Hedge fund investing: a practical approach to understanding investor motivation, manager profits, and fund performance

355 Pages·2016·4.93 MB·English

by  Mirabile, Kevin

Hedge Fund
Investing
Founded in 1807, John Wiley & Sons is the oldest independent publishing
company in the United States. With offices in North America, Europe,
Australia and Asia, Wiley is globally committed to developing and marketing
print and electronic products and services for our customers’ professional
and personal knowledge and understanding.
The Wiley Finance series contains books written specifically for finance
and investment professionals as well as sophisticated individual investors
and their financial advisors. Book topics range from portfolio management to
e-commerce, risk management, financial engineering, valuation and financial
instrument analysis, as well as much more.
For a list of available titles, visit our website at www.WileyFinance.com.
Hedge Fund
Investing
A Practical Approach
to Understanding Investor
Motivation, Manager Profits,
and Fund Performance
Second Edition
KEviN R. MiRABilE
Cover image: (top) © Rawpixel / Shutterstock; (bottom) © isak55 / Shutterstock
Cover design: Wiley
Copyright © 2016 by John Wiley & Sons, inc. All rights reserved.
Published by John Wiley & Sons, inc., Hoboken, New Jersey.
Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted
in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or
otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright
Act, without either the prior written permission of the Publisher, or authorization through
payment of the appropriate per-copy fee to the Copyright Clearance Center, inc., 222
Rosewood Drive, Danvers, MA 01923, [phone], fax [phone], or on the Web
at www.copyright.com. Requests to the Publisher for permission should be addressed to the
Permissions Department, John Wiley & Sons, inc., 111 River Street, Hoboken, NJ 07030,
[phone], fax [phone], or online at www.wiley.com/go/permissions.
limit of liability/Disclaimer of Warranty: While the publisher and author have used their
best efforts in preparing this book, they make no representations or warranties with respect
to the accuracy or completeness of the contents of this book and specifically disclaim any
implied warranties of merchantability or fitness for a particular purpose. No warranty may
be created or extended by sales representatives or written sales materials. The advice and
strategies contained herein may not be suitable for your situation. You should consult with a
professional where appropriate. Neither the publisher nor author shall be liable for any loss
of profit or any other commercial damages, including but not limited to special, incidental,
consequential, or other damages.
For general information on our other products and services or for technical support, please
contact our Customer Care Department within the United States at [phone], outside
the United States at [phone], or fax [phone].
Wiley publishes in a variety of print and electronic formats and by print-on-demand. Some
material included with standard print versions of this book may not be included in e-books or
in print-on-demand. if this book refers to media such as a CD or DvD that is not included in
the version you purchased, you may download this material at http://booksupport.wiley.com.
For more information about Wiley products, visit www.wiley.com.
iSBN 978-1-119-21035-1 (Hardcover)
iSBN 978-1-119-21039-9 (ePDF)
iSBN 978-1-119-21037-5 (ePub)
Printed in the United States of America.
This book is dedicated to my wife, Maureen,
and my children, Sarah, Andrew, and Will.
Contents
Preface ix
Acknowledgments xiii
About the Author xv
PArt One
Overview
ChAPter 1
the Basics of hedge Fund Investing 3
ChAPter 2
hedge Fund Strategies, Performance Measurement, and risk 21
ChAPter 3
Who Invests in hedge Funds and Why? 39
ChAPter 4
Industry trends, Flows, and Characteristics 65
PArt tWO
Understanding the Strategies
ChAPter 5
Global Macro Investing 87
ChAPter 6
equity-Oriented Styles 109
vii
viii Contents
ChAPter 7
Fixed-Income–Oriented Strategies 143
ChAPter 8
Multistrategy Funds, Funds of hedge Funds, and replication Products 173
ChAPter 9
Portfolio Financing and Secondary Market trading 191
PArt three
evaluating Individual Fund risk and reward
ChAPter 10
Measuring Performance and Performance Persistence 213
ChAPter 11
Impact of Fund Characteristics and terms on Performance 233
ChAPter 12
Performing Due Diligence on Specific Managers and Funds 247
ChAPter 13
evaluating the roles of Service Providers 271
ChAPter 14
Observations and Outlook 299
Glossary 309
references and Additional reading 319
Index 335
Preface
This book is designed to provide an overview of alternative investments
and, in particular, instill in readers a working knowledge of that portion
of alternative investments known as hedge fund investing.
The second edition of this book includes important updates related to
industry flows and performance, plus new material covering the exciting
new world of hedged mutual funds, secondary trading in hedge fund invest-
ments, and more information about the various techniques and instruments
used by hedge fund managers to finance their portfolios.
The original motivation to write this book was to deliver a holistic view
of hedge fund investing. That has not changed. The intention was to provide
a cradle‐to‐grave perspective for first‐time investors, for practitioners deal-
