ACC511 Managerial Finance

“Troy Dexter is an affluent venture capitalist based in Sydney. In 2009 Troy founded a hedge fund called Northwest Capital Management. A hedge fund is an investment fund whose aim is to deliver positive returns on money invested while minimising risk. A hedge fund can be thought of as a company whose main activity is to invest in a range of financial assets. Troy’s hedge fund adopts a macro investment strategy that aims to profit from significant shifts in the economy. Apart from his own money which he uses to invests in a range of financial assets, the fund is also open to investors who can participate in the fund for an annual management fee. Although hedge funds aim at reducing risk by employing different hedging techniques, there is still a certain element of risk as there are periods where the returns on investments are negative. Troy’s vision of the future is that the strong growth in Australian housing market will come to an end, economic growth will stall and the price of oil will escalate. This Troy is currently buying treasury bonds in the debt markets and energy stocks in the share market.

1. From the point of view of Northwest Capital Management, are treasury bonds and energy stocks direct or indirect securities Explain.
2. Consider an investor who invests money in Northwest Capital Management. The money ends up being invested in treasury bonds and energy stocks. From the perspective of the investor, does she hold direct securities by investing in Northwest Capital Management Explain.”(Petty et al., 2012, p. 79)

Please make sure you provide at least 5 different peer-reviewed references plus your prescribed textbook to develop and demonstrate your research skills as a financial analyst in training. Make sure you explain your reasons for choosing a position in each answer in your own words and supported by evidence in the form of peer-reviewed references.

In the given case study, Thomas Wilson has started a hedge fund, and is trying to reduce the risk associated with it, by investing in wide varieties of securities. The investors who invest in this hedge fund will earn an annual management fees, and the sole aim of the hedge funds is to make investment in such manner that risk is low and return is high. It is trying to opt for a variety of options, based on large number of assumptions made by it. In the long term it is expecting that the overall economic growth will stop, and there will be large scope of investment in oil and energy sector because of which if he invests in the same, he will grow, there is a large scale opportunity of investing in the oil and energy sector. Thus Thomas decides to invest in treasury bonds and the common share market of the energy sector.

• Direct securities are the kind of securities that are directly held by any individual in its own name, and indirect securities are the kind of securities that an individual holds in the name of other, such as investment in the name of any trust or fund. When the nuns are investing the money of the investors in the  securities that are traded in the market, they are doing the same in their own name and not in the name of any investor who is investing the money in their funds, they are concerned with investing the money in the manner, that will eventually reduce the overall risks and increase the returns of their portfolio. (Door, A.B. and Jagannathan, R., 2002 )

With the kind of assumptions made by Troy, the funds of North West management are invested in treasury stocks and energy stocks. If we look from the perspective of hedge fund, the hedge fund is investing directly in these securities, the total amount of funds that the invested by the investors. When the hedge funds invest in these type of securities, they are directly holding the securities in their own name, but the total amount of return that they eventually earn, will be disbursed to the investors in the form of annual fees. The total amount of money that the company earns in eventually given to the investors. The main aim of such investments is to reduce the overall risk and increase the overall return for the investors in the long run. (Hatch, N.W. and Dyer, J.H., 2004)

• The treasury bonds are the type of bonds that are marketable that bears affixed rate of interest on a debt security that has a maturity of more than ten years. In the given case, the company is investing in long term funds of such treasury bonds, and the company believes that over the year there will be low growth in case of housing sector sand high growth in case of investment in energy bonds. The main idea behind investment in such type of security is that eventually after ten years when they will mature the company will earn more than what it is investing today, keeping in view the time value of money. The risk involved is also less, because there is a steady flow of income for ten years in the form of semi-annual payment of interest, they are primarily treated as risk free bonds by the market. Hence they will help in hedging the risk to a great level.  The securities vary with maturity dates and coupon amount also vary. They are eventually risk free, they are backed by the U.S government, they can raise taxed and also insure full payment with increase in total amount of revenue attached with it. Investment since are backed by the government, and if there is fall in the overall economic growth over the years, it will lead to reduction in the total amount of return that the company will earn. They are direct securities that are held by the company, because the company is eventually gaining the return and nullifying the risk.( Gregarious, G.N., 2011.) When It comes to Investing in energy stocks by the company, the energy stocks are such type of stocks that are related to the energy sector of the government. These are related to production and distribution of energy. The overall performance of this sector is driven by the supply and demand of worldwide energy. Whenever there is an increase in the overall prices of oil and gas, the stocks will earn huge. The overall fortune that you earn from such type of shares are totally related to the fate of the prices of oil and gas , the overall growth in this sector. These security doesn’t provides a fixed income to the investors, however there is an option to short sell, if the investor goes bearish on the stock, and buy ,on , if the investor goes bullish on the stock. The overall return that the investor will eventually earn is very much absurd and not any. Therefore a large amount of speculation is involved in the same. The investor needs to work on the same, while taking investing decision. In this case, the Hedge fund believes that over the year there will be a significant increase in the overall price of oil and gas , hence it will be fruitful to invest in the same today, so that eventually earn huge in the future. Both of these kinds of securities are direct securities held by the company.(Duskier, P., Pullet, J.M., Wang, Z.J. and Zheng, L., 2011)

 If any investor invests directly in the hedge funds, and the amount is then invested by the fund manager in the energy stocks and the treasury bonds, then the investor is not holding any direct security in the company. The investment is not made in the name of the person who is investing the hedge funds, but by the hedge fund in its own name. The hedge fund manager eventually distributes the overall risk and return proportionately and the pays the investor, on the basis of amount invested by him. The investors are also paid an annual management fees. Thus the total amount of money invested by the investors in the hedge fund, which are eventually invested into treasury bonds and  energy stocks are not direct securities held by the investors. The investor on the basis of the total amount of money invested will earn return , and also management fees from  the  Northwest Capital Management. (Gregoriou, G.N., Karavas, V.N. and Rouah, F., 2003)

Conclusion

The overall conclusion that we draw from the same id that if the investors are investing in such funds which they believe that will make them earn huge return in the future, they can do so by investing in the energy stocks, which though have huge amount of risk involved with them ,because the prices are dependent on the overall prices of the oil and gassed. But the return they will earn eventually will be huge. In case of treasury stock it has the least amount of risk involved with it, and the total amount of money that will eventually make form the same, will be inclusive of affixed lump sum payment of interest and also since these bonds will mature in ten years, the overall return form the same, will also be huge, considering the time value of money a major decisive factor. If we keep reckoning the overall return and the risk factor, the portfolio seems to be balanced one, with equal amount of risk and return, the movement of all the funds are in opposite direction ,a ND not in the same line, this makes the portfolio diversified, and eventually the investor will gain from the sum. That is the major advantage that one can associate with hedge fund, it will help in reducing the risks and increasing the return, by investing in wide variety of securities available , keeping in mind, the overall demand of their investor.

References

Human capital and learning as a source of sustainable competitive advantage. Strategic management journal, 25(12), pp.1155-1178.

The good or the bad? Which mutual fund managers join hedge funds?. Review of Financial Studies, 24(9), pp.3008-3024.

Understanding mutual fund and hedge fund styles using return based style analysis (No. w9111). National Bureau of Economic Research.

Hedge Funds: Strategies, Risk Assessment, and Returns. Beard Books.

Funds of hedge funds: performance, assessment, diversification, and statistical properties. Butterworth-Heinemann.