What are hedge funds? Hedge funds pool investors' money and invest the money in an effort to make a positive return. Hedge funds typically have more flexible. PDF | The hedge fund industry has undergone tremendous changes in recent years. This paper examines: the structure of the industry; performance; assets. PDF | International Asset Management ('IAM') is the proud sponsor of the IAM Hedge Fund Research Programme of the Financial Markets Group. Within this.

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An Overview of the Various Investment Strategies Offered by Hedge Funds in the Marketplace Hedge funds offer investors a breadth of investment options. historical background to the evolution of hedge funds, the fund of funds Institutions, crepsandtinggranan.ml, April, Opportunistic and nimble investment vehicles, such as hedge funds, have been Hedge funds are investment companies with legal and organisational.

For example, hedge funds are highly flexible in their investment options because they can use financial instruments generally beyond the reach of mutual funds. However, a hedge fund does not necessarily use hedging techniques given that the classification scheme for hedge funds has broadened considerably over time. Thus, some hedge funds can invest in anything including stocks, derivatives, land, real estate, and currencies.

Few mutual funds short-sell stocks because they face some restrictions and the higher costs of operating a long-short portfolio. Hedge funds are highly flexible in their investment options because they can use financial instruments generally beyond the reach of mutual funds.

Third, hedge funds often use leverage.

That is, they can borrow funds to potentially increase their returns. However, leverage can destroy hedge fund returns as seen during the GFC. Fourth, the compensation or fee structure differs for hedge funds. Besides charging various fees, which are associated with more traditional pooled investments such as mutual funds, hedge funds also have a performance or incentive fee.

However, these fees have trended lower in recent years. Finally, hedge funds are lightly regulated. Yet, as a result of the GFC, hedge funds have come under increased regulatory scrutiny. Go to top About the Authors H.

Hedge Funds Dummies

There was a melt down in software stock in early P Chidambaram continued the liberalization and reform process, opening up of the companies, lifting taxes on long- term gains and introducing short-term turnover tax. The markets have recovered since then and we have witnessed a sustained rally that has taken the index over Chhabria states that the good thing about the Indian market, riding on the back of an economy that has grown by over 7 per cent in the last two years, is that investors can't miss being part of the growth if they invest in the Indian stock markets carefully.

It is estimated that every month around Rs. There are many equity analysts who assert Indian capital markets to achieve quantum leaps in the future. Further, other analysts like Jhunjhunwala , Jhunjhunwala and Barua et al advocated that investing in the Indian equity market would give attractive returns over the long run backed by strong fundamentals.

Moreover, Krishnamurthy studied that Indian stocks offer extraordinary high sustainable returns and are expected to maintain this trend. It was concluded that corporate India surprised the market with its strong growth in the first quarter of financial year It was also observed that the growth momentum was as broad-based as ever in this rally and not that only a handful of companies were contributing to net profits Economic Times, On the contrary Varadarajan argues that share prices of the Indian stocks are overvalued which would eventually lead to a downfall in the share prices.

He uses two indicators to determine whether current share prices are overvalued: He argues that such a correction has been on the cards for quite some time now; the only element missing is a proximate trigger which would sooner or later burst the share bubble.

In addition, Zore and Sen analyze that both globally as well as in India there are a lot of issues that cause concern. The global interest rate scenario will slacken the growth of the Indian economy to a great extent. In a mutual fund, the fund manager trades the fund's underlying securities, realizing capital gains or losses, and collects the dividend or interest income. The investment proceeds are then passed along to the individual investors.

The value of a share of the mutual fund, known as the net asset value per share NAV , is calculated daily based on the total value of the fund divided by the number of shares currently issued and outstanding.

The flow chart below describes broadly the working of a mutual fund: Figure 2. Though the growth was slow, but it accelerated from the year when non-UTI players entered the industry.

In the past decade, Indian mutual fund industry had seen dramatic improvements, both quality wise as well as quantity wise. The private sector entry to the fund family rose the AUM to Rs. The main reason of its poor growth is that the mutual fund industry in India is new in the country.

