In fact, many factors affect the riskiness of hedge funds, the return to
particular funds, and the popularity of an investment style. Certain strate-
gies such as convertible bond arbitrage remain attractive, despite existing
for decades. The early demise of many new hedge funds can be explained
by weaknesses in investment strategy, failure to establish systems and oper-
ating procedures, or simply bad timing for a fund of a particular style or
strategy.
QUESTIONS AND PROBLEMS
1.1
List three reasons to invest in hedge funds.
1.2
Why are press reports describing disasters with hedge fund invest-
ments not a valid reason to avoid investing in the products?
1.3
What is the difference between absolute return strategies and relative
return strategies?
1.4 Is it generally true that low correlation is better than high correla-
tion?
1.5
The growth in hedge fund assets under management has been much
more rapid than the growth in the number of hedge funds. How is
this possible?
1.6
Are any of these fees and/or design structures incompatible and never
be used together in the same fund: management fee, incentive fee,
hurdle rate, surrender fee, high-water mark, look-back, commission,
and ticket charge?
1.7
It is typical in a private equity fund to levy no incentive fee until an
investment is liquidated. Explain why this practice differs from the
pattern in hedge funds, where an incentive fee is levied on mark-to-
market gains in the fund.
1.8
Distinguish a commodity pool or futures fund from a hedge fund.
1.9
You run a hedge fund with $100 million under management. You
charge a management fee of 2.25 percent. What is the management
fee assessed on the entire fund for the month of February 2004?
1.10 Assume the hedge fund in question 1.9 earned 4.5 percent (gross re-
turn before fees). What incentive fee would the management com-
pany earn if the fund paid an incentive fee of 15 percent?
1.11 What is the incentive fee, assuming the same facts from question 1.9
but incorporating a hurdle rate of 5 percent?
1.12 Assume the same facts from question 1.9 but a high-water mark pro-
vision. In addition, the hedge fund lost 7 percent in January 2004.
What is the incentive fee for February 2004?
Introduction
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