and those that are multistrategy in nature. It also includes new sections on the financing market and the secondary market for trading in hedge fund investments.
Part Three explores the nature of absolute, relative, and risk-adjusted performance measures; the impact of fund characteristics related to compensation arrangements; fund terms; and environmental conditions that motivate behavior and influence performance. This section also covers the due diligence process for selecting a single hedge fund for investment from a universe of peers. Topics covered include how to quickly assess and evaluate the people, pedigree, and processes that establish the DNA of any fund; understanding the investment and risk management process of a fund; the impact of the fund’s business model and counterparty risk on the fund’s performance and sustainability; and the role of a fund’s service providers in creating opportunities for a fund, influencing a fund’s performance, or protecting investors from fraud, blowups, or other calamities.
The book ends with some final observations, a review of the challenges faced by the industry today, and the outlook or trends that are likely to continue going forward.
This book can be used by commercial practitioners on a stand-alone basis or by educators in conjunction with supplemental material available online that includes PowerPoint slides, Excel spreadsheets, end-of-chapter discussion questions, and a test bank of over 100 questions. Educators can download the test bank and other learning tools at Wiley’s Instructor Site.
Acknowledgments
This book is possible only as a result of the support of my family, Maureen, Sarah, Andrew, and Will, and all the terrific people I have had the chance to work with during my career, both in industry and in academia. I am also grateful to the alternative investor community at Fordham University and its many alumni, as well as all my friends and former colleagues who have lectured in my classroom or otherwise provided insights and information that contributed to this book and to my knowledge of the hedge fund industry over the years.
About the Author
Kevin R. Mirabile is currently a clinical assistant professor of finance at Fordham University where he teaches courses on the principles of finance, alternative investing, derivatives, and hedge funds. Mr. Mirabile has over 30 years of business development, regulatory, financing, accounting, trading, sales, and asset management experience in the United States and abroad. He is a former COO of Larch Lane Advisors, managing director and executive committee member at Barclays Capital, senior VP and operating committee member of Daiwa Securities, a principal at Morgan Stanley, and president of the Morgan Stanley Trust Company. His areas of expertise are in banking, asset management, and hedge fund investing.
Mr. Mirabile is an active industry consultant on the topics of hedge fund investing and operational and business model risk assessment. He has given lectures across the United States and abroad on the topics of alternative investing, hedge funds, and trends in asset management.
Mr. Mirabile is a CPA, a member of the AICPA, a member of the Greenwich Roundtable’s Founders Council, and a contributor to its “Best Practices” series on alternative investing. He is also a member of the Hedge Fund Association’s Education Committee.
Mr. Mirabile received his BS in accounting from SUNY Albany in 1983, earned his MS in banking and finance from Boston University in 2008, and completed his doctoral studies with a DPS degree in finance and economics from Pace University in May 2013.
PART One
Overview
CHAPTER 1
The Basics of Hedge Fund Investing
A newcomer to hedge fund investing can easily get overwhelmed by the complex terminology and unique characteristics associated with this type of investing. There is a lot to know and not always a lot of time to learn it. This chapter is meant to present the basics of hedge fund investing, including defining alternative investments, discussing the characteristics and structures of hedge funds on a standalone basis and relative to mutual funds, and evaluating the impact of hedge fund trading on the broader markets. This chapter lays the foundation for the rest of the book. Let’s get started.
Alternative investments is a term used to describe investments in nontraditional asset classes. Traditional asset classes include stocks, bonds, and sometimes commodities, and foreign exchange. Alternative investments include hard assets, collectables, real estate funds, private equity, venture capital, managed futures funds, hedge funds, and sometimes even structured products like CLOs and CDOs. Every institution seems to have its own set of rules for what is and is not an alternative investment.
Investors obtain alternative exposure by investing in vehicles such as private limited partnerships and alternative mutual funds. Alternatives may offer attractive portfolio benefits to investors, although on a stand-alone basis they can be more volatile or less liquid than traditional investments.
The more established and better understood traditional asset classes can be described as having large global markets, significant pools of liquidity, a high degree of price transparency, and regulation, along with well-established market microstructures. Stocks and bonds have been available to investors for centuries. Even mutual funds have been around in various shapes and sizes for well over 100 years. Alternatives and hedge funds, on the other hand, by even the broadest measures, only started in the late 1960s and really only began to grow in the early 1990s.
Alternative investing is not a mature industry. Alternative investments are considered relatively young in terms of life cycle and track records. Hedge funds are perhaps the newest form of alternatives and as such may also be the least understood. Their business models are also not as stable, well developed, or mature as those associated with traditional investing or even earlier forms of alternatives, such as real estate and private equity. The market value of publicly traded equity and debt is well over $250 trillion today. There are more than $15 trillion of investments in traditional stock and bond mutual funds in the United States and over $30 trillion globally. This compares to about $3 trillion invested globally in hedge funds at the end of Q1 2015.
So what exactly constitutes an alternative as opposed to a traditional investment? There are a few broad categories that most professionals would agree make up the universe of alternative investment opportunities.
Real estate investing includes direct investments or funds that invest in commercial or residential real estate or mortgages that produce rental income, interest income, and capital appreciation. Most funds are organized in specific regions or by specific types of properties.
Private equity investing includes direct investments or funds that take equity ownership in existing private companies in the hope of streamlining or improving management, negotiating favorable leverage terms with banks, and improving performance so that the fund may ultimately profit from an initial public offering (IPO) of the company’s shares.
Venture capital investing includes direct investments or funds that provide day-one capital to fund new business ideas. These early-stage investors hope to profit by sale of the company to a strategic investor or perhaps to a private equity fund that ultimately will help the company go public.
Managed futures investing includes funds that are specially dedicated to trading futures contracts based on directional or trend-following models. These funds are similar to hedge funds in many ways. They are different from hedge funds in that they are restricted to trading listed futures contracts and are regulated by the Commodity Futures Trading Commission (CFTC).
Hedge fund investing includes investments in either private investment partnerships, mutual funds or UCITS that trade stocks, bonds, commodities, or derivatives using leverage, short selling, and other techniques designed to enhance performance and reduce the volatility of traditional asset classes and investments.
In addition to the more established categories of alternative investments mentioned here, there continue to be newer emergent or exotic alternative strategies that come to the market every year. These exotic alternative investments include direct investments or funds that invest in life insurance