Large sections of Indian investors are yet to be familiarized with the concept. Hence, it is the prime responsibility of all mutual fund companies, to market the product correctly abreast of selling. The mutual fund industry can be broadly put into four phases according to the development of the sector: An investor or investment fund that is from or registered in a country outside of the one in which it is currently investing. Institutional investors include hedge funds, insurance companies, pension funds and mutual funds.

International institutional investors must register with the Securities and Exchange Board of India to participate in the market. FII investment is frequently referred to as hot money for the reason that it can leave the country at the same speed at which it comes in. This has become one of the main channels of international portfolio investment in India for foreigners The trickle of FII flows to India that began in January has gradually expanded to an average monthly inflow of close to Rs.

The sources of these FII flows are varied. The FIIs registered with SEBI come from as many as 28 countries including money management companies operating in India on behalf of foreign investors.

In particular institutions operating from Luxembourg, Cayman Islands or Channel Islands, or even those based at Singapore or Hong Kong are likely to be investing funds largely on behalf of residents in other countries. In India, retail investors play a very small role in capital markets.

This is mainly due to the risk aversion. The retail investors are mainly concentrated in four metros and Ahmedabad. Ahmedabad has major chunk of retail investors who are very much active in the stock investors. But slowly this scenario is changing with the increase in the number of Demat accounts through which these investors mainly invest.

But with Indian capital markets gaining popularity, there is high scope that the participation of retail investors will gradually increase. In Japan, too hedge funds are becoming the focus of more attention.

Industry participants believe that Asia could be the next region of growth for the hedge fund industry. The potential of Asian hedge funds is well supported by fundamentals. From an investment perspective, the volatility in the Asian markets in recent years has allowed long-short and other strategic players to out perform regional indices.

The relative inefficiency of the regional markets also presents arbitrage opportunities from a demand stand point US and European investors are expected to turn to alternatives in Asia as capacity in their home markets diminish. Further, the improving economic climate in South East Asia should help foreign fund managers and investors to refocus their attention on the region.

Overall, hedge funds look set to play a larger role in Asia. Hedge funds can provide benefits to financial markets by contributing to market efficiency and enhance liquidity. Many hedge fund advisors take speculative trading positions on behalf of their managed hedge funds based extensive research about the true value or future value of a security.

They may also use short term trading strategies to exploit perceived mis-pricings of securities. Because securities markets are dynamic, the result of such trading is that market prices of securities will move toward their true value.

Trading on behalf of hedge funds can thus bring price information to the securities markets, which can translate into market price efficiency.

Hedge funds also provide liquidity to the capital markets by participating in the market. They often assume risks by serving as ready counter parties to entities that wish to hedge risks.

For example, hedge funds are downloaders and sellers of certain derivatives, such as securitized financial instruments, that provide a mechanism for banks and other creditors to un-bundle the risks involved in real economic activity.

By actively participating in the secondary market for these instruments, hedge funds can help such entities to reduce or manage their own risks because a portion of the financial risks are shifted to investors in the form of these tradable financial instruments. By reallocating financial risks, this market activity provides the added benefit of lowering the financing costs shouldered by other sectors of the economy.

The absence of hedge funds from these markets could lead to fewer risk management choices and a higher cost of capital. Hedge fund can also serve as an important risk management tool for investors by providing valuable portfolio diversification. Hedge fund strategies are typically designed to protect investment principal. Hedge funds frequently use investment instruments e. In addition, hedge funds investment performance can exhibit low correlation to that of traditional investments in the equity and fixed income markets.

Institutional investors have used hedge funds to diversify their investments based on this historic low correlation with overall market activity. We have however, no information about any hedge funds domiciled in India. Further, on account of limited convertibility, offshore hedge funds have yet to offer their products to Indian investors within India. The liberalized scheme will allow Indian individual investors to explore the possibility of investing in offshore financial products.

Through this route hedge funs can derive economic benefit of investing in Indian securities without directly entering the Indian market as FIIs or their sub-accounts. Through recent amendments to the FII Regulations Regulation 15A and 20 A , the regulatory regime has been further strengthened and periodic disclosures regime has been introduced.

