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Hedge Funds – Where are the Customers’ Yachts?

October 30, 2012 in Hedging and Hedge Funds

Hedge funds Broker commissions and profits

An oft-quoted nugget from financial literature goes as follows:

A young man, about to be recruited into the financial markets, was being shown around New York and was shown some smart yachts anchored at the Battery. “Those are the yachts owned by the bankers, and there, those are the ones owned by the brokers,” said his guide.

“Nice,” said the novice, who then naively asked, “And… where are the customers’ yachts?”

The anecdote above is quoted here, in this chapter on the fees charged by hedge funds.

How do hedge funds charge their investors?

Most commonly, the fees charged by a hedge fund are of two kinds. One is a “management fee,” charged to meet the costs of operating and maintaining the fund. This fee is charged as a percentage of the value of assets under management, and is most often levied on a quarterly basis. The fee varies from fund to fund, but is usually in the range 1 – 2%.

The other fee, known as a “performance fee,” is charged by the fund for generating the returns on the investor’s fund, and is a sort of incentive payment for the deployment of the skills of the hedge fund manager. Calculated as a percentage of the profits achieved, the fee is governed by the terms and conditions specified in the offer documents of the fund. In some cases these fees are only payable if the manager grows the assets (i.e. earns returns) above the previous “high water mark,” i.e. the previous level up to which the manager has been paid the performance fee. Since the manager is not required to refund fees in the case of losses, new fees become payable only when the losses are recouped and the fund value becomes profitable again by crossing the high water mark.

Again, some terms specify that performance fees would be payable only on returns earned in excess of a certain, usually risk-free rate of return, called a “benchmark” rate.

The performance fee also varies from fund to fund, but the most common levy is 20% of the growth achieved.

From the above it is clear that the standard hedge fund fees structure is usually a 2% management fee plus a 20% performance fee – in hedge fund parlance this is known as a “two-and-twenty” structure.

It is imperative that you understand the implications of the fee plan. Get this: As an investor in a two-and-twenty fund, you will only earn returns after the hedge fund fees are paid. That means the hedge fund has to earn very high returns. That’s a tall order when world-wide interest rates are ruling at near-zero rates. This means that the manager will have to take very high risks with your money.

This also means that the manager has to be very good at reading and trading the markets.

This also means that you have to be doubly careful about the selection of your hedge fund.

Let us illustrate the two-and-twenty structure with an example below, which shows a fund starting with an investment of $1 billion and its performance for six years:

Starting AUM (Assets Under Management):







Return %







Gross Aum





















*Fees Calculation
Growth Amount







Perf fee (On Growth Amt)







Mgt Fee (On Opg. AUM)








Total Fee







Net Result After 6 Years
Client Earnings


Hedge Fund Mgr Earnings



See the point? After six years, the client had a loss of $189 million to show for the money invested and risks assumed. On the other hand, the hedge fund managers romped home with $279 million in fees.

No surprises then that there were no customers’ yachts in the harbor!

Weekly Forex Outlook

October 29, 2012 in Forex Analysis

This weekend’s outlook for various currency pairs come with some interesting charts. Please check the same at:

GBP/USD Outlook
EUR/USD Outlook
USD/JPY Outlook
EUR/JPY Outlook
GBP/JPY Outlook
AUD/USD Outlook
USD/CHF Outlook
AUD/JPY Outlook

Hurricane Sandy Closing in and Closing Down

October 28, 2012 in Miscellaneous

Hurricane Sandy

Hurricane Sandy is on it’s way and is expected to hit Southern New Jersey early on October 30. It is then expected to turn into a “Frankenstorm”, a new term conceived last week only as probably this is the first time this phenomenon will be witnessed by the modern world.

What is Frankenstorm?

One major storm merging with other weather systems and by which it’s destructive powers enhances. Coming from the Atlantic, Hurricane Sandy is expected to meet with the wintry weather moving east. This may turn Sandy into an icy hurricane. On the other hand the arctic winds from Canadian side are expected to join the forces to make it more lethal and what we may be getting is a Frankenstein of the Storms or a Frankenstorm.

