certain stocks that have such deteriorating fundamentals that the only direc- Jun Dec Jun Dec Jun Dec Jun Dec Jun .. Gov./Corp. TABLE Correlations in Best and Worst 44 S&P Ranked did well in (+ percent) and was not too greatly affected by the. Ask. STOCKS Friday, KrbrUHry 11, Open. High. Low. Close. Chge M ; oss SS 3; n3. oi; 9 4. SO Alaska (lold . Edition of Pittsburgh Daily Post. eIBD - Download as PDF File .pdf), Text File .txt) or read online. - (%) Big Pharma finds it cheaper to send work to CROs Wells Fargo Advtg Orleans Homebldrs OHB Bldg-Rsidnt/Comml 50 c39 cJan10 50 8 10 pJan10 10 k 0 75 Close
The two greatest risks are prepayment and valuation; all securities are marked to market, but the pricing and valuation models used by the different participants may vary, and overall market liquidity has a huge impact.
Recently, a category of funds has emerged that is committed to maintaining net short as opposed to pure short exposure. The short-biased managers invest mostly in short positions in equities and equity-derivative products. To effect the short sale, the manager borrows the stock from a counter-party often its prime broker and sells it in the market.
The broker keeps proceeds from the sale as collateral. An additional margin of typically 5 percent to 50 percent must be deposited in the form of liquid securities.
The margin is adjusted daily. Leverage is created because the margin is below percent. Short-selling can be time-consuming and expensive. The manager needs very efficient stock borrowing and lending facilities. Because of this, short positions are sometimes implemented by selling forward—selling stock index futures or buying put options and put warrants on single stocks or stock indices.
It is generally accepted that the short side of the market can be much less efficient than the long side of the market. Restrictions on short-selling vary from jurisdiction to jurisdiction. Europe does not have an uptick rule; in many emerging markets, short-selling is simply not possible. Derivatives can be used to get around some of these issues, particularly in the United States. Dedicated short bias represents 0. Emerging Markets This strategy involves equity or fixed-income investing, focusing on emerging markets around the world.
Certain commentators regard emerging market hedge funds as a contradiction in terms. Many of the emerging markets do not allow short-selling, nor do they offer viable futures or other derivative products with which to hedge.
Emerging markets represents 3 percent of all assets under management. Why Hedge Funds Make Money 25 Managed Futures The managed futures trading managers, otherwise called commodity trading advisers CTAs , trade in the listed financial and commodity futures markets around the world. They may also trade in the global currency markets. Most traders apply their individual disciplines to the markets using a systematic approach although a small percentage use a discretionary approach.
The systematic approach tends to use price and market-specific information in determining investment decisions. The discretionary approach tends to use price and market information as well as broader economic and political fundamentals in determining the investment decisions. Managed futures represents 3 percent of all assets under management. The majority of funds of funds invest in multiple hedge funds five to with different investment styles.
The objective is to smooth out the potential inconsistency of the returns from having all of the assets invested in a single hedge fund. Funds of funds can offer an effective way for an investor to gain exposure to a range of hedge funds and strategies without having to commit substantial assets or resources to the specific asset allocation, portfolio construction, and individual hedge fund selection.
A growing number of style or category-specific funds of funds have been launched during the last few years—for example, funds of funds that invest only in event-driven managers or funds of funds that invest only in equity market-neutral-style managers. Although the preponderance of evidence suggests hedge funds over time offer equity-like returns with lower risk profiles, few studies consider the sources of the returns.
Although the hedge fund structure is relatively new, the investment activities conducted within them are not. These investment activities typically center on market-making and proprietary trading. Historically, large financial institutions were the only organizations with the capital, infrastructure, and access to conduct the trading and investment activity now common to hedge funds. Senior positions on proprietary trading desks represented the top of the career ladder for professional traders.
With the advent of hedge funds, another rung was added to this ladder. Traders who could establish a history of profitability and proven expertise could now ply their craft with investor assets, potentially earning both higher incomes and the opportunity to control their professional destinies.
Over the last decade, two trends have developed. The hedge fund structure is drawing top-flight talent off the trading desks at an accelerating pace. In broad terms, the risk capital funding the market-making and speculative activities of the largest proprietary traders is increasingly coming from private sources in the form of hedge funds. These trading advantages include superior information first call on breaking news , reduced transaction costs either in the form of lower commissions or tighter quotes from the market-makers , and superior market access, as well as other structural and statutory benefits.
These edges exist or were granted because the markets need these liquidity and speculative functions to be performed to ensure their smooth operation.
They represent the first component of the inherent return in hedge funds. A second level of inherent return is created by virtue of the fact that most of the specialized activities conducted within hedge funds require a substantial research infrastructure.
It is not economic, in most cases, for traditional mutual funds to build the appropriate research capability, given the Why Hedge Funds Make Money 27 substantially lower fees they charge relative to hedge funds. Risk arbitrage, for example, requires specialized expertise from analysts and lawyers. Given the fact that there are a limited number of deals at any point in time and limited liquidity, it does not make economic sense for a fund charging 60 basis points to hire the individuals necessary to conduct the activity.
Virtually all hedge funds take advantage of some type of investment edge. Many enjoy multiple advantages. To take a basic example, a specialist on the floor of a stock exchange is granted market privileges that average investors do not receive.
Most notably, they are allowed to see the buildup of orders above and below the current price of the stocks they are assigned. Further, they are allowed to take the opposite side of customer transactions in their own trading accounts as well as receive other statutory advantages from the exchanges.
Finally, they execute their trades with the lowest possible transaction costs. Those factors are trading advantages, and the combination of those trading advantages means that even a specialist with a modest level of skill can ply his craft profitably. But not all specialists are equally profitable. Even specialists who cover companies with tremendous similarity can vary greatly in profitability. Although alpha usually determines the degree to which any given hedge fund prospers, virtually all successful hedge funds exploit some type of trading advantage.
These advantages include superior information, lower transaction costs, better market access, size advantages, and structural inequities in the markets in which they operate.
One of the most common advantages is superior information, which often manifests itself in situations where the hedge fund manager is dealing in a limited universe of securities and financial instruments. Typically, these managers will surface in an area where only a relatively small group of experts follows the instruments closely, though a larger group may follow the sector generally.
In these situations, a mismatch of both expertise and objectives can be exploited to the benefit of the hedge fund manager. For example, managers specializing in distressed securities develop tremendous expertise pertaining to a relatively small universe of companies. A given manager has the opportunity to learn more about a particular company than all but a handful of individuals. Further, activity in the securities of distressed companies typically companies in Chapter 11 usually precludes involvement from large public investment funds.
Relative size, either large or small, can be an edge. For instance, shortterm or day-trading equity firms typically benefit from the fact that their small size relative to large mutual funds allows them to capture smaller 28 HEDGE FUNDS market movements. Size advantages can generate other advantages. For example, managers dealing in below-investment grade debt in a particular emerging market country or region can find themselves among the largest investors in that narrow universe of securities.
As some of the largest players, they are viewed by the market as buyers or sellers of last resort. As a result, these managers tend to get the first call on breaking news, leading to an advantage in superior information.
That same size advantage compounds into superior market access as market-makers will typically make deeper and tighter quotes to the active investor compared to the occasional participant.
Large size usually translates into lower transaction costs. For example, most statistical arbitrage programs generate large volumes of equity trading, as every long position is matched against a short position.
Furthermore, positions are usually turned over quickly. This makes them very desirable clients to their prime brokers, who offer them low commission rates in addition to the benefits of superior market access and first call on information.
Other types of managers will benefit from structural inequities in the marketplace. Derivative markets, for example, exist for the purpose of transferring risk. They typically facilitate transactions in which one party, saddled with an unwanted market risk, contracts with another to lock in a future price—a discipline known as hedging. In that transaction, the speculator usually assumes the risk position at some discount or premium to fair-market value.
In essence, the hedger is paying what amounts to an insurance premium to the speculator who assumes the risk. Hedgers usually operate in derivative markets for non-economic reasons. Their motive is to operate their underlying businesses profitably rather that look to profit from their derivative market dealings. Another advantage lies in the broad investment mandates that are typical of most hedge funds.
Managers are not restricted to the long side only or to listed securities only. Hedge funds typically can employ a wider range of strategies to capture an investment idea than most traditional managers. Put simply, hedge funds function as vehicles to capture manager skill, or alpha. Virtually any financial activity can be packaged within the structure. The additional profitability of a trading enterprise directly related to these trading advantages is the inherent return of hedge funds.
As investment banks and other financial institutions retreat from the business of providing liquidity and speculative capital, that inherent return is being offered to investors in the form of hedge funds and other alternative investment vehicles.
Why Hedge Funds Make Money 29 Positive Selection of Alpha The inherent returns of the activities are amplified by a key attribute of the hedge fund structure: Performance-based compensation creates positive manager selection.
Only managers with established industry pedigrees have the credibility to raise initial assets. Only managers who continue to deliver compelling net returns to investors keep and grow their assets.
The hedge fund structure is attractive to top-tier talent as it affords greater financial rewards to managers who can deliver net performance on large pools of investor capital. Further, it allows successful managers to build their companies in their own image, working where and when they want.
The incentive-based compensation structure amplifies the positive selection process. Unlike mutual funds, most hedge funds have limited capacity to invest assets. As a result, they depend on incentive fees and must generate profits consistently to maintain their financial viability. This typically influences the mindset of hedge fund managers away from the complacency that can occur among traditional managers who dwell in a benchmarked universe.
