Research Proposal on "Performance Evaluation of How Hedge Funds"

Research Proposal 80 pages (19967 words) Sources: 25

[EXCERPT] . . . .

Performance Evaluation of How Hedge Funds Can Be Used to Augment the Overall Efficiency in German Pension Funds

Much attention has been given to hedge funds over the last few years, but the industry itself remains to a large degree, opaque. A lack of clarity and understanding of how these funds work, what they do, and how they can be used in conjunction with other kinds of funds is at the forefront of the knowledge and beliefs of most people when it comes to these funds.

High and unseen risks are involved when investing in these vehicles. However, the returns generated have attracted the attention of a growing number of institutional investors, including those who work with pension funds. Past studies have suggested that investments in these risky vehicles can improve the return expectation of a portfolio.

For pension funds, the results have shown that even small investments in hedge funds can generate a more efficient portfolio, but the numbers of hedge funds that fail each year is high. In the current financial crisis, the growth trend in the hedge fund industry has halted and is now showing signs of decline. This puts into question whether investing in hedge funds really is a wise decision. Some investments will bear fruit whilst others will have to be written off as losses.

This study looks at pension funds and how hedge funds can be used in order to augment and supplement their efficiency. Whether this can be done is a topic for debate, because hedge funds have not performed as well in recent years as they did in the past. In addition, they can be confusing and hard to understand for a lot of people, so many individuals are n

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ot comfortable using them as an investment vehicle.

The objective of the study is to look carefully at hedge funds and how they work, as well as pension funds and how they work, in order to determine whether they are actually a good fit for one another.

In order to do this, data will be analyzed that will show the performance of both of these vehicles and explain their inner workings more carefully. From that data, both quantitative and qualitative information can be collected and conclusions can be drawn.

TABLE OF CONTENTS

iiiABSTRACT

vLIST OF ILLUSTRATIONS

1 CHAPTER ONE: INTRODUCTION

Statement of the Problem

Problem Driver

Importance of the Study

Hypothesis

Objectives

Rationale for the Study

Methodology and Overview

10 CHAPTER TWO: REVIEW OF LITERATURE

What are Pension Plans?

What are Pension Funds?

What are Hedge Funds?

Using Hedge funds in pension funds

Investment Risk

Pension Funds, Hedge Funds, and Risk Management

Type and Number of Assets

Management Risk

Hedge Fund Databases

46 CHAPTER THREE -- RETURN AND RISK MEASUREMENT METHODS

Measuring Returns

Modern Portfolio Theory

Standard Deviation / Variance

Coefficient of Variation

Sharpe Ratio

Volatility Attribution Model

Marginal Contribution to Volatility

Inclusion of New Assets in a Portfolio

57 CHAPTER FOUR: EMPIRICAL ANALYSIS

Types of Pension Funds

Types of Hedge Funds

Method

63 CHAPTER FIVE: CONCLUSION

Findings

Limitations

Conclusion

Suggestions for Future Research

72 BIBLIOGRAPHICAL REFERENCES

80 APPENDICES

Table 2.1 The use of leverage by the different hedge fund styles as of December 2001

3

Table 5.1 Preliminary Calculations

69

Table 5.2 Sharpe ratio and 1 / Coefficient of Variation comparison

71

LIST OF ILLUSTRATIONS

Figure 2.1.1

The master / feeder structure

39

Figure 2.2

Security market line (SML)

44

Figure 3.1

Removing unsystematic risks through diversification

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CHAPTER ONE: INTRODUCTION

Statement of the Problem

The issue of hedge funds is one that has been misunderstood for many years. There are individuals that study these funds and discuss how significant they are for investing, and there are others that see them as some kind of risky endeavor that is really not important enough to focus on or that should be avoided. Both of these are valid points-of-view but, in recent years, it has generally been accepted that hedge funds are growing in popularity, and that the study of them is important, especially when it comes to considering them as investment vehicles that tie into pension funds. For a study such as this one, it is important to discuss hedge funds, but it is more important to look at how hedge funds affect pension plans and whether they are a good or bad investment vehicle. To that end, both hedge funds and pension funds must be discussed and understood well.

There has been dramatic growth in hedge funds over the last ten years. This growth is shown both in terms of assets under management and in the number of funds. The assets under management in hedge funds have grown from U.S.$40 billion in 1990 to U.S.$600 billion in 2003 (Schachter, 2004) to over U.S.$2.65 trillion as of April 2008, according to Hedge Fund Intelligence (2008). The numbers of hedge funds that currently exist, however, is difficult to obtain. In 2003, industry reports estimated that there were around 6,000 hedge funds worldwide. Both Schlachter (2004) and Lhabitant (2004) concurred with those figures. According to Hamilton (2008), there were 10,000 registered hedge funds in the Cayman Islands alone as of June 2008.

