HEDGE FUND RISK AND OTHER DISCLOSURES

Hedge funds, including fund of funds (“Hedge Funds”), are unregistered private investment partnerships, funds or pools that may invest and trade in many different markets, strategies and instruments (including securities, non-securities and derivatives) and are NOT subject to the same regulatory requirements as mutual funds, including mutual fund requirements to provide certain periodic and standardized pricing and valuation information to investors. There are substantial risks in investing in Hedge Funds. Persons interested in investing in Hedge Funds should carefully note the following:

  • Hedge Funds represent speculative investments and involve a high degree of risk. An investor could lose all or a substantial portion of his/her investment. Investors must have the financial ability, sophistication/experience and willingness to bear the risks of an investment in a Hedge Fund.

  • An investment in a Hedge Fund should be discretionary capital set aside strictly for speculative purposes.

  • An investment in a Hedge Fund is not suitable or desirable for all investors. Only qualified eligible investors may invest in Hedge Funds.

  • Hedge Fund offering documents are not reviewed or approved by federal or state regulators

  • Hedge Funds may be leveraged (including highly leveraged) and a Hedge Fund’s performance may be volatile

  • An investment in a Hedge Fund may be illiquid and there may be significant restrictions on transferring interests in a Hedge Fund. There is no secondary market for an investor’s investment in a Hedge Fund and none is expected to develop.

  • A Hedge Fund may have little or no operating history or performance and may use hypothetical or pro forma performance which may not reflect actual trading done by the manager or advisor and should be reviewed carefully. Investors should not place undue reliance on hypothetical or pro forma performance.

  • A Hedge Fund’s manager or advisor has total trading authority over the Hedge Fund.

  • A Hedge Fund may use a single advisor or employ a single strategy, which could mean a lack of diversification and higher risk.

  • A Hedge Fund (for example, a fund of funds) and its managers or advisors may rely on the trading expertise and experience of third-party managers or advisors, the identity of which may not be disclosed to investors

  • A Hedge Fund may involve a complex tax structure, which should be reviewed carefully.

  • A Hedge Fund may involve structures or strategies that may cause delays in important tax information being sent to investors.

  • A Hedge Fund may provide no transparency regarding its underlying investments (including sub-funds in a fund of funds structure) to investors. If this is the case, there will be no way for an investor to monitor the specific investments made by the Hedge Fund or, in a fund of funds structure, to know whether the sub-fund investments are consistent with the Hedge Fund’s investment strategy or risk levels.

  • A Hedge Fund may execute a substantial portion of trades on foreign exchanges or over-the-counter markets, which could mean higher risk.

  • A Hedge Fund’s fees and expenses-which may be substantial regardless of any positive return- will offset the Hedge Fund’s trading profits. In a fund of funds or similar structure, fees are generally charged at the fund as well as the sub-fund levels; therefore fees charged investors will be higher than those charged if the investor invested directly in the sub-fund(s).

  • Hedge Funds are not required to provide periodic pricing or valuation information to investors.

  • Hedge Funds and their managers/advisors may be subject to various conflicts of interest.

The above general summary is not a complete list of the risks and other important disclosures involved in investing in Hedge Funds and, with respect to any particular Hedge Fund, is subject to the more complete and specific disclosures contained in such Hedge Fund’s respective offering documents. Before making any investment, an investor should thoroughly review a Hedge Fund’s offering documents with the investor’s financial, legal and tax advisor to determine whether an investment in the Hedge Fund is suitable for the investor in light of the investor’s investment objectives, financial circumstances and tax situation.

All performance information is believed to be net of applicable fees unless otherwise specifically noted. No representation is made that any fund will or is likely to achieve its objectives or that any investor will or is likely to achieve results comparable to those shown or will make any profit at all or will be able to avoid incurring substantial losses. Past performance is not necessarily indicative, and is no guarantee, of future results.

The information on the Site is intended for informational, educational and research purposes only. Nothing on this Site is intended to be, nor should it be construed or used as, financial, legal, tax or investment advice, be an opinion of the appropriateness or suitability of an investment, or intended to be an offer, or the solicitation of any offer, to buy or sell any security or an endorsement or inducement to invest with any fund or fund manager. No such offer or solicitation may be made prior to the delivery of appropriate offering documents to qualified investors. Before making any investment, you should thoroughly review the particular fund’s confidential offering documents with your financial, legal and tax advisor and conduct such due diligence as you (and they) deem appropriate. We do not provide investment advice and no information or material on the Site is to be relied upon for the purpose of making investment or other decisions. Accordingly, we assume no responsibility or liability for any investment decisions or advice, treatment, or services rendered by any investor or any person or entity mentioned, featured on or linked to the Site.

The information on this Site is as of the date(s) indicated, is not a complete description of any fund, and is subject to the more complete disclosures and terms and conditions contained in a particular fund's offering documents, which may be obtained directly from the fund. Certain of the information, including investment returns, valuations, fund targets and strategies, has been supplied by the funds or their agents, and other third parties, and although believed to be reliable, has not been independently verified and its completeness and accuracy cannot be guaranteed. No warranty, express or implied, representation or guarantee is made as to the accuracy, validity, timeliness, completeness or suitability of this information.

