Some savings accounts require funds to be kept on deposit for a minimum length of time, but most permit unlimited access to funds. In the US, Regulation D, 12 CFR 204.2(d)(2)] limits the withdrawals, payments, and transfers that a savings account may perform. Banks comply with these regulations differently; some will immediately prevent the transfer from happening, while others will allow the transfer to occur but will notify the account holder upon violation of the regulation. True savings accounts do not offer cheque-writing privileges, although many institutions will call their higher-interest demand accounts or money market accounts “savings accounts.”

All savings accounts offer itemized lists of all financial transactions, traditionally through a passbook, but also through a bank statement.

About 65% of people in the United States have savings accounts and or earn immense interests on their savings accounts

Withdrawals from a savings account are occasionally costly and are sometimes much higher and more time-consuming than the same financial transaction being performed on a demand account. However, most savings accounts do not limit withdrawals, unlike certificates of deposit. In the United States, violations of Regulation D often involve a service charge, or even a downgrade of the account to a checking account. With online accounts, the main penalty is the time required for the Automated Clearing House to transfer funds from the online account to a “brick and mortar” bank where it can be easily accessed. During the period between when funds are withdrawn from the online bank and transferred to the local bank, no interest is earned.

Originally set-up by Alfred Jones in 1949 to eliminate risk by holding long positions and short-selling other stocks, the Hedge Fund industry has mushroomed in size to an estimated $2 trillion, and over 10,000 funds.

It is projected that over 20% of the New York Stock Exchange (NYSE) volume is hedge fund related. This along with the perceived lack of transparency in hedge fund reporting has led has led the public media (New York Times, CNBC, etc.) to declare the hedge fund the root of all evil.

Although headlines tend to focus on the spectacular blow-ups and frauds, the tremendous turnover in the industry is due to much less dramatic reasons. Over 5,000 funds failed in 2005 alone, fizzling out quietly due to operational issues such as the miscalculation of Net Asset Value’s (NAV), or errors and mistakes.

Hedge Fund investors are paying for a fund’s investment expertise. Fund managers need to be free from worry about how an honest mistake or error can open them up professionally and personally to tremendous liability.

Click here to download the full whitepaper on hedge fund insurance

Thanks to globalization for adding another acronym to my already information-overloaded brain. This one is called “IRO” or Investment Research Outsourcing. Over the next five years it is an acronym you will hear again and again. IRO, loosely defined, is the offshoring of front-office work to a 3^rd party provider.  In this article, I will look at the potential of integrating an IRO workstream into the Buy-side and Hedge Fund World.

GROWTH OF INVESTMENT RESEARCH OUTSOURCING

The growth of investment research outsourcing was initially driven by economics.  Sell-side Banks no longer had revenue streams to support the free distribution of research and therefore looked for a cheaper way.  The answer was tapping into offshore brain pools that could produce high quality White Label research at a lower cost.  By some estimates, you can get 3 analysts in India for the same price of 1 analyst in New York or London.

Given today’s bear market, write-offs, and reduced budgets at investment banks, outsourcing of front-office analysis will only continue to grow.  Estimates of IRO 2008 growth rate range from 20% to 40%.  The growth rate would probably be even larger except for the ability to scale resources.

BUY-SIDE MOTIVATION VS SELL-SIDE ECONOMICS

While the Sell-side is clearly motivated by cost, the Buy-side has a completely different motivation.  Most IRO firms tout time, depth of research, and resource scarcity as reasons for Buy-side motivation.  While these perceptions are on the right track they don’t fully explain the value that IRO brings, especially around the time dimension.  IRO firms state that an IRO workstream frees up higher level traders/analysts to spend more time on investment ideas while passing-off the “grunt” work of detailed research.  This may be true but it is only half the picture.  The value of IRO is the ability to create a 24*6 “Follow The Sun” investment process which moves from idea genesis through trade execution at a much quicker pace.  In essence, when your research day is ending in New York or London, it is just beginning in India.  In a world of clustered investment decisions, the ability to supercharge your investment process is the real-key to the buy-side IRO approach.

INTEGRATING AN IRO WORKSTREAM

Developing an IRO workstream can be as simple as making a call/sending an email or as complex as having an on-site IRO resource serve as a communication gateway to a dedicated external team.  In developing the IRO workstream, it is important to first understand your investment process.  Then, ask how an external resource can fit for specific time-bounded tasks. 

While the Sell-side IRO model grew via a  “hand over the wall” approach.  The Buy-side model is much more dependent on communication and investment process integration.   Thus, it is much more vital to define how, when, why, and what.  It is also important to think about how your resources will be affected by having external IRO resources. 

Most firms start out with a “direct connect” model of having a single dedicated IRO resource connect with 1 to many internal analysts.  The IRO team grows organically as they prove their worth.  As with any outsourced model, both teams have an implementation period where they “learn to dance with each other”.  A side benefit of the IRO workstream is the documentation and formalization of investment workflows.

BUY-SIDE SKILLS & IRO MARKET PERSPECTIVES

IRO firms vary in terms of geography and scale with the largest firms having research centers in India.  Most firms have experience in business due diligence, investment research, and valuation.  However, beyond these additional bandwidth skills, many firms have niche skills.  Some IRO firms have more experience with credit modeling while others offer abilities to perform quantitative modeling, or stress-testing.  A few offer complementary services such as business surveys and systems development. 

It is estimated that up to 20% of US Institutional Managers utilize IRO firms, with an annual global market size of $550 Million ($385M Sell-side & $185M Buy-side).  Given current conditions, this market will continue to grow rapidly.  This is the reason scale is perhaps the biggest challenge both for Buy-side clients as well as IRO firms.

EVALUATING AN IRO PARTNER

When looking at IRO partners, it is important to understand that the nature of the buy-side investment process is different from the sell-side roots of the industry.  A buy-side IRO workstream includes heterogeneous, time-bounded tasks that involve real-time communication.  A resource’s judgement is paramount.  Therefore, while past client experiences are helping in identifying domain expertise, the success ultimately rests on the IRO resource.  This is why you must see resume of potential resources, interview these resources, and “beta-test” any resources.

Scale is another key evaluation point.  With this industry growing rapidly and another growth wave coming from the sell-side, IRO firms have to balance the needs of new and existing clients.  This is not so easy in a high-growth environment where the experienced talent-pool is limited and resource scarcity raises expectations of employees.  Therefore, HR issues such as training and resource turnover become important factors.  The last thing you want to do as an asset manager is to train and re-train IRO resources.  Scale also includes issues such as physical infrastructure and ability to protect your intellectual property.  Lastly, a manager needs to understand how IRO firms manage the spectrum of client needs.  With scale concerns, it may not be good to be a small fish in a big pond.

Domain expertise specific to your investment strategy is also an important consideration.  Firms with domain expertise save learning curve time.  IRO firms with domain expertise also will likely have the potential of add-on and swappable resources.

SUMMARY

In today’s world of data overload and time-constrained decisions, an IRO workflow managed correctly, can make you a better manager.  It is also clear that this industry is moving beyond additional bandwidth into higher value service offerings.  An IRO workflow can serve as a key input to a “Follow the Sun” investment model.  Growth challenges lay ahead, but an IRO integration can streamline investment decisions

About the author:

Seth Berlin is Principal at Performance Thinking & Technologies ( www.p-t-t.com ).    PTT is a consulting firm that focuses on operations, reporting, and risk management for hedge funds and investors. He can be reached at www.p-t-t.com or at info@p-t-t.com. 

The Portfolio Manager, or hedge fund manager as they are also called, is the face and brains behind the fund. The PM has to be multi-functional as they not only call the shots, but also act as the salesman, convincing investors to trust in their strategy and hand over large amounts of capital.

Since hedge funds employ a wide array of strategies from long/short to asset based lending to global macro, firms want to find a portfolio manager who has experience in that specific sector. That is why this is probably the most competitive of positions within a hedge fund. Highly skilled portfolio managers are sought out by firms across the globe.

Some of the main duties of a Portfolio Manager include:

• Providing market research and implementing new investment product and strategies

• Create research and review platforms for new, existing and potential investment products

• Exceed client expectations with returns on investments

• Work closely with analysts and traders to ensure trading strategy is carried out correctly

• Construct and review performance reports to show to investors

• Work directly with marketer to relay investment strategy and risk measures for website and other forms of marketing for your hedge fund

• Performing due diligence visits and assessing investment management firms and quantitatively analyzing investment pools

• Having extensive knowledge of industry policies and regulations set in place by the SEC

• Focusing on capital introductions and networking to sign up new investors to your fund

While most positions within a hedge fund are generously salaried, it’s the Portfolio Managers who can potentially reap the big bucks. As explained by one manager to New York Magazine:

“Fifty million, sadly, leaves one flying commercial. Hedge fund money can put you into exhilarating conversations about the virtues of Gulfstreams versus Falcons.”

Here are some facts about the highest paid hedge fund managers as published by Alpha Magazine:

• Five of the managers on this year’s list each made more in 2007 than the $1.2 billion that JPMorgan Chase & Co. agreed to pay for the almost failed 85-year-old Bear Stearns Cos.

• When we published our inaugural list, in 2002, Soros led the way with $700 million, a showing that this year would have put him at No. 9. Back then it took $30 million to crack the top 25; this year, $360 million.

• The grand total earned by the top 25 in our 2003 ranking, almost $2.8 billion, was less than what any of the top three managers made this year and less than one fifth of what the top ten made altogether ($16.1 billion).

• Though we doubled the size of our list from 25 to 50 this year, longtime New York–based star managers Mark Kingdon of Kingdon Capital Management and Raj Rajaratnam of Galleon Group both miss the cut, despite each making about $200 million. This year’s minimum: $210 million.

Typically, a hedge fund manager’s salary depends directly on performance. Managers usually charge a standard 2/20 fee, which means 2% management fee and 20% performance fee. This may vary, with some managers charging 1% or 0% management fee while some charge upwards of 30-40% management fee. Since their “salaries” are considered capital gains, they are only required to pay the standard tax rate of 15%.

Quantitative analysts use their extensive math skills to develop software that analyzes statistical models for computerized financial trading strategies. Most quant hedge funds aim to be market-neutral by balancing both short and long positions. Global macro hedge funds are known for employing quantitative analysis to locate discrepancies in prices around the globe and capitalizing on them. The funds make their money when those prices return to normal.

As a quant, basic duties include:

• Conceive new trading ideas

• Partake in extensive research projects

• Find ways to reduce transaction costs and increase profitability

• Locate discrepancies in pricings throughout the market

• Develop software that locates price anomalies within the market

• Prepare written reports with supporting statistics to senior level management

No matter how good the quants are however, it is still up to the Portfolio Manager to call the shots on the actual trades. If the PM chooses to use high amounts of leverage while making risky bets, the hedge fund may still experience losses, no matter how good the quant is. That is why we saw many quant funds experience declines last year. The use of leverage magnifies even the smallest of losses, so even a fund “uncorrelated to the market” is still affected by market circumstances. Others explain the recent losses experienced by quant funds in another way. The sheer popularity of them makes for dozens of funds chasing the same dream, and using the same strategies thus reducing returns and raising risk.

Quants generally are the former straight A student who excels in math, computer science and engineering. They usually hold a PhD in Finance or Quantitative Mathematics. They have a vast understanding of statistics and calculus and can apply those theories to solve practical modeling and application problems. They are able to work independently but will also correspond on a daily basis with managers, clients, trader, IT personnel and other various groups. Junior quants may start off at around $80K, while more experienced Senior Quants can make upwards of $500K depending on the strategy and how successful it is.

That is why an extensive amount of study and research must go into the investments made within a hedge fund. Hedge funds have the luxury of investing in anything from traditional stocks and bonds to currencies to strip clubs. Anything goes. Therefore hedge fund managers realize that there is a world of opportunity awaiting them, they just need to find where the potential lies.

An analysts’ main job is to seek out these investment opportunities for hedge funds based on extensive research by locating undervalued securities or commodities, mispriced currencies, distressed companies, or a number of other situations which may eventually reap great returns. Analysts partake in growth studies of various companies to see if they are worth investing in. They look at numbers, trends, management or any factor that may tell a tale about their potential.

Risk analysis is another position employed by hedge funds. Risk analysts will work closely with the portfolio manager to assess risks on investments and tailor the strategy accordingly. They will also analyze market risks across various asset classes while developing risk models or profiles.

To sum it up, duties of analysts may include:

• Seeking out investment opportunities

• Locating undervalued securities and other discrepancies to capitalize upon

• Using quantitative methods to analyze market trends

• Looking at Risk vs. Reward

• Analyze and report hedge fund performance with suggestions on how to improve

• Working closely with the legal and compliance departments as well as the Portfolio Manager and traders

• Maintain reports of data, findings and valuation methodologies

• Creating monthly, quarterly and annual reports

To secure a job as a hedge fund analyst, a vast understanding of trading and hedge funds is required. Analysts have strong math and quantitative skills, along with knowledge of securities, equities, options, futures, commodities and currencies. Most analysts also have a degree in Finance. Interpersonal skills and excellent writing skills are also a must since you will be working very closely with others within the hedge fund, especially the VP and those at the top, presenting documents that you have constructed based on your research. Starting positions in the analysis field are generally around 40K, but Senior Analysts can make upwards of $250,000 a year or more, depending on the size of the hedge fund.

