Fund accounting Freelancer Group

Fund Accounting Services

2024-05-22T00:32:00.000-07:00

The excel allows for capturing of trades and price information provided by the major prime brokers, custodians and data vendors. Further, we administer both master-feeder structures using equalization or series processing as well as partnerships.

Portfolio valuations, financial statements and other (customized) reports;

Compute the Net Asset Values and maintain accounting records;

Compute and accrue for Performance fee and Management fee attributable to the Investment Manager, Custodian Fees, Administrator fees;

Payment of the Fund’s expenses and invoices;

Maintaining the fund’s General Ledger;

Assist in Corporate Governance;

Processing of investment trade related transactions and corporate actions;

Portfolio position reconciliation per independent broker/custody statement;

Cash reconciliation of the fund’s bank and broker accounts;

Accruing for dividend and interest and reconcile such to the broker/custody statement;

Preparation of accounting or accounting related reports to the investment manager and the auditor.

Overview of Interest Rate Swaps

2018-08-01T23:30:00.004-07:00

Overview of Interest Rate Swaps

An Interest Rate Swap represents a contractual arrangement between two parties, often referred to as "counterparties." These counterparties agree to exchange payments based on a specified principal amount over a fixed period.

In an interest rate swap, the actual principal amount is not swapped between the counterparties. Instead, they exchange interest payments based on a "notional amount" or "notional principal."

Each counterparty commits to paying either a "fixed" or "floating" interest rate to the other. As mentioned earlier, the notional amount is used solely for calculating the size of the cashflows to be exchanged.

The most common type of interest rate swap involves one counterparty paying a fixed rate (known as the swap rate) while receiving a floating rate, typically based on LIBOR.

The fixed leg of the swap is the part that is sensitive to changes in interest rates, akin to a fixed-rate bond. Conversely, the offsetting floating leg is generally insensitive to interest rate fluctuations because it is reset periodically during the swap's lifespan.

Market Size

According to the Bank for International Settlements, interest rate swaps constitute the largest segment of the global OTC ("Over The Counter") derivative market. As of December, the notional amount outstanding in OTC interest rate swaps was estimated to be $230 trillion. These contracts account for 55% of the entire $415 trillion OTC derivative market.

Key Terms

Notional Amount: The principal amount of the swap used for calculating interest amounts; it's not exchanged between counterparties.
Fixed Leg: One counterparty pays a fixed rate throughout the swap's term, and this rate remains constant. This counterparty is referred to as the Fixed Rate Payer.
Floating Leg: One counterparty pays a floating rate over the swap's term, with the frequency of payments determined by the interest-rate index used. For example, a swap tied to the three-month Libor would reset every three months, with payments due three months later.
Day Count Convention: Specifies the methodology for calculating interest payments, such as 30/360 or A/365.
Trade Date: The day the swap agreement was negotiated or traded.
Settlement Date: The date when the swap becomes effective, usually two days after the trade date.
Effective Date: The date when interest starts accruing, typically coinciding with the settlement date.
Termination Date: The date when the swap concludes, and the final interest payments are exchanged. Crucial for calculating the swap's value.
Payment Netting: When fixed and floating payments coincide on the same date, the amounts are usually netted, with the counterparty owing the difference paying that amount to the other.

Uses

Interest Rate Swaps serve several purposes:

Hedging: Funds use them to manage exposure to interest rate fluctuations by swapping fixed-rate obligations for floating rate obligations, or vice versa, aligning with their risk preferences.
Speculation: Hedge funds use swaps to speculate on interest rate changes or relationships between rates.
Leverage: Swaps allow hedge funds to gain exposure without allocating cash. They can enter into swaps that mirror specific interest rates or issues, such as the US 10 Year Treasury Note, paying a fixed rate while receiving floating, all without upfront cash allocation.

Accounting and Valuation

Interest Payment Calculations: Interest payments in a swap are calculated based on agreed-upon terms. The example provided illustrates the calculation process for both fixed and floating legs.
Valuation: Swaps are valued by summing the present value of future cash flows. At the outset, the present values of both fixed and floating legs are equal.

Termination Payments

Before a swap's term ends, parties can agree to terminate it. This involves calculating interest payments, settling outstanding obligations, and determining a termination payment. The "Out of the Money" counterparty reimburses the other.

US GAAP Requirements

US GAAP mandates separate disclosure of three swap elements: unrealized mark-to-market (valuation), interest income, and interest expense, based on each party's role in the swap. Financial statements should include these elements as distinct line items. Unrealized gains/losses appear under "Unrealized Gains/Losses on Derivatives," termination payments under "Realized Gains/Losses on Derivatives," and interest income/expense under relevant headings.

Other Points

Interest Rate Swaps can be "Vanilla" (fixed-for-floating), "Basis Swaps" (floating-for-floating), or involve different currencies.
The International Swaps and Derivatives Association (ISDA) established a legal framework for contracts like Interest Rate Swaps. Formal agreements under ISDA regulations specify swap parameters.
ISDA agreements often include collateral posting requirements. "Master netting agreements" allow aggregation of swaps with a single counterparty for collateral purposes, minimizing cash allocation.
Understanding day count accrual conventions is crucial for interest calculations in swaps.

Forward Contracts - Accounting

2018-08-01T23:24:00.004-07:00

1. Learning Objectives

Learn the key features of a Forward Contract (FWC).
Explain the reasons why an investor would engage in FWC trading.
Understand the complete cycle of a FWC trade, including initiating, valuing, liquidating, and taking delivery of a contract.

2. Content

2.1. Key Features of a FWC

A Forward Contract (FWC) is an agreement to buy or sell an asset, typically a currency, at a predetermined price on a future date. Key features of FWCs include:

2.1.1. Underlying Asset: FWCs are often based on currency exchange rates.

2.1.2. Trading Venue: FWCs are traded over-the-counter (OTC), meaning they are privately arranged contracts facilitated by brokers. Despite being OTC, they are highly liquid.

2.1.3. Cash Settlement: Unlike some other derivatives, cash settlement in FWCs occurs on the contract's maturity date rather than during the closing trade. This means that profits or losses are realized only at maturity.

2.2. Why Investors Use FWCs

Hedge funds engage in FWC trading for several reasons:

2.2.1. Portfolio Hedging: Hedge funds often hold diverse securities in various currencies. Fluctuations in currency rates impact the fund's Net Asset Value (NAV) since it is typically issued in the base currency of the fund. FWCs are used to hedge against currency risk. For instance, if a USD fund wishes to invest in a EUR security, it can use a FWC to hedge against potential EUR/USD exchange rate fluctuations.

2.2.2. Speculation: Hedge funds may trade currencies as an asset class. They can speculate on currency price movements, aiming to buy low and sell high.

2.2.3. Hedge Share Class: Hedge funds with multiple share classes may use FWCs to manage currency exposure for specific classes, although this topic is not covered in detail.

2.3. Trading a FWC

2.3.1. Opening and Closing a FWC:

Consider a scenario where a fund believes that the HKD will weaken against the USD in the coming months. On 05/17/06, they enter into a FWC to sell 10,000,000 HKD with a maturity date of 08/30/06 at a rate of 1,291,900 USD.

Each NAV date, the HKD 08/30/06 FWC is priced using Bloomberg forward rates for HKD/USD, and unrealized P/L is recorded on the balance sheet and income statement. Unrealized P/L arises from any movement in HKD/USD rates from the contract's agreed rate.

On 07/13/06, the fund decides to close the entire HKD contract by buying 10,000,000 HKD against 1,288,000 USD. This results in a gain of 3,900 USD, which is recognized as realized P/L on the closing trade date of 07/13/06. A receivable also impacts the balance sheet at this time.

The realized P/L occurs due to the movement in the USD/HKD rate from 0.12919 to 0.1288.

2.3.2. Taking Delivery of the FWC:

In the same example as above, but without the closing entry on 07/13/06, the following would happen:

On 08/30/06, cash movements occur in your broker statement as follows:

10,000,000 HKD is withdrawn from your HKD broker statement (the fund sold HKD).
1,291,900 USD is deposited into your USD broker statement.

These cash movements reflect the settlement of the original FWC contract on the maturity date.

This cycle illustrates how FWCs can be opened, valued, closed, or taken to delivery depending on the fund's strategy and market conditions.

Equity Swap - Accounting

2018-08-01T23:22:00.012-07:00

1. Learning Objectives
- Gain an understanding of the three primary components of equity swaps.
- Recognize distinctive features of equity swaps.
- Comprehend the motivations behind investors engaging in equity swap transactions.
2. Content
An equity swap is an over-the-counter (OTC) derivative where two parties exchange cash flows. One cash flow mirrors the performance of a commonly traded stock, while the other represents interest. Cash changes hands solely at the contract's closure, either during a sale or a cover transaction, which is a characteristic shared with most derivatives.
2.1. Three Profit/Loss Components of an Equity Swap
2.1.1. Equity Leg
This component reflects the performance of the underlying stock.
2.1.2. Interest Leg or Financing Leg
This component signifies the interest payment the "long" side of the contract pays to the "short" side in return for benefiting from the stock's performance. Consequently, the "long" side is termed the "floating rate payer" in the swap contract documents.
2.1.3. Dividend Leg
In equity swaps, all rights and obligations of the underlying stock concerning corporate actions remain applicable. Consequently, the "long" side of the contract receives any eligible dividends, with the issuing company not directly disbursing these dividends. Instead, the "short" side of the contract must remit any declared dividends to the "long" side.
2.2. Other Terms of an Equity Swap
2.2.1. Notional
An equity swap contract doesn't entail an actual cost. The trade doesn't involve cash initially but instead relies on an "underlying cost," termed the "notional" amount. This notional amount serves as the basis for calculating the interest component of the equity swap and represents the principal amount for interest calculation.
2.2.2. Resets
Equity swap contracts typically span three months, but cash flows don't wait for this duration. The contract incorporates preset cash flow dates during these three months, referred to as "reset dates." These resets may occur weekly or monthly, enabling the calculation of net profit or loss (P/L) at each reset date.
2.2.3. Valuation Date (NAV Date)
Valuation occurs on this date. Although it doesn't involve cash flows, it does consider unrealized equity P/L and accruals for interest and dividends, incorporating all three P/L components of the equity swap.
2.2.4. Dividends
Since dividends aren't paid directly by the company in equity swaps (the "short" side handles this), dividends are paid on the first reset date following the ex-date. This approach streamlines administration by consolidating cash flows of all three P/L components simultaneously. Notably, typical withholding taxes don't apply to equity swaps, as no shares are traded on a stock exchange.
2.3. Reasons for Investors to Use Equity Swaps
2.3.1. Leverage
Hedge funds frequently employ equity swaps for leverage since they involve no upfront cost. This absence of cost translates to a higher rate of return compared to actual stock trading.
2.3.2. Illiquid Markets
In situations where a hedge fund aims to trade a substantial volume of shares in a thinly traded market, equity swap contracts offer an effective solution, avoiding the potential market impact of large buy orders.
2.3.3. Currency Risk Mitigation
Trading foreign stocks exposes investors to currency risk, typically hedged through forward contracts. Equity swaps, being OTC instruments, provide flexibility in transaction currency, eliminating the need for additional currency hedges.
2.4. Trading an Equity Swap
Let's explore an example involving a long equity swap for the purchase of 10,000 shares of IBM US. The equity swap's mechanics, including reset calculations and valuation, illustrate how the contract evolves and generates net cash flows on settlement dates.

Trading an Equity Swap:

For example, suppose a fund intends to buy 10,000 shares of IBM US at $75.00 per share via an equity swap contract expiring in one month with weekly reset dates. The transaction unfolds as follows:

Contract Opening (Trade Date: 12th, Settlement Date: 15th): Purchase 10,000 shares, creating a notional of $750,000. No cash changes hands.
Reset Date #1 (Trade Date: 19th, Settlement Date: 22nd): Cash is exchanged, with IBM's price rising to $75.50. Profit from equity leg: $5,000; Interest payment: $776.72. No dividend applicable.

Notional X interest rate X # of days / 365

= 750,000.00 X 5.40% X 7 / 365

= $776.72

Therefore the fund must pay $776.72.

Reset Date #2 (Trade Date: 26th, Settlement Date: 29th): IBM's price falls to $75.25. Equity loss: $2,500; Interest payment: $810.85. No dividend applicable.
Valuation Date (NAV Date: 30th): IBM's price rises to $76.00. Unrealized equity gain: $7,500; Accrued interest: $116.49. No dividend applicable.
Reset Date #3 (Trade Date: 3rd, Settlement Date: 5th): IBM's price increases to $76.30. Equity gain: $10,500; Interest payment: $815.38. No dividend applicable.
Reset Date #4 (Trade Date: 14th, Settlement Date: 21st): IBM's price drops to $76.10. Equity loss: $2,000; Interest payment: $834.08; Dividend received: $3,000.

The net cash flows on the fund's prime broker account are tracked throughout these events, reflecting the gains and losses associated with the equity swap.

Equity - Accounting

2018-08-01T23:19:00.005-07:00

1. Learning Objectives

1.1. Identify the different types and features of equity At the conclusion of this workshop, participants will be able to distinguish between various types of equity and comprehend the unique characteristics associated with each.

