Chapter 05 - Financial Services: Mutual Funds and Hedge Funds

Chapter Five
Financial Services: Mutual Funds and Hedge Funds

Chapter Outline

Introduction

Size, Structure, and Composition of the Mutual Fund Industry

 Historical Trends
 Different Types of Mutual Funds
 Mutual Fund Objectives
 Investor Returns from Mutual Fund Ownership
 Mutual Fund Costs

Balance Sheet and Recent Trends for the Mutual Fund Industry
 Money Market Funds
 Long-Term Funds

Regulation of Mutual Funds

Global Issues in the Mutual Fund Industry

Hedge Funds
 Types of Hedge Funds
 Fees on Hedge Funds
 Offshore Hedge Funds
 Regulation of Hedge Funds

Summary

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Solutions for End-of-Chapter Questions and Problems

1. What is a mutual fund? In what sense is it a financial institution?

A mutual fund represents a pool of financial resources obtained from individuals and companies,
which is invested in the money and capital markets. This process represents another method for
economic savers to channel funds to companies and government units that need extra funds.

2. What are money market mutual funds? In what assets do these funds typically invest? What
factors have caused the strong growth in this type of fund since the late 1970s?

Money market mutual funds (MMMFs) invest in assets that have maturities of less than one year.
These assets primarily are Treasury bills, negotiable certificates of deposit, repurchase
agreements, and commercial paper. The growth in MMMFs since the late 1970s initially
occurred because of rising interest rates in the money markets, while Regulation Q restricted
interest rates on accounts in depository institutions. Many investors moved their short-term
savings from the depository institutions to the MMMFs as the spread in the earnings rate reached
double digits. A result of this activity was to introduce many investors to the capital markets for
the first time.

At the end of 2008, the share of long-term funds plunged to 59.1 percent of all funds, while
money market funds increased to 40.9 percent. Part of the move to money market funds was the
fact that during the worst of the financial crisis, the U.S. Treasury extended government
insurance to all money market mutual fund accounts on a temporary basis. As financial markets
tumbled in 2008, money market mutual funds moved investments out of corporate and foreign
bonds (12.4 percent of the total in 2007 and 5.0 percent in 2009) into safer securities such as U.S.
government securities (13.6 percent of the total investments in 2007 and 31.6 percent in 2009).

3. What are long-term mutual funds? In what assets do these funds usually invest? What
factors caused the strong growth in this type of fund from 1992 through 2007?

Long-term mutual funds primarily invest in assets that have maturities of more than one year.
The most common assets include long-term fixed-income bonds, common stock, and preferred
stocks. Some money market assets are included for liquidity purposes. The growth in these funds
in the 1990s and 2000s reflected the dramatic increase in equity returns, the reduction in
transaction costs, and the recognition of diversification benefits achievable through mutual
funds.

The financial crisis and the collapse in stock and other security prices produced a sharp drop in
mutual fund activity. At the end of 2008, total assets fell to $9,601.1 billion and the number of
accounts to 264,499. Investor demand for certain types of mutual funds plummeted, driven in
large part by deteriorating financial market conditions. Stock market funds suffered substantial
outflows, while inflow to U.S. government money market funds reached record highs. As the
economy recovered in 2009, so did assets invested in mutual funds, growing to $11,126.4 billion
by the end of the year.

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4. Using the data in Table 5-3, discuss the growth and ownership holdings over the last 29 years
of long-term funds versus short-term funds.

The dollar investment in the money market mutual funds (MMMF) exceeded the investment in
the long-term funds (LTF) in 1980. However, by 2007, the LTFs had more than a two to one
advantage on the MMMFs, $7,829 billion to $3,033 billion. The LTF grew at an annualized rate
of 19.6 percent, and the MMMF grew at an annualized rate of 14.6 percent. In each type of fund,
the largest investment source was the household sector, with growth of 11.9 percent annual rate
for the LTF and 89.4 percent for the MMMF.

The financial crisis and the collapse in stock and other security prices produced a sharp drop in
mutual fund activity. At the end of 2008, total assets fell to $9,601.1 billion and the number of
accounts to 264,499. Investor demand for certain types of mutual funds plummeted, driven in
large part by deteriorating financial market conditions. Stock market funds suffered substantial
outflows, while inflow to U.S. government money market funds reached record highs. As the
economy recovered in 2009, so did assets invested in mutual funds, growing to $11,126.4 billion
by the end of the year

5. Why did the proportion of equities in long-term funds increase from 38.3 percent in 1990
to over 70 percent by 2000, and then decrease to 63 percent in 2009? How might an
investor’s preference for a mutual funds objectives change over time?