Hedge funds have a few options. They may outsource this task to compliance professionals or they may designate the duties to a specific person within the firm. This person may or may not have other duties within the hedge fund. For a large hedge fund, the Chief Compliance Officer generally will not hold another position. Hedge funds may also choose to hire new staff to complete these functions.

According to the SEC, the following requirements must be met by advisors:

• Registration by filing a Form ADV under which hedge fund advisers must disclose information about their business, affiliates and owners as well as disciplinary history

• Comprehensive compliance procedures

• Designation of a Chief Compliance Officer

• Specific procedures governing proxy voting

• A code of ethics including requirements for personal securities reporting

• A commitment to a program of compliance controls combined with SEC examinations in order to foster a culture of compliance by advisers

There are several areas within a hedge fund that require compliance. Marketing for example, requires the compliance professional to be familiar with all of the do’s and don’ts associated with hedge fund advertising. For instance, a hedge fund website has many rules and regulations that must be abided by. Since hedge funds are generally considered riskier than other traditional investment vehicles, only accredited investors may have access to the site. Therefore not only does the website content have to be monitored and secured, but it must be verified that any users are in fact, accredited and able to invest in hedge funds. Other compliance issues stemming from websites include the use of language. Hedge funds must be careful not to “guarantee” anything, but rather present their product in a somewhat transparent light as possible while also portraying the various risks.

Compliance officers also must be familiar with the anti-money laundering procedures, which were set in place after 9/11 and ensures that companies establish anti-money laundering systems and supervisory systems. Compliance is also needed for the formation of the fund, from the set-up procedures to the step-by-step process needed to launch a hedge fund. Generally, a good legal team will require an adviser to disclose every aspect of how they plan to do business via the offering documents. Good compliance programs will outline exactly what an adviser says they will do, and abide by it. Otherwise, an investor may feel misled should the fund go awry and can claim an adviser did something wrong, a significant risk to the hedge fund. Making sure employees, especially the traders, are adhering to all standards is also up to the compliance department, along with investment management and monitoring risks involved. Here are a few of the standard tasks that may be assigned to you:

• Compliance training of new hires within the firm

• Support compliance testing and monitoring

• Prepare written documents to address any compliance problems within the company

• Preparing reviews on a quarterly and annual basis

• Conduct background checks on managers

• Maintain onshore and offshore fund documentation

• Draft documents such as resolutions and amendments

• Maintain compliance as outlined by the Investment Advisors Act of 1940 and the SEC

• Completion of subscription and redemption forms

Taking a job as a compliance professional requires several things. Usually a bachelors degree is preferred, along with some experience in working with investment advisory firm. Extensive knowledge and understanding of SEC guidelines is a must. Chief Compliance Officer positions require a law degree, but salaries generally range from 400,000 to over 1 million a year. CCO positions also usually require a minimum of 5 years experience and the ability to handle multiple large tasks.

In 1998, trading losses started to accumulate. It was clear that the Bayou strategy was not garnering the kind of returns that Israel had promised his investors. Instead of altering the strategy or closing up shop, Israel opted for another alternative. He started a fake corporation to audit Bayou, and produced false documentation overstating gains, understating losses and positioning Bayou in a light that actually made it look successful. In reality, the fund never made any money. Israel would consistently send out performance reports to investors and at one point claimed the fund was worth $450 million.

But Israel wasn’t necessarily losing money. He funneled all of the hedge funds trades through Bayou Securities, reaping huge commissions since hedge funds trade millions of dollars worth of stocks every day. So even as the hedge fund lost money, Israel still banked through his securities firm.

While investors were pleased with the façade of a brilliant investment, Israel and Marino were living the high life. Israel settled into a mansion just north of New York City that he rented from Donald Trump for $32,000 a month while Marino was parading around the east coast in his new Bentley.

In 2004, Israel started to panic and was desperate to make back what he lost in the fund. He suspended the fund’s trading activities and wired $150 million to a bank account overseas and proceeded to launch a “prime bank instrument” fraud. Basically, in this type of fraud, investors are promised above average returns, (in this case, 100% a week), since the manager supposedly has access to a “secret” trading platform. Of course, this is never the case as there is no “secret” trading platform in existence.

In July 2004, officials were alerted when an abnormally large transfer of $99 million was made into a Wachovia account in New Jersey, prompting the initial investigation and the ensuing demise of Bayou.

What was amazing about Bayou was how Israel managed to dupe investors into giving him such a substantial amount of money. One of the biggest obstacles new hedge funds face is securing initial capital. Israel not only did that, he did it to the tune of $300 million. He even got well established fund of funds to invest in Bayou, establishments that are adamant on conducting extensive background checks. Israel had the charm, contacts and Wall Street background to gain the trust of very affluent individuals. In retrospect, investors wish they had noticed some of the red flags accompanying Israel. For one, the fake accounting firm. With large hedge funds, there is almost always an established, big-name accounting firm used, which was not the case here. Also, Israel never charged a management fee, an action almost unheard of with hedge funds. He also gave no resistance to investors who wished to pull out, another tactic not usual in the hedge fund industry.

In April of this year, Israel was sentenced to 20 years in prison after pleading guilty to fraud. He was also ordered to pay $300 million back to investors.

On June 10^th, 2008, the same day he was supposed to start his 20-year sentence, Israel’s SUV was found abandoned on the banks of the Hudson River, with the words “Suicide is Painless” scrawled through the dust of the window. However, officials are reluctant to confirm his suicide for several reasons. For one, no body has turned up. The Bear Mountain Bridge, where Israel supposedly plunged to his death, has been used by others as a sure-fire suicide method. However, those bodies have turned up on the banks of the Hudson, usually only days after the jump.

Marino was sentenced to a 20 year term as well. Oddly enough, he also took the suicide route, writing a 6-page confession/suicide note. However, officials found him before he could act on it, and he is currently serving his sentence.

James Marquez is serving his 4 ½ year sentence for his role in the crime, which was determined to be around $6 million.

Due Diligence. In 2008, there is also a noticeable trend toward increased review of funds by investors and counterparties (e.g., prime brokers, fund administrators, and auditors). Fiduciaries have a duty to perform due diligence to ensure that a fund’s investment decisions are sound and compatible with their client’s risk profiles. Prospects may submit a due diligence checklist to management, requesting extensive information covering every major aspect of the fund’s organization, operation and management. Prospects may seek meetings with the officers of the fund and other persons significantly involved in the fund’s business.
How does a forex fund work? A forex fund requires infrastructure in the form of corporate entities. In the United Sates, we use a limited partnership as the fund and use an S corporation (or LLC) as the general partner (and forex adviser to) of the limited partnership. When set up outside the United States, both the forex fund and its advisor are set up as corporations in a low or zero tax country or other jurisdiction.
Managed Accounts. A CTA (commodity trading adviser) manages individual accounts, while a CPO (commodity pool operator) manages a fund (also called a “pool”). In our experience, many people lose interest in a managed account business when they experience the administrative hassles of managing separate accounts. However, some choose to be both.
Advertising and Attracting Investors. Unless listed on a recognized securities exchange, a forex fund cannot advertise to solicit new investors in the fund. A forex trader managing accounts, however, can advertise his or her managed account services. A few countries have rules similar to those of the United States in this regard. Prospective investors in the fund like to see that you have invested your own capital in the fund. It is also a good idea to show prospects that you take fees subject to a hurdle rate, which means that you earn fees only when trading profits exceed a minimum percentage. An investor in a forex fund should be sophisticated enough to understand the risks associated with forex trading. Many investors would be interested in forex funds if they had the opportunity. Because advertising of the fund and any other non-personal communications are prohibited, and the media has touted the risks over the benefits, investors must be sought in more direct and creative ways. A trader may find that in addition to family and close friends, many colleagues and casual acquaintances may be potential investors. If you are interested in getting investors for your fund, your selling efforts must be personally directed toward investors who are known to you. Advertising and any other non-personal communications are prohibited. For the forex trader who wants to trade for his family and friends, this is obviously no problem at all. Since the forex fund is an ideal vehicle to pool the resources of a small group of investors, forex funds can be especially appealing.
How do I set up a forex fund? In 2008, forex traders remain positioned to launch a forex fund quickly without much red tape. In short, starting a forex fund means hiring a legal adviser with the proper expertise to prepare the required documents and provide you with tax and regulatory advice. You will have to work closely with your lawyer to prepare the private placement memorandum (PPM), fund’s limited partnership agreement, and subscription agreement. A forex
fund can be developed and launched within 2 weeks (on an expedited basis) but the normal development time is about 4 weeks. Offshore funds, while they can be incorporated quickly, take a little longer to establish due to the time required to open a bank and brokerage account for the fund.
Favorable Tax Treatment. There are two ways to trade foreign currencies and they have different tax rates. “Foreign currency contracts” are taxed by Internal Revenue Code Section 988. Currency futures, otherwise known as “regulated futures contracts” are taxed under Section 1256. Forward contracts and over-the-counter options in other traded currencies for which there is also trading in regulated futures qualify as “Section 1256 contracts.” Gains from futures trading are taxed at a blended rate of 60% long-term gains and 40% short-term gains (regardless of how long a position is held). This 60/40 split gives futures traders an advantage over forex traders. While the long-term rate is capped at 15%, the short-term (or “ordinary”) rate can go as high as 35%. The maximum blended 60/40 rate is 23%. Forex gains are taxed at the short-term (“ordinary”) rates. Forex traders do not necessarily have to live with the higher “ordinary income” tax rates as they can “elect out” of ordinary income tax rates. Traders who do this will have their currency positions treated as Section 1256 contracts, and their gains will be taxed at the blended 60/40 rate. In addition, the fund will most likely qualify as a “trader in commodities” so that investors are able to deduct the fund’s expenses.
Securities Act of 1933. Forex funds are private and are not required to report returns, unlike mutual funds that are publicly traded and post their net asset values daily. In the United States, private (hedge) funds are unregistered securities offered as a private placement under the Securities Act of 1933. Also, in the United States, a forex fund is a Regulation D (Rule 506) offering in that it is an unregistered security offered as a private placement. Regulation D provides a safe harbor that exempts the private offering from compliance with the registration and prospectus delivery requirements of U.S. securities laws. However, Regulation D does not exempt an offering from compliance with the anti-fraud provisions of the law. You must supply all investors in your fund with offering documents (also called “disclosure documents”) disclosing comprehensive information about the fund.
Commodity Exchange Act. The Commodity Exchange Act (CEA) gives the Commodity Futures Trading Commission (CFTC) limited anti-fraud and anti-manipulation jurisdiction over off-exchange (also called over-the-counter or OTC) foreign currency futures and options transactions. “Forex transactions” are leveraged off-exchange foreign currency transactions where one party is a customer. The term does not include transactions that result in actual delivery within two days or that create an enforceable obligation to deliver between parties who are capable of making and taking delivery for business purposes.
Must I register with the CFTC? If you plan to trade currency futures contracts, currency futures options, or forward contracts, your fund must be approved by the CFTC. In addition, you must register with the National Futures Association (NFA) and become a CPO. The CEA defines a commodity pool as an “investment trust, syndicate or similar form of enterprise operated for the purpose of trading commodity interests.”
CFTC Exempt. A person who operates a commodity pool must register as a CPO unless an exemption applies. If you operate a pool that limits its trading solely to forex and only trades with authorized counterparties, it is not required to register as a CPO, but may do so voluntarily. Forex managed account managers are generally not required to register with the CFTC or become Members of NFA. Understand that any NFA Member forex dealer that services your customer accounts, or you introduce accounts to, is subject to NFA enforcement action for your conduct should your conduct violate NFA requirements. Violations can mean disciplinary action against your dealer even if it acts diligently and has no knowledge of your conduct. As a result, there is a trend among forex dealers to require NFA registration of forex traders managing customer accounts (including a fund). NFA compliance rules address the general issues of following just and equitable principles of trade and avoiding fraudulent behaviors.

Commodity Pools. If your forex fund trades in commodity futures or interests, it is also a commodity pool and you are a CPO. Any person who is involved with the commodity pool must register as an associate of the CPO. A registered CPO is required to provide a detailed disclosure statement (the prospectus) to prospective participants in the pool. Your Disclosure Documentmust also be filed with the NFA at least 21 days prior to the delivery of the documents to a prospective participant and updated often. There are exemptions from the CPO registration requirements.

Investment Adviser Registration. If you plan to execute more than an occasional equity trade in your forex fund, you might also have to register as an investment adviser. If you manage less than $30 million, you are not eligible to register with the SEC (unless you are based outside the United States or you are based in Wyoming) but are subject to applicable state law. Each state has its own registration requirements.

Offering Documents. Investors in your fund must receive all material information about the offering and the offering documents should be provided to all investors. Any investor who is not an accredited investor must have sufficient knowledge and experience in financial and business matters to be able to evaluate the merits and risks of your hedge fund. Since the PPM usually is the starting point for those conducting due diligence, it remains a crucial document.
Accredited Investors. Regulation D limits the number of non-accredited investors to 35. Generally, accredited investors includes persons whose net worth (or joint net worth with that person’s spouse) exceeds $1,000,000, or whose income was in excess of $200,000 in each of the two preceding years (or, together with that person’s spouse, in excess of $300,000 in each of the two preceding years) and who reasonably expect to reach the same level of income in the current year. There are numerous other categories of accredited investors.

