How are hedge funds structured? - Joseph Healey Healthcor

No one hedge fund resembles another, and the name of the game in today’s world of hedge fund investments is diversity. There are any number of strategies used with hedge funds, and many different types of investments to boot (everything from regular stocks and bonds to internet start-ups and currency). Let us not forget that hedge funds located outside of the United States function very differently from those within it! However, there are a few things about the structure of most hedge funds that everyone should know.

·         Hedge funds are private partnerships (or companies) between investors and skilled money managers. Investors do not make the investment decisions regarding the hedge fund portfolio; that is left up to the money manager. There are no assets or employees within the hedge fund – aside from, of course, the investments themselves.

• There are other roles within the hedge fund aside from investor and manager. These may include: administrator, prime broker, and distributor.
•  Depending on where the hedge fund is located, its legal status (including regulations and taxes) may differ greatly. In America, hedge funds are considered private investments and are therefore unregulated (although in some ways that is a misconception; there is indeed regulation for all kinds of investments, including hedge funds. The major difference is that in most cases the SEC does not regulate hedge funds). In offshore locations, the investor is required to pay fees, rather than the money coming from the fund itself. Taxes on offshore hedge funds are also paid out by the investment manager, according to how much they receive for managing the hedge fund.
•  Location really is a huge key to how hedge funds work. While many hedge funds may be technically located offshore, the majority of popular hedge fund managers can be found on shore, near financial hubs.
•  Most hedge funds are designed to be open ended. This means that investors can withdraw their money periodically from the fund, and also add money as time progresses. There may be a requirement for a minimum balance, and of course a requirement to open a hedge fund, but there are typically no other restrictions set on the balance amount. (Frequent withdrawals from hedge funds are not encouraged, however.)
•  Before redemption of the hedge fund, usually profits are not distributed to investors. The profits from hedge funds are typically arranged to be withdrawn either monthly, quarterly, annually, or bi-annually. Individual hedge funds may have specific policies about when money can be withdrawn from the hedge fund.

This was a brief outline of how hedge funds are structured and work. The reality of hedge funds is that they are complicated, diverse investment portfolios. As mentioned above, no hedge fund truly resembles another, even if the specialization of the investment(s) is similar, or if the strategies used are similar. A hedge fund located in New York is going to be very different from one located in London, and even two hedge funds both located in New York are going to be nearly unrecognizable from each other.

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Hedge fund trends 2012 - Joseph Healey

It may be beneficial for financial experts, and for investors and their money managers, to track hedge fund trends regularly. While the up and down nature of the financial market (even the hedge fund market, which promises absolute returns), it can be incredibly useful to analyze trends and attempt to see what will be happening in the future. The issue with trends, of course, is that they come and go, and with sometimes volatile hedge funds, they can do so very quickly. Still, here is a brief look at some of the most recent trends in the hedge fund market, looking specifically at the first quarter of 2012. 

By the nature of tracking trends, we must look back into 2011 to see what has changed – and what has carried over – from then. The most noticeable carry-over is the fact that bigger hedge fund investments seem to be doing the best. Smaller hedge funds are not seeing the same large returns, and in some cases may not be breaking even. Along with the continued asset rising of large funds, one of the trends that are noticeable in the first quarter of 2012 is the fact that hedge funds themselves are increasing. During the first three months of the new year alone, hedge funds increased by an average of over four and a half percent. 

Another trend that experts are keeping their eyes on is the fact that global investing is coming out on top. Emerging markets seem to be the place to invest, now, and it shows no signs of changing any time soon. Global funds saw great advances in assets during the first quarter of 2012 for sure.

Going back to performance in 2011 having an impact on 2012, it seems as though much of the positive performance seen now can be attributed to 2011. Net flow from 2011 that went to large funds made up one hundred and thirty-six percent.

While there have definitely been some “highs” in the trends of 2012 (and 2011), the fact is it wouldn’t be the investment market without a few lows. There have been some significant issues with some major hedge fund players; Paulson & Co has been having difficulty, and fell in 2001 from a summer month thirty-five billion (and change) to around twenty-eight billion in December. Paulson & Co are definitely not the only ones having trouble. 

Overall, the beginning of 2012 looks to be promising. With new capital pouring in to the hedge fund market, and the best performance the market has seen at the beginning of a year since way back in 2006, it seems as though hedge funds may be in for a great year. However, it is always important to keep tracking hedge fund trends, especially the negative ones. The wise investor or fund manager knows better than to trust calm waters for very long; things can, as mentioned before, change very quickly, and a complacent hedge fund is one that will see loss. Typically, hedge funds must be managed aggressively.

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Hedge fund indexes - Healthcor Joe Healey

A hedge fund index reflects the average performance of hedge funds and makes that information available to those who seek it out. It may be investable or non-investable (and, in such cases, purely informative rather than an investment opportunity), and hedge fund indices are quite different depending on which “method” is used to collect and analyze the data. This is a simplistic outline of the different types of hedge fund indices, how they work, and some of the issues that arise with using hedge fund indices in the first place.

First, the question of usability must be brought up. Many people argue that hedge fund indices are unsubstantiated, are prone to bias, and cannot be relied upon. It is true that much of hedge fund index information is self-reported by hedge fund companies, which can lead to a bias. As hedge funds are private investments, there is no central agency to which they must report, and that makes finding hedge funds willing to divulge their returns and performance problematic in many cases. Do not forget that hedge funds are incredibly diverse, as well, and that information on one hedge fund may not remotely resemble information on another. This can make it even more difficult to collate data on hedge fund performance in a cohesive way.

