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WIKI ANALYSIS
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This article describes a concept which could impact a variety of companies, countries or industries. To see what companies and articles reference this concept page, click here. |
Hedge funds impact the economy by affecting the stock market. Since some hedge funds are so huge their impact can be global, causing changes in oil prices, commodities, retail goods and magnified effects on stocks and mutual funds. If they then leave the stock market, and invest in bonds or commodities, individual investors could be adversely affected. Some estimates are that hedge funds have over $1 trillion in assets around the world.[1]
Hedge funds also help stock markets by acting as a source of liquidity, making major investments in publicly traded companies. Sometimes when a company requires new cash / investment, a hedge fund or foreign investment will come through when other sources of financing dry up. Hedge funds help the economy by giving companies other options for capital, especially when companies are concerned about taking on large foreign investments.
How to invest in the growth of Hedge Funds
- Most hedge funds are privately run and retail investors cannot invest in them. However, several investment banks, in particular Goldman Sachs Group (GS), run in-house hedge funds and investors can get exposure to the hedge fund boom by investing in these banks.
- Only a few “pure” hedge fund managers are publicly-traded companies, these include: Och-Ziff Capital Management Group LLC (NYSE:OZM), Fortress Investment Group LLC (NYSE:FIG) and London-headquartered GLG Partners, Inc. (NYSE:GLG).--Longshort 19:40, August 3, 2009 (PDT)
- Prime Brokers: Several investment banks act as prime brokers to hedge funds - executing stock trades and lending money to hedge funds to invest on margin, while also providing administrative support like renting office space. These banks benefit from the growth of the hedge fund industry as prime brokers make money on the interest they charge for debt financing and trading fees. Large amounts of margin trading, or excessive volatility in the market (trading back and forth) increase a prime broker's revenues.
The larger prime brokers by total 2006 assets:
| Largest Prime Brokers[2] | Total Assets (Billions) | Market Share |
| Morgan Stanley | $153 | 23% |
| Bear Stearns | $136 | 21% |
| Goldman Sachs | $119 | 18% |
| UBS | $47 | 7% |
| Credit Suisse | $25 | 4% |
Hedge Funds Defined
A hedge fund is a private investment fund charging a performance fee and typically open to only a limited range of qualified investors. In the United States, hedge funds are open to accredited investors only. Because of this restriction and creative legal structuring, they are exempt from any direct regulation by the SEC, FINRA and other regulatory bodies. Because of this exemption, hedge funds can put money in investments that are more exotic and riskier than those available to mutual funds - such as Short Selling, investing in Derivatives and Asset-backed securities.
The name originates from a common strategy in the early days of hedge funds - to "hedge" their bets by holding opposing positions in the market (IE one investment profits if a stock goes down, another when it goes up) in an attempt to earn returns regardless of the overall movement of the market. Over time, however, the term hedge fund has come to refer to any private asset manager pursuing exotic trading strategies.
A hedge fund's activities are limited only by the contracts governing the particular fund, so they can follow complex investment strategies, being long or short assets and entering into futures, swaps and other derivative contracts. They often hedge their investments against adverse moves in equity and other markets, because a common objective is to generate returns that are not closely correlated to those of the broader financial markets.
In most countries hedge funds are prohibited from marketing to non-accredited investors, unlike regulated retail investment funds such as mutual funds and pension funds, and are essentially private pools of managed assets. Because of this they have little incentive to release their private information to the public, and have acquired a corresponding reputation for secrecy.
Investment Styles
Following is a list of categories of the main investment styles applied by hedge funds according to the Credit Suisse First Boston Tremont Index:
- Convertible Arbitrage consists of hedge investing in convertible
securities. A typical approach is to be long the convertible bond and short the stock.
- Dedicated Short Bias, with which the fund manager invests mainly in equities and derivatives, maintaining net short exposure
- Emerging Markets implements an equity or fixed income strategy. Funds often employ a long-only strategy
- EquityMarket Neutral seeks to exploit market inefficiencies, usually, being simultaneously long and short within the same sector, industry, capitalization, country, etc
- Event-Driven consists of exploiting the price movement generated by a corporate event related to distressed stocks, mergers, takeovers, news, etc. In particular:
- Risk Arbitrage funds manage long and short positions in both companies involved in a merger or acquisition
- Distressed Securities funds invest in debt, equity or trade claims of companies
- Fixed Income Arbitrage intends to profit from price anomalies between related interest-rate securities
- GlobalMacro implements long and short positions in major capital or derivative markets, depending on the interpretation of economic trends
- Long/Short Equity consists of equity-oriented investing, without being market neutral. These funds can implement various styles, value and growth, and small-cap and large-cap stocks with a net long and short position. Futures and options may be used for hedging. Investments
may be related to a country, an industry or a sector
- Managed Futures is applied in futures and currency markets. Commodity TradingAdvisors (CTAs) apply systematic or discretionary strategies
- Multi-Strategy implements an investment approach diversifying by employing various strategies simultaneously to realize short- and longterm gains
Legal Structure
Legal structure is usually determined by the tax environment of the fund investors. Many hedge funds are domiciled -- have their legal residence -- offshore in countries unrelated to either the manager, investor or investment operations of the fund, with the objective of making taxes payable only by the investor and not additionally by the fund.
Funds ordinarily are run by hedge fund management companies, which may operate one or many funds domiciled in multiple jurisdictions.
For U.S-based investors who pay tax, hedge funds are often structured as limited partnerships because these receive relatively favourable tax treatment in the US. The hedge fund manager (usually structured as a corporate entity) is the general partner or manager and the investors are the limited partners or members respectively. The funds are pooled in the partnership or company and the general partner or manager makes all the investment decisions.
Non-US investors and U.S. entities that do not pay tax (such as pension funds) do not receive the same benefits from limited partnerships, and funds for these investors are often structured as offshore or unit trusts or investment companies. Hybrid or "Master-feeder " structures that contain both a US limited partnership and an offshore company allow hedge funds to attract capital from several different tax regimes.
At the end of 2004, 55% of the number of hedge funds, managing nearly two-thirds of total hedge fund assets, were registered offshore. The most popular offshore location was the Cayman Islands followed by British Virgin Islands, Bermuda and The Bahamas. The U.S. was the most popular onshore location accounting for 34% of the number of funds and 24% of assets. EU countries were the next most popular location with 9% of the number of funds and 11% of assets. Asia accounted for the majority of the remaining assets.
Onshore locations are far more important in terms of the location of hedge fund managers. New York City and the Gold Coast area of Connecticut (particularly Stamford, Connecticut and Greenwich, Connecticut) together are the world's leading location for hedge fund managers with about twice as many hedge fund managers as the next largest centre, London. This is not surprising considering that the US is the source of the bulk of hedge fund investments. London is Europe’s leading centre for the management of hedge funds. At end-2006, three-quarters of European hedge fund investments, totalling $400bn/£200bn, were managed within the UK, the vast majority from London. Assets managed out of London grew more than fourfold between 2002 and 2005 from $61bn to $225bn. Australia was the most important centre for the management of Asia-Pacific hedge funds. Managers located there accounted for around a quarter of the $140bn in Asia-Pacific hedge funds’ assets in 2006.
References
- ↑ The Economist, “Why Investors Should Fuss About Hedge Fund Fees," November 16, 2006
- ↑ 2007 Lipper HedgeWorld Prime Brokerage League Table, via The Wall Street Journal
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