This mindset is further augmented by the fact that most managers invest their personal capital in the funds they manage. The firm and its employees do only as well as the investors. It is not uncommon for successful hedge funds to close to new investments or even return capital to investors. This occurs because large hedge funds often earn more from incentive fees than from management fees. These factors coalesce to create an attitude where annual profitability is paramount.
These advantages can include cheaper costs, better market access, and superior information, as well as other structural and statutory benefits. These advantages are not new. In fact, they have existed for decades, but prior to the emergence of hedge funds, they were in the exclusive domain of large financial institutions that traditionally supplied liquidity and 30 HEDGE FUNDS speculative capital to the marketplace.
Starting with the inherent return as a foundation, the potential benefits of this return are amplified through the positive selection of alpha. This positive selection occurs because of the performance-based compensation intrinsic to all hedge funds. Incentive-based compensation creates a Darwinian model in which only the most talented managers can far exceed the earning potential available within the financial institutions from which they emerged.
The hedge funds have been added uniformly, and no discretion has been used to either overweight or underweight the allocation. What is interesting to note is that, as hedge funds are added, the index return increases and the volatility is reduced see Figure 2. Although a typical long-only manager may charge 10 to 85 basis points of assets under management, the hedge 18 1 17 16 15 14 13 12 11 7 10 6 9 5 2 4 8 8 9 10 11 3 12 13 14 15 Volatility Annualized Standard Deviation 1.
Pension Fund Index 4. Russell Return Index 4. Pension Fund Index 5. Hedge funds are able to command aboveaverage fees because they have historically provided superior risk-adjusted returns and they have very limited capacity. This is simply a case of supply and demand; the relatively small number of superior hedge fund managers are in such demand that they are under no business-related pressure to acquiesce to the institutional investors by dropping their fees. The high fees charged by hedge funds have created cultural difficulties for investors accustomed to fees measured in low basis points.
Few institutional investors, if questioned, would choose to invest with managers offering lower fees at the expense of reduced performance. Many of these hedge funds will give an institutional size discount, but their fees are still a multiple of standard institutional fees. Virtually all hedge fund managers recognize that their strategies work best when employed with a limited amount of capital.
In contrast, most institutional funds are effectively open-ended, with the managers believing that no asset cap is necessary. The management of a hedge fund normally has a very large personal stake in the fund and will not jeopardize the potential return on its own assets by taking in more client assets than it believes are optimal.
The cost of operating a hedge fund varies with the size of assets and the scope of the investment approach. The management fees charged by hedge funds usually range from 1 percent to 3 percent of assets per annum.
Generally speaking, managers expect to be able to cover the fixed costs of running their business with this fee revenue. As with institutional fund managers, these management fees are due regardless of the performance of the underlying fund. These fees are in addition to management fees and usually take the form of 5 percent to 50 percent of the profits charged on a schedule ranging from monthly to annual.
No fee is earned if the fund has a negative return as the vast majority of funds only pay incentive fees to the manager on new profits to the investor. This performance fee is key to understanding the motivations of a hedge fund manager.
The arrangement provides the incentive to the manager to focus on generating absolute returns on a manageable asset base. If successful in generating absolute returns, the hedge fund manager can earn as much as or more than a traditional manager running five or 10 times more capital.
The structure of institutional funds rewards asset-gathering and does not penalize mediocre performance; the hedge fund fee structure focuses the manager on positive absolute returns and not degrading these returns by taking on too much capital. The hedge fund fee structure benefits the fund by enabling it to attract the high-end talent necessary to run a successful fund. The chance to share in potential performance fees is a powerful recruiting tool and mirrors the Capacity 37 type of compensation schemes used in investment banks and other sophisticated entities.
Hedge fund managers can keep their overheads low by offering senior candidates a relatively modest salary with a healthy share of the performance fee. One of the key questions for hedge fund investors is determining which individual funds actually deserve these premium fees. The proliferation of pools of capital managed with a hedge fund fee structure has made it extremely important to perform proper due diligence on the universe of managers to answer this.
This due diligence allows an investor to concentrate on the types of hedge funds that will add value, on a net of fees basis, to the overall investment strategy. An institutional investor with substantial long equity exposure may be very willing to pay a premium fee to a manager who has a record of generating returns that are not correlated to the equity market. The same investor would probably be unwilling to pay hedge fund fees to a leveraged long equity-focused fund.
A fund that provides the investor with superior investment talent is structured to enable this talent to implement rationally a disciplined investment approach, reward absolute performance, and produce robust risk-adjusted returns, all of which is worth the higher fees to an institutional buyer. On a secondary basis, they may also be referring to the maximum number of people that a hedge fund may want to employ and the size of the infrastructure that they want to manage.
Not all boutique hedge fund managers want their businesses to grow into substantial asset management companies with the operational, political, and bureaucratic characteristics typical in such companies. It is well known that a limited number of managers demonstrate the ability to outperform over time. For many managers, performance often degrades once assets grow beyond a certain level. The reason for this is simple: Slippage is defined as the degree to which market prices are moved through the process of entering or exiting a position.
The larger the position, the greater the effect of slippage. Funds focusing on investing in the currency markets should be able to manage much more money than funds focusing on exotic fixed-income arbitrage opportunities.
Funds focusing on largecapitalization stocks should be able to manage more than those specializing in the micro- or small-capitalization arena. Greater transparency is commonly associated with providing greater investor protection from both a performance and a fiduciary perspective.
This is not always the case. Transparency is a double-edged sword with the potential to be misunderstood and misused. Certain levels of transparency are essential for effective due diligence. Investors and asset allocators must have some ability to look through to the underlying portfolio to understand whether the manager is adhering to stated investment parameters and whether the investment methodology is consistent with stated objectives.
This is particularly true for managers investing in unlisted securities and derivative instruments. There is a curious dichotomy in the mindset of investors in alternative investments.
Investors in private equity funds view lack of transparency and liquidity as par for the course and, often, as a benefit. However, lack of transparency and liquidity in a hedge fund can be regarded as a disadvantage.
Much of the recent clamor for transparency has focused on managers supplying full portfolio information to investors on a real-time basis. In this instance, transparency can have the ability to do more harm than good. The reasons are very straightforward: Again, this works against the best interests of investors. Furthermore, we have seen no empirical evidence to show that the use of the ubiquitous value-at-risk VAR models which are based on the mathematical formulae developed by some of the professionals who per- Notes 39 formed so badly in protects investors from major market setbacks.
The reasons are threefold: Real-time transparency is only valuable in two circumstances: Few investors have either of these advantages. By definition, more transparency means more information. Fifteen years ago there were discreet advantages to having information ahead of the crowd because you could act on the information before its impact was generally understood. Today, by the time you get the information, it is old and everyone else has it, too.
Therefore, you have no time to react before the herd. The majority of statistical and intellectual evidence suggests otherwise. However, by adding the positive selection of alpha, intrinsic in the structure of all hedge funds, the inherent return is enhanced.
Hedge funds are paid—and have the incentive—to trade and invest when others cannot, will not, or need to be on the other side. Reproduction or use of all or any part of the research is prohibited without the express written permission of both the author and the AIMA. The author and the AIMA retain all future publication rights to the original research paper and this chapter.
However, for managed futures to grow as an investment alternative, individuals need to increase their knowledge of and comfort level with the use of managed futures in their investment portfolios.
Basically, managed futures provide direct exposure to international financial and non-financial asset sectors while offering 41 42 MANAGED FUTURES through their ability to take both long and short investment positions easily a means to gain exposure to risk and return patterns not easily accessible with investments in traditional stock and bond portfolios.
Investors must come to appreciate that the investment benefits in managed futures are wellfounded in financial theory and empirical evidence.
Yet, managed futures, as an investment alternative, have been available only since the late s. Today, institutional investors, such as corporate and public pension funds, endowments and trusts, and bank trust departments as well as high net-worth individuals, include managed futures as one segment of a well-diversified portfolio.
Moreover, this number does not include the billions of dollars under management or in proprietary trading programs of major financial institutions, which trade similar strategies, but which do not report to traditional data sources. This growth in investor demand for managed futures products indicates investor appreciation of the potential benefits of managed futures—for example, reduced portfolio risk, potential for enhanced portfolio returns, ability to profit in different economic environments, and the ease of global diversification.
Results see Table 3. Bond Portfolio III Risk and Return Performance managed futures, as well as investment in stocks, bonds, and hedge funds, dominate those portfolios that invest solely in traditional stock and bond investments Portfolio I of U. In general, the correlation of CTA strategies with other CTA strategies depends on the degree to which the strategies are based on trend-following or discretionary approaches.
Because most CTAs follow trend-following strategies, the overall dollar-weighted and equal-weighted indices are also highly correlated with other CTA strategies dominated by trend-following indices. However, as shown in Table 3.
For instance, as Table 3. In contrast, as Table 3. Thus, they may not provide the diversification benefits with equities offered by CTAs. Investors must also realize the uniqueness of the time period. For instance, hedge funds have been marketed as offering unique risk and return properties that are not easily available through traditional investment securities or investment products.
These return opportunities stem from the expanded universe of securities available to trade and to the broader range of trading strategies. One reason for the supposedly low correlation and potential diversification benefit is that hedge funds often describe themselves as employing skill-based investment strategies that do not explicitly attempt to track a particular index.
