Financial Education

The Bera-Jarque statistic combines skewness and kurtosis into a single measurement, and determines whether kurtosis is unusually different from its expected value.

It is calculated as T/6[skewness^2 + (kurtosis^2/4)]

If the Bera-Jarque statistic is less than 5.99, the returns are considered normally distributed.

Event-driven style hedge funds typically focus on distressed securities or risk arbitrage.

The distressed securities style focuses on debt and equity of companies experiencing or expecting to experience financial difficulty. It includes reorganization, bankruptcy and distressed sales. Securities often trade at deep discounts due to regulatory restrictions on some investors, lack of research, low liquidity and excessive investor fear. Investors accept credit and liquidity risk in hope of long-term turnaround. Sometimes managers hedge with options, sometimes take active roles in restructuring the company.

The merger arbitrage style shorts the acquirer and goes long the acquiree to capture the spread.

Event-driven multi-strategy funds draw on multiple themes including merger/risk arbitrage, distressed securities and other themes such as Reg D private transactions

Kurtosis is the fourth central movement of a distribution. The first three movements are mean, standard deviation, and skewness. It measures the distribution’s peakedness and the thickness of its tails.

Leptokurtosis, or positive excess kurtosis,  indicates a distribution that is more peaked at the center and has fatter than normal tails.

Platykurtosis, or negative excess kurtosis, indicates a relatively flatter top and thinner tails.

Hedge funds using the equity long/short style invest in equities, combining long and short investments to reduce but not eliminate market exposure. Major sub-categories of the style include:

• Global
• Regional or industry focus
• Dedicated short bias
• Emerging market
• Market timing

The short selling style acts inversely to market direction.

The emerging markets style invests in all types of securities (equity, fixed, sovereign) in emerging markets. It tends to be more volatile and funds are often long-only due to local market restrictions on short selling.

The market timer style varies long and short exposure in reaction to market conditions.

Skewness is the third central movement of a distribution. The first two movements are the mean and the standard deviation. It measures the symmetry of a return distribution around its mean.

Zero skewness indicates a symmetrical distribution. Investors generally prefer higher skewness and avoid negative skewness if possible.

The predominant strategies within the tactical investment style are Global macro and commodity trading advisors (CTA).

The global macro strategy makes leveraged, directional, opportunistic investments in global currency, equity, bond and commodity markets on a discretionary basis. Managers usually rely on a top-down approach and base trading views on fundamental economic, political and market factors. They seek high returns with less concern over risk. Success is heavily dependent upon manager skill.

Discretionary traders base decisions on fundamental and technical analysis, and their experience. Systematic traders believe future price movements can be anticipated by quantitative analysis of historical price movements.

When measuring hedge fund performance, one simple tool is to look at average gains and losses for periods.

The average gain considers only periods in which there was a gain, and is the simple average return in those periods. Likewise, the average loss is the simple average return in all periods in which there was a loss.

The gain to loss ratio is the average gain divided by the average loss.

What the gain to loss ratio does not tell you is how many periods realized gains and how many realized losses. It also fails to account for compounding of returns.

Investors are required to hold for a specified time and provide a specified advance notice before redeeming. These restrictions permit the manager to take a longer-term point of view and invest in less liquid securities.

Hedge fund fees typically include a fee based on the amount of assets being managed and a fee based on the fund’s performance. The performance based fee is typically 20% of the performance in excess of some minimum target. So, for example, a firm with $100 million in beginning assets is expected to earn at least 2% per quarter, and in a given quarter their return is 3% ($3 million.) Their performance based fee would be 20% of the difference between the $3 million actually earned and the $2 million (2%) minimum requirement – or $200,000.

If, in the following quarter, the fund loses money and returns to $100 million in assets, obviously they would not earn a fee in that period. However, investors would also be reluctant to pay a fee for the fund simply recovering the $3 million lost. After all, they already paid a performance fee when the fund reached $103 million the first time.

As a result, fund structures typically include a “high water mark” provision. This provision stipulates that the fund cannot charge additional performance fees until the previous high value has been surpassed.

In order to keep investors from seeking a “free ride” by investing in funds that have recently suffered a loss in order to avoid performance fees until the high water mark is recovered, most funds employ accounting methods known as fee equalization to ensure that all investors in the fund are charged incentive fees on an equitable basis.

Most hedge funds charge 1-2% as a management fee plus 20% of net profits above a hurdle rate. Losses must typically be recouped before additional performance fees can be paid.