Hedge Fund Analysis E-Book

Frank J. Travers

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 524

Veröffentlichungsjahr: 2012

Beschreibung

A detailed, step-by-step book covering the entire hedge fund evaluation process Investing in hedge funds is different from investing in other asset classes. There is much less publicly available information about hedge funds performance than there is about mutual funds or individual stocks. Consequently, investing in this class requires more sophisticated investment knowledge, greater due diligence, and, in many cases, a better-developed ability to evaluate investment managers. Hedge Fund Analysis provides a broad framework of how to approach this endeavor, from initial screening to analytical techniques, interviewing skills, and legal and contract negotiations. Along the way, it demonstrates a variety of mechanisms for monitoring and tracking hedge funds and the underlying hedge fund portfolios--explaining each stage of the process in minute detail and providing specific examples which fully explain the opportunities and challenges you'll face each step of the way. * Provides a detailed look at how to source hedge funds, screen through them, and rank their strengths and weaknesses * Lays out a thorough process for evaluating funds, from initial interviews to performance analysis to onsite meetings * Reveals what questions to ask by strategy in order to understand the underlying risk factors associated with each * Highlights non-investment analysis, including operational due diligence and risk management, as integral elements in the process Written by a financial professional with over twenty years of experience conducting investment manager due diligence, this book will put you in a position to make more informed decisions when investing in hedge funds.

Leseprobe

Table of Contents

Series Page

Title Page

Copyright

Dedication

Introduction

My Objective in Writing This Book

The Structure of the Book

Contact

Part One: Background

Chapter 1: Hedge Fund History

So Who Invented the Hedge Fund?

The Samurai

The Academic

The Legend

The Innovator

Chapter 2: Hedge Fund Asset Class

Definition

Hedge Fund Structure

Hedge Fund Strategies

Advantages of Allocating to Hedge Funds

Hedge Fund Size and Age Impacts Performance

Part Two: Hedge Fund Due Diligence

Chapter 3: Due Diligence Process

Key Areas of Focus within Each Component of Due Diligence

The Due Diligence Process Highlighted in This Book

Putting It All Together

Some Initial Thoughts

Chapter 4: Initial Data Collection

Data Collection

Due Diligence Questionnaire (DDQ)

Fictional Capital Management

Other Materials

Further Analysis

13F Analysis

Hedge Fund Journal

Chapter 5: Initial Interview

Initial Call or Meeting

Phone Interviews

Meeting Notes

Chapter 6: Quantitative Analysis

Performance Measures

Absolute Return Measures

Absolute Risk Measures

Regression-Based Statistics

Peer Group Analysis

Chapter 7: Portfolio Analysis

Attribution Analysis

Fundamental Analysis

Evaluating Portfolio Data

Chapter 8: Onsite Interviews

Onsite Meeting Strategies

One-on-One Meetings

Meeting with More Than One Person

Different Perspectives

Meeting Notes

Onsite Interviews at Fictional Capital Management (FCM)

Chapter 9: Operational Due Diligence

Case Study: Bayou Fund

Definition

Importance of Operational Due Diligence

Categorization of Operational Due Diligence

Interview with FCM Operational Staff

Chapter 10: Risk Due Diligence

Graphical Depiction of Hedge Fund Risks

Risk Due Diligence

Factor Decomposition Analysis

Interview with FCM Risk Manager

Chapter 11: Reference and Background Checks

Onlist and Offlist References

Internet and Social Media

Contacting References

Problematic References

Whose References Should You Check?

How Many Reference Calls Are Enough?

Background Checks

Summary of Reference Calls for FCM

Chapter 12: Hedge Fund Scoring Model and Decision Making

Hedge Fund Scoring Model

Putting It All Together

About the Author

Frank J. Travers, CFA

Index

Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia, and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers' professional and personal knowledge and understanding.

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For a list of available titles, visit our Web site at www.WileyFinance.com.

Copyright © 2012 by Frank J. Travers. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, [phone], fax [phone], or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, [phone], fax [phone], or online at http://www.wiley.com/go/permissions.

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Library of Congress Cataloging-in-Publication Data:

Travers, Frank J.

Hedge fund analysis : an in-depth guide to evaluating return potential and assessing risks / Frank J. Travers. – 1st ed.

p. cm. – (Wiley finance ; 778)

Includes index.

