c
m
 


An aggressively managed portfolio of investments that uses advanced investment strategies such as
leveraged, long, short and derivative positions in both domestic and international markets with the goal of
generating high returns (either in an absolute sense or over a specified market benchmark).

Legally, hedge funds are most often set up as private investment partnerships that are open to a limited
number of investors and require a very large initial minimum investment. Investments in hedge funds
are illiquid as they often require investors keep their money in the fund for at least one year.

a  

 m
 

For the most part, hedge funds (unlike mutual funds) are unregulated because they cater to sophisticated
investors. In the U.S., laws require that the majority of investors in the fund be accredited. That is,
they must earn a minimum amount of money annually and have a net worth of more than $1 million,
along with a significant amount of investment knowledge. You can think of hedge funds as mutual funds
for the super rich. They are similar to mutual funds in that investments are pooled and professionally
managed, but differ in that the fund has far more flexibility in its investment strategies.

It is important to note that hedging is actually the practice of attempting to reduce risk, but the goal of
most hedge funds is to maximize return on investment. The name is mostly historical, as the first hedge
funds tried to hedge against the downside risk of a bear market by shorting the market (mutual funds
generally can't enter into short positions as one of their primary goals). Nowadays, hedge funds use
dozens of different strategies, so it isn't accurate to say that hedge funds just "hedge risk". In fact,
because hedge fund managers make speculative investments, these funds can carry more risk than the
overall market.

  is a lightly regulated investment fund that is typically open to a limited range of investors
who pay a performance fee to the fund's investment manager.
Every hedge fund has its own investment strategy that determines the type of investments it undertakes
and these strategies are highly individual. As a class, hedge funds undertake a wider range of investment
and trading activities than traditional long-only investment funds, and invest in a broader range of assets
including long and short positions in shares, bonds and commodities. As the name implies, hedge funds
often seek to hedge some of the risks inherent in their investments using a variety of methods, notably
short selling and derivatives.
In most jurisdictions, hedge funds are open only to a limited range of professional or wealthy investors
who meet criteria set by regulators, and are accordingly exempted from many of the regulations that
govern ordinary investment funds. The net asset value of a hedge fund can run into many billions of
dollars, and the gross assets of the fund will usually be higher still due to leverage. Hedge funds dominate
certain specialty markets such as trading within derivatives with high-yield ratings and distressed debt.[1]

History
Sociologist, author, and financial journalist Alfred W. Jones is credited with the creation of the first hedge
fund in 1949. Jones believed that price movements of an individual asset could be seen as having a
component due to the overall market and a component due to the performance of the asset itself. To
neutralize the effect of overall market movement, he balanced his portfolio by buying assets whose price
he expected to be stronger than the market and selling short assets he expected to be weaker than the
market. He saw that price movements due to the overall market would be cancelled out, because, if the
overall market rose, the loss on shorted assets would be cancelled by the additional gain on assets
bought and vice-versa. Because the effect is to 'hedge' that part of the risk due to overall market
movements, this type of portfolio became known as a hedge fund.
Industry size
Estimates of industry size vary widely due to the absence of central statistics, the lack of an agreed
definition of hedge funds and the rapid growth of the industry. As a general indicator of scale, the industry
may have managed around $2.5 trillion at its peak in the summer of 2008. The credit crunch has
caused assets under management (AUM) to fall sharply through a combination of trading losses and the
withdrawal of assets from funds by investors. Recent estimates suggest that hedge funds have more than
$2 trillion in AUM. A recent survey of hedge fund administrators indicates single manager hedge funds
have over $2.5 trillion in assets under administration ($AuA)

3
   



The 25 largest hedge fund managers had $519.7 billion in assets under management as of December 31,
2009. The largest manager is JP Morgan Chase ($53.5 billion) followed by Bridgewater Associates ($43.6
billion), Paulson & Co. ($32 billion), Brevan Howard ($27 billion), and Soros Fund Management ($27
billion).

Fees
A hedge fund manager will typically receive both a management fee and a performance fee (also known
as an incentive fee) from the fund. A typical manager may charge fees of "2 and 20", which refers to a
management fee of 2% of the fund's net asset value each year and a performance fee of 20% of the
fund's profit



 
As with other investment funds, the management fee is calculated as a percentage of the fund's net asset
value. Management fees typically range from 1% to 4% per annum, with 2% being the standard
figure.Management fees are usually expressed as an annual percentage, but calculated and paid monthly
or quarterly.
The business models of most hedge fund managers provide for the management fee to cover the
operating costs of the manager, leaving the performance fee for employee bonuses. However, the
management fees for large funds may form a significant part of the manager's profits.Management fees
associated with hedge funds have been under much scrutiny, with several large public pension funds,
notably CalPERS, calling on managers to reduce fees.



Performance fees (or "incentive fees") are one of the defining characteristics of hedge funds. The
manager's performance fee is calculated as a percentage of the fund's profits, usually counting both
realized and unrealized profits. By motivating the manager to generate returns, performance fees are
intended to align the interests of manager and investor more closely than flat fees. In the business
models of most managers, the performance fee is largely available for staff bonuses and so can be
extremely lucrative for managers who perform well. Several publications provide estimates of the annual
earnings of top hedge fund managers. Typically, hedge funds charge 20% of returns as a performance
fee. However, the range is wide with highly regarded managers charging higher fees. For
example Steven Cohen'sSAC Capital Partners charges a 35-50% performance fee while Jim Simons'
Medallion Fund charged a 45% performance fee.
Average incentive fees have declined since the start of the financial crisis, with the decline being more
pronounced in funds of hedge funds (FOFs). Incentive fees for single manager funds fell to 19.2 percent
(versus 19.34 percent in Q1 08) while FOFs fell to 6.9 percent (versus 8.05 percent in Q1 08). The
average incentive fee for funds launched in 2009 was 17.6 percent, 1.6 percent below the broader
industry average.
Performance fees have been criticized by many people, including notable investor Warren Buffett, who
believe that, by allowing managers to take a share of profit but providing no mechanism for them to share
losses, performance fees give managers an incentive to take excessive risk rather than targeting high
long-term returns. In an attempt to control this problem, fees are usually limited by a high water mark.
]
Ironically, Mr. Buffett charged incentive fees until his firm was very large
As the hedge fund remuneration structure is highly attractive it has been remarked that hedge funds are
best viewed "... not as a unique asset class but as a unique µfee structure¶.]
m 


