Hedge fund regulation and institutional investment risk

Hedge Fund Management Technique, the title for this thesis/Capstone, denotes the realm of research this study presents.

Point

HEDGE FUND Management TECHNIQUES

"...even the most promising hedge fund can fail."

Potential Profit "Promises"

Hedge funds "could make money [even] if stock, bond, commodity, and currency prices fell," however, as the introductory quote for this thesis/Capstone contends: "...even the most promising hedge fund can fail."

Initially, as techniques implemented were able to invest in ways that could make money even when stock, bond, commodity, and currency prices fell, the "promises" of hedge funds captivated investors' interest, who perceived hedge funds as a means to protect their money by "hedging" long-term stock investments' risks. Mutual funds' techniques, on the other hand, which invested solely in stocks and bonds, only made money only when the prices of stocks and bonds rose.

George O. Aragon and Wayne E. Ferson purport in "7 Hedge fund performance," purport that Hedge funds, in business for more than 60 years, prove similar, yet simultaneously differ from mutual funds. Like mutual funds, hedge funds, open-ended investment companies, pool dollars from a group of investors. Contrary to mutual funds, however, hedge funds do not have to comply with the Investment Company Act (U.S.).

The U.S. Investment Company Act of 1940, albeit, required hedge fund investors to invest a significantly higher minimum investment than mutual funds. To help limit hedge funds participation and "discourage" other forms of unregulated pools to highly sophisticated individuals: "Under, certain hedge funds only may accept investments from individuals who hold at least $5 million in investments."

Nevertheless, when hedge funds bank on other exemptions under the Investment Company Act or are managed outside the U.S., hedge funds may also accept other categories of investors.

Hedge funds, money managers that complete extremely risky investments, are not virtually regulated. In the past, few political leaders have expressed concern about their management techniques, however, currently urgency for reform for these investments exists, as pension funds, school endowments, and charities pursuing promises of "easy money" increasingly turn to hedge funds and potentially put their funds in jeopardy. During 20076, approximately 20% of pensions invested, on average about five percent of assets (some invest more), in hedge funds. Almost two-thirds of endowments, including charitable organizations and universities, invest through hedge funds, and allocate an average of 18% of their invested assets. One New York bank study estimated that before this decade ends, institutions, including pension funds, will account for approximately one-third of new money delegated to hedge funds.

Alfred W. Jones reportedly started hedge funds in the late 1940s, however, they did not "take off" until the 1970s and 1980s, when "new investment opportunities were created in world currencies and in the futures and options markets, which opened up commodity trading and allowed leveraged investing. Investors could make big bets, magnifying their potential wins (or losses), while only putting down a little money."

During this time, George Soros, Bruce Kovner, and Julian Robertson, reported legendary commodity and currency traders, along with epic hedge fund profits, noted from 50% to 100%, made investment "news."

As traders, such as Soros, Kovner, Robertson, repeatedly made money for their investors, numerous wealthy individuals who secured their services willing gave the hedge funds traders 20% of profits, along with two percent fees. During 2005, John Makin, an American Enterprise Institute scholar and a principal at Caxton Associates, a major hedge fund, purported that during the hedge funds' first10 years, traders were "all superb risk managers."

Hedge funds operated exempt from the securities laws regulating mutual funds, reportedly due to the fact their limited clientele were extremely wealthy. Only individuals with $200,000 in income or possessing a net worth of more than $1 million were permitted to "buy in." If rich investors, deemed sophisticated enough to evaluate managers, lost money in hedge funds, neither they, nor their managers, worried much. During the 1980s, the largest hedge funds, which managed several hundred million dollars for a limited number of investors, focused on nurturing long-term relationships with their investors. As the hedge funds repeatedly succeeded, their funds significantly increased in numbers and size. By the early 1990, the largest hedge funds managed more than a billion dollars.

"Hedge funds can arrest the development of whole economies, and they have the potential to crash the financial system," Janet Bush argues in the 2006 article, "Sell-Out! Why Hedge Funds Will Destroy the World: If Hedge Funds Were a Country, it Would Be the Eighth-Biggest on the Planet. They Can Sink Whole Economies, and Have the Potential to Crash the Entire Global Financial System. Yet They Are beyond Regulation. We Should Be Very Afraid." The potential destruction hedge funds can engender almost occurred in the past. In 1998, due to the influence of the Federal government, Fourteen Families" (an apposite Mafia reference) of Wall Street (major banks) pooled enough money to complete a $3.6bn bailout for Long-Term Capital Management, a hedge fund whose investments went south. At the time, according to the federal government, LTCM's abrupt, disorderly failure posed "unacceptable risks to the American economy."

In 2006, another not successful recount of hedge funds made financial news. Brian Hunter, a then 33-year-old Canadian energy trader, who had started his own firm, reportedly raised almost $1 billion for the endeavor. Critics of Hunter pointed out he had been primarily responsible for risky natural gas investments, which during September 2006 lost more than $6 billion for his former employer, Amaranth Advisors. Hunter's investments, reported caused Amaranth Advisors, one of the largest hedge funds (which he joined in 2004) to collapse.

As a result, the San Diego County pension filed a suit against Hunter for $150 million of the $175 million they invested with Amaranth, contending Hunter failed to deliver the diversified and risk-controlled investment strategy he promised. In addition, in regard to Hunter's investments, a Senate committee investigated manipulation of the natural gas futures market related to Hunter's investments. Prior to this particular hedge fund fiasco, Hunter's investment strategies were entangled in lawsuits filed by Deutsche Bank, his former employer. As hedge funds operate in the shadows, some contend, and are subject to only scant regulation of their investments, as well as information they share with investors, little keeps Hunter or other questionable traders from repeatedly recklessly investing other people's money.

Along with fulfilling and failing to fulfill promises of profits for investors in the past, research conducted by hedge funds helped expose corporate corruption, such as the notorious Enron case. In light of the myriad of current conflicting complementary, yet simultaneous challenging information enveloping hedge funds, while continually captivating personal and public interest, this researcher contends hedge funds to merit a scrupulous analysis to fulfill the thesis/Capstone required to partially fulfill the requirements for the Degree of ***.

