Archive for the 'Uncategorized' Category

28
Aug
09

HEDGE FUND

What is Hedge Fund?

The term “Hedge Fund” is defined as “any unregistered, privately-offered, managed pool of capital for wealthy, financially sophisticated investors.” Hedge funds are usually structured as partnerships, with the general partner being the portfolio manager, making the investment decisions, and the limited partners as the investors. The primary aim of most hedge funds is to reduce volatility and risk while attempting to preserve capital and deliver positive returns under all market conditions.

Hedge funds are subject to the same market rules and regulations as any trader. The strategies they utilize are not as easily accessible, especially for other regulated entities, such as mutual funds. To achieve this “absolute return”, hedge fund managers have the flexibility to incorporate different strategies and techniques that may include:

Short-selling: Sale of a security that you do not own, with the anticipation of purchasing it in the future, at a reduced cost.

Arbitrage: Simultaneous buying and selling of a financial instrument in different markets to profit from the difference between the prices

Hedging: Buying/selling a security to offset a potential loss on an investment.

Leverage: Borrowing money for investment purposes.

Trading options or derivatives: contracts whose values are based on the performance of any underlying financial asset, index or other investment.

Investing in anticipation of a specific event: merger transaction, hostile takeover, spin-off, exiting of bankruptcy proceedings, etc.

Investing in deeply discounted securities: of companies about to enter or exit financial distress or bankruptcy, often below liquidation value.

Many of the strategies used by hedge funds benefit from being non-correlated to the direction of equity markets

 A hedge fund may take long positions in certain stocks, and short positions in certain other stocks such that their portfolio beta is close to zero. A beta close to zero means that the portfolio will remain relatively unchanged due to the broad market movement. Such a portfolio will primarily change if the stocks move more than the broad market.

 This would become clear with the example –

 A stock trader believes that the stock price of IP Ltd. will rise over the next month, due to this company’s new and efficient method of producing gadgets. He wants to buy IP Ltd. shares to profit from their expected price increase. But IP Ltd. is part of the highly volatile gadget industry. If the trader simply bought the shares based on his belief that the IP Ltd. shares were underpriced, the trade would be a speculation.

Since the trader is interested in the company, rather than the industry, he wants to hedge out the industry risk by short selling an equal value (number of shares × price) of the shares of PANKAJ Ltd. direct competitor, PANKAJ Ltd.

The first day the trader’s portfolio is:

  Long 1000 shares of IP Ltd. at Re1 each

  Short 500 shares of PANKAJ Ltd. at Rs2 each

(Notice that the trader has sold short the same value of shares.)

 

On the second day, a favourable news story about the widgets industry is published and the value of all widgets stock goes up. IP Ltd., however, because it is a stronger company, goes up by 10%, while PANKAJ Ltd. goes up by just 5%:

  Long 1000 shares of IP Ltd. at Rs.1.10 each — Rs100 profit

  Short 500 shares of PANKAJ Ltd. at  Rs.2.10 each — Rs50 loss

(In a short position, the investor loses money when the price goes up.)

 

The trader might regret the hedge on day two, since it reduced the profits on the IP Ltd. position. But on the third day, an unfavourable news story is published about the health effects of widgets, and all widgets stocks crash — 50% is wiped off the value of the widgets industry in the course of a few hours. Nevertheless, since IP Ltd. is the better company, it suffers less than PANKAJ Ltd.:

Value of long position (IP Ltd.):

  Day 1 — Rs1000

  Day 2 — Rs1100

  Day 3 — Rs550 => Rs450 loss

 

Value of short position (PANKAJ Ltd.):

  Day 1 — Rs1000

  Day 2 — Rs1050

  Day 3 — Rs525

Without the hedge, the trader would have lost Rs450. But the hedge – the short sale of PANKAJ Ltd. – gives a profit of Rs475, for a net profit of Rs25 during a dramatic market collapse.

 Another important characteristic is that hedge funds borrow heavily to increase their portfolio size.

To improve their security-specific returns, hedge funds leverage their portfolio. The fund may collect, say, Rs 100 crore from investors, borrow Rs 50 crore, and invest Rs 150 crore.