A high water mark (or "loss carryforward provision") is often applied to a performance fee calculation. This
means that the manager receives performance fees only on increases in the net asset value (NAV) of the
fund in excess of the highest net asset value it has previously achieved. For example, if a fund were
launched at a NAV per share of $100, which then rose to $120 in its first year, a performance fee would
be payable on the $20 return for each share. If the next year it dropped to $110, no fee would be payable.
If in the third year the NAV per share rose to $130, a performance fee would be payable only on the $10
profit from $120 (the high water mark) to $130, rather than on the full return during that year from $110 to
$130.
High water marks are intended to link the manager's interests more closely to those of investors and to
reduce the incentive for managers to seek volatile trades.. If a high water mark is not used, a fund that
ends alternate years at $100 and $110 would generate a performance fee every other year, enriching the
manager but not the investors.
The mechanism does not provide complete protection to investors: A manager who has lost a significant
percentage of the fund's value may close the fund and start again with a clean slate, rather than continue
working for no performance fee until the loss has been made up.[14] This tactic is dependent on the
manager's ability to persuade investors to trust him or her with their money in the new fund.
m 

Some managers specify a hurdle rate, signifying that they will not charge a performance fee until the
fund's annualized performance exceeds a benchmark rate, such asT-bill yield, LIBOR or a fixed
percentage.[2] This links performance fees to the ability of the manager to provide a higher return than an
alternative, usually lower risk, investment.
With a "soft" hurdle, a performance fee is charged on the entire annualized return if the hurdle rate is
cleared. With a "hard" hurdle, a performance fee is only charged on returns above the hurdle rate. Before
the credit crisis of 2008, demand for hedge funds tended to outstrip supply, making hurdle rates relatively
rare.
c 

  
Some funds charge investors a redemption fee (or "withdrawal fee" or "surrender charge") if they
withdraw money from the fund. A redemption fee is often charged only during a specified period of time
(typically a year) following the date of investment, or only to withdrawals representing a specified portion
of an investment.
The purpose of the fee is to discourage short-term investment in the fund, thereby reducing turnover and
allowing the use of more complex, illiquid or long-term strategies. The fee may also dissuade investors
from withdrawing funds after periods of poor performance.
Unlike management and performance fees, redemption fees are usually retained by the fund and
therefore benefit the remaining investors rather than the manager.

Strategies
Hedge funds employ many different trading strategies, which are classified in many different ways. No
standard system is used. A hedge fund will typically commit itself to a particular strategy, particular
investment types and leverage limits via statements in its offering documentation, thereby giving investors
some indication of the nature of the particular fund.
Each strategy can be said to be built from a number of different elements:
' ¦ global macro, directional, event-driven, relative value (arbitrage), managed futures (CTA)
' 
 equity, fixed income, commodity, currency
' a   long/short, futures, options, swaps
' £ directional, market neutral
' ¦ emerging market, technology, healthcare etc.
'    discretionary/qualitative (where the individual investments are selected by managers),
systematic/quantitative (or "quant" - where the investments are selected according to numerical
methods using a computerized system)
' 
  multi-manager, multi-strategy, multi-fund, multi-market
The four main strategy groups are based on the investment style and have their own risk and return
characteristics. The most common label for a hedge fund is "long/short equity", meaning that the fund
takes both long and short positions in shares traded on public stock exchanges.



(Macro, Trading) Global Macro funds attempt to anticipate global macroeconomic events, generally using
all markets and instruments to generate a return.

' 

 - instead of being generated by software, trading is carried out by investment
managers selecting investments.
' ¦

 - trading is carried out using mathematical models and executed
by software without any human intervention other than the initial programming of the software.
'  
   (CTA, Managed futures, Trading) - the fund trades
in futures (or options) in commodity markets.
' ¦
  - the fund trades in diversified markets.
' ¦
  - the fund trades in currency markets.
'    - the fund attempts to profit from following long-term or short-term trends.
' ^ !   (Counter trend) - the fund attempts to profit from anticipating reversals in
such trends.
' !
 - the fund uses a combination of strategies.


(Equity hedge) Hedged investments with exposure to the equity market.

' 3  " (Equity hedge) - long equity positions hedged with short sales of stocks or stock
market index options.
' £ 
 - specialized in emerging markets, such as China, India etc.
' ¦  - expertise in niche areas such as technology, healthcare, biotechnology,
pharmaceuticals, energy, basic materials.
' à
 
 - invest in companies with more earnings growth than the broad equity market.
' à
 

 - invest in undervalued companies.
' †


 - equity trading using quantitative techniques.
' ¦ 
 - take advantage of declining equity markets using short positions.
' !
 - diversification through different styles to reduce risk.
£ !  
(Special situations) Exploit pricing inefficiencies caused by anticipated specific corporate events.

'   (Distressed debt) - specialized in companies trading at discounts to their value
because of (potential) bankruptcy.
' 

 (Risk arbitrage) - exploit pricing inefficiencies between merging companies.
' ¦

  - specialized in restructuring companies or companies engaged in a corporate
transaction.
' !
 - diversification through different styles to reduce risk.
'  

 - specialized in corporate fixed income securities.
' ·
  - specialized in private equities.
'  - take large positions in companies and use the ownership to be active in the management
·


(Arbitrage, Market neutral) Exploit pricing inefficiencies between related assets that are mispriced.

