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Hedge Fund Investing

Money and Markets — Mon, 26 Oct 2009 13:00:28 +0000

Hedge funds and the managers who run them have been getting a lot of publicity lately — and not of the flattering kind.

We have massive Ponzi schemes, equally massive losses and outsized systemic risks that are enough to frighten away even the hardiest of investors.

So before you leap, you need to look — carefully and deeply into this industry. When you do, however, you’ll also find that there’s a lot more to hedge funds than has been making it into the evening news …

Hedge funds are an integral part of our financial investment landscape. They often outperform the broad stock market by wide margins. Many are designed to make money in ANY market environment. And they are now more accessible to investors via a fast-growing new vehicle — funds of hedge funds.

This morning, I’ll give you a basic primer on hedge funds to help you decide if these unique investments are possibly right for you. And in the future, I’ll introduce you to specific funds — and strategies they use — for successful global investing.

What Are Hedge Funds?

The first hedge fund came out in 1949 as a strategy to neutralize the effect of overall market movements on a portfolio.

The strategy was simply to buy stocks that were expected to rise and selling short stocks expected to fall. The concept was to add BALANCE — to produce returns that were not market-dependent and tended to hedge a portfolio’s market exposure.

Nowadays, that has changed in a very fundamental way: Besides protecting a portfolio from downside risk, hedge funds often go for maximum return by deploying large amounts of leverage and investing in several asset classes among global markets.

Who Invests in Hedge Funds?

Hedge funds are private partnerships that are open to a limited number of investors, with qualification criteria determined by the SEC. To get into one, you’ll need to prove you have a net worth greater than $1 million and meet a minimum income requirement.

The reason for these stringent requirements is simple: The SEC feels that hedge funds are riskier and less transparent than mutual funds and most other investments.

Beyond high-net-worth individuals, institutional investors are also a dominant force behind the rising popularity of hedge funds. Two such groups are …

#1. Pension Funds

Unfortunately, U.S. corporate and government pension funds rarely have enough money in their kitty to cover all their expected future liabilities to their members. In fact, assuming the most likely future scenario, the expected shortfall is almost $1.5 trillion!

This is a major reason why pension fund managers have reached beyond traditional investment vehicles to seek outsized returns. And many fund managers think hedge funds are the best places to find them.

Estimates vary. But up to 20 percent of European and American pension funds — plus 40 percent of Japanese pensions — are believed to invest in hedge funds.

Two prime examples: As of January 2, 2009, the two largest government pension funds investing in hedge funds were the California Public Employees’ Retirement System with a total market value of $188 billion and the Ontario Teachers Pension Plan with $108 billion in net assets.

#2. Endowments

Endowments include colleges and universities as well as charitable institutions. And in the latest National Association of College and University Business Officers Endowment Study, hedge funds made up 18 percent of college and university portfolios on a dollar-weighted basis. This puts hedge funds second only to stocks (with a 48 percent allocation).

Additionally, the data reveals another not-so-surprising trend: The larger the institution, the higher the percentage of assets invested in hedge funds.

Even assuming no hanky-panky, the risks are clear. But don’t ignore …

Four Key Benefits Of
Investing in Hedge Funds

Benefit #1 — True diversification across multiple asset classes. Hedge funds operate in any and every asset class imaginable, from the traditional equities and bonds to currencies, commodities, real estate, and even fine art.

Benefit #2 —True global diversification. While most of the strategies used by hedge fund managers are concentrated in developed countries, there are funds focused on the emerging markets of Asia, Latin America, and Eastern Europe. I’m also seeing hedge funds foray into frontier markets — extremely underdeveloped markets of Africa and the Middle East.

Benefit #3 — Non-correlation with traditional investments. The instruments used by hedge funds are diverse. Hedge funds can utilize futures, swaps, and options. This allows them to produce returns that vary wildly from those of broad markets and more common investments.

Benefit #4 — The concept of absolute returns. Hedge funds exist to make money in any market environment. They’re not content to help you “lose less money than the averages.” They make their fees only if they give you a positive absolute return. This is a very powerful incentive. It’s backed by years of solid performance. And I think it’s the main reason the hedge fund industry has been attracting capital from all kinds of investors.

The following chart shows the annualized returns from 1997 to 2008 of various hedge fund strategies as compared to the S&P 500 index.

Among six of the most widely used hedge fund strategies, five have greatly outperformed the S&P 500 Index; only one fell short.

Clearly, if you are qualified for a hedge fund — or a fund of hedge funds — and you can gain the knowledge to help you avoid the pitfalls, this is not a track record you can afford to ignore.