ISBN 978-1-118-17546-0; ISBN 978-1-118-22710-7 (ebk); ISBN 978-1-118-23756-4 (ebk); ISBN 978-1-118-26474-4 (ebk)

1. Hedge funds. 2. Risk management. I. Title.

HG4530.T695 2012

332.64'524 –dc23

2012010597

I dedicate this book to my wife Tara and my children, Brendan, Sean, and Lauren.

Introduction

“An investment in knowledge pays the best interest.”

Benjamin Franklin

It is estimated that there are somewhere between 8,000 and 10,000 hedge funds in existence today. This leads to a number of questions.

How can we screen through this list to come up with a more manageable universe?

Why do we hire certain hedge fund managers and not others?

What factors go into hiring and firing decisions?

How do we evaluate and assess a portfolio manager's or team's investment edge?

What are the best questions to ask hedge fund managers in order to get a true sense of their skill set and how they may relate to other investments in your portfolio?

How can we accurately evaluate hedge fund risk and what kind of information do we need from the funds we hire to effectively monitor changes?

What are the biggest mistakes often made when analyzing hedge funds and, more importantly, how can we avoid them?

Effective hedge fund analysis requires that we answer these and hundreds of other questions covering all aspects of the hedge fund business including the underlying investment strategy, back office, administration, legal, operations, financial, marketing, client service, transparency, reporting, and so forth.

However, the process is dynamic and involves a combination of art and science to efficiently navigate the shifting waters. Have a look at Figure I.1.

Figure I.1 Necker's Cube

This three-dimensional image is known as a “Necker's cube.” It is named after Swiss crystallographer Louis Alber Necker, who discovered it in 1832. It is often used as a means of illustrating shifting perspectives. If you look at the image for a few seconds, you will quickly notice that it is a perfectly orthogonal cube that allows for two opposing interpretations of three-dimensionality. The images in Figure I.2 illustrate the two opposing views.

Figure I.2 Interpretation One: Downward Sloping Cube vs. Interpretation Two: Upward Sloping Cube

The illusion created by the Necker's cube is somewhat analogous to how we can interpret information gleaned in the due diligence process in many different ways…with each being correct.

Hedge fund analysis can be conducted in many different ways and can employ a myriad of models and techniques, but the basic elements of the process are always the same. This book will lay out a specific method of analyzing hedge funds.

My Objective in Writing This Book

When I graduated from college in late 1989, I thought I had acquired a fair amount of knowledge about the financial world and the investment business in particular. I started my first job all bright-eyed and bushy-tailed and expected to blaze a quick path to greatness. I expected to apply all the economic and financial theory I had mastered in school to my position as an analyst at a fund of funds company.

Needless to say, I was shocked at just how little I knew. So I did what came naturally…I went to the library and bookstores to find books that would provide some instruction on manager due diligence techniques. Surprise number two—there were none. I had to learn things the hard way.

A decade later, I had moved up through the ranks and had become a portfolio manager at a fund of funds organization, and one of my junior analysts asked me if I knew of any books that they could read on the topic of manager due diligence. I was sure that several books had been written since I had last looked, but a few Internet searches later concluded that there were still none. I decided then and there that I would try my hand at writing and planned a two-book series. The first would focus on the analytical techniques used to review traditional (long-only and long-biased) managers and the second would focus on alternative investments.

I was fortunate to find a great publisher in Wiley & Sons and published the first book, titled Investment Manager Analysis, in 2004. I planned on writing the follow-up immediately but life kind of got in the way. The market collapse in 2008 was a slap to the face of the hedge fund industry. Many hedge fund managers strayed from their stated strategies, and Madoff's colossal fraud brought the topic of hedge fund due diligence to the forefront.

While a great many books have been written about hedge funds and about analytical techniques, I felt that none detailed a start-to-finish process that incorporated all aspects of the process, including the following:

Components of Hedge Fund Due Diligence

Operational

Risk management

Investment

Accounting/financial

Legal

The Structure of the Book

This book is divided into two parts. The first part provides background information, including the history of the asset class, a discussion of its pros and cons, and finally how hedge funds fit in diversified institutional portfolios. The second part details a template for hedge fund due diligence with chapters dedicated to each aspect of the process.

