Foundation — The four equity-market strategies

Think of it like this

Key terms in this chapter

130/30 Fund

A long-short fund holding 130 per cent long positions and 30 per cent short positions as a percentage of total investable funds, so that net market exposure equals 100 per cent. The 120/20 variant works identically.

Acquiring Company

In a merger or acquisition, the company buying the shares of another company. It typically pays a premium over the target's unaffected share price to win board approval.

Activist Strategy

A strategy making a significant investment in an investee company to benefit from a material corporate event, large enough to participate in the management process, taking a private equity and long-term oriented approach.

Borrowing Fee

The fee a fund incurs to borrow securities in order to take short positions or make a short sale. It is an additional cost, alongside the dividends foregone on shares held short.

Business Continuity Plan

A documented plan setting out the course of action following material key-person events or natural disasters, accompanied by disaster recovery plans covering trade execution technology and client data.

Convergence Trade

A relative-value trade purchasing relatively under-valued bonds and selling relatively over-valued bonds, as LTCM did in European, Japanese and USA sovereign bond markets. The tiny spreads involved required very high leverage.

Conversion Ratio

The number of equity shares issuable for each convertible security on exercise. It is fairly priced when the market value of the shares receivable equals the face value of the bond.

Convertible Arbitrage Strategy

A long-short strategy taking a long position in a company's convertible securities and a simultaneous short position in its equity shares, to profit from mispricing of the conversion ratio independent of stock price movements.

Convertible Security

A hybrid debt instrument or preference share giving its holder the option to convert into equity shares at a pre-determined date and conversion ratio based on a pre-determined equity price.

Dedicated-Long Strategy

A strategy taking long positions exclusively, unlike a long-short strategy where the manager may take both. A dedicated-short strategy correspondingly takes only sell positions.

Directional Strategy

A strategy taking either a net long or a net short position based on a call on the direction of the overall market. It is the opposite of market-neutral, since the manager does not aim at a portfolio beta of zero.

Event-driven Strategy

A strategy taking positions in the equities or derivatives of one target company following a material corporate event such as debt restructuring, a merger, an acquisition, a spin-off or a change in management.

Global-Macro Strategy

A strategy taking long and short positions across currencies, fixed income securities, equities, commodities, real assets and interest rate derivatives, selecting on macro-economic trends rather than company fundamentals, across multiple markets and geographies.

Hedging Position

An opposite, sell-side position taken to minimise market risk from a fall in the value of a stock — a short futures position or a bought put option on an underlying with similar characteristics to the portfolio holding.

International Financial Services Centre (IFSC)

A centre governed by the SEBI (International Financial Services Centre) Guidelines, 2015, such as Gujarat International Finance Tec-City. A Category III AIF based there may delegate the investment management and advisory function to a third-party investment advisor.

Investment Due Diligence

The process by which institutional investors analyse the financial performance and influencing factors of a Category III AIF, to verify the expected return and risk factors stated in the PPM and to identify red flags before committing capital.

Key-Person Risk

The risk that an adverse event such as the death, insanity, incapacity or immovability of the investment manager will significantly hamper the fund's operations, tested through on-site meetings with the whole team.

Long-only Equity Strategy

A strategy taking only buy positions in selected stocks at the time of investment, aiming at absolute returns over the medium to long term with a strong emphasis on capital preservation. Hedging is permitted through short futures or bought put options.

Long-Short Equity Strategy

A strategy going long under-priced stocks and short over-priced ones relative to the manager's fair valuation, with the aim of taking advantage of undervalued and overvalued opportunities.

Long Term Capital Management (LTCM)

The US fund founded by John Meriwether of Salomon Brothers that ran convergence trades in sovereign bond markets. By 1998 it held USD 5 billion of equity against over USD 125 billion of borrowings, a leverage ratio of 30:1, and collapsed after the Russian sovereign default, requiring a bailout of USD 3.65 billion.

Maker-Checker Control

A basic internal control, verified in due diligence alongside access controls, under which one person initiates and another verifies transactions or entries involving confidential client data.

Manager Selection Process

The screening and selection process by which an AIF appoints its investment manager. An informal process may indicate the fund is privately managed by the sponsor and manager without aligning investors' interests.

Market-Neutral Strategy

A strategy taking equal long and short exposures so the fund has net zero or neutral exposure to a sector, industry or market-capitalisation, giving a beta of zero or close to zero, with the aim of minimising systematic risk.

Merger Arbitrage Strategy

An event-driven strategy taking a long position in the target company's shares and a short or long position in the acquiring company's shares, to profit from the spread created by the acquisition premium and the conversion ratio.

Pre-IPO Placement

The process of allotting pre-IPO shares to certain institutional investors just before the date of the investee company's IPO.

Pre-IPO Shares

Shares with unique identification numbers issued to employees or institutional investors, including Category III AIFs, before shares are offered to the general public in an IPO, at a discount to the issue price and subject to a minimum lock-in from listing.

Red Flag

Any internal or external factor identified during screening that may materially impact the stated risk-return objective of an investment.

Short-bias Strategy

A type of directional strategy in which the manager takes both long and short positions but maintains a net short exposure to the broad market.

Special Situations Strategy

Another name for the activist strategy, covering a fund taking or increasing a stake in a company undergoing NCLT proceedings that is likely to be acquired by a larger company in the same industry.

Target Company

In a merger or acquisition, the company selling its shares or being merged into the acquiring company.

Unsystematic Risk

The risk borne by exposures in individual stocks that is unrelated to market risk. It survives market neutrality and forces the manager to rebalance as individual prices move.