Research Methods for Finance and Accounting: Hedge Fund Report, Term B

This report provides a detailed analysis of hedge funds, covering their operational processes, advantages, and disadvantages. It begins with an introduction to hedging and hedge funds, defining them as alternative investments utilizing pooled funds for potentially high returns. The report explains the working process of hedge funds, including the use of derivatives, gearing, and short-selling, and emphasizes the role of fund managers' expertise. It presents an example of how a hedge fund operates, illustrating fee structures and investor returns. The advantages discussed include aggressive investment strategies, potential for large gains, and expert advice, while the disadvantages include high fees, the limitations of standard deviation in risk assessment, and the impact of downside capture and drawdown. The report concludes with recommendations for both hedge fund managers and investors, such as setting realistic investment goals, considering liquid alternative investments, and conducting thorough research on the hedge fund industry. Overall, the report offers a comprehensive overview of hedge funds, their complexities, and considerations for investment.

Running head: RESEARCH METHODS FOR ACCOUNTING
Research Methods for Accounting
Name of the Student
Name of the University
Author’s Note

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Table of Contents
Introduction......................................................................................................................................2
What is Hedge Fund........................................................................................................................2
Process to Work of Hedge Fund......................................................................................................3
Advantages of Hedge Fund.............................................................................................................5
Disadvantages of Hedge Fund.........................................................................................................6
Recommendations............................................................................................................................7
Conclusion.......................................................................................................................................8
References........................................................................................................................................9

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Introduction
At the time of conducting the financial operations of the businesses, the financial
managers of the companies are required to take into consideration many aspects of finance and
accounts. One such aspect is Hedging. Hedging is regarded as a crucial investment position and
the main intention of hedging is the offsetting of the potential losses or gains of the businesses
can be arised as a result of different investment activities and decisions of the companies (Tauser
and Čajka 2014). It needs to be mentioned that the Hedge Fund is an important aspects of the
process of hedging. Hedge fund is considered as an offshore investment fund that is formed as a
private limited partnership and it involves in the speculation to use borrowing and credit capital.
Hence, it is necessary for the business organizations as well as individuals to consider the aspects
of hedge fund in the investment activities (Davies, Kat and Lu 2016). The main aim of this report
is to analyze and evaluate various aspects of hedge funds.
What is Hedge Fund
The above discussion provides a short overview about hedge fund. The follow discussion
provides an in-depth overview about hedge fund.
Hedge fund is regarded as an alternative investment with the use of pooled funds that use
different types of investment strategies in order to earn healthy return for the investors. The
investment managers have the option to manage the hedge funds in aggressive manner in order
to use investment derivatives and it can also be leveraged in both international as well as
domestic market of United Kingdom in order to gain higher return from the investments. In this
context, it is crucial to mention that only the accredited investors can use the hedge funds due to

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the fact that the requirement for investment related regulations is less for them. In addition, the
presence of less regulation can be seen in the hedge funds as compared to other investment
vehicles like mutual funds (Cao et al. 2013). The following discussion shows certain
characteristics of the hedge funds:
o One major characteristic of hedge fund is that the qualified investors can only be able to
use the hedge fund. For this reason, the Securities and Exchange Commission of United
Kingdom can be considered as deemed qualified to bear the risks related to hedge funds.
o Another major characteristics of hedge fund is that it offers wider investment
opportunities that the other funds (Aragon, Hertzel and Shi 2013).
o In the hedge fund, the investors have the option to use borrowed money in order to
increase the return.
Process to Work of Hedge Fund
In this context, it needs to be mentioned that it is not an easy job to provide description
about how hedge funds work due to the fact that all the hedge funds use different investment
strategies. It is the responsibility of the investors to work out the risks related to the hedge funds
and it largely depends in the intended strategies of hedge funds. However, the presence of some
common facts can be seen in the operation process of hedge funds (Lan, Wang and Yang 2013).
In the operation process of hedge funds, the hedge fund managers have the option for the
use of complex financial tools like the derivatives. In this case, they can use different types of
derivatives like swaps, options and warrants (Davies, Kat and Lu 2016). The involvement of
different types of terms can be seen with the derivatives; like ‘gearing’ and ‘short selling’. In
case of hedge funds, gearing is regarded as the process to make large investments with the help