Performance-based Compensation. Performance-based compensation for fund advisers are paid as an allocation of profits, typically 20%, associated with the growth of the fund. There are state regulations regarding performance based fees and these regulations vary considerably. In some instances, the compensation agreement specifies that funds be only paid when the profits of the fund exceed a hurdle rate.

Blue Sky. Within 15 days of the first sale of your offering, an SEC Form D Notice of Sale must be filed with the SEC. Your fund must also comply with state blue-sky laws. In most states, Form U-2 must be filed. Conclusion. Forex funds are about making money and running a forex fund is a great way to do so. The desire to pool assets in a way that is proper, both from a business and a legal standpoint, has led many forex traders to start their own forex funds. For a successful forex trader, a forex fund is an efficient, legal, and professional way to trade your own money along with the money of those who want to benefit from your expertise. No longer just for the elite, forex funds will continue to grow in varying financial conditions because of their complete market freedom.

The private investment fund industry has years of success ahead of it. Talented forex traders will find profitable outlets for their skills, regardless of government regulation. Forex funds are about making money and running a forex fund is a great way to do so.

By Hannah M. Terhune, Esquire 2008©

Capital Management Services Group

hterhune@capitalmanagementservicesgroup.com

Many countries are competing against each other to provide the best playing field from a legal standpoint for private investment (hedge) funds. For a new, low budget offshore fund, Anguilla or the British Virgin Islands and not the Cayman Islands may well be the best choice. While many countries have increased services to meet the rising need for offshore funds and companies, the lawyers, fund administrators, and accountants in the better-known countries have also increased their fees significantly in the past few years. There is increased use of offshore companies and offshore banking services to protect against identity theft and the loss of wealth due to the global decline of the U.S. dollar. Many are surprised to learn how easy it is to operate offshore.

Experienced investors are not as worried about where the fund is located as you may think. Funds tend to be formed in countries that are relatively interested in helping them set up (meaning that they have good laws and a good reputation as a country to associate with) and operate without a lot of initial and residual expense. Always remember that the domicile of the fund need not be the same as that of its administrator and custodian. In our experience with fund organizers, it is their inexperience with international business formations and bank regulatory matters that causes the most problems in terms of starting and launching the fund in a timely fashion.

For all the rave about the Cayman Islands, it is important to keep in mind that it was a blacklisted country until 2001, about the time when it hired a lobbyist and a public relations firm in the United States to delete the American perception that it was a hotbed of money laundering. In recent years, Cayman representatives have “visited” the SEC, the Senate Banking Committee and the Vice President to promote the image that it is a law-abiding, well-run version of “Delaware.”
However, it is home some very recent and high profile fund disasters and the 700 or so Enron secret companies. In short, it hosts as much financial crime as the next country.

Best Location for an Offshore Fund. The short answer is no one place is best. You can form an offshore fund in any location that make sense and is affordable. There are many areas of the world that are considered prime offshore centers. The most widely used (and most expensive) locations are Bermuda, the Cayman Islands, Guernsey, Hong Kong, the Isle of Man, Jersey, Luxembourg, the Mauritius, Singapore, and Dublin. These locations provide a welcoming climate for funds in terms of the ample (and pricey) supply of sophisticated lawyers, bankers, and consultants offering legal and accounting advice. To appease the United States and the OECD, many of these jurisdictions have enacted “heavy handed” regulatory schemes which renders the costs of establishing and maintaining a fund in these countries prohibitive to all but the very wealthy.

Anguilla and the British Virgin Islands maintain a minimal regulatory scheme and the costs of establishing and maintaining a hedge fund in these countries are low. These countries (and other offshore financial centers) are no different from Delaware in terms of what they offer a business.

Why Setup Offshore? Many investment fund managers want to know when the time is right to set up a fund. It is best to ask and answer a series of questions: Where are your investors located and what matters to them? If you have a suitable investor base then the time is right to set up offshore. Consider setting up an offshore fund if you manage money for clients outside of your home country. It is that simple. Why would an invest or that does not live in your home country want to pay taxes there (or have to worry about paying taxes there)?

For U.S. based fund managers, also consider setting up an offshore fund if your U.S. investors are tax-exempt person (for example, retirement accounts, pension funds, etc.). Under U.S. law, Tax-Exempt Persons (TEP) investing in a fund that borrows money to trade or generate investment income become taxable on such investment (or trading income) as Unrelated Business Taxable Income (UBTI), despite the TEP’s otherwise tax-exempt status. The exposure to UBTI can be managed in many cases by investing in certain types of offshore funds.

Offshore Planning Trends in 2008. As a result of a “tweak” to its laws in November 2006, the Cayman Islands quietly become a much less attractive place to form a small offshore fund (meaning less than $10 million of seed capital). Anguilla (a country near the Cayman Islands) assumed that honor. However, in July 2007, the Cayman Islands again changed its law. Despite the law change published in the Cayman Islands on August 6, 2007 as the Mutual Fund Law (2007 Revision), Anguilla (and the British Virgin Islands)remain one of the best places to start a private offshore fund.

Anguilla.  Anguilla enacted its current Mutual Funds Act in 2004. As a country, it offers a low cost and efficient regulatory environment for private investment funds. The laws of Anguilla allow for three (3) types of investment funds, two (2) of which are important to fund managers starting a small offshore fund (in our experience). Those types of funds are the Private Fund and the Professional Fund. The laws of the Cayman Islands allow for four (4) types of investment funds, two (2) of which are important to fund managers starting a small offshore fund (in our experience). Those types of funds are the Category 4(3) Fund and the Category 4(4) Fund.

Comparison of Mutual Fund Law in the Cayman Islands with that of Anguilla. Below is a modest comparison of the legal landscape of Anguilla with that of the Cayman Islands.

Anguilla Private Fund versus Cayman Islands Category 4(4) Fund Minimum Investment/Subscription.  In Anguilla, there is no minimum subscription amount for investing into a Private Fund. The same is true of a Category 4(4) Fund in the Cayman Islands.  However, in Anguilla, a Private Fund can have 99 investors while in the Cayman Islands, a Category 4(4) Fund is limited to 15 investors (all of whom can vote to remove you as operator of the fund).

Audit Requirements. Neither country requires an audit nor the preparation of a prospectus; although most fund operators do so as a matter of practice.

Number of Investors in Fund. In Anguilla, a Private Fund can have up to ninety-nine (99) investors. In the Cayman Islands, a Category 4(4) Fund) is limited to fifteen (15) investors. In Anguilla, investors have no vote in the matters of a Private Fund. You can remain in control of the fund. In the Cayman Islands, you could lose control of a Category 4(4) Fund as investors have voting power sufficient to remove you as the fund’s operator.

Anguilla Professional Fund versus Cayman Island Category 4(3) Fund Minimum Investment/Subscription. In Anguilla, a Professional Fund requires a minimum investment of USD $100,000 (or its equivalent in any other currency). The $100,000 limit does not apply to an investment made by the fund’s manager, administrator, or promoter. In the Cayman Islands, a Category 4(3) Fund requires a minimum investment of USD $80,000 and this requirement applies to the fund’s manager, administrator, or promoter. Prior to August 2007, a Category 4(3) Fund also required a minimum investment of USD $100,000.

Audit Requirements. A Professional Fund in Anguilla is not required to submit audited financial statements annually to the government. A Category 4(3) Fund in the Cayman Island is required to file the fund’s current prospectus with the government, pay a substantial annual registration fee and file a financial schedule. A Professional Fund in Anguilla is not required to issue a prospectus, albeit, most usually do as a matter of practice.

Number of Investors in Fund. Neither the Professional Fund nor the Category 4(3) Fund has any size restriction (but only a minimum subscription amount as stated above). In Anguilla, a Professional Fund is open to “professional” investors, generously defined in Anguilla as a person whose ordinary business involves dealing in investments or who has signed a declaration that he, whether individually or jointly with his spouse, has net worth in excess of USD $1,000,000 or its equivalent.

In Anguilla, a fund may be in the form of an Anguilla domestic company, international business company, limited liability company, limited partnership, partnership, unit trust or protected cell company, protected cell accounts, segregated portfolio company, or segregated portfolio accounts. The corporate entities are extremely useful because they allow for the issuance of series or classes of shares with different rights thus allowing for the creation of umbrella funds and master/feeder structures. The use of an Anguilla domestic company also allows for the use of companies limited by guarantee and shares, as well as private companies.

Always remember that the domicile of the fund need not be the same as that of its administrator and custodian. A fund’s service providers can hail from the other side of the world. Moreover, the service providers’ location usually is the more important issue.

Why Setup a Fund? Market conditions have never been better for setting up a fund. Investors prefer to have money managed on a personal basis. Investors are trending away from Wall Street and heading toward “Main Street” when looking for help with their portfolios. It is no small secret that customized funds have taken up residence on Main Street and are attracting investors in droves. Traders that only dreamed of making a living by managing money for others are
turning those dreams into reality for themselves.

1. Read a fund’s prospectus or offering memorandum and related materials

The offering memorandum is a set of documents constructed by the legal counsel of the fund. It outlines investment strategies, lists all of the fees associated with the fund, goes over the time line, lists the services providers, and is the basic operating manual for the fund. Make sure you familiarize yourself with the basic principles of the fund so there are no surprises along the way.

2. Understand how a fund’s assets are valued

Depending on what the hedge fund invests in, the fund may be either liquid, or high illiquid. When the fund invests in illiquid securities, many times, they are hard to value. Hedge funds that invest in exotic securities require a much more intense understand of the strategy and the investment, so that you can better gauge the fluctuation of value.

3. Ask questions about fees

Typically, hedge funds charge a management fee as well as a performance fee. A standard fee structure would be 2/20 where the fund manager charges 2% managing the assets and 20% of the fund’s performance. These numbers can change, with some managers only charging 1% to manage the assets, or no fee at all. Performance fees can go as high as 45% on occasions. It all depends on the manager, so make sure you are well aware of the fee structure before going into the fund. If you invest in a fund of hedge fund, you may be charged a double layer of fees, with one going to hedge fund manager, and the other going to the fund of fund manager. Also check to see if there is a high water mark, or hurdle rate, which will also affect the fee structure. Ask if there is a penalty fee for leaving the fund early, as well.

4. Understand any limitations on your right to redeem your shares

Find out if there is a “lock-up” period, which is a period where you cannot redeem your investment. This may be a year or two. Remember, even if there is no spoken lock-up period or penalty for cashing in early, hedge fund managers sometimes can freeze redemptions without any notice, making it impossible for investors to redeem cash. However, this usually is a red flag, and many times when redemptions are stifled, the fund’s demise comes shortly thereafter. Or, as in some cases, redemptions are only frozen until market conditions become more desirable for the fund.

5. Research the backgrounds of hedge fund managers

Everyday it seems, there are headlines that detail fraudulent hedge funds or scheming hedge fund managers. When choosing a hedge fund, and thus choosing a hedge fund manager, its important to find out, did the manger run any previous funds? What is the manager’s performance record, with both this fund, and the last? What is the managers employment history? Has the manager ever been convicted of a crime? Was the manager let go from his previous position and why? Does the manager have sufficient experience with this kind of strategy? Because hedge funds enjoy light regulation, a manager can tank a fund, close its door, and open up a new one with a different fund name, without a problem. That’s why background checks are crucial. After all, a hedge fund is only as good as its manager.

6. Don’t be afraid to ask questions

It’s your money. You should know exactly where it is going, when you can get it back, and what you expect to gain from this investment. Hedge fund managers many times have years of experience on Wall Street along with a financial background. This can make for some pretty complicated investments. If you don’t share a repertoire in finance, you may have to dig a little in order to fully understand the strategy and where exactly your money is going.

Not to be confused with asset based lending, although similar, real estate hedge funds can employ several different strategies. Some are focused mainly on opportunities in publicly traded securities of real estate companies, primarily Real Estate Investment Trusts (REITs).

A REIT is a tax designation for a corporation investing in real estate that reduces or eliminates corporate income taxes. In return, REITs are required to distribute 90% of their income, which may be taxable in the hands of the investors. The REIT structure was designed to provide a similar structure for investment in real estate as mutual funds provide for investment in stocks.

Other real estate hedge funds focus on acquiring sub-performing properties either in one specific geographic location, or spanning the globe. They often purchase these properties at very attractive rates since the seller usually lacks liquidity.

Cliffwood has one of the original real estate hedge funds, launched in 1994. It engages in a long-short strategy and currently has about $100 million under management, along with a long-only fund. Total firm assets are about $586 million.

Blackacre Capital is another big name in real estate hedge funds. They often buy large hotels and projects with the goal of restructuring and developing. Blackacre just recently raised $890 million for their new real estate hedge fund.

Angelo Gordon & Co. launched it AG Long Short Realty Fund in 2003. The firm, which has amassed over $5 billion worth of real estate, focuses on investment grade rated securities that they feel are mispriced. They invest throughout the debt capital structure as well as in lower rated debt where if they see the opportunity for high returns.