' à  

 - exploit pricing inefficiencies between related fixed income securities.
' £"
 
 (Equity arbitrage) - being market neutral by maintaining a close balance
between long and short positions.
'  

 - exploit pricing inefficiencies between convertible securities and the
corresponding stocks.
' à  
 - fixed income arbitrage strategy using corporate fixed income instruments.
' !
  (Fixed-Income asset-backed) - fixed income arbitrage strategy using asset-
backed securities.
'     - as long / short equity but in credit markets instead of equity markets.
' ¦



 - equity market neutral strategy using statistical models.
' Ë


 - exploit the change in implied volatility instead of the change in price.
'  

 - non-fixed income arbitrage strategies based on the yield instead of the price.
' !
 - diversification through different styles to reduce risk.
' ·


 - the practice of taking advantage of regulatory differences between two or
more markets.



' à     (Multi-manager) - a hedge fund with a diversified portfolio of numerous
underlying hedge funds.
' à      (F3, F cube) - a fund invested in other funds of hedge funds.
' !
 - a hedge fund exploiting a combination of different hedge fund strategies to reduce
market risk.
' !

 - a hedge fund wherein the investment is spread along separate sub-managers
investing in their own strategy.
' 
!
  - unhedged equity fund with 130% long and 30% short positions, the market exposure
is 100%.
' 3 ! 
   - partly hedged fund excluding short selling but allow derivatives.
Hedge fund risk
Despite a "hedge" being a means of reducing the risk of a bet or investment, investing in certain types of
hedge fund can be a riskier proposition than investing in aregulated fund. Many hedge funds have some
of these characteristics:
3
 - in addition to money invested into the fund by investors, a hedge fund will
typically borrow money or trade on margin, with certain funds borrowing sums many times greater
than the initial investment. If a hedge fund has borrowed $9 for every $1 received from investors,
a loss of only 10% of the value of the investments of the hedge fund will wipe out 100% of the
value of the investor's stake in the fund, once the creditors have called in their loans. In
September 1998, shortly before its collapse, Long-Term Capital Management had $125 billion of
assets on a base of $4 billion of investors' money, a leverage of over 30 times. It also had off-
[15]
balance sheet positions with a notional value of approximately $1 trillion.
¦   - due to the nature of short selling, the losses that can be incurred on a losing bet
are in theory limitless, unless the short position directly hedges a corresponding long position.
Ordinary funds very rarely use short selling in this way.
 - hedge funds are more likely than other types of funds to take on underlying
investments that carry high degrees of risk, such as high yield bonds, distressed securities,
and collateralized debt obligations based on sub-prime mortgages.
 3


  - hedge funds are private entities with few public disclosure requirements.
It can therefore be difficult for an investor to assess trading strategies, diversification of
the portfolio, and other factors relevant to an investment decision.
3

 - hedge fund managers are, in some jurisdictions, not subject to as much
oversight from financial regulators as regulated funds, and therefore some may carry undisclosed
structural risks.
¦ 
 - certain hedge fund strategies involve writing out of the money call or put
options. If these expire in the money the fund may make large losses.
Investors in hedge funds are, in most countries, required to be sophisticated investors who are assumed
to be aware of these risks, and willing to take these risks because of the corresponding rewards:

 leverage amplifies profits as well as losses;

' short selling opens up new investment opportunities;
' riskier investments typically provide higher returns;
' secrecy helps to prevent imitation by competitors; and
' being unregulated reduces costs and allows the investment manager
more freedom to make decisions on a purely commercial basis.
One approach to diagnosing hedge fund risk is operational due diligence.

Hedge fund structure

A hedge fund is a vehicle for holding and investing the money of its investors. The fund itself has no
employees and no assets other than its investment portfolio andcash. The portfolio is managed by
the investment manager, a separate entity which is the actual business and has employees.
As well as the investment manager, the functions of a hedge fund are delegated to a number of other
service providers. The most common service providers are:
 ± prime brokerage services include lending money, acting as counterparty to
derivative contracts, lending securities for the purpose of short selling, trade execution, clearing
and settlement. Many prime brokers also provide custody services. Prime brokers are typically
parts of large investment banks.
 
 ± the administrator typically deals with the issue and redemption of interests and
shares, calculates the net asset value of the fund, and performs related back office functions. In
some funds, particularly in the U.S., some of these functions are performed by the investment
manager, a practice that gives rise to a potential conflict of interest inherent in having the
investment manager both determine the NAV and benefit from its increase through performance
fees. Outside of the U.S., regulations often require this role to be taken by a third party.
 - the distributor is responsible for marketing the fund to potential investors.
Frequently, this role is taken by the investment manager.

The legal structure of a specific hedge fund ± in particular its domicile and the type of legal entity used ±
is usually determined by the tax environment of the fund¶s expected investors. Regulatory considerations
will also play a role. Many hedge funds are established in offshore financial centres so that the fund can
avoid paying tax on the increase in the value of its portfolio. An investor will still pay tax on any profit it
makes when it realizes its investment, and the investment manager, usually based in a major financial
centre, will pay tax on the fees that it receives for managing the fund.
Around 60% of the number of hedge funds in 2009 were registered in offshore locations. The Cayman
Islands was the most popular registration location and accounted for 39% of the number of global hedge
funds. It was followed by Delaware (US) 27%, British Virgin Islands 7% and Bermuda 5%. Around 5% of
global hedge funds are registered in the EU, primarily in Ireland and Luxembourg.[16]

a  


 

In contrast to the funds themselves, investment managers are primarily located onshore in order to draw
on the major pools of financial talent and to be close to investors. With the bulk of hedge fund investment
coming from the U.S. East coast ± principally New York City and the Gold Coast area of Connecticut ±
this has become the leading location for hedge fund managers. It was estimated there were 7,000
investment managers in the United States in 2004.[17]
London is Europe¶s leading centre for hedge fund managers, with three-quarters of European hedge fund
investments, about $400 billion, at the end of 2009. Asia, and more particularly China, is taking on a more
important role as a source of funds for the global hedge fund industry. The UK and the U.S. are leading
locations for management of Asian hedge funds' assets with around a quarter of the total each.[18]