1.2. Understand why investors trade equities Upon completion of this workshop, participants will have a comprehensive understanding of the motivations driving investors to engage in equity trading, such as capital appreciation and dividends.

1.3. State the process involved in Equity trading Participants will be able to articulate the step-by-step process involved in trading equities, including the intricacies of placing orders, executing trades in the market, and the settlement and safekeeping of securities.

1.4. Understand the principles of Short Selling By the end of this workshop, participants will have a firm grasp of the concept of short selling, including its mechanics and potential risks.

1.5. Accounting & Valuation Participants will acquire knowledge related to the accounting practices and valuation methodologies employed when dealing with equity investments, encompassing considerations like cost calculations.

2. Content

2.1. Types of Equity

2.1.1. Common Shares Common shares, also known as ordinary shares, grant shareholders ownership in a company, entailing voting rights and the entitlement to dividends. In the event of liquidation, common shareholders rank last.

2.1.2. Preferred Shares Preferred shares are issued for a finite term and carry a fixed coupon rate. They lack voting rights but typically offer higher dividend yields. Preferred shareholders hold a superior claim over common shareholders in case of a company winding up.

Moreover, common shares may feature additional designations, including ADR shares and GDR shares, which represent foreign company ownership and are traded in U.S. dollars on American stock exchanges or foreign investment banks, respectively.

2.2. Features of Equity

2.2.1. Currency Each stock is denominated in a primary currency, although they may trade in multiple currencies worldwide. Institutional investors, such as hedge funds, predominantly trade in the primary currency due to its higher trading volume.

2.2.2. Country of Incorporation Every company is incorporated in a single country, and dividend withholding tax rates are determined based on this country of incorporation.

2.2.3. Country of Quotation While a stock may be traded on various exchanges globally, it has a primary exchange where it experiences the highest trading volume.

2.3. Why do Investors Trade Equities?

2.3.1. Capital Appreciation Investors engage in stock trading with the expectation of selling their holdings at a future date at a higher price, resulting in a capital gain. This motive is particularly common among those investing in common shares.

2.3.2. Dividends Some investors opt for stocks that offer substantial dividend payments. Preferred shares typically provide higher dividend yields compared to common shares.

2.4. Short Selling

Short selling involves selling borrowed securities in anticipation of a price decline, with the obligation to repurchase an equivalent number of shares at a later date. This strategy allows investors to profit from falling stock prices by selling high and buying low.

2.5. Accounting and Valuation of Equity

Equities can be purchased as individual units or in lot sizes, with the quoted price per share.

2.5.1. Calculating Cost

To compute the cost of a security, the formula is as follows: Cost = Quantity Purchased (Q) × Purchase Price (P) + Commission.

2.5.2. Calculating Unrealized

The market value (MV) of an equity position is determined by multiplying the quantity held by the ending market price per share on the NAV date. Unrealized profit or loss is calculated as MV minus Cost Base.

2.5.3. Calculating Realized

Realized profit or loss on an equity position is derived from Proceeds (net of commission) minus Cost Base. Proceeds are calculated as Quantity Sold × Price minus commissions, while Cost Base involves the quantity sold multiplied by the purchase price plus commissions.

These detailed explanations should provide a comprehensive understanding of the learning objectives and content related to equity trading and investment.

PERFORMANCE FEE EQUALISATION

2018-08-01T23:17:00.018-07:00

When setting up a fund, one of the first decisions a manager has to make is the choice of fund structure. Partnership structures are very common in US domestic funds because they offer tax transparency to investors. Accounting calculations for partnership structures are relatively straightforward. Individual capital accounts are maintained for each partner and performance fees are calculated at the capital account level per partner. Therefore, there are no equalization issues for managers to contend with.

In Europe, a combination of other fund structures is frequently used which requires calculations of per share/unit price. In calculating performance fees in these structures, the overriding concern among managers has been in determining how to fairly reward the manager for positive performance while at the same time ensuring investors are treated equitably. Essentially, this is where the various forms of performance fee Equalisation come in.

One of the most common methods of Equalisation - certainly among European managers - which we explore in this article is the ‘Equalisation Credit /Contingent Redemption’ approach. This form of Equalisation involves making certain adjustments on an investor’s account.

An Equalisation credit is awarded to investors who subscribe in periods when the Gross Asset Value (GAV) per share is greater than the fund High Water Mark (HWM). The amount of Equalisation awarded per share is the equivalent to the difference per share between the GAV and the Net Asset Value (NAV). This is to ensure that investors in the fund do not pay a fee to the manager for performance they did not enjoy. This Equalisation credit is invested with the other assets of the fund and may depreciate.

However, it will never appreciate above the maximum Equalisation credit i.e. that awarded on entry. Assuming an investor has an Equalisation credit at a period-end, additional shares in the fund will be awarded to them to the value of the total equalization credit available at that point in time. If the Equalisation credit is not applied in full at the first period-end, additional shares will continue to be allotted at each future period end until the Equalisation credit, allowing for subsequent appreciation or depreciation in the fund has been fully applied.

If an investor buys into a fund when the GAV/NAV per share is below the HWM, the investor will owe an additional performance fee relating to the fund growth from the share price at which it entered up to the HWM. This amount is referred to as the contingent redemption.

This calculation ensures that he investor does not benefit from a “free ride” up to the HWM. A contingent redemption will be applied at each period end until such a time as the GAV rises above the HWM. The investor will experience a reduction in their number of shares to the value of the contingent redemption. This redemption amount is paid directly to the manager by the fund, by way of a fee.

We provide further explanation below of this Equalisation Credit / Contingent Redemption approach by way of example scenarios.

Example Scenarios

Consider a fund with the following criteria:

Offer Price: $100

Performance Period: Yearly

Performance Fee Rate: 20%

NAV Frequency: Quarterly

There are four dealing days in the period, on which the deals listed in Table 1 are placed. An account of the adjustments and fees on each investor’s account based on the year-end NAV of the fund is summarised in Table 2 and 3.

Table 1: Shareholder Dealing

*DATE*	*Deal*	*Investor*	*Amount*	*GAV*	*Shares Issued*
Jan 1^st	Subscription	A	$10,000,000	$100	100,000
April 1st	Subscription	B	$10,500,000	$105	100,000
July 1^st	Subscription	C	$12,000,000	$120	100,000
Oct 1^st	Subscription	D	$9,000,000	$90	100,000

*FUND DATA*
GAV	110
HWM	100
NAV	108

Note: True value per share = NAV per share+ (Equalisation Credit issued- Equalisation Credit Lost) - Contingent Redemption

Table 3: Summary

Investor	Shares	NAV	Equalisation Credit	Account Values	Shares to Adjusted
A	100,000	108	Zero	$10,800,000	0.00
B	100,000	108	$100,000	$10,900,000	925.93
C	100,000	108	$200,000	$11,000,000	1851.85
D	100,000	108	($200,000)	$10,600,000	(1851.85)

Year-to-date this investor has enjoyed a return of $5 per share on their investment and so “owes” the manager a fee of $100,000. At year-end the NAV quoted is $108, thus not a true reflection of the market value on their account. As such, the fund crystallizes the $1 per share Equalisation factor issued on entry. As of January 1st in the new period, investor B will receive an additional $100,000 worth of shares in the fund. This ensures that the investor’s threshold will equal the fund HWM of $108 for the new period, meaning that this investment lot will never again be subjected to an Equalisation adjustment.

Investor C: this investor paid $120 per share on entry. Inclusive in this price was a fee accrual of $4 per share payable to the manager for the positive performance over the previous two quarters. As this investor did not participate in this performance they are issued with an Equalisation credit of $4 per share as compensation. The NAV of the fund on entry of $116 means that the investor’s account is valued at $11,600,000 ($116 *100,000 shares). The difference of $400,000 Equalisation ($4 * 100,000 shares) brings the value of the account up to the investment amount of $12,000,000.

A loss of $10 per share is incurred on this investment at year-end. Although the NAV reported is $108, this investor should not have to pay the manager a “performance” fee of $2 per share. As such, the fund will compensate investor D by crystallising $2 per share Equalisation. Thus, this investor will receive $200,000 worth of additional shares on January 1st in the new period. Note that there is still an additional $2 per share equalization on this investment that is lost as of December 31st. This is to ensure that the investor will never be compensated for any performance fee charged on their investment below the price at which they entered the fund.

Investor D: having enjoyed an increase in the value of their investment of $20 per share, investor D can expect to pay the manager a fee of 20% of this gain. However, the NAV of the fund is $108, thus the manager is only earning a fee of 10% of the increase in the value of this investor’s account. To ensure that investor D doesn’t get a “free ride” between the price they subscribed ($90) and the fund HWM ($100), the manager receives a fee of 20% of this difference in the form of a Contingent Redemption.

Essentially this means that $200,000 (i.e. $2 per share) worth of shares will be redeemed from their account at crystallisation. The proceeds will be paid to the manager and the investor’s threshold will increase to equal that of the fund HWM. This is a one-time adjustment on this investment that ensures the performance of these shares will move in line with the performance of the fund.

Crystallisation

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Note: shares issued/redeemed on crystallisation are calculated by dividing the Equalisation adjustment by the NAV per share at year-end. Although shares have been issued and redeemed from respective investor accounts, the total account value for each investor has not changed, as the equalization adjustment amount after crystallisation will then be zero.Advantages/Disadvantages

The Equalisation Credit /Contingent Redemption approach has both advantages and disadvantages.

Advantages

1. Only shares that have appreciated in value pay a performance fee.

2. All investors have the same amount at risk per share in the fund.

3. Every share in the fund has the same NAV per share.

4. The manager is rewarded fairly for the positive performance of all shares.

Disadvantages

1. Complex calculations may cause confusion among investors.

2. Published NAV per share may not be reflective of the actual value on an investor’s account, as only investors’ statements will reflect the Equalisation adjustment.

Performance fees

2018-08-01T22:24:00.004-07:00

It seems like you've provided a detailed description of various methods for calculating and allocating performance fees in hedge funds. These methods include the Partnership method, High Water Mark method, Equalization method, Equalization shares, Equalization account/depreciation deposit approach, and Multi-series.

Here's a brief summary of each method:

Partnership Method: In this method, performance fees are allocated based on each investor's capital at the beginning of the period. It's simple and transparent but may result in investors incurring annual income taxes.
High Water Mark Method: Performance fees are calculated at the fund level without considering individual investment performance. This method can be biased, especially for new investors, and may not accurately represent individual gains or losses.
Equalization Method: This method aims to replicate the partnership method. It equalizes the price per share across different NAVs by issuing notional shares or taking a portion of money invested into a separate account. It ensures fair charging of incentive fees and avoids the "free ride" and "clawback" issues.
Equalization Shares: Notional shares are issued when subscriptions are made, and they are adjusted based on the fund's performance. This method can be simple but may confuse investors as their holdings change monthly.
Equalization Account/Depreciation Deposit Approach: This method issues equalization accounts when GAV is above the HWM and depreciation deposits when GAV is below HWM. It ensures that investors pay incentive fees on the increased value of their investments and avoids the "free ride" issue.
Multi-Series: The fund comprises an initial series and subsequent subscriptions are allocated to new series. Each series reflects the fund's performance and avoids issues like "clawback" and "free ride." However, it can lead to complications if there are many series and may require reporting of all series.

It's important for hedge funds to choose a performance fee calculation and allocation method that aligns with their investment strategies and is transparent to investors. Each method has its advantages and disadvantages, so the choice may depend on the fund's specific circumstances and regulatory requirements.

Accredited Investors

2018-08-01T11:42:00.004-07:00

The Securities Act of 1933, which is enforced by the U.S. Securities and Exchange Commission (SEC), requires companies that offer or sell securities to register those securities with the SEC, unless they qualify for an exemption. One of the exemptions, provided under Rule 501 of Regulation D, involves selling securities to accredited investors. Here's a breakdown of the various categories of accredited investors as defined by Rule 501:

Institutions: This category includes entities like banks, insurance companies, registered investment companies, business development companies, and small business investment companies.
Employee Benefit Plans: If an employee benefit plan, as defined by the Employee Retirement Income Security Act (ERISA), makes its investment decisions or has total assets exceeding $5 million, it qualifies as an accredited investor. ERISA plans typically include pension plans and retirement plans offered by employers.
Large Charitable Organizations: Charitable organizations, corporations, or partnerships with assets exceeding $5 million are considered accredited investors. This is aimed at large charitable entities with substantial resources.
Company Insiders: Officers, directors, or general partners of the company offering the securities are deemed accredited investors. This recognizes their intimate knowledge of the company's operations and financials.
Entities Composed of Accredited Investors: A business entity is considered an accredited investor if all of its equity owners qualify as accredited investors themselves.
High Net Worth Individuals: Individual investors may qualify as accredited investors if they meet specific financial criteria. There are two primary ways for individual investors to qualify:
- Net Worth: An individual with a net worth (excluding their primary residence) that exceeds $1 million at the time of the securities purchase qualifies.
- Income: An individual with an annual income exceeding $200,000 in each of the two most recent years (or joint income with a spouse exceeding $300,000) and a reasonable expectation of the same income level in the current year qualifies.
Sophisticated Trusts: Trusts with assets exceeding $5 million, provided they were not created solely to acquire the offered securities, may be considered accredited investors. This category typically involves trusts managed by financially savvy individuals or institutions.

