| WHAT ARE HEDGE FUNDS? | | | | Investment Manager is free to undertake greater |
| | | | | risk on more volatile positions thereby exposing |
| In the securities world, the term "Hedge Fund" | | | | investors to potential substantial profit as well as |
| does not necessarily imply any use of "hedging" | | | | substantial losses. |
| as commonly understood; for example where | | | | Typically, Hedge Funds provide for the payment |
| commodity traders use options to "hedge" a | | | | of an Incentive Allocation or Performance Fee to |
| commodity position. Presently, in the securities | | | | the hedge Fund Manager/General Partner. |
| world the term "hedge fund" refers to any type | | | | Performance Fees range from 20% to 40% |
| of Private Investment Company operating under | | | | depending on the strategy employed by the |
| certain exemptions from registration under the | | | | Hedge Fund Manager. Typically, the Performance |
| Securities Act of 1933 and the Investment | | | | Fee provides for a "high water mark" structure |
| Company Act of 1940. "Hedge Funds" are often | | | | which provides that incentive fees are paid only |
| referred to as "alternate investment vehicles" and | | | | to the extent that the fund continues to meet or |
| are tailored to the needs of sophisticated, high net | | | | exceed the "high water mark." Additionally, typical |
| worth private investors. A Hedge Fund is generally | | | | Hedge Funds include Management Fee of 1% to |
| structured as a limited partnership having a | | | | 2% of all assets under management. |
| general partner responsible for the investment | | | | Generally there are two kinds of Hedge Funds. |
| activities and day-to-day operation of the fund, | | | | On the one hand, there are the huge worldwide |
| and limited partners who are the investors | | | | funds operated by charismatic managers such as |
| supplying capital but not participating in trading or | | | | George Soros. On the other hand, there are small |
| operations of the fund. The limited partners have | | | | boutique-styled Hedge Funds identified with a |
| limited liability. That is, their exposure to loss is | | | | particular segment or investment strategy. The |
| limited to their investment. The General Partner | | | | Fund Manager's expertise, experience and |
| has unlimited liability and is liable for the activities | | | | background in recognizing investment opportunity |
| of the partnership. The General Partners principals | | | | will dictate that fund's particular niche. For |
| limit their liability through the use of a corporation | | | | example, there are the "Biotech Hedge Funds" |
| or limited liability company as the General Partner. | | | | which are managed by experienced and highly |
| (Of course, the principals cannot limit their liability | | | | qualified investment managers who may also hold |
| from the application of the anti fraud provisions of | | | | advanced degrees in science and medicine. There |
| the Federal Securities Laws.) All of the investors' | | | | are "Tech Hedge Funds" specializing in the |
| capital is pooled and is utilized by the General | | | | technology sector managed by individuals having |
| Partner or Investment Manager to implement its | | | | specialized experience trading in that sector. With |
| trading or investment strategy. | | | | the emergence of day trading and the availability |
| Hedge Funds are "Non-Public Offerings." The | | | | of the trading technology, a number of floor |
| private offering exemption prohibits Hedge Funds | | | | traders and brokers are leaving the traditional |
| from making any public offering. Therefore, | | | | brokerage and exchange venue to participate in |
| Hedge Funds are prohibited from general | | | | the computer screen trading phenomena. |
| advertising and generally secure investors through | | | | The boutique "Hedge Fund" typically relies on the |
| word of mouth, consultants, registered | | | | particular skill and expertise of the Investment |
| representatives, brokers or investment advisors. | | | | Manager or Trader. The highly specialized |
| Hedge Funds have investors that are either | | | | Investment Manager may utilize a "Sector" style |
| "accredited investors" or "qualified purchasers." In | | | | of investing focusing on a particular industry or |
| general, the Federal Securities Laws define the | | | | economic sector. Conversely, an Investment |
| terms "accredited investor" and "qualified | | | | Manager utilizing a "Market Neutral" style will |
| purchaser" in terms of minimum asset and income | | | | maintain a portfolio of securities which are |
| threshold that must be met before they qualify | | | | generally ½ short and ½ long. Some |
| to be investors in the Hedge Fund. Since the | | | | Investment Managers utilize a "Value" investment |
| Hedge Fund generally limits investment to | | | | style based upon assets, cash flow and book |
| "accredited investors" or "qualified purchasers" | | | | value; while other Investment Managers follow the |
| both of whom are required to meet certain | | | | "Emerging Markets" style and invest in emerging |
| minimal asset and/or income thresholds, the Fund | | | | and foreign market equity and debt. "Trading" |
| Manager or administrator must gather background | | | | funds utilize an opportunistic investment style |
| information on potential investors to determine | | | | taking advantage of market trends, events and |
| whether they meet the minimum requirements to | | | | opportunities for short term profits. Each Fund |
| be "accredited investors" or "qualified purchasers." | | | | Manager develops and uses a particular |
| By making a non-public offering to certain kinds of | | | | investment style that is unique to the experience, |
| investors, (accredited investors or qualified | | | | expertise and personality of its manager. |
| purchasers) the investment vehicle will be exempt | | | | Unlike Hedge Funds, Mutual Funds raise money |
| from registration requirements of The Securities | | | | publicly; are highly regulated by the Securities and |
| Act of 1933 pursuant to the safe harbour | | | | Exchange Commission, the Internal Revenue |
| provisions of Rule 506 of Regulation D. Where the | | | | Service and other agencies; and offer investment |
| investment vehicle is limited to no more than 100 | | | | diversification and are restricted from purchasing |
| investors, and otherwise complies with the safe | | | | many types of derivative instruments, leveraging, |
| harbour provisions of Regulation D, such an | | | | short selling and other kinds of transactions. |
| investment entity is exempt from the extensive | | | | Unlike the Mutual Fund Managers, the Hedge |
| regulation pursuant to Section 3(c)1 of The | | | | Fund Manager generally invests in the fund that |
| Investment Company Act. Section 3(c)7 of The | | | | they manage and participate in profits as well as |
| Investment Company Act offers a similar | | | | risks with their investors. Unlike the Mutual Fund |
| exemption to private investment companies with | | | | fee structure (which is determined on assets |
| "qualified purchasers" as investors. | | | | under management) the Hedge Fund Manager |
| As an unregulated entity, the Hedge Fund | | | | receives incentive allocations on performance. |