In April of this year, The Praedium Group started to develop their new real estate hedge fund, attempting to profit from the disparities between indexes that track the public and private real estate markets.

]]> http://www.hedgeco.net/hedgeducation/hedge-fund-articles/real-estate-hedge-funds/feed/ http://www.hedgeco.net/hedgeducation/hedge-fund-articles/largest-hedge-funds/ http://www.hedgeco.net/hedgeducation/hedge-fund-articles/largest-hedge-funds/#comments Wed, 14 May 2008 20:32:59 +0000 HedgeCo Networks http://www.hedgeco.net/hedgeducation/hedge-fund-articles/largest-hedge-funds/ Continue Reading]]> While hedge funds are estimated to manage almost $3 trillion in assets, the top hedge funds are responsible for a large chunk of that number. In fact, the largest hedge funds manage about $1.6 trillion, more than half of total assets under management. Despite hedge funds losing a combined $24 billion in 2007, total assets grew over 30% from the previous year. Here is the current list of the largest hedge funds.

Taking the cake for the largest hedge fund manager is JPMorgan Chase , through both JP Morgan Chase Asset Management and Highbridge Capital Management. Despite posting losses of $8.5 billion through various funds last year, the company still overseas $44.7 billion in assets. JPMorgan Chase invests in everything from real estate to statistical arbitrage products while employing a diverse range of hedge fund mangers with differing styles and investment philosophies.

2 & 3. Bridgewater Associates and Farallon Capital Management

Tied for the number two position, these firms each manage $36 billion in assets. The Connecticut based Bridgewater prides itself on emerging markets, commodities, currency, global fixed income, bonds and equity investments.

The San Francisco based Farallon is the choice for many institutions and ultra-wealthy individuals. This hedge fund is very event driven and looks for opportunities to invest in, while shorting on others, in an attempt to hedge their risk. Farallon moved up three spots on the list since last year, mainly from capitalizing on the housing market situation.

4. Renaissance Technologies

Despite suffering losses from the U.S. subprime mortgage crisis, New York based Renaissance Technologies still managed to make the #4 spot, with $34 billion under management. The firm’s famed Medallion fund, which averages around 35% annual returns, charges investors a hefty 5% management fee and 44% performance fee. Renaissance employs a global macro strategy, and tends to hire experts with a scientific and mathematical background, rather than a financial one.

5. Och-Ziff Capital Management

After going public last year, Och-Ziff rose to the number 5 spot, managing $33.2 billion. The New York based hedge fund’s strategies include private equity, real estate, and equity restructuring, investing over half of their portfolio in foreign markets. The firm has been experiencing some recent trouble in 2008, with all four of their funds reporting losses in the first quarter. Executives attribute this to the $3.3 billion in expenses they incurred during the IPO and reorganization last November.

6. D.E. Shaw

Dropping a few spots on the list is DE Shaw, who manages $32.3 billion. The New York based hedge fund likes to buyout distressed companies, while financing and developing new companies. They also dabble in commodities, emerging markets, currencies, real estate, and venture capital. Like Renaissance Technologies, D.E. Shaw prides themselves on using math whizzes and computers to locate opportunities in the market. It is widely known that only 1 in every 500 applicants at D.E. Shaw makes the cut.

7. Goldman Sachs

Falling from the number two position is the New York based Goldman Sachs, who manages $29.2 billion, about $3 billion less than they managed last year. They generally invest in currency, real estate, private equity, and venture capital while using a multi-strategy approach. Goldman’s long-short Global Equity Opportunities fund and the Global Alpha fund both plummeted about 30 percent of their value last year as a result of the subprime fallout.

8. Paulson & Co

A new addition to the list, John Paulson and his company, Paulson & Co. now manage $29 billion after correctly betting that subprime loan holders would default on their mortgages. Paulson went down in history as having the biggest day ever on Wall Street, about $3 billion. The New York based hedge fund invests in public equity markets across the globe, and employs merger arbitrage, long/short, and event-driven strategies while using fundamental analysis to make its investments.

So what was the culprit behind the fund’s demise? Surprisingly, it all boiled down to one bad bet. The funds we have seen collapsing lately due to the subprime mortgage crisis and the credit crunch have all had a sort of “storm” of factors that have contributed to their demise. But with Amaranth, that wasn’t really the case, making the monumental loss even harder to believe.

By 2005, Amaranth had placed most of its capital into energy trades, mainly the natural gas market. The firms head trader, Brian Hunter, was garnering enormous profits for the hedge fund by placing huge bets on natural gas prices. Hoping to continue his streak of good luck, Hunter used 8:1 leverage to place more bets on the prices of gas using both long and short techniques. When prices went in the complete opposite direction of what Hunter had predicted, losses were catastrophic. With prices on natural gas being so volatile and depending on a number of different social, political, and economic events, making such heavy bets using massive amounts of leverage is not usually a smart move.

Amaranth suddenly had to inform investors that their $9 billion portfolio had experienced losses exceeding 65%. The fund suspended redemptions in the fall of 2006, then hired a liquidator only days later.

To make matters worse, the Commodity Futures Trading Commission (CFTC) charged Amaranth along with Brian Hunter with Attempted Manipulation of the Price of Natural Gas Futures, including making false statements to the New York Mercantile Exchange (NYMEX). These charges were in addition to the market manipulation charges brought on by the Federal Energy Regulatory Commission.

Apparently wanting to partake in the lawsuit frenzy, Amaranth filed a suit against JPMorgan Chase in late 2007, alleging that they had used their position as Amaranth’s clearing broker to prevent the hedge fund from transferring the remaining risk in its natural-gas derivatives portfolio to Goldman Sachs and Citadel Investment Group LLC. Amaranth is seeking $1 billion in damages.

The fund alleges that JPMorgan refused to execute a vital trade on Sept. 18, 2006, that would have transferred the fund’s natural-gas derivatives positions to Goldman Sachs in exchange for a concession payment of $1.85 billion from the fund. Amaranth accuses JPMorgan of wanting to take control of the portfolio themselves in hopes of gaining substantial profits.

“As a result, Goldman Sachs walked away from the trade,” the claim stated. “The effects on the fund were devastating.”

JPMorgan responded with their theory. “Amaranth’s lawsuit is an effort to rewrite history, and to blame JPMorgan for losses that were the result of Amaranth’s disastrous trading,” said Kristin Lemkau, a JPMorgan spokeswoman, in a statement. “JPMorgan’s conduct was entirely appropriate, and consistent with its rights and obligations as Amaranth’s future commissions merchant. The firm intends to defend this baseless lawsuit with the utmost vigor.”

The global macro manager usually uses leverage to make bets on price movements in any market of the world, hence the term “global.”  The term “macro” refers to the macroeconomic principles used by the manager to locate mispriced assets or market inefficiencies.  Because the manager may choose to invest in any market, in any corner of the globe, the possibilities are endless, and may be as risky or as conservative as that manager chooses.

It was George Soros who first catapulted the global macro approach onto the headlines.  His famous Quantum Hedge Fund used a global macro strategy to make him billions overnight, literally.  In 1992, Soros made a bet that the Bank of England would not support the pound participation in the European Exchange Rate Mechanism by jacking up interest rates in a depressed economy.  Soros was correct, and made his fortune when the Bank of England let the British currency devalue.  Investors were delighted when Soros’ fund returned 30% a year between its launch in 1968 and 2000.

Other global macro funds have also fared well, repeatedly showing a low correlation to the general markets.

Global macro trades can be either directional, where the manager bets on discrete price movements, or use relative value, where mispricings are highlighted between two similar assets, by betting on both the long and short sides.

Sometimes, a manger will correctly identify market inefficiencies, using a discretionary technique.  When a computer is used to do this, it is called a systematic approach.  Either way, it’s all about timing.  The hedge fund manager must capitalize on this swing in equilibrium, make the proper bets, and get out at the right time.  It is because of this limited window of time and risk that these hedge funds are able to produce vast returns in so little time.

Global macro hedge funds also exhibit a low correlation to the general equity market.  While they exact amount of assets under management is not known, global macro hedge funds are estimated to manage over $150 billion in capital, with that number rising every quarter.

In 2005, the housing market was booming. I can remember living in Miami, looking at one-bedroom condos, and not being able to get near them for less than $350,000. Demand was sky-high, and people who had purchased their homes for $150,000 a few years back, were suddenly making a killing on flipping them. Developers saw this demand and got greedy. Overnight it seemed, the skyline of Miami was flooded with cranes, and residential condos were being built on nearly every corner. Thousands of new units were springing up, leaving the obvious question: Are there enough buyers? The shortened answer was: No. This wasn’t confined to southern Florida, either. The entire country was experiencing the same dilemma on some scale.

Desperate to rent out these units, banks started lending to anyone and everyone that wanted to buy a home, even people with ugly or no credit. These “subprime” candidates were often misled, with banks offering them attractive interest rates up front, and failing to convey that these low interest rates would increase after an initial period.

According to an article published on subprimelosses.com, the amount of mortgages that reset to higher interest rates are as follows:

Inevitably, these individuals started defaulting on their mortgages due to higher interest rates, and the fact that they probably couldn’t afford them in the first place.

However, subprime mortgage-backed securities and Collaterized Debt Obligations were already in wide circulation and were present in many investment vehicles, including hedge funds. Some feel that ratings agencies like Moody’s presented these securities with little risk, while they were in fact, extremely risky.

To make matters even worse, the supply of open units far outweighed the demand. People who couldn’t pay their mortgages were unable to sell their homes, or took huge losses due to declining home values. The result was an overwhelming number of foreclosures. Many buyers purchased homes thinking they would flip them and make a quick buck. Most of these buyers already had another mortgage to pay, resulting in more foreclosures.

The biggest problem of the subprime crisis was the domino effect it had through the world’s economy. Because so many investment vehicles were dependent on these mortgage-backed securities, assets started to plummet when all of these foreclosures starting happening. While agencies have started to adjust their ratings, and banks are much more careful about who they lend to, we will probably still feel the wrath from the subprime crisis for months to come.

Drake had suspended redemptions in December of 2007, after the fund lost 25% of its value and investors rushed to withdraw money. Investors were denied the action of “liquidating investments in a market characterized by unprecedented illiquidity.” After experiencing sharp declines due to the subprime mortgage crisis, management was pondering the decision of shutting down due to “sharply negative performance and the extreme volatility and illiquidity of certain capital markets.”

The Global Opportunities Fund was launched in 2002 by the firms founder, Anthony Faillace and Steve Luttrell. In it’s heyday, the fund was posting returns of 13.4% a year on average.

So what fueled the collapse of this once-thriving hedge fund that oversaw over $4 billion in assets? Like many other hedge funds in 2007, the Global Opportunities Fund was hit hard by the subprime mortgage crisis and the credit crunch that followed. Drake, like these other funds, used heavy amounts of leverage as part of their strategy to buy bonds backed by subprime mortgages. When homeowners started to default on their mortgages at a catastrophic rate, these bonds started to plummet in value. Their lack of ample liquidity to begin with made the situation even harder to get out of. Brokerage firms then started to demand more cash or collateral to back their loans to hedge funds. On top of that, investors rush to withdraw money when there is a rumor of a liquidity crunch. All of these factors contributed to the collapse of the fund.

“Under normal market conditions, these divergent interests could both be met by exiting positions and generating the necessary proceeds to redeem investors,” Drake said. “But present market conditions have effectively prevented us from following this course of action.”

Drake plans to start a new fund later this year, and investors who choose to transfer their capital to the new fund will not pay performance fees until their losses are recouped. The liquidation is expected to be complete by early 2009 and investors will likely get most of their money back, the letter stated.

Drake’s struggle comes at a time when many hedge funds that manage large amounts of assets are being forced to liquidate. Just this month, London based Peloton Partners closed their two hedge funds that once managed $3 billion after their lenders pulled back on credit.

Drake, a New-York based company run by former BlackRock Inc. employees, also manages two other hedge funds, the $1.3 billion Absolute Return Fund which declined over 14% last year, and the $160 million Drake Low Volatility Fund.

Top 10 Currencies Traded

1. U.S dollar
2. Euro
3. Japanese yen
4. British pound sterling
5. Swiss franc
6. Australian dollar
7. Canadian dollar
8. Swedish krona
9. Hong Kong dollar
10. Norwegian krone

Because of the variety of traders involved and the fact that currencies are traded 24 hours a day except on weekends, the foreign exchange market is unlike any other financial market. Far different from the stock market, where everyone has access to the same prices, the forex market is based on access. The more money someone is trading, the better level of access they have. This is why investment banking firms are usually at the top, usually trading billions of dollars daily.

Top 10 Currency Traders

1. Deutsche Bank
2. UBS AG
3. Citi
4. Royal Bank of Scotland
5. Barclays Capital
6. Bank of America
7. HSBC
8. Goldman Sachs
9. JPMorgan
10. Morgan Stanley

The biggest factor that affects forex is the exchange rate. Because the value of currency is completely correlated to supply and demand, the price of one currency in relation to another is constantly shifting. Because supply and demand are influenced by a number of different factors, the foreign exchange market is extremely complex and ever-changing, and could be impacted by almost any social or economic event, worldwide. In most countries, there are little or no restrictions on capital flows, leaving the exchange rates open to adjustments based on their perceived values by the market forces.