Hurricane Sandy and Frankenstorm


What is expected?

  • Record tide as high as 3 meters.
  • Disruption of the lives of approximately 60 Million people in the East Cost of the U.S.
  • Possibilities of economic losses of the tune of U.S. Dollar 18 Billion.
  • Disruption of powers for millions for a week or more.

Hurricane Sandy and Precautions:

  • New York Stock Exchange (NYSE) will be closing the trading floors on October 30th. Trading will continue but will be moved to the electronic exchange.
  • Evacuation of 375,000 people to shelters. Hurricane Irene cause such first evacuation in the history of New York and this is the second.
  • Close to 6,000 flights are canceled. High possibilities of closure of bridges and tunnels.

The Story of Bridgewater Associates – Hedge Funds

October 28, 2012 in Hedging and Hedge Funds

Hedge funds - the story of Bridgewater Associates

From a January, 2008, newsletter by Bridgewater Associates cited in The New Yorker:

“If the economy goes down, it will not be a typical recession.” Rather, it would be a disaster in which “the financial deleveraging causes a financial crisis that causes an economic crisis. . . . This continues until there is reflation, currency devaluation and government guarantees of the efficacy of key financial intermediaries.”

That is prophetic as shown by subsequent events.

Bridgewater Associates, run by legendary hedge fund manager, Ray Dalio, is one of the most successful hedge funds ever. A ‘global macro’ firm, the firm manages about $130 billion in assets, primarily for institutional clients such as pension funds, endowments, charities and sovereign funds.

Ray Dalio founded the firm in 1975, commencing business from a two-bedroom apartment. The son of a jazz musician, he earned a side income as a golf caddy and often received stock tips from wealthy golfers. By age 12 he had made his first stock investment, and grew that to an investment worth a few thousand dollars by the time he entered college. He obtained a BA degree from Long Island University and an MBA from Harvard. He then served a short stint as a futures trader, and thereafter set up Bridgewater at age 25.

The firm currently operates out of a wooded, secluded and waterside headquarters located in Westport, CT, and has about 1200 employees. Bridgewater was ranked in 2010 and in 2011 as the biggest and best-performing hedge fund manager in the world.

Bridgewater Associates



The firm is known for its adept understanding of economic trends and events globally, and takes advantage of these macro moves by making trades in a huge variety of assets and markets around the world.  Dalio abhors risk, and its natural cousin, excessive leveraging. Key to his investing strategy is the dilution of risk by the means of innovative and varying distribution of assets (allocation), and a strict avoidance of excessive leverage. Where other hedge funds go for big-hit, ‘home-run’ returns, Bridgewater is known to take the route of smaller, but less riskier returns, generated over and over again.

The firm became a pioneer in its field by introducing strategies such as inflation-linked bonds, currency overlay and was the first to segregate its funds between and alpha (actively managed, higher returns) and beta (passively managed, standard market returns) investments. Its flagship funds were the Pure Alpha Fund and the All Weather Fund.

Starting from about $5 million in the nineties, assets under management (AUM) reached $33 billion by year 2000 and then onto $50 billion by 2007. The launch of the Pure Alpha Major Markets Fund catapulted AUM past the $100 billion mark in 2010.

The firm is reputed for its slightly off-beat (sometimes described as cult-like in the media)  management policies that demand complete transparency and adherence to a set of ‘Principles’ authored by Dalio that effectively dominates its culture, and methods of operation. Reportedly, these Principles are also linked into the computer system and used for investment analysis. All meetings are recorded electronically and are available to be viewed for training and analysis.

The firm’s Pure Alpha Fund earned over $13.8 billion during 2011. This brought the fund’s total earnings since its inception in 1975 to $35.8 billion, taking it past the $31.2 billion that was earned by Soros’ Quantum Fund between 1973 and 2011.