As at the end of March, , total investment by hedge funds. In the offshore derivative instruments PNs against Indian equity, are Rs. The fiscal year has seen a spectacular increase in FII activities in Indian market. Robust economic fundamentals, strong corporate earnings and improvement in market micro structure are driving the FII interest in India. Investors all over the world are keen to come to Indian market.

From informal discussions with institutional investors including some reputed and well established hedge funds, one could gauge the extent of interest they have about Indian markets.

Brokers download or sell securities on behalf of their clients on their proprietary account and issue such notes in favor of such foreign investors. Participatory Notes are simple derivative instruments that investors not registered in India or Mauritius use to trade in Indian markets.

These investors place their order through brokerage houses that have Mauritius-based FII accounts.

Derivatives and Hedge Funds

The brokerage houses then repatriate the dividends and capital gains back to these entities. In this case, the broker acts like an exchange: That is why capital market regulators dislike P-notes. Unlike China, where stock markets are not well developed and company information is relatively opaque, experts note that India has much of the necessary institutional framework for hedging, including a regulatory regime and good information disclosure standards.

Now, obviously the Chinese economy is larger, but the capital markets are better developed in India. If you look at the stock market, even if you were to include Hong Kong, the market cap in China relative to its GDP is lower. So if you're looking for investment opportunities where you won't suffer the consequences of illiquidity, India is the more attractive opportunity.

There is also enough liquidity in the big stocks for [domestic] investors to sell short. Even though there are restrictions, these are less binding than in other emerging markets.

Kamdar concurs and says, "The only matter that I find worrisome is that most of the time, without any substantial evidences the world over, any crisis in stick market is conveniently attributed to hedge funds. Now, with the transaction tax levied on trades carried out in the stock market, these increased volumes will also lead to revenue for the government. According to the authors of Sound Practices for Hedge Fund Managers , the three quantifiable risks, market risk, credit risk and liquidity risk are interrelated and as such should be studied separately as well as together, i.

Furthermore, the effect of leverage on all three key risk factors should also be properly assessed, as insolvency risk becomes a vital point. Botteron and Villager Risk Management Overview go further and divide the risk universe into exogenous intertwining risks, common to all markets, which include market, credit and liquidity risks, and endogenous risks, addressed by internal measures and regular due diligence, including operational and model risks.

Due to global macroeconomic perspectives their can be an event of market sudden slump. And the herding mentality of the Hedge Funds adds to this slump by continuously withdrawing money from the markets. Mostly interest rates, bond yields and the security prices are inter-related. So a small slump in one market leads to an adverse effect in other markets also.

This risk is mostly the impact of fixed income instruments; when interest rates go up, bond prices go down. The strategy of Fixed income instruments is to invest in corporate bonds and government bonds, so as to get risk free rate of return.

The bond yields depends a lot on the Interest rate prevailing and also inflation figures. The spread between long-term interest rates and short-term interest rates reflects, for example, the degree of inflation risk. When anxiety is high regarding inflation, the spread widens as investors demand higher long-term rates as compensation. And hedge funds known as Hot Money, if they sense in any risk in near future they exit the market.

But due to the huge investments and huge leveraged positions it carries out results in turmoil in the bond market. The Bond market is a classical example to show the effect of this kind of investment strategy. A position with a delta of zero is called delta neutral or delta hedged. Rebalancing or periodic adjustment is necessary to keep a position delta hedged as delta changes all the time.

This provides protection against small stock price movements. However, for larger movements, gamma1 neutrality is required. This is also one of the impacts on the Indian Capital Market. Volatility risk: The Greek letter Vega measures the impact of the change in volatility on the value of an option.

When Vega is high, the option is very sensitive to small changes in stock price volatility. Vega neutrality protects from such situations. Gamma is the first derivative of delta; it measures the delta sensitivity to changes in the underlying stock price. The larger the gamma, the more sensitive is the delta to stock price changes and the more frequent the required rebalancing.

It measures the degree to which two series of returns move up or down together. For example the correlation between the stock prices and their derivative instruments. Also the correlation between different industries like the construction and steel and cement industry.

