Hedge Funds and Managed Futures
Strategy map
Hedge funds are pooled, lightly regulated vehicles using long/short positioning, leverage, and derivatives. Map each strategy to its return driver: equity long/short (stock selection plus net and gross exposure), event driven (merger arbitrage, distressed, activism), relative value (convertible arbitrage, fixed income arbitrage, statistical arbitrage), global macro (directional views on rates, FX, commodities), and managed futures or CTAs (systematic trend following, often showing crisis-alpha behavior).
Know the mechanics: '2 and 20' fees with a high-water mark and sometimes a hurdle, plus lockups, gates, notice periods, and side pockets. Gross exposure equals longs plus shorts; net exposure equals longs minus shorts.
Traps
- Computing incentive fees without deducting the management fee, or without first clearing the high-water mark.
- Assuming market-neutral means zero risk. Low net exposure still permits high gross exposure and leverage.
- Confusing a hurdle (minimum return before fees) with a high-water mark (recovery of prior losses).
- Ignoring backfill, survivorship, and stale-pricing biases in hedge fund indices.
- Believing lockups protect investors; they mainly protect the manager's capital base.
Worked example
A fund starts at $100 with a 2% management fee, a 20% incentive fee, and a $100 high-water mark. It earns 20% gross. The management fee is $2.00, leaving $118.00. The incentive fee is 20% x ($118 - $100) = $3.60, so net value is $114.40, a 14.4% net return. If the next year returns -10%, ending value is $102.96 and no incentive fee is paid until the value again exceeds $114.40.