ing with hedge funds as clients or counterparties, and for students wishing
to learn how the sector operates from both a theoretical and a practical per-
spective. My personal experiences as a banker, accountant, service provider,
investor, and partner in a hedge fund and a fund of hedge funds allows me
to deliver some practical insights that I believe will facilitate learning.
The goal for this second edition is to once again present a comprehensive
view of the reasons people invest in the sector, discuss how the managers,
funds, and strategies interact, and recommend criteria people can use to se-
lect managers and funds—all without getting lost in too much detail. The
approach is to cover a wide range of material in sufficient detail to familiarize
readers with the issues, without getting lost in the multitude of regulations
and mathematics needed to fully investigate any single topic. The hope is that
by “keeping it simple” readers will learn enough about the asset class and the
process of investing to give them confidence to move forward with asking the
questions needed to become a great investor. Importantly, one of the goals
for this book, if not its primary goal, is to make the asset class accessible and
to demystify what is at times presented as an overly complex and esoteric
category of investing. My approach is to deliver a balanced discussion of the
broad spectrum of information needed to invest in hedge funds; however, it
is inevitable that certain sections garner more emphasis than others.
The vast majority of information in this text comes from my personal
experience in providing services to, trading with, lending to, or investing
in hedge funds over the past 25 years. It also includes the advice and input
ix
x Preface
of former colleagues and friends in the industry who share my interest in
promoting educational efforts about hedge fund investing. It is only through
education that the myths of hedge fund investing can be debunked and the
opportunities can be assessed objectively. In this way, more people can reap
the rewards and benefits of hedge fund investing while also fully under-
standing the risks of this exciting asset class.
The book is designed for those who have a basic knowledge of financial
instruments, markets, asset allocation, and portfolio management. A rudi-
mentary knowledge of statistics and some of the basic principles of calculus
is also helpful, although not a requirement.
The book is organized into three parts related to basic concepts and market
characteristics, an explanation of the individual strategies and financing tools
used by hedge fund managers, and an overview of the process needed for the
evaluation and analysis of individual managers and funds, including approaches
to performing a due diligence process on any one fund. Each chapter has its
own individual objectives and illustrations that can be read on their own or as
part of the complete text.
Part One of the book provides readers with an overview of alterna-
tive investments. It highlights the similarities and differences among various
types of alternatives, including hedge funds. It establishes the framework
for understanding fund‐level profit or loss calculations, performance mea-
surement, and risk. It also provides readers with an understanding of the
rationale for investing in hedge funds as well as the flows experienced by
the sector over time.
Part Two is designed to explore several of the most prominent hedge
fund investing strategies in more detail. It provides straightforward expla-
nations of the important terms, definitions, trades, organization structures,
portfolio constructions, performance measurements, and risk assessments
used in each strategy. Strategies are organized into those that are not directly
correlated to the traditional stock and bond market, those that are equity
or fixed‐income oriented, and those that are multistrategy in nature. It also
includes new sections on the financing market and the secondary market for
trading in hedge fund investments.
Part Three explores the nature of absolute, relative, and risk‐adjusted
performance measures; the impact of fund characteristics related to com-
pensation arrangements; fund terms; and environmental conditions that
motivate behavior and influence performance. This section also covers the
due diligence process for selecting a single hedge fund for investment from
a universe of peers. Topics covered include how to quickly assess and evalu-
ate the people, pedigree, and processes that establish the DNA of any fund;
understanding the investment and risk management process of a fund; the
impact of the fund’s business model and counterparty risk on the fund’s
Preface xi
performance and sustainability; and the role of a fund’s service providers
in creating opportunities for a fund, influencing a fund’s performance, or
protecting investors from fraud, blowups, or other calamities.
The book ends with some final observations, a review of the challenges
faced by the industry today, and the outlook or trends that are likely to
continue going forward.
This book can be used by commercial practitioners on a stand‐alone
basis or by educators in conjunction with supplemental material available
online that includes PowerPoint slides, Excel spreadsheets, end‐of‐chapter
discussion questions, and a test bank of over 100 questions. Educators can
download the test bank and other learning tools at Wiley’s Instructor Site.