Family Office Certification

Be certified in the area of family office management. The Chartered Family Office Specialist is offered by the Family Office Institute. Please visit our website at www.foinstitute.com

Starting a Hedge Fund

Starting a Hedge Fund

It is all about having enough capital to run the program (i.e.- trading strategies) and funding the costs to establish it. In the most basic start-up, two key forms are needed: 1) The Private Placement Memorandum and 2) Subscription Agreements.

In general, a Private Placement Memorandum, usually which is prepared by an attorney, is the description of the fund itself. It discusses it personnel, trading strategies, fees, fund withdrawals, and so forth. It also painstakingly describes the associated risks involved. This description of risk is exceedingly importantly in these times. The second document is the subscription agreement which is signed by the limited partners (investors).

As the fund progresses, due diligence reviews are conducted regularly to ensure self-compliance as well as a means to calm the nerves of potential investors. Some other documents that hedge fund managers might have are the following: 1) suitability letters, 2) state and federal regulatory forms, 3) accounting ledgers, 4) subscription logs, and so forth.

Further, all hedge funds need the services of auditors, attorneys, administrators (if foreign), and a prime broker. It is not unusual to spend at least $50 to $75 thousand to start. Establishing foreign hedge funds, in the Cayman’s for example, while similar in nature to domestic hedge funds, would have higher costs.

Hedge Funds- Fund of Funds, Part III- learn about strategies portfolio managers use http://ping.fm/D6RWI

Hedge Funds- Fund of Funds Part III

Hedge Funds:

StrategiesThis third article on Hedge Funds will focus on the various strategies utilized by portfolio managers to seek absolute returns. Some of the numerous categorizations accorded these strategies will be discussed. This introduction to the various trading strategies of hedge funds is meant to give a broad overview and not specifics. Additionally, there are a number of substrategies for a number of the general strategies. Each particular trading strategy could merit several articles by itself. This article will conclude with a caution regarding classifications.

Hedge funds, like mutual funds, are grouped based on their investment strategies. Organizations such as Morningstar and Lipper classify the approximately 16,000 mutual funds first by the type of securities being held, such as stock and bonds, and then by sub-components. Examples of these sub-components could be international versus domestic, value versus growth, and so forth.

Due to the number of hedge funds in the marketplace today, it makes sense that these funds be grouped by strategies as well. However, because of the lack of standardization of hedge fund trading strategies, database groups classify trading strategies differently. One manner of categorization is to group all hedge fund strategies into four broad styles:

Tactical, Relative-Value, Event-Driven,

and Hybrid.Two of the several predominant strategies used under the heading of

Tactical are labeled “Macrocentric” and “Short Selling.” Macrocentric strategies assume a global focus and seek to profit from broad changes in markets based on economic data and government intervention. The second strategy is called Short Selling. Under this strategy, a hedge fund manager sells short securities with the objective of buying them back in the future at lower prices. This strategy is premised on the belief that the market is going down. This short-selling strategy is one into which mutual funds are not permitted to participate. Various arbitrage strategies employed in the Relative-Value grouping include fixed-income and convertible arbitrage trading. A convertible arbitrage strategy is one where a hedge fund manager attempts to take advantage of price inequalities. On paper, this strategy should be lowrisk with a sizeable, upside potential. For example, the fund would purchase a security and then simultaneously go short on a related security. In terms of the fixed-income arbitrage strategy, the portfolio manager simply acquires individual fixed-income securities and simultaneously sells short similar fixed-income securities. Once again, as with convertible arbitrage, the goal is to simply seek profits from the mispricing between the two securities. For example, suppose the hedge fund manager identifies a particular relationship between Bond X and Bond Y. If the spread between the funds changes in any fashion, the hedge fund will enter into transactions seeking profits from the mispricing.Under the Event-Driven style, some of the more common strategies are “Distressed Securities” funds and “Opportunistic Events” funds. Distressed Securities funds invest in equities or debt instruments of struggling companies at major discounts to their estimated value. The spread between the estimated value and the present market value can lead to substantial profits. Hedge fund managers are basing their investment decisions on the belief that the market is not properly pricing these securities. Opportunistic Events funds are ones which seek opportunities from a one-time major event. These events have specific beginnings and endings. Examples include Initial Public Offerings (IPOs), unexpected earning releases, bankruptcies and major acquisitions. Sometimes, these groups of funds are linked with Merger Arbitrage funds. Merger Arbitrage funds seek profits from corporate takeovers, mergers, reorganizations, and leveraged buyouts.Our next article will address the returns, risks, and other characteristics of the various types of funds described above.