1.2: Study Area

This thesis/Capstone, which analyzes techniques hedge funds utilise, contends that despite the fact promising hedge funds may fail, investors utilising hedge fund management techniques, in fact, may "profit" from both rising and falling markets.

Questions contributing to confirming this study's thesis statement include:

1. What are hedge funds?

2. How do hedge funds compare to mutual funds?

3. What techniques do hedge funds utilise?

4. How do rising and falling markets impact hedge funds?

In this area, need to clarify "area" and/or region this thesis/Capstone encompasses.

1.3: This Study's Significance

This thesis/Capstone, analyzing techniques hedge funds utilise, proves significant as it highlights a contemporary controversial concern in the investment arena. During the course of this research effort, this researcher aims to return an increase in the readers' understanding of the techniques hedge funds utilise.

As hedge funds are not limited to one particular geographical region, this thesis/Capstone does not focus on any one particular country. Instead, it analyzes hedge funds techniques in the global financial arena.

1.4: Subsequent Sections/Research Method

For this thesis/Capstone, this researcher coheres to a traditional, fundamental thesis/Capstone framework, as this provides the best structure to present this study's points, while simultaneously meeting the academic criteria requirements mandated for partial degree fulfillment. This study's platform incorporates the following sections:

CHAPTER I: INTRODUCTION

1.1: Study Background: This section presents primary points relating to hedge funds/techniques.

1.2: Study Area: This segment advises that hedge funds/techniques are not unique to any one particular global.

1.3: This Study's Significance: This researcher notes that hedge funds/techniques comprise a significant, contemporary controversial concern.

1.4: Study Structure: This segment presents an outline of this study's subsequent sections.

1.5: Aim and Objectives: This section portrays this study's aim, as well as, a bulleted list of the objectives for this thesis/Capstone project.

CHAPTER II: LITERATURE REVIEW and ANALYSIS

2.1: Introduction: In this segment, this researcher introduces information relating to hedge funds techniques, and notes that the Literature Research Methodology constitutes the method utilized for this thesis/Capstone. Themes explored by the literature are related in this segment.

2.2: Study Method: This section briefly spotlights the Literature Review Methodology, noting that this researcher initially assesses more than 40 sources to, in the end; utilize 20 sources as relevant enough to support the thesis statement of this thesis/Capstone, analyzing hedge funds techniques.

2.3: Theme I: This study's first theme defines hedge funds and presents a synopsis of their history.

2.4: Theme 2: Ways hedge funds compare to mutual funds are noted in this section, this study's second theme.

2.5: Theme 3: segment denotes techniques hedge funds utilise in investing.

2.6: Theme 4: A number of ways rising and falling markets impact hedge funds, this section's theme links to the thesis statement for this thesis/Capstone.

2.7: Analysis: The analysis section presents a number of pertinent points retrieved from the reviewed literature.

CHAPTER III: DISCUSSION; CONCLUSIONS; RECOMMENDATIONS

3.1: Introduction: This final chapter's introduction reviews the original study aim and objectives presented at the start of this thesis/Capstone, relating to hedge funds techniques. This section also recounts this study's thesis statement.

3.2: Discussion: During this segment, this researcher relates final considerations regarding hedge funds techniques, cross-referencing several points the reviewed literature noted. This researcher also reiterates the validity of this study's thesis statement and notes the outcome/s of the Aim and Objectives initially projected for this thesis/Capstone.

3.3: Conclusion/s: In this segment, this researcher recounts the original research aim/research questions this thesis/Capstone purports, and provides contentions regarding the contemporary, controversial challenging concepts connected to hedge funds techniques.

3.4: Recommendations: Along with recommendations for future study, this researcher recounts considerations (in hindsight) of that may have enhanced this thesis/Capstone.

APPENDICES: This section presents additional material/s that complement

Information related in the body of this thesis/Capstone.

1.5: Aim and Objectives

Aim

Confirm the validity of this study's thesis statement, which contends that regardless of whether promising hedge funds fail or succeed, investors utilising hedge fund management techniques, in fact, may "profit" from both rising and falling markets.

Objective 1:

Research and define hedge funds.

Objective 2:

Compare hedge funds to mutual funds.

Objective 3:

Present techniques hedge funds utilise.

Objective 4:

Investigate how rising and falling markets impact hedge funds.

During the next section of this thesis/Capstone, this researcher relates information relating to hedge funds that reportedly "could make money [even] if stock, bond, commodity, and currency prices fell."

In addition, this next chapter also explores considerations contributing to the contention the introductory quote for this thesis/Capstone purports: "...even the most promising hedge fund can fail,"

to either ultimately support or contradict this study's thesis statement.

CHAPTER II

LITERATURE REVIEW and ANALYSIS

"There is something fascinating about science.

One gets such wholesale returns of conjecture out of such a trifling investment of fact."

- Mark Twain [Samuel Langhorne Clemens]

(1835 -- 1910), U.S. author.

2.1: Introduction

Hedge funds investment techniques, this researcher contends, do not constitute an "exact science." This segment of this thesis/Capstone, albeit, utilises the fascinating "science" of investing time into accessing and analyzing previous research relating to hedge funds techniques. The return for the investment in this study not only presents a select assortment of samplings of controversial conjectures relating to hedge funds investment techniques, but in fact, relates a myriad of facts.

For this thesis/Capstone, as noted in this study's introduction, this researcher investigates information relating to hedge funds techniques. The Literature Research Methodology constitutes the method utilized for this study effort, which explores and analyzes the following four primary themes:

Hedge funds and a synopsis of their history;

How hedge funds compare to mutual funds;

Techniques hedge funds utilise in investing;

Numerous ways rising and falling markets impact hedge funds.

2.2: Study Method

The Literature Review Methodology, the method used to develop this thesis/Capstone, consists of a methodical review of peer reviewed journals, along with other pertinent published and print and electronic bibliographies, articles, books, websites, and reports. English constitutes the language utilized in this search, with the majority of sources published from 2002 to the present. Searches conducted within these limits used key words and phrases, including, but not limited to:

Automated Trading Systems

Derivatives.