 
 
Limited partnerships are principally used for hedge funds aimed at US-based investors who pay tax, as
the investors will receive relatively favorable tax treatment in the US. The general partner of the limited
partnership is typically the investment manager (though is sometimes an offshore corporation) and the
investors are the limited partners. Offshore corporate funds are used for non-U.S. investors and U.S.
entities that do not pay tax (such as pension funds), as such investors do not receive the same tax
benefits from investing in a limited partnership. Unit trusts are typically marketed to Japanese investors.
Other than taxation, the type of entity used does not have a significant bearing on the nature of the fund.
Many hedge funds are structured as master-feeder funds. In such a structure, the investors will invest into
a feeder fund, which will, in turn, invest all of its assets into the master fund. The assets of the master
fund will then be managed by the investment manager in the usual way. This allows several feeder funds
(e.g. an offshore corporate fund, a U.S. limited partnership and a unit trust) to invest into the same master
fund, allowing an investment manager the benefit of managing the assets of a single entity while giving all
investors the best possible tax treatment.
The investment manager, which will have organized the establishment of the hedge fund, may retain an
interest in the hedge fund, either as the general partner of a limited partnership or as the holder of
³founder shares´ in a corporate fund. Founder shares typically have no economic rights, and voting rights
over only a limited range of issues, such as selection of the investment manager. The fund¶s strategic
decisions are taken by the board of directors of the fund, which is independent but generally loyal to the
investment manager.
# !  

Hedge funds are typically open-ended, meaning that the fund will periodically accept further investment
and allow investors to withdraw their money from the fund. For a fund structured as a company, shares
will be both issued and redeemed at the net asset value (³NAV´) per share, so that if the value of the
underlying investments has increased (and the NAV per share has therefore also increased) then the
investor will receive a larger sum on redemption than it paid on investment. Similarly, where a fund is
structured as a limited partnership the investor's account will be allocated its proportion of any increase or
decrease in the NAV of the fund, allowing an investor to withdraw more (or less) when it withdraws its
capital.
Investors do not typically trade shares or limited partnership interests among themselves and hedge
funds do not typically distribute profits to investors before redemption. This contrasts with a closed-ended
fund, which either has a limited number of shares which are traded among investors, and which
distributes its profits, or which has a limited lifespan at the end of which capital is returned to investors.

¦ 
Where a hedge fund holds assets that are hard to value reliably or are relatively illiquid (in comparison to
the redemption terms of the fund itself), the fund may employ a "side pocket". A side pocket is a
mechanism whereby the fund segregates the illiquid assets from the main portfolio of the fund and issues
investors with a new class of interests or shares which participate only in the assets in the side pocket.
Those interests/shares cannot be redeemed by the investor. Once the fund is able to sell the side pocket
assets, the fund will generally redeem the side pocket interests/shares and pay investors the proceeds.
Side pockets are designed to address issues relating to the need to value investors' holdings in the fund if
they choose to redeem. If an investor redeems when certain assets cannot be valued or sold, the fund
cannot be confident that the calculation of his redemption proceeds would be accurate. Moreover, his
redemption proceeds could only be obtained by selling the liquid assets of the fund. If the illiquid assets
subsequently turned out to be worth less than expected, the remaining investors would bear the full loss
while the redeemed investor would have borne none. Side pockets therefore allow a fund to ensure that
all investors in the fund at the time the relevant assets became illiquid will bear any loss on them equally
and allow the fund to continue subscriptions and redemptions in the meantime in respect of the main
portfolio. A similar problem, inverted, applies to subscriptions during the same period.
Side pockets are most commonly used by funds as an emergency measure. They were used extensively
following the collapse of Lehman Brothers in September 2008, when the market for certain types of
assets held by hedge funds collapsed, preventing the funds from selling or obtaining a market value for
the assets.
Specific types of fund may also use side pockets in the ordinary course of their business. A fund investing
in insurance products, for example, may routinely side pocket securities linked to natural disasters
following the occurrence of such a disaster. Once the damage has been assessed, the security can again
be valued with some accuracy.

3  
Corporate hedge funds sometimes list their shares on smaller stock exchanges, such as the Irish Stock
Exchange, as this provides a low level of regulatory oversight that is required by some investors. Shares
in the listed hedge fund are not generally traded on the exchange.
A fund listing is distinct from the listing or initial public offering (³IPO´) of shares in an investment
manager. Although widely reported as a "hedge-fund IPO",[19] the IPO of Fortress Investment Group
LLC was for the sale of the investment manager, not of the hedge funds that it managed.[20]

Regulatory issues
Part of what gives hedge funds their competitive edge, and their cachet in the public imagination, is that
they straddle multiple definitions and categories; some aspects of their dealings are well-regulated, while
others are unregulated or at best quasi-regulated.
$%¦%
 
The typical M
 investment company in the United States is required to be registered with the U.S.
Securities and Exchange Commission (SEC). Mutual funds are the most common type of registered
investment companies. Aside from registration and reporting requirements, investment companies are
subject to strict limitations on short-selling and the use of leverage. There are other limitations and
restrictions placed on public investment company managers, including the prohibition on charging
incentive or performance fees.
Although hedge funds are investment companies, they have avoided the typical regulations for
investment companies because of exceptions in the laws. The two major exemptions are set forth in
Sections 3(c)1 and 3(c)7 of the Investment Company Act of 1940. Those exemptions are for funds with
100 or fewer investors (a "3(c) 1 Fund") and funds where the investors are "qualified purchasers" (a "3(c)
[21]
7 Fund"). A qualified purchaser is an individual with over US$5,000,000 in investment assets. (Some
institutional investors also qualify as accredited investors or qualified purchasers.)[22] A 3(c)1 Fund cannot
have more than 100 investors, while a 3(c)7 Fund can have an unlimited number of investors.
The Securities Act of 1933 disclosure requirements apply only if the company seeks funds from the
general public, and the quarterly reporting requirements of the Securities Exchange Act of 1934 are only
required if the fund has more than 499 investors.[23] A 3(c)7 fund with more than 499 investors must
register its securities with the SEC.[24]
In order to comply with 3(c)(1) or 3(c)(7), hedge funds raise capital via private placement under
the Securities Act of 1933, and normally the shares sold do not have to be registered under Regulation D.
[ 


