Hedge Fund Street

What has school education got to do with Hedge Funds?

If you thought that school education has nothing to do with hedge funds, think again. Hedge-fund guru Joel Greenblatt applied Wall Street principles to an elementary school and won. P.S. 65Q was a small, struggling elementary school in working-class Ozone Park, Queens for quite some time.

It had opened some years back with the prime objective of providing education to children of extremely poor South American and South Asian immigrants. The school building itself was a former airplane-parts factory. The problem that the school was facing was that though it has over 540 students, they could not perform well in maths. In fact they could not even read properly. This situation was primarily due to lack of funds.

Greenblatt approached the school and after having a good look at the facilities asked the school to put up a figure that they would need. He wanted to accomplish a turnaround in education and learning level. The school authorities did their home work and put forth a proposal which was very much in line with what Greenblatt has thought they would need. They put forth a requirement of $1000 per student per year for 5 years in order to bring about the desired changes. This roughly translated into $ 2.5 million.

The hedge fund manager wanted to create an effective and affordable public-school prototype that could be franchised citywide. And this he did in a short timeframe of 5 years. In this period the school was able to turn around in a way that the genius had predicted. NY Metro reports:

“For weeks, Nelson fretted over how much to request. Finally, she decided to take Greenblatt at his word: To keep everyone from falling behind, she calculated, it would take an incremental $1,000 per student per year for five years, or $2.5 million”

Hedge Funds – Strategies that worked well

Hedge funds have the reputation of being able to give better returns than the rest of the financial instruments available. The fund managers are able to use strategies that enable them to utilize market downturns as well as the upswings. However the trick lies in the correct selection of the strategy. What works at one time may not work at the other. The foresight to pick the right stock or event also complements the ability to make gains. Here are some examples of how two leading hedge funds selected their strategy seeing the trend evolving in the last quarter of 2005.

Tremont Capital Management realized that in the last 3 months of 2005, three strategies pulled in a sizable money in the market. These are global macro, emerging market and dedicated short bias. Global macro pulled in $1.2 billion whereas emerging market strategy was able to get some $600 million. Short-bias strategy on the other hand could get in only about $30 million. Rest of the strategies including Event-driven, long/short equity, managed futures, multi-strategies, convertible arbitrage and equity market neutral either did not pull any assets or lost some part of it. This revelation forms the basis for the future course of investment for the hedge fund.

Okumus Capital Management is one hedge fund that is defying the usual trend and creating its own path. When most of the players are preferring to follow a long-only strategy and hedging it with shorts, this player is going its own way. Confident of it’s strategy, the fund is selling it’s long only fund to investors who want only long-only vehicle. The fund manages funds in the range of $750 million.

The fund is selling the long-only fund via its recently launched on-shore/domestic fund. This apparently is a strategy which has been adopted as a result of a specific demand from the funds investors. One way to satisfy the investors would have been to offer this class a personal managed account. But the fund managers found the process quite cumbersome and one that would involve a lot of back office work and hence settled for this option.

Okumus has also created three classes of fee payment taking into account the liquidity as well as returns. The benchmark for performance fee is the S&P 500 index. First class defines a management fee of 1.5% and 20% performance fee with a lock in period of one year. Class two charges 1% management fee and a performance fee is 17.5% for a lock-in period of 3 years. Third class fee structure involves payment of  0.75% management fee and a 50% performance fee which is charged on the difference between the index and the actual gains. The Street reports:

“Okumus picks have a hit ratio is 90, meaning that 90 trades out of 100 are profitable. The firm's flagship Okumus Opportunity Fund generated a 29% net annualized return since inception in 1997 with no down years, according to Okumus.”

Want to invest in hedge funds?

Man’s inherent desire to make his money generate more returns for him led to the invention of hedge funds. Hedge funds as one knows is an investment vehicle which is notorious for generating good returns when the others are trying to merely stay afloat. ‘Money creates more money’ – following this mantra, the hedge funds were initially designed for those with big bucks to spare. The funds used this money and by employing different strategies, were able to generate returns which ever way the market progressed. Risk and returns are always directly proportional and therefore for quite some time this asset class was reserved for those who could afford this risk and therefore reap the returns.

