Glossary
Alpha
The portion of an investment’s return that is not attributable to movement of an underlying index or benchmark (usually in a linear regression model). Alpha is often considered to be a measure of manager skill.
Beta
A measure the risk of an investment relative to its benchmark or index. It represents the change in investment return for every 1% change in the benchmark. If beta is greater than 1, the investment will typically gain or lose more than the index. If beta is negative, the investment will typically move in the opposite direction to the index.
Convertible Arbitrage
Arbitrageurs are simultaneously long the convertible securities and short the underlying security of the same issuer, aiming to profit from the spread between the two. Returns are generated from different cash flows and the convergence of valuations between the securities.
Correlation
The correlation coefficient is a statistical measure of the degree to which the returns on two assets are related. A correlation of –1.00 indicates that the two assets’ returns always move in opposite directions to one another, while a correlation of 1.00 indicates that they always move together. A correlation near zero suggests that returns are likely to be are independent of one another. To achieve optimal diversification in a portfolio it is desirable to invest in assets with low or negative correlations.
Distressed Securities
Managers invest in the securities of companies in financial difficulties when these securities trade at a substantial discount and the manager believes that an improvement in fortunes will materialise.
Downside Deviation
A measure of volatility that only takes into account returns below a specified threshold.
Drawdown
The largest decline in value experienced by a fund from a given point, over the indicated track record. Not necessarily a steady decline, but can even be a series of +/- returns where the negative returns are greater than the positive ones. The maximum drawdown is the largest peak-to-trough percentage fall in value over the entire indicated track record.
Equity Market Neutral
A strategy designed to exploit inefficiencies and relative valuation anomalies that involves matching long and short positions so that the fund is beta neutral.
Event Driven
A strategy of investing in a usually limited number of companies in some form of special situation such as a merger or reorganisation.
Fixed Income Arbitrage
A strategy that aims to profit from price differentials and anomalies between related interest bearing securities, often on a global scale.
Fund of Hedge Funds (FOHF)
A fund of hedge funds is a fund that itself invests in a number of different hedge funds with the aim of gaining the benefits of enhanced and more predictable performance whilst at the same time reducing the risks inherent in an undiversified portfolio. Funds of funds may be targeted at a particular strategy or geographic sector, or may encompass a wide range of individual fund styles.
GFSC
The Guernsey Financial Services Commission is the statutory body responsible for the development and supervision of finance businesses in Guernsey.
Global Macro
The classic hedge fund strategy followed by Soros and others, aiming to profit wherever the manager thinks fit, in any asset class, any country, and over any time frame.
Hedge Fund
A hedge fund is an investment fund, company or partnership, in most cases formed off-shore which is unrestricted in the range of investment styles and instruments it employs with the goal of producing substantial profits in a variety of market conditions. Hedge fund managers usually pursue a specific, focused and well-defined investment strategy.
High Watermark
The point at which a manager may accrue performance fees, the object being that no such fees are taken unless the fund is gaining NAV above any previously achieved peak in value.
High Yield
An event driven strategy that refers to investing in low grade fixed income securities of companies that show upside potential.
Hurdle Rate
The minimum return required before a manager can start to accrue performance fees, usually pitched at some measure of risk free rate.
Leverage
The borrowing of funds to increase the amount invested in any particular position in the expectation that the return on the position will exceed the cost of borrowing. Some trades target very small price spreads and a manager needs leverage to magnify these returns. Leverage both magnifies the risk of a strategy and creates an obligation to the lender that can give the lender some control over the manager’s positions.
Long / short equity
The most common hedge fund strategy involving both long and short equity positions but not with the objective of being market neutral. It is a directional strategy with the manager able to shift from net long to net short. Funds may target particular market segments or regions and employ derivatives and options to manage portfolio risk.
Market Neutral
Any strategy that attempts to eliminate market risk and be profitable in all market conditions.
Merger Arbitrage
See Risk Arbitrage.
Relative Value
A strategy that seeks to profit from pricing anomalies in related securities whereby the pricing is deviating from an historical norm or expected range.
Risk Arbitrage
An event driven strategy also known as Merger Arbitrage that involves a long position in the stock of a company being acquired and a simultaneous short position in the stock of the acquirer.
Risk-adjusted return
See Sharpe and Sortino Ratio.
Sharpe Ratio
A statistical measure of the risk adjusted return of an asset, calculated by dividing the return of the asset in excess of the risk free rate by the annualised standard deviation of its returns. The higher the ratio, the better the risk adjusted return.
Sortino Ratio
Similar to the Sharpe Ratio, the Sortino Ratio distinguishes between the ‘good’ upside volatility and ‘bad’ downside volatility in the Sharpe Ratio, using the downside deviation as the denominator.
Statistical Arbitrage
A mathematically modelled strategy that seeks to exploit mispricings in securities.
UKLA
The United Kingdom Listing Authority, a division of the Financial Services Authority, is the competent authority for listing securities on the London Stock Exchange.
Volatility
The measure of the risk of an asset in terms of the annualised standard deviation of its returns.