Hedge Funds

Course Number: MGT 647

Zhiwu Chen

ICF room 204, 46 Hillhouse Ave
203-432-5948
zhiwu.chen@yale.edu

Ezra Zask
ezrazask@aol.com

 

TA: Denis Sosyura
 

Time and Place: Monday, 4:10 to 7:10, Room A-53

Course website: http://www.som.yale.edu/Faculty/zc25/HedgeFund/hedgefund2005syllabus.html

Course Overview

This course is an in-depth study on the theory and management of hedge funds, in particular market-neutral funds and funds with various controled levels of risk exposure. We will focus on their controled-risk strategies, including equity strategies (market-neutral, long/short, etc), derivatives arbitrage, convertible arbitrage, fixed income arbitrage, and currency and global macro arbitrage. We will pay attention to issues at the operational level. Topics will include hedge fund compensation, performance evaluation, risk management, and the role of arbitrageurs in the capital market.

Assignments: Grades will be based on two assignments (each with 10% weight), two group cases (each 10%), one group project (20%) and a final exam (20%), with the remaining 20% of the final course grade determined by class participation. Class participation and attendence is required. The project and the cases will be done in groups of 2, but no more than 3. For each case, one group will be selected to do a presentation in class. For the project, two groups will be selected to present.

The course project involves four steps. Step 1:  select a hedge fund strategy (based on your own experience and reading of the literature, or based on your research). You may also do some back-testing of your strategy before taking the next step to make sure that you can have enough confidence in your strategy. If possible, start right away to track a paper portfolio and keep the daily performance numbers, which you can then analyze and include your report and presentation. You can track your strategy's performance on Yahoo Finance or Stock Trak (www.stocktrak.com). You should also track the daily changes in the market indices that you may later need to evaluate your fund's performance.  While tracking your strategy's performance, you can make changes to your portfolio positions on a forward-going basis (not retroactively). But, if and when you make changes, you should apply a 0.5% transaction fee. Step 2: conduct a performance evaluation and a performance attribution across market indices and well-known factors, for each of (1) the historical performance of the hedge fund style to which your chosen strategy belongs, (2) your back-test performance results of your strategy if you have those numbers, and (3) your paper portfolio's daily returns before November 15. You can use the S&P 500 and the NASDAQ Composite index as the two factors to take out the performance that is due to systematic risk. Step 3: After doing the performance evaluations, write a comprehensive report discussing "why" your hedge fund strategy is attractive and summarizing the performance evaluation results (to support your "why" arguments). Besides writing such a group report of 12+ pages, turn in a PPT presentation for your report. You should write both your report and PPT presentation as a hedge fund business plan/proposal, with potential investors as your target audience. In other words, your report and PPT presentation should be convincing to potential investors. The due date for the report and the PPT presentation is December 12, on which date two groups will be selected to present to the class.
 
 

Text: Jaeger, Robert, All About Hedge Funds

Suggested additional reading: Joseph Nicholas, Market-Neutral Investing: Long/short hedge fund strategies

  

Sept. 12, Lecture 1:  Introduction

• Jaeger, chapters 1-4* and chapters 12-15*
  

• *Goetzmann and Ross (2000) Hedge Funds, Theory and Performance

• *William N. Goetzmann, Roger G. Ibbotson and Stephen J. Brown, Offshore Hedge Funds: Survival & Performance 1989-1995

• *Stephen J. Brown and William N. Goetzmann, Hedge Funds with Style

• Carol Loomis, "Hard times come to the hedge funds," Fortune, 1969 (hard to believe that this article was published in 1969, but it sounds like today's debate).
  
  Prsentation files for today: Introduction   and  introduction to hedge funds by Will Goetzmann

• Jaeger, chapters 5-8*
  
• Nicholas, chapter 8 
• See Value at Risk: A Two Day Course. (required) For related references on different risk measures, check out Barry Schachter's website: http://www.gloriamundi.org/
• Robert Litterman and Kurt Winkelmann, Goldman Sachs, January 1996, Managing Market Exposure.
• William Fung and David Hsieh, The Risks in Hedge Fund Strategies: Theory and Evidence From Trend Following
• Pairs Trading: the performance of a relative value arbitrage strategy, Evan Gatev, William N. Goetzmann and K. Geert Rouwenhorst. (required)
• Mark L.Mitchell , Todd C.Pulvino and Erik Stafford, Limited Arbitrage in Equity Markets
 
Powerpoint Presentation Risk Management and Portfolio Formation, and   Pair Trading

Sept. 26:  Hedge funds in an investment portfolio

Lecture by Ezra Zask. PPT file is here.