According to Wikipedia, hedge funds have gained a reputation for aggressive currency speculation since 1996. They control billions of dollars of equity and may borrow billions more, and thus may overwhelm intervention by central banks to support almost any currency, if the economic fundamentals are in the hedge funds’ favor.

Hedge Funds, which have always been known to dabble in exotic investments, were therefore the perfect vehicle to trade in the foreign exchange market. Forex hedge fund managers must have a prolific understand of global economics. As with any hedge fund, the strategy employed in forex hedge funds depends entirely on the style of the manager, as there are many different strategies that may be used. Some popular ones include betting the position of the dollar against other currencies and a strategy where managers borrow in low-yielding currencies, then invest in higher-yielding units.

There are so many different strategies employed by by hedge fund managers, that the term “hedge” does not always apply. While some hedge funds are more risky than others, managers try to purvey the risks to investors, so they are fully aware what they are getting into.

There are many cases, however, where investors feel like managers weren’t being upfront with them about the inherent risks, like in the Bear Stearns case for example.

According to the Hedge Fund Association, there are 14 different common hedge-fund strategies, each with varying degrees of risk. The riskiest funds rely on market timing, investment in emerging markets with volatile growth, and short selling, which anticipates the future decline of a price of stock. Taking long/short positions and betting on both sides of events such as mergers, acquisitions and buyouts is thought to be a much more conservative strategy, along with investments in funds of funds.

Another popular hedge fund strategy that has increased dramatically in popularity due to its complete lack of correlation to the market, is asset-based lending. Since hedge funds that employ this type of strategy make their money off high interest payments from borrowers of their loans, the risk is more associated with defaulting by the borrowers, as opposed to volatility in the marketplace.

According to Citigroup, 93% of the return variance of equity non-hedge strategies could be explained by specific market factors. As for bond strategies, 24% of the performance moves among fixed-income arbitrage managers came from long-only market factors.

One of the most riskiest strategies used by hedge fund managers that has caused a handful of funds to implode is the use of heavy leverage backed by subprime mortgages. Many hedge fund managers did not predict that a number of these homeowners who had these types of mortgages would default, causing the bonds backed by them to plummet in value. Hedge funds like ones run by Bear Stearns and Drake Management lost billions of dollars resulting from the subprime mortgage crisis.

Let’s face it. If hedge funds had no risk attached to them, everybody would be throwing their money in. And you can’t reap rewards without taking a risk. This is why there are strict guidelines in place as to who may invest in hedge funds. Only accredited investors and qualified clients can place their money in hedge funds, since they are thought to be more educated than the typical investor and more aware of the risks involved.

These investors also must have a high net worth because there is a chance they may lose their entire investment. For investors who choose to pursue high returns in a short period of time, generally, there is more risk involved because the bets are higher. This is one of the staples of hedge funds, however. If investors wanted to take a more long-term approach, they may choose to invest in private equity or a mutual fund.

The most important lesson in terms of Hedge Fund Risk Management comes from the improper name of this kind of alternative investment: The idea that all systematic risks are diversified away is not applicable here, with the Hedge Fund returns, in reality, representing a combination of superior management of market inefficiencies and conscious exposure to some specific systematic risks. Only the systematic risks that are “undesirable” from a strategic point of view are diversified away. So, hedge funds, in reality, are not fully hedged.

Moreover, the adequate measure in terms of risk management exposure moves from the realm of excess risk in comparison to a benchmark to a total risk approach. Total return here is what matters for managers and investors and not a comparison of the hedge fund performance to some benchmark, like in other types of funds.

Also, the leptokurtosis (“fat tails”) and negative skewness associated to most class of hedge funds present a significant challenge to quantitative methodologies based on the assumption of returns normality (e.g. Riskmetrics classic approach), with the area becoming a very good study case for new approaches, like Extreme Value Theory (EVT).

Finally, with this complex framework in mind, the need for an initial and constant due diligence and managerial tracking surges as the most important issue from an investor’s or fund of funds’ perspective. Here, the obligation of full portfolio transparency (for legitimate investors, but not for the whole market) becomes mandatory for the successful risk manager, while, of course. other types of risk commonly non addressed through quantitative methodologies, (e.g. the liquidity barriers established through long “lock-up” periods) can’t also be underestimated.

Once aware of the formal conditions offered by a hedge fund manager, knowing your manager’s style in-depth and keeping frequent meetings and discussions based on updated full portfolio/single positions disclosures is the key to avoiding pitfalls as an investor.

Richard Wilson is a hedge fund consultant, founder of the Hedge Fund Group (HFG) and runs the Hedge Fund Consultants Blog.

Few hedge fund managers would predict that homeowners, mainly “subprime” borrowers, would be unable to make their monthly mortgage payment. The result was a foreclosure sweep across the nation, and banks are still writing down losses, upwards of $285 billion.

Both Bear’s High-Grade Structured Credit Strategies Enhanced Leverage Fund and its High-Grade Structured Credit Strategies Fund used massive amounts of leverage to purchase collateralized debt obligations backed by these subprime mortgages, as did many hedge funds around that time. As defaults surged on these subprime mortgages, Bear grappled with declines in the values of AAA and AA securities, as they said in a statement.

Creditors who were financing this heavy leveraged investment strategy started to panic, as they were using these subprime mortgage-backed bonds as collateral on the loans. Bear Stearns was then forced to pony up cash on their loans because the the subprime backed bonds that were used as collateral were plummeting in value. This led to a major liquidity shortage, forcing Bear to sell more bonds at a highly discounted rate in order to generate cash.

Bear Stearns then tried to infuse their Credit Strategies Fund with $1.6 billion of capital, in one of the largest bailouts in hedge fund history. But even the new influx of capital couldn’t save the sinking fund. Bear was forced to tell investors that there was “effectively no value left” in the funds which once managed over $10 billion.

To make matters worse, a judge ruled that the liquidation of the funds must be handled onshore, and not in the Caymans where the funds were originated. Bear was hoping for an offshore liquidation to shield some of its assets from creditors that were owed and to avoid transparency. Some also believe that judges in the Caymans are much more apt to favor management over creditors.

After the debacle, investors were furious, which sparked many lawsuits that are still pending. Investors argue that the fund managers were at fault, and shouldn’t have used such risky strategies involving high amounts of leverage with little cash to back it up. It was these types of funds which experienced the hardest hits when the housing market started to crash.

In one of the lawsuits, investors asserted that Bear “conceived, marketed and managed hedge funds that they knew would be viable so long as - but only so long as - the U.S. housing market continued to rise.” If this were the case, and there was no risk controls set in place, Bear would be at fault.

“Investors who sought to take advantage of the inimitable risk management reputation of Bear Stearns found themselves in a highly-complex hedge fund investment program that relied on overworked junior personnel to manage a conflict reporting process required by federal law,” said another investors who filed suit against Bear.

It didn’t take long before the bad press started circulating and Bear Stearns’ reputation started faltering, as a prime broker, and in general. While there were a multitude of factors that led to the failure and ultimate sale of Bear Stearns, investors became weary of the company after such an implosion. If you remember the fallout, the rumor of a cash shortage sent investors scrambling for money, which resulted in a real cash shortage. Maybe this lack of trust in Bear had something to do with it. Fast forward a few days; the Fed is helping JPMorgan purchase Bear Stearns and Bear T-shirts are selling on Ebay for more than their stock is worth.

This form of raising capital is popular among new companies, or ventures, with a limited history of operation, who are having trouble raising necessary funds. Usually, firms that provide venture capital generally have around $25 million to $1 billion to invest in emerging companies. However, venture capital is a form of private equity, and like many private equity funds, the manager wants a significant stake in the business, sometimes in the form of a leadership or decision-making role.

Venture capital is not easy to acquire, though it is sought after by a large number of small companies. Most firms that provide venture capital go through a very selective process and only invest in companies where they see huge growth potential. Since their paychecks are directly related to how well the companies perform, their selection process involves a detailed approach into their business strategy, management, and the company’s objectives.

Investors in venture capital funds are known as limited partners. This constituency comprises both high net worth individuals and institutions with large amounts of available capital, such as state and private pension funds, university financial endowments, foundations, insurance companies, and pooled investment vehicles, called fund of funds or mutual funds.

Typically, venture capital funds require a 10 year commitment, unlike other hedge funds that aim for significant returns in a shorter period of time. Like hedge funds, the general partners in a venture capital fund receive management fees of 2% of the assets. In addition, they also charge a performance fee usually around 20%-30% for profits, or “carried interest.”

According to Entrepreneur.com, the top ten venture capital firms are:

For Early Stage Companies

1. Maryland Technology Development Corporation
2. Draper Fisher Jurvetson
3. Tech Coast Angels
4. New Enterprise Associates
5. Khosla Ventures
6. Sequoia Capital
7. Village Ventures
8. Austin Ventures
9. Band of Angels
10. Omidyar Networks

For Later Stage Companies

1. Tech Coast Angels
2. Stonehenge Capital Company
3. Edison Venture Fund
4. HIG Capital Management
5. New Enterprise Associates
6. Sequoia Capital
7. Benchmark Capital
8. Polaris Venture Partners
9. Redpoint Ventures
10. Safeguard Scientifics Inc.

In fact, Sequoia Capital, listed here for both early and later stage companies, is rumored to be raising over $750 million to start their own hedge fund. Sequoia invests in technologically savvy companies including Apple and Yahoo, and has been adding former hedge fund managers recently to their roster of talent.

Not quite at Soros status, Steven Cohen of Greenwich, CT, is estimated to be worth $6.8 billion. He started his fund, SAC Capital in 1992 with $25 million in assets. Today, his 9 funds manage around $14 billion.

Also based in Greenwich are Ray Dalio of Bridgewater Associates and Paul Tudor Jones III of Tudor Investment Corp. Dalio started his hedge fund in 1975, and now manages $150 billion in assets, contributing to his $4 billion personal fortune. Tudor Jones launched his fund in 1980, and made millions when he predicted the stock market crash in 1987.

James Simons comes in at $5.5 billion, thanks to his hedge fund, Renaissance Technologies. He believes in high fees and high returns. His management fee is 5%, while his performance fee is 44%. This is far above the normal rate of 2/20, but investors in his fund don’t seem to mind.

Daniel Och of the famous Och-Ziff hedge fund is sitting pretty on the list with a net worth of $3.6 billion. He started his hedge fund with a $100 million initial investment from the 3 Ziff brothers (who also made the list), and now manages $33 billion.

Tied at $3.5 billion are Bruce Kovner of Caxton Global Investments and Stanley Druckenmiller of Duquesne Captial Management. Druckenmiller was the right hand man of Soros when they “broke” the British pound in 1992. Kovner started his fund in 1983, and has since netted returns of 25% annually.

Also making the cut are David Shaw of D.E. Shaw & Co. and David Tepper of Appaloosa Management. Both men have amassed fortunes of $2 billion. Louis Bacon of Moore Capital and Philip Falcone of Harbinger Captial Partners are each worth $1.7 billion.

John Arnold, 34, made the list of this years youngest billionaires. Arnold formerly traded oil for Enron. He now runs the hedge fund Centaurus Energy, and is worth an estimated $1.5 billion.

Marketing a hedge fund involves a myriad of considerations, including compliance not only with the regulatory requirements and restrictions of the jurisdiction in which the hedge fund is domiciled, but also the requirements and restrictions of each jurisdiction in which the fund’s target investors live. Here, we address the status of hedge fund regulation in the United States, with a particular focus on its implication for hedge fund marketing efforts.

Regulation of Hedge Fund Marketing

In order to avoid the requirement to register their securities under the Securities Act of 1933, hedge funds must be sold via
a private placement. In most instances, as stated in SEC Rule 502(c), such privately placed funds may not be offered or sold
“by any form of ‘general solicitation’ or ‘general advertising,’” including, but not limited to, the following:

• Any advertisement, article, notice, or other communication published in any newspaper, magazine, or similar media or broadcast over television or radio; or
• Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising

Limited by these restrictions, hedge funds may wonder how to market their funds. Below, we offer some suggestions based on prior SEC statements and based on guidance provided by the NASD (now FINRA, the Financial Industry Regulatory Authority) to its members in setting forth guidelines for marketing hedge funds.

Limited Audience for Solicitations

First and foremost, although the SEC has not defined the terms “general solicitation” and “general advertising,” it is clear that solicitations provided to a general audience will run afoul of Rule 502(c). Indeed, the SEC has indicated that it believes the following actions violate Rule 502(c):

• Mass mailings;

• Speaking to the media referencing an investment currently offered or contemplated, particularly where the discussion is an attempt to “condition the market” by making reference to the success or attractive return of previous investments; and

• Print, radio and television advertisements or solicitations regarding funding or investment matters. Accordingly, hedge funds should limit the audience from which they solicit investments, preferably to individuals or entities with which they have a pre-existing relationship. Even in the potentially fruitful situation of participating in an investment forum, hedge fund advisers should take care that the attendees are limited to accredited investors and, preferably, to investors with whom the advisers have a pre-existing relationship.