Hedge funds

Hedge funds techniques

Investment

Investment Company Act

Mutual funds

Risk management

James Simons

Technical Analysis Chart Reading

TradeStation

2.4: Hedge Funds Compared to Mutual Funds

The Investment Company Act, considered a contemporary cornerstone of mutual fund regulation, regulates the structure and operation of mutual funds. In addition to requiring prospective fund investors to obtain a prospectus possessing specific information about the fund's management, holdings, fees and expenses, and performance, the 1933 Act requires funds to:

"safeguard their portfolio securities,

"forward price their securities, and "keep detailed books and records."

Unlike mutual funds, hedge funds do not have to register with the SEC. Hedge funds, albeit, issue securities in "private offerings" that are not registered with the SEC under the Securities Act of 1933. Another difference between hedge funds and mutual funds: Regulations do not mandate that hedge funds provide periodic reports under the Securities Exchange Act of 1934. Similar to mutual funds and other securities market participants, however, laws do hold hedge funds accountable for prohibitions against fraud. Hedge funds managers also perform fiduciary duties identical to other investment advisers.

The following table (***) presents a comparison of differences noted between mutual and hedge funds.

Table (***): Comparing Mutual Funds and Hedge Funds

Fees

Mutual Funds

Federal law imposes a fiduciary duty on a mutual fund's investment adviser regarding the compensation it receives from the fund. In addition, mutual fund sales charges and other distribution fees are subject to specific regulatory limits under NASD rules. Mutual fund fees and expenses are disclosed in detail, as required by law, in a fee table at the front of every prospectus. They are presented in a standardized format, so that an investor can easily understand them and can compare expense ratios among different funds.

Fees

Hedge Funds

There are no limits on the fees a hedge fund adviser can charge its investors. Typically, the hedge fund manager charges an asset-based fee and a performance fee. Some have front-end sales charges, as well.

Leveraging Practices

Mutual Funds

The Investment Company Act severely restricts a mutual fund's ability to leverage or borrow against the value of securities in its portfolio. The SEC requires that funds engaging in certain investment techniques, including the use of options, futures, forward contracts and short selling, "cover" their positions. The effect of these constraints has been to strictly limit leveraging by mutual fund portfolio managers.

Leveraging Practices

Hedge Funds

Leveraging and other higher-risk investment strategies are a hallmark of hedge fund management. Hedge funds were originally designed to invest in equity securities and use leverage and short selling to "hedge" the portfolio's exposure to movements of the equity markets. Today, however, advisers to hedge funds utilize a wide variety of investment strategies and techniques. Many are very active traders of securities.

Pricing and Liquidity

Mutual Funds

Mutual funds are required to value their portfolios and price their securities daily based on market quotations that are readily available at market value and others at fair value, as determined in good faith by the board of directors. In addition to providing investors with timely information regarding the value of their investments, daily pricing is designed to ensure that both new investments and redemptions are made at accurate prices. Moreover, mutual funds are required by law to allow shareholders to redeem their shares at any time.

Pricing and Liquidity

Hedge Funds

There are no specific rules governing hedge fund pricing. Hedge fund investors may be unable to determine the value of their investment at any given time.

Investor Characteristics

Mutual Funds

The only qualification for investing in a mutual fund is having the minimum investment to open an account with a fund company, which is typically around $1,000, but can be lower. After the account has been opened, there is generally no minimum additional investment required, and many fund investors contribute relatively small amounts to their mutual funds on a regular basis as part of a long-term investment strategy.

Investor Characteristics

Hedge Funds

A significantly higher minimum investment is required from hedge fund investors. Under the Investment Company Act of 1940, certain hedge funds only may accept investments from individuals who hold at least $5 million in investments. This measure is intended to help limit participation in hedge funds and other types of unregulated pools to highly sophisticated individuals. Hedge funds can also accept other types of investors if they rely on other exemptions under the Investment Company Act or are operated outside the United States.

"Mutual funds are borrowing hedge funds' techniques -- and their fees," the 2006 article, "The long and the short of it; Asset management" Mutual funds mimic hedge funds)," published in the Economist (U.S.), states. Mutual funds, more tightly regulated than hedge funds, are reportedly beginning to acquire hedge funds and have begun to adopt some hedge funds techniques, including:

use of leverage, short-selling (betting on a price falling), and derivatives.

Contemporary Changes

During February 2006, Schroders, a British institution, an old-style fund manager created during Admiral Nelson's era, "agreed to buy NewFinance Capital, a London fund of hedge funds founded just four years ago, for up to $142m."

In 2005, America's Legg Mason acquired Permal, a French fund of hedge funds; making a down payment of $800m, the largest takeover in this realm up to February 2006.

During this time, another American company, Morningstar, reportedly planned to utilise a favourite hedge-fund style, investing in both long and short positions. Dan McNeela, an analyst for Morningstar, pointed out that during this time: "It's a very small percentage of mutual funds that do any shorting at all, but it's definitely becoming more common."

As numerous large fund managers, such as State Street Global Advisors and Goldman Sachs Asset Management, proposed to raise their chances to beat their benchmarks, yet maintain the same risk, instead of implementing simpler choices such as equities vs. bonds, they overlaid short-selling techniques on long-only portfolios, another hedge funds strategy.

Short-selling also began gaining respect, as in the U.S., with some restrictions; mutual funds, for example, could sell short, on leverage. In the European Union, using derivative instruments, rather than through underlying shares or bonds, changes in regulation permitted fund managers to take short positions by contracts for difference and credit default swaps.

Dion Friedland, Chairman of Magnum Funds, explains the difference between a hedge fund and a mutual fund, noting the following five key distinctions:

1. Mutual funds are measured on relative performance - that is, their performance is compared to a relevant index such as the S&P 500 Index or to other mutual funds in their sector. Hedge funds are expected to deliver absolute returns - they attempt to make profits under all circumstances, even when the relative indices are down.