These accredited investor criteria are in place to ensure that individuals or entities meeting them are deemed financially sophisticated or have the means to withstand potential investment risks. Companies can offer securities to accredited investors under certain exemptions without undergoing the more rigorous registration process required for public offerings. This allows them to raise capital from qualified investors more efficiently while minimizing the regulatory burden.

hedge fund performance fee calculations

2018-08-01T10:48:00.004-07:00

It appears that you've provided a detailed explanation of various methods for calculating and handling performance fees in the context of investment funds. Let's break down the key points from your text:

Introduction to Performance Fees:

Hedge funds have expenses that can be shared among shareholders based on their investments and the period they are invested.
Fees can be either "assets-based" or "performance-based." Assets-based fees include custody, management, or administration fees, while performance fees are the focus of the discussion.
The challenge with performance fees is that their calculation and payment may not align with the fund's liquidity, potentially leading to unequal charges to individual shareholders.

The "Free Ride" Syndrome:

New shareholders entering the fund when the Net Asset Value (NAV) is below the high water mark (HWM) may not be charged incentive fees until the fund surpasses the HWM. This is referred to as the "free ride" issue.
The problem can be exacerbated when a significant amount of new subscriptions is accepted, potentially neglecting the investment manager.

The "Clawback" Syndrome:

The "clawback" phenomenon occurs when the fund appreciates in capital and incentive fees are provisioned but subsequently falls below its HWM. In this case, the provisioned fees are reversed and benefit all shareholders, including new investors.
This situation can be unfair because only those who were charged the fees initially should benefit.

Calculation Methods for Performance Fees:

The Partnership Method:
- Performance fees are allocated on a pro-rata basis for each investor's capital at the beginning of the period.
- Provides a fair method for calculating carried interest but may result in investors incurring annual income taxes.
High Water Mark (HWM) Method:
- Treats all shareholders as a single pool and averages performance fees based on their investments.
- May be biased toward new investors and not reflective of individual gains or losses.
Equalization Method:
- Aims to replicate the partnership method by equalizing the price per share across different NAVs.
- Achieved through notional shares or equalization factors.
- Ensures that investors pay fees only on the increased value of their investments, avoiding the "free ride" and "clawback" issues.
- Fairly charges performance fees, and investors only pay taxes on realized gains.
Multi-Series Method:
- Involves issuing multiple series of shares with the same issuing price.
- Performance fees are calculated based on the beginning capital of each series and the HWM.
- Provides a fair distribution of carried interests among shareholders but can lead to complexities in reporting and administration.

Each method has its advantages and disadvantages, and the choice of which method to use may depend on factors such as the fund's volatility, tax implications, and reporting requirements. The goal is to find a method that fairly compensates fund managers while ensuring that investors are charged performance fees that align with their actual gains.

Sample Reports — Excel Fund Accounting

2018-08-01T09:38:00.004-07:00

I'm unable to access external websites or specific documents, so I can't review the sample reports you've mentioned on the given URLs. However, I can provide some general comments and suggestions on what makes financial reports easily understandable and effective:

Clarity and Simplicity: Reports should be clear and straightforward. Avoid using complex jargon or technical terms that your audience may not understand. Use simple language and explain any financial terms or concepts that might be unfamiliar.
Consistency: Maintain consistency in formatting, font size, and style throughout the report. Consistency helps users follow the information easily and reduces confusion.
Visual Elements: Incorporate charts, graphs, and tables to illustrate key points and trends. Visual elements can make data more digestible and help users quickly grasp important insights.
Summary and Highlights: Include a summary section or executive summary at the beginning of the report. Highlight the most significant findings or figures so that readers can get a quick overview before diving into the details.
Structure: Organize the report logically with a clear structure. Start with an introduction, followed by sections on income statements, balance sheets, cash flow statements, and any additional analysis or commentary.
Use of Color: While color can enhance the visual appeal, use it sparingly and meaningfully. Ensure that color choices don't obscure the information but rather assist in conveying the message.
Footnotes and Explanations: If there are complex transactions or accounting treatments, provide clear explanations in footnotes or a separate section. Transparency is crucial.
Comparisons and Trends: Include historical data or comparisons with industry benchmarks to provide context and help readers understand how the numbers have evolved over time.
Audience Consideration: Tailor the report to your audience. Boards, auditors, and management may have different priorities and interests. Make sure the report addresses their specific needs and concerns.
Digital Accessibility: Ensure that the report can be easily viewed and navigated in a digital format. PDFs are commonly used for this purpose as they are widely compatible.

Regarding the pricing and benefits of your back office services:

Pricing Model: A simple "pay as you go" monthly fee can be attractive to potential clients, as it eliminates the need for a large upfront investment. However, make sure your pricing aligns with the value you provide.
Cost Savings: Highlighting potential cost savings of up to 60% through outsourcing is a strong selling point. Be prepared to provide evidence or case studies that support this claim.
Expertise: Emphasize the expertise of your accounting team. Clients want assurance that their financial matters are being handled by skilled professionals.
Focus on Core Business: Stress the benefits of outsourcing, which include allowing clients to focus on their core business activities while you manage their financial responsibilities.

In summary, effective financial reports should be clear, concise, and tailored to the needs of your audience. Your pricing model and service benefits should be competitive and clearly communicated to potential clients.

2018-08-01T09:32:00.004-07:00

Investors buy and sell call and put options for various reasons, depending on their investment objectives, market expectations, and risk tolerance. Here are some of the primary motivations for buying and selling options:

Reasons for Buying Call Options:

Bullish Outlook: Investors buy call options when they are optimistic about the future price of the underlying asset (e.g., a stock). A call option gives the buyer the right to purchase the asset at a specified price (strike price) before or on the expiration date. If the asset's price rises, the call option can be profitable.
Leverage: Call options allow investors to control a larger position of the underlying asset for a fraction of the cost. This leverage can amplify potential profits if the asset's price moves in the desired direction.
Hedging: Call options can be used as a form of insurance to protect against potential price increases in assets the investor already holds. This is known as a covered call strategy.

Reasons for Buying Put Options:

Bearish Outlook: Investors buy put options when they expect the price of the underlying asset to decline. A put option provides the buyer with the right to sell the asset at the strike price, which can be higher than the market price, resulting in a profit if the asset's value decreases.
Hedging: Put options are used to hedge against potential losses in an existing portfolio. Investors can purchase put options to protect their holdings from declining prices.

Reasons for Selling Call Options (Writing Covered Calls):

Income Generation: Investors who already own the underlying asset may sell call options (write covered calls) to generate income from the premiums they receive from option buyers. If the option is exercised, they may be required to sell the asset at the strike price.
Neutral to Slightly Bearish Outlook: Selling call options can be profitable if the investor expects the asset's price to remain relatively stable or only increase slightly. As long as the option is not exercised, the seller keeps the premium.

Reasons for Selling Put Options:

Income Generation: Investors may sell put options to earn premiums. If the option expires worthless (i.e., the asset price does not drop below the strike price), the seller keeps the premium.
Bullish Outlook: Selling cash-secured put options can be a strategy for acquiring an asset at a lower price. If the put option is exercised, the seller is obligated to buy the asset at the strike price, which may be lower than the market price.
Neutral to Slightly Bullish Outlook: Selling put options can be profitable when the investor expects the asset's price to remain relatively stable or only decrease slightly. As long as the option is not exercised, the seller keeps the premium.
Risk Management: Selling put options can also be used as a risk management strategy to establish a price at which the investor is willing to buy the asset if it falls to a specific level.

In summary, investors use call and put options for various purposes, including speculation on price movements, generating income, hedging against potential losses, and managing risk. The choice between buying and selling options depends on an individual's market outlook and risk tolerance. Each options strategy comes with its own set of risks and potential rewards, and it's essential for investors to understand these factors before engaging in options trading.

HEDGE FUND BASICS AND MERITS

2018-08-01T09:11:00.004-07:00

Title: Demystifying Hedge Funds: A Primer on Their Origins and Characteristics

Introduction

Hedge funds, once shrouded in secrecy, have become a prominent and dynamic part of the financial world. These investment vehicles are known for their unique structures, strategies, and lack of transparency. In this article, we will delve into the basics of hedge funds, their origins, structures, and key characteristics that set them apart from traditional investment vehicles.

The Birth of Hedge Funds

The modern hedge fund era began in 1949, thanks to the pioneering work of Alfred Winslow Jones. He is credited with launching the first modern hedge fund, organized as a private partnership. Jones combined short sales and leverage to create a conservative investment approach, based on the belief that superior stock selection matters more than market direction. Jones's model outperformed the market, and he operated his fund in secret for nearly two decades.

Structures: US and Offshore

Hedge funds in the United States are typically structured as Limited Partnerships (LPs), while offshore funds often take the form of corporations. The choice of structure depends on various factors, including the number of investors and regulatory considerations.

Open- versus Closed-End

Most hedge funds operate as open-end funds, continuously issuing new shares to investors. Existing investors can redeem shares based on the fund's net asset value, subject to specified redemption policies.

The Lack of Transparency

Traditionally, hedge funds have been characterized by a lack of transparency. Many hedge funds, if they meet specific SEC exemptions, can operate without registering with the SEC. Additionally, they are not obligated to disclose performance information, asset allocations, or earnings to the public.

Performance-Based Fee Structure

Hedge fund managers are primarily compensated based on the profitability of the fund's investments, typically receiving 20% of the profits. Often, a "hurdle" rate of return must be achieved before the performance fee is paid. This fee structure provides managers with a strong incentive to maximize returns. Hedge funds also commonly charge a management fee based on a percentage of assets under management, typically ranging from 1% to 2%.

Fund Manager as Both General and Limited Partner

The fund manager plays a dual role as a general partner and a limited partner. While acting as the manager, they commit a significant portion of their wealth to the fund, aligning their interests with those of the investors.

High Minimum Investment

Due to restrictions on the number of investors that US-domiciled hedge funds can have, minimum investments in these funds are relatively high. This ensures that the fund manager can effectively implement their strategy.

Focus on Absolute Return

Hedge funds typically aim for risk-adjusted absolute returns, as opposed to traditional investment vehicles that strive to outperform market benchmarks. This approach emphasizes achieving positive returns regardless of broader market conditions.

Flexibility in Investment Tools

Hedge funds have extensive flexibility in the types of instruments they can invest in, including derivatives such as options, futures, convertibles, and warrants. This flexibility enables them to manage risk, capture market opportunities, and increase exposure as needed.

Flexibility in Investment Strategies

Hedge funds can employ a wide range of investment strategies, including leverage, short selling, arbitrage, and sector-specific focus. Managers can actively engage on both the long and short sides of the market.

Low Market Correlation

The diverse strategies and instruments used by hedge funds result in low correlations with traditional equity market benchmarks. This aligns with Alfred Winslow Jones's belief that superior stock selection matters more than market direction.

Liquidity Considerations

Hedge funds are typically less liquid than traditional investments, with most allowing redemptions on a quarterly basis. Some funds have longer lock-up periods, which can range from several months to a year, and may charge redemption fees.

Active Management

Hedge funds seek to add value through active management, employing various techniques to gain a competitive advantage. This can include superior information collection, access to opportunities, analysis of opportunities, and effective trade and portfolio structuring.

In conclusion, hedge funds have evolved significantly since their inception, and they continue to play a vital role in the investment landscape. Understanding their unique structures and characteristics is essential for investors seeking to navigate the world of alternative investments.

Side Pocket Investments

2018-08-01T07:16:00.002-07:00

A Side Pocket is a type of account used by hedge funds to separate illiquid investments from other more liquid assets in a portfolio. Only investors at the time of the creation of the sidepocket will be entitled to a share of the proceeds of the side pocket when it is eventually realized. Future investors will not receive any share of the side pocket.

Investors who receive a share of the side pocket at its creation and subsequently redeem from the fund will still receive a share of the side pocket's value when it gets realized.

What is an illiquid asset?

When an asset is illiquid, it does not mean that the asset has no value. Illiquid assets are difficult to sell because there may not be many buyers interested in purchasing the asset. Common examples of illiquid assets include real estate, antiques and securities that currently have low trading volume, such as those from companies delisted from the major stock exchanges. Investors often refer to stocks with low trading volume as thinly traded stocks.

Once created side pockets can almost be thought of and treated as a sub fund within a fund.

Typically side pocket investments are hard to value and do not even have a comparable security/ assets that can be used to price them against. In these cases it is often left to the fund manager to come up with an internal model to value the investment. As this raises significant conflict of interest issues it is not uncommon for the fund manager to waive any management and/or performance fees in these cases.

How are shareholders affected by the creation of a side pocket?

Existing Shareholders: When a fund manager decides to create a side pocket existing shareholders are allocated shares in the new side pocket account on a pro-rata basis. These shares cannot be redeemed until either the fund manager realizes a portion or all of the side pocket investment.