In a nutshell, the

Hybrid funds category of funds is one which combines several of the various strategies discussed above. Under this umbrella, the most common types are “Multistrategy” funds and “Funds of Funds”. Multistrategy funds employ two or more strategies at one time or at different times. The goal, once again, is to take advantage of opportunities. By having flexibility, the portfolio managers of these funds can relatively weigh strategies based on market conditions. These strategies lend themselves to diversity, but Funds of Funds are different from Multistrategy funds in that the Funds of Funds invest in different hedge funds, rather than in specific investments. Therefore, the Fund of Funds strategy tends to emphasize long-term performance with minimal volatility. Consequently, Funds of Funds are viewed as away to enter into the hedge fund investment arena by being diversified not only in terms of the various hedge fund strategies but also in terms of reducing manager risk. While this article has provided a general description of hedge fund categories, a caveat is warranted. Often, funds are misclassified under a particular style and trading strategy due to sudden changes in the market place or a change in portfolio managers. As a consequence, the investor must perform the necessary due diligence on each fund in which an investment is contemplated to gather current information about particular portfolios (including performance, risk, leverage and trading philosophy) in order to adequately determine the proper classification and whether such classification meets their investment needs.

Interested in Wealth Management? Come to

Interested in Wealth Management? Come to our free Open House Next Sat at the PBCC campus in Boca Raton from 10-11

Hedge Funds- Fund of Funds- Part II

Hedge Funds:

The Industry 

In our continuing series on hedge funds, this article will focus on the hedge fund industry as a whole. How large is the industry? Are hedge funds all off-shore or are some domestic? What are the various strategies and how dominant are they? These questions will be addressed in this paper.

As with mutual funds, there are a great number of diverse hedge funds. It is estimated that the total Assets Under Management (AUM) in hedge funds ranges from $1.4 trillion (HFR) to over $2 trillion (Source: Hedge Fund Intelligence). The general consensus suggests that the number of

Our next article will describe these techniques in more detail, but for purposes of this article,

Future articles will describe some of the other strategies that make up balance of hedge funds publishing their strategies and results.