USDJPY Bearish Engulfing – Potential Interim Reversal at 80.00 Handle

October 27, 2012 in Forex Analysis

USDJPY Bearish Engulfing – Potential Interim Reversal at 80.00 Handle

  • USD/JPY printed a bearish engulfing candle at the 80.00 handle – a key psychological level for the dollar/yen currency pair. 
  • The bearish engulfing line is a technical chart pattern which consists of a white/upside candle, which is then followed by a black candlestick that has completely eclipsed the prior move.  This forms after price moves above the prior days high (potentially trapping longs), and closes underneath – thus engulfing the previous days price action.
  • Yen-cross selling was likewise the order of the day on Friday as the market retraced gains printed earlier in the week.
See our Forex Weekly Analysis update.
USD/JPY Analysis
USDJPY Bearish Engulfing Candle – (D1)

USD/JPY Analysis : Bearish Engulfing

Hedge Funds – The Story of Long Term Capital Management

October 26, 2012 in Hedging and Hedge Funds

Hedge fund and long term capital management







This chapter is all about how a seemingly ‘can’t-do-wrong’ hedge fund went bust, and whose sheer size sent tremors down Wall Street and the financial markets, so much so that the government had to step in and take matters in hand to avoid a financial meltdown.

Long Term Capital Management, a hedge fund manager, was started in 1994 by John W Meriwether, who was at one time the head of bond trading at Salomon Brothers.

Meriwether included top bond traders from Salomon Brothers in the management of LTCM as well as cutting edge economists such as Myron S Scholes and Robert C Merton, who later went on to win the Nobel Prize. The investable funds were held in a Cayman Island registered partnership called Long-Term Capital Portfolio LP. With the help of Merrill Lynch the firm was able to raise capital of about $1 billion by February 1994.

Starting out with fixed income arbitration deals, LTCM gradually branched out to other trades such as merger arbitrage, interest rate swaps and options, because the firm soon exhausted available opportunities in fixed income. Meanwhile funds continued to pour in and the pressure to turn out market beating profits grew. Ultimately the firm had to take recourse to deals in which the spread was small but which required substantial funds for implementation. LTCM soon had a huge amount of debt on its books and by 1998 this figure had grown to $124.5 billion. Apart from this, LTCM also had over $1 trillion worth of open positions in interest rate derivatives and swaps. But so far, the fund had managed to keep a good record with investors getting returns of about 40% per annum.

In September 1998, the Russian government defaulted on their bonds causing international turmoil in the bond markets. Investors bailed out of bonds such as those issued by Japan and Europe, and piled into safe haven bonds issued by the United States. This turmoil caused huge variances in the prices of bonds and inflicted massive losses on LTCM – which lost about $1.85 billion of its capital.

In a domino effect, the fund had to bail out of other positions, many at a substantial loss because it was no longer possible to hold those trades for the time required to make a profit. Panicked investors headed for the exits, and this resulted in LTCM’s equity crashing from $2.3 billion to about $400 million in that same month.

It was a sobering example of how market realities could crush number-crunching and “just-can’t-fail” trades supported by the best financial brains and executed by star traders.

Unfortunately, the ramifications of the LTCM debacle stretched far beyond the firm itself and its investors. The huge debts, as well as the portfolio losses, could now unhinge Wall Street itself because of their sheer size and the chain reaction that could be set up in the form of end to end defaults.

After a rescue attempt organized by Goldman Sachs, Warren Buffett and AIG fizzled out, the Federal Reserve Bank of New York had to step in and organize a bailout of LTCM through various banks. Sounds familiar?

The bailout enabled the fund to continue its operations until 2000 by which time the money invested by the rescuers was repaid and the fund liquidated.

Why did we tell you this story? It’s because we want to tell it as it really is – in the financial markets, as also hedge funds, risk lurks around the corner, and you should be well aware of it.

We will continue with the good, bad and ugly of the hedge fund industry. Coming up next is the story of Bridgewater Associates, one of the most successful hedge funds in history.