Redeeming Shareholders: If a shareholder decides to redeem or partially redeem his shareholding from a fund that holds an illiquid asset they may not receive their full entitlement if the valuation of the asset was underestimated. The advantage of using a side pocket is that the proportion of the fund which is represented by the illiquid asset is only redeemed when it is capable of being accurately valued. This avoids prejudicing the redeeming shareholders and assures that the Net Asset Value of the fund is accurate.

New Shareholders: New shareholders will have no entitlement to shares in the side pocket holding the illiquid assets. This protects the new investor from any over estimation of the side pockets valuation and allows them to enter the fund based on the fair value of the remainder of the funds liquid portfolio.

Creating a Side Pocket:

The following issues need to be taken into account when creating a Side Pocket:

The existing shareholders will receive a pro-rata share of the new class proportionate to their holding in the fund at the time of creation of the class.
The documentation of the fund should be amended to cater for the creation of side pockets. This will include making the necessary updates to the prospectus.
The creation of the side pocket represents a change in the terms upon which investors originally invested in the fund and consequently the approval of the shareholders will be required to create the side pocket.
The new class alone will benefit from any interest, dividend or other income accruing to the side pocketed investment.
Shares in the new side pocket class can only be redeemed when the illiquid assets can be valued accurately.
The new class of shares will be valued on each dealing day.

SEC and Side Pockets

Since 2010, the Securities and Exchange Commission (SEC) has launched numerous investigations into side pocket accounts. These investigations have been launched in response to investor complaints regarding their inability to redeem their side pocket hedge fund shares on demand. The SEC investigations include the valuation methods that fund managers use for side pocket accounts, due to a concern that the managers may be overstating their value. The SEC is looking into the general lack of disclosure given to investors regarding asset allocation percentages from the general portfolio into side pockets.

With the liquidity issues suffered by Hedge Funds in recent years it is no longer unusual to see funds create side pockets for the treatment of illiquid assets. Side pockets can however create as many issues as they solve. Here are a few:

Some parties feel side pockets are just another way of protecting manager's fees by putting certain investments into a magic box - never to be seen again.
Complex issues have arisen surrounding the crystallisation of performance fees and the adjustment of High Water Marks. This just serves to highlight the potential conflict of interests that may emerge over time.
It is essential that the framework for how and when side pockets can be created be laid out in order to avoid contentious issues arising from the extent of the manager's discretion to designate investments into a side pocket.
Creditors agreements should be put in place where the side-pocketed investment has been leveraged. This is necessary to prevent creditors having recourse to the liquid element of the portfolio.
Using side pockets has been viewed as adding a layer of secrecy and susceptible to abuse if the side pocket investments are not included in the fee calculations.

Executed properly, side pockets are a useful tool to help level the playing field for investors in a hedge fund which is experiencing liquidity issues. Creating a side pocket is not a silver bullet for fund liquidity issues and serval operationial and ethical issues must be considered before creating one. The main concern should be the fair treatment of all investors in the fund.

DERIVATIVES – INTRODUCTION & ACCOUNTING

2018-08-01T05:56:00.005-07:00

The provided content gives an introduction to derivatives and outlines their accounting aspects. Here's a breakdown of the key points:

Introduction to Derivatives:

Definition of Derivatives: Derivatives are financial contracts whose value depends on the performance of an underlying asset, such as commodities, debt instruments, currency, or stocks.
Types of Derivatives:
- Commodity Derivatives: Derivatives with underlying assets like agricultural commodities or precious metals.
- Financial Derivatives: Derivatives with underlying assets like debt instruments, currency, share price indices, or equity shares.
Risk Management Tools: Derivatives are used as risk management tools to hedge against price fluctuations and to speculate on future price movements.

Future Contracts:

Definition: A futures contract is an agreement to buy or sell an underlying asset at a specified future date and price. These contracts are standardized and traded on exchanges.
Underlying Assets: Futures can have underlying assets like agricultural commodities or financial assets like stocks and bonds.
Obligations: Buyers commit to purchasing, and sellers commit to delivering, the underlying asset at the agreed-upon price and date.
Margin: Both parties are required to deposit initial margin to cover potential losses. Daily changes in the contract's value are marked to market (MTM).
Settlement: Contracts can be closed before expiry by taking an opposite position in the market. Settlement can involve physical delivery or cash settlement, depending on the type of contract.

Option Contracts:

Definition: Options are contracts that give the holder the right (but not the obligation) to buy (call option) or sell (put option) an underlying asset at a specified price on or before a future date.
American vs. European Options: American options can be exercised anytime before expiry, while European options can only be exercised on the expiry date.
Rights and Obligations: Options involve a buyer (holder) who has the right but not the obligation and a seller (writer) who has the obligation but not the right to fulfill the contract.

Accounting Aspects:

Initial Margin: Initial margin paid for futures contracts is recorded in an "Initial Margin" account. It can be paid in cash or collateral.
Mark to Market (MTM): Daily changes in futures contracts are marked to market, and the difference is settled in cash. MTM margin is recorded in an "MTM Margin" account.
Final Settlement: On contract expiry, the profit or loss is computed as the difference between the final settlement price and the contract price. It's recognized in the Profit and Loss account.
Open Interest: Open interest is the number of open contracts that have not been closed or settled. Debit balances in MTM accounts represent potential losses, while credit balances represent potential gains.
Option Contracts Accounting: Premium paid for option contracts is recorded in an "Option Premium" account. Premium received is recognized as income in the "Option Premium" account. The difference between the market premium and the paid premium may be provisioned for.
Disclosures: Accounting policies, details of outstanding contracts at year-end (open interests), and other disclosures are required as per accounting standards and regulatory guidelines.

Overall, the content provides a comprehensive overview of derivatives, their types, and their accounting treatment. It covers the key aspects of futures and options contracts and highlights the importance of disclosure and prudent accounting practices in derivatives trading.

Fixed Income

2018-08-01T05:55:00.006-07:00

The content you've provided covers various aspects of fixed income securities, including bonds, their issuers, coupon types, coupon calculations, discount paper, the difference between debt and equity, the risk-return tradeoff, and bond trading and valuation. Here's a summary of the key points from your content:

Learning Objectives:
- Identify the features of fixed income securities.
- Understand who the bond issuers are.
- Identify different coupon types.
- Learn how to calculate coupons.
- Understand what discount paper is.
- Differentiate between debt and equity.
- Grasp the concept of risk vs. return.
- Explain bond trading and valuation.
Content:
- Debt Instruments (Bonds): These are securities issued by institutions to raise money. Bondholders lend money to entities (e.g., companies or governments) for a specific period at a fixed interest rate (coupon rate).
- Bond Holders: Bondholders are creditors of the bond issuer and have no control over the issuer's decision-making processes. Bonds are considered fixed income securities because their returns are predictable if held until maturity.

2.1. Bond Issuers:

Corporations: Companies issue bonds to raise funds for various purposes, and corporate bonds usually offer higher interest rates than government bonds due to higher perceived risk.
Governments: Governments issue bonds when tax receipts are insufficient to cover expenses, using the funds for infrastructure, social programs, etc.

2.2. Coupon Types:

Fixed Rate: The interest rate remains constant throughout the bond's life, with periodic interest payments based on the bond's face value.
Floating Rate: The interest rate varies with market conditions (e.g., LIBOR plus a spread) and is reset at each coupon payment date.

2.3. Calculating Interest:

Interest is calculated based on the bond's coupon rate, frequency of payments, and the number of days since the last payment date, using different day-count methods (e.g., 30/360, Actual/Actual, Actual/365).

2.4. Discount Paper:

Short-term debt instruments issued at a discount and maturing at par. They don't pay interest coupons; instead, the return comes from the appreciation of the paper's value. Example: U.S. Treasury Bills.

2.5. Debt vs. Equity:

Bonds represent debt, while stocks represent equity. Bondholders are creditors with a claim on assets and receive fixed interest payments. Shareholders are owners with voting rights and a share in profits.

2.6. Risk vs. Return:

Yield reflects the return on a bond and can change as the bond's price changes. Yield to maturity (YTM) accounts for reinvestment of interest payments and potential gains/losses if held to maturity.
Bond prices move inversely to prevailing interest rates: rising rates lead to falling bond prices and vice versa.

2.7. Accounting & Valuation:

Bond prices change daily in the market. Bonds are treated "clean" for accounting, meaning accrued interest is separated from the principal.
Sellers are entitled to accrued interest up to the settlement date, added to the agreed-upon price for net cash flow.
Unrealized gains/losses and interest accrual are calculated for accounting and tax purposes.
Realized gains/losses occur when bonds are sold, and the proceeds differ from the base cost.

The content provides comprehensive information on fixed income securities, bond types, and their accounting treatment. It also emphasizes the importance of understanding bond pricing and accounting for accrued interest in trading and valuation.

Master Feeder Fund

2018-08-01T05:48:00.002-07:00

What is a Master Feeder Fund?

A master feeder fund is a type of hedge fund structure.

Investors place their money into feeder funds which then invests into a master fund. It is the master fund that actually invests in the market. All the market trading occurs at the master fund level.

The purpose of the feeder fund is to, funnily enough, 'feed' investor funds into the master fund and then receive the flow of P&L back which in is turn then feed to each investor at the feeder level.

Sound complicated? It can take a couple of reads for it sink in. Hopefully the following sections will help tie it all together so it starts making some sense.

A typical master feeder structure is comprised of:

One master fund
Two feeder funds as below:
Onshore fund, Limited partnership organised in the U.S. LTD (for U.S. investors)
Offshore corporation LP (for non-U.S. and U.S. tax-exempt investors)

Understanding Master Feeder Funds:

One way to understand Master Feeder funds is a method that works for a lot of things in life - follow the money! An investor starts at the feeder fund where they invest their money. This capital then flows from the feeder fund into the master fund. The master fund takes this cash and invests it on the markets. The P&L generated at the master fund is then allocated back to the two feeder funds. Finally the feeder funds allocate the P&L back down to the investor.

At this stage the capital has flowed full circle from investor to feeder to master back to feeder and finally back to investor.

Capital Flows

As mentioned earlier when understanding master feeder funds following the flow of money can help. Here we'll take a look at how the capital (investor's money) moves around the structure from one entity to the other.

Investing starts with the investor subscribing their cash into the feeder fund. The feeder fund then takes this capital along with any other subscriptions and invests them into the master fund.

For their investment in the feeder the investor will receive a shareholding in the case of the Offshore Ltd feeder or a percentage allocation in the case of the Onshore LP feeder.

It's good to note at this point that the feeder fund doesn't necessarily have to invest all of the capital received from the investor into the master. It can keep some capital back to pay expenses or even make direct feeder investments. In the majority of cases though the feeder will invest all its capital into the master fund and then withdraw capital when necessary to pay expenses.

When the respective feeder invests, to the master fund it appears as an investment from one of its investors. The master fund can then allocates the feeders a percentage allocation of the master funds P&L based on their holding in the master fund.

P&L Generation

Once the master fund has received in capital from the investor via the feeder funds it invests this cash on the markets. The portfolio is held at the master fund and any trading expenses, interest, dividends, buys, sells etc are accounted for here.

At the close of each reporting period a valuation of the master fund is completed. Based on this valuation the Fund Administrator will be able to calculate the amount of P&L generated by the master fund. As the feeder holding in the master fund is known the P&L can be allocated back down to the feeders based on their allocated ownership of the master fund.

Next up, how the P&L, which is generated at the master, flows back down to the feeders and then finally to the investor.

P&L Allocation

Now that the P&L generated at the master fund has flown down to the feeders the next and final step is to allocate it to the investors.
Each investor in the feeder will have either an amount of shares in the case of the offshore feeder or a percentage ownership in the case of the onshore feeder. These are used as the basis to calculate each investors pro-rata entitlement of P&L from the feeder total and ultimately the master fund.

You have now seen the full cycle of investor capital through the master feeder fund structure and the flow of P&L back down to the investor.

Essentially when a feeder fund invests in a master fund it is like buying shares in any other 'security'. However when a feeder fund invests in a security it cannot 'peer into' the underlying investment, it can for its investment in the master fund. This allows for the tax attributes e.g. dividends, income etc. to flow from the master to the feeder.

Why use a Master Feeder Fund?

A master-feeder fund structure is commonly used to manage funds raised from U.S. taxable investors and non-U.S. investors into one central vehicle - the master fund. Below are the two main reasons for using a master feeder fund structure:

To save money. By creating a bigger pooled fund operational costs are reduced on a per investor basis.
In order to effectively manage both U.S. taxable investors and non-U.S. investors in a single structure allowing the fund to cater for both sets of investors.

Advantages

Multiple portfolios consolidated into one
Reduced trading, transaction and operational costs
Combined assets can be used to obtain better financing deals
Flexible legal structure, additional feeder/master funds can be added
General Partners performance fee will be able to maintain the underlying tax attributes of the onshore feeder
Lessens administrative burden of accounting for multiple portfolios
Reduces start-up costs

Disadvantages

Tax accounting can become complicated
May not offer advantages to all investors at all times
Offshore fund subject to 30% withholding tax on U.S. dividends

Management Fees

Management fees are payments made by the investors in the feeder funds to the fund manager as compensation for managing the fund. They are typically charged at the feeder fund level only. The rate charged by the Investment Manager to the Investors is outlined in the Partnership Agreement.

