Praise for INVESTING IN HEDGE FUNDS: STRATEGIES FOR THE NEW MARKETPLACE by Joseph G Nicholas “This book tells all It explains how [hedge funds] work THIS IS A SERIOUS AND IMPORTANT BOOK ON THE SUBJECT AND MUST BE READ BY ANY SERIOUS INVESTOR.” TradersWorld Magazine “N I C H O L A S H A S D O N E A N I N V A L U A B L E S E R V I C E in laying out exactly how hedge funds work, who runs them, how they incorporate, their benefits and risks, and how to go about selecting one.” the street.com “For investors who want to learn about hedge funds from A-to-Z, T H I S B O O K I S A M U S T - R E A D For those who think they already know about the approximately 4,500 hedge funds with close to $300 billion in assets, R E A D T H I S B O O K A N D L E A R N W H A T Y O U D O N ’ T K N O W ” peter morgan kash Senior Managing Director, Paramount Capital Asset Management Board Member, Hedge Fund Association Adjunct Professor, Wharton School of Business “In light of the dramatic increase of investments in hedge funds, the recent media attention, and the widespread need to better understand these complex strategies, J O E NICHOLAS HAS CREATED A KEY INVESTOR GUIDE TO HEDGE including the unique and valuable perspective of having top hedge fund managers describe what they in their own words.” timothy j leach Chief Investment Officer Wells Fargo Private Client Services FUNDS, “I have yet to find a book W H I C H D O E S S U C H A G O O D J O B of demystifying an area which has been kept deliberately opaque (with good reason) by its players.” AIMA (Alternative Investment Management Association) Newsletter “Joe Nicholas has written the definitive book on what one needs to know to invest in hedge funds I T I S A C L E A R , C O N C I S E A N A L Y S I S of an area that is too often misunderstood IT SHOULD BE REQUIRED READING FOR ANYONE CONSIDERI N G T H I S T Y P E O F A L T E R N A T I V E I N V E S T M E N T ” cappy r mcgarr President McGarr Capital Holdings, LLC “Investing in Hedge Funds is the first comprehensive study of what hedge funds are and how they work T H I S I S A N E S S E N TIAL BOOK FOR ALL INVESTORS CURIOUS ABOUT ALTERNATIVE INVESTMENT STRATEGIES Joseph Nicholas details the range of investment strategies pursued by hedge fund managers and writes in a clear, lucid style I HIGHLY RECOMMEND THIS BOOK TO ACADEMICS AND PROFESSIONALS WHO WANT TO LEARN ABOUT HEDGE FUNDS ” professor william n goetzmann Director, International Center for Finance Yale School of Management “ I N V E S T I N G I N H E D G E F U N D S I S A G R E A T P R I M E R for anyone looking at our industry W E L L - R E S E A R C H E D A N D C L E A R L Y W R I T T E N , this comprehensive guide should help both novices and experienced hedge fund investors gain a better understanding of how funds generate their returns and assist them in determining if hedge funds are right for them.” ron pollack Chief Investment Officer Monitor Fund Advisors, LLC This page intentionally left blank INVESTING IN Hedge FUNDS ALSO BY JOSEPH G NICHOLAS Hedge Fund of Funds Investing: New Strategies for the Hedge Fund Marketplace by Joseph G Nicholas Market-Neutral Investing: Long/Short Hedge Fund Strategies by Joseph G Nicholas Also available from BLOOMBERG PRESS Investing in REITs: Real Estate Investment Trusts Revised and Updated Edition by Ralph L Block Wall Street Secrets for Tax-Efficient Investing: From Tax Pain to Investment Gain by Robert N Gordon with Jan M Rosen The Money-Making Guide to Bonds: Straightforward Strategies for Picking the Right Bonds and Bond Funds by Hildy Richelson and Stan Richelson A complete list of our titles is available at www.bloomberg.com/books ATTENTION CORPORATIONS this book is available for bulk purchase at special discount Special editions or chapter reprints can also be customized to specifications For information, please e-mail Bloomberg Press, p r e s s @ b l o o m b e r g c o m Attention: Director of Special Sales, or phone 609-750-5070 INVESTING IN Hedge FUNDS Strategies for the New Marketplace J O S E P H G N I C H O L A S B L O O M B E R G P R E S S P R I N C E T O N © 1999 by Joseph G Nicholas All rights reserved Protected under the Berne Convention Printed in the United States of America No part of this book may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher except in the case of brief quotations embodied in critical articles and reviews For information, please write: Permissions Department, Bloomberg Press, 100 Business Park Drive, P.O Box 888, Princeton, NJ 08542-0888 U.S.A BLOOMBERG, BLOOMBERG NEWS, BLOOMBERG FINANCIAL MARKETS, OPEN BLOOMBERG, THE BLOOMBERG FORUM, COMPANY CONNECTION, COMPANY CONNEX, BLOOMBERG PRESS, BLOOMBERG PROFESSIONAL LIBRARY, BLOOMBERG PERSONAL BOOKSHELF, and BLOOMBERG SMALL BUSINESS are trademarks and service marks of Bloomberg L.P All rights reserved This publication contains the author’s opinions and is designed to provide accurate and authoritative information It is sold with the understanding that the author, publisher, and Bloomberg L.P are not engaged in rendering legal, accounting, investment-planning, or other professional advice The reader should seek the services of a qualified professional for such advice; the author, publisher, and Bloomberg L.P cannot be held responsible for any loss incurred as a result of specific investments or planning decisions made by the reader All charts, graphs, and illustrations contained herein were created from data provided by Hedge Fund Research, Inc All rights reserved Reprint by permission only Nicholas, Joseph G., 1959– Investing in hedge funds: strategies for the new marketplace / Joseph G Nicholas p cm (Bloomberg personal bookshelf) Includes bibliographical references and index ISBN 1-57660-060-2 Hedge Funds United States I Title II Title: Hedge funds III Series HG4930.N53 1999 332.64’5 dc21 98-45960 CIP Book design by Don Morris Design SOURCE: BPTHESANS-PLAIN 5/12 SMALLCAPS TRACK 50 First edition published 1999 10 To my parents Diana and George Nicholas I N T R O D U C T I O N Why a book about Hedge Funds? Why Now? P A R T I Keys to Understanding C H A P T E R 20 What Is a Hedge Fund? C H A P T E R 22 The Hedge Fund Investment Structure P A R T I I Investing with Knowledge C H A P T E R Hedge Fund Strategies C H A P T E R 60 Fixed-Income Arbitrage C H A P T E R 104 Convertible Arbitrage C H A P T E R 118 Merger (Risk) Arbitrage C H A P T E R 132 Distressed Securities C H A P T E R 88 Equity Market-Neutral C H A P T E R 58 142 Event-Driven Strategies 156 36 ... page intentionally left blank INVESTING IN Hedge FUNDS ALSO BY JOSEPH G NICHOLAS Hedge Fund of Funds Investing: New Strategies for the Hedge Fund Marketplace by Joseph G Nicholas Market-Neutral Investing: ...Praise for INVESTING IN HEDGE FUNDS: STRATEGIES FOR THE NEW MARKETPLACE by Joseph G Nicholas “This book tells all It explains how [hedge funds] work THIS IS A SERIOUS AND IMPORTANT BOOK ON THE SUBJECT... Street Secrets for Tax-Efficient Investing: From Tax Pain to Investment Gain by Robert N Gordon with Jan M Rosen The Money-Making Guide to Bonds: Straightforward Strategies for Picking the Right Bonds