There is also reverse correlation between stock prices plummeted and bond markets rose and vice-versa Jaeger, R. This is particular to Managed Futures. Just like equities, commodities are subject to delta and volatility risks. Due to alternative positions of hedging the volatility of the derivative prices increases.

In order to get absolute gains, Hedge Funds try to increase bets on one position and keep on adding to that net position. Amaranth LLC is the best example to suit this type of risk.

Due to huge leverage positions build up in these two futures, the losses kept on accumulated. Due to huge losses the fund has to be liquidated there by impacting to a great extent the futures price of the crude. The strategy of managed futures is to get money out of the arbitrage of currency fluctuations.

Key Figures

Hedge Funds are not long-term players and they invest for a short period of time. So this Hot money may try to capitalize the currency fluctuations that happen regularly. East Asian crisis and the recent Yuan Carry of trade phenomenon can be attributed to this type of Managed Futures trading strategy of Hedge Funds.

This led to the Asian Financial Crisis. This type of risk becomes critical while handling derivatives. When investors perceive a high credit risk, they demand a higher yield on the money they lend and vice-versa.

Market Dispersion and the Profitability of Hedge Funds

Indian markets follow the system of Mark-to-Market settlement. But this system is not exercised in case of private players who take a large leverage positions.

Due to the large leverage position builds up and due to the increase in volatility of the prices of derivative instruments this type of risk arises. The mayhem created in the stock markets in May can be attributed to the credit risk arising of the Distressed securities and Convertible arbitrage strategies.

Due to this their was a slump in the market to a certain extent. But due to the drop in prices their was a call by many players to withdrew from the market. Due to this selling many big investors suffered and to cut down the losses and pay the margin money their was an across the board selling. Thus if big and hot money like Hedge Funds leads to this type of margin pressures there could be a bigger slump and increased volatility in the stock prices.

It can be further subdivided into three risks. The First one is related to short selling activity; a manager might be forced to redownload a borrowed asset due to an adverse market condition. The second risk affects the cash reserves of a fund, as it may have to redeem part of its debt obligations or pay margin calls. Liquidity is one of the main problems in the Indian Stock markets. Liquidity problem is the main problem facing FIIs. The reason is simple: The only option for FIIs is to trade among themselves.

There is also the danger that they may lose value of their investments if they sell in a big way. Soueissy, M. It occurs due to the incorrect valuation of an investment opportunity by a financial instrument.

Sophisticated software has been heavily relied upon in the past and will continue to do so and erroneous results could jeopardize a whole strategy. The simplest example would be an out dated model that is no longer reliable to correctly evaluate present new market conditions. Indeed, all funds that are faced with foreign exchange issues try to put in place effective hedging techniques using futures, forwards and other swap instruments; sometimes, they fail and losses arise. Style drift: For example, in , Fenchurch Capital Management, a fixed income arbitrage fund switched from U.

The fund pleaded guilty to securities fraud, theft and misappropriation of property. According to Silverman, methodology is how one will go about studying any phenomenon. In social research, methodology is defined very broadly e. Like theories, methodologies cannot be true or false, only more or less useful. In the study carried out the exact problem is not known. The study has been done to get an insight into the Hedge Funds and their investment strategies, so as to make an analytical study about their impact on Indian Capital markets.

Hence, the research type is Exploratory. The type of data collected is mainly secondary data. After the relationship is established, a detailed analysis of the hedge fund strategies of investment is done. Also an analytical study of Hedge funds impact on Indian Capital markets is done based on individual investment strategy.

The two most common types of research method are Qualitative and Quantitative. Qualitative and Quantitative research can be seen to represent two paradigms, each historically assuming different ontology and epistemologies, assumptions, values, and philosophy underlying methods and techniques, and their use are inherent in these paradigms Evans, A Qualitative research is defined by Strauss and Corbin as "any kind of research that produces findings not arrived at by means of statistical procedures or other means of quantification".

For our analysis and interpretation we have used Qualitative research. I will be adopting Quantitative method as a part of my research study as numerical calculations and facts and figures are more important to understand properly the impact of hedge funds on the Indian Capital Market.