Because their goal is to maximize long-term returns independently of a proscribed traditional stock and bond index, they emphasize absolute returns and not returns relative to a predetermined index. It is important to realize, however, that although hedge funds do not emphasize benchmark tracking, this does not mean that their entire return is based solely on manager skill or is independent of the movement of underlying stock, bond, or currency markets.
Hedge fund managers often track a particular investment strategy or investment opportunity. When appropriately grouped, these hedge fund strategies have been shown to be driven by the same common market factors, such as changes in stock and bond returns or stock market volatility, that drive the traditional stock and bond markets.
For instance, Table 3. A positive negative value indicates an increase decrease in the returns of the strategy as the spread increases. A positive negative value indicates an increase decrease in returns when the VIX implied volatility increases. In contrast, managed futures universe returns are not correlated with the stock and bond markets or changes in equity market volatility, but track indices that reflect trend-following return patterns.
In contrast, managed futures programs that are not trend-following in structure are not correlated with these trend-following indices such that investments across trend-following and non-trend-following strategies may offer diversification. Managed futures trade in markets that offer investors the same market integrity and safety as stock and bond markets.
Managed futures investment, as is the case for stocks and bonds, provide investors with the assurance that their investment managers work with a high degree of government oversight and self-regulation and trade primarily in closely regulated markets.
Managed futures are not more risky than traditional equity investment. Investment in a single CTA is shown to have risks and returns that are similar to investment in a single equity investment. Moreover, a portfolio of CTAs is also shown to have risks and returns that are similar to traditional equity portfolio investments. Most traditional money managers and many hedge fund managers are restricted by regulation or convention to holding primarily long investment positions and from using actively traded futures and option contracts which offer lower transaction costs and lower market impact costs than direct stock or bond investment.
Thus, in contrast to most stock and bond investment vehicles, managed futures offer unique return opportunities, which exist through trading a wide variety of global stock and bond futures and options markets and through holding either long or short investment positions in different economic environments for example, arbitrage opportunities, rising and falling stock and bond markets, and changing market volatility.
As a result of these differing investment styles and investment opportunities, managed futures traders have the potential for a positive return, even though futures and options markets in total provide a zero net gain among all market participants. Thus, managed futures are shown on average to have a low return correlation with traditional stock and bond markets as well as many hedge fund strategies and to offer investors the potential for reduced portfolio risk and enhanced investment return.
As important, for properly constructed portfolios, managed futures are also shown to offer unique downside risk control along with upside return potential. The Benefits of Managed Futures. Schneeweis, Thomas, and Joe Pescatore, editors.
The Handbook of Alternative Investment Strategies: Annualized standard deviations are derived by multiplying the monthly data by the square root of The additional CTA indices are segmented by CTA reporting strategy for example, currency, financial, diversified or style discretionary, trend-following.
For hedge funds, event-driven indicates the median of the reporting hedge funds grouped as distressed and risk arbitrage. The Zurich Fund of Funds is the median of reporting fund of funds where capital is allocated among a number of hedge funds. The Zurich Global Established is the median of the reporting hedge fund managers who are primarily hedge equity managers with a long bias who pay attention to economic changes, but are more bottom-up oriented in that they tend to be stock-pickers.
It is important to note that the Zurich CTA and hedge fund universe returns used in this study are not the same as the Zurich hedge fund indices that are designed specifically to track particular strategies that meet predefined criteria and are, by design, more style pure.
However, growing default rates, a growing supply of distressed securities, and dwindling hedge fund and bank demand reduced its attractiveness. For another look at this category, see Chapter 11 on high yield investments. Notwithstanding some very serious issues regarding markto-market pricing of these inherently illiquid securities, the asset class has been a successful complement to many fund-of-fund strategies when viewed over the long term, based on its counter-cyclical nature.
Mark-to-market pricing, or the lack of it, has undoubtedly smoothed the monthly volatility, an issue I will discuss in depth later. Prior to that, in the s and early s, distressed managers soared, annualizing 25 to 40 percent with few statistical outliers. Volatility, although certainly higher during these boom years, was not overly so, yielding Sharpe ratios in excess of 2. The fall of Drexel Burnham Lambert and the high yield market overall made the opportunity especially attractive for value investors with a long-term perspective.
Investors liquidated these positions en masse, due to the negative stigma associated with these defaulted or soon-to-default securities or by obligation due to their investment charter.
A good example of the typical s distressed play was U. Gypsum Corporation USG , which attempted to repeal a takeover attempt through a leveraged recapitalization.
As a side note, USG has once again filed for Chapter 11 bankruptcy protection as a result of the mounting threat of asbestos litigations. Poor asset quality, low default rates, and a strong equity bull market made distressed investing both uninteresting and highly directional towards the middle and latter half of the s. Passive approaches to the asset class were particularly dismal, as poor management, misguided business models, and operational difficulties made many businesses not worth saving.
High yield credit quality deteriorated significantly, and much of what was outstanding had little to speak of in terms of asset quality and recurring cash flow. Although default rates remained low, record levels of high yield debt outstanding produced record default volume. The distressed market grew by default, while the high yield market, which often serves as an incubator to distressed securities, still traded at a historically low spread to Treasuries, despite the deteriorating new issuance credit quality.
What would normally have traded at a greater than basis point spread to comparable Treasuries priced much richer, discounting the risk of default. High yield investors continued to demand new product, and corporations, seeing an excellent financing opportunity, rushed to issue high yield securities.
Investment banks jumped at the opportunity to generate fee income off the sale of such securities to the market and did not do a proper job in weeding out flawed businesses from the high yield market. Although large high yield new issuance resulted in a larger supply of distressed secu- Performance and Market Profile 59 rities albeit with low default rates , it did so only on an absolute-dollar basis.
Some distressed investors and commercial and investment banks continued to allocate capital to the distressed sector, albeit across an inferior investment opportunity set. Supply and Demand Factors These factors all contributed to growing default rates, and a rapidly increasing supply of distressed securities. In addition, the demand for distressed securities dwindled as hedge funds and commercial and investment banks quickly reduced leverage or exited the business following the credit and liquidity crisis in the Fall of The Event-Driven Index includes both distressed and risk arbitrage managers, implying a much more severe quarterly outflow for the distressed sector see Figure 4.
Once the negative outflows from proprietary sources are factored in, the total withdrawal of capital became monumental. Hence, with rising default rates, poor quality merchandise, and record high yield new issuance, distressed supply quickly outstripped demand.
A Primer on the Bankruptcy and Restructuring Process Investing in distressed situations involves purchasing the claims of companies that have already either filed for Chapter 11 or Chapter 7 bankruptcy protection, are trying to avoid Chapter 11 through an out-of-court debt restructuring with their creditors, or are in immediate danger of doing so.
Companies in danger of filing will typically trade at a wide spread to Treasuries, reflecting this risk. There are basically two general investment philosophies to distressed securities investing: Relative value investors will choose a more passive approach and, to some extent, ride the coattails of the activist investors who seek to add value in the reorganization process.
Distressed investments vary widely in terms of the type of security available: Investment debt, bank loans, trade claims, private placements, real estate mortgages, and lease contracts are examples of the most common types.
Distressed investments can also take the form of direct investments and debtor-in-possession DIP financings. The supply of available distressed debt is highly cyclical in nature, based on a variety of economic, capital market, company specific, corporate structure, and technical factors. Performance and Market Profile 61 Distressed investors generally attempt to profit on pricing inefficiencies associated with such securities, the negative stigma associated with such claims, or simply an inability on behalf of the original investors to value such claims accurately or direct their legal interests during restructuring proceedings.
When considering a potential investment, distressed investors consider a variety of factors. Industry practitioners Barnhill, Maxwell, and Shenkman summarize the most important considerations as follows: Why is the company in distress? Outlining the programme to the European parliament.
Mr Jacques Santer, Coromis- Santer. However, some sectors of industry and busi- ness are likely to be disap- pointed that as far as taxa- tion is concerned, the proposals of Mr Mario Monti, the single market commis- sioner.
Many businesses would like to see, for example, introduc- tion of a harmonised VAT system, but agreement between member states has proved all but impossible. According to the Commis- sion, between and Mr Monti believes this is the result of "tax competi- tion" between member states as they attempt to lure savings from other member states by cutting taxes on savings, while compensating with increases of tax on labour.
The difference of approach might be explained by the fact that, while the administration of the merger regulation had been widely admired by European businesses, the administration of anti -com- petitive accords was consid- ered less successful. The Commission had ruled in December that the original usage contract between Eurotunnel. The court decided the Commission bad misunder- stood the contract when it concluded that the rights to the tunnel were divided strictly between the shuttle services run by Euro- tunnel and the international freight and passenger ser- vices operated by the rail- ways.
BR and SNCF did not enjoy an exclusive duopoly because Eurotunnel was free to sell its tunnel capacity to other operators, the court ruled. Germany and France seek more flexibility By Caroline Southey in Brussels France and Germany yesterday formally launched joint proposals for a multi- speed Europe in which groups of countries could press ahead with greater integration without having to wait for all member states.
The plans aim to allow the EU to enlarge to as many as 37 members without threatening pros- pects of stronger political and economic ties among more advanced countries.
The Franco-German initia- tive was presented as a joint contribution to a debate on flexibility due to take place next week as part of con- tinuing talks In the inter- governmental conference to revise the Maastricht treaty. The plans face stiff resis- tance from the UK govern- ment which could exercise Its veto to the treaty changes in the closing stages of the IGC.