FINRA Guidelines Regarding the Content of Solicitations

In 2003, FINRA studied hedge fund marketing materials and then issued guidance for member firms in the form of a member update regarding the marketing of hedge funds by its members. FINRA maintains this general guidance today.
Although this guidance does not apply directly to hedge funds, it provides a useful framework for hedge fund marketing materials. In reviewing member marketing of hedge funds, FINRA found that some examples of hedge fund sales literature included “unbalanced presentations about the particular hedge funds
being offered” and, therefore, failed “to provide investors with a sound basis for evaluating whether to invest in the funds.”

NASD Member Update October 9, 2003, NASD Review of Hedge Fund Advertising Results in Formal Action. FINRA’s
review identified four general areas of concern in hedge fund advertising: (i) risk disclosure; (ii) misleading and exaggerated
language; (iii) performance; and (iv) general solicitations. We address these areas below.

Risk DisclosureAccording to the guidance, hedge fund promotional materials must be a balanced, fair presentation of the risks and potential disadvantages of hedge fund investing. Communications regarding hedge funds and funds of hedge funds must adequately disclose the risks associated with these products. Presentations must address the risks associated with hedge funds in general, as well as the specific risks associated with the fund being offered including, but not limited to, the risks associated with a fund’s structure, investment strategies, portfolio securities, tax treatment, etc. For example, members must balance sales material or oral presentations that promote the advantages of hedge fund investing with full disclosure of the risks that hedge funds present, including the fact that hedge
funds:

• Often engage in leverage and other speculative investment practices that may increase the risk of investment loss;
• Can be highly illiquid;
• Are not required to provide periodic pricing or valuation information to investors;
• May involve complex tax structures and delays in distributing important tax information;
• Are not subject to the same regulatory requirements as mutual funds; and
• Often charge high fees

NASD Notice to Members 03-07, NASD Reminds Members of Obligations When Selling Hedge Funds. In addition, it may also be advisable to highlight to potential investors the fact that a hedge fund investment may not be suitable for all investors and, in particular, to suggest that it is suitable only for the most sophisticated investors. Indeed, some FINRA comments have called for disclosure of accredited investor requirements in hedge fund marketing materials.

Performance

Hedge fund managers should restrict discussions of performance results to actual performance of the fund being promoted.
FINRA has noted that some marketing materials contain language that states or implies that an investor can expect a specific rate of return from investing in a fund. Such projections or predictions of investment results are prohibited. Generally, funds should be very cautious about forward-looking statements with respect to securities investments. Moreover, where a fund has experienced a period of extraordinary performance, disclosure of the reasons for extraordinary market performance, and the fact that such performance may not be repeated in the future, is advisable.

New funds need to be particularly cautious regarding their marketing materials because any attempts to attribute the performance of another product to a new fund that has either a limited operating history or no operating history may be misleading.

Misleading or Exaggerated Language

In its first Compliance Alert letter to the chief compliance officers of registered firms, the SEC staff stated the most common deficiency in adviser advertising was that “many” advisory firms did not include in the advertisements of their performance returns the disclosures necessary to prevent their advertising from being misleading. For example, firms did not:

• Deduct advisory fees from performance results;

• Disclose whether results reflected dividends; or

• Disclose differences with the particular index being used to benchmark performance claims.

FINRA’s Member Conduct Rule inherited from the NASD provides that no material fact or qualification may be omitted from marketing materials if the omission would cause the communication to be misleading. In the context of hedge funds, FINRA generally considers the disclosure of the inherent and particular risks of an investment, investment strategy or underlying assets, liquidity restrictions, withdrawal rights and fees and performance fees and charges to be material. Thus, performance calculations should be presented net of the fees charged. If the performance description is not calculated net of fees charged, the fees to be deducted must be disclosed, along with a disclosure that the funds’ performance would be lower if the fees were deducted.

Performance presentations should also illustrate downside volatility and should not highlight only successful investments or
reporting periods with positive results. Note that providing a prospectus does not satisfy the duty to provide balanced sales
materials and oral presentations. Exaggerated, unwarranted or misleading statements or claims
are prohibited. Typically, the use of superlatives in the description of the fund or its performance is not advisable. The use of objective language to describe the fund’s performance is advised.

FINRA noted particular deficiencies where marketing
materials:

• Make unbalanced presentations about the particular hedge funds being offered;

• Contain exaggerated, unwarranted or misleading statements or claims, unwarranted forecasts or projections of future performance;

• Refer to a hedge fund as an “ideal fund for conservative investors” when the fund had a limited operating history, was speculative and involved a high degree of risk; indicate that hedge funds are subject to regulatory oversight;

• Present hypothetical results for specific hedge funds that had limited operating history or no operating history;

• State that a fund’s objective is to produce a steady or predictable return when, in fact, the fund’s prospectus did not disclose such an objective;

• Use language that states or implies that hedge funds or funds of funds are appropriate for all investors or should be part of all investors’ portfolios: and

• State or imply that an investor can expect a specific rate of return from investing in a fund.

Best Practices Noted by the SEC

Recently, the SEC’s Office of Compliance Inspections and Examinations (OCIE) offered examples of policies and procedures
in place at the firms with fewer performance advertising deficiencies. Such policies include:

• A multi-level review process among an adviser’s performance group, portfolio managers, and marketing group for the accuracy of marketing materials prior to their use;
• The creation of “tolerance reports” on a monthly basis to compare all composite accounts to their respective benchmarks, with any material discrepancies being investigated;
• A composite committee review of all accounts on at least a quarterly basis to ensure proper composite construction and maintenance; and
• The use of a second independent pricing service to periodically verify the accuracy of prices supplied by the primary pricing service, with any material discrepancies in prices being investigated.

Conclusion

In summary, we recommend:

• Targeting solicitations to individual potential investors or to a discrete group of accredited investors, preferably already known to the hedge fund adviser;
• Disclosing the risks and potential disadvantages of a hedge fund investment, as well as particular risks involved in investing in the particular fund at issue;
• Restricting discussions of performance to actual past performance, net of fees charged; and
• Disclosing statutory investor-eligibility requirements.

These marketing recommendations must be understood against the broader context of accelerating initiatives to regulate the hedge fund industry in the United States.

James R. Hedges, IV and Charlotte Luer are partners in LJH Financial
Marketing Strategies, a firm that provides marketing and investor
relations support to hedge funds ranging from multi-billion dollar firms
to emerging managers. They may be reached at 212.925.8703 or email
at jhedges@ljh.com or cluer@ljhfm.com. The firm’s Web site is
www.ljhfm.com.

Lucinda O. McConathy and Patricia C. O’Prey are partners in the law
firm of Richards Kibbe & Orbe LLP. They represent hedge funds,
commercial banks, investment banks, brokerage firms, and other
financial services institutions, along with individual traders and
executives, in private civil litigation and government investigations and
litigation. Ms. McConathy may be reached in RK&O’s Washington, D.C.
office at 202.261.2992 and Ms. O’Prey may be reached in RK&O’s New
York office at 212.530.1969. RK&O’s Web site is www.rkollp.com.

Jones employed two strategies still used heavily by hedge fund managers today: Leverage and short-selling. To avoid requirements set in place by the Investment Act of 1940, Jones limited the number of investors to 99 and set up the fund as a limited partnership.

Even though Jones garnered sizable returns in his first few years heading the fund, his strategy did not come into the mainstream until the late 60’s. When George Soros and Warren Buffet adopted Jones’ strategy and launched their own funds, hedge funds were suddenly being sought after by an elite group of investors.

What caught the attention of the investors was how these hedge funds had little correlation to the market. They were “hedged” against any downtown or slump in the economy. While the S & P was lagging, Jones’ investors continued to make money on a yearly basis. He decided to charge his clients a 20% performance fee, still used today by hedge fund managers. However, while most managers today also charge a management fee (usually 1-2%), Jones did not charge his investors anything unless the fund made a profit.

Hedge funds still enjoy limited regulation and are not required to make periodic reports with the SEC under the Securities and Exchange Act of 1934. Because of this, hedge funds have much more limited transparency than do mutual funds. While there have been recent attempts by the SEC to tighten up hedge fund regulation, they still enjoy the freedom and secrecy that other investment vehicles do not.

The SEC warns, “You should also be aware that, while the SEC may conduct examinations of any hedge fund manager that is registered as an investment adviser under the Investment Advisers Act, the SEC and other securities regulators generally have limited ability to check routinely on hedge fund activities.”

The one thing they do have control over, however, is who may invest in these hedge funds. The SEC mandates that only accredited investors or qualified clients may participate in hedge funds, due to the higher risk involved. However, the typical hedge fund investor is thought to be well educated when it comes to funds, and risks are usually communicated by the hedge fund manager.

In addition, in order to keep hedge funds “private” and in compliance with the Securities Act of 1933, soliciting or marketing is strictly limited. While hedge funds may have a website, only approved, qualified investors may access the site after their net worth is confirmed.

Today, there are over 10,000 hedge funds in existence with close to $3 trillion in assets under management. While some of them still use the staple strategy of leverage and short-selling, hedge funds today employ hundreds of different strategies, and not all all of them are “hedged,” as Jones’ was. Still, his business model that successfully dodged U.S regulation and his innovative investment strategy were the basis for the hedge fund industry today.

However, once you sign up as an accredited investor, you may view these databases online. Sites like hedgefund.net, hedgefundintelligence.com, and HedgeCo.Net, all offer hedge fund database complete with information on each fund. The database on HedgeCo.Net for example, is free to use for approved clients. Many other sites will charge a fee for investors. It is typical for the sites to charge the hedge fund manager, depending on how much information he would like displayed about his fund. These databases let the investor search by name of the fund, hedge fund strategy, manager, assets under management, returns, or a number of other ways. Databases are used frequently by investors to shop for new funds, keep an eye on a particular fund, or to compare funds.

This manager brings a specific strategy or investment philosophy to the table. Maybe he chooses to use leverage, or short a particular stock. Maybe he uses asset-backed lending or has a global-macro approach. Whatever strategy he uses, the accredited investor or qualified client believes that this strategy will garner them some good returns, and therefore invests with this manager. Their investment is in the form of a lot of cash, usually upwards of a half million dollars.

The hedge fund manager takes whatever initial capital he gets, whether it be from a number of investors, family, friends, maybe even his own money, and invests accordingly. While hedge funds aren’t “regulated,” the manager does have the responsibility of providing transparency to his investors. There are a wide range of statistics, numbers and charts that the investor will expect to receive on a regular basis. This is why the hedge fund manager must hire an administrator, to keep track of all of the documents relating to the fund. This way, the manager can focus on running the hedge fund and not administrative duties.

So where do these multi-million dollar paychecks for the hedge fund manager come in? Fees, fees and more fees. First, the manager gets to charge a management fee. This is independent of how the fund performs. The management fee is usually 1 to 2% of assets under management. Then comes the performance fee, which if the fund performs well, can be very lucrative. The performance fee is generally 20% but may go as high as 40% depending what the hedge fund manager likes to charge. James Simon, who runs Renaissance Technologies and who has garnered massive returns for his investors, charges a management fee of 5% and a performance fee of 44%.

When it comes down to close the fund down, assets are generally distributed to investors or transferred into a new hedge fund started by the same company. If the fund does not perform well, things get a little trickier. Whatever assets that are left are usually distributed to investors. However, the shutting down of a fund due to poor performance is generally preceded by the manager freezing investor redemptions. This is to avoid a mad rush by investors when the liquidity is probably not available. Sometimes, assets are frozen to wait out undesirable market conditions in hopes that things will improve. In either scenario, shutting down the fund after a poor performance is usually the last possible resort. Managers don’t want the reputation that comes with a failed fund, and investors don’t want a negative return on their contribution.

Let’s say a builder is in the process of constructing a tower and funds run dry. The builder will receive a loan from the hedge fund and put the tower up as collateral. If they fail to repay the loan, the hedge fund gets ownership of the tower. Usually, asset-backed loans have a very high percentage rate, and are generally considered to be a last resort for some companies. However, if they cannot secure a loan from a bank, an asset-backed loan may be their only option in order to complete the project.

While hedge funds that employ the asset-backed lending strategy are thought to be independent of market conditions, the current economic conditions are the ideal setting for these types of funds. With the subprime mortgage meltdown and the $285 billion in losses suffered by the banks, loans are much harder to secure. If the company must choose between an abnormally high interest rate offered by a hedge fund or to leave their project unfinished, they are going to choose the higher interest rate.

So how does an investor make money off an asset-based lending hedge fund? Quite simply, the investor shares profits from the high percentage rates. As long as the companies do not default on their loans, the hedge fund will make a sizable amount of capital from those percentage rates. If the companies do default on their loans, the hedge fund manager then moves to reorganize the project. This may include finding new project managers, completing the project, or finding a buyer.

Funds which specify a soft hurdle rate charge a performance fee based on the entire annualized return. Funds which use a hard hurdle rate only charge a performance fee on returns above the hurdle rate.

Let’s say, for example, a hedge fund manager sets a hurdle rate at 5%, which is a standard annual rate. If the fund garners a 50% return in one year, the manager will only collect performance fees for 45% of that gain.

