The hedge fund is a known term for almost every person who ever thought about investing. It’s common to relate hedge funds with something extraordinary, high-income, and unregulated. Fortunately, it’s not true. Before we dive into the investor’s toolkit, let’s revise what the hedge funds really are.
The Essence of Hedge
Hedge funds are investment entities, closed partnerships between portfolio managers and investors, focused on maximizing returns. The main differences between hedge funds and other institutional funds are in a spectrum of available trading strategies, as well as a special system of fees for asset management.
According to Hedgeweek, smaller investors are typically paying average fees of 1.5 & 20, while institutional investors are paying significantly lower fees with an estimated average of 1 & 15.
However, not everyone can be an investor.
The use of derivatives and borrowed capital means additional risks, therefore the investment is available only to individuals and legal entities with high income and/or assets, i.e. qualified investors since it is believed that they do not need government protection from potential losses on financial markets.
In the aftermath of the global financial crisis of 2007, the “unregulated” statement is no longer relevant to any American hedge fund that manages assets over the US $100 million. Only offshore hedge funds and small American hedge funds remain “unregulated”. But due to the inability to adequately assess the investment risks of offshore hedge funds, many investors prefer regulated funds to offshore hedge funds. In particular, the European UCITS funds are classified as regulated hedge funds.
What it’s Like to Become a Hedge Fund Investor
As already mentioned, most hedge funds operate with really big dollars, thus filtering out unprepared investors from entry. This means that the entry process is most likely to start as a meeting of investors and fund managers and a lot of things are negotiated tet-a-tet. A lot of massive hedge funds don’t even have an official website, so you never know the details of their performance before the meeting.
The LinkedIn profile of Renaissance Technologies LLC (looks empty), whose portfolio value exceeds $80 billion.
Sounds crazy, I know. In the digital era, it seems like big financial institutions must be as transparent as possible, but transparency is still a weakness of hedge funds.
So, choosing a hedge fund starts with painful research and filtering companies by criteria such as lifetime, assets under management, profitability, and risk. Investors usually prefer to invest in funds with a history of more than three years and assets under management over $100 million.
After choosing this variety, you need to contact each fund and arrange a meeting. Next, you need to carry out the due diligence procedure. It’s crucial because you will be acquiring shares that are alternative to the market, where strategy and choice of the manager mean the key factors of success.
Due diligence is the matter of a separate article or two, but let’s point out the most important parts of it. The process can be divided into operational and investment due diligence.
Operational due diligence needs to find out about:
- Potential lack of risk control. It can be very dangerous not to have the appropriate level of control and the ability to see the fund performance anytime or so;
- Conflict of interest: between you as an investor and your portfolio manager. This may apply to the assessment of growth indicators or the level of acceptable risk, for example.
Investment due diligence is needed to understand:
- Knowledge & experience of investment managers;
- Alpha of the past years;
- Difference between this fund and their competitors;
- Approximate profitability and risk in the investment strategy;
- Strategies in different phases of the cycle and market conditions. You may have a different vision of market development, so you are looking for what suits you best.
Risk Control and the Level of Transparency
So, due diligence is the first and very important part of an investor’s toolkit, if he wants to achieve the goals of profit. It’s fair enough that you can opt for the help of specialized consulting companies for conducting the due diligence properly, even though you are an institutional investor having an in-house research department.
Ok, perhaps you are happy with finding a prospective hedge fund to invest in, and also due diligence seems to show good results. After you sign the partnership agreement and become a partner of this hedge fund, your next goal is to be in the know of what’s going on inside this fund and how AUM are performing.
Unfortunately, it’s very normal for a hedge fund to confine itself to mere reporting and lack of transparency for its investors. Defined by law, funds must prepare a partnership agreement or offering memorandum for prospective investors that explains the following:
- The fund’s investment style
- The fund’s structure
- The fund manager’s background
A hedge fund should also undergo an annual audit of holdings and performance and give this report to all fund investors. And that’s it. It’s not mandatory for hedge funds to have a client dashboard of performance or to even respond to an immediate performance status request from your side.
In other words, a simple and transparent system of AUM performance control could be a significant advantage for a hedge fund in the eyes of investors. Luckily, fund managers also understand this crucial point and sometimes use special reporting/monitoring software to grant performance management access to their investors.
Software Hedge Funds Use to Stay More Transparent
With MetaTrader 5, funds remain as transparent as possible due to its possibility of providing end-to-end analytics and real-time reporting. Basically, MetaTrader 5 is a suite of tools for building and managing the hedge fund: the platform supports the creation of different types of accounts, e.g. traders and investors.
Investors, in turn, can be granted direct access to watch the performance of their assets under management. Any investor in any country can log into their terminal from a PC or a mobile device to check the current status.
It’s very notable that MT5 is an independent system for different purposes of hedge fund managements, thus it doesn’t need to be connected to any third-party reporting tools, be it email sendings or print.
The SimCorp Coric platform helps investment managers improve client experience by accurately and consistently communicating with clients while reducing the operational burden associated with producing frequent high-quality client reports, presentations and pitchbooks.
Funds can also utilize the SimCorp Dimension, a multi-asset risk and performance management solution, for internal controls and reporting to investors.
Pages is a client communications solution for investment managers, insurance companies, and banks that generate distinctive client statements and slide presentations for print, electronic or face-to-face meetings.
Pages automate the client reporting process and ensures the fund is meeting its client’s requirements. Pages’ users benefit from fully integrated client reporting features that seamlessly integrate data, rich text and graphics into the client reports.
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