Mr Michel Bamier, French minister for EU affairs, and Mr Werner Hoyer, German secretary of state for foreign affairs, yesterday stressed that the idea was to allow greater flexibility, but within limits. This meant respect- ing the ETTs acquis commit- nautaire - the core body of EU legislation - and protect- ing the Commission's right to monitor laws.
In addition, no member state should be allowed to veto planned action of a group of member states, and all countries willing and able to take part in any initiative should be allowed to do so. Mr Hoyer said the plans were designed to prepare the EU for the next milieu- ium. W hen Nomura, the Japanese securi- ties firm, said this week that it was Interested in buying a stake in a Czech bank that might soon be offered for sale, Mr Vaclav Klaus, the Czech prime min- ister.
Mr Klaus rarely reacts to the sentiments of foreign investors. His enthusiasm on this occasion, cynics suggested, was evidence not just of a volte-face - he had previ- ously favoured strong domestic investors for the banks - but of his despera- tion to turn the tide of recent bad news from the banking sector.
The perception that fraud was involved in some of these failures - several peo- ple have been charged with finanrtfli wrongdoing in the Kreditni case - is wide- spread. Financial propriety has become an issue in the cam- paign for elections to a new senate in less than a month.
Since then, it has faced an uphill battle to present a united face to the electorate, with divisions emerging within the cabinet and also in the ODS. Mr Klaus has barely suppressed a very Assets held. Mr Klaus "is running not only a minority government hut a very Incoherent one," notes Mr Jiri Pehe, director of research at the Open Media Research Institute, a think tank.
Nothing less than a con- vincing victory over the opposition Social Democrats CSSD in the senate election - a first-past-the-post vote for 81 seats - will do to restore his authority and convince the public that his hand is still firmly on the wheel, Mr Pehe says.
However not everything is gloomy for the prime minis- ter. He is exploiting an increasingly acrimonious row within the CSSD over insubordination by party members against its leader.
Mr Milos Zeman, who is con- sidered to have put too much emphasis on defeating the government In a recent vote on the budget His strategy backfired when four of his colleagues defied him to vote in favour of the measure. Moody's Investors Service, the credit rating agency, gave a vote of confidence to the banking sector yesterday with a generally positive report on the long-term pros- pects for the main banks. This should boost efforts to complete privatisation of the sector when the cabinet studies the issue later this month.
Ending the banking crisis is a priority for the govern- ment. The central bank's inter- vention to save Agrobanks sent a signal that the leading banks would not be allowed to fail. Additional measures last week also made an extra KC The fact that the govern- ment approved the measure - parliament must do so.
During the deal, the offices provided a 24 hour a day, seven day a week service, ensuring response time was immediate. ABN AMRO Bank was one ol'lhe first global banks lo recognise the need to offer aerospace clients specialist assistance and debt constructions.
Today, customers are served from regional centres with specialist knowledge of the global in- dustry. Local branches are further involved, to ensure that lull advantage can be taken of local knowledge and possibilities. Struc- tured aircraft finance deals offer clients the best possible proposal, while dedicated relationship managers ensure that all dealings are simple and efficient. Mr Ross had planned to leave Israel earlier this week but was asked to postpone his departure as Israeli and Palestinian negotiators sought to iron out funda- mental differences over the security of the Jewish settlers living in the centre of Hebron and surrounded by , Palestinians.
It is not finished yet. I hope it will end quickly. The leaders have not met since the Washington sum- mit earlier this month. Israeli officials have recently suggested moving quickly towards a final set- tlement - much earlier than the planned date of How- ever, he was reluctant to say whether such a settlement would lead to the establish- ment of a Palestinian state.
Mr Chirac, who was on the second day of a two-day state visit to Israel, had ear- lier said only a Palestinian state would bring security to Israel, remarks which were not warmly received in the Israeli press or by govern- ment officials. It also assigned a Ba3 sovereign ceiling for ratings of long-term foreign currency-denominated bank deposits and Not Prime ceilings for short-term obligations.
The grade places Egypt above other emerging markets such as Turkey, Brazil and Jordan, on a par with Mexico and Venezuela but below Bahrain. Mr Boutros Ghali said: Moody's could not grasp the strong foundation of our economic reforms and the rich diversity of our economy. Mr Arvind Subram ani an. IMF representative in Egypt said: The Global One Calling Card, relied on by millions of international travelers, now serves more frequent flyer programs than any other international calling card.
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In the flrst six months of , twice as many lives were lost at -'sea than in the. Forty years on, a tanker 20 times as large may have only 20 men on board. The new standards would go a long way to reduce the fatigue factor, he said. Regu- larising hours of work, and rest would prevent. Clintbs and the Democrats, including the issue of cam- paign contributions from for- r elgn sources.
Four polls give the presi- dent leads ran g in g from 15 to 22 points. Mr Dole's trustworthiness, to which he constantly refers, is now ranked no higher than Mr Clinton's, dropping 7 points over the last two weeks. The message from other p6Us was Bhnllar. A Harris poll gave Mr Clinton 54 per cent. Mr Dole 36 per cent and Mr Perot 7 per cent. The Dole campaign tried to put the best thee on the polling numbers.
Mr Nelson Warfield, his press secretary. Mr Dole appeared to be switching his message back to his tax-cutting economic plan. Of the polls, he said: Probably some are in the middle. Mr AlemAn, who needed 45 par cent of the vote to avoid a run-off election, is expec- ted to take office on January lOfOr a five-year term. Mr Ortega was still demanding a probe into ' alleged irregularities and had not ceded defeat yester- day morning.
However, inde- pendent observers pro- nounced the elections free and Fair The Liberal Alliance also emerged as the largest single party In the National Assem- bly, although without an absolute majority.
Most of the smaller parties that played an Important role. According to Mr Oscar Rene Vargas, a political ana- lyst: One of the most poten- tially explosive issues on the new agenda Is Mr AlemAn's election promise to satisfy aU those whose property was confiscated during the San- dinista years.
Ms Miriam Argfiello of the Popular Conservative Alli- ance, one of the losing 21 presidential candidates, said: But what I do know is that the country has been completely polarised by the vote. Although Mr AlemAn bas emphasised the Sandinlsta hierarchy that took personal advantage of prope r ty com- mandeered by the revolu- tion, many small beneficia- ries of the redistribution fear they will also be affected.
Mr JosA Evenor Taboada, president of the central bank, commented: This policy is credited with stabi- lising runaway inflation and laying the foundations for three years of economic growth.
But with unemployment and underemployment of more than 50 per cent, the big issue is jobs. He favours a tight check on public spending as well as private investment as the motor for job creation. Although the main busi- ness organisations voiced a preference for the Liberal Alliance just before the elec- tions, the local private sector is not completely comfort- able with Mr AlemAn. One reason is that his close ties with the Cuban community in Miami worry some local business families who fear they will be deprived of old privileges and lose out on new ones.
He said the damage was compounded by the fact that Cuba was still struggling to emerge from five years of severe recession, triggered by the collapse of trade and aid ties with the former Soviet bloc.
The island is already facing a balance of payments squeeze caused largely by rising costs of essential imports. More than 21, hectares of bananas, a food staple for Cubans, were destroyed and more than Upwards of , hectares of sugar cane, the main export crop, were affected. More than 78, houses were damaged, 5, of them destroyed.
Sugar mills, factories, schools and hospi- tals were also hit, as were water distribution and elec- tricity networks. Mr Ferradaz said the national economic plan for would have to be revised to take account of the damage.
He asked the United Nations to provide humanitarian assistance, specifically food, medicines, construction materials and farming equipment. Mr Nelson Torres, sugar minister, told Cuban radio that although large areas of sugar cane had been blown flat or flooded, be believed the island would be able to increase sugar production in the coming season above the improved 4.
Damage to tourism Instal- lations was minimal, Mr Ferradaz said. The monthly survey from FTEL, the respected economic think-tank, indicated the economy was accelerating out of recession, with most businesses predicting increased output in the final quarter. However, production in September fell 3. Demand also dropped back slightly in September, mainl y as a result of a harsh austerity package announced by Mr Roque Fernandez, the new economy minister, in August.
Most Independent analysts predict growth in gross domestic product of per cent in , following last year's contraction of 4. A union report accused Bridgestone of double standards by never laying off Japanese employees but illegally replacing striking workers at its US Firestone subsidiary.
The union's campaign has been mounted internationally, a growing practice as labour seeks to confront the power of multinationals. The company's labour difficulties began in when it asked for extensive concessions from US workers, provoking a bitter strike.
Nancy Dunne, Washington Caracas jail riot kills 30 A riot and fire which erupted at a jail in Caracas yesterday left more than so inmates dead, Venezuela's justice ministry said. The National Guard fired tear gas to disperse the inmates and a fire broke out.
The jail, located in the city's El Paraiso neighbourhood, was only built for 1, inmates, Mr Malval said. An IMF mission is due here at the end of the week. But they met a cautious initial reac- tion from the local financial community which had been expecting a smaller devalua- tion. Share prices rose 2 per cent, but dealers said trading volume was only average.
In the unofficial foreign exchange market, the dollar traded at Rs The devaluation also met a negative response from busi- ness and opposition leaders. Nonetheless, most bankers agreed tough measures had become inevitable. The proceeds of Rs2bn in the first year will replace trans- fers from central govern- ment. Defence spending, which takes up a quarter of government expenditure, is not being cut directly, but it will fall in.