2. Mutual funds are highly regulated, restricting the use of short selling and derivatives. These regulations serve as handcuffs, making it more difficult to outperform the market or to protect the assets of the fund in a downturn. Hedge funds, on the other hand, are unregulated and therefore unrestricted - they allow for short selling and other strategies designed to accelerate performance or reduce volatility. However, an informal restriction is generally imposed on all hedge fund managers by professional investors who understand the different strategies and typically invest in a particular fund because of the manager's expertise in a particular investment strategy. These investors require and expect the hedge fund to stay within its area of specialization and competence. Hence, one of the defining characteristics of hedge funds is that they tend to be specialized, operating within a given niche, specialty or industry that requires a particular expertise.

3. Mutual funds generally remunerate management based on a percent of assets under management. Hedge funds always remunerate managers with performance-related incentive fees as well as a fixed fee. Investing for absolute returns is more demanding than simply seeking relative returns and requires greater skill, knowledge, and talent. Not surprisingly, the incentive-based performance fees tend to attract the most talented investment managers to the hedge fund industry.

4. Mutual funds are not able to effectively protect portfolios against declining markets other than by going into cash or by shorting a limited amount of stock index futures. Hedge funds, on the other hand, are often able to protect against declining markets by utilizing various hedging strategies. The strategies used, of course, vary tremendously depending on the investment style and type of hedge fund. But as a result of these hedging strategies, certain types of hedge funds are able to generate positive returns even in declining markets.

5. The future performance of mutual funds is dependent on the direction of the equity markets. It can be compared to putting a cork on the surface of the ocean - the cork will go up and down with the waves. The future performance of many hedge fund strategies tends to be highly predictable and not dependent on the direction of the equity markets. It can be compared to a submarine traveling in an almost straight line below the surface, not impacted by the effect of the waves.

Hedge Fund Performance Features

Hedge funds, defined as investment pools which possess "the ability to invest in diversified financial instruments," potentially benefit from rising, as well as, falling markets.

Individual hedge funds possess particular risk-return characteristics; contingent on instruments utilized and targeted investment markets. Investors gain two main benefits from utilising a fund of hedge funds:

1. Diversification among a variety of hedge funds confirms risk extends among a number of hedge fund strategies and managers.

2. Funds of hedge funds employ specialised analyst teams to execute due diligence and scrutinize each hedge fund investment, a practice a non-specialist would deem difficult to accomplish.

In hedge funds, "compensation contracts include a significant performance fee, a share of the fund's returns, frequently after the fund performance exceeds a 'high water mark'."

1. Hedge funds secretive nature limits historical data and, even when available, reflects numerous potential biases.

2. Hedge funds' broad investment mandates give investors the flexibility to trade often, consequently creating time-variation in risk exposures.

3. The dearth of transparency about hedge fund strategy contributes challenges for choosing an appropriate benchmark to measure a fund's performance.

4. Asset illiquidity likewise challenges the ability to evaluate reported returns, as biases may exist in the measured performance when asset values are nonsynchronously measured.

***This may or may not work in this secion:

During December 2006, the New York Times reported that to "tap growing demand for Islamic investment products," in addition to conventional mutual funds, the Deutsche Bank (Appendix ***), one of the world's leading financial service providers, announced that "DWS Investments, Deutsche Bank's mutual fund business unit, introduced... [five mutual funds], which will not invest in alcohol, gambling or companies with large amounts of debt."

2.5: Techniques Hedge Funds Utilise in Investing

Hedge funds utilize 14 distinct investment strategies/techniques, with each presenting various degrees of risk and return. A hedge fund trader needs to know and understand characteristics of the various hedge fund strategies to capitalize on their diverse investment opportunities. "A macro hedge fund, for example, invests in stock and bond markets and other investment opportunities, such as currencies, in hopes of profiting on significant shifts in such things as global interest rates and countries' economic policies." The following table (***) reflects numerous hedge funds styles and denotes a number of differences.

Table (***): Types of Hedge Funds (copied/adapted)

Aggressive Growth: Invests in equities expected to experience acceleration in growth of earnings per share. Generally high P/E ratios, low or no dividends; often smaller and micro cap stocks which are expected to experience rapid growth. Includes sector specialist funds such as technology, banking, or biotechnology. Hedges by shorting equities where earnings disappointment is expected or by shorting stock indexes. Tends to be "long-biased." Expected Volatility: High

Distressed Securities: Buys equity, debt, or trade claims at deep discounts of companies in or facing bankruptcy or reorganization. Profits from the market's lack of understanding of the true value of the deeply discounted securities and because the majority of institutional investors cannot own below investment grade securities. (This selling pressure creates the deep discount.) Results generally not dependent on the direction of the markets. Expected Volatility: Low - Moderate

Emerging Markets: Invests in equity or debt of emerging (less mature) markets that tend to have higher inflation and volatile growth. Short selling is not permitted in many emerging markets, and, therefore, effective hedging is often not available, although Brady debt can be partially hedged via U.S. Treasury futures and currency markets. Expected Volatility: Very High

Funds of Hedge Funds: Mix and match hedge funds and other pooled investment vehicles. This blending of different strategies and asset classes aims to provide a more stable long-term investment return than any of the individual funds. Returns, risk, and volatility can be controlled by the mix of underlying strategies and funds. Capital preservation is generally an important consideration. Volatility depends on the mix and ratio of strategies employed. Expected Volatility: Low - Moderate - High

Income: Invests with primary focus on yield or current income rather than solely on capital gains. May utilize leverage to buy bonds and sometimes fixed income derivatives in order to profit from principal appreciation and interest income. Expected Volatility: Low

Macro: Aims to profit from changes in global economies, typically brought about by shifts in government policy that impact interest rates, in turn affecting currency, stock, and bond markets. Participates in all major markets -- equities, bonds, currencies and commodities -- though not always at the same time. Uses leverage and derivatives to accentuate the impact of market moves. Utilizes hedging, but the leveraged directional investments tend to make the largest impact on performance. Expected Volatility: Very High