Though logically appealing, this practice has diminished as demand for hedge funds has outstripped supply and hurdles are now rare.

Hedge funds usually employ a high water mark, sometimes by itself, and sometimes in conjunction with a hurdle rate.

• A natural person who or a company that immediately after entering into the contract has at least $ 750,000 under the management of the investment adviser

• Has a net worth (together, in the case of a natural person, with assets held jointly with a spouse) of more than $1,500,000 at the time the contract is entered into

The reason that qualified clients are more sought after is because in most states, hedge fund managers are only allowed to charge a performance fee (generally 20%) to qualified clients. This means that accredited investors are only required to pay the management fee (usually 2%). This is somewhat of a gray area, however, because as soon as an accredited investor reaches the $1.5 million mark, their status changes to a qualified client. Non-U.S. persons are not required to meet the prerequisites of a qualified client.

• a bank, insurance company, registered investment company, business development company, or small business investment company

• an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million

• a charitable organization, corporation, or partnership with assets exceeding $5 million

• a director, executive officer, or general partner of the company selling the securities

• a business in which all the equity owners are accredited investors

• a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase

• a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year

• a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.

An accredited investor is not to be confused with a qualified client. While both sets of investors are able to put their money into hedge funds, most states will only let hedge fund managers charge a performance fee (usually 20%) to qualified clients. This means that accredited investors are only required to pay the management fee (usually 2%).

Basically, Regulation D outlines the stipulations for hedge funds, since they vary greatly from traditional investment vehicles. Hedge funds are very loosely regulated and most individuals who invest in them are thought to have plenty of experience when it comes to investing. Therefore, most of Regulation D deals with who hedge funds may target, and less about the structure of hedge funds.

Rule 501 of Regulation D provides the definition “accredited investor” as any natural person who had an individual income in excess of $200,000 for each of the two most recent years or joint income with that person’s spouse in excess of $300,000 for each of those years and has a reasonable expectation of reaching the same income level in the current year.

Rule 502 of Regulation D contains the general conditions that must be met to take advantage of the exemptions under Regulation D. This rule prohibits any form of a general solicitation or general advertising. Hedge funds cannot be made available to the general public, so hedge fund managers do not have the luxury of mass marketing their product. Rather, they must take advantage of the outlets they can use. This includes websites, though only accredited investors are allowed to enter the site. The general public may see the homepage, but the homepage is not allowed to list any information about the actual fund. Rather, the homepage will contain only the company logo and the login option.

Rule 503 requires issuer to file a Form D with the SEC when they make an offering under Regulation D.

Rule 504 and 505 allows the SEC to exempt issuances of under $5,000,000 from registration.

Rule 506 says that any company who meets the following criteria is exempt from registration:

• Can raise an unlimited amount of capital
• Does not use general solicitation or advertising to market the securities
• Sale of securities can be to an unlimited number of accredited investors and up to 35 other purchasers. Unlike Rule 505, all non-accredited investors, either alone or with a purchaser representative, must be sophisticated - that is, they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment
• Seller must be available to answer questions by prospective purchasers
• Financial statement requirements as for Rule 505
• Purchasers receive restricted securities, which may not be freely traded in the secondary market after the offering

Finally, Rule 507 penalizes the issuers who do not file the form D as required by Rule 503.

A recent survey showed that over half of participating hedge funds expected a multi-asset class trading platform to be available within 2 years. I’m sure it will be sooner than that. There is a lot of money to be skimmed within a multi-asset class platform and many hedge funds would pay a premium for more anonymity and speed in trading across assets within one account.

I wouldn’t be surprised if HFN, HedgeCo or Eureka was already investing in figuring out how to create some sort of limited use hedge fund platform aimed to be used by individual hedge fund investors. The demand is there for whoever can release this first and start moving up the learning curve on making it work with a diverse range of hedge fund managers who are large enough to handle more frequent investments and redemptions from investors.

Richard Wilson is a hedge fund consultant, founder of the Hedge Fund Group (HFG) and runs the Hedge Fund Consultants Blog.

Not to be confused with hedge fund due diligence, which is the analysis of hedge fund managers and their businesses, hedge fund research groups help hedge fund portfolio managers and traders gain unique insight into a wide range of markets, instruments and asset classes. I have met several of these research firms through the Hedge Fund Group (HFG) and writing here in this hedge fund blog.

Types of Hedge Fund Research

• Commodity Currency Hedge Fund Research
• Retail Sector Hedge Fund Research
• Global Macro Hedge Fund Research
• Emerging Markets Hedge Fund Research
• BRIC Hedge Fund Research
• Russian Hedge Fund Research
• Micro Cap Hedge Fund Research
• Metals Hedge Fund Research
• Real Estate Hedge Fund Research
• International Equities Hedge Fund Research

Richard Wilson is a hedge fund consultant, founder of the Hedge Fund Group (HFG) and runs the Hedge Fund Consultants Blog.

1. Read a fund’s prospectus or offering memorandum and related materials
2. Understand how a fund’s assets are valued
3. Ask questions about fees
4. Understand any limitations on your right to redeem your shares
5. Research the backgrounds of hedge fund managers
6. Don’t be afraid to ask questions

Richard Wilson is a hedge fund consultant, founder of the Hedge Fund Group (HFG) and runs the Hedge Fund Consultants Blog.

Hedge funds usually aim to produce returns in a relatively short amount of time, while private equity funds have a much longer hold period, since they have a prolonged interest in the companies in which they are investing. This is why it is much harder for investors in private equity funds to withdraw their money; it is usually tied up for quite some time. In some cases, investments can be held for 10-12 years. Generally, hedge funds also aim to produce higher returns than private equity funds. In regards to risk, the private equity fund is analyzed to include both short-term and long-term risk assessment and they are able to adjust their tolerance for risk as market conditions vary. Volatility is usually seen as an advantage to hedge funds, since it is an opportunity to garner higher returns, whereas private equity funds tend to be a bit more conservative.

Private equity funds are also very interested in the strategic plan of the company and will engage in research, evaluate results, and have an active participation on the board of directors. They even aim to replace the senior management in some instances. Their due diligence process is therefore generally much more entailed than the due diligence that a hedge fund manager may employ.

Many times, private equity funds invest in businesses with the intention of obtaining a controlling interest in hopes of later restructuring that company. The restructuring may come through leveraged buyouts, venture capital, growth capital, mezzanine debt, or a number of other strategies.

Some big players in the private equity fund world include the Carlyle Group, who manages roughly $33 billion in assets, and the Blackstone Group, who’s assets total over $28 billion.

On March 18, Martin Wolf wrote in the Financial Times that collapses are inherent in the hedge fund model because hedge fund managers have thus far been more lucky than skilled. I believe there definitely is a certain percentage of Alpha seeking managers who are indeed truly skilled but a large majority of managers have ignored the lessons of the efficient market hypothesis or unlike my MBA students have skipped class when the classic Black-Sholes option pricing model was being discussed. I have always argued that Alpha is a constantly moving target and seekers of Alpha may want to study Heisenberg’s uncertainty principle which describes how the momentum of an uncertainly moving target may be described more accurately through a probabilistic distribution rather than an assumed intermittent occurrence. This failure of managers to constantly seek a changing alpha which may occasionally have low probability occurrences will result in an extinction of their species.

The fittest species to survive in the hedge fund universe will be those who, as Darwin wrote, “vary however slightly in a manner profitable to itself” or in other words constantly seek Alpha by having an evenly spread probabilistic distribution of returns rather than maximize returns from higher probability events. Indeed this will be the species that will not only survive but also thrive. - Guest Blogger Eric Abhyankar Eric Abhyankar is a professor of finance at the University of Northern Virginia, Prague and provides consulting to the funds industry on finding new markets for asset gathering.

Richard Wilson is a hedge fund consultant, founder of the Hedge Fund Group (HFG) and runs the Hedge Fund Consultants Blog.

The basic services offered by a prime broker give a money manager the ability to trade with multiple brokerage houses while maintaining, in a centralized master account at their prime broker, all of the hedge fund’s cash and securities. Additionally, the prime broker offers stock loan services, portfolio reporting, consolidated cash management and other services. Fundamentally, the advent of the prime broker freed the money manager from the more time consuming and expensive aspects of running a fund. These services worked because they also allowed the money manager to maintain relationships with multiple brokerage houses for IPO allocations, research, best execution, conference access and other products.

Fund of Funds have some drawbacks however. The first to come to mind is the double layer of fees. When dealing with fund of funds, an investor must understand that the underlying funds charge a fee, as well as the fund of funds manager. This translates to “layers” of fees before the investor receives dollar one. Transparency issues are also important. Research such as the individual manager’s background and reputation, not to mention the nature of the investments that they are utilizing, are all issues a fund of fund manager must investigate. Therefore, you are relying on the fund of fund manager’s talent and expertise in choosing managers, when investing in a fund of funds. Investors look for Fund of Fund because hopefully they provide more stable returns while reducing risk.

Therefore hedge fund managers rely upon hedge fund advisory services to introduce capital and distribute hedge funds directly to qualified clients. The methods vary by which information can be disseminated. Traditionally, networking was the preferred means of doing business. Hedge funds would rely upon the established relationships between advisory services and their high-net worth clientele. But, with the growth of the Internet, electronic communication has transformed the hedge fund industry where online databases, hedge fund consultants, and advisory services are a fingertip away.

Internet websites have to be careful with respect to general solicitations and advertising, and thus must limit the content of the website in addition to the people who have access to the site. Hedge fund advisers using the Internet to market hedge funds are subject to the same registration exemptions as they would be in engaging in private offerings. If advisers and hedge funds do not adhere to the SEC guidance on the use of the Internet in private offerings, they will not be able to rely upon the exemption from the registration requirements of the Securities and Investment Acts.

Operating a website must take into account these necessary rules:

• The site operates using a password.
• There is no reference on the home page to a specific fund.
• The internal pages of the website are available to only qualified clients who filled out a questionnaire establishing that fact.
• Prospective investors are required to wait thirty days after qualification before investing in any fund.

The genesis of these rules comes from several no-action letters, most notably Lamp Technologies, Inc.

Distressed Securities
Buys equity, debt, or trade claims at deep discounts of companies in or facing bankruptcy or reorganization. Profits from the market’s lack of understanding of the true value of the deeply discounted securities and because the majority of institutional investors cannot own below investment grade securities. (This selling pressure creates the deep discount.) Results generally not dependent on the direction of the markets.
Expected Volatility: Low - Moderate

Emerging Markets:
Invests in equity or debt of emerging (less mature) markets that tend to have higher inflation and volatile growth. Short selling is not permitted in many emerging markets, and, therefore, effective hedging is often not available, although Brady debt can be partially hedged via U.S. Treasury futures and currency markets.
Expected Volatility: Very High

Funds of Hedge Funds:
Mix and match hedge funds and other pooled investment vehicles. This blending of different strategies and asset classes aims to provide a more stable long-term investment return than any of the individual funds. Returns, risk, and volatility can be controlled by the mix of underlying strategies and funds. Capital preservation is generally an important consideration. Volatility depends on the mix and ratio of strategies employed.
Expected Volatility: Low - Moderate - High

Income:
Invests with primary focus on yield or current income rather than solely on capital gains. May utilize leverage to buy bonds and sometimes fixed income derivatives in order to profit from principal appreciation and interest income.
Expected Volatility: Low

Macro:
Aims to profit from changes in global economies, typically brought about by shifts in government policy that impact interest rates, in turn affecting currency, stock, and bond markets. Participates in all major markets — equities, bonds, currencies and commodities — though not always at the same time. Uses leverage and derivatives to accentuate the impact of market moves. Utilizes hedging, but the leveraged directional investments tend to make the largest impact on performance.
Expected Volatility: Very High

Market Neutral - Arbitrage:
Attempts to hedge out most market risk by taking offsetting positions, often in different securities of the same issuer. For example, can be long convertible bonds and short the underlying issuers equity. May also use futures to hedge out interest rate risk. Focuses on obtaining returns with low or no correlation to both the equity and bond markets. These relative value strategies include fixed income arbitrage, mortgage backed securities, capital structure arbitrage, and closed-end fund arbitrage.
Expected Volatility: Low

Market Neutral - Securities Hedging:
Invests equally in long and short equity portfolios generally in the same sectors of the market. Market risk is greatly reduced, but effective stock analysis and stock picking is essential to obtaining meaningful results. Leverage may be used to enhance returns. Usually low or no correlation to the market. Sometimes uses market index futures to hedge out systematic (market) risk. Relative benchmark index usually T-bills.
Expected Volatility: Low

Market Timing:
Allocates assets among different asset classes depending on the manager’s view of the economic or market outlook. Portfolio emphasis may swing widely between asset classes. Unpredictability of market movements and the difficulty of timing entry and exit from markets add to the volatility of this strategy.
Expected Volatility: High

Opportunistic:
Investment theme changes from strategy to strategy as opportunities arise to profit from events such as IPOs, sudden price changes often caused by an interim earnings disappointment, hostile bids, and other event-driven opportunities. May utilize several of these investing styles at a given time and is not restricted to any particular investment approach or asset class.
Expected Volatility: Variable