hedge funds in existence today exceeds 8,000 and, if one includes the fund of funds in this calculation, the hedge fund universe would top 10,000 funds. Why the lack of an exact count? The actual number of funds is not available due to both the minimal filing requirements and the lack of mandatory registration to any particular database or regulatory organization. While various hedge fund databases, such as Hedge Fund Net (HFN) and Hedge Fund Research, Inc. (HFR), maintain listings of the funds enrolled within their organizations, they do not incorporate the total universe of funds. The number of funds seems large because, according to HFR, only 3% of the funds have AUM over $1 billion and more than 70% of funds have assets under $100 million. However, in another instance where bigger may not be better, these smaller funds seem to perform better than the larger ones. A PerTrac historical study of large and small size hedge funds concluding that smaller funds tend to outperform larger hedge funds (Source: PerTrac 5-19-08) suggested that the results were akin to small cap funds generating greater returns than large-cap stocks. In terms of age, most hedge funds have track records of less than 10 years with the majority of the hedge funds having been in existence between three to seven years. Roughly 1/3 of all hedge funds are domiciled in the United States with the State of Delaware having the bulk of those registrations. The remaining 65% to 70 % are offshore funds with the majority of these funds registered in the Cayman Islands. Interestingly, approximately 80% of all hedge funds, both domestic and off-shore, are managed by hedge fund managers located in the United States. Reasons for establishing off-shore hedge funds will be a future topic of this series of articles. AUM can also be broken down by trading strategies and/or self-designated classifications. Because the number of hedge fund trading strategies exceeds those of mutual funds, the choice of selecting individual funds to meet the specific goals of investors and money managers can be daunting. However, with proper training, investors, money managers, and pension trustees can gain an adequate understanding of the various techniques utilized by these funds in order to correctly measure the performance and risk associated with certain strategies. As with all areas of hedge funds, there are no uniformed categorizations of strategies; however, numerous databases and research institutes have been categorizing funds for purposes of performance measurements. An overall composition of the hedge fund industry suggests that Equity Hedge type strategies are the most common in terms of AUM (40%+) and in number of funds (60%). Relative Value strategies are second in both AUM (24%) and by number of funds(20%).Equity Hedge strategies consist of short bias funds, growth funds, value funds, and multi-strategy funds, while Relative Value strategies are comprised of fixed income funds and volatility funds.Although every attempt has been made to assure accuracy, we do not give any express or implied warranty as to its accuracy. We do not accept any liability for error or omission. Examples are provided for illustrative purposes only and should not be construed as investment advice or strategy.

Virtus Capital Management, LLC

Dr. Joel M. DiCicco, CPA, VP – Portfolio Management

Dr. Rainford Knight, VP – Portfolio Management

Dr. DiCicco and Dr. Knight are portfolio managers of Virtus Capital Partners, LP, a multi-strategy fund of funds.

Dr. DiCicco has over 20 years of practitioner experience in the areas of finance, taxation and accounting. Dr. DiCicco has extensive experience in the valuation of sophisticated financial products and their applicable tax treatment as a result of his work for the U.S. Treasury and is an adjunct professor at Florida Atlantic University, teaching finance and accounting at both the undergraduate and graduate levels. He also offers online workshops and certifications to enhance any career in the industries of finance or economics through his newest venture; The DiCicco Financial Products Institute at www.DiCiccoFPI.com

Dr. Knight has over 15 years of practical experience in finance including investment analysis, venture capital

valuation, mortgage pool analytics and mergers and acquisitions. Dr. Knight is an adjunct professor of finance at

Florida Atlantic University and the University of Miami, where he teaches at both the undergraduate and graduate

(MBA/Executive) level including: Investment Analysis, Investment Management and Portfolio Construction.

Hedge Funds-Fund of Funds Part 1

Hedge Funds:

The Primer 

Welcome to the inaugural article on hedge funds. This series of papers regarding hedge funds as an alternative investment vehicle hopes to convey the importance of this investment construct as part of one’s portfolio. However, while this series of articles will address the advantages of investing in hedge funds, it will also warn readers to be cognizant of some of the pitfalls. These monthly papers will progressively address all aspects of hedge funds. Topics covering hedge fund structures, fees, and terminology, as well as risk measurements and the various selection methodologies will be addressed early in the series. Later, several articles will be dedicated to focusing on hedge funds as part of one’s asset allocation strategy because of the added returns and reduced risks hedge funds can deliver to a portfolio. Afterwards, papers on the various trading strategies of hedge funds will be reviewed due to the significant differences. For instance, global macro strategies are quite different than fixed income arbitrage funds. We will review numerous strategies to familiarize the readers with their goals, the inherent rewards and risks, and the benchmarks one should consider before investing. Furthermore, special attention will be paid to the relationships between the various strategies and more conventional investments, such as mutual funds.

So, what is a hedge fund? Technically, hedge funds are pooled investment vehicles which, but for certain exemptions, would be considered investment companies under the Investment Company Act of 1940 (the Act which regulates mutual funds). Thus, with a little poetic license, a hedge fund can be likened to a mutual fund. However, because hedge funds are not constrained by the Investment Company Act, they are permitted to engage in a wide-range of trading and investment strategies not typically permitted by mutual funds. Some would view the world of hedge funds as for only the rich and famous, whereas mutual funds are for ordinary folks. However, with the number of hedge funds increasing daily, this distinction between income classes is lessening and some hedge funds are lowering the minimum investment size to accommodate a wider range of investors.