Best regards,

Monty Agarwal
Money and Markets

This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

Don’t Expect The $68 Billion Pfizer-Wyeth Deal To Lift Merger Market

Money Morning — Mon, 02 Feb 2009 16:14:30 +0000

When Pfizer Inc. (PFE) unveiled a $68 billion buyout offer for U.S. rival Wyeth (WYE) last week, it sparked hopes that the deal might re-ignite the moribund merger market. But when the Wall Street dealmakers take a closer look, those flames will likely be doused in cold water.

For those rooting for a revival of buyout activity, the merger of the two companies shows that corporate predators are still on the prowl and adequate financing is still available for some big transactions.

But as Money Morning reported recently as part of its ongoing “Outlook 2009” economic forecasting series, the credit crisis has put the mergers-and-acquisitions (M&A) market into a deep freeze. And not even the marriage of these two U.S. pharmaceutical giants will be enough to thaw out the deal-making market anytime soon.

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Both the size of the deal and the players involved represent a unique combination of favorable financing terms and corporate balance sheets that not many other companies can match in the current economic climate.

Pfizer, a company with strong cash flow and lots of cash on its balance sheet, did get $22.5 billion in financing for the Wyeth buyout, but others are unlikely to get the same terms. The drug company has a rare, stellar "AAA" credit rating from Standard & Poor’s Inc. [Editor’s Note: For a related story that studies the problems associated with the Pfizer-Wyeth merger that appears elsewhere in today’s issue of Money Morning, please click here].

Furthermore, lenders are “favoring sectors where there is the most stability” in earnings and revenue outlooks, like health-care stocks as well as certain education and technology firms, Howard Lanser, an investment banker at R.W. Baird, told BusinessWeek.

Other sectors such as retail are currently out of favor and likely to stay that way, he said.

That makes a return to the heady days of the mid 2000s – when bountiful M&A activity lined the pockets of Wall Street investment bankers – an unlikely pipe dream.

The volume of global mergers and acquisitions could fall about 35% in 2009 from an expected volume of $3.1 trillion in 2008, investment bankers say. That would be less than half of last year’s record $4.4 trillion in deals.

"There are substantial headwinds facing M&A and the headwinds are not subsiding," Cary Kochman, co-head for Mergers and Acquisitions for the Americas at UBS AG (UBS), told the Reuters.

The No. 1 issue is the lack of available credit. Banks and other lenders have pulled back from financing deals, making loans, especially for big deals, scarce and more expensive.

“You are less likely to see deal sizes beyond the $20 billion mark in 2009,” said Larry Slaughter, co-head of European M&A for JPMorgan Chase & Co (JPM). “The balance-sheet capacity of the banking system will make it tough to finance much-bigger transactions.”

And fear is playing a close second fiddle to financing as a barrier to any revival of M&A activity. Most firms are holding onto any cash they have as insurance against a prolonged economic downturn.

"It takes a little courage to step forward and pursue M&A in this environment," Lanser says. "To spend that cash can be a big psychological hurdle."

Private Equity & Hedge Funds No Help

Even the so-called “masters of the M&A universe” – the leveraged buyout firms – are unlikely to ride to the rescue this time.

The Blackstone Group LP (BX), the No. 1 leveraged-buyout firm is staying on the sidelines searching for profits by advising companies in restructuring distressed debt.

The company that orchestrated a then record $34 billion acquisition of Equity Office Properties Trust in 2007 is playing a more modest role working consulting with AIG (AIG), as it sheds units worth about $60 billion to repay the government after its bailout last year.

Bankruptcies at investment banking’s most-hallowed companies like Bear Stearns and Lehman Bros Holdings Inc. (LEHMQ) obliterated the global financial system after buyout firms helped inflate the credit bubble. Now the private equity and hedge funds may be next to go, as LBO deal making enters the gravest crisis in its 40-year history.

Buyout firms such as KKR & Co. (KKR) and the Carlyle Group went on a record-breaking shopping spree in 2006-07, saddling themselves with $1.5 trillion in assets that they intended to sell for a profit. Since then, they haven’t been able to find buyers so they can reap the 20% profits they get for such deals.

“This is part of the biggest bubble to burst in our history.” Roy Smith, a former Goldman, Sachs & Co. (GS) partner told Bloomberg News.
As many as 40 of the biggest 100 companies may collapse by 2011 as their debt- strapped assets default, according to a 2008 report by Boston Consulting Group Inc.

“These guys had a sense they could do no wrong,” Paul Schaye, managing partner of New York-based Chestnut Hill Partners, told Bloomberg.. “ Now they’re going through a very sobering experience. They have to figure out how to survive this environment.”

So what will persuade dealmakers to take on added risk in such a gloomy environment? Turns out the the very things preventing consolidation now – the recession and credit crunch – could spark the revival Wall Street craves.

Only the Fit Survive

“There is going to be a need for a lot of companies to consolidate to survive,” Mark DeGennaro, managing director at investment bank Gruppo, Levey & Co. told Bloomberg. Firms with falling sales figures and credit trouble may have no choice but to find buyers – often at very low prices, he said.