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of small deposits with the aim to magnify the profits and losses from the investments. On the
other hand, short-selling is regarded as the process to sell something that the inventors do not
own yet due to the possibility of decrease in the pries so that the investors can buy back them at
cheaper price (Cao et al. 2013). In the working process of hedge funds, the investors have to
largely rely on the skill and knowledge of the fund managers in order to make good investment
decisions. The hedge funds do not provide the guarantee to provide good return when the stocks
go up even the hedge funds have specialization in specific bonds. One crucial aspect is that the
hedge fund managers have the right to charge specific fees based on their performance along
with the annual fees on the bonds (Bebchuk, Brav and Jiang 2015). The working process of
hedge funds can be explained with the following example:
In an hypothetical situation, Mr. Alex set up a business in UK named Global Investment
Limited, LLC. As per the operating agreement, Alex will receive 25% of any profit over 3% per
year and he also has the opting to invest in anything like mutual funds, bonds, stocks and others.
In this situation, an investor invests £100 million into the hedge fund of Alex by writing a check
and Alex puts it into the brokerage account by deploying it as per the guidelines. Alex has the
option to use the money to buy a restaurant or to start a new business. Thus, the main purpose for
Alex is to put the cash of the investors at the highest rate possible in order get healthy return
from them. Now, for the sake of argument, Alex made an unbelievable investment in the year
that doubles the asset of the company from £100 million to £200 million. Now, based on the
agreement of the company, the first 3% belongs to the inventor with any amount more than that
being split 25% to Alex and 75% to the investors. In this situation, there would be reduction in
£100 gain by £3 million in the presence of the hurdle rate. The remaining of £97 million is split
25% to Alex and 75% to the investor. Thus, as per the net result, Alex receives £24.25 million as

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compensation. The investor receives £3 milling as hurdle and £72.75 million from the split
(Bebchuk, Brav and Jiang 2015).
Advantages of Hedge Fund
The above discussion shows the main working process of hedge funds. Now, it needs to
be mentioned that there are some major advantage of hedge funds and they are discussed below:
Aggressive Investment Strategies: The use of aggressive investment strategies used by the hedge
fund managers in order to gain higher return is considered as a major advantage of hedge funds.
For example, the name of some of the major investment strategies can be mentioned like
leverage, derivatives and others and these can be use un both the UK marker and the
international market. The right of the investors to borrow and trade money on top of their gained
capital can be considered as an aggressive strategy as it can enhance the scope to gain higher
return and it also employs effective risk management tool in the process (Bollen 2013).
Large Amount of Gains: Another major advantage of hedge funds is that the investors get the
chance to obtain huge large amount of money by using the hedge funds in the investment
portfolio. The main aim of the hedge funds is the acquisition of high return in spite of the
presence of market fluctuations in the provided period. The strategy of ‘global macro’ approach
can be presented as an example as this strategy helps in the forecasting of the investment
opportunities in the future economic events of UK (Getmansky, Lee and Lo 2015).
Advice of the Experts: In the process of hedge funds, the investors get expert advice from the
hedge fund managers and it is considered as one of the major advantages of hedge funds. In this
process, the investors are required to pay handsome amount to the managers for their expert

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opinions as the managers are extremely experienced and knowledgeable in the areas of financial
investments. This aspect increases the chance to gain higher return (Bollen 2013).
Disadvantages of Hedge Fund
Apart from the advantages, the presence of some of the major disadvantages can also be
seen. They are discussed below:
Large Fees for Investment: The investors have to incur large amount of fees to the fund
managers in order to make investments in the hedge funds. Fox example, the investors have to
pay both the performance fees along with the management fees. This is highly criticized
disadvantage of hedge funds (Stowell 2017).
Standard Deviation: The use of the statistical tool that is standard deviation is considered as
another main disadvantage of hedge funds and it is used for the anticipation of the involved risks
in the hedge funds. However, the failure of standard deviation can be seen in depicting the whole
risk scenario related to the hedge funds (Lim 2015).
Downside Capture: Hedge fund managers use downside capture, a risk management measure,
for assessing the level of correlation of the hedge funds at the time of the decline of the market.
However, the underperformance of this aspect can be seen in case the fund managers use it in
case of widely different types of investment.
Drawdown: It is considered as a major statistic for the estimation of the overall rate of return on
an investment as compared to the most recent highest rate of return. However, this aspect fails to
provide the correct statistics in case the hedge funds do not perform constantly (He and Kou
2018).