Part One: Background

Hedge fund history

Growth of the industry

Pros and cons

How hedge funds can fit in diversified portfolios

Part Two: Hedge Fund Due Diligence

Process template

Hedge fund universe and filtering

Initial information request

The initial interview

Performance analysis

Investment & portfolio analysis

Risk analysis

Operational analysis

Accounting/financial analysis

Legal analysis

Detailed face-to-face interviews

Primer on interviewing skills

Quantitative due diligence modelling

Putting it all together

Part Two details a methodical process which the reader can use to analyze hedge fund managers. To illustrate how each step in the process works, I have created a fictional manager (Fictional Capital Management or “FCM”) and take the reader through each step in the process, peeling back the onion one layer at a time so that we can ultimately make an informed and intelligent investment decision.

Since I am writing this book for the practitioner and for anyone else looking to evaluate and understand how hedge funds work, my writing style will lean more toward the practical than the academic. There are a great many books and scholarly papers that explain the nitty-gritty of the investment world and I will defer to them as source material for understanding how a swap works or how to employ Beysian methods in quantitative risk management. This book will assume a level of comfort with global investing, financial instruments, and how the markets work. It is my goal to create a book that will point out what is important in hedge fund analysis and how to take the massive amounts of information that we are bombarded with daily to make sound investment decisions.

Contact

If you have any comments or questions, please feel free to contact me at [email protected]. I encourage readers to contact me with any questions that they may have and to ask for clarification of any of the material presented in this book.

Part One

Background

Chapter 1

Hedge Fund History

“History doesn't repeat itself, but it does rhyme.”

Mark Twain

I recently read an article printed in the financial press that questioned the viability of hedge funds as an asset class. Following the bear market decline and the corresponding volatile market environment, the article suggested that investors had begun to question whether or not hedge funds actually hedge and whether or not the asset class was doomed. Managers responded that it had become too hard to find profitable shorts, as all the best shorts quickly become crowded trades—which can lead to short squeezes.

The author of the article suggested that many hedge fund managers had become overconfident going into the market decline and had begun to invest outside of their core mandates and, even worse, did not do a good job of matching the liquidity of their fund's underlying investments with that of their underlying investors. As a result, some hedge fund investors are still waiting to receive redemption proceeds.

Additionally, the article highlighted that the SEC is tracking hedge funds more closely and that they are currently determining how to best regulate them.

What is most striking about the article (titled “Hard Times Come to the Hedge Funds”) is that it was written by Carol Loomis and was published by Fortune magazine in June 1970.1 The bear market referred to in the article occurred the previous year and had a disastrous impact on the hedge fund industry. Many hedge funds shut down and the asset class went into a dark period that lasted nearly two decades. I suggest that readers interested in hedge fund history read this article in its entirety because it provides perspective on hedge fund history and clearly shows that no matter how much things change and progress, history is likely to repeat itself (or at least rhyme).

So Who Invented the Hedge Fund?

The hedge fund industry is generally linked historically to Alfred Winslow Jones, who created the basic format for the hedge fund—which still exists to this day. However, a number of other early pioneers had invested with an absolute return methodology long before Jones entered the investment business.

The Samurai

It has been suggested2 that the world's first commodity trading advisor (CTA) or macro fund was created and managed to great success in the mid- to late 1700s in Japan. During the Tokugawa shogunate (1615 to 1867) Japan changed from many separate provinces to a single unified country. This had a positive impact on commerce and the nation's official marketplace for rice, which effectively was the currency in Japan, formed in Osaka due to its favorable location near the sea. The Dojima Rice Exchange was officially set up in the late 1600s and initially dealt only in the physical purchase and sale of rice. However, as rice became big business, more and more rice farmers and merchants began to sell “coupons” against the future delivery of rice. These coupons became actively traded because they provided buyers and sellers the ability to effectively go long or short various grades of rice at different delivery dates in the future. This market is generally considered to be the world's first futures exchange.

Munehisa Honma was born in 1724 into a wealthy merchant family in Sakata. He took over the family business in 1750, and his talent and skill as a trader has since become the stuff of legend. His first innovation was to study years' worth of price, weather, and crop data (it is rumored that he analyzed hundreds of years' worth of data) and to make forecasts of rice production and quality based on changes in weather and other seasonal effects. By reviewing the historical price movements and plotting them against other factors, he was able to anticipate when rice harvests would be strong and when they would be weak—and trade using that information. This combination of historical technical data combined with fundamental information gave him a genuine edge over his trading competition. This is a concept that we now take for granted, but back then no one else had thought to do it.