Corporations with cash on their balance sheets or stronger share prices have been taking advantage of the drop in equity valuations among their rivals to do deals.

In fact, 2008 was marked by a jump in hostile or unsolicited deal activity, including InBev’s (ABI) planned acquisition of Anheuser-Busch Cos. Inc. (BUD) and Exelon Corp.’s (EXC) bid for NRG Energy Inc. (NRG).

And despite the obvious risks, some private equity firms will still dip their toes in the LBO waters.

“The best returns in private equity have come in a period like the one we’re just entering,” Blackstone founder Stephen A. Schwarzman said in a speech to investors and buyout firms in Dubai in October. “This is an absolute wonderful time.”

Another traditional provider of capital – sovereign wealth funds – may also step up to the plate.

“Even though the price of oil is volatile, they have substantial amounts of money…they need to get to work and generate a reasonable rate of return,” Alan Alpert Senior Partner of M&A Transaction Services at Deloitte Touche Tohmatsu told Boardmember.com. “I think you’ll see sovereign wealth funds come back into the U.S. market and make investments.”

By Don Miller
Money Morning

Hedge Funds Have Another $200 Billion to go to Complete Their “De-leveraging”

Money Morning — Tue, 25 Nov 2008 14:42:33 +0000

Hedge funds looking to slash their use of borrowed money may have to unload another $200 billion in assets to reach their objectives, a new study found, though a Money Morning expert believes the exit door could get pretty narrow should the holiday shopping season get off to a rocky start later this week.

Investors yanked $40 billion from the $1.5 trillion hedge fund industry in October, a month in which market losses slashed industry assets by an additional $115 billion, Hedge Fund Research Inc., reported. A new survey of hedge fund managers conducted by Sanford C. Bernstein & Co. LLC found that 63% said the sale of assets to cut leverage was at least half completed. Another 23% said the process was three-quarters complete.

To end this process – known in industry parlance as “de-leveraging” – “we estimate that roughly $200 billion will be additionally unwound,” Sanford C. Bernstein analyst Adam Parker wrote in a Nov. 21 report to clients.

Bernstein based its survey on interviews with managers of more than 65 hedge funds, with total assets of $100 billion. The interviews took place during the first two weeks of this month.

But retired hedge fund manager Shah Gilani, an editor for both Money Morning and the Trigger Event Strategist, says surveys as this one are often of limited use.

“Most hedge fund managers … are never going to tell you their positions,” Gilani says. “Never. It serves them no purpose whatsoever.”

Hedge funds are private investment funds that are open to a limited range of investors, largely because regulators allow them to pursue wider investment strategies and invest in a broader range of assets. In an effort to boost trading profits, they also use borrowed money, or leverage – a reality that more recently has forced them to dump assets to meet tighter lending requirements and to raise cash to fund client redemptions.

The amount of gross leverage used by hedge funds fell to 142% of assets from 175% in 2006 and 2007, Bloomberg News reported. Hedge funds have raised their cash holdings to an average of 31% of assets now, up substantially from the average of 7% in the previous two years, according to the survey.

This de-leveraging has caused losses in the U.S. stock-and-bond markets to snowball: The Standard & Poor’s Index 500 Index fell 38% this year through October, while hedge funds lost an average of 16%, according to data compiled by Hedge Fund Research Inc. At the end of last week, the S&P 500 was down 46% so far this year.

Some respondents said they expect this de-leveraging to continue as long as the Chicago Board Options Exchange Volatility Index, known as the VIX, remains elevated, Sanford C. Bernstein’s Parker said.

Of the hedge fund managers surveyed, 52% said the process of investor withdrawals is complete and that the transfers of money to clients will be done by the end of the first quarter, while 41% said they think half of redemptions are yet to come.

Clients putting in 30-day notices to withdraw their money for the end of December may be a catalyst for further de-leveraging, “a possible explanation for the recent steep sell-off,” Parker said.

But Gilani counsels investors to watch for retail sales reports from this Friday, the day after the Thanksgiving holiday – better-known as “Black Friday,” the unofficial start of the holiday shopping season. Analysts are projecting a poor shopping season, though the actual numerical estimates range from poor to downright dismal.

“If this traditional harbinger of the Christmas shopping season is, indeed, black, then the pummeling the markets will take from Monday morning’s sell-off will crystallize investors’ resolve to withdraw heavily in December,” Gilani says. “The potential implosion could be self-fulfilling as already-vulnerable retailers take it on the chin – with more than a few being forced seek bankruptcy protection.”

According to the survey, 42% of hedge funds use stock-market strategies, 25% use such “special-situation” events as mergers-and-acquisitions and spin-offs, 16% invest in emerging markets, 10% play fixed-income strategies, and 8% use a “macro” approach that invests in everything from commodities to stocks, the Bernstein survey found.