Over the last few years the growth of hedge funds has been dramatic, and the hedge fund industry has experienced a number of changes as the motives to invest in these vehicles have evolved over time. In the 1990s, according to Borla and Masetti (2003), money managers from big institutions defected to the world of hedge funds in pursuit of an ostentatious life style. They invested a large portion of their own financial wealth into their own funds in the hopes of generating a high return by finding niches to generate so called 'absolute returns' while limiting their portfolio risk. The effectiveness of these processes however is questionable due to the opacity of the hedge fund industry.

As hedge funds invest in a vast array of different instruments which include securities, options, futures, and other derivative instruments, standards for risk and return measurement have yet to be defined. Furthermore, the existing hedge fund databases are affected to a greater or lesser degree by several biases and inaccuracies. This raises the question of whether hedge funds are suitable investment vehicles for pension funds, or whether they subject the pension fund owners to too much risk.

Problem Driver

The issue driving this study is to not only show the seriousness of the problem in question, but to come up with ideas that will help to show how this problem can be reduced in size. The best way to do this is to first analyze the problem to determine just how serious it actually is, and then use that seriousness as a wake-up call for those who have been looking the other way and avoiding dealing with the issue. Many pension fund managers are believed to have done this because they want to ensure that they get good commissions, but when they do not fully inform their clients about hedge funds it can end up being detrimental to all of the parties involved.

Hedge funds are relatively unregulated, as they are typically structured in such a way to benefit from the majority of regulatory exemptions. This allows those who work with hedge funds to pursue broad investment policies and encompass a wide variety of asset classes, with no strict limits on leverage, shorting, and the use of derivatives. The financial regulations set in place for other types of institutional markets essentially pursue three objectives:

To protect the investors from abuse and default through licensing / registration, minimum disclosure requirements and increased transparency.

To reduce systemic risks while ensuring soundness and integrity of the financial system by imposing capital adequacy and margin requirements.

To ensure market price stability though position limits / trade practice restrictions (Lhabitant, 2002).

Only a few advanced countries, such as the U.S. And Europe, have basic regulations for hedge funds. These regulations encompass aspects such as which investors are allowed to invest in hedge funds and the size limits that are placed on unregulated hedge funds. Due to the lack of regulation, hedge fund managers are accorded broad freedoms with respect to transparency as well as the risk and return profile of the hedge fund strategy to be pursued, potentially to the detriment of those who are expecting to see their pension funds continue to grow (Lhabitant, 2002).

Hedge funds are often associated with the pursuit of absolute return strategies. The term 'absolute return' refers to managers exploiting investment opportunities, while protecting their principal investment from potential financial loss. Long positions are secured by selling short, buying futures, options or by using other financial instruments to secure their investments (Ineichen, 2003). The combination of the misnomer 'hedge fund' and the idea that hedge funds will produce returns regardless of the direction of the larger market can greatly deceive investors. As the number of funds multiplies, the quest for earning absolute returns means taking aggressive positions that leave the fund exposed to… READ MORE

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Quoted Instructions for "Performance Evaluation of How Hedge Funds" Assignment:

“

I have already written my thesis (which i will be sending to you), however the critic was:

1) it was in its structure TOO descriptive and should have been more analytical.

2)I did not take into consideration how a pension fund really works.

3) In terms of leverage i was too opaque

4) My problematic was not clearly defined

5) My hypothesis was poor

6) Questioning the added value of my paragraphs

7) No thread and transition

8) My data was not correctly presented

Therefore it has to be completely rewritten. feel free to make any changes you deem necessary.

Should you require more time DO NOT HESITATE to ask for it!!!

My deadline is the 26th of August.

Please do not plagiarize as computer verifications will be made using e.g. past thesis / Internet / certain books. I am not sure how it works so please be careful.

The data i used are either the monthly performance or net asset value of hedge funds and pension funds. This data should be used and will be sent by email in form of an excel.

The calculations made using the monthly performance and net asset value can be used or redone completely.

The efficient frontier graphs were deemed as unlogical by my *****. Please develop them or replace them altogether.

I will require the excel with the calculations made that are presented in the thesis!!!

Starting Monday You may contact me via email.

Should there be any problems, please contact me ASAP. Should you need more time to make it better, please contact me ASAP this can be given in exchange for proof that some of the work has already been done. I am not unreasonable and can be negotiated with.

Should you have any questions AT ALL please contact me via email.

The Guideline for the thesis were as follows:

The following elements must figure in the graduating project, in this order:

- Cover page

- Title page

- Oath of personal nature of work

- Information page on the companies met

- Confidentiality (if necessary)

- Summary/Abstract

- Table of contents

- List of tables

- List of illustrations

- List of abbreviations

- List of symbols used

- Glossary

- Introduction

- Main body of text including literature review, methodology, results

- Conclusions and recommendations

- Bibliographical references

- Detailed bibliography

- Appendices

III.2.1 *****“ Title Page

This is the first page of the graduating project. It takes the same form as the cover, but is printed on ordinary paper.

