What is a hedge fund?
 Are hedge funds well established as an asset class?
 What should I note about the risks of investing in hedge funds?
 Why are the risks of investing in hedge funds of a different nature compared to unit trusts?
 What are some of the financial instruments a hedge fund can invest?
 How do hedge funds compare with unit trusts?
 Why are hedge funds less transparent with respect to information than traditional unit trusts?
 Why are hedge funds called absolute return strategies?
 What are the main benefits of hedge funds?
 What is correlation and why is it important?
 Are hedge funds risky?
 Why have you used the CSFB/Tremont Hedge Fund index?
 Is a hedge fund similar to a unit trust?
 What are some of the non-mainstream investment strategies?
 Why are hedge funds important investments in the future?
 How much should I put in important investments in the future?
 What is a Fund of Hedge Funds?
 Can I invest directly in the individual hedge funds directly instead?
 What is the minimum investment amount?
 What kinds of fees are involved?
 How liquid are hedge funds?
 What are the implications if the valuation of the hedge fund is done on a less frequent basis?

 Strategies that use leverage, short-selling, arbitrage, derivatives and

 Investment in non-mainstream asset classes (investments other than listed equities, bonds and cash)

Hedge Funds are considered an important part of the alternative investment asset class, where the returns are uncorrelated to the traditional financial markets. In the past, hedge funds were only available to institutional clients and very wealthy private banking individuals. Today, even conservative pension funds and endowment funds are allocating part of their portfolios in hedge funds. There are more than 5,000 funds operating globally with total assets managed at around US$500 billion.

The risks involved in hedge funds investing and unit trusts investing are of a different nature than those offered by the traditional "long only" unit trusts. Like unit trusts, it is also possible to lose part or all of your capital investing in hedge funds.

		Unit Trusts	Hedge Funds
	Can invest in	Equities and/or Bonds, Money Market Instruments	Equities, Bonds, Forex, Commodities, Derivatives
	Investment strategy	Long only, no leverage	Can be net-long or net-short or even neutral to market exposure. Leverage allowed.
	Incentive-Based fees	No	Yes
	Investing in	Market performance	Manager skill
	Performance	Relative to benchmark indices	Absolute Performance
	Valuation	Daily	Usually monthly or quarterly
	Investment Amount	As low as S$1,000	Varies - depends on structure
	Information Transparency	Relatively Higher	Relatively Lower
	Volatility	Similar to benchmark index	Historically less than equities

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Hedge Funds as an asset class has historically offered to the investor equity type of returns at typically half the volatility offered by equities. Hedge funds are also lowly correlated to financial markets that make them attractive investments for portfolio diversification.

According to the CSFB/ Tremont Hedge Fund index, the 3 year average returns of the index is about 9-10% while the S&P 500 and MSCI World US$ indices have both returned an average of a negative 7-8% over the same period

Correlation measures the degree of linear association between two events. For example, when the US markets rise, the European markets also have the tendency to rise in tandem as well. This is an example of positive correlation. In times of global political instability, financial markets would typically fall while gold prices would rise. This is an example of negative correlation. If your investment assets have low correlation with each other, the price falls in some assets would be offset by the gains made in other assets – leading to a less volatile portfolio return (i.e. less risk). In general, hedge funds typically showed downside protection by having only slightly negative returns or flat returns when the financial markets are bearish.

 This is a common question, no thanks to the negative publicity created by the failure of LTCM (Long Term Capital Management). However, it is worth emphasizing that LTCM is essentially a single manager hedge fund that is opened to institutions only. There was a general lack of transparency of the hedge fund and there was an extremely high level of leverage involved, magnifying the risk exposures.

As a proxy for the performance of hedge funds in general, we have used the CSFB/Tremont Hedge Fund Index as a guide. The index is one of the more popular and established hedge fund indices. To date, it consists of 2,600 hedge funds managing at least US$10 million each. For more information, please refer to www.hedgeindex.com

It is similar in the sense that they are both pooled investment vehicles where the fund manager manages the fund and a management fee is levied on the size of the assets managed.

There are three main categories of hedge funds. These are Relative Value, Event Driven and Opportunistic.

 Relative Value strategies seek to profit from pricing differences due to market inefficiencies. Examples of such strategies are: Fixed Income Arbitrage (bonds), Equity Market Neutral (equities) or Convertible Arbitrage (convertible bonds).

 Event Driven strategies are executed when there is some corporate event like a takeover or merger (Risk Arbitrage) or a bond default due to a company’s bankruptcy (Distressed Securities).

 Opportunistic strategies are directional bets in currencies and commoditiy futures (Managed Futures) and bonds or equities in anticipation of certain broad market movements (Global Macro). On a micro level by selecting specific stocks, this can be found in Equity Long/Short and Emerging Markets Strategies.

Generally, the macro trend of equities has been a 15-20 year cycle since the beginning of the last century. The last bull market which can be said to have started in the early 80s, have run its course cumulating in the peak of 2000. The next phase is most likely to see a more bearish overall tone in equities. As a result, funds that can go short and execute non-mainstream investment strategies can optimize the opportunities that the increasing efficient market may offer.

As hedge funds lack liquidity relative to unit trusts due to positions that have been taken to execute the investment strategy, hedge funds should form a part of your overall investment portfolio. A typical portfolio would contain 10-20% hedge funds. You should consider hedge funds investing in the light of your circumstances, financial resources and entire investment program. You are also advised to approach your financial planner for assistance.

A fund of hedge funds is a portfolio in which a professional manager will allocate capital across a range of hedge funds, which in turn may invest in a wide range if investment markets using differing techniques. The manager will be responsible for deciding which investment strategies should be invested in as well as selection of the most appropriate hedge funds for the chosen strategy.

The strategy is to optimise the returns and correlation offered by the different hedge funds following different strategies and managed by different fund managers. As the different investment strategies perform differently in different time periods, there is diversification across the different investment strategies. Furthermore, there is also diversification across hedge fund managers who may have different risk profiles, orientation and focus in the strategy they follow. A fund of hedge funds also mitigates the negative effects through diversification in the event that a hedge fund fails. The managers of the fund of hedge funds are also able to enforce monitoring and reallocation of hedge funds, further reducing hedge fund failure risk. Fund of hedge funds is an excellent way to get started in hedge funds due to its risk reducing diversified approach that is its key advantage.

It may not always be possible because some hedge funds may be closed to individuals for further investment. Furthermore, there may be a higher minimum investment quantum involved. Other disadvantages are a higher risk approach to investing as your fund would not be optimally allocated across the hedge fund managers due to lack of transparency and the relative sophistication of the investment allocation and monitoring process.

Single Hedge Funds	S$100,000
Fund of Funds	S$20,000
Capital Guaranteed	NIL
Capital Protected	NIL

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