Shadow Accounting - A Look Inside Hedge Funds

SHADOW ACCOUNTING: A LO O K INSID E HE D GE FUN DS WHAT IS A HEDGE FUND? • An alternative private investment vehicle • Available to Accredited Investors (net worth over $1 million excluding value of primary residence) and Qualified Purchasers (over $5 million in investments) AI $1 million QP | $5 million Designed to protect investment portfolios from market uncertainties • Intended to generate positive returns in up and down markets HEDGE FUNDS: THE PLUS SIDE Diversification Returns not often correlated with other asset classes Downside Protection Usually less volatile than typical long-only portfolios Absolute Return Focus Concentrate on making positive returns in all kinds of markets HOW HEDGE FUNDS WORK Take for example a fictional company called Profitable Investments, LLC Goal: Increase the investor's money at the highest rate possible, but adjusted for risk Start . Initial Investment •.. $100 million 9 = 10 million Can be invested on anything of value, such as: BL-8158A JLATOR collectibles bonds M+ stocks mutual funds startups gold real estate . After i year ••• The $100 million doubles to $200 million $200 million -$100 million $100 million Initial Investment Profit This is called “hurdle" rate on Wall Street. Why? Because hedge fund managers have to clear this before receiving a payment. Based on the operating agreement: $4 million The first 4% goes to the investor Profit less the 4% hurdle $100 million $4 million $96 million $72 million $24 million 75% goes to the investor 25% goes to the manager investor .. manager •.. $76 million $24 million $4 million hurdle + $72 million SHADOW ACCOUNTING TODAY IS USED BY: %24 Hedge Funds Managers Traders Fund-of-fund Pensions Endowment Corporations Funds Security features Managers include BEST PRACTICES: SHADOW ACCOUNTING Benefits for Investors Additional protection of their funds Critical for detailing earnings 6,500 Benefits for Managers 6,250 Accurate records of the trades executed and valued Accurate calculation of the reported results Ability to evaluate the reported results of underlying managers in a fund of hedge funds WHY IS SHADOW ACCOUNTING IMPORTANT? 84% 76% 65% of hedge fund managers shadow the administrator who provides the Net Asset Value (NAV) for the fund of investors say it is important for hedge fund managers to maintain shadow accounting of managers say the primary reason for shadow accounting is to provide a back-up that mitigates the risk of error KEY VARIABLES TRACKED IN 34E COF SHADOW ACCOUNTING hiseer 85% 84% 80% 80% 77% 76% 76% 71% 64% б0% 39% Calculation Trade Trade P&L Risk Investor of NAV Processing production and allocation reconciliation reporting reporting Investment valuation Cash reconciliation Partner/ shareholder Investment valuation no-OTC Cash/ collateral management OTC activity (listed) WHO PAYS? INVESTORS VS. HEDGE FUNDS MANAGERS HEDGE FUNDS INVESTORS Which of the following costs do you currently or expect to pass on? Which of the following costs do you not object to passing on? 80 70 Ilililu бо 50 40 30 20 10 72% 67% 49% 64% 47% 57% 42% 62% 33% 55% 29% 36% 27% 67% 13% 29% 9% 43% Non-travel research Research- related D&O Regulatory examinations Trader insurance compensation expenses travel Regulatory registration Тах Cost of Marketing examinations shadow expenses accounting Hedge funds Investors Sources: http://www.hedgefundmarketing.org/hedge-fund-definition/ http://www.forbes.com/2000/07/15/feat.html http://dealbook.nytimes.com/2012/09/05/pruning-hedge-fund-regulation-without-cultivating-better-rules/ http://www.investopedia.com/university/hedge-fund/place-in-portfolio.asp#axzz2lınawo5p http://beginnersinvest.about.com/od/hedgefunds/a/what-is-a-hedge-fund.htm http://richard-wilson.blogspot.com/2008/03/history-of-hedge-funds.html http://www.jwigga.com/origin-of-hedge-funds/ http://www.investopedia.com/terms/m/michael-steinhardt.asp http://www.fundinguniverse.com/company-histories/soros-fund-management-lle-history/ http://eprints.Ise.ac.uk/24675/1/dp477-pdf http://www.scribd.com/doc/65238186/Handbook-of-Hedge-Funds-Lhabitant http://www.investopedia.com/university/greatest/julianrobertson.aspwaxzz2ID28ZQen http://www.investopedia.com/terms/b/bullmarket.aspwaxzz2ID28ZQen http://www.investopedia.com/features/crashes/crashes6.asp#axzz2ID28ZQen http://www.hedgefundprofiler.com/Documents/51.pdf http://www.cy.com/Publication/vwLUAssets/2011_survey_highlights:_global_hedge_fund_market/SFILE/Hedge%20Fund%20Survey%202011_FINAL.pdf (pages 22-25) Brought to you by: STRATA FUND SERVICES LLC ...... E.... *..... ...... E ...... ...... ......