You may also check:

1) Types of Hedge Funds

2) Hedge Funds – Pros & Cons


Gold Tech/Sentiment Update – 25/10/12

October 25, 2012 in Trading with Other Commodities

Gold Tech/Sentiment Update – 25/10/12

  • Gold has continued its recent downside after finding interim resistance near the nine-month highs.  Gold prices have dropped over 5% during the previous 2 weeks.
  • Recent low gold prices might prove to be attractive for potential new buyers.  India’s Diwali festival approaches with a possible increase in demand for the previous metal. 
  • From the technical perspective the $1700 per oz level and close 38.2% Fib ret might provide some kind of support.  It is also worth noting that the 61.8% level is aligned with previous resistance highs around $1630 should gold see a sustained drop in value.

Gold Analysis

Forex Technical Update 25th October 2012

October 25, 2012 in Forex Analysis

EURUSD Technical Update 25th October 2012 

  • Euro/dollar is at present trading close to the weekly lows after a failure to sustain price above the 1.300 resistance level. 1.3000 is a key technical level for the EURUSD.
  •  The current level is marked by the 61.8% Fibonacci retrace of the prior swing higher.  

EURUSD Daily Chart 

EUR/USD daily chart

Profile photo of Daniel

by Daniel

USD/JPY Strategic Analysis

October 24, 2012 in Forex Analysis


USDJPY (79.86) -Against the Japanese yen the dollar changed hands for ¥79.83, little changed from ¥79.85 Tuesday. The U.S. dollar declined in Asian trading hours Wednesday after a preliminary gauge of Chinese manufacturing rose, helping underpin optimism that the world’s second-largest economy is improving.


Demand for riskier assets appeared to grow Wednesday after the preliminary version of HSBC’s China manufacturing Purchasing Managers’ Index (PMI) for October rose to 49.1 on a 100-point scale, up from September’s final reading of 47.9 Anything above 50 represents expansion for manufacturing activity, while anything under 50 signals contraction. The PMI data followed last week’s Chinese gross domestic product data that showed a decline in line with economist forecasts, as well as stronger-than-expected retail sales data and industrial production data.


The yen has retreated over the past few weeks on growing market expectations that the Bank of Japan will unveil further monetary stimulus at its policy meeting next week in a bid to help the export-focused economy through a global slowdown. Economy minister Maehara, who attended the last BoJ meeting earlier this month, has indicated that he may attend the next meeting as well, adding to the perception that BoJ will expand the asset purchase program. Speculation has included an increase in the BoJ asset purchase program by a notable ¥20trn and the loan program designed to encourage overseas investment beyond March.


USD/JPY remains in a tight range with 80.00 just overhead still proving challenging. Market players have been busy pricing in more BOJ easing, which coupled with rising US Treasury yields, keep the yen under pressure. The yen has lost its attractive as safe haven, although dollar can make little progress in such a negative sentiment environment against its Japanese counterpart. Technically, the pair still holds a bullish stance according to technical readings.

Hedge Funds – Pros and Cons

October 24, 2012 in Hedging and Hedge Funds

Pros and Cons of Hedge Funds








Before you start looking at hedge funds as your ticket to financial nirvana, it would be useful to understand the arguments both for, and against investing in hedge funds. As they say, buyers beware!

Hedge Funds – The Arguments “Against”

One of the most common grounds for criticising hedge funds is their high cost to the investor. Apart from a basic account fee, investors also have to shell out performance fee. Taken together, these charges could be very high, sometimes as high as 50%! In the case of a Fund of Funds, another layer of fees is added to the charges incurred on the underlying funds.

Hedge funds are not easily accessible to the average retail investor, and their doors are only open usually to well-heeled, “accredited” investors who are financially savvy and able to weather the risks of investing in a hedge fund. These investors are able to meet the criteria of a minimum size of investment (which can be very high) and agree to lock-in periods for extended lengths of time.

Hedge funds are usually cagey about publicly disclosing their trading strategies and portfolios. So the average investor, used to a far greater transparency such as in mutual funds, may find it difficult to get as much information as he may desire. Often these strategies are highly complex and proprietary, and very difficult to understand.

