Hedge funds in its immediate context are the investment portfolio that are aggressively managed by hedge fund managers and more often uses a much more advanced strategies of investments. These strategies could fall under leverage, derivative instances, the long or the short ones which more often happen in the international and domestic markets. They mainly have a profound objective and goal of generating considerably high returns either in a specific niche of market or invariably in absolute terms. In the legal terms, the hedge funds are in most cases set substantially as partnerships of private investments that are very much open to a ranger of investors (Erickson, 2014).
These investors come together accumulate funds and then let it be managed by a professional; hedge fund manager. To this effect, they advertently require large initial capital investment, which is usually provided by the private investors themselves. These large pools of money generated by these investors are largely not regulated. In comparison with the mutual funds, the hedge funds do not at all take long positions to sometimes make use of the derivatives and also are not allowed to borrow (Edesess, 2014). It is estimated in Australia that about 68% of these hedge funds use the leverage and 20% were borrowed. We have to also acknowledge the fact the hedge funds have a short simple lifespan of about three and a half years and they invariably appear to depict highly opportunistic nature in terms of investments. This in itself makes it to be in a platform of making more gain at the same time bringing for an avenue of risk in different stances (Bargman, 2014).
In this paper a great exploration into the return and risk performance of the various strategies employed in the management of the hedge funds. To be more specific, we examine the various characteristics of the numerous investment strategies, the risks that they are exposed to and also the return adjusted to such strategies (Erickson, 2014). From this critique you will definitely find that the there is a low relationship involving the returns on the hedge funds and the market. Hence in the field of diversification, hedge funds would depict a higher stance of potential investment opportunities (Edesess, 2014).
We would explore application of the equilibrium models such as CAPM, and the Asset pricing model and the fama and French model to determine the performance of such investment portfolio. We would also narrow down to the Woolworths Limited (WOW), Oil Search Limited (OSH) AND Telstra Corporation Limited (TLS) located in Australia (Erickson, 2014). Here we posit for one that the investors of these hedge funds depicted highly sophisticated stance in their decisions and that they are rationally thinking in terms of their investment goals and achievements. In this sense we hypothesize that strategies of investments are therefore based on the thorough quantitative analysis and modeling, very much have low beta risk exposure and for that matter are likely to bring forth higher positive and Sharpe ratios (Edesess, 2014).
Why categorize the portfolios into long buying and short selling
To define the long and short position, it is investment plans to buy stock that are expected to appreciate and sell the stocks that in the near future are anticipated to decline in value (Erickson, 2014). To this effect the main reason for including both the stances is to depict the preferably popular variation of this short /long model is to really get to understand the gist of the a matter that due to various stocks that are encompassed within a specific sector tending to connotatively move up and down in some set of pattern of unison, we intend to investigate what happens when different sector are used and the various short long stances that are depicted in this ordeal. For instance, at the point when the interest rates are rising, a hedge is likely to short sectors that are interest sensitive sectors such as utilities, and definitely buy stock on defensive strategies like the health care ( Scharfman, 2014).the companies; Woolworths Limited (WOW), and Oil Search Limited (OSH) will be categorized as short strategy and the Telstra Corporation Limited (TLS) categorized into long strategies.
The investment strategies
There different types of investment strategies that are used in the in the field of hedge fund investments this depends on the various factors that comes with the situations of investments (Erickson, 2014). These include;
The convertible arbitrage strategies which in essence revolves around buying the convertible securities and trying to hedge those buying positions by going short on the underlying common shares. This strategy basically capitalize the instinctively embedded option in these bonds by buying the land selling the equities
The fixed income strategy; this in essence takes opportunistic behavior on the changing prices of the different types of the income securities which are fixed at the same time they tend to minimize their exposure to risk that comes with the interest rates. The event driven strategies which basically, try to predict the happenings of the corporate events and try to take the necessary actions and positions make profits (Edesess, 2014), These and many more strategies will help us know the best strategies to use and also the best performance that we can rely on.
Empirical results and analysis
The alpha for the Woolworth stands at 3.12% , for the oil search limited, it stands at 2.12% and for the Telstra Corporation Limited (TLS it stands at -1.32%. looking at these results, the Woolworth company is ranked first in terms of performance ;followed by the oil search company and lastly the Telstra Corporation Limited (TLS) a close look at the Woolworth company , it has outperformed –the benchmark index by 3.12%, this a great move by the management who have tried their level best to –ensure the great performance by adding more value to the returns. This is clear indication also that they have used a proper hedging strategy to hedge the price volatility. On the part of the Telstra Corporation Limited (TLS), the company has underperformed by below the benchmark –by 1.32%, the management therefore need to beef up their management techniques since this scares away the potential investors to their stocks. The first two companies have a considerably beta alpha. (Farleigh, 2005).