One of the biggest differences between hedge funds and mutual funds is the regulatory environment. Mutual funds are regulated by the Securities and Exchange Commission (“SEC”) under the Investment Company Act of 1940 as well as certain portions of the Securities Acts of 1933, the Securities Exchange Act of 1934, and in some instances provisions of the Investment Advisers Act of 1940. Most hedge funds are exempt from regulation by the Investment Company Act and the Investment Advisers Act and are typically exempt from registration as a public offering under the Securities Act. However, hedge funds are subject to anti-fraud provisions of Securities Act, the Investment Advisers Act and state securities laws. These regulations and exemptions will be explained in a subsequent article.

Another major distinction concerns liquidity. Typically, mutual fund investors can readily access their funds due to cash reserves maintained by the mutual fund and/or cash received from continuous purchases by other mutual fund investors. As such, a mutual fund investor can usually receive their check within a week. Hedge funds, on the other hand, are not as liquid because of their desire to be more fully invested in their strategies and the fewer number of investors making regular investments into the fund. Consequently, most hedge funds incorporate into their offering memorandums restrictions on investor withdrawals ranging anywhere from several months to a year or more. However, the most acute distinction between hedge funds and mutual funds is the type of strategies and investments permitted. In most cases, mutual funds are not permitted to hedge with “short” sales or similar transactions. Further, most mutual funds are not permitted to utilize extensive leverage in the purchase of securities. Hedge funds, on the other hand, have no limitations in these areas. While hedging with short transactions and the utilization of leverage creates certain risks, the inability to properly hedge and utilize leverage may require the fund manager to forego certain opportunities or liquidate a position prematurely.

While there are other distinctions, the last one to be described for this article concerns fees. A typical mutual fund can charge sales fees, redemption fees, management fees and distribution charges. Hedge funds structure their fees differently. In general, there are only two types of fees assessed by hedge funds, the management fee and the performance fee. As with mutual funds, the management fee rates vary and are relatively small. All other fees assessed by hedge funds, though, are performance based and usually incorporate a minimum return to the investor before the fund manager realizes any profit.

The next article in this series will address the hedge fund industry as a whole and will include information regarding the number of funds, types of strategies, and amount of funds under management.

Although every attempt has been made to assure accuracy, we do not give any express or implied warranty as to its accuracy and will not undertake to update any information herein. We do not accept any liability for error or omission. Examples are provided for illustrative purposes only and should not be construed as investment advice or strategy.

Virtus Capital Management, LLC

Dr. Joel M. DiCicco, CPA, VP – Portfolio Management

Dr. Rainford Knight, VP – Portfolio Management

Dr. DiCicco and Dr. Knight are portfolio managers of Virtus Capital Partners, LP, a multi-strategy fund of funds.

 

Dr. DiCicco has over 20 years of practitioner experience in the areas of finance, taxation and accounting.  Dr. DiCicco has extensive experience in the valuation of sophisticated financial products and their applicable tax treatment as a result of his work for the U.S. Treasury and is an adjunct professor at Florida Atlantic University, teaching finance and accounting at both the undergraduate and graduate levels.  Dr. DiCicco is a partner and founder of The DiCicco Financial Products Institute which assists professionals, career changers, business school graduates and recent college graduates in attaining their goals by offering top-notch training and certification programs in the field of finance.  www.DiCiccoFPI.com

Dr. Knight has over 15 years of practical experience in finance including investment analysis, venture capital valuation, mortgage pool analytics and mergers and acquisitions. Dr. Knight is an adjunct professor of finance at Florida Atlantic University and the University of Miami, where he teaches at both the undergraduate and graduate (MBA/Executive) level including: Investment Analysis, Investment Management and Portfolio Construction.