Market Neutral - Arbitrage: Attempts to hedge out most market risk by taking offsetting positions, often in different securities of the same issuer. For example, can be long convertible bonds and short the underlying issuers equity. May also use futures to hedge out interest rate risk. Focuses on obtaining returns with low or no correlation to both the equity and bond markets. These relative value strategies include fixed income arbitrage, mortgage backed securities, capital structure arbitrage, and closed-end fund arbitrage. Expected Volatility: Low

Market Neutral - Securities Hedging: Invests equally in long and short equity portfolios generally in the same sectors of the market. Market risk is greatly reduced, but effective stock analysis and stock picking is essential to obtaining meaningful results. Leverage may be used to enhance returns. Usually low or no correlation to the market. Sometimes uses market index futures to hedge out systematic (market) risk. Relative benchmark index usually T-bills. Expected Volatility: Low

Market Timing: Allocates assets among different asset classes depending on the manager's view of the economic or market outlook. Portfolio emphasis may swing widely between asset classes. Unpredictability of market movements and the difficulty of timing entry and exit from markets add to the volatility of this strategy. Expected Volatility: High

Opportunistic: Investment theme changes from strategy to strategy as opportunities arise to profit from events such as IPOs, sudden price changes often caused by an interim earnings disappointment, hostile bids, and other event-driven opportunities. May utilize several of these investing styles at a given time and is not restricted to any particular investment approach or asset class. Expected Volatility: Variable

Multi-Strategy: Investment approach is diversified by employing various strategies simultaneously to realize short- and long-term gains. Other strategies may include systems trading such as trend following and various diversified technical strategies. This style of investing allows the manager to overweight or underweight different strategies to best capitalize on current investment opportunities. Expected Volatility: Variable

Short Selling: Sells securities short in anticipation of being able to rebuy them at a future date at a lower price due to the manager's assessment of the overvaluation of the securities, or the market, or in anticipation of earnings disappointments often due to accounting irregularities, new competition, change of management, etc. Often used as a hedge to offset long-only portfolios and by those who feel the market is approaching a bearish cycle. High risk. Expected Volatility: Very High

Special Situations: Invests in event-driven situations such as mergers, hostile takeovers, reorganizations, or leveraged buyouts. May involve simultaneous purchase of stock in companies being acquired, and the sale of stock in its acquirer, hoping to profit from the spread between the current market price and the ultimate purchase price of the company. May also utilize derivatives to leverage returns and to hedge out interest rate and/or market risk. Results generally not dependent on direction of market. Expected Volatility: Moderate

Value: Invests in securities perceived to be selling at deep discounts to their intrinsic or potential worth. Such securities may be out of favor or underfollowed by analysts. Long-term holding, patience, and strong discipline are often required until the ultimate value is recognized by the market. Expected Volatility: Low - Moderate

Aggressive Growth: Invests in equities expected to experience acceleration in growth of earnings per share. Generally high P/E ratios, low or no dividends; often smaller and micro cap stocks which are expected to experience rapid growth. Includes sector specialist funds such as technology, banking, or biotechnology. Hedges by shorting equities where earnings disappointment is expected or by shorting stock indexes. Tends to be "long-biased." Expected Volatility: High

Distressed Securities: Buys equity, debt, or trade claims at deep discounts of companies in or facing bankruptcy or reorganization. Profits from the market's lack of understanding of the true value of the deeply discounted securities and because the majority of institutional investors cannot own below investment grade securities. (This selling pressure creates the deep discount.) Results generally not dependent on the direction of the markets. Expected Volatility: Low - Moderate

Emerging Markets: Invests in equity or debt of emerging (less mature) markets that tend to have higher inflation and volatile growth. Short selling is not permitted in many emerging markets, and, therefore, effective hedging is often not available, although Brady debt can be partially hedged via U.S. Treasury futures and currency markets. Expected Volatility: Very High

Funds of Hedge Funds: Mix and match hedge funds and other pooled investment vehicles. This blending of different strategies and asset classes aims to provide a more stable long-term investment return than any of the individual funds. Returns, risk, and volatility can be controlled by the mix of underlying strategies and funds. Capital preservation is generally an important consideration. Volatility depends on the mix and ratio of strategies employed. Expected Volatility: Low - Moderate - High

Income: Invests with primary focus on yield or current income rather than solely on capital gains. May utilize leverage to buy bonds and sometimes fixed income derivatives in order to profit from principal appreciation and interest income. Expected Volatility: Low

Macro: Aims to profit from changes in global economies, typically brought about by shifts in government policy that impact interest rates, in turn affecting currency, stock, and bond markets. Participates in all major markets -- equities, bonds, currencies and commodities -- though not always at the same time. Uses leverage and derivatives to accentuate the impact of market moves. Utilizes hedging, but the leveraged directional investments tend to make the largest impact on performance. Expected Volatility: Very High

Market Neutral - Arbitrage: Attempts to hedge out most market risk by taking offsetting positions, often in different securities of the same issuer. For example, can be long convertible bonds and short the underlying issuers equity. May also use futures to hedge out interest rate risk. Focuses on obtaining returns with low or no correlation to both the equity and bond markets. These relative value strategies include fixed income arbitrage, mortgage backed securities, capital structure arbitrage, and closed-end fund arbitrage. Expected Volatility: Low

Market Neutral - Securities Hedging: Invests equally in long and short equity portfolios generally in the same sectors of the market. Market risk is greatly reduced, but effective stock analysis and stock picking is essential to obtaining meaningful results. Leverage may be used to enhance returns. Usually low or no correlation to the market. Sometimes uses market index futures to hedge out systematic (market) risk. Relative benchmark index usually T-bills. Expected Volatility: Low

Market Timing: Allocates assets among different asset classes depending on the manager's view of the economic or market outlook. Portfolio emphasis may swing widely between asset classes. Unpredictability of market movements and the difficulty of timing entry and exit from markets add to the volatility of this strategy. Expected Volatility: High

Opportunistic: Investment theme changes from strategy to strategy as opportunities arise to profit from events such as IPOs, sudden price changes often caused by an interim earnings disappointment, hostile bids, and other event-driven opportunities. May utilize several of these investing styles at a given time and is not restricted to any particular investment approach or asset class. Expected Volatility: Variable