]
Although it is possible to have non-accredited investors in a hedge fund, the exemptions under
the Investment Company Act, combined with the restrictions contained in Regulation D, effectively require
[25]
hedge funds to be offered solely to accredited investors. An accredited investor is an individual person
with a minimum net worth of $1,000,000 or, alternatively, a minimum income of US$200,000 in each of
the last two years and a reasonable expectation of reaching the same income level in the current year.
For banks and corporate entities, the minimum net worth is $5,000,000 in invested assets.[25]
There have been attempts to register hedge fund investment managers. There are numerous issues
surrounding these proposed requirements. A client who is charged an incentive fee must be a "qualified
client" under Advisers Act Rule 205-3. To be a qualified client, an individual must have US$750,000 in
assets invested with the adviser or a net worth in excess of US$1.5 million, or be one of certain high-level
[26]
employees of the investment adviser.
In December 2004, the SEC issued a rule change that required most hedge fund advisers to register with
the SEC by February 1, 2006, as investment advisers under the Investment Advisers Act.[27] The
requirement, with minor exceptions, applied to firms managing in excess of US$25,000,000 with over 14
investors. The SEC stated that it was adopting a "risk-based approach" to monitoring hedge funds as part
[28]
of its evolving regulatory regimen for the burgeoning industry. The new rule was controversial, with two
[29]
commissioners dissenting. The rule change was challenged in court by a hedge fund manager, and, in
June 2006, the U.S. Court of Appeals for the District of Columbia overturned it and sent it back to the
agency to be reviewed. See Goldstein v. SEC. In response to the court decision, in 2007 the SEC
adopted Rule 206(4)-8. Rule 206(4)-8, unlike the earlier challenged rule, "does not impose additional
filing, reporting or disclosure obligations" but does potentially increase "the risk of enforcement action" for
negligent or fraudulent activity.[30]
In February 2007, the President's Working Group on Financial Markets rejected further regulation of
[31][32][33]
hedge funds and said that the industry should instead follow voluntary guidelines. In November
2009 the House Financial Services Committee passed a bill that would allow states to oversee hedge
funds and other investment advisors with $100m or less in assets under management, leaving larger
investment managers up to the Securities and Exchange Commission. Because the SEC currently
regulates advisers with $25m or more under management, the bill would shift 43% of these companies, or
roughly 710, back over to state oversight[34]


 $%¦%
" 
Hedge funds are similar to private equity funds in many respects. Both are lightly regulated, private pools
of capital that invest in securities and compensate their managers with a share of the fund's profits. Most
hedge funds invest in relatively liquid assets, and permit investors to enter or leave the fund, perhaps
requiring some months notice. Private equity funds invest primarily in very illiquid assets such as early-
stage companies and so investors are "locked in" for the entire term of the fund. Hedge funds often invest
in private equity companies' acquisition funds.
Between 2004 and February 2006, some hedge funds adopted 25-month lock-up rules expressly to
exempt themselves from the SEC's new registration requirements and cause them to fall under the
[ 


]
registration exemption that had been intended to exempt private equity funds.

 $%¦%
 
Like hedge funds, mutual funds are pools of investment capital (i.e., money people want to invest).
However, there are many differences between the two, including:

' Mutual funds are regulated by the SEC, while hedge

funds are not
' A hedge fund investor must be an accredited
investor with certain exceptions (employees, etc.)
' Mutual funds must price and be liquid on a daily
basis
Some hedge funds that are based offshore report their prices to the à 
, but for most there is
no method of ascertaining pricing on a regular basis. In addition, mutual funds must have a prospectus
available to anyone that requests one (either electronically or via U.S. postal mail), and must disclose
their asset allocation quarterly, whereas hedge funds do not have to abide by these terms.
Hedge funds also ordinarily do not have daily liquidity, but rather "lock up" periods of time where the total
returns are generated (net of fees) for their investors and then returned when the term ends, through a
passthrough requiring CPAs and U.S. Tax W-forms. Hedge fund investors tolerate these policies because
hedge funds are expected to generate higher total returns for their investors versus mutual funds.
Recently, however, the mutual fund industry has created
products with features that have traditionally been found
only in hedge funds.
Mutual funds that utilize some of the trading strategies
noted above have appeared. Grizzly Short Fund
(GRZZX), for example, is always net short, while
Arbitrage Fund (ARBFX) specializes in merger arbitrage.
Such funds are SEC regulated, but they offer hedge fund
strategies and protection for mutual fund investors.
Also, a few mutual funds have introduced performance-
based fees, where the compensation to the manager is
based on the performance of the fund. However, under
Section 205(b) of the Investment Advisers Act of 1940,
such compensation is limited to so-called "fulcrum
[35]
fees". Under these arrangements, fees can be
performance-based so long as they increase and
decrease symmetrically.
For example, the TFS Capital Small Cap Fund (TFSSX)
has a management fee that behaves, within limits and
symmetrically, similarly to a hedge fund "0 and 50" fee:
A 0% management fee coupled with a 50% performance
fee if the fund outperforms its benchmark index.
However, the 125 bp base fee is reduced (but not below
zero) by 50% of underperformance and increased (but
not to more than 250 bp) by 50% of outperformance.[36]
[edit] $%¦%
 