But now with the hedge fund market having crossed the $1 trillion mark, and with a phenomenal rise in the number of hedge fund operators, the booty is available for the not so rich average investors as well. The average middle class investor can also choose from various strategies available and make his money grow. It is imperative however to analyze the fund and its strategy and keep a close watch on the market as well. Read more on this in the C S Monitor report.

CDOs – The new generation hedge fund investment game plan

Year 2005 was a landmark year of sorts for hedge funds. Not only did it see doubling up of the industry’s asset base but also saw it cross the $1trillion mark. It was also a year which saw dwindling of profits and a large number of hedge fund managers close shops and go home. The year also saw SEC get into action and work towards regulating the unregulated hedge fund market. Therefore in a way it was a year that saw a good amount of upheaval yet progress towards institutionalization.

Optimists like Peter Cockhill and James Bagnall of Ogier say that the industry is in its best form ever and is expanding. Figures revealed by Cayman Islands Monetary Authority (CIMA) confirm this trend. The report made public recently by CIMA confirms that over 900 new funds have registered with it in the first nine months of 2005 itself. Cayman Islands is a kind of a haven for hedge funds because of the relaxed tax regime and the intrinsic money center that it is. CIMA also revealed in its report that growth in hedge fund registrations was up 112% from 2003 in 2004. All this further confirming the good health of the industry. We can treat Cayman figures to be quite authentic and indicative of the growth of hedge funds since more funds are domiciled in Cayman than anywhere else.

Despite all this optimism, the current returns from the industry has been far from encouraging. The optimists wave it off again say that the industry is slated for good growth. This is primarily because of the agility of the fund managers and also their innovativeness. Every passing day sees a newer strategy or a new investment class. The fund managers are continuously discovering newer areas for investing. Some of the newer area include investing in venture capital, private equity and mezzanine lending.

Today hedge fund managers are also offering open-ended investment vehicles with a private equity sub-fund element. This enables them to be a part of investment in illiquid securities as well. By doing this, hedge fund managers are making sure that investors get various combinations of risk and returns under the same roof. 

Yet another area that the hedge funds have discovered is management of collateralised debt obligations (CDO’s). Generally banks use this specially purpose vehicle to offload debt from their balance sheets. However changes in accounting rules and the new Basel II regulatory framework is allowing large financial institutions also to offload the management of the riskier elements of securitizations and the hedge funds are making use of this opportunity. For the uninitiated, CDO is a fixed income product that is a securitisation of other bonds, loans and financial instruments. It is generally used as a means of financing pools of assets such as mortgages and credit card debt.

Analysts see this kind of investment as somewhat unusual since it implies that the funds have to assure banks that they will be committed for a long duration. Traditionally hedge funds are known for their short term flings. Long term commitments is not something that comes to them naturally.

Despite this some funds like Cheyne Capital Management are proposing to come out with investment companies which will take on the management of these high yield financial investments.

The transition from a completely liquid to a somewhat illiquid investment structure is helping fund managers infuse some degree of newness in the hedge fund arena. Apart from this, it also helps them to safeguard their own position and strategy under heavy redemption requests. Hedge Week reports:

“the demand for idiosyncratic and imaginative managers continues to be high and that the need for a sophisticated, international and tax neutral jurisdiction such as Cayman remains strong.”

Commission appoints ABP as an observer of expert hedge fund group

The European Union has been looking at the alternative investment market place with a keen eye for some time now. In July last year, a green paper was published by the commission which proposed the formation of special groups on investment funds. The commission has thereafter been busy in the formulation of groups that would look into how the EU framework for investment funds could be improved.

The main task of the group will be to find out if the operators in the specialized asset classes face significant difficulties in organizing their activities in the European marketplace. They would also be responsible for pin pointing the issues that require special attention from EU policy makers. The commission has for this specific purpose suggested the formation of a wider industry group with several sub-groups. This proposal has now been implemented with the formation of an expert group on Alternative Investment Funds and their sub-groups. The groups have been formed based on nominations received from 13 European-level associations, including the European Federation for Retirement Provision. It has been mandated that the sub groups will meet on several occasions till June 2006. They will put together their assessment in these meetings. Thereafter the findings will be compiled and be fed into the Commission's White Paper on investments funds and related impact assessment work. This paper is scheduled for publication in October 2006.