Multi Strategy:
Investment approach is diversified by employing various strategies simultaneously to realize short- and long-term gains. Other strategies may include systems trading such as trend following and various diversified technical strategies. This style of investing allows the manager to overweight or underweight different strategies to best capitalize on current investment opportunities.
Expected Volatility: Variable

Short Selling:
Sells securities short in anticipation of being able to rebuy them at a future date at a lower price due to the manager’s assessment of the overvaluation of the securities, or the market, or in anticipation of earnings disappointments often due to accounting irregularities, new competition, change of management, etc. Often used as a hedge to offset long-only portfolios and by those who feel the market is approaching a bearish cycle. High risk.
Expected Volatility: Very High

Special Situations:
Invests in event-driven situations such as mergers, hostile takeovers, reorganizations, or leveraged buyouts. May involve simultaneous purchase of stock in companies being acquired, and the sale of stock in its acquirer, hoping to profit from the spread between the current market price and the ultimate purchase price of the company. May also utilize derivatives to leverage returns and to hedge out interest rate and/or market risk. Results generally not dependent on direction of market.
Expected Volatility: Moderate

Value:
Invests in securities perceived to be selling at deep discounts to their intrinsic or potential worth. Such securities may be out of favor or underfollowed by analysts. Long-term holding, patience, and strong discipline are often required until the ultimate value is recognized by the market.
Expected Volatility: Low - Moderate

The financial markets have taken, and continue to take, particular notice of the condition of the insurers of municipal bonds. Recent rapid and adverse effects of sub-prime mortgages and other sub-prime financial instruments on the creditworthiness of bond insurers may often not be reflected in market data and bond descriptions provided by market sources to broker/dealers and others. As such, the Notice specifically states that since “rating agency reports” are to be utilized in making suitability determinations concerning insured municipal bonds, independent market information concerning the creditworthiness of bond insurers “may be material information about the transaction.” Broker/dealers and others who deal in insured municipal bonds are instructed to consider both the actual rating actions and any “potential rating actions” that may affect the credit rating and status of the insurers of the municipal bonds they offer and sell. They must consider it not only from a suitability standpoint for the underlying bond itself, but also from a fair pricing standpoint. Arguably, issues of fair pricing have applicability not only to retail investors but sophisticated ones as well, especially those matters where violations of a state uniform securities act provision are alleged.

The Notice states that broker/dealers and municipal bond dealers should: (a) pay increased attention to the facts and circumstances concerning transactions in insured municipal bonds; (b) review past MSRB notices concerning disclosure requirements and other MSRB notices concerning suitability determinations; and (c) review how transactions in insured municipal bonds are being recommended, priced and confirmed.

These new obligations for broker/dealers and municipal bond dealers markedly increase the burden upon market participants to ascertain information concerning the creditworthiness of bond insurers. Notwithstanding one’s sophistication, fund managers should confirm that approved broker/dealers and municipal bond dealers utilized for trading review and revise their written supervisory procedures regarding suitability and pricing determinations to reflect actual and potential credit rating issues, and also determine whether their service providers can assist them in obtaining the information needed to comply with these recent directives from the MSRB. For example, those who utilize prime brokers should verify whether their service providers are taking steps to ensure that trade confirmations and statements contain the appropriate disclosures concerning the timeliness and accuracy of credit ratings. Finally, traders who rely on “bid sheets” and other descriptions of insured municipal bonds from others may wish to take steps to independently determine the accuracy and timeliness of their data.

It was recently announced that Dubai International Capital (DIC) invested a 9.9% stake in an American hedge fund Och-Ziff earlier this month. Other US investment firms that have sold pieces of their firms to investment groups in Dubai include The Carlyle Group and Apollo Management. Each has resulted in minority ownership of less than 15%, but I believe we just starting to see the beginning of a trend here. More up and coming financial centers such as China, Brazil, and the United Arab Emirates will be playing catch-up to other financial centers by making large investments in US and UK based investment firms.

Richard Wilson is a hedge fund consultant, founder of the Hedge Fund Group (HFG) and runs the Hedge Fund Consultants Blog.

These types of statistics are important to keep in mind, if in 12 months hedge funds gained $500B then on average hedge funds raised over $42B per month. So when you read an article about a hedge fund blowing up and losing $2B it is a horrible stituation for that hedge fund manager and their investors but industry wide it is merely a speck on the radar and the former level of hedge fund industry assets are gained back in less than 2 days.

Richard Wilson is a hedge fund consultant, founder of the Hedge Fund Group (HFG) and runs the Hedge Fund Consultants Blog.

130/30

130/30 hedge funds are one of the fast growing strategies within the hedge fund industry. 130/30 hedge funds are like normal 100% long managers except they are allowed to short 30% of the value of the portfolio and then use those shorting proceeds to go an additional 30% long in the portfolio. The end results is a overall portfolio position of 130% long and 30% short.

Green Investing

Green and socially responsible investing has been growing steady and many predict the total market for green and socially responsible mandates just on the institutional level will be 3-4x where it is at right now. Many green hedge funds have been seeing strong returns and it is an area that is not yet over-crowded or dominated by large players. New York used to be the sole center for green hedge fund management but Europe, specifcally London is now gaining ground in this area of the industry.

Green hedge funds can range in strategies from screen for equities that only invest in “green businesses” to carbon trading, renewable energy credit trading, ethanol trading and emissions trading. Similar to many other hedge fund strategies green hedge funds are playing risk arbitrage and variations of long-term value and short term momentum growth plays to earn returns for their investors.

Litigation Funding

This is where a hedge fund dedicates a portfolio or section of a portfolio towards funding litigation that the manager believe highly favors the party they are supporting. With third party litigation funding, the investors cover a portion or all of the costs of litigation in exchange for a share of awards by the court. Funds employing this strategy retain legal experts and refer to niche experts on each case before weighing in on the change of possible victory.

Multi-Strategy Hedge Funds

Multi strategy hedge funds use several strategies within the same pool of assets. They might seek returns from running money focused on shorting equities, investing in global real estate projects, and seeking momentum focused event driven strategies. The diversification benefits help to smooth returns, reduce volatility and decrease asset-class and single-strategy risks. These funds may allocate funds to a certain strategy in response to market trends allowing them to more easily capitalize on favorable market conditions. Due to the unpredictable nature of this type of fund, the volatility varies. A downside to this form of investing is that they will rarely be the highest performing fund over a short time period. This is because the diversification dilutes the returns of any highly profitable strategy. The long term consistency, however, generally outweighs this risk.

Richard Wilson is a hedge fund consultant, founder of the Hedge Fund Group (HFG) and runs the Hedge Fund Consultants Blog.

Family office professionals will take the time to ensure your separately managed acocunt investments are balanced and in line with your 401k or IRA investments. Their employees are often experienced and sophisticated enough to understand unified managed accounts (umas), and will be able to explain them to clientele so they may be employed where appropriate. While many family offices use hedge fund of funds, family office professionals will often find an individual hedge fund manager that fits you best if they do not already have one that they work with, and ultimately they are known for working harder to make you happy because they only work with a smaller group of core clients. Many high net worth individuals belong to health groups where doctors will take the time to set down with you for a couple hours each quarter or year and talk about your health and habits. This type of highly personal attention is equivelant to what you get in a financial sense at the best family offices.

Richard Wilson is a hedge fund consultant, founder of the Hedge Fund Group (HFG) and runs the Hedge Fund Consultants Blog.

The FBI recently had agents posing as a Florida-based hedge fund managers to nab 10 individuals in 5 kickback schemes connected to securities sales. The SEC charged 10 individuals and the U.S. Attorneys office charged six with criminal offenses.

In each case the posing hedge fund manager told the targets that their actions must be kept secret because it violated his fiduciary duties, making it explicitly known that what was going on was illegal and unethical. “This case illustrates the Commission’s ability to work together with criminal authorities in creative ways to uncover fraudulent schemes and to protect our markets,” Linda Chatman Thomas, the head of the SEC’s enforcement division, said.

Bottom Line: If you are smart enough and hard working enough to be successful then you don’t need to cut corners and blatantly break securities laws. Innovation and relationships are the competitive advantage that should make you extremely profitable, not cheating the system.

Richard Wilson is a hedge fund consultant, founder of the Hedge Fund Group (HFG) and runs the Hedge Fund Consultants Blog.

Top 10 Hedge Fund Myths

1. Most hedge fund managers are billionaires
2. Hedge Funds are risky investment vehicles
3. The hedge fund industry in general is struggling and investors are most investors are taking their money out of these types of investments
4. The United States has the same access to hedge funds as other developed countries
5. Hedge Funds aren’t performing as well as mutual funds or stock market indicies
6. It is very hard to get any job within the hedge fund industry
7. Hedge fund managers generally drive Ferrari’s and live in extreme excess
8. It is hard to learn anything about what hedge funds do or even what strategies they use
9. Hedge funds blow up all the time
10. Most hedge funds manage billions of dollars of capital

Richard Wilson is a hedge fund consultant, founder of the Hedge Fund Group (HFG) and runs the Hedge Fund Consultants Blog.

1. Understand the DNA of the many distinct distribution channels open to hedge funds for raising capital and
2. Having an electronic hedge fund of fund of hedge fund database of the right people to call on within those channels.

While some people develop their own databases from scratch, this is often a long painful road with many days spent leaving voicemails with firms that have gone out of business, merged, switched investment focus or charge too high of fees to work with. This has led to many hedge funds investing in fund hedge fund databases that are automatically updated with half a dozen pages of information on fees, structure, management information, etc. This trend with hedge fund databases goes along with the “outsource everything that is not our core competence” model that many both emerging managers and $1B+ players have taken.

9 Fund of Hedge Fund Database Tips

If you need a list of hedge fund of funds or are thinking of purchasing a fund of hedge fund directory or database here are my top 9 tips:

1. Take the time to call or at least email the firm who offers a fund of hedge fund database, these will sometimes be referred to as fund of hedge fund or fof directories.
2. Only work with well known, reputable firms that specialize in providing hedge fund databases or hedge fund of fund databases. Avoid small shop fly-by-nighters at all costs
3. Take the time to really get familiar with the information provided within the database, ask for a sample of what the information will look like. It really is an investment that could save you literally thousands of hours IF you pick the right hedge fund database for your business model. See a Hedge Fund of Fund of Hedge Fund Database Sample.
4. Ensure that the database is updated at least once a quarter, contact details and firm information gets old very quickly.
5. Expect to pay $750-$8,000 for a high quality hedge fund database, many cost around $2,800 while others can cost up to $30,000/year. Be sure and know the trade-offs of buying a physical database versus subscribing to one online. If you don’t have a hard copy of the data in Excel or Access format you may not be able to use it once a time-based subscription expires. For some firms this is fine, for others it would be a costly mistake.
6. Make sure the hedge fund database you use is compatible with your systems. Do you use SalesForce? Act? Goldmine? Excel? Word?(lord help you)
7. While you are kicking the tires of your potential new hedge fund database make sure it has complete information on a firm. You don’t want to call a firm asking if you can send over your PowerPoint presentation only to find out they are really a competitor or a division within another firm you called that same day.
8. Don’t steal a database. This may sound obvious, but it is common for employees to copy parts of a database for later use or use some other un-ethical means of obtaining database details. Don’t, it is not worth it. Always take the high road and you can stand behind every action you have ever taken.
9. This list only contains 9 tips instead of 10 because this one is worth more than the rest combined. Ask hard questions when you are buying fund of hedge fund database. Ask how often your database details will be updated. Ask exactly how many hedge funds are updating their information. Some databases will say that they have details on 9,000 hedge funds while the reality is that some of them haven’t updated their information in 4 years…make sure all of the data is being updated at least once a year.

Richard Wilson is a hedge fund consultant, founder of the Hedge Fund Group (HFG) and runs the Hedge Fund Consultants Blog.

Many of these sovereign wealth funds have made headlines by taking large long-term positions in western companies such as Citigroup. Below are some of the recent transactions involving hedge funds and banks who invest in hedge funds:

• UBS sold a 9% stake to the Government of Singapore Investment Corporation and another $1.77B stake to a undisclosed investor from the Middle East
• Abu Dhabi Investment Authority the sovereign fund of the Gulf Arab state acquired a 4.9% state in Citigroup for $7.5B
• Central Hujin Investment Co. acquired 71% of China Everbright Bank for $2.7B
• Dubai International Capital, ran by Dubai’s ruler Sheikh Mohammed bin Rashid Al Moktoum acquired 9.9% stake in Och-Ziff Capital Management Group for $1.1B
• China’s Citic Securities and Bear Stearns agree to invest $1B in each other and run a 50/50 JV in Hong Kong
• Abu Dhabi-based Mubadala Development Co. of the Abu Dhabi government regime paid $1.35B for a 7.5% stake in Carlyle Group
• Dubai International Capital took a 2.87% in ICICI Bank of India for $750M
• China state investment company paid $3B for a 10% stake in Blackstone
• Dubai International Capital bought an undisclosed stake in HSBC Holdings

Richard Wilson is a hedge fund consultant, founder of the Hedge Fund Group (HFG) and runs the Hedge Fund Consultants Blog.