Hedge funds are exempt from regulation in the United
States. Several bills have been introduced in the 110th
Congress (2007±08), however, relating to such funds.
Among them are:

' S. 681, a bill to restrict the use of offshore tax

havens and abusive tax shelters to inappropriately
avoid Federal taxation;
' H.R. 3417, which would establish a Commission on
the Tax Treatment of Hedge Funds and Private
Equity to investigate imposing regulations;
' S. 1402, a bill to amend the Investment Advisors Act
of 1940, with respect to the exemption to registration
requirements for hedge funds; and
' S. 1624, a bill to amend the Internal Revenue Code
of 1986 to provide that the exception from the
treatment of publicly traded partnerships as
corporations for partnerships with passive-type
 income shall not apply to partnerships directly or
indirectly deriving income from providing investment
adviser and related asset management services.
' S. 3268, a bill to amend the Commodity Exchange
Act to prevent excessive price speculation with
respect to energy commodities. The bill would give
the federal regulator of futures markets the
resources to detect, prevent, and punish price
manipulation and excessive speculation.
None of the bills has received serious consideration yet.
[edit]$&
 
Hedge funds managed by UK hedge fund managers are
always incorporated outside the UK, usually in an
offshore location such as the Cayman Islands, and are
not directly regulated by the UK authorities. However, a
hedge fund manager based in the UK is required to be
authorised and regulated by the UK's Financial Services
Authority, and accordingly the UK hedge fund industry is
regulated.
As the UK is part of the European Union, the UK hedge
fund industry will also be affected by the EU's Directive
on Alternative Investment Fund Managers.
[edit]# 
 
Many offshore centers are keen to encourage the
establishment of hedge funds. To do this they offer some
combination of professional services, a favorable tax
environment, and business-friendly regulation. Major
centers include Cayman
Islands, Dublin, Luxembourg, British Virgin Islands,
and Bermuda. The Cayman Islands have been
estimated to be home to about 75% of world¶s hedge
funds, with nearly half the industry's estimated $1.225
[37]
trillion AUM.
Hedge funds have to file accounts and conduct their
business in compliance with the requirements of these
offshore centres. Typical rules concern restrictions on
the availability of funds to retail investors (Dublin),
protection of client confidentiality (Luxembourg) and the
requirement for the fund to be independent of the fund
manager.

[edit]Hedge fund indices

This article a



a a
 
 
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There are many indices that track the hedge fund
industry, and these fall into three main categories. In
their historical order of development they are Non-
investable, Investable and Clone.
In traditional equity investment, indices play a central
and unambiguous role. They are widely accepted as
representative, and products such as futures and ETFs
provide investable access to them in most developed
markets. However hedge funds are illiquid,
heterogeneous and ephemeral, which makes it hard to
construct a satisfactory index. Non-investable indices
are representative, but, due to various biases, their
quoted returns may not be available in practice.
Investable indices achieve liquidity at the expense of
limited representativeness. Clone indices seek to
replicate some statistical properties of hedge funds but
are not directly based on them. None of these
approaches is wholly satisfactory.
[edit]^ ! 
 
Non-investable indices are indicative in nature, and aim
to represent the performance of some database of
hedge funds using some measure such as mean,
median or weighted mean from a hedge fund database.
The databases have diverse selection criteria and
methods of construction, and no single database
captures all funds. This leads to significant differences in
reported performance between different indices.
Although they aim to be representative, non-investable
indices suffer from a lengthy and largely unavoidable list
of biases.
Funds¶ participation in a database is voluntary, leading
to self-selection bias because those funds that choose to
report may not be typical of funds as a whole. For
example, some do not report because of poor results or
because they have already reached their target size and
do not wish to raise further money.
The short lifetimes of many hedge funds means that
there are many new entrants and many departures each
year, which raises the problem of survivorship bias. If we
examine only funds that have survived to the present,
we will overestimate past returns because many of the
worst-performing funds have not survived, and the
observed association between fund youth and fund
performance suggests that this bias may be substantial.
When a fund is added to a database for the first time, all
or part of its historical data is recorded ex-post in the
database. It is likely that funds only publish their results
when they are favorable, so that the average
performances displayed by the funds during their
incubation period are inflated. This is known as "instant
history bias´ or ³backfill bias´.
[edit]a 
 
Investable indices are an attempt to reduce these
problems by ensuring that the return of the index is
available to shareholders. To create an investable index,
the index provider selects funds and develops structured
products or derivative instruments that deliver the
performance of the index. When investors buy these
products the index provider makes the investments in
the underlying funds, making an investable index similar
in some ways to a fund of hedge funds portfolio.
To make the index investable, hedge funds must agree
to accept investments on the terms given by the
constructor. To make the index liquid, these terms must
include provisions for redemptions that some managers
may consider too onerous to be acceptable. This means
that investable indices do not represent the total
universe of hedge funds, and most seriously they may
under-represent more successful managers.
[edit]m  
 
The most recent addition to the field approach the
problem in a different manner. Instead of reflecting the
performance of actual hedge funds they take a statistical
approach to the analysis of historic hedge fund returns,
and use this to construct a model of how hedge fund
returns respond to the movements of various investable
financial assets. This model is then used to construct an
investable portfolio of those assets. This makes the
index investable, and in principle they can be as
representative as the hedge fund database from which
they were constructed.
However, they rely on a statistical modelling process. As
replication indices have a relatively short history it is not
yet possible to know how reliable this process will be in
practice, although initially indications are that much of
hedge fund returns can be replicated in this manner
without the problems of illiquidity, transparency and
fraud that exist in direct hedge fund investments.

