Chapter 16

Absolut return strategies are hedge fund strategies that seek to minimize market risk and total risk.

The annuity view of hedge fund fees represents the prospective stream of cash flows from fees available to a hedge fund manager.

Asymmetric incentive fees, in which managers earn a portion of investment gains without compensating investors for investment losses, are generally prohibited for stock and bond funds offered as '40 Act mutual funds in the United States.

The at-the-money incentive fee approximation expresses the value of a managerial incentive fee as the product of 40%, the fund's NAV, the incentive fee percentage, and the volatility of the assets (o1) over the option's life.

Capacity is the limit on the quantity of capital that can be deployed without substantially diminished performance.

A classification of hedge fund strategies is an organized grouping and labeling of hedge fund strategies.

A closet indexer is a manager who attempts to generate returns that mimic an index while claiming to be an active manager.

Consolidation is an increase in the proportion of a market represented by a relatively small number of participants (i.e., the industry concentration).

Convergent strategies profit when relative value spreads move tighter, meaning that two securities move toward relative values that are perceived to be more appropriate.

Diversified strategies are hedge funds strategies that seek to diversify across a number of different investment themes.

Equity strategies are hedge fund strategies that exhibit substantial market risk.

Event-driven strategies are hedge fund strategies that seek to earn returns by taking on event risk, such as failed mergers, that other investors are not willing or prepared to take.

Excessive conservatism is inappropriately high risk aversion by the manager, since the manager's total income and total wealth may be highly sensitive to fund performance.

Fee bias is when index returns overstate what a new investor can obtain in the hedge fund marketplace because the fees used to estimate index returns are lower than the typical fees that a new investor would pay.

Fund mortality, the liquidation or cessation of operations of funds, illustrates the risk of individual hedge funds and is an important issue in hedge fund analysis.

A fund of funds in this context is a hedge fund with underlying investments that are predominantly investments in other hedge funds.

Headline risk is dispersion in economic value from events so important, unexpected, or controversial that they are the center of major news stories.

A hedge fund program refers to the processes and procedures for the construction, monitoring, and maintenance of a portfolio of hedge funds.

The high-water mark (HWM) is the highes NAV of the fund on which an incentive fee has been paid.

The incentive fee option value is the risk-adjusted present value of the incentive fees to a manager that have been adjusted for its optionality.

Instant history bias or backfill bias occurs when an index contains histories of return that predate the entry date of the corresponding funds into a database and thereby cause the index to disproportionately reflect the characteristics of funds that are added to a database.

The investablity of an index is the extent to which market participants can invest to actually achieve the returns of the index.

Liquidation bias occurs when an index disproportionately reflects the characteristics of funds that are not near liquidation.

The lock-in effect in this context refers to the pressure exerted on managers to aviod further risk once high profitability and a high incentive fee have been achieved.

Managerial coinvesting is this context is an agreement between fund managers and fund investors that the managers will invest their own money in the fund.

The terms managing returns and massaging returns refer to efforts by managers to alter reported investment returns toward preferred targets through accounting decisions or investment changes.

The terms managing returns and massaging returns refer to efforts by managers to alter reported investment returns toward preferred targets through accounting decisions or investment changes.

A multistrategy fund deploys its underlying investments with a variety of strategies and sub-managers, much as a corporation would use its divisions.

Event risk is effectively an off-balance-sheet risk that is, a risk exposure that is not explicitly reflected in the statement of financial positions.

An investment strategy is referred to as opportunistic when a major goal is to seek attractive returns through locating superior underlying investments.

Optimal contracting between investors and hedge fund managers attempts to align the interests of both parties to the extent that the interests can be aligned cost-effectively, with marginal benefits that exceed marginal costs.

The option view of incentive fees uses option theory to demonstrate the ability of managers to increase the present value of their fees by increasing the volatility of the fund's assets.

Participation bias may occur for a successful hedge fund manager who closes a fund and stops reporting results because the fund no longer needs to attract new capital.

A perverse incentive is an incentive that motivates the receiver of the incentive to work in opposition to the interests of the provider of the incentive.

A pure asset gatherer is a manager focused primarily on increasing the AUM of the fund. A pure asset gatherer is likely to take very little risk in a portfolio and, like mutual fund managers, become a closet indexer.

A relative return product is an investment with returns that are substantially driven by broad market returns and that should therefore be evaluated on the basis of how the investment's return compares with broad market returns.

Relative value strategies are hedge fund strategies that seek to earn returns by taking risks regarding the covergence of values between securities.

The representativeness of a sample is the extent to which the characteristics of that sample are similar to the characteristics of the universe.

In investments, a safe harbor denotes an area that is explicitly protected by one set of regulations from another set of regulations.

Short volatility exposure is any risk exposure that causes losses when underlying asset return volatilities increase.

A single-manager hedge fund, or single hedge fund, has underlying investments that are not allocations to other hedge funds.

Strategy definitions, the method of grouping similar funds, raise two problems: (1) definitions of strategies can be very difficult for index providers to establish and specify, and (2) some funds can be difficult to classify in the process of applying the definition.

Synthetic hedge funds attempt to mimic hedge fund returns using listed securities and mathematical models.