Hedge Fund Analysis: An In-Depth Guide to Evaluating Return Potential and Assessing Risks


Praise for Hedge Fund Analysis

"A comprehensive and thoughtful, step-by-step guide to finding, evaluating, and performing due diligence on hedge funds, written by a seasoned professional. With its practical, real-life examples and its valuable insights into the industry, it should be a must-read for investors interested in hedge funds."
—Frank Brochin, Chief Investment Officer, StoneWater Capital LLC

"Hedge Fund Analysis is a clear, concise, and thorough review of the due diligence process and serves as an excellent guide for anyone looking to identify talent in this opaque corner of the investment universe. The book provides a valuable introduction to a complicated exercise for those new to the industry and is an excellent refresher for the experienced analyst."
—D. Jeffrey Dramstad, CFA, Director, Investment Strategy and Due Diligence, Clark Enterprises, Inc.

"Conducting thorough analysis of all aspects of a hedge fund can be a challenging, multidisciplinary exercise. This book provides a great introduction for investors seeking to evaluate both investment and operational risks in hedge funds, and highlights the importance of detailed operational due diligence."
—Jason Scharfman, Managing Partner, Corgentum Consulting, LLC

"Travers provides a comprehensive, yet accessible guide to hedge fund analysis that belongs on the reference shelf of any investor."
—Meredith Jones, Director, Rothstein Kass

"Hedge Fund Analysis is a thoughtful, thorough book on the hedge fund industry and manager selection process. Travers explains in plain English and great detail the difficult process of finding and selecting a strong hedge fund manager. This book is a must-read for anyone trying to select a hedge fund manager."
—Christopher Ainsworth, President, California Hedge Fund Association

FRANK J. TRAVERS, CFA, is a portfolio manager at Larch Lane Advisors. He has over two decades of experience analyzing traditional long-only, private equity, and hedge fund strategies. Previously, he was the director of research at First Peninsula Capital and a portfolio manager at Pine Street Advisors and CIC Group. Additionally, he held positions as the director of due diligence at CIBC World Markets, associate director of international equity research at Evaluation Associates, and senior analyst positions at Morgan Stanley Asset Management and RCB Trust. Travers is the author of Investment Manager Analysis: A Comprehensive Guide to Portfolio Selection, Monitoring, and Optimization, also published by Wiley. He received his BS in finance from St. John's University and his MBA from Fordham University.

Introduction xi

PART ONE Background

CHAPTER 1 Hedge Fund History 3

So Who Invented the Hedge Fund? 4

The Samurai 4

The Academic 5

The Legend 14

The Innovator 17

CHAPTER 2 Hedge Fund Asset Class 29

Definition 29

Hedge Fund Structure 31

Hedge Fund Strategies 32

Advantages of Allocating to Hedge Funds 43

Hedge Fund Size and Age Impacts Performance 52

PART TWO Hedge Fund Due Diligence

CHAPTER 3 Due Diligence Process 57

Key Areas of Focus within Each Component of Due Diligence 57

The Due Diligence Process Highlighted in This Book 60

Putting It All Together 67

Some Initial Thoughts 70

CHAPTER 4 Initial Data Collection 77

Data Collection 78

Due Diligence Questionnaire (DDQ) 80

Fictional Capital Management 80

Other Materials 106

Further Analysis 108

13F Analysis 116

Hedge Fund Journal 119

CHAPTER 5 Initial Interview 121

Initial Call or Meeting 121

Phone Interviews 122

Meeting Notes 139

CHAPTER 6 Quantitative Analysis 145

Performance Measures 146

Absolute Return Measures 146

Absolute Risk Measures 154

Regression-Based Statistics 164

Peer Group Analysis 168

CHAPTER 7 Portfolio Analysis 173

Attribution Analysis 174

Fundamental Analysis 189

Evaluating Portfolio Data 193

CHAPTER 8 Onsite Interviews 217

Onsite Meeting Strategies 219

One-on-One Meetings 219

Meeting with More Than One Person 222

Different Perspectives 223

Meeting Notes 224

Onsite Interviews at Fictional Capital Management (FCM) 228

CHAPTER 9 Operational Due Diligence 259

Case Study: Bayou Fund 259

Definition 261

Importance of Operational Due Diligence 263

Categorization of Operational Due Diligence 267

Interview with FCM Operational Staff 301

CHAPTER 10 Risk Due Diligence 309

Graphical Depiction of Hedge Fund Risks 312

Risk Due Diligence 314

Factor Decomposition Analysis 330

Interview with FCM Risk Manager 333

CHAPTER 11 Reference and Background Checks 339

Onlist and Offlist References 340

Internet and Social Media 341

Contacting References 343

Problematic References 346

Whose References Should You Check? 349

How Many Reference Calls Are Enough? 350

Background Checks 352

Summary of Reference Calls for FCM 353

CHAPTER 12 Hedge Fund Scoring Model and Decision Making 357

Hedge Fund Scoring Model 358

Putting It All Together 374

About the Author 379

Index 381