Alternative Investments Management

Managed Funds

Actively managed funds are funds that try to outperform their benchmarks (usually the relevant indexes) through the implementation of a sophisticated investment strategy. In contrast, passive (index) funds match the performance of a particular stock market index such as the S&P 500 index in the United States or the EuroSTOXX 50 in Europe.

Trading strategies of actively managed funds try to generate excess returns or lower investment risk. Trading strategies are usually built on technical or fundamental analysis of individual firms or sectors, anticipation of macroeconomic trends, or the application of (proprietary) models of the financial market.

In turn, actively managed funds usually charge higher fees from investors compared to their passive index counterparts. In addition to that, more trading expenses are incurred because the portfolio composition is changed more frequently. On the other hand, trading expenses are usually rather low for index funds because the composition of stock market indices is stable over time.

In order to evaluate the performance of actively managed funds, returns must be put into relation to risk. Common measures are Jensen’s alpha, Treynor ratio, or Sharpe ratio. Academic research has shown mixed results concerning the success of actively managed funds: On average actively managed funds tend to underperform their benchmarks since expenses and fees frequently reduce performance to a significant extent as found e.g. by Carhart (1997).

Active management is primary suited for ineficient markets where fund managers may create value by investing in targets for which they have informational advantage. This point of view is substantiated e.g. by Kacperczyk et al. (2005) who document that concentrated funds perform better than broadly diversified portfolios.

Managed Funds Association (MFA)

The Managed Funds Association represents the interests of the alternative investment industry professionals, as well as the service providers who support the hedge fund industry.

MFA’s membership consists of professionals with an expertise in alternative investment strategies including hedge funds, funds of funds, futures funds, commodity trading advisors, and commodity pool operators.

Managed Funds Association promotes activities designed to advance the common purposes of all members of the alternative investment industry. It also enhances the image and understanding of that industry, furthers constructive dialogue with the regulators of the industry, and monitors and interprets regulations that direct the alternative investment industry.

MFA provides communication and education for investors, regulators, legislators, the financial media, and members; supports expansion of the industry through a representative ofi ce in Washington and its objective is mainly educational programs; and offers professional development for its members by providing a forum for the exchange of ideas among its members. MFA cultivates an environment where professionals from the industry have the best chance to better perform and at the same time serve the requirements of their clients.

The Foundation of MFA provides grants for economic, business, and financial research on the use of derivatives as an essential investment management tool. The Foundation makes grants available to universities, colleges, academic foundations, academic institutions, individuals, and other research entities.

Management Buy-In

A management buy-in (MBI) is the purchase of a company by an outside management team. In contrast to a management buy-out, where the purchaser is already working for the company, the outside management team wants to replace the existing management. The management buy-in group usually evaluates several companies searching for an undervalued business.

The team leader is usually highly experienced, for example, a (former) board member of another company. By replacing the existing management and applying new strategies to the business, the management buy-in group intends to enhance the value of the company.

The outside management team can either buy shares of the company (share deal) or assets (asset deal) or both (roll over). Most management buy-in transactions are leveraged buy-outs (LBO). The amount of capital needed to buy the company is either provided through bank loans or through high-yield debt (junk bonds).

The repayment of the loan is made out of the free cashflow generated from the company, whereas the assets of the company serve as collateral for the loans. The strategy of a management buy-in can also be combined with a management buy-out.

If the outside management group considers any existing managers of the company of great further value, the new board of directors may also include a former manager of the company, who can share his experience with the new management group. In case of a family business, the question of succession can also be solved by a management buy-in.

Management Buy-Out

A management buy-out (MBO) is the purchase of a company by its existing management. The managers buy at least a large part of the shares or the whole company. Frequently the management team wants to gain independence and a chance to influence the future strategy of the business in order to achieve a capital gain by increasing the value of the company.

Given that they are now investing their own equity, they tend to be highly motivated. Often the management will take the company private in order to avoid the duties and costs connected with being public. Another reason for the existing management to go for a management buy-out would be to save their jobs.

The business would otherwise be shut down or sold to another company that would exchange the management. Since the managers of a company usually don’t have enough money to finance the purchase themselves, the main challenge of a management buy-out is its financing.

If the purchase is mainly financed by debt—either bank loans or bonds—the transaction can also be referred to as a leveraged buy-out (LBO). Another source of funds can be derived from private equity investors who get part of the shares in return for the capital invested.

However, private equity investors tend to have different aims compared to the management. The latter will take a long-term view, whereas private equity investors want to maximize their returns by making an exit after a few years. In the meantime, they will impose certain terms on the management about the way the company should be run.

Management Fee

Management fee is an annual fee that is charged to investors regardless of the level of return for a particular asset. This fee is a standard cost that money managers charge for managing investor capital.

The costs associated with management include administration, investor relations, and professional management. Fees can be accrued on a daily, monthly, or even quarterly basis based on assets under management at the end, beginning, or an average for a particular period.

Hedge fund managers typically charge fees between 1 and 3% and these fees are substantially higher than other investment vehicles, such as mutual funds. Also, funds of hedge funds charge an extra layer of management fees in order to cover the expenses associated with investing in the underlying hedge funds as well as managing investor capital.

Many-to-Many

Many-to-many refers to a trading platform in which there are multiple buyers trading with multiple sellers and specifically where the participants can make bids and offers or accept bids and offers made by others.

This is in contrast to one-to-many markets where a single counterparty trades with all comers. Many-to-many is the most common type of market, and all exchanges and markets that are regulated by the CFTC, even lightly regulated ones, are many-to-many markets.

While the Commodity Exchange Act does not define the terms many-to-many or one-to-many, it does define “trading facility” in such a way that a many-to-many platform is a trading facility and a one-to-many platform is not.

This is relevant because one-to-many marketsare exempt from CFTC r egulations (such as those described in Section 2(g)), or mostly exempt from CFTC regulations (such as those described in Section 2(h)(1), which are subject only to regulations prohibiting fraud and manipulation). Many-to-many markets, on the other hand, are generally subject to CFTC regulations.

But the Commodity Exchange Act, like most legislation, is messy and complex and there are some many-to-many markets that are exempt from CFTC regulation. For example, under Section 2(d)(2), the “electronic trading facility exclusion,” entities called eligible contract participants can trade commodities called excluded commodities on electronic many-to-many markets and be exempt from CFTC regulations.

Margin

A margin is collateral that the owner of a position in futures contracts, options, or other securities must deposit to cover the credit risk of his counterparty, a broker, or a clearinghouse member. Hence, the key role of margins is to make markets operationally smoother by limiting default risk. This risk can arise if the holder has completed any of the following:

Entered into a futures contracts
Sold securities (including derivatives) short
Borrowed cash from the counterparty to buy securities

The collateral a trader has to provide can be in the form of cash or short-term bonds, or any security allowed by the specific terms of the related contract. The portfolio margining systems is rather simple. The collateral, that is, cash, is deposited on a margin account.

The amount that must be deposited at contract inception is called initial margin, or initial margin requirement. At the end of each day the margin account is adjusted to reflect the trader’s profit and loss: this is the mark-to-market mechanism.

There is a minimum amount, the maintenance margin, of collateral that must be maintained in a margin account, to ensure that the balance never becomes negative. this minimum amount is also referred to as minimum maintenance. This level is a minimum, and a number of brokerages have maintenance requirements lower than the initial margin.

Finally, the investor will receive a margin call if the value of the securities in the portfolio drops below the maintenance margin: the investor has to deposit extra-collateral, known as variation margin, to bring the account up to the required level. If this does not happen, the broker closes the position, limiting counterparty risk.

A number of market participants are involved in the margining process. Traders are required to maintain margin accounts with brokers. Brokers (if they are not clearinghouse members) are requested to maintain margins, called clearing margins, with members of the clearinghouse. The clearinghouse acts as an intermediary that settles trades and regulates delivery.

Portfolio margining is one of the most important financial safeguards, ensuring integrity to the system. In fact, the clearing service provider settles its accounts daily. As daily closing prices change the value of outstanding positions of each underlying or index in customers’ accounts, the clearing service provider collects margins from those who have lost money, and credits the funds to the accounts of the investor having made a profit.

Thus, prior to the start of each trading day, the entire amount of losses on the previous trading is collected and all profits are credited. Basically, a futures contract is closed out and rewritten each day, thus avoiding major losses.

In addition, many exchanges use real-time risk system in order to determine the margin requirement on the basis of the estimated risk in a customer’s portfolio, projecting the potential losses (e.g., estimating value at-risk and performing stress tests, often with sophisticate risk models) that could be created by various moves in the underlying equity or index markets.

Doing so, since portfolio margining accounts better reflect this actual market risk, these exchanges can require less equity on deposit, providing greater leverage to the investors.