Multi-Strategy: Investment approach is diversified by employing various strategies simultaneously to realize short- and long-term gains. Other strategies may include systems trading such as trend following and various diversified technical strategies. This style of investing allows the manager to overweight or underweight different strategies to best capitalize on current investment opportunities. Expected Volatility: Variable

Short Selling: Sells securities short in anticipation of being able to rebuy them at a future date at a lower price due to the manager's assessment of the overvaluation of the securities, or the market, or in anticipation of earnings disappointments often due to accounting irregularities, new competition, change of management, etc. Often used as a hedge to offset long-only portfolios and by those who feel the market is approaching a bearish cycle. High risk. Expected Volatility: Very High

Special Situations: Invests in event-driven situations such as mergers, hostile takeovers, reorganizations, or leveraged buyouts. May involve simultaneous purchase of stock in companies being acquired, and the sale of stock in its acquirer, hoping to profit from the spread between the current market price and the ultimate purchase price of the company. May also utilize derivatives to leverage returns and to hedge out interest rate and/or market risk. Results generally not dependent on direction of market. Expected Volatility: Moderate

Value: Invests in securities perceived to be selling at deep discounts to their intrinsic or potential worth. Such securities may be out of favor or underfollowed by analysts. Long-term holding, patience, and strong discipline are often required until the ultimate value is recognized by the market. Expected Volatility: Low - Moderate

Predictability of future results, as the previous table (***) depicts, "shows a strong correlation with the volatility of each [Hedge Fund] strategy. Future performance of strategies with high volatility is far less predictable than future performance from strategies experiencing low or moderate volatility."

As the minimum typical investment of $250,000 for hedge funds may be more than some investors could or may want to invest, Schlosser contends that the following, frequently overlooked, hedge funds techniques, may prove profitable, while providing protection for an investor's portfolio, in other types of investment ventures:

PROTECTIVE PUTS: This strategy permits investors to profit on a stock falling in value. The investor sells stocks borrowed from a broker and then waits for the stock price of the stock to fall before he/she buys it back, or "covers" the purchase at a lower price and retains profits. The investor risks, however, that the stock's price may go up and continue to rise.

The majority of investors basically hope to protect themselves (rather than profit outright) when a stock declines. A simple hedge: "Buy a put option," involves "a put," the right for an investor to sell his/her stock at a specified price prior to a pre-destined date, a form of insurance. If an investor owns the same 500 shares of Microsoft that he/she purchased during 1988, and he/she hears that Bill Gates just sold two million of his shares, this would most likely be considered either a bad sign -- or more money for Gates' Foundation. Either reason, the investor decides, he/she wants to wait a few months before cashing cash out. With the shares trading at $50, an investor purchases buy put options on the stock with a "strike price" of, for instance, $45 expiring the third Friday in January 2003. Despite this option being a bit costly, it affords some peace of mind, as no matter how low the Microsoft shares goes during the next four months, the investor retains the right to sell his/her shares at $45.

COVERED CALL: Another different options strategy an investor may utilize to pocket money in a sideways market is to try a covered call. Again, using the example of 500 shares of Microsoft at $50, if the investor does not expect a big run-up in the immediate future, he/she "could enter into a call option contract for October, selling to a speculative buyer" (securing one through a broker) the right to purchase his/her shares for $55, no matter how high or low the market price reaches prior to the contracts' expiration date. In this particular covered call scenario, the buyer would pay the seller a $1.30 per share fee; allotting the seller $650 profit, minus a small transaction fee. If the stock does not move or falls, the seller will likely keep his/her shares. The worst-case scenario in this case would be that the stock would rise to $85, for example, and the seller would have to sell his/her shares for $55.

COLLAR: When puts and calls are combined, they offer potentially cost-free protection against the downside on a stock; a technique known as a collar. In this simple principle, the stock owner sells the call to pay for the put. Again, utilising the Microsoft stock example, he/she could sell call options for January with a price of $55 for $3.50 and then he/she could consequently use the $3.50 per share earnings to purchase January put options at $45.

LIMIT ORDER: If an investor does not own Microsoft, but decides for $50 a share, he would like to own this stock. he/she also determines, however, that costs more than a several dollars over $50 would be considered expensive. An investor may request a limit order (includes a slightly more expensive commission than a regular market buy or sell order), giving his/her broker a definite price for executing the trade. This option counters the possibility the investor would pay much more than he/she expected, if Merrill Lynch upgraded Microsoft and sent stock prices zooming upwards before the investor's broker completed the anticipated Microsoft purchase.

STOP-LOSS/TRAILING STOP: A simple, inexpensive ways an investor may backstop his/her holdings and complete his/her routine chores is to, a Martha Stewart purportedly did: utilize a stop-loss order. A stop-loss order, an instruction to a person's broker, instructs the broker to sell your stock when a stock reaches a particular price. Many investors reportedly fail to employ this one vital elementary investing technique. When an investor sets a stop-loss for example, of 20% below what he/she paid for the security, this can save him/her the pain of massive one-day selloffs. This practice, which provides protection for a negligible fee, also offers discipline when an investor becomes too attached to a particular stock.

A variation on the stop-loss, the trailing stop, can shield an investor from losing out on hefty upward moves even when he/she caps the downside of his/her stock. Instead of locking in his/her sell order when the shares recede from the owner's purchase price, the trailing-stop target rises when stock climbs. When the stock rises 15% after an investor places an order and then plummets, an investor receives the additional upside before he/she sells his/her stock.

Data Issues: Academic research on hedge funds primarily focused on five alternative commercial databases: "the U.S. Offshore Funds Directory, Managed Account Reports (MAR), the Hedge Fund Research (HFR) database, TASS and CSFB/Tremont."

One primary features these databases have in common with available pension funds' databases: funds self-report (voluntary basis) to a data vendor, which consequently may create numerous potential biases, including survivorship, back-filling, and smoothing biases.

