 6% return plus 75% of any prots above a 6% hurdle rate.
Buffett himself received 25% of prots above the 6% rate. Buffett was a contrarian, and
specialized in nding and buying stocks that he thought were undervalued. When the
market soared in the late 1960s, he couldnt nd enough undervalued stocks to practice his
traditional approach and he dissolved the partnership instead of changing his approach.
George Soros, another renowned hedge fund investor, may be even greater at it than
Buffett. His compound annual return from 1969 to 2001, after deducting fees, was
31.6%. During the rst decade of that period, the 1970s, only a few other, mostly small,
hedge funds were in the market. A handful of prominent money managers set up funds
during the 1980s, but hedge funds proliferated in the 1990s, as money managers left big
nancial institutions and set up shop on their own. Not only did hedge funds multiply
during this period, but a wide range of investment approaches appeared.
Absolute Returns
2 of 5
Irrespective of the
history of hedge
funds or whether
hedge funds are
leading or lagging
the establishment,
the pursuit of
absolute returns is
probably as old as
civilization and
trade itself. However, so is lemming-like trend
following.
Absolute Return
Most investment managers have some sort of benchmark. Many measure themselves against
the S&P 500 index, for example. If the index goes down, but their funds go down less, they
have succeeded. If their funds earn more value than the index, they have succeeded.
Absolute return managers do not measure themselves against an index. They aim to
make money no matter what the overall market is doing. They may use derivatives
and other tools or techniques to exploit a downward trend. They may go long or short.
Contrary to popular misconception, these managers are not cowboys. They tend to be
extremely conservative, and they often use sophisticated nancial instruments, not to
speculate, but to hedge. Their Ten Commandments are ten iterations of: Thou shalt not
lose. Absolute return managers are more sensitive to risk and more apt to manage it than
long-only investors.
The success of hedge funds in attracting new investors is rather surprising given their
generally negative press. Hedge funds are open to some justied criticism on several counts:
Magnitude Once hedge funds get really big, they have trouble delivering superior,
or even positive, returns.
Leverage Highly leveraged hedge funds have sometimes threatened the stability
of the entire nancial system. The most notable example was Long Term Capital
Management (LTCM).
Transparency Transparency allows third parties to monitor risk, but hedge funds
are quite secretive and it is difcult to know exactly what they are doing.
Stability of funding A run on the bank scenario can cause serious market disruption. Hedge funds need stable fund sources. Many LTCM trades were actually good
trades and might have scored if investors had not rushed to pull out their capital.
Pride As the proverb has it, pride goeth before a fall. Hedge fund managers need
a great deal of self-condence, because they receive rich compensation when they
are right. Being right made them managers in the rst place, and betting on their
convictions is a sine qua non of further success. Such condence can easily evolve
into arrogance and lead to disastrous missteps.
The top three hedge fund investment styles, measured by their outcomes in the third
quarter of 2001, were:
Equity Long/Short $228 billion in assets, roughly 46% of total hedge fund assets.
Event $108 billion, roughly 22% of total.
Macro, global $40 billion, 8% of total.
Absolute Returns
3 of 5
The average age of hedge funds has declined as more and more new hedge funds have
emerged. This means, of course, that evaluating and selecting good managers is getting
more difcult. The eld is so crowded that you may easily confuse luck with skill. Even
so, several myths about hedge funds should be debunked, including:
Hedge funds are high-risk investments In fact, any investment may be high-risk
when it is not diversied. Hedge funds are inherently no riskier than technology or
transportation stocks. Diversication is important in every case.
Hedge funds are gambles Although hedge funds speculate, they are not necessarily speculative. Every investment is a speculation, but hedge funds may be more protective of principal than other types of funds, precisely because they often hedge.
Hedge funds do great regardless of market moves In fact, like other investments,
hedge funds have good years and bad years.
Hedge funds always hedge Hedge fund managers choose when to hedge and when
not to, and take risks when they judge the risks to be good investments.
Short and long are opposites In fact, in an investing context, short and long are
not the mirror image of each other. Short positions have a different risk prole than
long positions and need to be handled with greater caution. However, most long/short
investors consider a pure long strategy to be quite speculative compared to a strategy
that balances long and short positions.
Hedge funds usually, but not always, outperform mutual funds in the aggregate. This
makes sense since most mutual funds cannot exploit a down market or defend against
one effectively. Hedge funds do not aim at a benchmark; by and large, the only measure
of hedge fund success is cash won in the markets. A good benchmark of hedge fund
performance is unlikely to be developed because such a metric would have to be:
Hedge fund styles are too diverse and idiosyncratic to t a benchmark. The best funds
do well because they are run by superlative risk managers. Investing in hedge funds has
disadvantages, most notably the relative absence of transparency. But fees seem to be
money well spent hedge funds are no costlier than other investments when the costs
are viewed in the context of performance. To some extent, hedge fund success ies in the
face of efcient market theory, but efcient market theory itself often ies in the face of
plainly observable facts.
Styles
Some of the main hedge fund styles include:
Convertible arbitrage Most managers in this area buy bonds, warrants or convertible bonds and hedge away the market exposure. A formula allows them to calculate
a fair value relationship between the stock and the convertible. When the convertible
is under-priced relative to the stock, they buy.
Fixed income arbitrage This school applies a similar arbitrage approach to bonds
and other xed income investments.
Market-neutral equity These funds aim to exploit inefciencies in the equity
market by holding roughly equivalent long and short positions. Managers take a statistical approach to historical price analysis to discern good potential trades.
Absolute Returns
4 of 5
A small, wellperforming fund
attracts assets.
Unlike mutual
funds, many absolute return strategies have limited
capacity.
Active funds
underperform
passive funds
because active
money management is more
costly than passive money management.
Some say hedge funds represent a paradigm shift in investing. Others suggest that hedge
funds are a bubble waiting to pop. The truth is probably somewhere between these
extremes. Hedge funds are neither extremely risky nor sure things. The most important
advice to prospective investors is to know what risk you are taking before you take it,
and if you arent sure, dont.
Buzz-Words
Absolute return / Arbitrage / Convertible / Emerging markets / Hedge fund / Hybrid
investments / Leverage / Market neutral / Stability / Transparency
Absolute Returns
5 of 5