Typically the Investment Manager will allow themselves the flexibility to charge different rates to different investors, classes or feeders. In some cases cash in withheld at the feeder level to pay the management fees. If there is not sufficient cash available to meet the payment then the feeder may choose to redeem capital from the master to cover the cost.

Performance Fees

Like management fees, performance fees are charged at the feeder level only. Once the P&L generated at the master fund has been allocated to each feeder performance fees can be calculated and allocated per partner. In the onshore feeder, this will take the form of a reallocation of profit from the limited partner to the general partner. In the offshore feeder, the performance fee is calculated by series.

Equalisation can be used to ensure that performance fees have been allocated to each investor in the offshore fund fairly. (Because
allocating performance fees based on shares owned only it does not include the carried forward losses or timing of subscriptions.)

In order for fund managers to receive their fees in the most tax-beneficial manner the following is put in place:

Onshore (LTD) feeders re-allocate their fees from the limited partners (the investors) to the general partners - the fund manager.
Offshore (LP) feeders are corporations and must charge their fees to the shareholders. In the shareholder case fund managers take their performance fee in the form of deferred compensation.

Since reallocating income is still an acceptable way of compensating the manager in a tax-efficient way the shareholder feeder is set up to allow the reallocation of income back to the manager. This requires the following to be in place:

The fund manager becomes a general partner of the master fund
The master fund P&L flows to the feeder fund where the performance fee is calculated
When the fund is closed for the period the fund manager takes it's fee

Impact of FATCA on Hedge Funds

2018-08-01T05:39:00.005-07:00

The content you provided outlines the impact of the Foreign Account Tax Compliance Act (FATCA) on funds and other collective investment schemes, which are considered Foreign Financial Institutions (FFIs) under FATCA. FATCA is a U.S. tax law aimed at combating tax evasion by U.S. taxpayers using foreign accounts and investments. Here are some key points from the provided information:

Applicability of FATCA: FATCA applies to FFIs, including various types of collective investment vehicles such as hedge funds, private equity funds, mutual funds, and venture capital funds, regardless of whether they have U.S. investors or U.S. investments.
Obligations Under FATCA: FFIs have several obligations under FATCA, including classification, registration, due diligence, withholding, and annual reporting.
Classification: FFIs must classify themselves based on the relevant Inter-Governmental Agreement (IGA) or FATCA regulations. Different classifications may have different compliance requirements and exemptions, which can reduce the compliance burden.
Registration: Most FFIs are required to register with the U.S. Internal Revenue Service (IRS) and obtain a Global Intermediary Identification Number (GIIN). The GIIN is used to verify an FFI's status.
Due Diligence: FFIs must conduct due diligence to identify financial accounts (typically investors in the fund) that need to be reported annually. This process involves identifying U.S. accounts, Non-Participating FFI accounts, and recalcitrant accounts. The FFI is responsible for determining the account holder's U.S. status.
Withholding: If financial account holders of the fund do not comply with FATCA requirements, there may be withholding on U.S. source payments made to those accounts. The FFI can either withhold and remit payments to the IRS or report the payments to the immediate payer.
Reporting: FFIs can be classified as reporting or non-reporting FFIs. Reporting FFIs may need to report on their account holders based on agreements with local tax authorities or the IRS, depending on the jurisdiction and agreements in place.

The provided content also mentions that the impact of FATCA on different entities, such as trusts, banks, and other investment entities, can vary. Additionally, it directs readers to visit a website and contact a consulting firm for more information and assistance with FATCA compliance.

Overall, the information outlines the key compliance requirements and considerations for funds and collective investment schemes under FATCA, emphasizing the importance of classification, due diligence, and reporting to ensure compliance with this U.S. tax law.

REPO

2018-08-01T05:18:00.006-07:00

Repo or Repurchase agreement is a money market instrument, which enables short-term borrowing and lending against securities. Under the repo agreement the holder of the bond sells it with an agreement to repurchase the same at an agreed rate and date. The forward clean price is set at a level, which is different from the spot clean price by adjusting the difference between repo interest rate and coupon earned on the security. This transaction is nothing but a collateralized lending. For the lender of cash the securities sold by the borrower is the collateral and for the borrower of cash the cash received from lender is the security. The lender of securities (who is the borrower of cash) is said to be doing ‘repo’ and the lender of cash (who is the borrower of securities) is said to be doing ‘reverse repo’. Whether a transaction is termed as repo or reverse repo is determined by who initiates the first leg of the transaction. Repo transaction help in borrowing cash and tiding over short term deficits and reverse repo transaction helps in earning some return on the idle cash.

Repo Basics:
- A repo, or repurchase agreement, is a short-term money market instrument used for borrowing and lending funds against securities.
- In a repo, the holder of a bond (usually the borrower) sells it with an agreement to repurchase the same bond at an agreed-upon rate and date.
Forward Clean Price:
- The forward clean price is set at a level different from the spot clean price. This adjustment is based on the difference between the repo interest rate and the coupon earned on the security.
Collateralized Lending:
- In a repo transaction, the securities being sold by the borrower serve as collateral.
- For the lender of cash, the securities act as collateral, while for the borrower of cash, the cash received from the lender serves as security.
Repo vs. Reverse Repo:
- Whether a transaction is termed a repo or reverse repo depends on who initiates the first leg of the transaction.
- The lender of securities (borrower of cash) initiates a repo, while the lender of cash (borrower of securities) initiates a reverse repo.
- Repo transactions help borrowers obtain cash to cover short-term deficits, while reverse repo transactions help lenders earn a return on idle cash.
Two Legs of Repo:
- Repo transactions involve two legs: the first leg when securities and cash are borrowed, and the second leg when they are returned.
- Settlement amount on the first leg includes the value of the securities at the transaction price and accrued interest.
- Settlement amount on the second leg includes repo interest, accrued interest, and the return of the principal amount borrowed.
Numerical Example:
- You provided a numerical example to illustrate a repo transaction:
  - Trade date: 13th July 2004
  - Settlement date: 13th July 2004
  - Trade price: 108.50
  - Face Value: 100,000
  - Security: 12.5% 20-Sep-2008
  - Repo rate: 7.5%
  - Repo term: 2 days
- You calculated the settlement amounts for both the first and second legs of the repo transaction.
Repo Rate:
- The repo rate, which is agreed upon in the repo transaction, is typically lower compared to the interbank borrowing rate because it involves collateralized borrowing.

Your explanation provides a comprehensive understanding of how repo transactions work and how they are used in the financial markets for short-term borrowing and lending purposes, with a focus on the calculation of settlement amounts and the role of collateral.

Glossary of Technical Terms - Fund Accounting

2018-08-01T04:55:00.002-07:00

Glossary of Technical Terms

American Depositary Receipts (ADRs)

Certificates issued by a U.S. depositary bank, representing foreign shares held by the bank, usually by a branch or correspondent in the country of issue. One ADR may represent a portion of a foreign share, one share or a bundle of shares of a foreign corporation. If the ADR's are "sponsored," the corporation provides financial information and other assistance to the bank and may subsidize the administration of the ADRs. "Unsponsored" ADRs do not receive such assistance. ADRs carry the same currency, political and economic risks as the underlying foreign share; the prices of the two, adjusted for the SDR/ordinary ratio, are kept essentially identical by arbitrage. American depositary shares(ADSs) are a similar form of certification.

American option

An option that may be exercised at any time up to and including the expiration date.

American Stock Exchange (AMEX)

The second-largest stock exchange in the United States. It trades mostly in small-to medium-sized companies.

American-style option

An option contract that can be exercised at any time between the date of purchase and the expiration date. Most exchange-traded options are American style.

Announcement date

Date on which particular news concerning a given company is announced to the public. Used in event studies, which researchers use to evaluate the economic impact of events of interest.

Arbitrage

The simultaneous buying and selling of a security at two different prices in two different markets, resulting in profits without risk. Perfectly efficient markets present no arbitrage opportunities. Perfectly efficient markets seldom exist.

Arm's length price

The price at which a willing buyer and a willing unrelated seller would freely agree to transact.

Asian option

Option based on the average price of the asset during the life of the option.

Ask

This is the quoted ask, or the lowest price an investor will accept to sell a stock. Practically speaking, this is the quoted offer at which an investor can buy shares of stock; also called the offer price.

Ask price

A dealer's price to sell a security; also called the offer price.

Asset-backed security

A security that is collateralized by loans, leases, receivables, or installment contracts on personal property, not real estate.

At-the-money

An option is at-the-money if the strike price of the option is equal to the market price of the underlying security. For example, if xyz stock is trading at 54, then the xyz 54 option is at-the-money

Barrier options

Contracts with trigger points that, when crossed, automatically generate buying or selling of other options. These are very exotic options.

Basis point

In the bond market, the smallest measure used for quoting yields is a basis point. Each percentage point of yield in bonds equals 100 basis points. Basis points also are used for interest rates. An interest rate of 5% is 50 basis points greater than an interest rate of 4.5%.

Basket options

Packages that involve the exchange of more than two currencies against a base currency at expiration. The basket option buyer purchases the right, but not the obligation, to receive designated currencies in exchange for a base currency, either at the prevailing spot market rate or at a prearranged rate of exchange. A basket option is generally used by multinational corporations with multicurrency cash flows since it is generally cheaper to buy an option on a basket of currencies than to buy individual options on each of the currencies that make up the basket.

Bear

An investor who believes a stock or the overall market will decline. A bear market is a prolonged period of falling stock prices, usually by 20% or more..

Bid price

This is the quoted bid, or the highest price an investor is willing to pay to buy a security. Practically speaking, this is the available price at which an investor can sell shares of stock.

Bid-asked spread

The difference between the bid and asked prices.

Binomial option pricing model

An option pricing model in which the underlying asset can take on only two possible, discrete values in the next time period for each value that it can take on in the preceding time period.

Black-Scholes option-pricing model

A model for pricing call options based on arbitrage arguments that uses the stock price, the exercise price, the risk-free interest rate, the time to expiration, and the standard deviation of the stock return.

in the domestic sterling market.

Broker

An individual who is paid a commission for executing customer orders. Either a floor broker who executes orders on the floor of the exchange, or an upstairs broker who handles retail customers and their orders.

Call option

An option contract that gives its holder the right (but not the obligation) to purchase a specified number of shares of the underlying stock at the given strike price, on or before the expiration date of the contract.

Call premium

Premium in price above the par value of a bond or share of preferred stock that must be paid to holders to redeem the bond or share of preferred stock before its scheduled maturity date.

Capital gain

When a stock is sold for a profit, it's the difference between the net sales price of securities and their net cost, or original basis. If a stock is sold below cost, the difference is a capital loss.

Cash dividend

A dividend paid in cash to a company's shareholders. The amount is normally based on profitability and is taxable as income. A cash distribution may include capital gains and return of capital in addition to the dividend.

Commission

The fee paid to a broker to execute a trade, based on number of shares, bonds, options, and/or their dollar value. In 1975, deregulation led to the creation of discount brokers, who charge lower commissions than full service brokers. Full service brokers offer advice and usually have a full staff of analysts who follow specific industries. Discount brokers simply execute a client's order -- and usually do not offer an opinion on a stock. Also known as a round-turn.

Common stock

These are securities that represent equity ownership in a company. Common shares let an investor vote on such matters as the election of directors. They also give the holder a share in a company's profits via dividend payments or the capital appreciation of the security.

Counterparty risk

The risk that the other party to an agreement will default. In an options contract, the risk to the option buyer that the option writer will not buy or sell the underlying as agreed.

Covered call

A short call option position in which the writer owns the number of shares of the underlying stock represented by the option contracts. Covered calls generally limit the risk the writer takes because the stock does not have to be bought at the market price, if the holder of that option decides to exercise it.

Covered Put

A put option position in which the option writer also is short the corresponding stock or has deposited, in a cash account, cash or cash equivalents equal to the exercise of the option. This limits the option writer's risk because money or stock is already set aside. In the event that the holder of the put option decides to exercise the option, the writer's risk is more limited than it would be on an uncovered or naked put option.

Credit analysis

The process of analyzing information on companies and bond issues in order to estimate the ability of the issuer to live up to its future contractual obligations.

Credit risk

The risk that an issuer of debt securities or a borrower may default on his obligations, or that the payment may not be made on a negotiable instrument.

Cross hedging

The practice of hedging with a futures contract that is different from the underlying being hedged.

Cross rates

The exchange rate between two currencies expressed as the ratio of two foreign exchange rates that are both expressed in terms of a third currency.

Cumulative preferred stock

Preferred stock whose dividends accrue, should the issuer not make timely dividend payments.

Cumulative Translation Adjustment (CTA) account

An entry in a translated balance sheet in which gains and/or losses from translation have been accumulated over a period of years. The CTA account is required under the FASB No. 52 rule.

