ahooWhat is hedge fund? Fund that can be used for hedging? No no no my dear. Basically hedge fund is very close to being a mutual fund (aka unit trust). The main different is that hedge fund is not regulated by the local investment regulatory authorities. In our case is the Securities Comissions (SC).
Investment Mandate
Since it's not regulated also means that hedge fund has more flexible investment mandate. For example a unit trust in Malaysia can't hold more than 15% of its portfolio on a single stock while hedge fund does not has this regulation. In another word, a hedge fund can invest all into just a few stocks. On an extreme example is less than 5 stocks.
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Leveraging (Borrowing)
Hedge fund can borrow to invest. Don't be suprise to find hedge funds that borrow up to 1000% of its initial capital to invest. Alternatively hedge fund also can invest into derevative only which eventually leverage its position without owning the underlying asset.
Profit Sharing
Most hedge funds practice profit sharing as part of their management fees. For example a hedge fund can set a minimum benchmark of 5%. Any return of the fund above the threshold of 5% will be split at 80:20 (invester:manager) with the hedge fund manager.
Example:-
Benchmark (Threshold) = 5%
Fund performance = 30%
Profit sharing (investor:manager) = 80:20
Thus the performance bonus for the manager is 20% of 25% (30%-5%) which is 5%.
There are very important point to take note:-
1) there is no loss sharing with the manager
2) normally there is a minimum or fixed management fees (eg 1% per annum of the asset under management) despite the performance of the fund
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Fund Manager Commitment
Due to the profit sharing feature, some fund manager might tend to take higher than normal risk because he will be awarded for the extra gain but won't be penalise for the lose. Therefore some company actualy enquire the manager themself to invest into their own fund (certain % of the fund's net asset value) so that the fund manager will be more cautious to manage its own money which is part of the fund itself.
Valuation and Liquidation
Most hedge fund do not practice daily valuation. They are either priced twice monthly, once monthly or even quarter yearly (rare case). This is due to the reason that some of the instruments that the fund invest into might not be liquid enough to be valued daily. Logically if there is not liquidity (no transaction) on the instrument, its difficult to get the most accurate price on the daily basis.
Liquidation (or redemption) on the fund is also done according to its valuation frequency, among the other reasons to do that is due to the ease in managing its cash flow. A fund which has a stable NAV (less unit creation or unit redemption) is easier to manage because you can plan when to realise your profit or gain.
Fund of Hedge Funds
This is a mutual fund which invest it's asset into many other hedge funds. Due to the nature of hedge funds which are unregulated, thus naturally imposed a higher risk to the investors. Therefore to reduce risk, a mutual fund is created to invest into a few other hedge funds and their performances are monitored by a mutual fund (regulated) manager. Not all countries allow Fund of Hedge Funds ( a type of FOF - Fund of Funds ).
Hedge Funds in Malaysia
Basically there is no pure hedge fund to date in Malaysia. Due to its high risk level and the complicated instruments used by hedge funds. Infact in Singapore, hedge fund is a niche product but globally hedge funds activities have grown substantially. But the feature of hedge fund can appear in many different form of mutual funds such as fund of fund, capital protected fund or structured products.
Risk Level of Hedge Funds
Hedge fund do not necessary means higher risk, but due to it's unregulated nature, investors tend to be more keen on the higher risk (focused portfolio and leveraging) hedge funds. As pre-mentioned, there are capital guaranteed hedge funds.
