Hedge funds minimal risk


Direction - the "special situation"

The second direction of hedge fund managers of this type - Investment Banking. The object of investment of these funds are shares and / or debentures of leading multinational corporations in the U.S., Western Europe and South-East Asia, held on the eve of (or in) various corporate reorganizations - mergers, acquisitions, spin-off divisions and subsidiaries, split into several independent companies, bankruptcy reorganizations. Prior to the beginning of these events (and often - up to their end) true value of these companies is difficult to assess the majority of portfolio managers of investment (not to mention the individual investors), using standard methods of fundamental and technical analysis.

Investment banking approach, based on a specific methodology for assessing companies and focuses on "special situation" allows the flexibility to respond to the developments and profitably seize the opportunities for investment. As a result of that which is hidden from the eyes of the majority of investors become the subject of this type of fund managers and a source of profit. So, for example, the new intrinsic value formed from the merger or acquisition may be substantially higher mechanical sum of market values of the merging firms.

On the other hand, overly diversified companies are often traded with the so-called "conglomerate discount", and their market value falls below the long amount of intrinsic value of its constituent parts. As companies by budding or fragmentation of the parent company are independent conglomerate discount disappears, and the investors who bought the stock before the reorganization process, are very high profits.

Merging or being absorbed by the most profitable (and least risky) are often situations where a wave of mergers and acquisitions entirely covers a particular industry. Such was the case in the global automotive industry and in the banking industry in the second half of 1998. Any major merger (for example, a relatively recent Daimler-Chrysler) usually boosts the stock price of other companies sector. Quite often, the "special situation" are the result of some macroeconomic or political trends when entire sectors of countries or regions are undervalued stock market (as, for example, took place in early 1998 with the Korean industrial groups).

Risk skillfully invests in "special situations" minimal. In the worst case - there is no reorganization, expected by fund managers. Then, instead of a "special situation" in the Fund's portfolio are just blue-chip stocks - companies such as General Motors, DuPont, Fiat, Volvo, Deutche Bank, Daewoo, - the strength of technological, commercial and financial position is not in doubt. Thus, the maximum risk, which is subject to the fund - to get the average market growth dynamics.

But if the expected reorganization still starts, the stock price of these companies rise sharply upward, rewarding fund managers for insight and patience and ensuring a low correlated fund market.

The more undervalued shares of a firm before the reorganization, the more aggressive set up its leadership, the greater the chance that the predicted changes will make a profit, and finance professionals.

For example, there was the German chemical and pharmaceutical concern Hoechst, standing on the threshold of spin-off of its chemical production and transformation into a pure pharmaceutical company. Prospects eliminate substantial (30-60%) "conglomerate discount" identified a positive trend Hoechst shares in mid-1998, despite the correction of global stock markets. By purchasing the shares on May 5 for $ 40, the managers of this type of hedge funds in a month completed 24% of net profit, while the U.S. stock market fell over the same period from 2.5% (S & P) to 4.6% (NASDAQ).

Dealing in bonds

In recent years, the activities of hedge funds has a significant impact on the behavior of financial instruments of almost all major market segments. For example, the capital market is these funds provide the most major purchases of convertible bonds and simultaneously hold the game for a fall in shares of their respective corporations, stimulating discharge papers and a drop in prices.

Clearly, this is a key moment for the trader, trading in the capital market of convertible bonds. After all, this tactic is because hedge funds are oriented to receive interest on convertible bonds and thus operate on two components: the bonds on which the interest is paid, and an option contract that gives the right to exchange the bond for share. Selling option contracts, funds are beginning to play a fall, making it difficult to increase prices and delivery of the conversion rate. This means that as long as the bonds are not converted into shares of the company will have to pay interest on it, which, in fact, expect to hedge funds. Some analysts point to the operation of hedge funds as one of the reasons why the shares of most companies, announced the launch of convertible bonds, are beginning to lose in price.

Unlike private investors, who recently try to invest their capital in the audited hedge funds, large institutional investors are increasingly placing their money in so-called "funds of funds". But it is - a topic for another conversation.