Currency arbitrage

Taking advantage of divergences in exchange rates in different money markets by buying a currency in one market and selling it in another market.

Currency future

A financial future contract for the delivery of a specified foreign currency.

Currency option

An option to buy or sell a foreign currency.

Current assets

Value of cash, accounts receivable, inventories, marketable securities and other assets that could be converted to cash in less than 1 year.

Current liabilities

Amount owed for salaries, interest, accounts payable and other debts due within 1 year.

Current / noncurrent method

Under this currency translation method, all of a foreign subsidiary's current assets and liabilities are translated into home currency at the current exchange rate while noncurrent assets and liabilities are translated at the historical exchange rate, that is, the rate in effect at the time the asset was acquired or the liability incurred.

Custodial fees

Fees charged by an institution that holds securities in safekeeping for an investor.

Date of payment

Date dividend checks are mailed.

Date of record

Date on which holders of record in a firm's stock ledger are designated as the recipients of either dividends or stock rights.

Day order

An order to buy or sell stock that automatically expires if it can't be executed on the day it is entered.

Day trading

Refers to establishing and liquidating the same position or positions within one day's trading.

Debt securities

IOUs created through loan-type transactions - commercial paper, bank CDs, bills, bonds, and other instruments.

Debt-service coverage ratio

Earnings before interest and income taxes plus one-third rental charges, divided by interest expense plus one-third rental charges plus the quantity of principal repayments divided by one minus the tax rate.

Debt swap

A set of transactions (also called a debt-equity swap) in which a firm buys a country's dollar bank debt at a discount and swaps this debt with the central bank for local currency that it can use to acquire local equity.

Declaration date

The date on which a firm's directors meet and announce the date and amount of the next dividend.

Default premium

A differential in promised yield that compensates the investor for the risk inherent in purchasing a corporate bond that entails some risk of default.

Default risk

Also referred to as credit risk (as gauged by commercial rating companies), the risk that an issuer of a bond may be unable to make timely principal and interest payments.

Deferred taxes

A non-cash expense that provides a source of free cash flow. Amount allocated during the period to cover tax liabilities that have not yet been paid.

Delivery options

The options available to the seller of an interest rate futures contract, including the quality option, the timing option, and the wild card option. Delivery options make the buyer uncertain of which Treasury Bond will be delivered or when it will be delivered.

Delivery versus payment

A transaction in which the buyer's payment for securities is due at the time of delivery (usually to a bank acting as agent for the buyer) upon receipt of the securities. The payment may be made by bank wire, check, or direct credit to an account.

Depository Trust Company (DTC)

DTC is a user-owned securities depository which accepts deposits of eligible securities for custody, executes book-entry deliveries and records book-entry pledges of securities in its custody, and provides for withdrawals of securities from its custody.

Derivative instruments

Contracts such as options and futures whose price is derived from the price of the underlying financial asset.

Derivative markets

Markets for derivative instruments.

Derivative security

A financial security, such as an option, or future, whose value is derived in part from the value and characteristics of another security, the underlying security.

Detachable warrant

A warrant entitles the holder to buy a given number of shares of stock at a stipulated price. A detachable warrant is one that may be sold separately from the package it may have originally been issued with (usually a bond).

Direct quote

For foreign exchange, the number of U.S. dollars needed to buy one unit of a foreign currency.

Discount rate

The interest rate that the Federal Reserve charges a bank to borrow funds when a bank is temporarily short of funds. Collateral is necessary to borrow, and such borrowing is quite limited because the Fed views it as a privilege to be used to meet short-term liquidity needs, and not a device to increase earnings.

Dividend

A dividend is a portion of a company's profit paid to common and preferred shareholders. A stock selling for

$20 a share with an annual dividend of $1 a share yields the investor 5%.

Dividend clawback

With respect to a project financing, an arrangement under which the sponsors of a project agree to contribute as equity any prior dividends received from the project to the extent necessary to cover any cash deficiencies.

Dividend payout ratio

Percentage of earnings paid out as dividends.

Dividends per share

Amount of cash paid to shareholders expressed as dollars per share.

Dividend policy

An established guide for the firm to determine the amount of money it will pay as dividends.

Dividend rate

The fixed or floating rate paid on preferred stock based on par value.

Dividend rights

A shareholders' rights to receive per-share dividends identical to those other shareholders receive.

Dividends per share

Dividends paid for the past 12 months divided by the number of common shares outstanding, as reported by a company. The number of shares often is determined by a weighted average of shares outstanding over the reporting term.

Earnings before interest and taxes (EBIT)

A financial measure defined as revenues less cost of goods sold and selling, general, and administrative expenses. In other words, operating and non-operating profit before the deduction of interest and income taxes.

Earnings per share (EPS)

EPS, as it is called, is a company's profit divided by its number of outstanding shares. If a company earned $2 million in one year had 2 million shares of stock outstanding, its EPS would be $1 per share. The company often uses a weighted average of shares outstanding over the reporting term.

Effective annual interest rate

An annual measure of the time value of money that fully reflects the effects of compounding.

Effective annual yield

Annualized interest rate on a security computed using compound interest techniques.

Effective call price

The strike price in an optional redemption provision plus the accrued interest to the redemption date.

Effective date

In an interest rate swap, the date the swap begins accruing interest.

Effective margin (EM)

Used with SAT performance measures, the amount equaling the net earned spread, or margin, of income on the assets in excess of financing costs for a given interest rate and prepayment rate scenario.

Effective rate

A measure of the time value of money that fully reflects the effects of compounding.

Electronic depository transfers

The transfer of funds between bank accounts through the Automated Clearing House (ACH) system.

Embedded option

An option that is part of the structure of a bond that provides either the bondholder or issuer the right to take some action against the other party, as opposed to a bare option, which trades separately from any underlying security.

Emerging markets

The financial markets of developing economies.

Employee stock fund

A firm-sponsored program that enables employees to purchase shares of the firm's common stock on a preferential basis.

Equity

Represents ownership interest in a firm. Also the residual dollar value of a futures trading account, assuming its liquidation at the going market price.

Equity cap

An agreement in which one party, for an upfront premium, agrees to compensate the other at specific time periods if a designated stock market benchmark is greater than a predetermined level.

Equity options

Securities that give the holder the right to buy or sell a specified number of shares of stock, at a specified price for a certain (limited) time period. Typically one option equals 100 shares of stock.

Equity swap

A swap in which the cash flows that are exchanged are based on the total return on some stock market index and an interest rate (either a fixed rate or a floating rate).

Eurobond

A bond that is (1) underwritten by an international syndicate, (2) offered at issuance simultaneously to investors in a number of countries, and (3) issued outside the jurisdiction of any single country.

Exchange

The marketplace in which shares, options and futures on stocks, bonds, commodities and indices are traded. Principal US stock exchanges are: New York Stock Exchange (NYSE), American Stock Exchange (AMEX) and the National Association of Securities Dealers (NASDAQ)

The Exchange

A nickname for the New York stock exchange. Also known as the Big Board. More than 2,000 common and preferred stocks are traded. The exchange is the oldest in the United States, founded in 1792, and the largest. It is located on Wall Street in New York City.

Exchange rate risk

Also called currency risk, the risk of an investment's value changing because of currency exchange rates.

Execution

The process of completing an order to buy or sell securities. Once a trade is executed, it is reported by a Confirmation Report; settlement (payment and transfer of ownership) occurs in the U.S. between 1 (mutual funds) and 5 (stocks) days after an order is executed. Settlement times for exchange listed stocks are in the process of being reduced to three days in the U. S.

Execution costs

The difference between the execution price of a security and the price that would have existed in the absence of a trade, which can be further divided into market impact costs and market timing costs.

Ex-dividend

This literally means "without dividend." The buyer of shares when they are quoted ex-dividend is not entitled to receive a declared dividend.

Ex-dividend date

The first day of trading when the seller, rather than the buyer, of a stock will be entitled to the most recently announced dividend payment. This date set by the NYSE (and generally followed on other US exchanges) is currently two business days before the record date. A stock that has gone ex-dividend is marked with an x in newspaper listings on that date.

Ex-rights

In connection with a rights offering, shares of stock that are trading without the rights attached.

Ex-rights date

The date on which a share of common stock begins trading ex-rights.

Fair market price

Amount at which an asset would change hands between two parties, both having knowledge of the relevant facts. Also referred to as market price.

Fixed asset

Long-lived property owned by a firm that is used by a firm in the production of its income. Tangible fixed assets include real estate, plant, and equipment. Intangible fixed assets include patents, trademarks, and customer recognition.

Forward contract

A cash market transaction in which delivery of the commodity is deferred until after the contract has been made. It is not standardized and is not traded on organized exchanges. Although the delivery is made in the future, the price is determined at the initial trade date.

Futures

A term used to designate all contracts covering the sale of financial instruments or physical commodities for future delivery on a commodity exchange.

Futures contract

Agreement to buy or sell a set number of shares of a specific stock in a designated future month at a price agreed upon by the buyer and seller. The contracts themselves are often traded on the futures market. A futures contract differs from an option because an option is the right to buy or sell, whereas a futures contract is the promise to actually make a transaction. A future is part of a class of securities called derivatives, so named because such securities derive their value from the worth of an underlying investment.

Hedge fund

A fund that may employ a variety of techniques to enhance returns, such as both buying and shorting stocks based on a valuation model.

Hedging

A strategy designed to reduce investment risk using call options, put options, short selling, or futures contracts. A hedge can help lock in existing profits. Its purpose is to reduce the volatility of a portfolio, by reducing the risk of loss.

Income statement (statement of operations)

A statement showing the revenues, expenses, and income (the difference between revenues and expenses) of a corporation over some period of time.

Index arbitrage

An investment/trading strategy that exploits divergences between actual and theoretical futures prices.

Index option

A call or put option based on a stock market index.

Initial margin requirement

When buying securities on margin, the proportion of the total market value of the securities that the investor must pay for in cash. The Security Exchange Act of 1934 gives the board of governors of the Federal Reserve the responsibility to set initial margin requirements, but individual brokerage firms are free to set higher requirements. In futures contracts, initial margin requirements are set by the exchange.

Initial public offering (IPO)

A company's first sale of stock to the public. Securities offered in an IPO are often, but not always, those of young, small companies seeking outside equity capital and a public market for their stock. Investors purchasing stock in IPOs generally must be prepared to accept very large risks for the possibility of large gains. IPO's by investment companies (closed-end funds) usually contain underwriting fees which represent a load to buyers.

Interest

The price paid for borrowing money. It is expressed as a percentage rate over a period of time and reflects the rate of exchange of present consumption for future consumption. Also, a share or title in property.

Interest payments

Contractual debt payments based on the coupon rate of interest and the principal amount.

Interest rate swap

A binding agreement between counterparties to exchange periodic interest payments on some predetermined dollar principal, which is called the notional principal amount. For example, one party will pay fixed and receive variable.

Interest subsidy

A firm's deduction of the interest payments on its debt from its earnings before it calculates its tax bill under current tax law.

In-the-money

A put option that has a strike price higher than the underlying futures price, or a call option with a strike price lower than the underlying futures price. For example, if the March COMEX silver futures contract is trading at $6 an ounce, a March call with a strike price of $5.50 would be considered in-the-money by $0.50 an ounce.

Last-In-First-Out (LIFO)

A method of valuing inventory that uses the cost of the most recent item in inventory first.

Liability

A financial obligation, or the cash outlay that must be made at a specific time to satisfy the contractual terms of such an obligation.

LIBOR

The London Interbank Offered Rate; the rate of interest that major international banks in London charge each other for borrowings. Many variable interest rates in the U.S. are based on spreads off of LIBOR. There are many different LIBOR tenors.

LIFO (Last-in-first-out)

The last-in-first-out inventory valuation methodology. A method of valuing inventory that uses the cost of the most recent item in inventory first.

Liquidity

A market is liquid when it has a high level of trading activity, allowing buying and selling with minimum price disturbance. Also a market characterized by the ability to buy and sell with relative ease.

Long-term assets

Value of property, equipment and other capital assets minus the depreciation. This is an entry in the bookkeeping records of a company, usually on a "cost" basis and thus does not necessarily reflect the market value of the assets.

Management fee

An investment advisory fee charged by the financial advisor to a fund based on the fund's average assets, but sometimes determined on a sliding scale that declines as the dollar amount of the fund increases.

Margin

This allows investors to buy securities by borrowing money from a broker. The margin is the difference between the market value of a stock and the loan a broker makes.

Margin account (Stocks)

A leverageable account in which stocks can be purchased for a combination of cash and a loan. The loan in the margin account is collateralized by the stock and, if the value of the stock drops sufficiently, the owner will be asked to either put in more cash, or sell a portion of the stock. Margin rules are federally regulated, but margin requirements and interest may vary among broker/dealers.

Margin call

A demand for additional funds because of adverse price movement. Maintenance margin requirement, security deposit maintenance

Marked-to-market

An arrangement whereby the profits or losses on a futures contract are settled each day.

Market capitalization

The total dollar value of all outstanding shares. Computed as shares times current market price. It is a measure of corporate size.

