Hedge fund manager definition by “ForexSQ.com” experts, Finding our the difference between hedge fund portfolio managers and hedge fund performance managers, You will also learn about hedge fund managers strategies or how hedge fund managers do risk management. Our top experts conducted this article because you know also about the hedge fund managers fees.
What Is A Hedge Fund Manager
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A hedge fund is an investment fund that pools capital from accredited individuals or institutional investors and invests in a variety of assets, often with complex portfolio-construction and risk-management techniques. It is administered by a professional investment management firm, and often structured as a limited partnership, limited liability company, or similar vehicle. Hedge funds are generally distinct from mutual funds as their use of leverage is not capped by regulators and distinct from private equity funds as the majority of hedge funds invest in relatively liquid assets.
The name hedge fund originated from the paired long and short positions that the first of these funds used to hedge market risk. Over time, the types and nature of the hedging concepts expanded, as did the different types of investment vehicles. Today, hedge funds engage in a diverse range of markets and strategies and employ a wide variety of financial instruments and risk management techniques.
Hedge funds are made available only to certain accredited investors and cannot be offered or sold to the general public. As such, they generally avoid direct regulatory oversight, bypass licensing requirements applicable to investment companies, and operate with greater flexibility than mutual funds and other investment funds. However, regulations passed in the United States and Europe after the financial crisis of 2007–08 were intended to increase government oversight of hedge funds and eliminate certain regulatory gaps.
Hedge funds have existed for many decades, and became increasingly popular, growing to be one of the world‘s largest asset management classes by 2014. However, according to a report by Hedge Fund Research published October 2015, hedge fund industry assets shrank “by $95 billion to 2.87 trillion in the third quarter, making 2015 their worst year since 2008. One of the best performing hedge funds in 2014 William Ackman’s Pershing Square Holdings portfolio, which had roughly $20 billion earlier in 2015 declined by 12.6 percent by October 2015 to $16.5 billion in assets.
Hedge funds are most often open-ended and allow additions or withdrawals by their investors (generally on a monthly or quarterly basis. A hedge fund’s value is calculated as a share of the fund’s net asset value, meaning that increases and decreases in the value of the fund’s investment assets (and fund expenses) are directly reflected in the amount an investor can later withdraw.
Many hedge fund investment strategies aim to achieve a positive return on investment regardless of whether markets are rising or falling (“absolute return”). Hedge fund managers often invest money of their own in the fund they manage, which serves to align their own interests with those of the investors in the fund. A hedge fund typically pays its investment manager an annual management fee (for example 1% of the assets of the fund), and a performance fee (for example 20% of the increase in the fund’s net asset value during the year). Some hedge funds have several billion dollars of assets under management (AUM). As of 2009, hedge funds represented 1.1% of the total funds and assets held by financial institutions. As of June 2013, the estimated size of the global hedge fund industry was US$2.4 trillion.
Hedge Fund Managers Strategies
Hedge fund strategies are generally classified among four major categories: global macro, directional, event-driven, and relative value (arbitrage) Strategies within these categories each entail characteristic risk and return profiles. A fund may employ a single strategy or multiple strategies for flexibility, for risk management, or for diversification. The hedge fund’s prospectus, also known as an offering memorandum, offers potential investors information about key aspects of the fund, including the fund’s investment strategy, investment type, and leverage limit.
The elements contributing to a hedge fund strategy include: the hedge fund’s approach to the market; the particular instrument used; the market sector the fund specializes in (e.g. healthcare); the method used to select investments; and the amount of diversification within the fund. There are a variety of market approaches to different asset classes, including equity, fixed income, commodity, and currency. Instruments used include: equities, fixed income, futures, options and swaps. Strategies can be divided into those in which investments can be selected by managers, known as “discretionary/qualitative”, or those in which investments are selected using a computerized system, known as “systematic/quantitative”. The amount of diversification within the fund can vary; funds may be multi-strategy, multi-fund, multi-market, multi-manager or a combination.
Sometimes hedge fund strategies are described as absolute return and are classified as either market neutral or directional. Market neutral funds have less correlation to overall market performance by “neutralizing” the effect of market swings, whereas directional funds utilize trends and inconsistencies in the market and have greater exposure to the market’s fluctuations
Hedge Fund Risk Management
Investment in hedge funds may provide diversification which can reduce the overall risk of an investor’s portfolio. Managers of hedge funds use particular trading strategies and instruments with the specific aim of reducing market risks to produce risk-adjusted returns that are consistent with investors’ desired level of risk. Hedge funds ideally produce returns relatively uncorrelated with market indices. While “hedging” can be a way of reducing the risk of an investment, hedge funds, like all other investment types, are not immune to risk. According to a report by the Hennessee Group, hedge funds were approximately one-third less volatile than the S&P 500 between 1993 and 2010.
Investors in hedge funds are, in most countries, required to be qualified investors who are assumed to be aware of the investment risks, and accept these risks because of the potential returns relative to those risks. Fund managers may employ extensive risk management strategies in order to protect the fund and investors. According to the Financial Times, “big hedge funds have some of the most sophisticated and exacting risk management practices anywhere in asset management. Hedge fund managers may hold a large number of investment positions for short durations and are likely to have a particularly comprehensive risk management system in place. Funds may have “risk officers” who assess and manage risks but are not otherwise involved in trading, and may employ strategies such as formal portfolio risk models. A variety of measuring techniques and models may be used to calculate the risk incurred by a hedge fund’s activities; fund managers may use different models depending on their fund’s structure and investment strategy. Some factors, such as normality of return, are not always accounted for by conventional risk measurement methodologies. Funds which use value at risk as a measurement of risk may compensate for this by employing additional models such as drawdown and “time under water” to ensure all risks are captured.
