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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What are the regulations regarding hedge funds in other countries besides the U.S.? - Healthcor Joseph Healey

Hedge funds have definitely gone global. While America is one of the “hubs” or financial centers for hedge funds and other types of investments, the international market has seen the lucrative promise of hedge funds, and jumped on board. Additionally, many Americans have seen the benefits of holding offshore hedge funds, and that brings an entirely new dimension to the subject of hedge fund regulation outside of the United States. With so many domestic individuals seeking international hedge funds because of their different laws and regulations, it can complicate matters.

Offshore hedge funds are perhaps the most popular “destination” for this type of investment. There are a few reasons for this; one is that there are no universal requirements for “accredited” investors as there is in the US. Another reason is the structure of offshore hedge funds themselves; they are structured as corporations/companies rather than limited partnerships. What this means for offshore hedge funds is that there is virtually no limit to the number of potential investors, whereas in America, there are strict regulations in place with regards to that. However, there is a “hang up” to Americans investing in offshore hedge funds – they are only legally permitted to do so if they have established offshore life insurance, or established an offshore trust. The popular offshore locations include the Cayman Islands, Dublin, Luxembourg, Bermuda, and more.

Singapore is fairly loosely regulated, especially in comparison to Hong Kong and other Asian financial centers. Smaller funds will continue to be able to operate without licensing even as their regulations and rules change. In Hong Kong, the regulatory structure of hedge funds is very similar to that of mutual funds. In India, the Securities and Exchange Board of India (SEBI) decided to place a ban on any investments made by unregulated companies/entities with participatory notes. 

The European Union is a big center for hedge funds, and they have their own set of rules and regulations. They are not too dissimilar to regulation within the United States, choosing to focus on the regulation of money managers. The FSA (Financial Services Authority) in the United Kingdom requires that fund managers register and become authorized, adhering to the FSA’s regulation. As there are many countries within the European Union, and each has their own set of regulatory laws, having cohesive legislation for the whole EU is difficult. However, with the passing of AIFMD, the EU is one step closer to being able to regulate hedge fund managers all across the board.

However, it should be noted that the Dodd-Frank Act from the US will affect overseas hedge fund investments. Any hedge funds with more than fifteen American investors, and with twenty-five million dollars or more, must register with SEC. Some international funds, especially in Asia, had already registered with the SEC prior to the act, but this act ushers in a whole new era of international hedge fund regulation.

It does seem as though there is a shift internationally to increase regulation on hedge funds, but thus far it has not been overwhelming.

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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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How are hedge funds structured? - Joseph Healy

No one hedge fund is structured like any other. There are a number of factors that come into play, mostly having to do with what state (or even country) the hedge fund is located in, the hedge fund manager’s practices, policies, and specific skill set, and of course the amount of money in the fund itself. Furthermore, the diversity of the investments in the hedge fund changes the structure of the hedge fund as well; a typical, well-managed portfolio has more than one type of investment at a time. In a way, hedge fund investments can be “mixed and matched” in order to achieve the best results. Investment managers can use a risk parity strategy with one investment, and on another use fixed income arbitrage, for example.

Typically, a hedge fund is comprised of an investor (either an individual or a company), and the investor enters into a partnership with the hedge fund money manager – or (when there are multiple parties) else enters into a company with the manager. Once established, the hedge fund company will make investments; this is the hands-on part of the partnership or company. The investor virtually has no role in the investment process, and is not nearly as involved in the decision making, business practices part of the hedge fund.

Other people may provide services in a hedge fund as well. These may include a distributor, who primarily markets the funds to investors; a prime broker, who do the majority of the work with lending money and securities; and an administrator, who handles the withdrawals and subscriptions of investors. This is a very basic outline of what various people within the hedge fund may do, and every hedge fund is different. A hedge fund never has any employees or assets other than the investments within the fund itself.

The taxation and regulation of hedge funds varies greatly depending on the location of the fund itself. For example, hedge funds in America are considered very loosely regulated (they typically do not have to report to SEC, for one). A lot of hedge fund companies take advantage of tax opportunities by establishing the fund in an offshore financial center, so that the investor pays taxes on the portfolio, and it doesn’t come out of the fund itself. However, despite many hedge funds being technically located offshore, a lot of investment managers are located onshore.

Legally, hedge funds are usually formed as limited partnerships, or limited liability companies. The general partner is the investment/money manager, and the limited partner(s) is the investor themselves. Hedge funds are considered private investments and are not held up to the same amount of regulation that other investments are. While hedge funds are often referred to as “unregulated,” the fact is that there is some regulation that has to take place by law – it is simply different than regulation for other types of investment. An example of how hedge fund regulation functions is that investors are heavily scrutinized and must meet certain criteria before being approved.

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