Market prices

The amount of money that a willing buyer pays to acquire something from a willing seller, when a buyer and seller are independent and when such an exchange is motivated by only commercial consideration.

Market return

The return on the market portfolio.

Market value

(1) The price at which a security is trading and could presumably be purchased or sold. (2) The value investors believe a firm is worth; calculated by multiplying the number of shares outstanding by the current market price of a firm's shares.

Maturity

For a bond, the date on which the principal is required to be repaid. In an interest rate swap, the date that the swap stops accruing interest.

Mortgage

A loan secured by the collateral of some specified real estate property which obliges the borrower to make a predetermined series of payments.

Mutual fund

Mutual funds are pools of money that are managed by an investment company. They offer investors a variety of goals, depending on the fund and its investment charter. Some funds, for example, seek to generate income on a regular basis. Others seek to preserve an investor's money. Still others seek to invest in companies that are growing at a rapid pace. Funds can impose a sales charge, or load, on investors when they buy or sell shares. Many funds these days are no load and impose no sales charge. Mutual funds are investment companies regulated by the Investment Company Act of 1940.

NASDAQ

National Association of Securities Dealers Automatic Quotation System. An electronic quotation system that provides price quotations to market participants about the more actively traded common stock issues in the OTC market. About 4,000 common stock issues are included in the NASDAQ system.

Net asset value (NAV)

The value of a fund's investments. For a mutual fund, the net asset value per share usually represents the fund's market price, subject to a possible sales or redemption charge. For a closed end fund, the market price may vary significantly from the net asset value.

Net assets

The difference between total assets on the one hand and current liabilities and noncapitalized long-term liabilities on the other hand.

Net income

The company's total earnings, reflecting revenues adjusted for costs of doing business, depreciation, interest, taxes and other expenses.

Net investment

Gross, or total, investment minus depreciation.

Net present value (NPV)

The present value of the expected future cash flows minus the cost.

Option

Gives the buyer the right, but not the obligation, to buy or sell an asset at a set price on or before a given date. Investors, not companies, issue options. Investors who purchase call options bet the stock will be worth more than the price set by the option (the strike price), plus the price they paid for the option itself. Buyers of put options bet the stock's price will go down below the price set by the option. An option is part of a class of securities called derivatives, so named because these securities derive their value from the worth of an underlying investment.

Options contract

A contract that, in exchange for the option price, gives the option buyer the right, but not the obligation, to buy (or sell) a financial asset at the exercise price from (or to) the option seller within a specified time period, or on a specified date (expiration date).

Out-of-the-money option

A call option is out-of-the-money if the strike price is greater than the market price of the underlying security. A put option is out-of-the-money if the strike price is less than the market price of the underlying security.

P/E ratio

Assume XYZ Co. sells for $25.50 per share and has earned $2.55 per share this year;

$25. 50 = 10 times $2. 55

XYZ stock sells for 10 times earnings. P/E = Current stock price divided by trailing annual earnings per share or expected annual earnings per share.

Payment date

The date on which each shareholder of record will be sent a check for the declared dividend.

Portfolio

A collection of investments, real and/or financial.

Preferred shares

Preferred shares give investors a fixed dividend from the company's earnings. And more importantly: preferred shareholders get paid before common shareholders.

Preferred stock

A security that shows ownership in a corporation and gives the holder a claim, prior to the claim of common stockholders, on earnings and also generally on assets in the event of liquidation. Most preferred stock pays a fixed dividend that is paid prior to the common stock dividend, stated in a dollar amount or as a percentage of par value. This stock does not usually carry voting rights. The stock shares characteristics of both common stock and debt.

Premium

(1) Amount paid for a bond above the par value. (2) The price of an option contract; also, in futures trading, the amount the futures price exceeds the price of the spot commodity.

Purchase

To buy, to be long, to have an ownership position.

An option granting the right to sell the underlying futures contract. Opposite of a call.

Put option

This security gives investors the right to sell (or put) fixed number of shares at a fixed price within a given time frame. An investor, for example, might wish to have the right to sell shares of a stock at a certain price by a certain time in order to protect, or hedge, an existing investment.

Quotation

The bid and offered prices a dealer is willing to buy or sell at.

Rate of interest

The rate, as a proportion of the principal, at which interest is computed.

Record date

(1) Date by which a shareholder must officially own shares in order to be entitled to a dividend. For example, a firm might declare a dividend on Nov 1, payable Dec 1 to holders of record Nov 15. Once a trade is executed an investor becomes the "owner of record" on settlement, which currently takes 5 business days for securities, and one business day for mutual funds. Stocks trade ex-dividend the fourth day before the record date, since the seller will still be the owner of record and is thus entitled to the dividend. (2) The date that determines who is entitled to payment of principal and interest due to be paid on a security. The record date for most MBSs is the last day of the month, however the last day on which they may be presented for the transfer is the last business day of the month. The record date for CMOs and asset-backed securities vary with each issue.

Redeemable

Eligible for redemption under the terms of the indenture.

Secondary market

The market where securities are traded after they are initially offered in the primary market. Most trading is done in the secondary market. The New York stock Exchange, as well as all other stock exchanges, the bond markets, etc., are secondary markets. Seasoned securities are traded in the secondary market.

Security

Piece of paper that proves ownership of stocks, bonds and other investments.

Settlement

When payment is made for a trade.

Settlement date

The date on which payment is made to settle a trade. For stocks traded on US exchanges, settlement is currently 3 business days after the trade. For mutual funds, settlement usually occurs in the U.S.the day following the trade. In some regional markets, foreign shares may require months to settle.

Settlement price

A figure determined by the closing range which is used to calculate gains and losses in futures market accounts. Settlement prices are used to determine gains, losses, margin calls, and invoice prices for deliveries.

Shareholders' equity

This is a company's total assets minus total liabilities. A company's net worth is the same thing.

Short position

Occurs when a person sells stocks he or she does not yet own. Shares must be borrowed, before the sale, to make "good delivery" to the buyer. Eventually, the shares must be bought to close out the transaction. This technique is used when an investor believes the stock price will go down.

Spread

(1) The gap between bid and ask prices of a stock or other security. (2) The simultaneous purchase and sale of separate futures or options contracts for the same commodity for delivery in different months. Also known as a straddle. (3) Difference between the price at which an underwriter buys an issue from a firm and the price at which the underwriter sells it to the public. (4) The price an issuer pays above a benchmark fixed-income yield to borrow money.

Stock

Ownership of a corporation which is represented by shares which represent a piece of the corporation's assets and earnings.

Stock dividend

Payment of a corporate dividend in the form of stock rather than cash. The stock dividend may be additional shares in the company, or it may be shares in a subsidiary being spun off to shareholders. Stock dividends are often used to conserve cash needed to operate the business. Unlike a cash dividend, stock dividends are not taxed until sold.

Stock exchanges

Formal organizations, approved and regulated by the Securities and Exchange Commission (SEC), that are made up of members that use the facilities to exchange certain common stocks. The two major national stock exchanges are the New York Stock Exchange (NYSE) and the American Stock Exchange (ASE or AMEX). Five regional stock exchanges include the Midwest, Pacific, Philadelphia, Boston, and Cincinnati. The Arizona stock exchange is an after hours electronic marketplace where anonymous participants trade stocks via personal computers.

Stock option

An option in which the underlying is the common stock of a corporation.

Stock split

Occurs when a firm issues new shares of stock but in turn lowers the current market price of its stock to a level that is proportionate to pre-split prices. For example, if IBM trades at $100 before a 2-for-1 split, after the split it will trade at $50 and holders of the stock will have twice as many shares than they had before the split.

Take a position

To buy or sell short; that is, to have some amount that is owned or owed on an asset or derivative security.

Trade date

In an interest rate swap, the date that the counterparties commit to the swap. Also, the date on which a trade occurs. Trades generally settle (are paid for) 1-5 business days after a trade date. With stocks, settlement is generally 3 business days after the trade.

Trading

Buying and selling securities.

Transactions costs

The time, effort, and money necessary, including such things as commission fees and the cost of physically moving the asset from seller to buyer.

Underlying

The "something" that the parties agree to exchange in a derivative contract.

Underlying asset

The asset that an option gives the option holder the right to buy or to sell.

Underlying security

Options: the security subject to being purchased or sold upon exercise of an option contract. For example, IBM stock is the underlying security to IBM options. Depository receipts: The class, series and number of the foreign shares represented by the depository receipt.

Value-added tax

Method of indirect taxation whereby a tax is levied at each stage of production on the value added at that specific stage.

Value-at-Risk model (VAR)

Procedure for estimating the probability of portfolio losses exceeding some specified proportion based on a statistical analysis of historical market price trends, correlations, and volatilities.

Warrant

A security entitling the holder to buy a proportionate amount of stock at some specified future date at a specified price, usually one higher than current market. This "warrant" is then traded as a security, the price of which reflects the value of the underlying stock. Warrants are issued by corporations and often used as a "sweetener" bundled with another class of security to enhance the marketability of the latter. Warrants are like call options, but with much longer time spans -- sometimes years. In addition, warrants are offered by corporations whereas exchange traded call options are not issued by firms.

Withholding tax

A tax levied by a country of source on income paid, usually on dividends remitted to the home country of the firm operating in a foreign country. Tax levied on dividends paid abroad.

Writer

The seller of an option, usually an individual, bank, or company, that issues the option and consequently has the obligation to sell the asset ( if a call) or to buy the asset (if a put) on which the option is written if the option buyer exercises the option.

Yield curve

The graphical depiction of the relationship between the yield on bonds of the same credit quality but different maturities.

Yield ratio

The quotient of two bond yields.

Yield to maturity

The percentage rate of return paid on a bond, note or other fixed income security if you buy and hold it to its maturity date. The calculation for YTM is based on the coupon rate, length of time to maturity and market price. It assumes that coupon interest paid over the life of the bond will be reinvested at the same rate.

Understanding Master-Feeder Accounting

2018-08-01T04:46:00.005-07:00

It appears that you've provided a detailed article about master-feeder funds and related topics. This article covers various aspects of master-feeder funds, including their structure, advantages, disadvantages, operational considerations, and advanced topics. Here's a summary of the key points in the article:

1. Master-Feeder Fund Structure:

A master-feeder fund is a two-tiered investment structure.
Investors deposit capital into a feeder fund, which then invests in a master fund managed by the same advisor.
The master fund invests in the market according to the partnership agreement.

2. Master-Feeder Fund Characteristics:

Feeder funds receive capital from investors and invest it in the master fund.
All income attributes generated by the master fund, such as dividends, interest, gains, and tax adjustments, pass through to the feeder funds.

3. Master-Feeder Fund Types:

A typical master-feeder structure includes one U.S. ("onshore") feeder and one non-U.S. ("offshore") feeder.
Feeder funds can differ in terms of investor types, fee structures, minimum investments, etc.

4. Advantages of Master-Feeder Structure:

Reduced trading costs as there's no need to split tax lots.
Streamlined administrative burden.
Greater financing benefits due to combined assets.

5. Disadvantages of Master-Feeder Structure:

Offshore funds may be subject to withholding tax on U.S. dividends.
Different investment strategies may not suit all investors.
Uneven allocations of profit and loss can be complex.

6. Differences from Fund of Funds:

Master-feeder funds provide more detailed income attributes information than fund of funds.
Fund of funds may not receive underlying details until year-end.

7. Capital Flows:

Capital contributions begin at the feeder fund and determine ownership percentages in both feeder and master funds.

8. Generation of Profit and Loss:

Both master and feeder funds handle profit and loss allocation, but feeder funds also carry their expenses.

9. Allocation of Profit and Loss:

Master funds allocate gains and losses based on economic and tax ownership percentages.
Tax allocations are necessary due to variations in cash flows between feeders.

10. Management Fees and Performance Fees: - Management and performance fees are typically charged at the feeder fund level. - Management fees can be negotiated individually within the feeder.

11. Hot Issue Allocation Methodologies: - Pro Rata, Pure Lookthrough, and Investment Lookthrough methods are used for hot issue profit and loss allocation.

12. Multiple Masters/Multiple Feeders: - Feeder funds can invest in multiple master funds, making profit and loss management more complex.

13. Direct Investments in the Master Fund by Non-Feeder Limited Partners: - Individual investors can directly invest in the master fund, subject to different fee structures.

14. Currency Hedges: - Currency hedges may be required for feeders based in different currencies than the master fund's base currency.

15. Side Pocket Classes: - Side pockets can disrupt the processing of master-feeder structures due to special handling requirements.

16. Performance Fees/Management Fees at the Master: - Some funds charge management fees and performance fees at the master fund level.

17. Performance Fees for Offshore Feeders: - Offshore funds charge performance fees differently, which may require equalization adjustments.

18. Bid/Ask NAV: - Some funds allow investors to purchase shares at the asked NAV and redeem them at the bid NAV, with specific allocation rules.

This comprehensive article provides insights into the intricacies of master-feeder funds and their operational aspects, making it a valuable resource for those interested in this investment structure.

