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Investment Strategies of Hedge Funds


Since the first hedge fund was launched in 1949 by Alfred Winslow Jones, the industry has grown impressively. In 2005 it reached the record size of 1.3 trillion dollars and 8000 hedge funds. Responsible for a big slice of the daily trading volumes of financial markets, hedge funds are among the top clients for brokers, given the level of trading fees they generate.

The hedge fund world is a very heterogeneous one: there are hedge funds that encompass only a few people and those with trading floors bigger than soccer fields. The hedge fund world seems to be the place where the ability to generate positive uncorrelated returns resides, even though performances are not publicly disclosed.

And still, this remarkable phenomenon is surrounded by an aura of mystery. Using real-life examples and case studies, this book provides an intensive learning experience, and helps readers understand the investment strategies of hedge funds showing them how they can invest to make money in an uncorrelated way with financial markets.

Filippo Stefanini is the Head of Research at Eurizon AI SGR where he is responsible for analysing, selecting and monitoring hedge funds and newcits funds.  Eurizon AI SGR SpA is the alternative investment company of the banking group Intesa San Paolo and specialises in managing funds of hedge funds. He has been a lecturer in Risk Management at the University of Bergamo (Italy) since 2007. Filippo Stefanini was  the Deputy Chief Investment Officer and Head of Asset Allocation at Aletti Gestielle Alternative SGR from 2001 to mid 2008. He previously worked as a consultant for Accenture in the Asset Management and Investment Banking areas. Filippo is the author of “Investment Strategies of Hedge Funds” and “Newcits: Investing in UCITS Compliant Hedge Funds”, both published by John Wiley & Sons. He has also co-authored some Italian language books published by Il Sole 24 Ore entitled “I fondi newcits”, “Hedge Funds: strategie di investimento” and “Hedge Funds: Investire per generare rendimenti assoluti”.



About the Author.

1. A Few Initial Remarks.

1.1 What is a hedge fund?

1.2 History of hedge funds.

1.3 Proprietary trading.

1.4 The growth of the hedge fund industry.

1.5 Main characteristics of the current industry.

1.6 Capacity.

1.7 Commissions.

1.8 Industry performance overview.

1.9 The hedge fund manager.

1.10 Alpha and beta.

1.11 Investment strategies.

1.12 Explorers and frontiers.

1.13 SEC’s vigilance.

1.14 Considerations on performance sustainability.

1.15 Capacity and performance sustainability.

1.16 Ability or chance?

1.17 The importance of avoiding losses.

1.18 Decreasing returns with longer investment horizons.

1.19 Business case: A hedge fund start-up.

2. Arbitrage.

2.1 The transaction costs barrier.

2.2 ADR arbitrage.

2.3 Arbitrage between off-the-run and on-the-run thirty-year Treasury Bonds.

3. Short Selling.

3.1 A brief history of short selling.

3.2 What is short selling?

3.3 A simplified example of short selling on US markets.

3.4 Who lends securities for short selling?

3.5 Regulations governing short selling.

3.6 The risks of short selling.

3.7 Short interest and short interest ratio.

3.8 Wall Street’s alter ego.

3.9 Stock picking in short selling.

3.10 The art of contrary thinking.

3.11 Measuring the strategy’s historical performance.

3.12 Conclusions.

4. Long/Short Equity.

4.1 History of the first hedge fund.

4.2 Market exposure.

4.3 Management styles.

4.4 Specialized long/short equity funds.

4.5 Share class arbitrage.

4.6 Pairs trading.

4.7 Covered call and covered put options sale.

4.8 Strategy’s historical performance analysis.

4.9 Equity market neutral.

5. Merger Arbitrage.

5.1 A brief history of M&A.

5.2 Strategy description.

5.3 Risk associated with the outcome of an extraordinary corporate event.

5.4 Types of mergers and acquisitions.

5.5 Risk management.

5.6 Strategy’s historical performance analysis.

5.7 Conclusions.

6. Convertible Bond Arbitrage.

6.1 Why issue a convertible bond?

6.2 A brief history of convertible bonds.

6.3 The convertible bond market.

6.4 Definitions.

6.5 Quantitative models to value convertible bonds.

6.6 Implied volatility and historical volatility.

6.7 Convertible bond arbitrage.

6.8 Mandatory convertibles.

6.9 Strategy’s historical performance analysis.

6.10 Risk control.

6.11 Conclusions.

7. Fixed Income Arbitrage.

7.1 Issuance driven arbitrage or snap trade.

7.2 Yield curve arbitrage.

7.3 Intermarket spread trading.

7.4 Futures basis trading or basis trading.

7.5 Swap spread trading.

7.6 Capital structure arbitrage.

7.7 Long/short credit or credit pair trading.

7.8 Carry trade.

7.9 Break-even inflation trades.

7.10 Cross-currency relative value trade.

7.11 Treasuries over eurodollars (TED) spread or international credit spread.

7.12 Leveraged loans.

7.13 Strategy’s historical performance analysis.

7.14 Conclusions.

8. Strategies on CDOs.

8.1 A brief history of CDOs.

8.2 Hedge fund investment strategies.

8.3 Conclusions.

9. Mortgage-Backed Securities Arbitrage.

9.1 A brief history of mortgage-backed securities.

9.2 Originators of mortgage-backed securities.

9.3 The industry of mortgage-backed securities.

9.4 The sensitivity of mortgage-backed securities to interest rates.

9.5 Arbitrage on mortgage-backed securities.

9.6 Risk factors.

9.7 Strategy’s historical performance analysis.

9.8 Conclusions.

10. Distressed Securities.

10.1 A brief history of distressed securities.

10.2 The distressed debt market.

10.3 Bankruptcy laws.

10.4 Strategy description.

10.5 Risks.

10.6 A brief consideration of the directional nature of distressed securities hedge funds.

10.7 Trade claims.

10.8 Strategy’s historical performance analysis.

10.9 Conclusions.

11. Event Driven or Special Situations.

11.1 Activist investors.

11.2 Strategy’s historical performance analysis.

12. Multi-strategy.

12.1 Multi-strategy funds.

12.2 Strategy’s historical performance analysis.

13. Managed Futures.

13.1 What is a futures contract?

13.2 A brief history of managed futures.

13.3 Managed futures strategy.

13.4 “Do storks deliver babies?” and the predictability of financial time series.

13.5 Strategy’s historical performance analysis.

13.6 Conclusions.

14. Global Macro.

14.1 A brief history of macro funds.

14.2 Investment strategies adopted.

14.3 The characteristics shared by great traders.

14.4 The legs of a trade.

14.5 The theory of reflexivity by George Soros.

14.6 Debt emerging markets.

14.7 Strategy’s historical performance analysis.

14.8 Conclusions.

15. Other Strategies.

15.1 Holding company arbitrage.

15.2 Closed-end fund arbitrage.

15.3 Statistical arbitrage.

15.4 Index arbitrage.

15.5 Volatility trading.

15.6 Split-strike conversion.

15.7 Lending.

15.8 PIPEs or Regulation D.

15.9 Real estate.

15.10 Natural resources.

15.11 Energy trading.

15.12 Natural events.

16. Hedge Fund Performance Analysis.

16.1 Risks inherent in hedge fund investments.

16.2 Hedge fund strategies indices.

16.3 Statistical analysis of indices.

16.4 Value at risk.

16.5 Statistical analysis of data from the LIPPER TASS database.

17. Conclusions.