AN INTRODUCTION
UNDERSTANDING A CRITICAL TOOL IN THE
GLOBAL ECONOMY
What is a hedge fund?
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While hedge funds have grown in popularity, their size is
relatively small compared to the markets where they invest. A
recent FCA study noted that, by AUM, hedge funds are the
third largest type of alternative investments.(5)
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Total Number of Funds Assets Under
Management
10,096
(in trillions)
9,966
9,810
9,575
9,462
9,284
9,237
9,045
8,661
15.0
13.8
3,873
2,383
2.80
610
2010
1990
1995
2000
2005
2006
2007
2008
2009
2012
2013
Key Players:
Portfolio Determines strategy and is invested in the fund
Manager(s) (compensated based on fund’s annual performance)
Portfolio Manager
Investors
Investors
Legal Advisors,
Registrar and
Transfer Agent
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Who can invest in hedge
funds?
U.S. regulations limit hedge fund
participants to “accredited investors”
or “qualified purchasers.”
MFA has created an infographic about who can invest in hedge funds and 11
the due diligence process.
Who invests in hedge
funds?
About 66 percent of global hedge fund assets come from
institutional investors such as pension funds, and university
and nonprofit endowments.
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Who invests in hedge
funds?
University and college endowments were some of the first
institutional investors to partner with hedge funds to help meet
their financial needs and expand educational opportunities
nationwide.
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Who invests in hedge
funds?
Pension plans across the U.S. and around the world invest in
hedge funds to: help diversify their portfolio, manage risk,
and deliver reliable returns over time. These investments
help build retirement security for hundreds of millions of
workers and retirees.
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Who invests in hedge funds?
Today, the 200 largest investors utilize hedge funds at a
growing rate and continue to increase their investments each
year.
Public Pension Plans Union Pension Plans
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Today, the 200 largest U.S. retirement funds
utilize hedge funds at a growing rate.
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Why invest in hedge funds?
Hedge funds offer investors
the ability to diversify and
achieve risk-adjusted returns,
offering protecting in volatile
markets.
Source: Preqin Special Report: The Real Value of Hedge Fund Investment, June, 2014. 1
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Do hedge funds make a
difference?
Yes. True to the objectives outlined by the majority of investors,
hedge fund allocations help to reduce risk in their overall
portfolios. In fact, 80% of investors believe that their portfolio risk
would increase if hedge funds were removed from their
portfolios.
Source: Preqin Special Report: The Real Value of Hedge Fund Investment, June, 2014. 2
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Institutional Trends
In a 2014 Preqin study, 92% of investors said they expect to maintain or
increase their allocation to hedge funds in 2014.
The Robert Wood Johnson Foundation held nearly $1.58 billion in hedge
fund investments at the end of 2012, approximately 17% of total assets.
In 2012, General Motor’s $68.7 billion pension fund had hedge fund
investments totaling $3.7 billion.
Investment managers use economic variables and the impact these have
on markets to develop investment strategies.
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How do hedge funds invest?
Event Driven
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How do hedge funds invest?
Relative Value
Positions may involve future corporate transactions, but these positions are
predicated on realization of a pricing discrepancy between related securities
rather than the outcome of the corporate transaction.
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How do hedge funds invest?
Equity Funds
Investment managers maintain long and short positions in equity and equity
derivative securities.
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5
How do hedge funds invest?
Quantitative Funds
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How do hedge funds invest?
Multi-Strategy Funds
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How do hedge funds invest?
• Managed Futures Trading (CTAs)
• Managed futures traders–also known as commodity trading advisors
(CTAs)–are able to invest in up to 150 global futures markets.
• They trade in these markets using futures, forwards, and options contracts in
everything from grains and gold, to currencies, stock indexes, and government
bond futures.
• Because they can go both long and short they have the ability to make
money in both rising and falling markets.
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produced consistently
higher returns with
substantially less Risk vs. Return
Hennessee Hedge Fund Index vs. Benchmarks
volatility. (1987-2012)
Fee structures vary, though “2 and 20” fees are typical: 2% management fee
for administrative expenses; 20% performance allocation over a specific high
water mark.
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Hedge funds do not pose a
• systemic
Their size is small compared to risk:
the broader
financial services industry
• Hedge funds are not highly leveraged
• They aren’t susceptible to runs
“I would not think that any hedge fund or private equity fund would become
a systemically critical firm individually.”
“We conclude that hedge funds do not currently pose systemic risk to the
Australian financial system or the wider economy.”
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Compared to other U.S.
markets, there is far
less concentration among
hedge
Assets funds.
Under Management
(in trillions)
U.S. Bank Holding Companies: Top 5 Hold >60% ofAssets
U.S. Mutual Funds: Top 3 Mutual Fund Families Hold >35% ofAssets
$2.8 trillion
$240.1 billion
Source: FFIEC, 12/31/2011; Bloomberg News, 2/15/12; fund websites; Hedge Fund Research, Q2 2014; 33
Absolute Return Billion Dollar Club, 03/2014
Hedge funds’ leverage risk is
low.
Hedge fund leverage is governed largely by private relationships
with its prime brokers. A fund posts collateral with this prime broker
to secure its trades and the broker uses its own risk matrix to
determine how much to lend. A recent FCA report noted that hedge
fund leverage is generally low.(3)
At Height of Financial Crisis
Investment
Hedge Funds Hedge Funds Investment Banks
Banks