It will be a more justifiable method here in this research rather than analyzing answers from the respondents in the form of Questionnaires, Interviews and other feedbacks. According to Naresh K. Malhotra a research design is a blueprint or framework for conducting the research project. In simple words it is a plan for study that guides the collection and analysis of data. One of its key features is to join the parts and phases of the enquiry together.

It should be comprehensive in its coverage of the work i. A research design lays the base for conducting the project and ensures that the research plan is conducted efficiently and effectively. This research has been undertaken to explore the possible impacts of hedge funds on the Indian Capital Market. For this as discussed earlier Quantitative research is adopted in which certain statistical techniques are utilized. This study is to elucidate the different strategies of Hedge Fund managers and their possible impact on Indian Capital markets and to understand how hedge funds are beneficial.

The main objectives of this dissertation are: While undertaking the report, I have confronted with the following limitations: The objectives of this study were to study the Hedge Fund investment strategies, as these investment vehicles are dreaded in many countries.

After doing a detailed study of the strategies, an analytical framework is done whether there is any potential for Hedge Funds in India and also to study the possible impact of Hedge Funds on the Indian Financial Markets.

After the relationship is established, a small study on the relationship between the key Hedge Fund indices and the corresponding Strategy Index is taken to establish whether the Hedge Fund strategies has any direct relationship to four biggest crisis in the Financial World.

The four crises taken for study are 1 Bond Crisis 2 Thai Crisis 3 Russian Crisis 4 TMT Crisis After the relationship is established, a detailed analysis of the hedge fund strategies of investment is done. The data from is taken because, after in free regulations regarding FII were introduced. Since the calculated value is more than the theoretical value the null hypothesis is rejected. Therefore it is thus established that there is strong relationship between the Hedge Fund inflows and the Sensex returns Also the correlation between the Hedge Funds turnover and the Sensex returns is 0.

Therefore the Hedge fund inflows result in a positive return in the Sensex. The returns are compared and an analytical framework is arrived in the end by observing the returns.

The HFRI was up by 5. This was its worst performance on record. The HFRI was down by 4. TMT Crash: The HFRI was up by Crisis Crisis down 4. Crisis 9. Crisis down Crisis down 6. This proves that Hedge Funds played a vital role in the culmination of the above said crisis. Hedge funds as a whole are becoming an important segment of the asset management industry and gaining popularity from investors particularly from the high net worth investors, universities, charitable funds, endowments, pension funds, insurance and other institutional investors.

The assets under management of the hedge funds are growing on a double digit rate. All hedge funds are not necessarily speculative funds though most of them provide an alternative investment options for the investors through innovative investment strategy.

Many people argue that a hedge fund has a short investment horizon and that its investments would be volatile — hot money — while the regulated FII has a longer horizon and its investments would be less volatile. However, as finance theory teaches us, correlations are usually more important than volatility. Funds Of Funds Hedge Funds: By Dan Barufaldi Although hedge funds usually get negative media focus, many hedge funds are actually very good investments and can be an integral part of a well- diversified portfolio.

Related Articles. A hedge fund is basically an investment partnership. It's the marriage of a fund manager and the investors, who pool their money together into the fund. After decades at the top of the investment food chain, hedge funds may be in decline. Find out whether hedge funds, which have come under tremendous pressure to improve their performance, managed to earn their fee in Find out how average investors are breaking into what was once reserved for the ultra rich.

Experience and hard work go a long way toward securing a position in the challenging field of hedge funds.Sage Publications, Inc, pp- 17 Taylor, P. Though these types of Hedge Funds are absent in India because there is no free convertibility of Rupee, this strategy may pose danger in future when India is planning to allow Capital Account Convertibility. While undertaking the report, I have confronted with the following limitations: The hedge must be adjusted by selling short more shares.

Karandikar, M. This investment strategy, mainly invests in companies which are planning to merge or one company downloading another company. Hedge fund managers are usually motivated to maximise absolute returns under any market condition.

Investments by regulated FIIs tend to be highly correlated because they face common redemption pressures and common home country regulatory environments.