What should I name my Hedge Fund?
For start-up hedge fund managers, finding the right name for the hedge fund and management company can be very difficult. You want to be able to convey the message with your name, but there are other considerations such as general hedge fund naming conventions and of course the availability of good domain names (for your hedge fund website). Below are some general ideas we recommend when asked about naming: Continue reading
Hedge Fund Investment Strategies
Long-short equity is a popular hedge fund strategy where in which the manager initiates both long and short positions in the portfolio. The exact strategy or substratgey the manager uses will be proprietary and the percentage of longs and shorts will differ with each manager. Continue reading
Many life settlement hedge fund managers which establish life settlement hedge funds come from the insurance industry (although we have dealt with managers who are also registered as investment advisors). Accordingly, many managers are surprised when we discuss the issue of potential investment advisory registration. The central question is whether life settlements are securities. Continue reading
Over the past few years life settlements have become a more attractive investment opportunity and there is an increase in the amount of hedge funds which are being formed to invest in various life settlement strategies. This article will discuss life settlements and will introduce some of the issues which hedge fund managers should discuss with their attorney if they want to start a life settlement hedge fund.
From Viaticals to Life Settlements and Premium Finance
Life Settlements are the younger sibling to the Viatical industry which was popular in the 1980’s with regard to AIDS patients (see SEC description of Viatical’s below). A “life settlement” usually refers to a secondary market transaction on an insurance policy. Typically an insured will sell its insurance policy to a third party (the investor) who will pay the insured more than the cash surrender value of the policy, but less than the death benefit. The investor will then be liable for the premium payments and will receive the death benefit upon the death of the insured. Continue reading
SEC Discusses Hedge Funds and Funds of Hedge Funds
The following release comes to us from the SEC and provides some very basic background on the hedge fund industry. The release can be found here. Continue reading
This article is part of a series examining the statements in a report issued by the Government Accountability Office (GAO) in February 2008. The items in this report are important because they provide insight into how the government views the hedge fund industry and how that might influence the future regulatory environment for hedge funds. The excerpt below is part of a larger report issued by the GAO; a PDF of the entire report can be found here. Continue reading
All too often start up hedge fund managers do not realize that starting a hedge fund is really starting a business and that considerations need to be given to managing the business as well instituting the trading program. In a perfect world the hedge fund manager would be able to simply implement his program and have all of the back office, IT, compliance and other services outsourced. One option obviously is a hedge fund hotel which provides this type of support to beginning managers. For those managers who do not use hedge fund hotels, greater emphasis needs to be placed on understanding the business they are getting into.
The term “hedge fund” is an imprecise description of any type of pooled investment vehicle which utilizes an investment strategy (generally involving securities) to make money. There are many different types of strategies which a hedge fund manger might use to make its returns, including the following:
In addition to these more “traditional” types of hedge fund strategies, there are different types of investment strategies which are forming all of the time including asset based lending hedge funds, life settlement hedge funds, among other types. Sometimes lumped into the hedge fund category are Private Equity Funds and Venture Capital Funds which are pooled investment vehicles like hedge funds, but typically have different focuses and structures from hedge funds.
In the coming weeks we will detailing the main characteristics of the above strategies and what hedge fund managers running these strategies need to think about when crafting an investment program for their hedge fund. Below I’ve also reprinted a summary of the different hedge fund strategies as stated in a hedge fund report issued by the Government Accountability Office earlier this year. The report can be found here.
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Appendix III: Various Hedge Fund Investment Strategies Defined:
Hedge funds seek absolute rather than relative return–that is, look to make a positive return whether the overall (stock or bond) market is up or down–in a variety of market environments and use various investment styles and strategies, and invest in a wide variety of financial instruments, some of which follow:
Convertible arbitrage: Typically attempt to extract value by purchasing convertible securities while hedging the equity, credit, and interest rate exposures with short positions of the equity of the issuing firm and other appropriate fixed-income related derivatives.
Dedicated shorts: Specialize in short-selling securities that are perceived to be overpriced–typically equities.
Emerging market: Specialize in trading the securities of developing economies.
Equity market neutral: Typically trade long-short portfolios of equities with little directional exposure to the stock market.
Event driven: Specialize in trading corporate events, such as merger transactions or corporate restructuring.
Fixed income arbitrage: Typically trade long-short portfolios of bonds.
Macro: Take bets on directional movements in stocks, bonds, foreign exchange rates, and commodity prices.
Long/short equity: Typically exposed to a long-short portfolio of equities with a long bias.
Managed futures: Specialize in futures trading–typically employing trend following strategies.
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Oftentimes government sources of information provide us with good, comprehensive definitions like the discussion below on hedge funds. The Government Accountability Office released a report on Defined Benefit Plans Investing in Hedge Funds that detailed pension plan investments in hedge funds (for our account of the complete article, please see Hedge Fund Report by GAO). Below is an except from that report which provides a good overview of the hedge fund industry and regulatory environment. The full report can be found here.
Although there is no statutory or universally accepted definition of hedge funds, the term is commonly used to describe pooled investment vehicles that are privately organized and administered by professional managers and that often engage in active trading of various types of securities, commodity futures, options contracts, and other investment vehicles. In recent years, hedge funds have grown rapidly. As we reported in January 2008, according to industry estimates, from 1998 to early 2007, the number of funds grew from more than 3,000 to more than 9,000 and assets under management from more than $200 billion to more than $2 trillion globally.
