The concept underlying this trend is the lack of accessibility to hedge funds for non-accredited retail investors, and through the implementation of the forthcoming proposed structure, we are confident J. P Morgan Chase with be able to provide added value to both its clients and its investors. Hedge Fund Market: The Trend From the inception of the first hedge fund in 1949 by A. W. Jones, skepticism has surrounded this investment vehicle.
There's a specialist from your university waiting to help you with that essay.
Tell us what you need to have done now!
order now
Over recent years however, the benefits of diversification have caused a wider breadth of investors to look past their mystique and gain reasonable insight into the investment alternative that has been attracting some of the most affluent of investors for well over 50 years. Now, as mutual funds prove to be by comparison quite inefficient, and a reversion to general stock picking proves difficult with current market turbulence, more and more of the investing public are looking to alternate vehicles.
This trend is quickly becoming resolute. Credibility for this is drawn from the massive purchases of mortgage-backed securities in 2007-2008, valued at $8. 91 trillion in 2009 even after recessionary levels of write-offs had occurred. Furthermore, with market activity steadily globalizing2, opportunities created by capturing such a trend are incalculable. Hedge Funds: The Structure Hedge funds are unique as an investment vehicle primarily for one reason: their structure.
Hedge funds are set up as partnerships, with investors gaining access to management techniques by signing on as limited partners. In this format, investors have no responsibility for running the company, or in this case as the company consists primarily of the fund, managing that pool of capital. The investors are instead legally guaranteed a proportional percentage of the profits, less management expenses.
Advantages and Disadvantages of the Structure This structure has both its pros and cons. The benefits come from all investors being partners. Based on the assumption that a “partner” chooses to take such a position based on a full understanding of his or her company and its operations. In this case, the company refers to the fund manager(s), with operations being replaced by trading techniques and strategies.
As investors are accordingly assumed to have done prudent research before taking their position, the fund is able to assume any strategy it chooses, invest in any asset class, take both long and short in investments, and utilize leverage as is determined advantageous. The only restriction to this is that the fund’s board of directors must approve any major strategic changes, however as this board generally consists of the fund manager and some or the larger investors in the fund, we can assume this to be a minor formality in most cases. The second advantage is derived from the same nderlying principle: hedge funds adhering to the accredited investor policy and having less than 499 “partners” do not have to register with the Securities and Exchange Commission (SEC), which allows the funds to evade public posting of financial results, and more importantly does not require they release their investment strategy publically. This allows funds to retain their competitive advantage on a specific investment strategy for long periods of time without other funds replicating the strategy and eroding its effectiveness. There are however drawbacks from an investors standpoint to this breed of fund.
The first is derived from the partnership structure. To withdraw money from a hedge fund, dependent on the fund, this can take anywhere from weeks to months: this being a result of having do legally deregister the investor as a partner, and pertinent to large investors, measures have to be taken to ensure the withdrawal of capital does not affect the strategy’s profit earning potential for other investors. The second downside resulting from the 499-partner constraint, is that well-performing hedge funds often have investment minimums in excess of $1 million3.
The third disadvantage of hedge funds is their confinement by the SEC to seek new investors solely through word of mouth. Where the opportunity lies In examining hedge fund structure, we quickly recognize its primary limitation: exclusivity through the accredited investor clause. This clause states that for a hedge fund to avoid the basic limitations of other more traditional fund structures, retail investors must have a thorough understanding of the investment profile of the fund, as well as over $5 million in investible assets. For institutional investors, this number is $25 million.
While this clause allows Hedge Funds to avoid registration with the SEC, it restricts the fund from accepting any non-accredited investors from investing in hedge funds. This population constitutes the vast majority of investors domestically. Furthermore, as markets expand to less wealthy nations, we note that here an even more concentrated percentage of populations fit these criteria. Capitalizing on the Opportunity Already positioned to capitalize on this trend, J. P. Morgan Chase is licensed as a broker-dealer, which allows the firm to resell investment products to retail investors.
Furthermore, with $271. 8 billion4 in cash and cash equivalents alone (as at year end, 2010), the firm meets the Accredited Investor stipulation. As could be derived from the former statement, to structure this new market in accordance with the stipulations laid out by the SEC, J. P. Morgan Chase will serve as the limited partner to the hedge funds. Upon making these initial purchases into the various funds that will make up their market offering, J. P. Morgan will break down these larger purchases of assets into smaller units.
These new units of assets can then be resold to existing clients within J. P. Morgan Chase’s retail banking network. As this new market will be the first of its kind for retail clients, the firm can expect to attract new clients as a result of this offering. Justifying the Value in Hedge Funds Since the inception of the first “hedged” fund, performance among top hedge fund managers has consistently exceeded that of mutual funds. However to provide a more valid measure, even when performance is compared category-wide we still see advantage in hedge funds.
As an example, average hedge fund returns from 2008-2010 were as follows: -8. 37%, 22. 38%, and 18. 08%. The same figures for mutual funds were -22. 91%, 21. 16%, and 10. 23%5. Behind the numbers, hedge funds have two robust advantages over traditionally rigid fund structures. The first is the pay-for-performance model. Hedge fund managers are in most circumstances paid based on the funds performance, and are paid well. Because of this, a disproportionate number of the world’s top money managers and traders have transitioned to hedge funds.
The second advantage as relating to earlier discussion is a result of the funds’ freedom to use short selling, derivatives, and leverage as they please to boost performance and lower risk. Aligned Client and Firm Interest The establishment of a market for hedge funds will benefit J. P. Morgan Chase, its clients, as well the hedge funds for which its will be invested. These benefits are as follows: 1. Benefits to J. P. Morgan Chase – With first mover’s advantage, development of the stated market would grant J. P.
Morgan Chase primary access to all domestic retail investors with interests in alternate investments. By charging a set rate for providing this service to clients, it will provide the firm constant and growing cash flows in both bull markets where investors seek to capitalize on aggressive leverage strategies, as well as in bear markets where investors are looking to mitigate risk with various hedging strategies. 2. Benefits to clients – This new market will benefit retail investors in two primary ways.