[edit]Debates and controversies

[edit]¦
Hedge funds came under heightened scrutiny as a result
of the failure of Long-Term Capital Management (LTCM)
in 1998, which necessitated a bailout coordinated (but
not financed) by the U.S. Federal Reserve. Critics have
charged that hedge funds pose systemic risks
highlighted by the LTCM disaster. The
excessive leverage(through derivatives) that can be
used by hedge funds to achieve their return[38] is outlined
as one of the main factors of the hedge funds'
contribution to systemic risk.
The ECB (European Central Bank) issued a warning in
June 2006 on hedge fund risk for financial stability and
systemic risk: "... the increasingly similar positioning of
individual hedge funds within broad hedge fund
investment strategies is another major risk for financial
stability, which warrants close monitoring despite the
essential lack of any possible remedies. Some believe
that broad hedge fund investment strategies have also
become increasingly correlated, thereby further
increasing the potential adverse effects of disorderly
exits from crowded trades."[39][40] However the ECB
statement has been disputed by parts of the financial
industry.[41]
The potential for systemic risk was highlighted by the
near-collapse of two Bear Stearns hedge funds in June
2007.[42] The funds invested in mortgage-backed
securities. The funds' financial problems necessitated an
infusion of cash into one of the funds from Bear Stearns
but no outside assistance. It was the largest fund bailout
since Long Term Capital Management's collapse in
1998. The U.S. Securities and Exchange commission is
investigating.[43]

[edit]

 

As private, lightly regulated entities, hedge funds are not
obliged to disclose their activities to third parties. This is
in contrast to a regulated mutual fund (or unit trust),
which will typically have to meet regulatory requirements
for disclosure. An investor in a hedge fund usually has
direct access to the investment advisor of the fund, and
may enjoy more personalized reporting than investors in
retail investment funds. This may include detailed
discussions of risks assumed and significant positions.
However, this high level of disclosure is not available to
non-investors, contributing to hedge funds' reputation for
secrecy, while some hedge funds have very limited
transparency even to investors.[ 


]
Funds may choose to report some information in the
interest of recruiting additional investors. Much of the
data available in consolidated databases is self-reported
and unverified.[44] A study was done on two major
databases containing hedge fund data. The study noted
that 465 common funds had significant differences in
reported information (e.g. returns, inception date, net
assets value, incentive fee, management fee, investment
styles, etc.) and that 5% of return numbers and 5% of
[45]
NAV numbers were dramatically different. With these
limitations, investors have to do their own research,
[46]
which may cost on the scale of $50,000.
Some hedge funds, mainly American, do not use third
parties either as the custodian of their assets or as their
administrator (who will calculate the NAV of the fund).
This can lead to conflicts of interest, and in extreme
cases can assist fraud. In a recent example, Kirk Wright
of International Management Associates has been
accused of mail fraud and other securities
[47]
violations which allegedly defrauded clients of close to
$180 million.[48] In December 2008, Bernard Madoff was
arrested for running a $50 billion Ponzi scheme.[49] While
Madoff did not run a hedge fund, several hedge funds
(so called feeder funds), of which the largest was
Fairfield Sentry, were overseen by Madoff and practically
all their funds were funnelled to Madoff. This case clearly
does illustrate the value of independent verification of
assets.
[edit]



Alpha appears to have been becoming rarer for two
related reasons. First, the increase in traded volume
may have been reducing the market anomalies that are
a source of hedge fund performance. Second, the
remuneration model is attracting more managers, which
may dilute the talent available in the industry, though
these causes are disputed.[50]

[edit]$%¦% 
 
In June 2006, the Senate Judiciary Committee began an
investigation into the links between hedge funds and
independent analysts.[51]
The U.S. Securities and Exchange Commission (SEC) is
also focusing resources on investigating insider trading
by hedge funds.[52][53]
[edit]

 
Performance statistics are hard to obtain because of
restrictions on advertising and the lack of centralised
collection. However summaries are occasionally
available in various journals.[54][55]
The question of how performance should be adjusted for
the amount of risk that is being taken has led to literature
that is both abundant and controversial. Traditional
indicators (Sharpe, Treynor, Jensen) work best when
returns follow a symmetrical distribution. In that case,
risk is represented by the standard deviation.
Unfortunately, hedge fund returns are not normally
distributed, and hedge fund return series
are autocorrelated. Consequently, traditional
performance measures suffer from theoretical problems
when they are applied to hedge funds, making them
even less reliable than is suggested by the shortness of
the available return series.[2]
Several innovative performance measures have been
introduced in an attempt to deal with this problem:
Modified Sharpe ratio by Gregoriou and Gueyie (2003),
Omega by Keating and Shadwick (2002), Alternative
Investments Risk Adjusted Performance (AIRAP) by
Sharma (2004), and Kappa by Kaplan and Knowles
(2004). However, there is no consensus on the most
appropriate absolute performance measure, and
traditional performance measures are still widely used in
[2]
the industry.
[edit]Ë
 


 

According to Modern Portfolio Theory, rational investors
will seek to hold portfolios that are mean/variance
efficient (that is, portfolios offer the highest level of return
per unit of risk, and the lowest level of risk per unit of
return). One of the attractive features of hedge funds (in
particular market neutral and similar funds) is that they
sometimes have a modest correlation with traditional
assets such as equities. This means that hedge funds
have a potentially quite valuable role in investment
[2]
portfolios as diversifiers, reducing overall portfolio risk.
However, there are three reasons why one might not
wish to allocate a high proportion of assets into hedge
funds. These reasons are:

1. Hedge funds are highly individual and it is hard

to estimate the likely returns or risks;
2. Hedge funds¶ low correlation with other assets
tends to dissipate during stressful market
events, making them much less useful for
diversification than they may appear; and
3. Hedge fund returns are reduced considerably
by the high fee structures that are typically
charged.
Several studies have suggested that hedge funds are
sufficiently diversifying to merit inclusion in investor
portfolios, but this is disputed for example by Mark
Kritzman[56][57] who performed a mean-variance
optimization calculation on an opportunity set that
consisted of a stock index fund, a bond index fund, and
ten hypothetical hedge funds. The optimizer found that a
mean-variance efficient portfolio did not contain any
allocation to hedge funds, largely because of the impact
of performance fees. To demonstrate this, Kritzman
repeated the optimization using an assumption that the
hedge funds incurred no performance fees. The result
from this second optimization was an allocation of 74%
to hedge funds.
The other factor reducing the attractiveness of hedge
funds in a diversified portfolio is that they tend to under-
perform during equity bear markets, just when an
investor needs part of their portfolio to add value.[2] For
example, in January-September 2008, the Credit
[58]
Suisse/Tremont Hedge Fund Index was down 9.87%.
According to the same index series, even "dedicated
short bias" funds had a return of -6.08% during
September 2008. In other words, even though low
average correlations may appear to make hedge funds
 attractive this may not work in turbulent period, for
example around the collapse of Lehman Brothers in
September 2008.
Hedge funds posted disappointing returns in 2008, but
the average hedge fund return of -18.65% (the HFRI
Fund Weighted Composite Index return) was far better
than the returns generated by most assets other than
cash. The S&P 500 total return was -37.00% in 2008,
and that was one of the best performing equity indices in
the world. Several equity markets lost more than half
their value. Most foreign and domestic corporate debt
indices also suffered in 2008, posting losses significantly
worse than the average hedge fund. Mutual funds also
performed much worse than hedge funds in 2008.
According to Lipper, the average U.S. domestic equity
mutual fund decreased 37.6% in 2008. The average
international equity mutual fund declined 45.8%. The
average sector mutual fund dropped 39.7%. The
average China mutual fund declined 52.7% and the
average Latin America mutual fund plummeted 57.3%.
Real estate, both residential and commercial, also
suffered significant drops in 2008. In summary, hedge
funds outperformed many similarly-risky investment
options in 2008.

[edit]^
   

' Amaranth Advisors

' Bridgewater Associates
' Citadel Investment Group
' D.E. Shaw
' Fortress Investment Group
' GLG Partners
' Long-Term Capital Management
' Man Group
' Marshall Wace
' Renaissance Technologies
' Tiger Asia Fund
' Third Point LLC
' SAC Capital Advisors
' Soros Fund Management
' The Children's Investment Fund Management (TCI)

The list of top hedge funds companies in India.

a
  - HFG India Continuum Fund

Hudson Fairfax Group (HFG) is an investment partnership focused on India¶s aerospace, defense,
homeland security and other strategic sectors. It is based in New York with an advisory office in New
|elhi. Its team has five decades of focused experience in the sector combining investment and
industry expertise. Hudson Fairfax Group, through its predecessor company, started as an investment
advisory firm in 2005. It ran an investment fund, the HFG India Continuum Fund, which invested in
publicly traded Indian securities. |uring the operation of its fund, HFG was a Registered Investment
Advisor (RIA) with the U.S. Securities & Exchange Commission and a Foreign Institutional Investor
(FII) with the Securities & Exchange Board of India.

[  
Avatar Investment Management

Avatar Investment Management is the investment advisor to three funds. Headquartered in Mauritius,
the funds are focussed on the Indian public and private equity markets. In order to meet the approval
of various regulatory bodies around the world, only accredited investors may apply to invest.

 
India |eep Value Fund

India Investment Advisors, LLC was founded by Robin Rodriguez and Raj Agarwal in 2006 to pursue
the number of significant investment opportunities presented by the burgeoning Indian capital and
real estate markets. As a result, the India |eep Value Fund was launched in April 2006. The Fund's
Managers seek to achieve long-term capital gains by acting as pro-active deep value investors in
publicly-traded Indian stocks.

 
Fair value

Fair Value Capital is a highly specialized and exclusive Investment Advisory Firm focused on |eep
Value Investment opportunities primarily in Indian equity markets. It seek absolute, long-term returns
for its investments while minimizing investment risks using a Value oriented approach towards our
investments. Fair Value specializes in |eep Value Investments in the Indian equity markets.


 
Indea Capital Pte Ltd

Indea Capital Pte. Ltd (Indea) is a Singapore based investment advisor. Indea was formed in 2002 to
provide boutique fund management services to institutions, foundations, family offices and high net-
worth individuals. In July 2003, Indea launched the Indea Absolute Return Fund (IARF), a directional
fund investing in India and Indian companies globally. The principals have a combined over 30 years
of experience in researching and investing in India. In addition to the Singapore office, Indea has a
research presence in Mumbai, India.


 
India Capital Fund

India Capital FundSM is an open-ended Investment Company incorporated in Mauritius which has
invested in India since 1994. Shares of the India Capital FundSM


 
Monsoon Capital Equity Value Fund

India Capital FundSM is an open-ended Investment Company incorporated in Mauritius which has
invested in India since 1994. Shares of the India Capital Fund

 
 
Karma Capital Management, LLC

Monsoon Capital is the adviser to onshore and offshore private investment partnerships and
specializes in equity investments in India.


 
Atyant Capital

Karma Capital Management LLC is an organization with dedicated professionals engaged in providing
specialist, fundamentally based, alpha-seeking India Focused products including long-only equity and
long-short products. Our wealth of experience has guided us in offering attractive risk-adjusted,
performance-driven products that take advantage of market opportunities and meet specific client
objectives. From diversified proprietary fund portfolios to customized programs for a full range of
global institutional investors, our capabilities and product offerings address the various investment
needs of investors around the world.


 
Atlantis India Opportunities Fund

Rahul leads Atyant Capital Advisors, advisor to the Atyant Capital India Fund. In the last 10 years he¶s
managed money exclusively in the Indian markets. His mission is to consistently identify the best 10-
15 investment ideas from among the thousands of publicly-traded Indian corporations. Rahul¶s value-
based investment philosophy stands apart due to his belief in the paramount importance of corporate
governance, specifically how management operates with its minority shareholders in mind.Prior to
Atyant, Rahul spent four years leading Meridian Investments, generating a 430% absolute return for
the firm¶s high net worth clients.