Any indices and other financial benchmarks shown are provided for illustrative purposes only, are unmanaged, reflect reinvestment of income and dividends and do not reflect the impact of advisory fees. Investors cannot invest directly in an index. Comparisons to indexes have limitations because indexes have volatility and other material characteristics that may differ from a particular hedge fund. For example, a hedge fund may typically hold substantially fewer securities than are contained in an index. Indices also may contain securities or types of securities that are not comparable to those traded by a hedge fund. Therefore, a hedge fund’s performance may differ substantially from the performance of an index. Because of these differences, indexes should not be relied upon as an accurate measure of comparison.

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The Hedge Fund: Consistency and Prevailing Return Indices

The Hedge Fund Allocator’s Boxing Match Dilemma     

 

In this corner, we have the undisputed champion of Outlier Risk ” Low Vol” Fund and how the implicit risk is often not implicit in the track record

vs.

And In this corner, we have the undisputed champion of High Vol Funds where the implicit risk is often more apparent in the track record.

 

Investors in hedge funds in contrast to mutual funds, tend to place more emphasis on track records at least on a shorter-term basis. Hedge fund investors tend to examine monthly returns and drawdowns and mutual fund investors tend to examine quarterly or annual returns and or adopt the throw away the key mentality.

 

However, investors learned or should have learned in 2008 that relying and particularly over-relying on the extrapolation of risks with certain strategies – particularly “ low vol” / “ low risk” strategies - from monthly returns can be costly. A number of strategies produce smooth attractive returns with little or modest volatility until they don’t. Option selling strategies, for example, may produce years of consistent positive returns with no losing months. Even a simplistic unsophisticated approach can be beguiling. If for example, a trader sells many way out of the options on the S&P, invariably, the options will expire worthless and the option seller’s track record will appear seductively “low risk” with consistent returns, no losses, and low vol.  To the uninitiated and uneducated investor, this will appear as a low-risk track with excellent reliable returns.

 

The problem with this hypothetical record is that on average at least once a year from 2000 to present, there has been 20 times the S&P has risen in one day 51 to 116 points. If a trader is a massive seller of call options the day before, it is likely the trader will suffer massive losses or at least significant volatility and interim drawdowns in trying to trade out of the losses.

 

This is not a knock at against option traders or any low vol strategy. Nor is it fair to assume that all “ low vol” traders are subject to extraordinary “outlier” risk. Rather it is counsel to understand what one is investing in and to avoid over-dependence on an individual or correlated low vol strategies – particularly if you do not completely understand how the fund is trading.

 

There is a dynamic tension in the spectrum of risk.  For the purpose the discussion, the generalization is that “low vol” strategies appear to be less risk in the short term but are subject to large “outlier” due to sudden unanticipated outlier episodic events, even anticipated outlier episodic events that are poorly managed and or outright trading errors in which for example the manager does not lift the legs of a hedge concurrently at exactly the most inauspicious time.

 

I like many other investors including many of whom I count much more intelligent than myself have learned these lessons in the school of high knocks, both on an undergraduate and graduate basis. Anyone remembers, “little” known firms such as Bear Stearns and Lehman Brothers. The problem is that people forget. Past performance is not necessarily indicative of future results, is the required disclosure. The problem is that investors tend to forget the past and wipe the slate clean. I suggest the following disclosure should be added:  Hope springs eternal.

 

The problem is that the status quo including when things are going well can be almost hypnotically seductive. Right now, in the economy, things appear to be going well. Wall Street is cheering the loosening of regulations. Was the reaction to the 2008 crisis too severe and were amendments to regulations post-2008 too severe? Or are we juicing up the economy with economic steroids with historical amnesia taking over? My concern is more of the latter. Are our economic muscles bulging now but quietly eroding our economic testicles which will be apparent only too soon enough?

 

Everyone is happy now, but you cannot fool mother nature. Life humbles and the markets speed it up.

 

And are we inflicting damage on the environment that will not be costly not only on the most important personal level but which is inextricably entwined and ultimately impactful on an economic level? What are the economic costs of more cancer and illness induced or exacerbated by environmental damages to the air, land, drinking water, and oceans?  Does anyone believe that the environment is sufficiently clean? I am concerned that we are being seduced by the pied piper of consistent economic returns, but which are fraught with “What me Worry-Alfred E Neuman” outlier risk returns that will rear its ugly head again. Some have foretold the drastic economic downturns 2001-2003 and 2008 but in general the common denominator, that all was good until it wasn’t. Sound familiar?

 

Am I foretelling gloom and doom? No. Am I attacking low vol funds? Absolutely not.

The two points that I am trying to bring home is the need for balance and everything is cyclical. Caveat Emptor.

 

No intent is made to:

  1. Provide investment advice, 

  2. Recommend a specific fund or type of funds.

The purpose of this article is to explain:

  1. The purpose of the indices

  2. The reasoning behind the indices

  3. The characteristics of each index