In addition to assessing the market-related risks that may arise from an investment, investors commonly employ operational due diligence to assess the risk that error or fraud at a hedge fund might result in loss to the investor. Considerations will include the organization and management of operations at the hedge fund manager, whether the investment strategy is likely to be sustainable, and the fund’s ability to develop as a company.
Hedge Fund Managers Fees
Hedge fund management firms typically charge their funds both a management fee and a performance fee.
Management fees are calculated as a percentage of the fund’s net asset value and typically range from 1% to 4% per annum, with 2% being standard.They are usually expressed as an annual percentage, but calculated and paid monthly or quarterly. Management fees for hedge funds are designed to cover the operating costs of the manager, whereas the performance fee provides the manager’s profits. However, due to economies of scale the management fee from larger funds can generate a significant part of a manager’s profits, and as a result some fees have been criticized by some public pension funds, such as CalPERS, for being too high.
The performance fee is typically 20% of the fund’s profits during any year, though they range between 10% and 50%. Performance fees are intended to provide an incentive for a manager to generate profits.Performance fees have been criticized by Warren Buffett, who believes that because hedge funds share only the profits and not the losses, such fees create an incentive for high-risk investment management. Performance fee rates have fallen since the start of the credit crunch.
Almost all hedge fund performance fees include a “high water mark” (or “loss carryforward provision”), which means that the performance fee only applies to net profits (i.e., profits after losses in previous years have been recovered). This prevents managers from receiving fees for volatile performance, though a manager will sometimes close a fund that has suffered serious losses and start a new fund, rather than attempting to recover the losses over a number of years without performance fee.
Some performance fees include a “hurdle”, so that a fee is only paid on the fund’s performance in excess of a benchmark rate (e.g. LIBOR) or a fixed percentage. A “soft” hurdle means the performance fee is calculated on all the fund’s returns if the hurdle rate is cleared. A “hard” hurdle is calculated only on returns above the hurdle rate. A hurdle is intended to ensure that a manager is only rewarded if the fund generates returns in excess of the returns that the investor would have received if they had invested their money elsewhere.
Some hedge funds charge a redemption fee (or withdrawal fee) for early withdrawals during a specified period of time (typically a year) or when withdrawals exceed a predetermined percentage of the original investment. The purpose of the fee is to discourage short-term investing, reduce turnover and deter withdrawals after periods of poor performance. Unlike management fees and performance fees, redemption fees are usually kept by the fund.
Hedge Fund Portfolio Managers
Hedge fund management firms are usually owned by their portfolio managers, who are therefore entitled to any profits that the business makes. As management fees are intended to cover the firm’s operating costs, performance fees (and any excess management fees) are generally distributed to the firm’s owners as profits. Many managers also have large stakes in their own funds.
Top hedge fund managers earn what has been termed “extraordinary” amounts of money, with the highest-grossing getting up to $4 billion per year. Earnings at the top are far higher than in any other sector of the financial industry. “They wouldn’t even consider getting out of bed for the $13m (£8m) Goldman Sachs’ boss Lloyd Blankfein was paid last year,” writes Richard Anderson, a BBC Business reporter. Collectively, the top 25 hedge fund managers regularly earn more than all 500 of the chief executives in the S&P 500. Most hedge fund managers are remunerated much less, however, and the competitiveness of the industry, along with the structure of financial incentives, means that failure can lead to not getting paid. The BBC quotes an industry insider who says “a lot of managers are not making any money at all.”
In 2011, the top manager earned $3,000m, the tenth earned $210m and the 30th earned $80m. In 2011, the average earnings for the 25 highest compensated hedge fund managers in the United States was $576 million. According to Absolute Return + Alpha, in 2011 the mean total compensation for all hedge fund investment professionals was $690,786 and the median compensation was $312,329. The same figures for hedge fund CEOs were $1,037,151 and $600,000, and for chief investment officers were $1,039,974 and $300,000 respectively.
Of the 1,226 people on the Forbes World’s Billionaires list for 2012, 36 of the financiers listed “derived significant chunks” of their wealth from hedge fund management. Among the richest 1,000 people in the United Kingdom, 54 were hedge fund managers, according to the Sunday Times Rich List for 2012. (Funds do not tend to report compensation. Published lists of the amounts earned by top managers use estimates based on factors such as the fees charged by their funds and the capital they are thought to have invested in them.) Read about the best Australian hedge fund managers here.
Hedge Fund Managers Performance
Performance statistics for individual hedge funds are difficult to obtain, as the funds have historically not been required to report their performance to a central repository and restrictions against public offerings and advertisement have led many managers to refuse to provide performance information publicly. However, summaries of individual hedge fund performance are occasionally available in industry journals and databases and investment consultancy Hennessee Group.
One estimate is that the average hedge fund returned 11.4% per year, representing a 6.7% return above overall market performance before fees, based on performance data from 8,400 hedge funds. Another is that between January 2000 and December 2009 the hedge funds outperformed other investments were significantly less volatile, with stocks falling 2.62% per year over the decade and hedge funds rising 6.54%.
Hedge funds performance is measured by comparing their returns to an estimate of their risk. Common measures are the Sharpe ratio., Treynor measure and Jensen’s alpha. These measures work best when returns follow normal distributions without auto-correlation, and these assumptions are often not met in practice.
Top Hedge Fund Companies
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