The low level of accountability results in frequent cases of fraud, such as the alleged activities of Bernie Madoff. The investor may find it difficult to conduct a suitable due diligence, and hence may lose money to con artists and fraudsters.

Hedge funds are loosely regulated and do not need to register themselves with the SEC, and hence are not required to submit periodic returns which may highlight problems in advance, and allow an investor to bail out in time. Protection available to investors such as for bank deposits is not available on hedge fund investors.

Typically, a hedge fund uses borrowed capital or utilises derivatives to magnify the possible gains on its strategies. Called “leveraging,” this also inflicts huge losses if the bets go wrong. Hedge funds are therefore not suitable for investors who do not have the stomach for such gut-wrenching losses.

Hedge Funds – The Arguments “For”

Hedge funds are able to operate much more flexibly compared to other vehicles, and can therefore generate returns higher than the market and other more conservative avenues such as mutual funds and ETFs. A competent hedge fund manager may generate returns that would be above average even after the higher fee component.

The high fees may be looked at from another angle – the performance fees/bonus is actually an incentive to the manager to earn greater returns, with the investor being the resultant beneficiary.

Hedge funds, as their name suggests, can effectively ‘hedge’ risks and volatility, and therefore may manage competently the higher leverage in their control. In such a situation the investor is in a situation where risk is controlled but the door to higher returns is nevertheless open.

A hedge fund can offer a diversity of investment strategies that an individual investor would not be able to implement by himself. As the hedge fund may deploy a specialist manager for each such strategy or investment pool, the investor has access to a cross-section of expertise.

There, now you have both sides of the coin for Pros and Cons of Hedge Funds!

You may also check:

1) What are Hedge Funds?
2) Types of Hedge Funds
3) Hedge Fund and Long-term Capital Management


Euro zone Debt Crisis and EUR/USD Outlook – What’s New?

October 23, 2012 in Forex Analysis

EUR/USD had a strong fall, which as of now we will avoid to term as “free fall”. The pair had gone to 1.3139 but could not retest the previous high of 1.3172. This brings the first indication that further consolidation may take.

Before analyzing the current price action technically, let’s try to see what  what other factors are there which can affect the market sentiments as far as EUR/USD is concerned.

EUR/USD Daily Chart:

EUR/USD Daily Chart October 24, 2012

Euro zone Debt Crisis

Debt crisis and Euro zone’s efforts for rescue, as a whole, has been the pivot around which the whole market sentiments have been rotating. A small tick of news here and a strong jump of optimism there, another tick and whole optimism hides behind the walls of sheer pessimism. The old story of the market movements that ultimately what wins is the sentiments over any technical or fundamental analysis (at least in the short-term).

Debt Crisis – What is New?

The latest development in the series has been opposition raised for the very legalities of ESM or European Stability Mechanism. The complaint was raised to the highest court of European Union by Irish Parliament’s Independent member Thomas Pringle.

Pingle’s argument involve Article 125 of the treaty.

The court decision on this should be reached by the end of 2012.

The ruling in this matter may very well go in the favor of the ESM and bailout efforts as the earlier decision of  Federal Constitutional Court of Germany came in September but still it adds one more hurdle in the actual execution of the rescue plans. And it brings in another force which bring pessimism in the high tidal ocean of market sentiments.

Other Economic Events

Euro – Yesterday:

The preliminary report of consumer confidence from Euro zone was slightly better though not much changed from the previous release. The consumer confidence reading came out as -25.6 against the previous -25.9

Euro and U.S. Dollar Today:

Euro zone:

Today’s main economic releases Purchasing Manager Index (PMI) from Euro zone and Germany and IFO business climate, assessment and expectation reports from Germany. All these economic releases are between GMT 7:28 to 8:00.


Today’s main economic releases are Markit manufacturing PMI (prelim) at GMT 12:58 and new home sales at GMT 14:00. Another more important event is interest rate decision at GMT 18:15 but no change is expected in the interest rates. Fed’s Monetary Policy Statement and press conference may need some attention at GMT 18:15.

