Accounting

This example does not include other assets that might appear on a
hedge fund balance sheet. These assets are likely not large, compared to the
assets described. If the fund buys bonds, part of the value of the position
will appear as accrued interest. The fund may also have margin on deposit
at futures brokers. The fund may invest the excess cash balances in money
market instruments. The fund may also have receivables reflecting divi-
dends declared but not paid or funds deposited by partners awaiting in-
vestment. The fund may also carry past expenditures (professional fees, for
example) as assets to delay recognizing the expense.
Liabilities
If a hedge fund carries short positions, those positions show up
as liabilities. It may seem counterintuitive to classify a short as a liability
instead of a negative asset, but accountants go to great lengths to avoid
showing negative values in any account. In fact, a short sale of a bond
looks very much like a loan, which is clearly a liability. In both cases, the
lender gives the fund a loan balance (also described as the proceeds of the
short sale). In both cases, the hedge fund makes periodic interest payments
to the other party. Finally, the loan repayment of principal corresponds
with buying back the bond.
A short sale of a stock doesn't correspond with a conventional liability
but represents a liability all the same. Because the short represents a future
obligation to pay out cash (buy back the position), it is carried as a liability
even though common stock would clearly be considered an asset out of the
context of levered trading.
The short sale of $70 million worth of stock in the previous example
would appear as a liability on the books of the hedge fund. The fund could
also create leverage by borrowing against the long position. Suppose, to
extend the example, the hedge fund pledges $80 million worth of stock
and borrows $50 million. The $50 million would show up as a higher cash
balance and also as a short-term liability because the loan balance would
need to be repaid at the end of the financing term.
In this example, the hedge fund would no longer possess the $80 in
common stock because it is delivered to the lending counterparty. How-
ever, the lender only holds the collateral (stock) to assure repayment of the
loan and must return the shares to the hedge fund when the loan is repaid.
In other words, the hedge fund still owns the stock even though it is being
held by the lender. As a result, the lending trade does not reduce the size of
the long-term assets. Similarly, the fund continues to show a short position
of $70 million in the second issue after making delivery on the sale because
the financing trades do not affect the number of shares the fund must buy
in the future.
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