Not that the strategy really matters, Gilani said.

“It doesn’t matter where managers have been invested, the tide has taken all their holdings out to sea. The only players with sandcastles still standing in the Hamptons are those who have been massively short,” Gilani said. “Stocks … down; corporate bonds … down; oil …down; commodities…down; gold …down. [The markets have been so thoroughly pummeled that] it’s a bit like that old story about the fallen boxer, who’s down on the canvas and taking the 10-count. When his manager later asks him what happened, the boxer says: ‘You told me to wait ‘til the eight-count …[but] I looked up at the clock and it was only 7:30’.”

While the survey has focused on the important issue of de-leveraging, there’s another issue facing hedge funds that’s going to be a crucial issue for that industry to address in the not-too-distant future – source of funds, he said.

“Longer-term, what is even more insidious that no-one’s really talking about is that the source of funds that hedge funds use for their leverage, emanating from their banks and prime brokers, isn’t there. Period. No more Lehman (LEHMQ), no more Bear Stearns [now part of JP Morgan Chase & Co. (JPM)], and Morgan Stanley (MS) and Goldman Sachs Group Inc. (GS) are still de-leveraging. Do you think they’re going to give the money to failing hedge funds?”

By William Patalon III
Money Morning

Hedge Fund Job Tips

Richard Wilson — Fri, 21 Mar 2008 11:29:41 +0000

Hedge fund jobs are becoming harder to get as more MBA and PhD graduates target this niche of the investment industry upon graduation. While the job market within the hedge fund industry is becoming more competitive the truth is that every hedge fund is looking for something slightly different and if you do enough research almost anyone can find one that meets their skillset.

That said, below is a list of traits, experience and education that hedge funds do typically look for in candidates.

Quantitative experience and abilities

CFA Designation

Education – Ivy league, MBA, Quant focussed PhD

Signs of loyalty, passion, and being humble

Something extra such as PR expertise, asset gathering ability, or a source of information advantage

High quality names from your last few hedge fund jobs – large wirehouse experience

How much money did you personally bring in to the firm or make for the firm?

A stomach for a high commission/bonus structure

The Top 50 Most Useful Hedge Fund Websites

Richard Wilson — Thu, 20 Mar 2008 01:33:59 +0000

Hedge funds are now mentioned over 1,000 times a day via blogs, newspapers, magazines and television. There are now over 15,000 hedge fund managers and over 200 different portfolio management strategies used by them. Many people learn bits and pieces about hedge funds through the media but newspapers and magazines usually have agendas or editors who cover everything that happened in finance or investments with no real background in the hedge fund industry. Here are the top 50 hedge fund websites to help you learn more about hedge funds.

Richard C. Wilson
Hedge Fund Blog

Institutional Hedge Fund Investors

Richard Wilson — Tue, 19 Feb 2008 12:17:43 +0000

SEI recently completed a survey of institutional investors and their perspective on hedge funds. 100 institutions were surveyed and 47 were currently invested in hedge funds. Even the ones who were investing in hedge funds had extra due diligence steps to ensure that each allocation to a hedge fund manager is done in a deliberate and cautious fashion.

Top 5 Factors Institutional Investors Look For In Hedge Funds

Reporting & Transparency (85% of institutional hedge fund investors reported that they would not invest in a strategy they did not understand)
Institutional Quality Infrastructure and Operations (54% of institutional investors pointed out that better managed firms return higher performance)
People. Build stable hedge fund management teams at all levels
Shift away from focusing exclusively on performance to investment disciplines
Moderate to High Performance

The white paper where this information came from concludes by stating: The take-away message is that institutions clearly prefer to do business with institutional-style organizations,â€ concluded Schaeffer. â€œFor hedge funds, the challenge will be to fit the profile of an institutional-quality fund while preserving the performance attributes that attracted major investors in the first place.â€

by Richard Wilson, hedge fund consultant and writer

Top 5 Hedge Fund Myths

Richard Wilson — Fri, 01 Feb 2008 18:42:34 +0000

There was an interesting article posted over the weekend by the Business Times Online this week entitled “Hedge Fund Managers, Lords of Lucre.” The article discusses the general public’s view of hedge funds and how they make money. The journalist who wrote the article uses several extreme examples while depicting the hedge fund industry, this is part of why I write in this blog. There are a lot of aspects about the hedge fund industry that would be hard or nearly impossible to learn by reading mainstream media sources on the subject. To help answer the question about who hedge fund managers are here is a list of what is NOT true.

Most hedge fund managers are billionaires

It is very hard to get any job within the hedge fund industry

Hedge Funds aren’t performing as well as mutual funds or stock market indicies

The hedge fund industry in general is struggling and investors are most investors are taking their money out of these types of investments

Hedge Funds are risky investment vehicles

by Richard Wilson, hedge fund consultant and writer