Spending is to be reduced by Rs27bn. Revenues are to rise by Rsi3bn through additional service charges to Importers and on foreign travel. To compen- sate, the government is to exempt medicines and news- papers from the unpopular general sales tax.
The State Bank also intro- duced a temporary 17 per cent interest rate on foreign currency deposits channelled to it through commercial banks. This should attract a fresh inflow of currency to replenish the reserves. Credit to public sector cor- porations will be restricted and legislation is planned to facilitate the recovery of overdue loans by state banks through attachment of col- lateral.
Bad debts in the banking system amount to Rsl20bn, equivalent to about 6 per cent of gross domestic product and a large drag on government finances. Bankers expressed con- cern about the ability of the government to push through the package. Mr Jafarey is known to have annoyed IMF officials in the past by failing to live up to commitments made in nego- tiations. Indian banks under pressure on rates By Quentin Peel and Tony Tassel I in Bombay Indian banks are coming under mounting pressure to cut interest rates quickly and step up lending activity following an easing in mone- tary policy at the weekend.
The Reserve Bank of India, the central bank, announced a broad package of measures over the weekend aimed at reviving economic growth through freeing bank resources for lending and reducing the cost of credit. The move brought wide- spread cheer to Indian finan- cial markets yesterday. After a public holiday on Monday, the BSE 30 Index, the country's most promi- nent share market indicator, rose In addition, the finance ministry has called a meet- ing with leading banks on - November 8 and 9 to discuss bank lending policies.
Already two state-owned 20 per cent even though inflation is running at around 6. Although H ank prime rates currently range from Others, including the country's largest commercial bank, the State Bank of India, are expected to make a decision on rate cuts over the next few days.
The moves will bring wide- spread relief to Indian busi- nesses, many of which are paying interest at more than move might help spur a recovery in bank credi t growth after a slump in the first half of current fiscal year to March. This was mainly because of a fall in demand, with many corporates delay- ing decisions to take up credit because of high inter- est rates. Some analysts suggest the slowdown in credit growth was partly caused by bureaucratic delays by banks in processing loan applications.
One banking industry source said bank delays had choked the sys- tem. With, these borrowings repaid, he indicated that the latest easing of policy would have a more pronounced impact.
Mr Rangarajan also allayed concerns that increased government bor- rowings might soak up the increased liquidity arising from the changes. About 80 per cent of the government's budgeted gross market borrowing for had already been completed, and there was no indication of an increase beyond the targeted limits.
Inflation was expected to remain under control at per cent in despite the Impact of the easier mon- etary policy. As such, inflat ion should remain within the forecast range, given an expected gross domestic product growth of around 6.
Mahathir plea for information curbs Malaysian executive faces court charges By James Kynge in Kuala Lumpur Dr Mahathir Mohamad, Malaysia's prime minister, placed fresh empha- sis yesterday on the need to restrict information, in remarks which appeared to be at odds with a national drive to win investment from western media companies.
Dr Mahathir said the rapid advance of technology had rendered traditional government controls impotent He appealed to broadcast- era and journalists to practise self- censorship to shield the public from foreign propaganda, deviationist teachings, pornography and other undesirables. Censors in broadcasting centres had the responsibility not only to censor unwanted material but also to choose programmes that could help promote good behaviour.
He said then that there would be no censorship within the corridor, a sq km zone intended to serve as a base for world-class media and information technology companies. By James Kynge The boss of a Malaysian gaming company, Repco Holdings, has been charged in court with giving a mis- leading statement likely to influ- ence trading in the company's shares, officials said yesterday. The court action, being brought by the Securities Commission, is an indication of Malaysia's determina- tion to combat excessive speculation and other abuses as it liberalises its financial markets.
He pleaded not guilty and was allowed bail until his trial next February. The Securities Commission case involves a profit forecast which Repco made on January 27 this year. A week later, however, it with- drew the forecast, citing premature assumptions related to the prospects of its gaming business. It then pub- lished a new pre-tax profit projec- tion for the year of MS8 L82m. Repco is listed on the Kuala Lum- pur Stock Exchange's second board.
The company's share fell 6. Diplomatic analysts saw it as a positive signal that China's anger over a resolution on Tibet, passed in the. German parlia- ment in June, had cooled. Sino- German relations appeared firmly back on track as Mr Klaus Kink el, the German foreign minis- ter, finished two days of talks in Beijing aimed at clearing up the damage paving the way for a visit by President Roman Herzog next month- China was also concilia- tory about Mr Kink el's deci- sion to bring up in discus- sions fhp cases of a number of dissidents.
Including Mr Wang Dan, the detained stu- dent leader. However it Hag elicited envy among companies from some other countries who argue that a cosy political relationship between Bonn and Beijing has helped German compa- nies win co ntra c ts.
German companies appeared relieved that the dispute over Tibet appeared to have blown over. The rep- resentative of one semi-offi- cial organisation involved in promotion of bilateral trade said he knew of no contracts which had been lost directly as.
Other German industry representatives tried to play down the disagreement. Mr Wang Jiang Bing of Roland Berger, the manage- ment consultants, said to medium-sized projects which make up the bulk of German investment in China, were relatively unaf- fected by political manoeu- vres.
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Marino, NapoO- Haiy. The deadBne or receiving offers Is 2 pm on 14th November The General Manager Dr. Interested parties can request a copy of toe complete call for bids from AJN. Azienda Napoletana Mottfite - Via G. Mr Tung, who has stepped down as chairman of Orient Overseas to mount his campaign. The coincident index of economic indicators fell further to Three stayed on the plus side, while two remained negative.
The three-month moving average for the diffusion index has stayed over Seoul Sri Lanka reverses sell-offs. Sri Lanka's parliament yesterday passed legislation re-acquiring state enterprises privatised by the previous government voted out two years ago. Withdrawal of either, unlikely to bring the government down, but wfll push ' President Ghandrika Kxxmaratunga to seek support minority Tamil parties.
Amcd Jayasinghe, Ramos keeps promise Imptemarmnion of- Urucu-Coari 'Product Pipefine. Designed for the rigours of hour flights, F ym 8. Nothing can fly you farther, faster, in greater comfort than the Global Express' jet. Since the reforms began in the mids, New Zealand had halved unemployment tO 6 per cent, cat annual inflation from around is per cent to 2 per cent and turned a budget deficit equivalent to 9 per cent of gross domestic product into a fiscal surplus.
The report noted that economic growth had averaged 4 per cent since , adding that the reforms were estimated to have increased New Zealand's growth potential by about 1 per cent a year. Subsidies to the agricultural sector, which accounts directly and indirectly for a big chunk of New Zealand's exports, have been slashed from 3.
Support for fanners is the lowest in any OECD country. However, in one of th e few notes of criticism, the WTO report said much of New Zealand's agricultural exports were still subject to licensing controls operated by statutory marketing boards, some with monopoly powers.
WORLD TRADE Road to Vietnam still bumpy ride By Jeremy Grant m Hanoi Foreign investors hoping for an easier ride in Vietnam, where legal potholes are many and success stories few, are likely to be in for a disappointment For months, Vietnamese officials have hinted at radi- cal changes to be made to the four-year-old foreign investment law that would cut red tape and clarify con- fusion over mortgages and land use rights. The country urgently needs to reverse declining investment figures. Econo- mists estimate only about a quarter of total commit- ments has been disbursed.
Significant changes, how- ever. Final drafts usually make it on to the statute book unaltered. Instead, Hanoi will proba- bly only tinker with the law. For example, it is expected to ban wholly-owned foreign projects in power generation, the manufacture of telecom- munications equipment, and in airports and ports. But very few Investors are likely to consider such investments anyway. Also, all foreign projects will have to be insured with Vietnamese insurance com- panies. Wholly-owned ventures in insurance, banned in earlier drafts, will be allowed.
Observers say the main reason for the apparent dilu- tion of early proposals is reluctance by officials to give concessions to foreign Investors at a time of creep- ing political conservatism and lingering doubt about the role of foreign invest- ment in the communist-run country. They have spearheaded criticism of the perceived dominance of foreign over local busi- nessmen. Many Vietnamese businessmen, too, are sensi- tive about the Inability of their cash-strapped compa- nies to contribute much equity to foreign joint ven- tures.
Local newspapers cover the Issue regularly almost as a point of national pride. However, some observers point out that Gange s to the foreign investment law are less im portnnf than a thor- ough overhaul of the envi- ronment in which they are implemented.
Part of the problem is Vietnam's enthu- siasm for lawmaking. An average of between 30 and 40 laws and decrees are issued weekly by ministries, the central bank and the govern- menL The effect of this often overlapping legislation Is confusion and repeated dis- ruption to business plans.
Now Ukraine's nearly bankrupt military industrial complex, the second biggest In the for- mer Soviet Union, is court- ing new clients in an already crowded world arms market The latest United Nations arms registry shows Ukrai- nian arms exports are on the rise, reversing the decline of the past four years. Other former Warsaw Pact members have made similar forays into the market. Rus- sia re-emerged in as an important global weapons supplier, its share jumping from 4 per cent to 17 In a year.
Ukraine would like to fol- low. It remains unclear, how- ever whether the country is really emerging as an arms supplier in the same league as Israel or South Africa, considered second-tier exporters after the US, Britain and Russia. Its main products are tanks, trans- port aircraft ships, and mis- siles and missile guidance technology.