• Manoris Chatiras, 2004, "Benefits of hedge funds: update 2004",  University of Massachussetts  - Amherst. (required, in packet)
  
• Harry Kat, 2002, "In search of  the optimal fund of hedge funds",  Cass Business School, City University, London

Oct. 3: Fund of funds and construction of  multi-manager hedge fund portfolios

(first homework assignment due)

Speaker: Robert Jaeger, CIO, Evaluation Associates, INC.  Presentation file is attached here.

• Jaeger, chapters 7 and 11.*
• Other readings in packet
  

Oct. 10, Lecture 4:  Equity return models and stock selection (first case due)

• Nicholas, chapter 9
• Zhiwu Chen and Ming Dong, "Stock Valuation and Investment Strategies", Yale School of Management. (required)
• Zhiwu Chen and Jan Jindra, "A Valuation Study of Stock-Market Seasonality and Firm Size", Yale School of Management.
• Narasimhan Jegadeesh and Sheridan Titman, "Profitability of Momentum Strategies: An Evaluation of Alternative Explanations".
• Lee, Myers & Swaminathan (1998) on the residual-income stock valuation model.
• 
  Presentation file for this lecture:  Stock valuation models

First case presentation at the beginning of class: the HBS Common Fund case. Questions to work on for the case are here.

Oct. 24, Lecture 5: Market impact/slippage costs, and trading strategies and systems

• Zhiwu Chen , Werner Stanzl and Masahiro Watanabe, "Price Impact Costs and the Limit of Arbitrage," Yale School of Management. (required)
• Plexus Group, "Time of Day Effects on Trading Costs. (required)
• Plexus Group, "Draifting Icebergs: perceptions and reality in trading costs. (required)
• There are more reports by The Plexus Group on its webiste: http://www.plexusgroup.com/fs_speechespapers.html
• Powerpoint Presentation for Price Impact and Fund Size,
  
• 
  Here is the main presentation file for today.
  

Nov. 4, Lecture 7:  Futures funds and options arbitrage 

Speaker: Mark Rosenberg, President of SSARIS (owned by State Street Global Advisors and BPA) and a board memeber of the National Futures Association.  Because they cannot accommodate 50 people on site, we will have this class at school. His presentation file is here.

•   Jaeger, chapter 10.
•   PPT slides in the course packet

Nov. 7, Lecture 8: Fixed-income, currency and global macro hedge funds:  (second case report due)

Second case presentation: the Orange County case at the beginning of class. Orange County Case Philippe Jorion's Orange County Case: Using Value-At-Risk to Control Financial Risk. Reading for the case: * Hedge Funds and the Asian Currency Crisis of 1997 , Stephen J. Brown and William N. Goetzmann.

Speaker:

• Nicholas, chapter 5 and 6  (required) 
  
• Philippe Jorion, 1999, Risk Management Lessons from Long-Term Capital Management
• Fang Cai, 2001, Does the Market Conspire Against the Weak? An Empirical Study of Front Running Behavior During the LTCM Crisis

     Slides for this topic are in part 1 and part 2.

Nov. 14:  Covertable bond hedge funds

Speaker: Bill Feingold , Managing Director of  FrontPoint Convertible Arbitrage Fund, one of several hedge fund strategies managed by FrontPoint.

The materials for his lecture are: slide summary, a background read,  and an example for discussion.


Nov. 28:  Emerging Market Funds

Speaker:  Satyen Mehta, partner and founder, Neon Capital Management. Neon Capital specializes in emerging market fund management.  Formerly with JP Morgan Investment Management.

Dec. 5: Risk management and hedge fund operational issues in practice.

Guest speaker: Dr. Barry Schachter, Managing Director of Risk Management, SAC Capital Advisors; Formerly, head of enterprise risk management, Caxton Associates; Chase Manhattan Bank, responsible for portfolio market risk management, VaR model, stress testing, market risk economic and regulatory capital; Comptroller of the Currency, responsible for evaluation of bank market risk measurement systems; Commodity Futures Trading Commission, acting head of economic research group and project leader for OTC derivatives study; Ten years in academia teaching and doing research in derivatives and risk management.  Check out Barry Schachter's website: http://www.gloriamundi.org/

Here is Barry's PPT file you can download. On fund operational risk management, see the slides by clicking here. 

Dec. 12: Student project presentations and hedge fund performance evaluation (project report due)

Group presentations during the first session.

Speaker for the remainder of class :  Todd Petzel,  Chief Investment Officer, Azimuth Trust Company .

Performance Evaluation. linear models, attribution analysis, benchmarking trend followers.

• Stephen J.Brown , William N.Goetzmann and Bing Liang, 2002, Fees on Fees in Funds of Funds .
• William Fung and David A.Hsieh, 2001, Benchmarks of Hedge Fund Performance: Information Content and Measurement Biases .

For an easy-to-read article on the Sharpe Ratio, see http://www.investopedia.com/offsite.asp?URL=http://www.venus.it/homes/ik2hlb/sr.htm