In the above instance, an unleveraged fund may have gained only 3 per cent of Rs 100 crore. But a hedge fund that has borrowed Rs 50 crore will gain 3 per cent on Rs 150 crore less interest cost on Rs 50 crore.

Who runs them?

A lot of hedge funds are run by former bankers or traditional investment managers who set up their own funds. They can make a lot of money out of them by charging high fees, typically a 2 per cent management fee as well as 20 per cent of the profits.

 Who invests in them?

Because they are unregulated and risky, the managers will only accept investment from wealthy, sophisticated investors (High Net-Worth Individuals).Some banks, pension funds, and companies also invest.

 There are approximately 14 distinct investment strategies used by hedge funds, each offering different degrees of risk and return. A macro hedge fund, for example, invests in stock and bond markets and other investment opportunities, such as currencies, in hopes of profiting on significant shifts in such things as global interest rates and countries’ economic policies. A macro hedge fund is more volatile but potentially faster growing than a distressed-securities hedge fund that buys the equity or debt of companies about to enter or exit financial distress. An equity hedge fund may be global or country specific, hedging against downturns in equity markets by shorting overvalued stocks or stock indexes. A relative value hedge fund takes advantage of price or spread inefficiencies. Knowing and understanding the characteristics of the many different hedge fund strategies is essential to capitalizing on their variety of investment opportunities.

 It is important to understand the differences between the various hedge fund strategies because all hedge funds are not the same — investment returns, volatility, and risk vary enormously among the different hedge fund strategies. Some strategies which are not correlated to equity markets are able to deliver consistent returns with extremely low risk of loss, while others may be as or more volatile than mutual funds. A successful fund of funds recognizes these differences and blends various strategies and asset classes together to create more stable long-term investment returns than any of the individual funds.

03
Apr
08

Effects of Loan-waiver

Before the budget

With a sorry 2.6% growth in the first year of the 11th Plan (compared to 3.8% in 2006-07) and a declining share in the GDP-24% in 2001-02 to 17.5% in 2007-08 which was attributed to slackening growth of rabi crops-the agricultural sector is crying out for long-term answers to economic viability.
There has been a loss of dynamism in the agriculture and allied sectors in recent years, pointing to poor credit reach, gradual degradation of natural resources through overuse and inept use of fertilisers, low public investment in agriculture and inability to attract sufficient private investment because of lower/unattractive returns, poor use of irrigation potential, an extension system in shambles and a delayed start to long-term productivity-boosting schemes.

Ironically, while accepting that production, yield and irrigated area added, have all stagnated or come down for key crops-paddy, wheat, pulses, oilseeds, even sugarcane- the government harps on one mantra to boost production: announce minimum support price (MSP) for these well before the sowing season. Indications, thankfully, are that the government will finally move into this regime as a matter of long-term policy. Presumably, this will also mean aligning support prices close to market prices.

Farmer Friendly Decisions

  1. Complete waiver of loans for small and marginal farmers holding upto 2 hectares of land. Agricultural loans restructured by banks through special packages. All such loans will also be eligible for waiver under the scheme. Implementation of loan waiver scheme is scheduled to be completed by June 30, 2008. Farmers will also be eligible for fresh loans. Govt plans to allocate 60,000 crore for this scheme
  2. New scheme of debt-waiver and debt relief for farmers.
  3. All agriculture loans disbursed by PSU banks, co-operatives till March 2007 waiting recovery to be covered under scheme
  4. One-time settlement scheme for “all other” farmers

Implications of the budget decisions

If you are a farmer that has less than 2 hectares of land and have taken a loan, government has announced that it will waive your loan. The Government of India will compensate the bank.

How does the relief to the farmer work out? How will the Rs 60,000 crore be provided for? What does providing liquidity to the banks mean ?
How the government explains it is that this is money out of the banking system. Some of it is already overdue, already non-performing assets.
So banks are already unsure as to how much of this Rs 60,000 crore would come back to them. It was decided to write off the loans and agree to provide liquidity of the equivalent amount to the banks. The banks have welcomed this arrangement, because they will have fresh liquidity to lend.
Everyone claims that waiving the loans would be a huge relief for farmers who are having a tough time with rising production cost and dwindling profit or growing loss.

