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Credit Suisse / Tremont Hedge Fund Benchmark Performance Index
Barclay Hedge Fund Index
Eurekahedge Asian Hedge Fund Index
Originally, additional financial instruments (for instance, Options) were used to "hedge" a portfolio of strictly equity securities or fixed income securities, resulting in a "hedged" fund that had some protection (market neutral) depending on which direction individual stocks or the broader market moved, or which direction interest rates moved.
However, Hedge Funds, or Managed Funds or Alternative Investments, have really become to be designed to invest in several asset classes simultaneously and result in a total portfolio of investments that would still prosper as various markets changed over time. Overall, hedge funds have the ability to be flexible: to go both short and long, use leverage (borrowing directly or using margin accounts (to increase investment size beyond what would be capable from initial investment / share purchases), and utilize derivative instruments. However, there are many funds that are very conservatively designed and use no leverage at all.
In the United States, the fund structure is usually a private investment limited partnership with the Fund Manager being the General Partner. Originally, as per the Investment Company Act of 1940, Section 3(c)(1) the hedge fund is opened to a maximum of 99 "sophisticated" investors (a net worth in excess of USD$1 million and annual income for the past two years has been in excess of USD$200,000), or the investor is a qualified institution, thus avoiding SEC regulations. The net worth of the individual investor was revised as per the terms of Investment Company Act of 1996, Section 3(c)(7), such that the individul investor must now be a "Qualified Purchaser" with a net worth in excess of USD$5 million. Many hedge funds do have minimum investment guidelines and a share redemption prohibition, thus they are normally potrayed as being structured as only for wealthy investors. In addition, some are domiciled in offshore tax havens and are not open to investment by United States citizens.
The hedge fund industry is still largely unregulated. Research conducted by the SEC in September 2003, intially indicated that the agency would request that hedge fund managers / advisors now register with the SEC as per the Investment Advisers Act of 1940 (required of asset managers) and also be subject to periodic examinations. If an offshore fund has more than 14 U.S. investors it will have to register with the SEC. Presently, all hedge fund managers located in Europe must be registered with the respective national securities regulator of the nation they are located in.
Hedge funds have a professional manager / management team that charge a management fee (based on the total amount of assets under management) and a percentage of the net annual profits (Incentive fee or Performance fee). The Manager usually has discretionary authority to move in and out of investments without the prior authorization of investors as long as the investment is determined to fit a predetermined criteria. Some well known hedge funds have been purposefully designed to make macroeconomic, speculative and leveraged bets on market directions. The standard compensation within the hedge fund industry is 1.0% to 2.0% managment fee (2.0% of the amount of total assets under management during a specific period) and 20.0% of the positive earnings / gains / return on the assets that the funde manager has selected. If a fund has a loss in a given year then the manager must first pass what is known as a high watermark (the investors' principal plus invested earnings equal the same amount prior to the loss) before the fund manager can begin to share in the gains again. For instance, if the fund declines by 10% in one year then the next year the fund must first have a positive return of 15.0% before the fund manager earns 20.0% of the subsequent gain in asset value / earnings. In a bad year, such as 2008, it is not uncommon for the fund manager to reduce the standard compensation to 1.6% management fee and 15.0% to 18.0% share in the fund's gain. In a very bad year, it is not uncommon for a fund to return principal to investors rather than attempt to try and earn one's way back as a large fund has analysts, traders and administrative personnel that have to be paid and those wages come from the fund's annual positive performance.
Hedge funds cannot perform all of the functions they need to do on their own thus they are usually closely assisted by prime brokerages, which includes providing financing, securities lending, trade clearing, cash management accounts, back office accounting and custody.
A fund can be correlated to a specific market, commodity or follow its own proprietary strategy based on the experience and specialization of the Manager and the purpose of the fund.
Agressive Growth: a fund management strategy that invests in equities (both listed, exchange traded and private placement) of companies (both domestic and overseas) in certain industry sectors that will experience strong growth due economic conditions.
Arbitrage: a fund managment strategy that will attempt to identify correlating investments in order to have offsetting positions in a particular market, industry sector or commidity.
Distressed Securities (Vulture) Fund: a fund management strategy that invests in the securities (equities and discounted debt) of corporations that may have performed well in the past but are presently in reorganization or are perhaps considering Chapter 11 bankruptcy protection. The bet is that the company is a "fallen angel" that can make a strong comeback.
Emerging Markets: a fund management strategy that invests in securies (equity and debt, both listed and exchange traded and private placement) of nations or corporations in rapidly developing economies.
Fund of funds: an investment fund that invests in other hedge funds, mutual funds and asset securitizations instead of individual securities, as a way to achieve diversification. Allocations are made on the principle of non-correlating performance. The fund's Manager usually charge a management fee and a percentage of the net annual profits (performance fee) on top of the fees that the funds they invest in also charge.
Global Macro: a fund management strategy that trades (actually un-hedged) on directional estimates of interest rates or currency exchange rates.
LBO: an investment fund that provides financing / investment in long-term acquisitions and spin-offs, management-led spin-offs.
Managed Futures: futures contracts as an actual asset class allocation in a portfolio. This strategy is utilized by a Commodity Trading Advisor (CTA), a fund that primarily invests in commodity futures contracts. CTAs are regulated by the Commodity Futures Trading Commission and the National Futures Association
Multi-Strategy fund: invests in individual stocks and bonds and make use of exchange traded futures and options and make limited use of OTC products, other than for currency markets. Invests in derivatives and underlying asset classes to increase return and manage risk through diversification by investing in low or slightly negative correlation of asset classes, diverse investment styles and on-going risk monitoring.
Overlay: operating in the futures, options and forward markets for tactical asset allocation, currency and options strategies. Also known as a alpha strategy.
Hedge fund database (not every fund has a public / public accessible website).
