Hedge Fund Glossary
Alpha
Measures the value that an investment manager produces, by comparing
the manager's performance to that of a risk-free investment (usually a
Treasury bill). For example, if a fund had an alpha of 1.0 during a given
month, it would have produced a return during that month that was one
percentage point higher than the benchmark Treasury. Alpha can also be
used as a measure of residual risk, relative to the market in which a
fund participates.
Annual rate of return
The compounded gain or loss in a fund's net asset value during a calendar
year.
Arbitrage investment strategy
An approach that aims at exploiting price differentials that exist as
a result of market inefficiencies. Arbitrage plays typically involve purchasing
a security in one market, while selling an instrument with similar performance
characteristics in another market -- earning returns that far exceed the
risk incurred.
Average annual return (annualized rate of return)
Cumulative gains and losses divided by the number of years of an investment's
life, with compounding taken into account. The measure is used to compare
returns on investments for periods ranging from partial to multiple years.
Average monthly return
Cumulative gains and losses divided by the number of months
of the investment's life, with compounding taken into account.
Average rate of return
The mean average of a fund's returns over a given number of
periods. It is calculated by dividing the sum of the rates of return over
those periods by the number of periods
Beta
Gauges the risk of a fund by measuring the volatility of its past returns
in relation to the returns of a benchmark, such as the S&P 500 index.
A fund with a beta of 0.7 has experienced gains and losses that are 70%
of the benchmark's changes. A beta of 1.3 means the total return is likely
to move up or down 30% more than the index. A fund with a 1.0 beta is
expected to move in sync with the index.
Bottom-up investment strategy
An approach that seeks to identify investments that will produce strong
returns, before assessing the influence that economic factor will have
on those assets
Closed fund
A hedge fund or open-end mutual fund that has at least temporarily stopped
accepting capital from investors, usually due to rapid asset growth. Not
to be confused with a closed-end fund.
Compounded monthly return
The average monthly increase that, when compounding is taken into account,
would have produced a fund's total return over any period of time. For
example, if a fund had a one-year return of 20%, its compounded monthly
return would be 1.53% -- the amount it would have needed to gain in each
of 12 months to achieve that full-year result.
Convertible arbitrage investment strategy
A conservative, market-neutral approach that aims to profit from pricing
differences or inefficiencies between the values of convertible bonds
and common stock issued by the same company. Managers of such funds generally
purchase undervalued convertible bonds and short-sell the same issuers'
stock. The approach typically involves a medium-term holding period and
results in low volatility.
Derivative
A financial instrument whose performance is linked to a specific
security, index or financial instrument. Typically, derivatives are used
to transfer risk or negotiate the future sale or delivery of an investment.
Derivative instruments come in four basic forms: forward contracts, futures
contracts, swaps and options.
Distressed securities investment strategy
Purchasing deeply discounted securities that were issued by
troubled or bankrupts companies. Also, short-selling the stocks of those
corporations. Such funds are usually able to achieve low correlations
to the broader financial markets. The approach generally involves a medium-
to long-term holding period.
Drawdown
The percentage loss that a fund incurs from its peak net asset
value to its lowest value. The maximum drawdown over a significant period
is sometimes employed as a means of measuring the risk of a vehicle. Usually
expressed as a percentage decline in net asset value.
Emerging-markets investment strategy
Investing in stocks or bonds issued by companies and government
entities in developing countries, usually in Latin America, Eastern Europe,
Africa and Asia. Such funds typically employ a short- to medium-term holding
period and experience high volatility.
Event-driven investment strategy
An approach that seeks to anticipate certain events, such as mergers or corporate restructurings. Such funds, which include risk-arbitrage vehicles and entities that buy distressed securities, typically employ medium-term holding periods and experience moderate volatility.Fixed income investment strategy
An approach in which the manager invests primarily in bonds,
annuities or preferred stock. The investments can be long positions, short
sales or both. Such funds are often highly leveraged.
Fixed-income arbitrage investment strategy
An approach that aims to profit from pricing differentials
or inefficiencies by purchasing a bond, annuity or preferred stock and
simultaneously selling short a related security. Such funds are often
highly leveraged.
Fund of funds (multi-manager vehicle)
An investment vehicle whose holdings consist of shares in
hedge funds and private-equity funds. Some of these multi-manager vehicles
limit their holdings to specific managers or investment strategies, while
others are more diversified. Investors in funds of funds are willing to
pay two sets of fees, one to the fund-of-funds manager and another set
of (usually higher) fees to the managers of the underlying funds
Fundamental analysis investment strategy
An approach that relies on valuing stocks by examining companies' financials
and operations, including sales, earnings, growth potential, asset size
and quality, indebtedness, management, products and competition.