What does the government aim to achieve by providing the loan waiver?
The 60,000 crore loan waiver will apparently touch crores of smll farmers in the remotest corners of our country does two things. One, it provides relief on 4 cr homes. Multiply that by 5.5, the size of the number of people in an average Indian home (as per 2001 census) and you have a total of 22 crore people touched directly by the largesee. That’s a lot of consumers.
Two, we need to understand a basic fact. For the farm homes in question, a rupee saved as an outgo on interest and indeed principal, is a rupee earned. This means that both interest burden and loan amount are off. So four cr farmers and their 18 cr dependents will now be rid of their debt burden from the formal sector. They still have the burden of the principal and interest due to the money lenders. Nevertheless, burden removed is a burden removed.
The moneylender’s cash flows are going be touched that much more. The small farmer will now pay the interest he owes that much more promptly. And if he runs out of money he still has an option of going to his friendly neighborhood bank and reapply for a loan.
The question arises- Will this loan waiver bring about an anticipated change in consumption? Engneering consumption artificially is a process that takes years altogether.

But will this step save the farmers of India? Will it revive agriculture in India?
This step is only going to put farmers and agriculture sector as a whole in deep trouble in coming years. We need a long term solution than a short term patch up to revive agriculture.
The fact that fresh loanees have not only plateaued, but actually nosedived in 2008-09 in a sector defined by farm distress have been hided. Indications are that the impending relief package will address this. Despite the diagnosis, the government is keener on populist initiatives such as loan waivers and rescheduling rather than a long-term solution to volatile fluctuations in crop prices that increased farmer suicides.
Admittedly, even a 2% cess would only come up with a modicum (Rs 8,000 crore-odd) of what’s really needed, but the government dodges any other long-term measure on the farm distress relief front.
It is a known fact that agricultural sector in India is suffering because agriculture no longer is a profitable business. As long as it is not a profitable business, people who are already into it try to get out of it and also it won’t attract more people into it.
Who wants to invest or waste time on something that won’t give them back their investment?
Instead of waiving Rs.60,000 crores of loan, if the government has used this money to increase the procurement price of agricultural products by say 3 times the present price the farmers who cultivate it would have made some profit and they will also be motivated to continue agriculture.
Also,
The waiver is meant for farmers owning less than 2 hectares of land with borrowings from commercial or rural regional banks and cooperatives. But half the farmers falling in this category (49.7%) have taken loans from local moneylenders. The scheme would provide no respite to this half of the indebted farmers.
The Budget makes not even a passing reference to the massive produce price fluctuation problems being faced by the farmer.

24
Mar
08

Private Equity

The contents of the article are:

  1. Basics of Private Equity
  2. Types of PE Investment
  3. Difference between VC and PE
  4. The INDIAN Perspective
  5. Private Equity Market

To download the article, CLICK HERE

23
Jan
08

Sovereign Wealth Funds

A Sovereign wealth fund (SWF) is a fund owned by a state composed of financial assets such as stocks, bonds, property or other financial instruments .

Sovereign wealth funds are, broadly defined, entities that can manage the national savings for the purposes of investment. The accumulated funds may have their origin in, or may represent foreign currency deposits, gold, SDRs and IMF reserve position held by central banks and monetary authorities, along with other national assets such as pension investments, oil funds, or other industrial and financial holdings. These are assets of the sovereign nations which are typically (but not necessarily) held in domestic and different reserve currencies such as the dollar, euro and yen. The names attributed to the management entities may include central banks, official investment companies, state pension funds, sovereign oil funds and so on.

There have been attempts to distinguish funds held by sovereign entities from foreign exchange reserves held by central banks. The former can be characterized as maximizing long term return , with the latter serving short term currency stabilization and liquidity management. This distinction points in the right direction, but is still unsatisfactory. Many central banks in recent years possess reserves massively in excess of needs for liquidity or foreign exchange management. Moreover it is widely believed most have diversified hugely into assets other than short term, highly liquid monetary ones (almost no data is available however to back up this assertion). Some central banks even have begun buying equities or derivatives of differing ilk (even if fairly safe ones, like Overnight Interest rate swaps).