These are all areas where competition is fierce. Ukraine can still break in, believes an analyst in Kiev. They're very price competitive, too.
The previous year it shipped 56 air-to-air missiles to China and performed well in muni- tions, according to the UN Register of Conventional Arms. Possibly its greatest strength lies in its missile and missile guidance facili- ties at Kharkiv and Dnepro- petrovsk, both industrial cities in the east, which are considered among the best In the world. The govern- ment also insists it is strengthening its legal base to fulfil all international obligations on the export of missile technology.
Conversion of military plants has been only partly successful. For Instance, it is providing rockets for Sea Launch, a new commer- cial satellite launch venture that brings together Ukrai- nian, Russian, Norwegian and US companies. He considers Ukraine's large Pakistani deal as atypical.
As far as the Pakistani deal was concerned, says , a diplomat, the Ukrainian gov- ernment felt confident that it could provide the neces- sary sovereign guarantee because many of the tanks had already been built. The rest of the order is to be filled over the next four years. The Kiev government is now negotiating with Rus- sian sub-contractors which provide electronics and sights for the TUD. Other producers have sought formal alliances.
The latest model of Antonov transport aircraft, the An, is befog developed jointly by Ukraine, Russia and Uzbeki- stan. But these countries are inexperienced in creating industrial consortia.
Another formidable chal- lenge is to improve market- ing and service. The panel said the US should return all anti-dumping duties collected on cement since they were imposed in Mexico said yesterday it reserved the right to take the case to the WTO, whose tougher dispute settlement rules do not give member states the right of v eto. Brussels has since resc inde d the duties but has refused to adopt the report on the grounds that it is now in the process of revising its anti-dumping rules.
Japan said yesterday it might call a special meeting of the Gatt anti-dumping exnmnittee in a last attempt to. Hanoi said last year it needed a refinery to reduce reliance on imports and cut its fuel bill, despite signs of refining overcapacity in the region.
The area's poor infrastructure was also cited as a serious hurdle: Itself impossible before all parties agree on a financing formula. The modernisation will raise capacity from 1, to 4, tonnes of cement a day. Under the contract, Hughes would install about 17, telephone lines. Tdur of the reactors will be the biggest in the world, each weighing 1, tons. Running wild, they can threaten a company's existence. To help you handle your risks, we have instituted the Account Team: This team is dedicated to your industry and wi ensure continuity of service for you company.
Both wanted and unwantet changes it initiates itself. Unfor- tunately, it can also fall victim to unwanted changes. From December, its suppli- ers will: T im Tucker, chief information officer erf ShopKo. Although data warehouses were first developed in the early s, there has been a surge in their popularity over the past few years, as a result of improvements in technology and the increasing need for managers to gain rapid access to information.
Data warehouses make it easier to access and analyse information because they bring together data from a number of systems that sup- port business functions. They arrange the informa- tion in a way that makes it easy to analyse, using such techniques as data-mining, data visualisation and desk- top mapping. It predicts that the proportion of medium-to- large companies with data warehouses will rise from 20 per cent to 80 per cent over the next five years.
The increasing familiarity with data warehousing has allowed suppliers and com- panies to focus on a new issue: Now people are t hinking lees about building a warehouse and mare about how to use it" says David Gittmgs. He -believes that there is pressure to open ware- houses up to a far wider group , of people, inside and oiitside the organisation.
Hie Web is the perfect vehicle for it," says Stewart Holness. The individual user only has to know how to use a stan- dard Web browser, which is relatively cheap and simple to run.
Many companies are likely to see benefits in opening up their warehouses to their employees, suppliers and customers. MicxoStrategy thinks that they could go even further. It argues that many businesses, such as market research companies, credit card issuers, telecom- munications companies, banks and insurance compa- nies have accumulated demographic data that would be of interest to other companies in planning their sales and marketing.
Those companies could allow other companies to access their data warehouses through the Internet. By charging for its use, they could turn a cost centre Into a profit centre, it says. Wednesday of each month step in this direction, by allowing its clients to access its data remotely.
Wilson notes, however, that Axciom is careful about which companies receive its data in this way. It would not distribute data over the Web without vetting the recipients, he says. The question of bow widely data is distributed raises some delicate issues. Consumers may be sensitive about data becoming more widely available; in the US there have been moves to tighten regulations on how consumer data is used.
More generally, companies are nervous about the pros- pect of making corporate data available over the Web, because of the risk that it would allow competitors to gain access to strategic information. But he believes that it can be solved by careful software design. He draws a distinction between the type of corpo- rate information that may be freely, disseminated inside or outside the organisation, and more commercially sensitive data, such as breakdowns of product sales, which should only be accessed by a limited number of employees.
The security measures needed for more confidential infor- mation would add considera- bly to. Another issue that could hinder the take-up of Web warehousing concerns con- gestion on the Internet.
Users of a data warehouse would quickly become frus- trated and disillusioned if it proved difficult to gain access to the Website. But suppliers believe the potential benefits of opening up data warehouses through the Net will outweigh their drawbacks. Many have already designed technology that will allow companies to integrate their data ware- houses with the Web.
In addition to allowing large companies to mine their data warehouses with Web browsers. IBM has pro- posed a service for smaller companies that cannot afford or do not need com- plete data warehousing systems.
They will be able to use warehouses hosted by IBM, fed by data sent to and fro over the Internet. The companies that are getting involved In this mar- ket have high expectations.
David Wells thinks the suppliers' confidence in Web warehousing is justified because the risks and costs of connecting a data ware- house to the Web are lim- ited. Not only is the market ewmil, but the costs of setting up secure Credit-card software were prohibitive.
However, in the past month, off-the-shelf software and. These services mark the coming of age of consumer commerce on the Internet. But Forrester estimates it will be worth Sbn by , and otbers are even more bullish. He points to Trafford Software, which will be the first company to adopt pjpex's service.
In Canada, iStar will take over not only sales and advertising but, through its link with the Canada Post Corporation, distribution as welL The other factor companies must consider before moving online is the. As David Aldridge, a vice-president of iCat, points out. By making it possible for a small team with a well organised distribution network to compete with the biggest retailers in the world, the Internet provides enormous opportunities for specialised groups, Mr Nuttall says. Oxford, says the large retailers should be watching out.
It all started a month ago when my col- lege-age daughter needed a new flatmate. Spurred on by the pros- pect of paying the rent for the vacant room. I eagerly took on the task of checking out these applicants. Since credit reports do not tell much about a year-old. I looked again to the Net Finding these young peo- ple on the Internet and learning about their life- styles proved remarkably easy.
The Handbook of Alternativ Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Sections or of the United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Rosewood Drive, Danvers, MA , , fax It is sold with the understanding that the publisher is not engaged in professional services.
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He is an acknowledged authority on derivative markets and has spent his career writing and publishing about them. He was the editor-in-chief of Futures Magazine and is currently a contributing editor. He has edited and written a number of training courses and books, the most recent of which was The Complete Guide to Electronic Futures Trading published by McGraw-Hill.
Tremont is a global source for alternative investment solutions focused on three specific areas: HedgeWorld provides news and features about hedge funds. Visit Tremont at tremontadvisers. He has had a number of senior management positions with investment management and investment banking firms, including First Chicago Investment Advisors.
He is a director of a number or publicly owned companies including Azteca Foods, Inc. He received his B. He is a frequent speaker at academic and professional conferences, and is a member of the Pacific Pension Institute. He is the author of two leading textbooks in investments and corporate finance. He received his Ph. He is an acknowledged authority on employing direct-marketing strategies in investor relations programs.
Modesitt is chief financial officer of Kern County Resources, Ltd. He has been founding principal of two investment banking boutiques, and was the editor of a highly regarded newsletter on private investments.
Prior to joining Mesirow, Mr. Roberts has more than 18 years of real estate experience, including 11 years in real estate development with a national hospitality firm. He has a M.
His research on managed futures performance was commissioned by the Alternative Investment Management Association in and has been updated frequently. Prior to joining the Council, he held senior positions with a number of financial institutions.
He was deputy chief economist with Chemical Bank and with Merrill Lynch, and was the chief economist of the Conference Board of Canada. We have provided information on the most common investment alternatives employed for diversification and for protection from cyclical dips in the equities and debt markets.
The contributors to this book are acknowledged authorities in their respective areas, and all have had extensive experience in developing alternative investing strategies. Each chapter focuses on the unique attributes of its respective vehicle or strategy: Trillions of dollars are invested throughout the world for retirement plans, endowments, foundations, family offices, and corporations.
The preservation of this wealth is critical to the welfare of the citizens of developed and emerging countries. The theme of this book is wealth preservation. Alternative investments are strategic wealth preservation vehicles and strategies. They are not necessarily speculative. They afford hedging protection and return enhancement when prudently employed. Being informed about the structure and nature of these alternatives is the first step in prudent employment.
A Consideration By Ben Warwick Investment pros have tried numerous methods to protect their clients against the occasionally vicious whims of market volatility. They all lead to one rather unconventional conclusion: Hedge funds and other alternative investments are better suited to generate exceptional returns than their more traditional mutual fund progenitors. Even HSmokey Bear had his problems. In , Americans were in the midst of the largest world war in history. Later dubbed Smokey, the animal became the symbol for fire safety and prevention.
There was only one problem with the campaign: No one seemed cognizant that fire is a natural part of the ecological cycle. That all changed in , a year that witnessed the greatest drought in nearly a century. All that was necessary were a few controlled fires, and the woods would once again be safe for all to enjoy. There was only one problem with this new approach: Land management policies, based on commercial logging and cattle grazing, removed surrounding prairie grasses.