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Recommendations
It is required for the hedge fund managers to maintain some aspects in order to make
correct hedge fund investments. These recommendations are provided below:
o It is needed for the hedge fund managers to set realistic investment goals as well as
important schedule as they have to face disastrous consequences in case they rush to start
a new hedge fund. For this reason, the recommendation for them is to make effective
investment strategies for the selection of best hedge fund strategy (Soydemir, Smolarski
and Shin 2014).
o As pet another recommendation, the hedge fund managers are needed to be cautious
enough at the time of the consideration of the liquid alternative investments. For this
reason, the requirement for them is the making of well informed decisions related to the
registered products as well as investment services (Chen and Jung 2016).
o In order to make correct decision related to the hedge funds, the hedge fund managers are
recommended to use the cloud based solutions rather than traditional on-premise
solutions. At the same time, it is also the recommendation that the hedge fund managers
need to put more focus on the development of disaster recovery plans (Soydemir,
Smolarski and Shin 2014).
o It is recommended to the hedge fund managers to take into consideration all the
operations risks related to the development of the hedge funds as the valuation of
operational risks is considered as a crucial step for the development of correct investment
decisions.

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o For the investors, the recommendation is to do all the necessary research about the hedge
fund industry for gaining in-depth knowledge about them and to get clear picture about
the risk involved in the investment in hedge funds (Chen and Jung 2016).
Conclusion
From the above discussion, it can be seen that there are many dimensions of hedge fund
that both the investors as well as the hedge fund managers are needed to take into consideration.
From the above discussion, it can be observed that there are some specific characteristics of
hedge fund that the fund managers and investors are needed to take into consideration. The
above discussion indicates towards the fact that the hedge funds work in a specific manner where
both the investors as well as the hedge fund companies receives certain amount of money and it
is beneficial for both of them. From the above discussion, it can be also seen that the hedge fund
both have the advantages as well as disadvantages. Some of the major advantages are the
presence of aggressive strategies, expert opinion, wider return and others. At the same time, there
are many disadvantages of hedge fund like huge fees, standard deviation, downside capture,
drawdown and others. For this reason, the above discussion provides some recommendations for
both the hedge fund managers and investors for effective hedge fund investment.

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References
Aragon, G.O., Hertzel, M. and Shi, Z., 2013. Why do hedge funds avoid disclosure? Evidence
from confidential 13F filings. Journal of Financial and Quantitative Analysis, 48(5), pp.1499-
1518.
Bebchuk, L.A., Brav, A. and Jiang, W., 2015. The long-term effects of hedge fund activism (No.
w21227). National Bureau of Economic Research.
Bollen, N.P., 2013. Zero-R 2 hedge funds and market neutrality. Journal of Financial and
Quantitative analysis, 48(2), pp.519-547.
Cao, C., Chen, Y., Liang, B. and Lo, A.W., 2013. Can hedge funds time market
liquidity?. Journal of Financial Economics, 109(2), pp.493-516.
Cao, C., Chen, Y., Liang, B. and Lo, A.W., 2013. Can hedge funds time market
liquidity?. Journal of Financial Economics, 109(2), pp.493-516.
Chen, J. and Jung, M.J., 2016. Activist hedge funds and firm disclosure. Review of Financial
Economics, 29, pp.52-63.
Davies, R.J., Kat, H.M. and Lu, S., 2016. Fund of hedge funds portfolio selection: A multiple-
objective approach. In Derivatives and Hedge Funds (pp. 45-71). Palgrave Macmillan, London.
Davies, R.J., Kat, H.M. and Lu, S., 2016. Fund of hedge funds portfolio selection: A multiple-
objective approach. In Derivatives and Hedge Funds (pp. 45-71). Palgrave Macmillan, London.
Getmansky, M., Lee, P.A. and Lo, A.W., 2015. Hedge funds: A dynamic industry in
transition. Annual Review of Financial Economics, 7, pp.483-577.

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He, X.D. and Kou, S., 2018. Profit sharing in hedge funds. Mathematical Finance, 28(1), pp.50-
81.
Lan, Y., Wang, N. and Yang, J., 2013. The economics of hedge funds. Journal of Financial
Economics, 110(2), pp.300-323.
Lim, J., 2015. The role of activist hedge funds in financially distressed firms. Journal of
Financial and Quantitative Analysis, 50(6), pp.1321-1351.
Soydemir, G., Smolarski, J. and Shin, S., 2014. Hedge funds, fund attributes and risk adjusted
returns. Journal of Economics and Finance, 38(1), pp.133-149.
Stowell, D.P., 2017. Investment banks, hedge funds, and private equity. Academic Press.
TAUŠER, J. and ČAJKA, R., 2014. Hedging techniques in commodity risk
management. Agricultural Economics/Zemedelska Ekonomika, 60(4).