Side Pockets Investments

2018-08-01T03:53:00.005-07:00

The concept of side pockets in investment funds is a mechanism used to segregate illiquid or hard-to-value securities from the fund's normal trading portfolio. Here are the key points and considerations related to side pockets:

1. Purpose of Side Pockets:

Illiquid or Hard-to-Value Securities: Side pockets are created when certain securities held by a fund are illiquid or challenging to value. This separation helps protect the fund from the effects of investor withdrawals related to these securities.
Valuation Issue Mitigation: Side pockets can be used to eliminate valuation issues, especially when a fund has periodic openings where a solid net asset value is required.

2. Participation:

Participation in side pockets is typically based on either the investor's pro rata share of the entire fund or proportional to the non-side pocketed capital at the time of acquisition.
Fund documents should specify participation limits and address the effects of additions and withdrawals near the time of side pocket creation to ensure fairness.

3. Expenses and Fees:

Allocation of expenses and fees related to side pockets is crucial. The allocation methods can vary, and it's important to maintain transparency and fairness.
Fund-wide expenses, management fees, and holdbacks should be carefully considered and substantiated, especially when they are charged based on side pocket capital values.

4. Incentive Allocations:

Incentive allocations can be based on specific events, such as a sale or becoming liquid, or they may be vague in fund documents.
The approach taken for incentive allocations should be in accordance with the fund's documents, approved by the fund auditor and attorney.

5. Disclosures:

When a fund creates a side pocket, it should provide clear disclosures to investors, explaining the reasons for creating the side pocket, its duration, and other relevant details.
Year-end audits should include specific information about the side pocket, such as limitations on participation and valuation.

6. Offshore Structures:

Side pockets are less common in offshore funds due to complexities in share accounting and higher concerns about liquidity among non-US investors.
In offshore funds, side pockets are often established in special classes, with capital obtained through share redemptions from existing normal series.

7. Reporting Results:

Side pockets are typically not included in fund-level performance reports because they are not shared by all investors.
The percentage return on normal commingled capital is considered more accurate, and including side pocket valuations can diminish the accuracy of performance reporting.
Side pocket pay-offs or write-downs are event-driven, and their inclusion in monthly returns can be misleading.

8. Fairness and Transparency:

The ultimate goal of using side pockets should be fairness and transparency to both existing and new investors.
Decisions related to side pockets should consider the complexity they add and the materiality of the assets involved, with consultation with fund counsel, auditors, and administrators advised.

In summary, side pockets are a mechanism to address illiquidity or valuation challenges in investment funds, but their use involves careful consideration of participation, expenses, fees, incentives, disclosures, and reporting to ensure fairness and transparency to investors. Consulting with legal and financial experts is recommended when implementing side pockets in a fund.

Corporate Actions - Accounting Materials

2018-08-01T02:47:00.006-07:00

1. Corporate Actions Overview

Corporate Actions refer to events initiated by a corporation that have an impact on its shareholders and creditors.
These actions can affect a single security or multiple securities issued by the corporation.
Corporate Actions apply to both equity and debt securities, with variations in the types of actions for each.
They can be categorized as either mandatory or voluntary. Mandatory actions involve no choice for security holders and often occur automatically. Voluntary actions allow security holders to decide on their participation and may require some action on their part.
To check corporate actions, you can use Bloomberg, for instance, by typing "IBM Equity <GO>CACS <GO>" to access historical corporate actions for IBM Equity.

2. Types of Corporate Actions

2.1 Cash Dividend

Dividends are distributions of a company's earnings to its shareholders and are declared by the board of directors.
There are three key dates for dividends: Announcement Date, Ex-Dividend Date, and Payment Date.
The Announcement Date is when the company declares the dividend amount.
The Ex-Dividend Date is when a security is traded without entitlement to the declared dividend.
The Payment Date is when the dividend is paid to shareholders.

2.2 Stock Dividend

Stock dividends are paid as additional shares rather than cash.
They are also known as "scrip dividends" and may have different tax implications than cash dividends.
Stock dividends can be used to make shares more affordable to small investors.

2.3 Stock Split and Reverse Stock Split

A stock split increases the number of outstanding shares, often making them more affordable to investors.
A reverse stock split reduces the number of outstanding shares, typically to prevent delisting or gain market respectability.
Both actions affect the stock's price and market capitalization but not its underlying value.

2.4 Spin-offs

A spin-off occurs when a company separates a part of its business into a new subsidiary and distributes shares of that subsidiary to its shareholders.
The balance sheet of the spin-off company inherits the historical cost of assets and liabilities transferred.
Reasons for spin-offs include disposing of problematic subsidiaries and reducing parent company debt.

2.5 In Default

In the context of fixed income securities, a company is in default when it cannot meet its periodic interest payments.
Bloomberg alerts for default information in public companies.

2.6 Rights Offering

Companies issue rights to current shareholders, allowing them to purchase additional shares, often at a discount, to finance special projects.
Rights can be transferable and are common in closed-end funds.

2.7 Dissolution/Re-Organization/Merger/Acquisition

This category includes various actions related to corporate restructuring, often occurring during financial distress or mergers and acquisitions.
Chapter 7 and Chapter 11 bankruptcy are options for financially distressed companies.
Delisting and liquidation follow bankruptcy.
Successful restructuring can lead to relisting and changes in equity and debt structures.

2.7.4 Merger and Acquisition

Acquiring companies announce proposed deal terms to shareholders.
Shareholders may receive cash, stock, or a combination of both in M&A deals.
After completion, target company shares are replaced with the acquiring company's shares or cash, depending on the terms of the deal.

This rewritten version provides a concise overview of corporate actions and their types, making the information more accessible and understandable.

Performance: Time Weighted Return vs. Internal Rate of Return

2018-08-01T02:43:00.004-07:00

You've provided a clear explanation of the differences between Simple Rate of Return (SRR), Internal Rate of Return (IRR), and Time Weighted Return (TWR), which are all measures of investment performance. Let's summarize the key points:

Simple Rate of Return (SRR):
- Measures the percentage change in market value.
- Often used for benchmarks or indices where there are no cash flows.
- Simple to calculate but not suitable for analyzing an individual's investment portfolio.
Internal Rate of Return (IRR):
- Also known as dollar-weighted return.
- Measures a portfolio's actual performance between two dates, considering cash inflows and outflows.
- Gives more weight to time periods with higher investment amounts.
- Useful for assessing whether a portfolio is meeting specific financial goals.
- Not ideal for analyzing underlying asset performance or comparing different investment managers.
Time Weighted Return (TWR):
- Captures the true performance of the underlying assets by eliminating the effects of capital additions and withdrawals.
- Reflects the return on the very first dollar invested in the portfolio.
- Calculated by dividing the performance period into sub-intervals and then linking the individual IRRs with equal weighting.
- More suitable for evaluating the performance of underlying assets and comparing different investment managers or benchmark indices.
- Helps assess how well the manager performed with the money invested.

Bottom Line:

TWR is a better measure of how well the manager performed with the invested assets, as it eliminates the impact of cash flows.
IRR reflects the overall growth of the portfolio and is useful for assessing whether financial goals are being met.
Understanding these distinctions is crucial for making informed investment decisions and evaluating portfolio performance accurately.

Corporate actions

2018-08-01T02:39:00.004-07:00

Corporate actions are specific actions taken by a corporation (company) that can have significant impacts on its equity structure and share prices. These actions are typically approved by the company's board of directors and may require disclosure to the relevant stock exchanges. Here are explanations of some common corporate actions:

1. Stock Splits: A stock split is a corporate action in which a company divides its existing shares into multiple shares. The most common type is a forward stock split, where each existing share is split into multiple new shares. For example, in a 2-for-1 stock split, each shareholder receives two shares for every one share they previously held. Stock splits do not affect the total market value of the company but increase the number of shares outstanding and reduce the share price proportionally. This is often done to make shares more affordable to a broader range of investors.

2. Dividend Payout: Dividends are payments made by a company to its shareholders, typically in cash. Dividends are usually paid out of the company's earnings. There are two types of dividends: interim dividends, which are paid during the fiscal year, and final dividends, which are paid at the end of the fiscal year. The amount of dividend per share is usually expressed as a percentage of the share's face value. Dividend payments can impact a company's retained earnings and influence its share price.

3. Stock Dividend: A stock dividend is a distribution of additional shares to existing shareholders instead of cash. It does not affect the company's overall equity structure, but it increases the number of shares held by each shareholder, diluting their ownership percentage. Stock dividends are often expressed as a percentage of shares held and are typically used as a way to distribute profits while conserving cash.

4. Rights Issue: A rights issue is a method by which a company offers its existing shareholders the right to buy additional shares at a discounted price. Shareholders can exercise these rights within a specified time frame. Rights issues allow companies to raise additional capital while giving existing shareholders the opportunity to maintain their proportional ownership in the company.

5. Mergers and Acquisitions: Mergers and acquisitions (M&A) involve one company purchasing or merging with another company. M&A transactions can take various forms, including stock-for-stock mergers, cash acquisitions, or a combination of both. Shareholders of the acquired company may receive cash, stock, or a combination of both, depending on the terms of the deal. M&A transactions can impact the share prices of both the acquiring and acquired companies.

6. Spin-offs: A spin-off occurs when a company separates a division or subsidiary into an independent, publicly traded entity. Shareholders of the parent company may receive shares of the newly created company in proportion to their existing holdings. Spin-offs are often done to unlock value in specific business units and allow them to operate independently.

7. Share Buybacks: Share buybacks, also known as stock repurchases, involve a company repurchasing its own shares from the open market. This reduces the number of outstanding shares, potentially increasing the ownership percentage of existing shareholders and, in some cases, boosting the share price. Buybacks are often used to return excess cash to shareholders or to support the company's stock price.

8. Stock Beta: Stock beta measures the sensitivity of a stock's returns to changes in the overall market returns, usually represented by a market index like the S&P 500. A stock with a beta greater than 1 is considered more volatile than the market, while a stock with a beta less than 1 is considered less volatile. Beta is used by investors to assess a stock's risk and its correlation with market movements.

Understanding these corporate actions is essential for investors and analysts because they can have a significant impact on a company's financial structure, share prices, and overall market performance. It's important to stay informed about any corporate actions announced by companies in which you hold shares, as they can affect your investment decisions.

Side letters - Hedge Fund

2018-08-01T01:54:00.004-07:00

Side Letters in Hedge Funds

Definition: Side letters are specialized agreements often entered into between a hedge fund's investor and the fund itself, or sometimes with the fund's investment manager. These agreements contain terms and conditions that are separate from or in addition to the terms outlined in the fund's standard subscription agreement and offering document.

Purpose: Side letters serve various purposes, including offering favorable terms to significant or large investors or accommodating key investors to meet their internal or regulatory restrictions, such as pension funds. These agreements are essentially customized arrangements that cater to specific investor needs.

Popular Side Letter Terms: Common terms found in side letters include:

Waiver or Reduction of Redemption Fees or Lock-Up Periods: Providing more favorable redemption terms to certain investors.
Waiver of Redemption Provisions: Granting exceptions to standard redemption rules.
Shorter Redemption Periods: Allowing certain investors to redeem their investments more quickly.
Modification of Gates and Redemption Restrictions: Customizing gating provisions and other redemption restrictions.
Waiver or Reduction of Management or Incentive Fees: Adjusting the fee structure for specific investors.
Advance Notice of Critical Changes: Notifying investors about significant changes affecting the investment manager or fund.
Limitation of In-Kind Distributions: Restricting the fund's ability to make in-kind distributions to certain investors.
Access to Information: Providing preferential access to information about the fund's investment strategy and financials.
"Most Favored Nation" Provisions: Ensuring that earlier investors receive identical terms to subsequent investors.
Jurisdiction for Arbitration/Choice of Law: Specifying the jurisdiction for dispute resolution and choice of law, especially relevant for pension funds.

Legal Considerations: When considering side letters, certain legal considerations must be taken into account:

Disclosure in Offering Documents: The fund's offering document and articles should disclose the existence and nature of side letters, especially if these letters contain or may contain material terms. This is to ensure transparency for prospective investors.
Definition of "Material Term": The AIMA (Alternative Investment Management Association) Guidance Note on Side Letters provides a definition for "material term." A material term is one that enhances an investor's ability to redeem shares or make determinations regarding redemption in a way that might reasonably put other investors of the same class at a material disadvantage.
Consequences of Non-Disclosure: Failing to disclose side letters in the offering document may lead to the fund acting outside its stated objectives, potentially abusing its powers. This could provide grounds for challenging the transaction.
Flexibility for Additional Classes: The offering document and articles should allow the fund to create additional classes of shares, partnership interests, or units with special rights, if necessary. This is important for accommodating the terms outlined in side letters.

Cayman Islands Law: Under Cayman Islands law, the basic principle is that all investors within the same class must be treated equally concerning their class rights. If the fund intends to grant special terms to a specific investor that amount to class rights, these terms should be detailed in the issuance of a separate class of shares.

In summary, side letters in hedge funds are specialized agreements tailored to accommodate specific investor needs. Proper disclosure and adherence to legal considerations are crucial to maintain transparency and comply with regulatory requirements, ensuring that all investors are treated fairly and equally within the same class.