Survivorship Bias: When funds perform poorly and are liquidated, they may "disappear" from a database. In turn, when these "dead" funds are removed from the database, a form of survivorship bias in the reported returns develops. The average returns of the surviving funds, for example, "overstates the expected returns to fund investors." When funds close to new investors, they, consequently, do not continue to value the "advertising" this reporting implies and may elect choose to no longer report to a database When successful funds "die" due to closing to new investors with a success record, the common bias, however, takes the opposite course. Hedge fund data providers like HFR have retained data for dead funds for approximately the past 25 years, which permits survivorship biases estimates.

Backfilling: If the database contains returns that precede a fund's entry into the database, backfilling transpires. Due to fund incubation period, backfilled returns may add an upward bias in the estimated performance level, contributing to a manager of numerous funds determining to continue only those funds reporting above average performance histories. Evans (2003) notes mutual funds, as well as pension funds and hedge funds similarly, that enter the database this way are "incubated" before open to the public. When funds advertise by entering the database solely when they merit positive records, the initial reported returns are biased upwards. Because the databases frequently did not offer dates funds were added to the database, estimates of backfilling prove to be limited, however, Park (1995) identified hedge funds, with their prior history, added to databases.

Smoothing: As investors voluntarily report returns in hedge fund databases, the primarily unregulated funds possess some flexibility in their reports. In particular, illiquid assets "raise the issue of smoothing in the reported returns. While mutual funds are restricted to hold no more than 5% of their portfolio in illiquid assets, hedge funds face no such restrictions." At the discretion of the fund, illiquid assets may be carried at historical cost for a period of time, even if the true market value changes. In turn, this produces the prospect to even out reported returns; consequently presenting the notion of lower return volatility. In addition, smoothing generates biases in hedge funds systematic risk measures. (Asness et al., 2001). According to Getmansky et al. (2004), hedge fund assets' infrequent valuation can stimulate autocorrelation, in the shape of moving standard components, into hedge fund returns.

Dynamic Risk Exposures: For hedge funds, dynamic trading strategies and risk exposures prove particularly relevant.

In one of the most prominent studies of the hedge funds' dynamic strategies, Fung and Hsieh (1997) conduct a style analysis utilising monthly returns of mutual funds and hedge funds. When Fung and Hsieh (1997) calculated the approximate extent fund return variation could be explained by traditional benchmarks (i.e. buy-and-hold returns from equities, bonds, commodities, and currencies), they discovered a conspicuous disparity "in the distribution of [R.sup.2] between the two sample[s] of funds. Specifically, 47% of mutual funds have [R.sup.2]'s above 75%, and 92% have [R.sup.2]'s above 50%. In contrast, nearly half (48%) of the hedge fund [R.sup.2]'s are below 25%."

In addition, Fung and Hsieh (1997) explain, a substantial fraction (25%) of hedge funds, contrary to mutual funds, have negative exposure to the benchmarks. According to Fung and Hsieh (1997), within an asset class, hedge funds may display a number of various trading activities and consequently reflect different returns than mutual funds, noted in the previous paragraph's figures. Five mutually orthogonal principal components, Fung and Hsieh find, can elucidate, on average, 43% of the return variance in a sample of hedge funds. Returns on these factors, albeit, relate to traditional benchmarks in a nonlinear way.

The dearth of/in of reporting, along with, opaqueness constitutes long-term criticisms of hedge funds and funds of hedge funds. Currently, albeit, investors more readily access and monitor hedge fund performance in more transparent ways, as investors may more readily access and monitor hedge fund performance. Because listed hedge funds constitute public companies, they must comply with the exchange's requirements for reporting information. Unlike past practices with rare transparency, the majority of listed funds of hedge funds now offer access "to their whole portfolio on a monthly or quarterly basis, publish weekly performance estimates and have investor conference calls to explain their performance and outlook."

TradeStation

TradeStation, an electronic trading platform, permits clients to design, test and monitor their personal custom trading strategies and then automate these techniques with direct-access order execution. In March 2003, Barron's magazine named TradeStation "Best Broker for Active Trading" and rated a first-time perfect 5.0 score for order execution. In February 2004 and 2003, Technical Analysis of Stocks and Commodities magazine noted TreadeStation as "Best Direct-Access Stock Broker, Best Direct-Access Futures Broker," "Best Professional Platform," and "Best Institutional Platform."

In 2004, PR Newswire reports that, for the second consecutive year, Technical Analysis of Stocks and Commodities (periodicals for active traders), awarded TradeStation "the Readers' Choice Awards for best Direct- Access Stock Brokerage," "best Direct-Access Futures Brokerage," "best Institutional Platform," and "best Professional Platform."

The following figure (***) portrays a sample screen in one of TradeStation's programs.

Figure (***): TradeStation Report

Figure (***), which follows, presents another example from TradeStation.

Figure (***): TradeStation Report

2.6: Ways Rising and Falling Markets Impact Hedge Funds

." Although hedge funds, as this study's introduction notes, purport they possess the potential to make a profit even when "stock, bond, commodity, and currency prices fell,"

"...even the most promising hedge fund can fail."

"Hedge Fund Is Latest Victim of Credit Crunch,"

the August 20, 2007 headline of the Evening Standard (London, England) article, for example, portrays one way falling markets may impact hedge funds. The article reported: "A London hedge fund was today forced to issue a profits warning as it became the latest victim of the global credit crunch

2.7: Analysis

As the Evening Standard (August 20, 2007) headline purports, "Hedge Fund Is Latest Victim of Credit Crunch."

Despite the contention noted earlier in this thesis/Capstone, hedge funds "could make money [even] if stock, bond, commodity, and currency prices fell," however, as newspaper headlines repeatedly remind investors: "...even the most promising hedge fund can fail."

George Soros and James Simons

When hedge funds initially appeared during the 1970s, as their name indicates, they committed to - hedging. "They would be both long and short securities or currencies at the same time, hoping to benefit from a spread between the positions, which would eventually narrow."