EUR/USD Price Action and Technical Outlook:

1) As mentioned above that the failure of retesting the previous 1.3172 and fall from 1.3149 indicate the possibilities of further downward consolidation.

2) If we check the weekly chart of EUR/USD, it shows a sideways move for past 6 weeks, after the pair had broken the resistance of the mid-term price action channel very strongly. We also see that the price has been getting support just below 5-week EMA (the green EMA line in the following chart). The price action is well above 200-day Moving Average.

EUR/USD Weekly Chart

EUR/USD Weekly Chart October 24, 2012

EUR/USD- What To Expect?

A break below 1.2950 should bring further consolidation towards 1.2920 first and then possibly towards the 55-day EMA support near 1.2880/1.2890. This level is just above the low of previous weeks candle. Any decisive break below these supports may bring further deeper moves towards the 38.2% retracement of the recent overall upward move.

EUR/USD Retracement?

EUR/USD daily chart 382 retracement

While saying all this, as we all know that the market is very sensitive right now and any small tick here and there may act as a big force and bring some unexpected moves. The weekly MACD still stays above the signal line and with a wide gap. There has been a loss of momentum but still some further upward gains can be expected after any possible consolidation:



Types of Hedge Funds

October 23, 2012 in Hedging and Hedge Funds

Various types of hedge funds










Now that you have an understanding of what hedge funds are, let’s look at their different kinds.

Hedge fund categories and types

Hedge funds may be broadly categorised as follows:

Equity – directional hedge funds are focused on stocks and maybe long– or short– oriented. On a net basis, these funds are either long or short in their exposure to stocks. Typically, these could also have a regional or country focus – e.g. ‘Asia/Pacific,’ ‘China,’ ‘US’ etc. or ‘Emerging Markets.’

Debt – directional hedge funds focus on fixed income and debt products, and maybe long or short, but usually are seen to be net long. So you could have hedge funds here that could be long or short or long only. Here too there could be a focus on regional or country-specific debt.

Event-based hedge funds look to generate returns by taking positions in specific situations or events, e.g. mergers and acquisitions, bankruptcy proceedings, distressed asset sales, distressed securities, corporate events such as stock repurchase, dividends and other types.

Global derivative hedge funds, as the name suggests, have a global arena, and use derivatives and other financial instruments to profit from currency movements and macro developments. Another kind is a fund that uses technical analysis and computer-system driven trades to profit from changing trends. These funds may trade a huge variety of assets such as commodities, bonds, interest rate instruments and various types of indices.

Multi-strategy hedge funds are hedge funds that employ various strategies to take advantage of emerging developments in the markets, and do not restrict themselves to a particular strategy or focus. Hence a single fund may be practicing many different investment techniques, each overseen by a specialist manager. Fund of Funds (a fund that invests in other funds) may effect multi-strategy through investing in a variety of specialized hedge funds, each with a different strategy.

Relative value hedge funds seek to profit from miss-pricing or other market inefficiencies that result in a pricing imbalance between pairs of related securities – the fund will buy the under-priced security and short the over-priced one. For example a Convertible Arbitrage fund would look to make a return from a pricing anomaly between a company’s stock and its convertible bond or debenture. Similarly, debt- and diversified arbitrage funds look for such opportunities in global debt markets or across different, but linked asset classes.

Type-wise Fund Assets Under Management

Here’s a graphic illustration of the distribution of the hedge fund AUM across different types as at the end of the Second Quarter of 2012 using data sourced from BarclayHedge.

These categories may change as global sentiments change. It can be seen, for instance, that AUM (Asset Under Management) in the hedge fund category of Fixed Income is the highest at $229.2 billion – this shows investors’ preference for a safer asset category in these troubled times of debt crisis and a global slowdown.

In a ‘risk-on’ environment you would find that funds would flow in greater measure to the equity oriented funds.

Maybe the above discussion would help you find your own fund type – one that meets your investing and risk preferences. Stay tuned as we delve more into hedge funds in later chapters.

You may also check:

1) What are Hedge Funds?
2) Hedge Funds – Pros & Cons
3) Hedge Fund and Long-term Capital Management