Such grasses encourage moderate fires that tend to burn out quickly. As a result, prescribed burns were hotter, deadlier, and spread much faster than anyone had anticipated. It was supposed to burn acres but was fanned by winds of 50 miles per hour in drought conditions.
It burned more than 47, acres and engulfed homes. About 25, people were forced to evacuate. In an effort to curtail naturally occurring disasters, such as the Russian rubleinspired stock market meltdown or the equally vicious Nasdaq carnage of late , investment pros have tried numerous methods of protecting their clients against the occasionally vicious whims of market volatility.
Much like the Forest Service, it remains questionable whether these attempts have resulted in any positive consequences. Sadly, investment managers have been as unsuccessful in adding value during bull markets as they had during bear market periods.
As a result, actively managed funds have become increasingly correlated to passive indices. What solutions are available to those truly committed to producing excellent risk-adjusted returns? The purpose of this chapter is to describe the components necessary to build an actively managed fund capable of generating consistent, market-beating returns. A return in excess of a broad representation of the U. A return on par with the U. The previous requirements assume that the fund is considered in lieu of an investment in the stock market.
If the fund is to be used as a diversifier in a traditional portfolio, it must be non-correlated with the return of either A Dubious Track Record 3 the stock or bond market. The fund should also generate an absolute return that is large enough to keep from dragging down the performance of the overall portfolio.
As we shall see, the requirements for building such a fund are vexing. Factors at the root of this difficulty include dealing with the issue of idea generation, the problems of asset size versus performance, and the question of determining which parts of the investment landscape are best suited for that most illusive of quarry—tradable market inefficiencies.
This exercise will lead us to a rather unconventional conclusion: This example is much more the exception than the rule: Of course, this period coincided with the most spectacular bull market in history—a point not missed by proponents of active management. The year was the perfect year for evaluating the promise of active management to produce attractive returns during periods of declining stock prices and increased market volatility. Instead of the broad market advances that made indexed funds the investment of choice in the last decade, proved to be a year in which a select handful of stocks performed spectacularly enough to take the market indices to new highs.
So how did active managers fare? Still, investment managers seem to be obsessed with beating the market, even though they often end up defeating themselves in the process. As we shall see, the problem is more with the latter than with the former.
The most common method is the use of company fundamentals in discerning the fair value of a firm. This style of investing was inaugurated in , when the landmark text Security Analysis, by Benjamin Graham and David Dodd, was published. Like many great ideas, fundamental analysis is much easier to perform on paper than it is in the real world.
This is partly due to the large herd of investment professionals who use the method to manage billions of dollars in client assets. The resulting plethora of suspender-clad fund pros chasing the few incorrectly priced stocks that boast enough trading volume to buy and sell in large chunks makes a difficult game nearly impossible to win.
Curiously, the group most enamored with fundamental analysis is its biggest customer. Institutional investors seem absolutely giddy about discussing various fundamentally-based methodologies with investment management candidates. Yet, it seems that this fundamental fetish shared by many big-time consumers of investment advice is a response to the bad reputation of the other school of investment philosophy: Market technicians believe that all of the information necessary to make a valid buy or sell decision is contained in the price of the security in ques- A Costly Conundrum 5 tion.
As a result, an examination of sales growth, profit margins, or other company-specific metrics is deemed to be unnecessary for predicting stock price movement. A cursory examination of price trends, trading volume, and other market indicators is all that is necessary, proponents of the approach argue.
Even though security prices have an occasional tendency to move in trends, the financial witchcraft associated with technical analysis is anathema to the gatekeepers of pension assets and other sizable pools of money. Perhaps my investment manager is not keeping up with the market indices, these investors seem to be thinking, but at least they are not reading price charts. Unfortunately, this evidence amounts to a molehill compared to the mountains of data that suggest the market-beating potential of human intervention in the capital markets—regardless of the approach used —is close to nil.
When one examines just how good his or her forecasting ability must be, the difficulty in generating market-beating returns takes on a particularly astringent taste. On the flip side, one could make a large number of prescient but less accurate predictions. Note that the depth requirement dips dramatically as the number of useful insights approaches The curve only begins to flatten out as the number of good ideas passes A natural conclusion after examining Figure 1.
After all, how can one generate such a large number of investable ideas without a cadre of highly trained professionals? Judging by the vast increase in hiring by securities firms, this line of thinking is hardly original. The numbers become even more staggering for experienced players. Some forward-thinking firms with the need to decrease their per-thought costs have sequestered at least part of their decision-making needs to computers.
Quantitative models are excellent at sifting through mountains of economic and company-specific data, of course, but human intervention in the form of programmers is necessary to make this possible. As a result, computers have minimized —but not completely eliminated—the cost problems associated with generating the next great investing idea. Much has been written about the decreasing levy charged by brokerage firms in the past few years, which has served to vastly increase the vol- The Real Problem 7 ume of trading on domestic exchanges.
However, it is the other costs associated with buying and selling securities that is most troubling among market professionals. One of the most egregious is market impact, which is defined as the difference between the execution price and the posted price for a stock. Market impact can be substantial and is often quite large at the worst possible moment. In fact, the spread could widen so much that the manager may decide that, based solely on market impact, the trade is simply not economically feasible.
Managers are thus forced to hold a position they do not want, which prevents them from using the cash gained from the transaction to buy a stock they do want to own.
According to Charles Ellis, author of the classic tome Investment Policy, active managers would have to be correct, on average, more than 80 percent of the time to make up for the implementation costs incurred in active trading. Unless market pros can get a grip on the onerous effects of such costs, the odds of generating market-beating returns appear quite slim.
This one fact explains why so many investment managers are called to greatness. The most effective solution—limiting the amount of client assets that they are willing to accept—seems an abomination to many. However, by directing a relatively modest-sized portfolio, there is no doubt that advisors are able to implement their market strategies in a more effective manner. Investment firms are barking up the right tree when they obsess about minimizing their transaction costs.
If managers think that they have truly found a way to generate market-beating returns—be it through fundamental analysis, technical analysis, or a combination of the two—the trick is to maximize their fee revenue per unit of client assets under management. This solution can take many forms. Some market pros may want to manage a much larger pool of client monies. In this view, managers assume that their revenue which would consist solely of an asset-based fee in this model is as dependent on their marketing acumen as it is on their breadth of market knowledge.
Managers with a bit more ingenuity might decide to cap the amount of client assets they are willing to oversee. In return, they demand higher fees per dollar under advisement. This usually takes the form of a performance fee, which enables managers to profit from the success of their trading activities. This latter course of action is commonly packaged in an unregulated pool of client assets referred to as a hedge fund. Such vehicles have the additional advantage of giving managers the freedom to express themselves in any way they deem most prudent in the capital markets.
This lack of regulatory constraint is lauded by some and derided by others. It should be noted that the hedge fund alternative is only rational if the investment pro is truly generating positive alpha. Unfortunately, a plethora of non-rational money managers have decided on this approach. It seems that David Ricardo tilled the soil of his intellect quite well indeed.
He left school at the tender age of 14 to pursue his career as a speculator. By his mids, he had amassed a fortune on the stock market. He retired from business at the age of 42 and spent the remainder of his life as a member of Parliament. This law became the foundation of the free-trade movement, which set Great Britain on the course of exporting manufactured goods and importing raw materials.
As we will see, this idea forms another important topic for alphaproducing investment managers—whether to specialize in a given style or sector of the market or branch out to include other strategies. Andrew Lo and A. When they began examining stock price changes in , they were shocked to find a substantial degree of auto-correlative behavior—evidence that previous price changes could have been used to forecast changes in the next period. Their findings were sufficiently overwhelming to refute the Random Walk Hypothesis, which states that asset price changes are totally unpredictable.
The most important insight from their work occurred when they repeated the study 11 years later, using prices from to In stark contrast to their earlier finding, the newer data conformed more closely with the random walk model than the original sample period.
Upon further investigation, they learned that over the past decade several investment firms—most notably, Morgan Stanley and D. Shaw—were engaged in a type of stock trading specifically designed to take advantage of the kinds of patterns uncovered in their earlier study. David Shaw, a former computer science professor cum investment manager, reported similar market exploits.
When he founded D. Shaw and Company in the early s, a number of easily identifiable market inefficiencies could be exploited. According to him, increased competition caused many strategies to disappear. However, as an early adopter, he was able to use the profits earned from this prior trading to subsidize the costly research required to find more market eccentricities.
There lies the rub. Specialists who limit themselves to one particular market anomaly may soon find themselves out of a job if they do their job correctly in the first place—that is, if they mine a market inefficiency to its extinction.
It is much better to use profits from such a discovery to underwrite further financial expeditions in other areas of the investment universe. One such grotto may be the universe of small cap stocks. As a result, an opportunity appears for savvy buy-side analysts to pick the next diamond in the rough. Some evidence supports this view, as nearly one-half of all small-cap domestic mutual funds have exceeded the return of the Russell Index over the last five years.
Perhaps this is one rip in the efficient market veil that will take a while to mend. The failure of analysts to keep up with the major market indices has been widely explained by the conflicts of interests inherent in such an environment. Many believe that the dramatic underperformance of analyst recommendations is due to the conflicts of interest that arise when the Wall Street firms act as investment bankers to the companies their analysts cover. That certainly explains part of the problem; another issue less commonly raised is the tendency for analysts to act in herd-like fashion, recommending one stock in near unison.
