An Empirical Study of Hedge Funds in India

and its Strategies

Ms. Parul KumarJIMS, Rohini,

New Delhi

Hedge Funds

“To hedge one’s bets” i.e. betting on other side to limit the possibility of loss on a speculation.

Hedge funds◦ pool of funds of the highly influential

investors,◦opened to limited number of investors◦require high investment ◦include large number of expertise based

investment strategies ◦broad range objectives of risk and return.

Hedge Funds Contd.They can invest in any type of opportunity luring in the any market,

be it options, derivatives, equities, bonds, undervalue securities, currencies, situations such as mergers or bankruptcies, domestic as well as international markets etc,

where they can expect to receive attractive returns in all kind of risky situations.

Main motive of Hedge Funds

Protecting capital (i.e. the private pool of funds)

Generating superior returns in all kinds of markets (i.e. even they promise takings in bearish markets)

While attempting to minimize the risk i.e. to hedge.

2000 2001 2002 2003 2004 2005 2006 2007 2008-50%

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

MSCI All- Country World IndexHedge Fund Research Index Fund Weighted Composite Index

Bear Market Achievers Riding Asset Growth Crisis

Annualized Hedge Funds Return (2000 – 2009)

Objective

First Objective

•How hedge funds have set their mark in India•Lucrative opportunities in India

Second Objective

•Which hedge fund strategy has proved to be best globally in the last 5 years i.e. from year 2006-2010.

Hedge Funds in IndiaAsian countries are offering many

opportunitiesMarket in UK and US are facing

◦huge meltdowns◦ investors are finding hard to sustain there◦money making options are drying

India is offering various necessary conditions for hedge funds to explore with its◦secondary market liquidity◦Futures◦options, etc.

Hedge Funds in India (Contd.)

Investment can be made through FII (Foreign Institutional Investors) route.

1% management fees of the investment amount

doesn’t charge anything on performance or profit of the fund

Thus giving India a plus point from others

Thus attracting more HNIs to enter India through these.

Incremental Nominal GDP in billion US $

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

2035-2050

2020-2035

2006-2020

Source: Goldman Sachs Report

Working Age Population Growth Rates (% p.a.)

India

Turk

ey

Braz

il US

Indo

nesia

Austra

lia

Mex

ico

Canad

a UK

Fran

ce

China

Spain

Italy

Germ

any

Kore

a

Japa

n

Russia

-1.50%

-1.00%

-0.50%

0.00%

0.50%

1.00%% p.a.

Source: PwC Report

Hedge Funds in India

Cater to Individual Investors

First Implicati

onUncorrelated returns

Surge in

earnings

Loose charm

for other investm

ent avenues

Second Implicati

onIncrease in

demand

Increase

competition

Reducing

investment fees

Also has cost to it

Registration

Independent audit

Transparency

Proper disclosure

Performance of Indian Hedge Funds• $44,000 million AUM (assets under

management) of all Indian hedge funds

• India’s high beta market generate effective returns.

2006• Bull Run• Q-India, Halbis, Baer Capital,

Insynergy & FMG outperformed major hedge fund indices.

2007• Experiment with complex strategies,

resulted hard on the returns.• India index was the worst performing

index with loss of around 50%.2008

• More cautious in year 2009 and 2010• Taking some worthwhile sectoral and

stock calls2009

• Gloomy picture of hedge fund success• First 7 months having almost deep

losses and very bleak returns• Funds which focused on inflation

sensitive India gained around 15.48% according to HFRX India index

2010

Hedge Fund Strategies Emerging Markets

◦ Invest in emerging markets ◦ Emerging markets offer less options for short selling, so these are

mostly long biased and employ growth or value approach to investing in equities.

Convertible Arbitrage◦ Make profit from arbitrage of convertible securities ◦ Make money from mispricing & volatility ◦ Usually buy a convertible bond, and take a short position in underlying

equity. Long- Short Equity

◦ Base strategy of the initial hedge fund formations by Jones. ◦ Hedging portfolio of longs by portfolio of shorts. ◦ Main focus on the stock picking opportunities.

Global macro◦ Invest in developed as well as developing countries.◦ Enough flexibility can invest in any security in any market where there

is an opportunity. ◦ These can be illiquid & carry a high risk due to correlation of emerging

economies.

Hedge Fund Strategies (Contd.)