Analysis of industry portfolio
The portfolio that contains the three companies has alpha of 2.35% this in itself is a good gesture since it indicates that it has outperformed the stipulated benchmark by 2.35%, the managers of the portfolio therefore has shown a strong indication that they have added much value to the portfolio itself. For the two companies that have gone short, that is the Woolworth Company and the oil search company their portfolio alpha is 3.11% which is an indicative effect that their performance is good and that it has outperformed the benchmark by a greater percentage. Looking at the alpha for the portfolio of the companies that have gone long, their alpha stands at -2.43% this is in itself an underperformance below the stipulated benchmark. From this we can clearly accentuated that the companies that go long, always encounter much performance risks because the prices are always quite volatile and at the same time the range of hedging techniques are quite small.
Portfolio risk analysis
From our findings, considering two company portfolios for the oil search company and the Woolworth Company which have gone short, their standard deviation is 0.042325 and a Sharpe ratio of 0.051112. For the companies that have gone long, that is the Telstra Corporation Limited (TLS) its standard deviation is1.326 with a Sharpe ratio of 1.4. the overall portfolio risk stands at 0.000456. (Erickson, 2014). The combination with the lowest standard deviation was Woolworth limited and the oil search company this in itself is a clear indication that this portfolio is evidently having a lower risk as compared to the portfolio of the companies that go long which are quite risky to venture in because they indicate an instinctively higher risk . The analysis here could simply mean that in the event of diversification in terms of investments, a potential investor should opt to invest in the Woolworth limited and the oil search company. This is because at these companies the general risk involved in them is very low (Scharfman, 2014). Looking at the general portfolio risk for the three companies which stands at 0.000456, the risk involved here is far much less and this forms a good gesture that the one is able to invest without fear of loss in this kind of portfolio basing our argument of the results outlines.
Risk influence on hedge fund
The wholesome of investigations and statistics indicates that most of the well known strategies to hedge fund investment have in most case depicted a non linear correlation in terms of risk and return. This is clearly manifested and outlined the betas that have been calculated thereof on the option based factors of risk that revolves around these companies (Erickson, 2014). Taking a particular case, the invariable payoffs of the events like the arbitrage, event driven, the restructuring, the convertible arbitrage strategies and the relative value arbitrage strategies resembles that of the probable writing of a put option that is depicted the market index, to this effect, it may lead to these investment strategies vary proportionately with the economic actives that occurs in the realms (Edesess, 2014)..
This in turn could mean a huge lose of investment during the tough economic times since there will be direct relationship between these stances, such that the equity value would go down. Or it may be caused by the investment manager who on their effort to up their game as indicated by the Sharpe and response to their incentive contract, goes ahead and considerably creates either directly or indirectly more often through dynamic trading , a payoff that is most definitely similar t that of writing a put option (Farleigh, 2005). The events of risk vulnerability in the arbitrage and the value of relative arbitrage estimated can is also consistent with findings and the research of the Mitchell and Pulvino and goetzmann whose instinctively use thorough and detailed methodology to discern the risks and return of these strategies.
Persistence in the hedge fund returns
Most Financial managers characteristically evaluate the previous investment yield for various hedge fund officers, with a perception that, previous investment success would be a good forecaster of forthcoming success (Farleigh, 2005). We took time and tested this hypothesis by looking at whether victors in the investment arena tend to replicate their success in the future years .from the statistical data analysis carried out about this hypothesis, it is came out clearly that there is indeed a higher correlation between the firms with higher returns and their past performance because they have advertently built a strong portfolio of clientele base, they have also got variety of experience in terms of employee management, the customer base and reputational risks are also very low owing to the fact that they have experience good performance in the past( Scharfman, 2014).
An examining into the data provide by the Woolworth limited and tesla limits calculation data analysis was carried out where we measured the hedge fund’s alpha which we assumed as the return that was from the hedge fund then we subtracted the mean return for all the hedge funds and maintaining the following of the same strategy (Farleigh, 2005). The action of the parametric and consequently various evaluations that are not parametric of sector year performance consistency were done. The results reflected that there is substantial amounts of consistency from quarter one through to quarter four for the January year of 1994 to December 1998. The HFR database from which this data was coined is well known to be documented having a considerably lower attrition rate, however, and also to encompass far failed funds than other databanks (Scharfman, 2014).
In conclusion it is an indispensible fact that the risk and the returnee of each and every company is at a trade of to each other. This is because they depict an inverse relationship to each other. The beta values of the company portfolios that depict the risk involved I the investment therefore tries to bring out some of the ventures that could be considerably profitable in various stances. It is a fact that as the beta values rise more risks are involved. We find the Woolworth Company less risky in terms of investment because of the lower beta. The study of risk and return trade off therefore gives us a clear platform to discern the best investment practice to explore.
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