Question

1. Explain how venture capital funds are different from private equity funds.

2. What are some various hedge fund strategies? Is there any evidence that one strategy works better than another? If you were going to invest in a hedge fund, or perhaps work for one, what type of hedge fund appeals to you? Why? Is there any evidence that investments in hedge funds out perform the overall market, e.g. S&P 500?

3. What is the legal structure of funds, i.e. how are they structured? What is the means by which most fund managers are compensated?

4. Funds are lightly regulated by the SEC or Federal Reserve. What do you think some of the benefits and risks of that light regulation might be?

Answer 1

1) Venture capital funds are those which invest in early stage companies also called start up where as private companies are focused towards more mature stage company which are facing distress but there is high probability of turnaround. The venture capital focus on finding new companies which are going to bring some innovation in society. Private equity firm uses a combination of debt and equity for investment whereas the venture capital firm focuses on taking equity stake in the company. The investment horizon of venture capital firms is slightly longer than private equity firm.

2) There are many types of hedge fund strategies like

· Long/short equity

· Merger/Arbitrage

· Event driven

· Market neutral

· Credit event related

· Fixed income arbitrage

         Not necessarily most large hedge funds use a combination of strategy so we can not say that one strategy will produce a better result than others. If I am going to invest in a hedge funds then I would look for a hedge fund which uses a combination of strategies rather than focusing on just one. It is because markets are dynamic and one strategy is not going to perform always better so it is better to have large number of strategies. Not necessary, most hedge funds try to generate a return which is sustainable and those which produce large return after adjusting for fee, those strategies are quite risky and it is also difficult to have a reliable record of the performance of these funds.

3) Most hedge funds from a legal stand point are set up as a private investment limited partnership. The investment in hedge funds are mostly for qualified investors who meet the criteria of net worth. The capital investment required is high so it is open to small set of people. The fee structure of hedge funds consists of asset man agent fee plus the performance fee. For example, 1% of the asset under management and 20% of performance.

4) These funds are regulated by SEC but in comparison to other funds like mutual funds the regulation is quite less. The benefits associated with this is that managers can take up position as they want with in the limits of the strategy, be it long or shorting an asset or taking high leverage and can try to produce better result or high returns. The risk associated with this is that because of high risk this often creates a situation large loss and can often result in large losses.