III.2.2 *****“ Acknowledgements

If necessary or demanded, you must thank the organisations or people who helped or supported you in your project. This is particularly important if a third person made a contribution. You should specify this contribution here.

III.2.3 *****“ Summary / Abstract

The summary should not exceed a page in length and should be presented with single interline spacing. It should relate the main points of the project in terms of objectives, context, approach, results and conclusions.

Be careful! A summary is not an introduction.

III.2.4 *****“ Table of contents

The table of contents shows the relative position and the page numbers of ALL the elements in the graduating project *****“ from page 1, the title page, to the last appendix. All the main sub-chapters are generally included here too. It is not normally necessary to include all the titles of the different sections in the text; all depends on the length and the complexity of your graduating project. To guide you, remember that a table of contents should not go over 3 or 4 pages. If the table of contents is longer, then you have included too many details.

III.2.5 *****“ List of tables

Tables are useful to summarise data and results. Each table must be numbered and referenced in the text. The number, the title and the page number of each table are grouped together in the list of tables.

III.2.6 *****“ Table of illustrations

On the page following the table of contents, the table of illustrations summarises each illustration number, its title and its page number.

III.2.7 *****“ Table of acronyms and abbreviations

If you wish to use acronyms and abbreviations frequently in your text, you should think about including a list of all abbreviations and their meanings, presented in table-form.

III.2.8 *****“ Table of symbols and units

If symbols are used frequently (for example financial symbols), it is useful to regroup them in a table with their definitions.

III.2.9 *****“ Glossary

If technical terms that are specific to an industrial sector, to a company or to a project field are used frequently, it may be useful to regroup them in a glossary.

III.2.10 *****“ Introduction

This section presents the subject, the problem, the objectives and the plan of the graduating project. The introduction must be concise.

III.2.11 *****“ Main body of text

The body of the text will be sub-divided into chapters or sections. As an indication, the length of the text should be between 20,000 and 25,000 words and should not exceed 30,000 words, for the main body of the text.

To obtain information on the body of the text, look at section 11.3

In the main body of the text, think about careful layout. Good organisation and coherent progression between the different sections is vital. This includes introductions, transitions and conclusions which link different themes and ideas to be developed.

III.2.12 *****“ General conclusions

This section is presented in the form of a series of affirmations in logical order (*****which can be deduced*****) from the data presented in the body of the text. These affirmations are the logical consequence of analysis and discussion which you have presented concerning the work undertaken.

III.2.13 *****“ Bibliographical references

The list of references appears immediately after the conclusions. All authors (whether the reference is to a book or an article) are listed in alphabetical order, indicating for each work, the name of all the authors. If, in the text, you make repeated references to the same book or article, it is not necessary to repeat it in the list of references.

The important information to describe a book, as either a reference or bibliographical element, are the following. They must be indicated in a specific order:

Last name of author

First names or initials of author

Year of publication (in parentheses)

Title (in italics)

Editor

Edition (if necessary)

Pages quoted

An example below:

Wild R., (1991), Production and Operations Management, Cassell, Fourth Edition

The important information for describing an article, as a reference or as a bibliographical element, is the following. They must be indicated in a specific order:

Last name of author

First names or initials of author

Year of publication (in parentheses)

Title of article (in inverted commas)

Name of journal (in italics)

Volume number

Instalment number

Month (if necessary)

Page numbers (beginning and end of article)

For example:

Macbeth D.K., (1985), *****The flexible manufacturing mission *****“ some implications for management*****, Int. J of Operations and Production Management, vol 5(1), pp 27 to 31.

References are numbered on a separate page, after the main body of text. If you are quoting from more than one work of a same author for the same year, you should add the suffix a, b etc. *****“ for example, (Macbeth, 1985a) *****“ in your text.

You can note quotes of other authors directly in the text, but avoid doing so too often. The best way consists of paraphrasing the main points of his/her work using your own words. Avoid copying whole sentences and paragraphs.

You can also make reference to brochures and to company manuals. You can also reference important interviews indicating the name of the person; his/her job description, the name of the company, the date and the note *****private communication***** or *****interview with the author*****.

III.2.14 *****“ Bibliography

The bibliography lists the books, articles, and other sources of information that are pertinent to your graduating project but that are not quoted in the text. The bibliography is listed after references, on a separate page.

III.2.15 *****“ Appendices

Read section III.1.8 for the use of appendices. It must make reference to all the appendices in the body of the text. Each appendix begins on a new page.

*****

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