The sub groups formed are in various areas of asset classes including hedge funds and private equity. The hedge fund subgroup has 15 experts including executives from Barclays Global Investors, Goldman Sachs and MAN. The private equity subgroup however has 10 experts. For the hedge fund sub-group, Stichting Pensioenfonds ABP has been named as an observer in its capacity as a wholesale investor. IPE reports:

“The Dutch civil service scheme’s Robert Coomans is one of five observers to the group that was announced today, as part of a wider industry group that also includes a private equity sub-group.”

New Hedge fund raises record billions

Convexity Capital, a brand new hedge fund on the block has broken all previous records by raising $6 billion at the onset itself. The new fund is a fixed income fund. The fund is an initiative of Jack Meyer who is a former fund manager of Harvard’s $26 billion endowment fund.

His illustrious stint at Harvard has earned him the reputation of being one of the best in the industry. No wonder then that the fund’s initial collection has surpassed all previous known collections. For instance, Convexity has also crossed the feat accomplished by Eric Mindich of  Eton Park fund. The fund had been able to raise $3 billion last year. The Street reports:

“During his 15 years at Harvard's $26 billion endowment, Meyer gained a reputation as one of the best hedge fund investors in the country. He dragged 30 people from Harvard along with him to Convexity.”

Hedge Funds: Are they ready to take off?

These days everybody is paying attention to Hedge Funds, the government, the investors, the fund managers and the media. With new regulatory changes, things are changing fast and opinions are changing even faster.

There is news about funds being pulled out of the market as also of new funds emerging every month. This is leaving many new investors confused about what is happening. The point to note, is that even as larger funds are facing trouble over registration, the smaller ones are sensing a new opportunity by keeping a low asset and a low clientele profile and catering to rich investors alone.

Perhaps the industry could get a big impetus if the regulations made it mandatory to publish periodic investor related data similar to what the mutual fund industry does. However, that could threaten the very nature of Hedge Fund investments as it would mean revealing all their activities and financial game plans taking away the secrecy it is known for.

Great Literature for Hedge Fund Investors

Of late, some of the 'letters' that Hedge Fund investors are receiving have a language that is so eloquent and full of poetry that they deserve to be placed along side other popular literary works. Deviating from the dry and lack luster style that most finance write ups adopt, Fund managers are beginning to rely more on prose, poetry and interesting analogies to make their fund 'read' better to prospective as well as existing clients.

The point remains whether sounding off investors with impressive flowery words actually make any effect. Hedge Fund investors are generally looking for big profits and think in terms of numbers, will the use of rhyming couplets and sonnets in investment letters have any impression on them. Putting up parallels that explain strategies is fine or even inspirational real stories may make a difference, but to think investors have the time or the interest to read pages of literature on the performance of their funds is too much to expect.

Are Hedge Fund Indexes any good?

When in investing in bonds or equity, to a large extent we depend upon indexes for making our decisions. They allow us to rely on the research that goes into building the index. It isn't the same with Hedge Funds.

The volatile nature of Hedge Funds defy the use of Indexes. However, a growing number of diversified investors is leading to a number of changes in the industry including an increase in the use of indexes. However, there is no standard or composite Hedge Fund Index available for investors. Different Indexes use different calculations for reprsenting returns and use different approaches to make their analysis. The large number of strategies available further add to the difficulty of building an Index that can truly represent funds dealing in each particular strategy.

The best way to go around building an Index for investors is to build their own Indexes that answer their investment needs. This may need a little bit of hard work calling for research, study, a lot of phone calls and calculations. But then you get the best possible answers to most of your questions.

Investors confused about hedge fund figures

Just when everyone thought that the hedge fund industry is becoming a little less secretive it seems to have gotten more complicated. The lightly regulated industry has for long been in the eye of storm raisers regarding their behind the curtain activities. Even when the industry has bloated to over $1.1 trillion, the figures that the industry trackers continue to push into the market cause more confusion.

This was evident when two of the industry trackers revealed the net assets that were pulled out of the market. Tremont Capital Management Inc. recently announced that the investors have removed $4.3 billion from hedge funds in the last quarter of 2005. Tremont Capital tracks around 3,200 hedge funds. On the other hand Hedge Fund Research Inc. said that the number was around $824 million. Hedge Fund Research tracks 6,700 hedge funds. The two figures are separated by billions of dollars. Therefore, in a nut-shell since no central database exists, the accuracy of the data collected, analyzed and interpreted can be questionable.

SEC has mandated that hedge funds register with it so as to allow it to have a better idea about the functioning and performance of the funds. However most of the funds are still outside its jurisdiction. Those who are registered also are not bound by any rule to share authentic data with one centralized agency. This obviously leads to a situation wherein the fund is free to reveal whet ever info it wants to divulge to whom-so-ever it wishes to. This then leads to discrepancy in figures such as that being witnessed here. Compare this situation with mutual funds wherein the $8.8 trillion industry's trade group is able to supply fairly accurate data every month. Reuters reports:

“This sort of discrepancy, which analysts say occurs often, may be confusing investors even more in a lightly regulated industry where assets have doubled in the last 5 years but which has also been called secretive by analysts and clients.”

Renaissance’s mega-hedge fund attracts billions

In 2002 when Renaissance announced that they are returning most of the outside investors money, many investors were disappointed. Renaissance Technologies Corp’ Medallion fund has for years given very high returns. The process of returning money to investors finally completed in 2005. But the returns hungry investors were not left without an option. They were given the option of investing in yet another promising fund from Renaissance which started sometime in mid 2005. Renaissance wants to reserve the rights of investing in Medallion to a chosen few including employees, their families and some friends. The reason for this is evident. The fund has been returning over 34% annually for the past 15 years and the hedge fund managers want the benefits to be shared amongst the chosen few. The fund has return over $7 billion and currently manages only $5 billion. Medallion has been known to trade in and out of a vast array of global securities, including commodities, stocks, bonds, currencies and options.

The outside investors are clearly not happy with this despite the fact that they had to pay very high asset management and fund performance fee. When the entire industry charges a management fee of 2%, Medallion fund charges 5% of assets under management. Apart from this, the fund takes a whooping 44% of profits above watermark when the industry standards hover around 20%.

Renaissance has however invited investors to invest in a relatively new fund launched in mid 2005. The statistical predictive modeling of the fund ensures that the fund can handle up to $100 billion which is in sharp contrast with the capability of Medallion. As such more and more investors can now invest in the fund. However the two funds are somewhat different in their overall approach on investing. The new fund will be restricting its investment to US equities which is a relatively small pool when compared with the global security diversity of Medallion. Apart from this, the new fund is designed for mostly ‘long’ strategy where as Medallion, does more "shorting" and trades more quickly. Apart from this, the fund requires the investor to put in at least $20 million in the fund. Another key differentiator is that the investors can chose from four different fee structures.

Both the funds are managed by financier James Simons. He was formerly a math professor at MIT, Harvard and SUNY Stony Brook. His consistent par excellence performance has catapulted him to the level of industry stalwarts like George Soros, Paul Tudor Jones and Bruce Kovner.

The new fund is based on a model created by dozens of mathematicians, statisticians, scientists and even astronomers. It is managed out of 50-acre facility in suburban Stony Brook, New York. The mega computers employed at the facility are programmed to do high level data and number crunching in order to give good and reliable predictions. 

Despite the high pedigree of the new fund, some investors are skeptic about the overall performance of the fund. Some feel that the mere fact that the fund ultimately plans to invest $100 billion on the market can force it to take large positions in illiquid smaller stocks and therefore hamper exits.

Despite what ever apprehensions that the skeptics may have, the fund has already garnered $4 billion and promises to pull more. On their part Renaissance has assured investors that the growth of assets of the fund will be gradual. If at any point the model falters, the fund will stop pouring money into it without taking it to $100 billion, its predicted ceiling. Reuters reports:

“So far, investors have not been shy, ponying up more than $4 billion for the new Institutional Equities Fund since opening in mid-2005, according to people close to the situation.”

Growth of Hedge fund continues despite enhanced scrutiny

The industry that has seen its assets double up in five years to cross the $ 1 trillion mark continues to grow. The growth is despite the fact that the industry is being watched more closely by regulators than it ever was. This was made evident at the semi-annual Managed Funds Association meeting in Key Biscayne, Florida. The members evaluated the extent of money pouring into the funds and also the type of investors who are still queuing up to share the diminishing booty.

Chief amongst them are pension plans. In order to meet their payout obligations they have to generate minimum returns of 8 to 10%. This obviously is not possible by merely investing in stocks and bonds. Therefore they are forecasted to be a key contributor to the hedge fund kitty. Fund managers are busy luring this category in a big way. However they cannot accept more than 25% of their total asset base from pension plans. Employee Retirement Income Security Act (ERISA), the federal law that governs corporate pension plans, has placed the ceiling in order to minimize the risk to risk averse pension plan investors. However, the fund managers are seeking to change this law through Managed Fund Association. They want the ceiling to be raised to 50% of ERISA money.

The members also observed that the demand for hedge funds is also coming from cash-rich investors in the Middle East. This class of investor is traditionally has a lot of cash and is not afraid of investing in alternative investment vehicles. This observation was made by George Hall, founder of the Clinton Group, a large multi-strategy hedge fund that started in 1991.

Hall also said that in the era of increased scrutiny by regulators and investors, the industry continues to attract a lot of money. Investors are willing to invest in funds that are reliable and have a strong fund manager behind it. Take the case of Jack Meyer, former head of Harvard University's endowment fund, who was able to raise $6 billion for a new hedge fund. It is being said that it is the biggest ever initial fund-raising for a new hedge fund.

George Hall added that the reputation of the fund manager is good enough for pulling in the cash but one small wrongly publicized act can cause the money to leave the fund also. His fund faced the consequence of a highly publicized regulatory investigation by loosing a lot of investor money. Though the fund was completely exonerated from any wrongdoing in December 2005, it failed to get the investor confidence back. Reuters reports:

“But even if the rule is changed, hedge fund managers are still facing rising costs and demands from potential investors that often take months of work to address.”

Angelica directors face pressure from The Steel Partners Hedge Fund

The Steel Partners II LP hedge fund have been constantly pressurizing Angelica Corp in order to improve the company’s performance and therefore enhance investor value. The Steel Partners currently control about 20% of the company’s shares. As a major shareholder, the hedge fund has expressed its concern about the performance of the company time and time again.

Earlier the company had heeded to their advice and had formulated a special committee to take care of the concerns of Steel. However the hedge fund has expressed dissatisfaction with its activities. It is now asking the company to replace two of its existing directors. The hedge funds wants to replace the two directors with its own people. The directors who are being asked to step down are Stephen O'Hara, Angelica's chief executive, and Ronald Kruszewski, who is the head of the committee formed to address Steel's concerns. They are to be replaced by James Henderson and John Quicke, vice presidents of Steel Partners Ltd.

Angelica has even offered that that it will allow the inclusion of new directors in addition to its existing 8 directors. However the hedge fund has not accepted the offer and continues to ask for the removal of 2 directors so as to keep the number of directors limited to 8.

Since the company is not acting upon the request of the hedge fund, Steel has decided to send a proxy solicitation to Angelica's shareholders ahead of the company's annual meeting in May. This was made clear via a filing with the SEC recently.

Steel Partners II LP has observed that in the 3rd quarter of 2005, the company reported a loss of $381,000. However the company had made a net profit of $1.6 million in the same period a year ago. Representatives of Steel attribute this attrition in profits is clearly an outcome of Angelica's aggressive acquisition strategy in the last two years. STL Today reports:

“Steel, led by Warren Lichtenstein, is among a growing number of hedge funds that have taken an activist role in pushing for management changes.”

Hiring a Hedge Fund Administrator

Hedge Fund managers are often taxed by a varied amount of work that range from administration to forming compliance reports. All these can cost a great deal of infrastructure, time and effort. Hedge Fund Administrator can take away a lot of these headaches by providing the necessary resources to managing operational and administrative activities. An administrator takes care of clients and investors, prepares compliance reports and supports all operational and administrative functions.

There are two types of services that these administrators provide,fund accounting and fund administration. Fund accounting take care of financial or GAAP reporting and other reports that are legally required to be generated. Fund administration service clients and do the administrative and accounting jobs of a fund. Even investors appreciate the services of an administrator since they know that they help keep their money safe. HedgeCo reports:

Hiring a edge fund administrator increases the size of your operations by providing a virtual administrative and operations staff. Your investors will pay approximately one basis point (0.01%) of return per month for the benefits of these services, a cost, which will barely reduces the returns of your fund, but will greatly enhance the service.

Significance of a Hedge Fund Administrator

A Hedge Fund Administrator plays a very supportive role in the management of Hedge Funds.

They provide reports on financial and tax compliance, service clients and investors and help in the administration and operation of the fund.

Hedge Fund administrators take away the headache of providing all the infrastructure that is required for carrying out all administrative and operational activities.

There are two types of service providers, those catering to fund accounting and the other to fund administration.

Hedge Funds see new growth in 2006

2005 was not a very good year for Hedge Fund managers, with most of them performing badly. Fortunately, the market looks more promising in 2006. The new year started with new opportunities by way of rising oil prices, an increased volatility in the Japanese stock market and some high level deals. Merrill Lynch Hedge Fund Index showed that the average hedge fund was up by 1.17 %.

A wave of take-over bids and restructuring happening in the corporate world has encouraged event driven funds to remain active. Equity and fixed income markets have shown a volatility that favor hedge fund investments. In January 2006, investments in emerging economies dominated the market. Hedge Fund managers see this as a 'phenomenal' start to the new year. CNN Money reports:

Top performing strategies for the month include emerging markets, which invest in the debt and equities of emerging economies. Emerging market hedge funds 'January performance is "just phenomenal," thanks to big economic gains in Latin America in particular, said Larry Smith, chief investment officer of global macro fund Third Wave Global Investors.

Will Convertible strategy work in 2006?

Last year a number of Hedge Fund managers were left with a bad taste after their convertible securities showed up with a very poor performance. Imprecise pricing led to significant losses and a lot of hedge funds were even driven to closing shop. Certain experts are however expecting the tide to turn the other way in 2006.

The stock market is expected to be much more volatile this year leading to a drop in interest rates and making the market conducive for a convetibles strategy. Convertibles strategy suit those investors who seek high income and are willing to be patient enough to wait for the conversion.

However if prices do not show variations, there is not much to gain from convertibles. But 2006 is expected to be different and will offer the necessary fluctuations for the convertible market to take advantage of. Unfortunately there aren't too many players in this segment as there were earlier. Market Watch reports:

Tom Ray from Inflective Asset Management in Manhattan believes the stock market will be much more volatile this year as interest rates rise and housing dips. That he says will be good for the convertible market as people seek to capitalize on the risk the market bears.

Hedge Funds hedge new rules as regulation tightens

With an explosive growth in Hedge Funds, the Federal regulators want them to be registered with the Securities and Exchange Commission from 8 February, 2006. The new rule makes it mandatory for Hedge funds with more than 14 clients and $30 million in assets to register themselves. However, Hedge funds are finding loopholes in the law to escape registration.

Fearing tight scrutiny of their activities, hedge funds are locking up their money for two or more years and are not inviting any new clients. But locking up investments has affected liquidity and that makes it unattractive to a certain segment of investors. Hedge Funds are avoiding registration in order to save on costs.

Registered firms are required to keep accurate and complete records of all transactions and communications which makes operations expensive and cumbersome. Certain experts believe that the new rule will divide the hedge fund industry into two, with smaller players that service wealthy customers not registering themselves by using exemptions while the larger ones that cater to institutions opting for registration. Times Leader reports:

In July 2004, there were anywhere from 2,300 to 3,500 fund advisers counseling about 7,000 funds with assets of nearly $800 billion, according to SEC documents. About 60 percent of those advisers, or nearly 1,400 to 2,100, had at least $25 million in assets, making them eligible to register with the SEC instead of with a state regulator.

From the Classroom: What is Arbitrage?

Arbitrage is commonly used to denote risk-free trading. The idea behind arbitrage is to take advantage of any price differential between two markets by buying from one and selling in the other. Arbitrage in its pure form is risk free and often called as True Arbitrage. It is generally the market makers who are able to use true arbitrage as they have the necessary capital and resources to invest in large amounts and make use of these opportunities.

Retail traders are not able to indulge in true arbitrage for lack of large amount of capital. They generally take to trading in risk arbitrage, also known as statistical arbitrage. Risk arbitrage arise out of situations where a price difference occurs due to an event whose happening is subject to uncertainty. Examples of such an event would be a merger or a takeover which may or may not take place but which may lead to price fluctuations. The different types of risk arbitrage are Merger and Takeover Arbitrage, Liquidation Arbitrage, and Pairs Trading also known as relative-value arbitrage. Investopedia reports:

Arbitrage, however, can take other forms. Risk arbitrage (or statistical arbitrage) is the second form of arbitrage. Unlike pure arbitrage, risk arbitrage entails--you guessed it-- risk.

From the Classroom: What is Margin Trading?

Margin trading is defined as taking a loan from your broker for buying stocks. Margin trading involves high risk as not only do you carry the normal risks associated with trading but in case you lose, you also have to pay back the amount you borrowed to make the investment.

For trading in margin, a special account called margin account is required to be opened. Under the law, a margin account holder must fulfill two conditions. First, proceeds for stocks sold in a margin account are held by the broker against the repayment of the loan and second, the account must have a minimum balance called the maintenance margin.

If an investor fails to keep the maintenance margin in his account, then he is liable for a Margin Call. A Margin call means the investor is forced to deposit more funds in the margin trading account or sell his stocks in order to pay his loan. Margin trading can however yield great returns if the investor know how to leverage the money that he has borrowed. Fund Library reports:

You can draw some parallels between margin trading and the casino. Margin is a high risk strategy that can yield a huge profit if executed correctly. The dark side of margin is that you can lose your shirt and any other assets you're wearing.

Legislation in Cayman Islands headed for amendments

The Cayman Islands are said to be home to 80% of the total offshore hedge funds that exist. It recently strengthened this unique position by registering the 10,000th fund in its domicile. The Cayman Islands Monetary Authority (CIMA) is set to introduce several changes in its legislation in order to make the rules more in line with the recommendations of the International Monetary Fund.

The changes are being considered after it was examined by a working group of government officers and private sector representatives.The amendments include both minor and major changes like a change in the classification of the fund names to increasing the minimum initial investment amount.

Another important change expected is the removal of the dual regulation that required Funds domiciled abroad to be registered with CIMA for them to fall under the administration of Cayman and similar registration for Cayman-domiciled funds for them to be serviced by other administrators. The changes are expected to provide greater scope of growth for the Cayman hedge fund administrators. Hedgeweek reports:

Cayman has long pioneered cutting-edge regulatory and legislative transitions that have enabled the jurisdiction to flourish, including the flexible effective Mutual Funds Law. A re-examination of the legislation by a working group has recommended various amendments that industry members anticipate will be enacted in 2006.

From the Classroom: What is Short Selling?

Short selling is selling of stock by an investor when he expects their prices to drop in the near future. This does not make much sense to those who always believed profit lies in selling when prices go up, in other words in going long.

The difference between short and long selling is that in the former the seller of the stock does not own the shares but only holds it in borrowing from another investor. Here is how it works. You borrow shares from your broker. These borrowed shares are sold and the money is credited to you, but sooner or later you are expected to buy back the shares and return them to your broker.

At the time of buying back you make a profit if the price falls, however you may also lose money if their price rise at the time of buy back. As the stocks are borrowed and sold, any dividends or rights declared go to the lender of the stock. To go for short stocks, you also have to open a margin account since your status remains as that of a borrower and not an owner of the stocks. Investopedia reports:

Short selling is the selling of a stock that the seller doesn't own. More specifically, short sale is the sale of a security that isn't owned by the seller, but that is promised to be delivered.