Nature and Purpose

SWFs are typically created when governments have budgetary surpluses and have little or no international debt. This excess liquidity is not always possible or desirable to hold as money or to channel it into consumption immediately. This is especially the case when a nation depends on raw material exports like oil, copper or diamonds. To reduce the volatility of government revenues, counter the boom-bust cycles’ adverse effect on government spending and the national economy or build up savings for future generations, SWFs may be created. One example of such a fund is The Government Pension Fund of Norway.

Other reasons for creating SWFs may be economical, or strategic, such as war chests for uncertain times. For example, the Kuwait Investment Authority during the Gulf war managed excess reserves above the level needed for currency reserves (although many central banks do that now). The Government of Singapore Investment Corporation is partially the expression of a desire to create an international financial center. The Korean Investment Corporation has since been similarly managed.

To download two documents:

  • Why India Should welcome but watch sovereign wealth funds
  • The Rise of Sovereign Wealth Funds

Click here

19
Jan
08

Mutual Funds Basics

WHAT ARE MUTUAL FUNDS?

Mutual funds are money-managing institutions set up to professionally invest the money pooled in from the public. These schemes are managed by Asset Management Companies (AMC), which are sponsored by different financial institutions or companies.

Each unit of these schemes reflects the share of investor in the respective fund and its appreciation is judged by the Net Asset Value (NAV) of the scheme. The NAV is directly linked to the bullish and bearish trends of the markets as the pooled money is invested either inequity shares or in debentures or treasury bills. Indian Mutual Funds unveils this multi-dimensional avenue, with its intricacies, in a fashionable manner as mutual funds up-hold ample scope of generating decent returns by some thoughtful investment

 Concept of Mutual Funds

 

Mutual Fund Operation Flow Chart

Mutual Fund Operation Flow Chart

 Mutual Funds – Organisation

There are many entities involved and the diagram below illustrates the organisational set up of a mutual fund:

Organisation of a Mutual Fund

Organisation of a Mutual Fund

Advantages of Mutual Funds

 The advantages of investing in a Mutual Fund are:

  • Diversification: The best mutual funds design their portfolios so individual investments will react differently to the same economic conditions. For example, economic conditions like a rise in interest rates may cause certain securities in a diversified portfolio to decrease in value. Other securities in the portfolio will respond to the same economic conditions by increasing in value. When a portfolio is balanced in this way, the value of the overall portfolio should gradually increase over time, even if some securities lose value.
  • Professional Management: Most mutual funds pay topflight professionals to manage their investments. These managers decide what securities the fund will buy and sell.
  • Regulatory oversight: Mutual funds are subject to many government regulations that protect investors from fraud.
  • Liquidity: It’s easy to get your money out of a mutual fund. Write a check, make a call, and you’ve got the cash.
  • Convenience: You can usually buy mutual fund shares by mail, phone, or over the Internet.
  • Low cost: Mutual fund expenses are often no more than 1.5 percent of your investment. Expenses for Index Funds are less than that, because index funds are not actively managed. Instead, they automatically buy stock in companies that are listed on a specific index
  • Transparency
  • Flexibility
  • Choice of schemes
  • Tax benefits
  • Well regulated

Drawbacks of Mutual Funds

Mutual funds have their drawbacks and may not be for everyone:

  • No Guarantees: No investment is risk free. If the entire stock market declines in value, the value of mutual fund shares will go down as well, no matter how balanced the portfolio. Investors encounter fewer risks when they invest in mutual funds than when they buy and sell stocks on their own. However, anyone who invests through a mutual fund runs the risk of losing money.
  • Fees and commissions: All funds charge administrative fees to cover their day-to-day expenses. Some funds also charge sales commissions or “loads” to compensate brokers, financial consultants, or financial planners. Even if you don’t use a broker or other financial adviser, you will pay a sales commission if you buy shares in a Load Fund.
  • Taxes: During a typical year, most actively managed mutual funds sell anywhere from 20 to 70 percent of the securities in their portfolios. If your fund makes a profit on its sales, you will pay taxes on the income you receive, even if you reinvest the money you made.
  • Management risk: When you invest in a mutual fund, you depend on the fund’s manager to make the right decisions regarding the fund’s portfolio. If the manager does not perform as well as you had hoped, you might not make as much money on your investment as you expected. Of course, if you invest in Index Funds, you forego management risk, because these funds do not employ managers.



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