Event Driven◦ Focus on events of corporate life cycle like merger and

acquisitions, buybacks, demerger, spin-offs etc,. Merger/Risk Arbitrage

◦ Focus on the companies which are going through any merger or takeover

◦ Both the acquiring company and the target. ◦ The risk is deal risk rather than a market risk.

Distressed Securities◦ Buying the bonds or securities of companies facing or

approaching bankruptcy or restructuring ◦ Tries to benefit from the price movement of these securities.

Equity Market Neutral◦ Market timing rather than stock picking. ◦ Taking long and short position in the undervalued and

overvalued securities ◦ Has low volatility.

Methodology

Use of secondary data ◦ Related to the returns (ROR) ◦ Various hedge fund strategies

Average of returns from year 2006-2010 are taken into consideration ◦ conclude the ranking of each strategy ◦ comparison from the data extracted from Hedge

funds research and Dow Jones Credit Suisse indices.12 strategies from Hedge fund research indices 7 strategies from Dow Jones Credit Suisse

indices Risk levels are measured through standard

deviation between last 5 years.

HFRX Returns 10 09 08 07 06 Avg Stdev Min Max Rank

Global Hedge Fund 5.19 13.4 (23.25) 9.26 2.72 1.46 14.40 (23.25) 13.4 7

Equal Weighted Strategies

5.29 11.44 (21.9) 8.83 1.28 0.99 13.35 (21.9) 11.44 8

Absolute Return (0.12) (3.58) (13.09) 7.43 (0.03) (1.88) 7.45 (13.09) 7.43 11

Market Directional 9.32 29.34 (29.7) 10.45 4.2 4.72 21.48 (29.7) 29.34 2

Convertible Arbitrage 8.76 42.46 (58.37) 9.57 (5.69) (0.65) 36.77 (58.37) 42.46 10

Distressed Securities 8.34 (5.6) (30.69) 9.56 1.21 (3.44) 16.41 (30.69) 9.56 12

Equity Hedge 8.92 13.14 (25.45) 9.23 4.19 2.01 15.67 (25.45) 13.14 4

Equity Market Neutral 2.64 (5.56) (1.16) 4.76 0.21 0.18 3.93 (5.56) 4.76 9

Event Driven 1.98 16.59 (22.11) 10.32 2.81 1.92 14.70 (22.11) 16.59 5

Macro (1.73) (8.78) 5.61 5.61 6.67 1.48 6.64 (8.78) 6.67 6

Merger Arbitrage 5.69 8.14 3.69 10.73 3.72 6.39 3.03 3.69 10.73 1

Relative Value Arbitrage

7.65 38.47 (37.6) 10.65 (0.97) 3.64 27.39 (37.6) 38.47 3

Table I: Hedge Fund Research Index (HFRX) Returns, 2006-2010

Dow Jones Credit Suisse indices

10 9 8 7 6 Avg Stdev Min Max Rank

Convertible Arbitrage 0.9 3.24 -2.79 0.11 1.04 0.50 2.18 -2.79 3.24 7

Emerging Markets 0.81 2.04 -2.19 2.51 1.8 0.99 1.89 -2.19 2.51 1

Event Driven s 0.6 1.6 -1.46 1.64 1.03 0.68 1.27 -1.46 1.64 6

Fixed Income Arbitrage 0.38 0.3 1.01 1.29 0.86 0.77 0.42 0.3 1.29 3

Global Macro 0.69 0.48 0.98 1.21 0.39 0.75 0.34 0.39 1.21 4

Long/Short Equity 0.58 1.47 -0.85 1.5 1.02 0.74 0.97 -0.85 1.5 5

Managed Futures 1.14 -1.08 2.29 1.39 0.99 0.95 1.24 -1.08 2.29 2

Table II: Dow Jones Credit Suisse Hedge Fund Indices Returns, 2006-2010

FindingsHedge Fund Research

Index Dow Jones Credit Suisse

index

1. Merger Arbitrage with return of 6.39%

1. Emerging Markets (return +0.99%)

2. Market directional with return of 4.72%

2. Managed futures (return 0.95%)

3. HFRX index returns for emerging markets is 17.12 % for 2010

4. HFRX India Index returns is 15.47% for 2010

• Convertible Equity Arbitrage ranked last on the basis of return in both the indices strategy need to be evaluated further

limited options available for convertible securities