Hedge funds also have received considerable media attention as a result of the high-profile collapse of several hedge funds, and consequent losses suffered by investors in these funds. Although hedge funds have the reputation of being risky investment vehicles that seek exceptional returns on investment, this was not their original purpose, and is not true of all hedge funds today. Founded in the 1940s, one of the first hedge funds invested in equities and used leverage and short selling to protect or “hedge” the portfolio from its exposure to movements in the stockmarket.* Over time, hedge funds diversified their investment portfolios and engaged in a wider variety of investment strategies. Because hedge funds are typically exempt from registration under the Investment Company Act of 1940, they are generally not subject to the same federal securities regulations as mutual funds. They may invest in a wide variety of financial instruments, including stocks and bonds, currencies, futures contracts, and other assets. Hedge funds tend to be opportunistic in seeking positive returns while avoiding loss of principal, and retaining considerable strategic flexibility. Unlike a mutual fund, which must strictly abide by the detailed investment policy and other limitations specified in its prospectus, most hedge funds specify broad objectives and authorize multiple strategies. As a result, most hedge fund trading strategies are dynamic, often changing rapidly to adjust to market conditions.
Hedge funds are typically structured and operated as limited partnerships or limited liability companies exempt from certain registration, disclosure and other requirements under the Securities Act of 1933, Securities Exchange Act of 1934, Investment Company Act of 1940, and Investment Advisers Act of 1940 that apply in connection to other investment pools, such as mutual funds. For example, to allow them to qualify for various exemptions under such laws, hedge funds usually limit the number of investors, refrain from advertising to the general public, and solicit fund participation only from large institutions and wealthy individuals. The presumption is that investors in hedge funds have the sophistication to understand the risks involved in investing in them and the resources to absorb any losses they may suffer. Although many workers may be impacted by any losses resulting from pension fund investment in hedge funds, a pension plan counts as a single investor that does not prevent a hedge fund from qualifying for the various statutory exemptions.
Individuals and institutions may also invest in hedge funds through funds of hedge funds, which are investment funds that buy shares of multiple underlying hedge funds. Fund of funds managers invest in other hedge funds rather than trade directly in the financial markets, and thus offer investors broader exposure to different hedge fund managers and strategies. Like hedge funds, funds of funds may be exempt from various aspects of federal securities and investment law and regulation.
* Leverage involves the use of borrowed money or other techniques to potentially increase an investment’s value or return without increasing the amount invested. A short sale is the sale of a security that the seller does not own or a sale that is consummated by the delivery of a security borrowed by, or for, the account of the seller. Short selling is used to profit by a decline in the price of the security.
Other HFLB articles which relate to items in this article include:
There are many reasons why a registered investment advisor will choose to become a hedge fund manager. Or, manage a hedge fund in addition to managing separately managed accounts. Besides higher fees, there are other advantages of the hedge fund structure over the traditional asset management business.
Advantages of the Hedge Fund Structure
The three central advantages of the hedge fund structure over the separately managed account structure are (1) ease of management, (2) potentially lower transaction costs, and (3) tax efficiencies.
1. Ease of management – one of the great things about running a hedge fund is that the manager only has to manage one single brokerage account. With a separately managed account business a manager will need to make separate trades for each account or do a block trade and then allocate the trade among a number of clients. Either way the separately managed account manager is subject to much more back office and paperwork which is not only time consuming, but costly as well.
2. Potentially lower costs – depending on the structure, the hedge fund structure could potentially save on costs to the account holders. Whereas the individual accounts would be subject to trading fees on each transaction, the costs are lower for the hedge fund which only manages one account.
3. Tax efficiencies – probably one of the more attractive aspects for an advisor to a hedge fund is the ability for the manager to receive more attractive tax results. As a general partner in the hedge fund, the manager will generally receive an “allocation” of income instead of a fee. When the manager receives an “allocation” instead of a fee then the underlying tax attributes will remain. That is to say if the fund allocates the manager gains and a portion of those gains are characterized as long term at the fund level, then the gains will also be long term for the manager which will result in a lower tax bill. In a separately managed account structure the manager would not be able to get the allocation.
Other Potential Hedge Fund Structure Advantages
In addition there is the possibility that the manager which was registered as an investment adviser with the SEC or state securities commission would not need to be registered. For example if a manager had 20 SMA clients and managed more than $30 million, it would be required to register with the SEC. However, if all of the clients subscribed to a hedge fund managed by the manager, the manager would not need to be required to register with the SEC because of the exemption from registration provided by Section 203(b)(3) of the Investment Advisers Act of 1940.
One of the other things to note is that in the hedge fund structure the manager will usually invest alongside the investors. Sometimes the investment can represent a large percentage of the manager’s liquid net worth; this should provide some comfort to investors to know that the manager’s interests are aligned with their own. This is not usually present in the typical separately managed account structure.
Potential Objections from Separate Account Clients
Generally the above Most of the above benefit the manager instead of the SMA client, who will lose transparency and freedom to pull assets at any time. For a manager switching SMA clients to a hedge fund clients they may encounter these objections – in these instances the maanger may decided to accommodate the client by providing certain transparency or liquidity preferences to the (former) SMA client through a side letter arrangement.
Please contact us if you have a question or would like to start up a hedge fund. Related HFLB articles: