Hedge Funds

This article explains how hedge funds use different strategies to mitigate risk
Hedging means managing risk. A fund manager employs a particular hedging technique in order to mitigate a particular type of risk.


For example, a market risk can be hedged against by selling a broad collection of securities short, in equal proportion to one's long exposure or by buying put options on an index. You can hedge against interest rate, inflation, currency etc.


Tools for hedging include raising cash, selling short, buying or selling options, futures, commodity and currency futures etc.

A hedge fund is a private investment partnership. Hedge funds tend to be skill based investment strategies that attempt to obtain returns based on a unique skill or strategy. The primary aim of most hedge funds is to reduce volatility and risk while attempting to preserve capital and deliver positive returns under all market conditions.

It designs a strategy to reduce investment risks using call options, put options, short selling or futures contracts. The hedge insures against the possibility of a future loss. These funds have the potential to deliver positive returns under all market conditions. Further, they have access to highly specialised strategies.

The hedge fund managers adopt different strategies to multiply returns on investments. They invest both long and short, in the securities of companies which are expected to change in price over a short period of time due to an unusual event. By pairing individual long positions with related short positions, the market-level risk is reduced significantly. Investments are made in securities that have the potential for significant future growth. The portfolio is made after considering factors like interest rates, economic policies, inflation etc.

The fund provides an investment portfolio with lower levels of risk and can deliver returns not correlated with the performance of the stock markets. Hedge funds have historically offered higher returns than stocks and bond markets.

There are different investment strategies used by hedge funds, each offering different degrees of risk and return. A macro hedge fund invests in stocks and bond markets and other investment opportunities, like currencies, in the hope of profiting on significant shifts in global interest rates and countries' economic policies. A macro hedge fund is more volatile but potentially faster-growing. An equity hedge fund may be global or country-specific, hedging against downturns in equity markets by shorting overvalued stocks or stock indices.

Hedge funds invest using different strategies. These strategies include investing in asset classes such as stocks, bonds, commodities, currencies, and returns enhancing tools such as leverage, derivatives, and arbitrage.

Some hedging strategies used by these funds:

Selling short: Selling shares without owning them, hoping to buy them back at a future date at a lower price in the expectation that their prices will drop.

Discounted securities: Investing in deeply discounted securities of companies about to enter or exit financial distress or bankruptcy, often below liquidation value.

Derivatives: Trading options or derivatives - contracts whose values are based on the performance of any underlying financial asset, index or investment.

Arbitrage: Seeking to exploit pricing inefficiencies between related securities. For example, can be long convertible bonds and short the underlying issuer's equity.

Investing: Investing in anticipation of a specific event - merger etc.

All hedge funds are not the same. Returns, volatility, and risk vary enormously among the different hedge fund strategies. Some strategies which are not correlated to equity markets can deliver consistent returns with extremely low risk of loss, while others may be as or more volatile than mutual funds.

Maintain a household budget sheet

Though maintaining an expense sheet and budgeting looks mundane, it is a very critical step in personal money management and can help reduce worries in an uncertain economic scenario.

The main objectives of maintaining a budget sheet is to track and control the day to day expenses, to provide and prepare for the priority needs and to create financial backups to counter any unforeseen needs. Ideally one should do this exercise for at least 6 months if not more which will definitely give a lot of food for thought.

The budgeting process has two main steps. First, preparation and maintenance of an expense sheet, and second, deriving a cash-flow statement. The simplest way to do this is to create a template on Excel and regularly update the same.

Steps to create a budget sheet

Define the basic heads of expense and list all the expenses under each head

Committed expenses: Includes expenses, which are a must and are recurring in nature. Rentals, groceries, school fees, telephones, fuel, vehicle servicing, etc.

EMIs: Sum of all the EMIs including any credit card payments.

Personal expenses: Are expenses which are personal in nature like clothing, cosmetics, toys, grooming etc. These are expenses which are mostly variable and can be controlled to some extent.

Contributions to dependents: Would include financial support to elderly parents and less fortunate relatives, etc.

Saving expenses : Includes payments made towards insurance premiums, mutual fund SIPs, RDs, post office savings etc

Luxury expenses: These are spending to maintain one’s lifestyle. Includes expenses which are not a must and can be done without. For eg: Restaurants, clubs, vacations, hosting parties, purchase of gadgets etc. 2. Assign frequency for each expense: The frequencies can be monthly, quarterly, half yearly and yearly. The idea of this would be to be prepared for all non monthly expenses which could be very worrisome if not planned for.

With the budget sheet ready, the next step is to create a cash-flow statement which will give us the break-up of income v/s expense — frequency wise and tell us exactly the surpluses which can be channelised into the investment portfolio.

Sample cash-flow statement

In the chart below you can see the break up of the income v/s expenditure. Though the monthly surplus reflects as Rs 12,000, the actual surplus taking into consideration the quarterly, half yearly and yearly expenses is Rs 8200.

Junior bank accounts

IF YOU’RE one of those who started a bank account when you were 18 and about to leave home for college, refrain from passing on this piece of information to a young person if you want to protect your dignity. Otherwise, be prepared to see the smirk and hear the condescending tone of a four-feet something person, elaborate on how he/ she was exposed to banking at the age of 10.

Exposure comes early these days. Kids aren’t content with paper money or being the banker in a game of Monopoly. They want to be a part of the real financial system and enjoy the benefits that their parent’s have- like having an account of their own, using an ATM card to withdraw cash, having a debit card to occasionally go shopping and so on. Most banks in India now provide the opportunity to start a savings account in a child’s name.

KNOW THE BASICS

Junior accounts in most banks are available for children up to 18 years of age. However, the minimum age to start such an account could be as low as one day. Before going any further, it must be clarified that while this may be in the child’s name, operating this account is possible only under the guardianship of a parent or a legal guardian. While the parents may ask for a particular amount to be diverted to this account on a steady basis, children also have the opportunity to depositing their savings into this account. Depending upon the bank, a minimum balance may also have to be maintained.

WEIGH THE BENEFITS

Starting such an account is not just about providing your child a source of cash and making him/her feel good. The attempt is to ingratiate the child into learning how the financial system works and to inculcate a sense of discipline especially when it comes to using ATM and debit cards. The child also inculcates the habit of savings and budgeting, by ensuring that surplus money they receive through various sources like pocket money, gifts, scholarships etc is deposited in their bank account. Moreover, it also gives children, particularly those in middle school, to practically understand the concept such as interest. For parents, this is also seen as a way of building up a cash store not just to deal with your child’s current needs but also for the future needs. This also ensures that a steady income is diverted on a regular basis.

EXERT PARENTAL CONTROL

To prevent parents from worrying about the misuse of money and cards, banks provide parents/guardians with scope to exert a great deal of parental control over a children’s account. It is predominantly up to the parent whether he/she wants an ATM or debit card to be issued. Even when such cards are issued, the bank allows the parent to determine limits regarding the amounts that can be withdrawn using an ATM or spent using a debit card. Moreover, for any transactions done using cheques, the signature of the guardian on the cheque is essential. The passwords necessary to conduct transactions online or over the phone are also given to the guardian and they are encouraged not to divulge these readily to their children. Apart from sending a quarterly physical statement or a monthly e-mail statement to the parents, the bank also sends free SMS/e-mail alerts to parents if the transactions conducted by the child crosses the threshold level.

CHECK OUT THE BENEFITS

In some banks, there are certain benefits that you are offered if you have a children’s account. HDFC’s Kids Advantage Plan offers free education insurance cover of about Rs 1,00,000 in the event of the parent’s death in a vehicular accident. Also, when the funds in the account exceed or reach a particular amount, then the bank automatically transfers some part of it into a fixed or term deposit.

STEP BY STEP

• To start such an account, you will need documents which prove the child’s date of birth
• The guardian also needs to submit documents to prove his identity, address and his relationship with the child

There are specific accounts which can be operated by children alone but the age and the mode of transaction varies from bank to bank. At Punjab National Bank, students above the age of 10 can open zero-balance accounts and are given both ATM cards and cheque books. However, at HDFC, the self-operated account for minors is available for children above 12 but the minor will be forced to conduct all transactions at a bank branch.

Thematic mutual funds

Thematic funds should be considered only if you have built up a sizeable portfolio and allocated your assets appropriately

WHO IS IT MEANT FOR?

Strictly speaking, if you’re a first-time investor, then a thematic fund may not be the right kind of product for you. For a first time investor, diversified equity funds should be the first step. Thematic funds are generally seen as more of a product for informed investors. An investor should look at investing in thematic funds only after one has built up a sizeable portfolio and has allocated one’s assets appropriately. What this means is that you should explore thematic funds only after you have an adequate exposure to both small cap and mid-cap stocks and have the capacity to bear a sizeable amount of risk. Even then experts recommend minimal exposure.

FALLOUTS

At any given time, there is generally one segment in which more interest is shown than others, which then becomes the flavour of the season. Investors immediately begin clamouring for it. However, the fallout of this is that some themes or flavours get taken to unwarranted heights and the effects are immediately on the price. The prices of stocks go skyrocketing in such a situation and much beyond their intrinsic value. Too much money begins chasing too few stocks and they immediately get overvalued.

RISKS AHEAD

Investors looking at putting their hard-earned money into thematic funds need to be aware that there is a sufficiently high level of risk associated with them. It is a classic case of putting all your eggs into one basket and by investing in concentrated segments, you are perhaps putting yourself in a precarious position.

However, mutual fund houses strategise as much as they can to reduce the level of risk involved. The method is simple and involves a small amount of diversification. For instance, when a mutual fund house comes out with a theme fund on infrastructure, it does not solely invest in the stocks of infrastructure companies but also puts money into stocks of allied sectors like steel. When a particular sector then takes a hit, the fund relies on these stocks to support it, if not bail them out of the situation.

DECISION-MAKING

The key to deciding whether or not to invest in a particular theme fund lies in asking yourself the crucial question of why that particular theme is enjoying the importance at the moment. Once you have a satisfactory answer, the next thing you need to ask is the prospects of that particular theme. Queries on that front are generally addressed by doing a thorough search and taking into account all stocks, private equity, earnings and possibilities of growth associated with that theme.

The performance of your theme also depends on the fund manager’s skill to identify the funds with growth potential. Only about 20 in every 100 themes are known to give positive results. Moreover, you cannot decide your theme based entirely on the positive results shown by the theme in other markets and need to check for its viability in your market.

One should not give undue importance to looking at the track record of that particular thematic fund. Given the vacillating nature of theme funds, investors should take a more holistic view and look at the track record of the fund house also by the performance of the other funds that come under its purview.

FUTURE PROSPECTS

Timing is crucial in terms of investing in thematic funds and experts recommend that investors need to give the thematic fund a period of three to five years to pan out and begin to perform well. As for the performance of thematic funds in India, experts say the early entrants into the industry, which invested a few years ago, have a definite advantage.

Looking ahead, experts have a few recommendations in terms of sectors or theme that could possibly yield good returns. Infrastructure is perhaps the top of the list, followed by financial services and the energy sector. Investors should look at putting their money in these sectors through a systematic investment plan over 5-10 years.

Indemnity insurance

With rising awareness and courts getting consumer friendly, more aggrieved clients are taking professionals to court.

How indemnity insurance minimises the financial impact of such adverse rulings? Read on……….

SAMPLE this: An Illinois jury recently awarded the parents of a seven-year-old boy $12 million in a medical malpractice case against the doctor who delivered the ‘disabled’ child. In another case last year, an elderly man’s death brought a $5.25-mn malpractice verdict against a Texas doctor, while a Washington, DC, judge filed a $67-mn lawsuit against his drycleaner just for losing his favourite pair of pants!

If you, however, thought such things can happen in western world only, think again. For, India’s premier medical institution AIIMS was also some time back ordered to pay Rs 5 lakh in damages to a woman for surgically removing one of her body parts after wrongly diagnosing that it was affected by cancer. And that’s not the ‘lone’ case of medical negligence or error where the victim or the victim’s family had been awarded compensation.

In fact, with rising consumer awareness and courts becoming more consumer-friendly, several other patients have sued doctors and hospitals, and it is only a matter of time before disgruntled clients take other professionals and professional bodies — such as CAs, lawyers, architects, consultants, law firms, IT companies, BPOs and financial institutions — to court. Currently, no matter what professional business you’re in, client expectations of service and quality of advice continue to grow. The downside, however, is the increasing number of claims for alleged negligence or breach of duty, the cost of which, in some cases, can be exorbitant.

One saving grace, however, is that the extent of damage can be reduced if someone has already opted for professional indemnity insurance, and any loss or damage caused to the victim is not the result of any deliberate act or willful neglect. Broadly speaking, professional indemnity insurance — commonly known as PI insurance — is a financial instrument that indemnifies professionals against any legal liability such as injury, loss or damage, caused due to their professional negligence, or, in other words, an error or omission committed while performing a service. This also covers the legal expenses that a professional has to incur to defend such court cases.

One salient feature of indemnity insurance is that the scope of cover varies with each profession. Registered medical practitioners such as surgeons, physicians and cardiologists, for instance, are protected against legal liability claims made by any of their patients that may be based on bodily injuries and/ or death, while engineers and architects are protected against liability arising out of design defect, inappropriate design leading to construction damage, and loss of life to the third party. The policy also deals with professional liability exposures of accountants and lawyers who hold themselves out to the public as professionals who are willing to perform professional services, for a fee, as independent contractors or their employees, partners or shareholders. The three conventional theories of recovery against accountants and lawyers are breach of contract, tort and statutory violations.

Indemnity insurance, however, doesn’t cover liabilities arising out of criminal acts or any act committed in violation of any law or ordinance, besides services rendered while under the influence of intoxicants. Likewise, fines, penalties, punitive or exemplary damages are not covered, nor any third party public liability or losses arising out of war and nuclear perils. Similarly, breach of confidentiality or prior knowledge or anticipation of a claim will only lead to the rebuttal of a claim. In fact, each insurer has its own list of exclusions which must be carefully taken into consideration before taking any cover.

Currently, apart from state-run insurers such as United India Assurance, New India Assurance, National Insurance and Oriental Insurance, private players such as Bajaj Allianz General Insurance, Tata AIG, ICICI Lombard, Reliance and Iffco Tokio are offering this cover to professionals. Some insurers even have separate policies for doctors, CAs, engineers, lawyers, architects and stock brokers.

There is no fixed limit of indemnity though and this depends on the insured’s perception of risk and the area of operations. Generally, however, individuals buy liability limits in the range of Rs 2 lakh to Rs 5 crore, while this can go up to Rs 500 crore in the case of professional bodies and companies. For determining the indemnity limit, thus, the insured has to assess his risk, the probability of the occurrence, and the maximum loss he can bear without jeopardising his business. US, European and Australian companies usually mandate that their Indian service providers have at least $1 million limit of indemnity, but some large BPOs or IT companies may have $10m or higher limits; a financial services company may have a minimum of $100m limit of indemnity.

So far as the premium rates are concerned, they are based on the risk profile of the insured and can cost up to 2.5% of the limit of indemnity. Broadly speaking, the premiums can range between 0.2% and 2.5% of the limit of indemnity, depending upon the type of coverage and the quality of risk.

Whatever be the case, the sum insured should be chosen in a manner that it covers any legal obligation that the insured may face at any given point of time based on The adequacy of sum insured and the coverage with extensions opted are the most important factors to be borne in mind while taking the cover.

FINEPRINT

WHO’S COVERED

Professionals such as doctors, CAs, engineers, architects, consultants, lawyers, advocates and professional bodies

SCOPE OF COVERAGE

Protection against claims brought in respect of negligent acts, errors or omissions in the performance of professional services. Defence expenses and damages arising because of judgements and arbitration awards are also covered

COMMON EXCLUSIONS

Prior knowledge or anticipation of a claim; intentional loss; breach of confidentiality; services rendered while under the influence of intoxicants; fines, penalties, exemplary, punitive damages; dishonesty of employees; etc

LIMIT OF INDEMNITY - No fixed limit

PREMIUM RATES - Between 0.2% and 2.5% of the limit of indemnity

HUF ACCOUNTS - Widen income base & get tax relief

LOOKING at ways and means to split your identity for the purpose of better accounting and tax-saving provisions? Well, you could take a cue from the times when people lived in joint families and shared joint incomes. The same concept can help you save on income tax if you open a Hindu Undivided Family (HUF) account. In fact, the account — coming under the provisions of the HUF Act — can help you enjoy driving your brother’s or father’s luxury car and yet save some tax by claiming depreciation on the same in your business. The only thing required is to know the details of this Act and its implications in saving tax.

FLEXI-OPTIONS

Unlike the name suggests, a HUF does not mean only a Hindu family but even Jains, Buddhist and Sikhs can form HUFs. Generally a HUF consists of at least two members, of which one must be a male, and are lineally ascended from common ancestors. But smaller partitioned families can also form HUF with only one male member. According to the Supreme Court (C.I.T. v. Veerappa Chettiar, 76 I.T.R. 467), an HUF can consist of only female members after the death of the last male members. Alternatively, lineal ascendants can also form a HUF by way of gifting assets for achieving an objective. A HUF further includes wives and unmarried daughters of the family.

As the nomenclatures go, the senior-most member is known as karta. The co-parceners are males, while females are known as members. A karta usually manages the assets of the HUF. Co-parceners enjoy the right to ask for partition, which takes place by distributing the assets of the HUF. In case of partition, members get only maintenance. The assets of a HUF include either gifts given by members/ karta or bequeathed assets or assets received on partition.

HANDY IN SAVING TAX

According to the Income-tax Act, an HUF is a separate entity and enjoys the same exemptions that any individual gets. It is eligible for a slab rate and 80C deductions. An income up to Rs 1.5 lakh is taxfree for the HUF, too, and it can earn money from different sources such as business property, capital gain and other sources, except salary. Since exemptions and deductions can be claimed twice, by creating a HUF, there can be a significant tax advantage. For instance, if the total income of an individual is Rs 3 lakh, he is liable to pay a tax of Rs 15,000 assuming no investment is made for tax deduction. But if the person is a member of HUF and half of the amount is taxable in hands of HUF and rest in his own hands, the person is not liable to pay any tax, as any income up to Rs 1.5 lakh is tax-free.

REAPING OTHER BENEFITS

Once the HUF is formed with some assets either received from ancestors or contributed by members, this asset base of the HUF can also be increased by borrowings and thereafter using the assets for business. The wealth earned by the HUF will be taxable only in hands of HUF and will not be clubbed with member’s earnings. Even if the business fails, the liability will not be with members. The liability of a HUF is limited to its assets. Hence, no liability lies with members on their individual capacity. Usually, an employer restricts an employee to run any business separately. So, an employee can use the HUF window to run business and also save on tax.

POINTS TO PONDER

A HUF is formed for the betterment of the whole family and thus, any business decision will require the consent of all members. One must think for a long-term viability of the HUF because otherwise, it may lead to an acrimonious situation in the family in future.

A HUF gives tax advantage but one must remember that once the income of a family is assessed as a HUF, it will continue to be assessed as a HUF income, until the HUF is partitioned completely. Moreover, since every member owns the assets of the HUF, these cannot be used only for individual interest. Importantly, the income earned by the HUF — from investments made in a partnership firm, managed either by the karta or other members — will be taxable in the hands of the HUF, but salary drawn by members will be clubbed with their own earnings. One can pass on one’s asset to the HUF but this usually does not give any tax benefits. Any gift to the HUF of more than Rs 50,000 is taxable in the hands of the HUF.

EFFECTIVE LISTENING SKILLS

MOST CEOS COMPLAIN that people in the workplace just don’t ‘listen’. Most of us hear but don’t listen and instead we spend time thinking about what we are going to say next. Poor listening skills can create misunderstandings, make us miss deadlines and focus our attention on the wrong issues in the workplace.

Simple steps to improving your listening skills :

Awareness: Recognising it as an area of improvement sets you on the path to becoming a better listener.

Convey Interest: Set aside whatever you’re doing and give the speaker your 100% attention. This offers encouragement to the speaker and he/she doesn’t feel compelled to speak faster or abbreviate their message. Convey interest nonverbally by nodding, maintaining direct eye contact and leaning forward.

Speaker’s Non-Verbal Cues: Watch out for the speaker’s gestures, facial expressions, tone and volume of voice, as being alert to these cues increases your ability to comprehend the full message.

No ‘Overtaking’: ‘Overtaking’ on the verbal highway or finishing off the speaker’s sentences makes him/her feel rushed and under pressure. Wait till the speaker has finished before interjecting with your comments. If you interrupt by mistake, apologise.

Summarise: If you aren’t sure of the message, ask the speaker to repeat it. Then, you summarise it, evaluating your own understanding while doing so.

Ask Questions: This shows genuine interest and offers encouragement to the speaker. Questions like “Do you mean to say…” or “Is this what you have in mind…?” paraphrase the speaker’s remarks.

Fight Impatience: As we think several times faster than we speak, we become impatient and lose concentration. Instead, use your mind to analyse the speaker’s message and extract the essence.

Pause: A pause is an effective communication tool — it shows you are thinking before speaking and also creates a certain degree of suspense.

As Ernest Hemingway famously remarked “I like to listen. I have learned a great deal from listening carefully. Most people never listen.”