The thinking that perpetuates such actions is simple: That same thinking is rife in the investment management business. Job security is preserved if the returns of mutual funds are sufficiently close to the market indices and tightly clustered so that mistakes cannot be easily discerned. I believe that these behavioral biases explain why traditional mutual funds with asset-based fees have produced mediocre results over the years.
Simply put, the managers of these funds are not motivated to generate the best possible return; they are paid to follow the indices and not rock the boat. As Ricardan thinkers, alternative investment managers have an entirely different view of their role in the investment process. Hedge fund managers are a good example. Hedge fund fees encourage exceptional performance, while the commonly high amount of manager investment in the fund serves as a stopgap measure against excessive speculation.
A further incentive to performance is the widespread practice of limiting the amount of funds under management. Transparency issues, liquidity issues, and the tendency of convergence strategies to correlate highly during tumultuous market periods are all important topics worthy of discussion.
However, in our experience, they fulfill an important objective in client portfolios—the generation of market-beating returns. The often trumpeted spectacular successes of the likes of George Soros and Julian Robertson over the last two decades, contrasted with the dramatic losses of Long Term Capital Management and others in , have done little to advance understanding of an industry frequently shrouded in mystery.
Indeed, these examples have only fueled wild speculation and misconceptions, much of it press-driven, that hedge funds represent the ultimate roulette table for a chosen few. This perception, however, is inconsistent with the reality that hedge funds have remained one of the fastest growing financial sectors, experiencing unprecedented growth throughout the s.
This chapter will show that hedge funds can produce superior riskadjusted returns. We recognize that statistical results are routinely discounted by cynics who attribute these results to convenient curve-fitting or optimization. However, we contend that the results are not a statistical aberration but rather the result of the inherent source of return in the asset class. These terms are augmented by the positive selection of alpha intrinsic in the structure of all hedge funds.
Hedge funds are paid to trade —and have the incentive to do so—when others cannot, will not, or need to be on the other side. However, we recognize certain exceptions in niche markets and where it is difficult to implement a short position—for example, specialist distressed securities and high yield managers.
In , when Alfred Jones established the first hedge fund in the United States, the defining characteristic of a hedge fund was that it hedged against the likelihood of a declining market.
Hedging was employed by businesses as far back as the 17th century, mainly in the commodity industries where producers and merchants hedged against adverse price changes. In his original hedge fund model, Jones merged two speculative tools—short sales and leverage—into a conservative form of investing.
Short selling was employed to take advantage of opportunities. Jones used leverage to obtain profits and short selling through baskets of stocks to control risk.
He believed that during a rising market, good stock selection would identify stocks that rise more than the market, while good short stock selection would identify stocks that rise less than the market.
However, in a declining market, good long selections will fall less than the market, and good short stock selection will fall more than the market, yielding a net profit in all markets. He set up a general partnership in and converted it to a limited partnership in Although his fund used leverage and short selling, it also employed performance-based fee compensation.
Each of the previous characteristics was not unique in itself. What was unique, however, was that Jones operated in complete secrecy for 17 years. By the time his secret was revealed, it had already become the model for the hedge fund industry. Introduction 15 Jones kept all of his own money in the fund, realizing early that he could not expect his investors to take risks with their money that he would not be willing to assume with his own capital.
Curiously, Jones became uncomfortable with his own ability to pick stocks and, as a result, employed stock pickers to supplement his own stock-picking ability. In , Jones hired another stock picker to run a portion of the fund. Soon, he had as many as eight stock pickers, autonomously managing portions of the fund. By , at the age of 82, he had created the first fund of funds by amending his partnership agreement to reflect a formal fund of funds structure.
The so-called hedgers were, in fact, long leveraged and totally exposed as they went into the bear market of the early s. During this time, many of the new hedge fund managers were put out of business.
As Jones pointed out, few managers have the ability to short the market because most equity managers have a long-only mentality. During the next decade, only a modest number of hedge funds were established. In , when Tremont began tracking hedge fund managers, it was able to identify a mere 68 funds. Fifteen years later, TASS, the investment research subsidiary of Tremont, was tracking 2, funds and managers including commodity trading advisers.
Most of these funds had raised assets to manage on a word-of-mouth basis from wealthy individuals. Not only were they outperforming in bull markets but in bear market environments as well. The press began to write articles and profiles drawing attention to these remarkable funds and their extraordinary managers.
Because of this, they were prohibited from advertising, relying on word-ofmouth references to grow their assets. The majority of funds were organized as limited partnerships, allowing only 99 investors; the hedge fund managers, therefore, required high minimum investments. In the United States and Europe, the hedge fund industry of the s was an exclusive club of wealthy individuals and their private bankers.
Hedge funds currently represent one of the fastest growing segments of the investment management community. During the s, the number of funds increased at an average rate of The reason for the unprecedented growth is simple: Having attained significant personal wealth as fund managers or proprietary traders, the talented managers are leaving large companies to manage their own money.
They are establishing simple, corporate structures with limited employees and forming funds with absolute and risk-adjusted return objectives. These funds typically charge performance fees, usually 20 percent of the profits.
By limiting the size of assets under management, these companies can react quickly to events in the financial community, trading without impacting share prices. During the s, the flight of money managers from large institutions accelerated, with a resulting surge in the number of hedge funds see Figure 2.
Their fledgling operations were funded, increasingly, by the new No. Size of the Industry 17 wealth that had been created by the unprecedented bull run in the equity markets.
Almost all invest a substantial portion of their net worth in the fund alongside their investors. The s saw another interesting phenomena: A number of the established money managers stopped accepting new money to manage; some even returned money to their investors.
Limiting assets in many investment styles is one of the most basic tenets of hedge fund investing if the performance expectations are going to continue to be met.
This reflects the fact that managers make much more money from performance fees and investment income than they do from management fees. Lack of access to certain established funds created a large funds of funds business. A fund of funds offers a wide array of managers for a lower minimum investment while providing oversight and monitoring of the investment.
As in the mutual fund industry, where more funds than stocks exist on the New York Stock Exchange, one day there may be more funds of funds than individual hedge funds. Although many of the original and truly great hedge fund managers may no longer be available to investors, the market continues to be well supplied with newcomers.
We estimate that there are more than 5, funds in the whole industry. However, in excess of 90 percent of the U. About one-third of the funds but more than 90 percent of the fund managers are domiciled in the United States see Figure 2. There are a number of reasons for this: The hedge fund industry has evolved in a culture of secrecy. This secrecy was mandated in the United States for statutory reasons, and hedge funds are neither allowed to advertise nor to hold themselves out as investment opportunities to the public.
Further, the culture of secrecy stemmed from the fact that most hedge funds either carry short positions or operate in unlisted securities. British Virgin Islands Fund managers domiciled in the United States 2. Hedge funds in the United States are almost always structured as private limited partnerships. So are many other forms of non-public investment designed for the sophisticated investor. It is not unusual for private, nonSEC-registered funds to be included, accidentally or otherwise, in the overall hedge fund count.
Primary Investment Categories of Hedge Funds 19 3. Although more than 80 percent of the total assets under management in the industry are invested in the equity markets, the investment disciplines used are diverse and distinct.
Tremont and TASS have defined 10 primary investment categories in the hedge fund industry: All asset figures in the sections below are as of December The objective is not to be market-neutral. The manager has the ability to shift from value to growth; from among small-, medium-, and large-capitalization stocks; and from a net long position to a net short position.
The strategy may hedge with options and futures. Convertible Arbitrage This strategy is identified by hedged investing in the convertible securities of a company. A typical investment position is long the convertible and short the common stock of the company issuing the convertible. Positions are designed to generate profits from the bond and the short sale while protecting principal from directional market moves.
Hedge funds may limit their activities to a single market such as the United States or they may invest globally. There are two components to the overall return from a convertible arbitrage position: The static return is comprised of the coupon from the convertible bond plus the interest rebate on the cash from the short sale minus the dividend on the underlying short stock.
The volatility return is comprised of profits generated by short-term position adjustments of the short stock position. Adjustments are necessary to account for the changing ratio of stock needed to hedge the underlying convertible bonds as prices fluctuate. Leverage may be employed to augment both the static and volatility return.
Convertible arbitrage represents 5. Event-Driven This strategy is categorized by equity-oriented investing designed to capture price movement generated by an anticipated corporate event.
The Eventdriven category primarily includes: It also includes Regulation D Reg D investing and high yield investing. Event-driven represents 19 percent of all assets under management.
Risk Arbitrage Risk arbitrage specialists invest simultaneously in long and short positions in both companies involved in a merger or acquisition. Risk arbitrageurs are typically long the stock of the company being acquired and short the stock of the acquiring company.
The risk to the arbitrageur is that the deal fails. Risk arbitrageurs seek to capture the price differential between the stock of the target and the stock of the acquirer. Profits result as the price of the target stock converges with the stock price of the acquirer. Distressed Securities Distressed securities funds invest in the debt, equity, or trade claims of companies that are in financial distress, typically in bankruptcy.
In this context, distressed means companies in need of legal action or restructuring to revive them, not companies in need of some approved medication.
These securities generally trade at substantial discounts to par value. Hedge fund managers can invest in a range of instruments from secured debt at the low end of the risk scale to common stock at the high end of the risk scale.
The Handbook of Alternative Investments (Wiley Finance)
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