Global Financial Markets
Hedge Fund has several definitions, but none of them accepted globally, however, it is refer to a fund, which can get hold of long and short positions, purchase and then sell low/undervalued securities, possesses a pool of securities and sometimes other assets, and tends to invest in an opportunistic environment where it anticipates extraordinary gains at low risk. The basic aim of many of the hedge funds is to decrease unpredictability and risk while at the same time keep on putting efforts for the preservation of capital and hand over affirmative and encouraging returns under all market conditions.
“Alfred Winslow Jones is credited with establishing one of the first hedge funds as a private partnership in 1949. That hedge fund invested in equities and used leverage and short selling to “hedge” the portfolio’s exposure to movements of the corporate equity markets”. (Loomis, 1970) During the last few decades, hedge funds have started to broaden its investment portfolios’ horizons to incorporate other financial tools and active in diverse investment strategies.
These days, along with trading equities, HF may trade fixed income and convertible securities, currencies, exchange-traded futures, futures contracts, and other no-securities derivations. However, hedge funds sometimes do not utilize the hedging and arbitrage strategies, as they were used to employ in the past. Role of Hedge Funds within the Global Financial Markets The traditional method for purchasing stocks and bonds is to study companies and industries and build venture on basics like management quality, competition, strategy, company profits, market share and P/E ratios.
“A less conventional and more challenging approach is to make investments based not on these “micro events” affecting companies but on macro events”. (Friedland, 2006) Macro events are continuously changing in global economies, typically brought about by shifts in government policy which impact interest rates, which, in turn, affect all financial instruments, including currency, stock, and bond markets. Macro investors anticipate such events and shifts and profit by investing in financial instruments whose prices are most directly influenced by these trends.
(Friedland, 2006) Accordingly, they participate in all major markets (equities, bonds, currencies, and commodities), though not always at the same time, and often use leverage and derivatives to accentuate the impact of market moves. It is this use of leverage on directional bets, which often are not hedged, that has the greatest impact on the performance of macro funds and results in the high volatility that some macro funds experience. (Friedland, 2006) Not surprisingly, macro investing is perceived by many to be a high risk, volatile investment strategy.
This perception has been fueled and, indeed, exaggerated by the media, which take great glee in reporting whenever a well-known hedge fund manager suffers a significant loss. There are probably as many approaches to identifying and capitalizing on macro trends as there are macro hedge fund managers. But all the players and their approaches have several things in common. First, as mentioned, macro players are willing to invest across multiple sectors and trading instruments.
They move from opportunity to opportunity, trend to trend, strategy to strategy – whatever kind of investments that expected shifts in economic policies, political climates, or interest rates make attractive. (Friedland, 2006) Benefits of Hedge Funds • Many hedge fund strategies have the ability to generate positive returns in both rising and falling equity and bond markets. • Inclusion of hedge funds in a balanced portfolio reduces overall portfolio risk and volatility and increases returns.
• Huge variety of hedge fund investment styles – many uncorrelated with each other – provides investors with a wide choice of hedge fund strategies to meet their investment objectives. • Academic research proves hedge funds have higher returns and lower overall risk than traditional investment funds. • Hedge funds provide an ideal long-term investment solution, eliminating the need to correctly time entry and exit from markets. Adding hedge funds to an investment portfolio provides diversification not otherwise available in traditional investing.
(Friedland, 2006) Hedge Funds Strategies A wide range of hedging strategies is available to hedge funds. For example: • selling short – selling shares without owning them, hoping to buy them back at a future date at a lower price in the expectation that their price will drop. • using arbitrage – seeking to exploit pricing inefficiencies between related securities – for example, can be long convertible bonds and short the underlying issuers equity.
• Trading options or derivatives – contracts whose values are based on the performance of any underlying financial asset, index or other investment. • investing in anticipation of a specific event – merger transaction, hostile takeover, spin-off, exiting of bankruptcy proceedings, etc. • investing in deeply discounted securities – of companies about to enter or exit financial distress or bankruptcy, often below liquidation value.
• Many of the strategies used by hedge funds benefit from being non-correlated to the direction of equity markets. (Friedland, 2006) Conclusion The popular misconception is that all hedge funds are volatile — that they all use global macro strategies and place large directional bets on stocks, currencies, bonds, commodities, and gold, while using lots of leverage. In reality, less than 5% of hedge funds are global macro funds. Most hedge funds use derivatives only for hedging or don’t use derivatives at all, and many use no leverage.
Hedge funds generally employ an absolute return approach to investing through which they seek to make money in a variety of market environments. Registered investment companies, in contrast, tend to favor a relative return approach. These funds attempt to duplicate or exceed the performance of a selected asset class or securities index.
Loomis, Carol. (1970), Hard Times Come to Hedge Funds (“Loomis”), Fortune 100, 101 Friedland, Dion. (2006), Global Macro Investing, Magnum Funds, retrieved from http://www. magnum. com/hedgefunds/globalmacroinvesting. asp