In time, albeit, a number of hedge funds started to drift from the original concept, yet as they usually traded in large volume, the traders continued to earn substantial profits for investors. After he took a short position against the British pound when Britain abandoned the common European currency peg in the early 1990s, techniques and currency funds utilized by, George Soros became particularly well-known. During this period, hedge funds "gained a reputation for presenting the well-heeled with above-average market gains in a market already known for above-average gains."

In 2005, James Simons, founder of hedge fund Renaissance Technologies, surpassed his competitors in the hedge-fund world last year, clearing $1.7bn ([pound]850m). Simons, also a mathematician, credits his success to the highly complex statistical models which constitute the trading base for his $25bn fund is based.

Technical Analysis and Chart Reading

Need additional info

Japanese Candlesticks

Although candlesticks may provide helpful pointers for short-term direction, Vizhon Corporation and associates stress that "trading on the strength of candlestick signals alone is not advisable." They note that in Technical Analysis, Jack Schwager performed comparatively extensive tests with candlesticks over a number of markets and found results disappointing. The following two figures (***) portray examples of candlesticks, the Japanese have utilized since the 17th century to analyze rice prices. Steve Nison introduced Candlesticks into contemporary technical analysis in his book, Japanese Candlestick Charting Techniques.

Figure (***): Candlestick Report

Candlesticks

Candlesticks present data identical to a normal bar chart, however, spotlight the relationship between opening and closing prices. The narrow stick depicts the range of prices traded during the high to low period. The broad mid-section relates the period's opening and closing prices.

If the close is higher than the open - the candlestick mid-section is hollow or shaded blue/green.

If the open is higher than the close - the candlestick mid-section is filled in or shaded red.

Figure (***): TradeStation Report

One reported advantage of candlesticks "is the ability to highlight trend weakness and reversal signals that may not be apparent on a normal bar chart."

(Appendix ***)

The next figure (***) notes various hedge funds strategies and recounts volatility noted earlier in this thesis/Capstone.

Figure ***: Hedge Fund Strategies (adapted)

CHAPTER III

DISCUSSION, CONCLUSION, and RECOMMENDATIONS

"Success is somebody else's failure."

- Ursula K. Le Guin (b. 1929), U.S. author

3.1: Introduction

For one individual to succeed, another person has to lose, the idea Guin purports in this final chapter's introductory quote, this researcher contends, does not necessarily constitute the absolute truth, or the result of scientific research. In a similar sense, this researcher purports, when some of the contentions about hedge funds presented in this thesis/Capstone succeed or prove true, ones contradicting the true contentions may not necessarily fail, or always prove false.

Sometimes they may

Sometimes they may not.

Sometimes, however, this researcher purports, research "earned" from efforts invested in this thesis/Capstone indicates that techniques that may prove to succeed for hedge funds in one scenario, may subsequently fail in another, and vice versa.

More info here

3.2: Discussion

Answers to the research questions contributing to confirming this study's thesis statement include:

Hedge funds

Hedge funds compare to mutual funds?

Hedge funds are managed

Rising and falling markets impact hedge funds by:

One:

Two:

Three:

3.3: Conclusion/s

In this segment, this researcher recounts the original research aim/research questions this thesis/Capstone purports, and provides contentions regarding the contemporary, controversial challenging concepts connected to hedge funds techniques.

Recount of Aim and Objectives

Aim

During the course of this thesis/Capstone, as noted in its introduction, this researcher proposed to fulfill the aim of confirming the validity of this study's thesis statement, purporting that regardless of whether promising hedge funds fail or succeed, investors utilising hedge fund management techniques, in fact, may "profit" from both rising and falling markets. Research does in fact validate this contention, this researcher alleges, as evidenced by:

ADD NUMBER of Substantiating points in this section

Point

Point

Point

At the start of this thesis/Capstone, this researcher proposed to analyze hedge funds techniques. In addition to accomplishing this proposed goal, this study met the original Aim proposed for this thesis/Capstone. This researcher contends that efforts invested into meeting each of the four objectives initially proposed for this study proved profitable.

Objective 1:

Research defines hedge funds and relates numerous historical and contemporary facts about techniques traders utilze.

Objective 2:

This study compares hedge funds to mutual funds.

Objective 3:

This thesis/Capstone present numerous techniques hedge funds utilise.

Objective 4:

This study presents information denoting ways rising and falling markets impact hedge funds.

Ultimately, this researchers asserts that this thesis/Capstone, which analyzes techniques hedge funds utilise, confirms the thesis that despite the fact promising hedge funds may fail, investors utilising hedge fund management techniques, in fact, may "profit" from both rising and falling markets.

3.4: Recommendations

Along with recommendations for future study, this researcher recounts considerations (in hindsight) of that may have enhanced this thesis/Capstone.

Profits

Past performance of hedge forms or any other type investment does not necessarily indicate future results. Past performances, albeit, by traders or individuals investing in other life ventures, do frequently prove to reveal a hint of what may come, as well as, reflect one's current credibility. Many hedges funds today no longer contend with former long-term criticisms regarding their opaqueness and lack of reporting. Today, however, as investors are in a position to access and monitor hedge fund performance in a much more transparent way, perhaps hedge funds need to be even more open. In turn, perhaps hedge funds, as well as, investors will continue to mutually "profit" from rising and falling markets.

GLOSSARY

Mutual Funds: Investment companies mandated to register with the U.S. Securities and Exchange Commission (SEC) and, consequently, become subject to meticulous regulatory oversight. "Virtually every aspect of a mutual fund's structure and operation is subject to strict regulation under four federal laws:

1. The Securities Act of 1933,

2. The Securities Exchange Act of 1934,

3. The Investment Company Act of 1940 and

4. The Investment Advisers Act.

The Securities Act of 1933, (SEC):

…oversees the mutual fund industry's compliance with specific regulations, including, the Internal Revenue Code which set additional requirements regarding a fund's portfolio diversification and its distribution of earnings, and the National Association of Securities Dealers, Inc. (NASD) oversees most mutual fund advertisements and other sales materials. In addition, mutual funds must have directors who are responsible for extensive oversight of the fund's policies and procedures. For virtually all funds, at least a majority of their directors must be independent from the fund's management.