The first form of a hedge fund index is known to be a non-investable index. This type is the one most prone to self-selection bias, as all performance information gleaned from hedge funds was gotten voluntarily. A non-investable index tracks performance in a variety of ways, using mean, median, and weighted mean, and as such, any result from a database search may not match another. Some people still consider it a valuable tool – and any information is better than absolutely no information, in any case.

The second form is the investable index. The main difference is that investment portfolios are created by the index manager, and interested shareholders can invest in the portfolios (as long as they accept all of the terms set forth by the index provider). This creates a functioning investment opportunity, very similar to a hedge fund portfolio in and of itself.

Finally, there is hedge fund replication. This tracks the historical performance of hedge fund returns, and using the data discovered, creates models that illustrate how hedge fund returns will behave under different investment scenarios.This model is also turned into a portfolio that can be invested in. This is the newest of the three forms of hedge fund indices, and because of its newness, there are still questions as to how well this hedge fund replication index method will work in the long term. It is not yet known how accurate hedge fund replication may be in practice.

Despite the drawbacks to using any of the hedge fund indices, there are some definite bonuses. Financial experts (and money managers) are able to study the hedge fund market to better understand how it functions and changes, and can adjust their strategies accordingly.

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Controversies and debates about hedge funds - joe healy

Hedge funds have seen their share of debate and controversy over the years, but none so much as after the year 1998. That was when Long-Term Capital Management, a speculative hedge fund in Connecticut, failed and required bailout from other financial companies and institutions. The failure of LTCM, which had been using absolute return strategies, shook up the financial industry, and many were gravely concerned about the future of hedge funds. When information about LTCM’s practices, including evidence of tax avoidance, became public knowledge, the media, the general public, and even some of the financial sector were up in arms about ramifications to the hedge fund industry.

Some saw the collapse of Long-Term Capital Management, and their alleged illegal activities, as a sign of pending doom for many other hedge funds. The bailout, which was under the supervision of the Federal Reserve, ended up costing financial institutions over three and a half billion dollars – and it was a desperate measure to stop the rest of the financial market from experiencing difficulties. The ultimate losses of LTCM cost around four and a half billion dollars, and the hedge fund eventually went under in 2000. With such a huge scare, and such a huge bailout, there was great concern about systemic risk (the whole financial system failing). Any hedge funds who acted similarly to LTCM were considered, by some, to be at risk of failure. Multiple hedge funds requiring bailout to stave off systemic risk was a very real possibility at the time. However, LTCM was the major failure and the biggest bailout to date, and there has not been any systemic failure before or after LTCM.

The fear of systemic risk is far from the only criticism that hedge funds have seen. A major concern with critics is the fact that there is so little transparency required in hedge funds. For one, it makes it difficult to track average performance of hedge funds when so few comprehensively disclose information. For another, a lack of transparency can mean a bigger opportunity for fraud, and there have been several big cases of fraud in the last several years that critics cite as evidence that there should be more disclosure and more regulation. However, hedge funds remain private investments, and are not – in most circumstances – required to divulge information to a third party. There is also a concern of conflict of interest in cases where Americans do not use third parties to act as custodians or administrators of their funds; in some such cases of proven conflict of interest, there have been allegations of fraud and securities violations.

Hedge funds may be debated in the public realm, and may be occasionally subjected to new rules and regulations, but it remains fairly unregulated compared to other investment types. Unless hedge funds are some day no longer considered private investments, there is no sign of this changing in a major way. The SEC does investigate allegations of insider trading and other fraudulent activities when it can, but it is not as involved with hedge funds as many would prefer.

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What are the regulations regarding hedge funds in the United States? - Joseph Healy

While the average person might hear the word “unregulated” tossed around in regards to hedge funds inside of the United States, this is technically untrue. Yes, hedge funds are considered private investments, and therefore investors and hedge fund managers (either as partnerships or as a company) do not have to register with the SEC (Securities and Exchanges Commission). However, there are some exceptions to that rule, and most importantly, hedge funds cannot legally be fully unregulated.

First of all, some of the multiple exceptions to hedge funds not being required to report information to the Securities and Exchanges Commission include:

•  Even though a fund can have unlimited investors, if they number more than four hundred and ninety-nine in total, they must register their securities with the SEC, according to the Securities Exchange Act of 1934.
•  If a hedge fund wants to advertise or make public offerings, they must sell said offerings under the private offerings rule of SEC. This requires either filing a registration statement with SEC, or adversely following the private placement rules under the Securities Act of 1933.
•  If a hedge fund adviser who is registered with the SEC wishes to charge a performance or an incentive fee, all investors must meet the standards for qualification set forth by the Investment Advisers Act of 1940 Rule 205–3.

As for other regulation that hedge funds are subjected to, compliance with the SEC is only the beginning. One of the most efficient ways to keep track of hedge funds, and to try and keep a handle on potential fraud, is to make stringent rules for investors. Investors must meet a specific set of criterion (and some of this will vary depending upon state) before they can begin to invest. For example, investors who meet a qualified purchaser qualification will have five million dollars as a bare minimum in investment assets. An investment company would need a minimum of twenty-five million dollars in order to qualify. 

Even though the regulations for hedge funds are quite lax compared to some other types of investments – and keep in mind this is because hedge funds are considered private investments – they are indeed regulated. Fraud is a very real possibility in any investment scenario, and when such large sums are dealt with in hedge funds, schemes and fraud can occur and must be prevented. There have been several high profile cases of hedge fund schemes in the news over the last several years, and that has drawn both media and public attention onto the fact that hedge funds have a very unique regulatory status. In fact, there have been several attempts (mostly by the Securities and Exchanges Commission) to bring more regulation to hedge funds, including a rule change that required all hedge fund advisers to register under the Investment Advisers Act. This rule change was subsequently contested, overturned, and sent back to the SEC for review. Some are eager to regulate hedge funds, and some continue to hotly contest the practice.

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