The primary reason for the increased proportion of funds in equities during the 1990s was the
strength of the equity market that was driven by the underlying strength of the economy during
this period. Contrarily, the economy experienced its worst recession since the Great Depression
in the late 2000s, causing investors to retreat from equities as preferred investments.

The pattern of investor preferences also changes over the life of an investor for reasons other
than changes in economic activity. Aggressive high growth funds may be preferred during the
early career years of the 20s, 30s, and into the 40s. As investors mature and retirement becomes
a closer reality, investors may switch to a balance of growth and income funds. Finally, at
retirement investors may try to protect their investment savings by switching to high yield stock
and bond funds.

6. How does the risk of short-term funds differ from the risk of long-term funds?

The principal type of risk for short-term funds is interest rate risk, because of the predominance
of fixed-income securities. Because of the shortness of maturity of the assets, which often is less
than 60 days, this risk is mitigated to a large extent. Short-term funds generally have virtually no
liquidity or default risk because of the types of assets held. An exception occurred during the
financial crisis of 2008-2009. In September 2008, Primary Reserve Fund, a large and reputedly
conservative money market fund had holdings of $785 million in commercial paper issued by
Lehman. As a result of Lehman’s failure, shares in Primary Reserve Fund ‘broke the buck’ (i.e.,
fell below $1), meaning that its investors lost principal. This was the first incidence of a share

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price dip below a dollar for any money market mutual fund open to the general public. This fund
had built a reputation for safe investment. Hence its exposure to Lehman scared investors,
leading to a broad run on money market mutual funds. Within a few days more than $200 billion
had flowed out of these funds. The U.S. Treasury stopped the run by extending government
insurance to all money market mutual fund accounts held in participating money market funds as
of the close of business on September 19, 2008. The insurance coverage lasted for one year
(through September 18, 2009).

Long-term equity funds typically are well diversified, and the risk is more systematic or market
based. Bond funds have extensive interest rate risk because of their long-term, fixed-rate nature.
Sector, or industry-specific, funds have systematic (market) and unsystematic risk, regardless of
whether they are equity or bond funds.

7. What are the economic reasons for the existence of mutual funds; that is, what benefits do
mutual funds provide for investors? Why do individuals rather than corporations hold most
mutual funds?

One major economic reason for the existence of mutual funds is the ability to achieve
diversification through risk pooling for small investors. By pooling investments from a large
number of small investors, fund managers are able to hold well-diversified portfolios of assets. In
addition, managers can obtain lower transaction costs because of the volume of transactions,
both in dollars and numbers, and they benefit from research, information, and monitoring
activities at reduced costs.

Many small investors are able to gain benefits of the money and capital markets by using mutual
funds. Once an account is opened in a fund, a small amount of money can be invested on a
periodic basis. In many cases, the amount of the investment would be insufficient for direct
access to the money and capital markets. On the other hand, corporations are more likely to be
able to diversify by holding a large bundle of individual securities and assets, and money and
capital markets are easily accessible by direct investment. Further, an argument can be made that
the goal of corporations should be to maximize shareholder wealth, not to be diversified.

8. What are the principal demographics of household owners who own mutual funds? What
are the primary reasons why household owners invest in mutual funds?

Investors tend to be in their primary income generating years, are married with college degrees,
have other retirement plans, and prefer equity funds as opposed to bond, hybrid, or money
market funds. Most individuals are using the funds as vehicles for retirement savings, while
many households are using the funds as savings vehicles for children’s education.

9. What change in regulatory guidelines occurred in 2009 that had the primary purpose of
giving investors a better understanding of the risks and objectives of a fund?

In March 2009, the SEC adopted amendments to the form used by mutual funds to register under
the Investment Company Act of 1940 and to offer their securities under the Securities Act of
1933 in order to enhance the disclosures that are provided to mutual fund investors. The

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amendments (first proposed in November 2007) required key information to appear in plain
English in a standardized order at the front of the mutual fund statutory prospectus. The new
amendment also included a new option for satisfying prospectus delivery obligations with
respect to mutual fund securities under the Securities Act. Under the option, key information is
sent or given to investors in the form of a summary prospectus and the statutory prospectus is
provided on an Internet Web site. The improved disclosure framework was intended to provide
investors with information that is easier to use and more readily accessible, while retaining the
comprehensive quality of the information that was previously available.

10. What are the three possible components reflected in the return an investor receives from a
mutual fund?

The investor receives the income and dividends paid by the companies, the capital gains from the
sale of securities by the mutual fund, and the capital appreciation of the underlying assets.

11. How is the net asset value (NAV) of a mutual fund determined? What is meant by the term
marked-to-market daily?

Net Asset Value (NAV) is the market value of each ownership share of the mutual fund. The
total market value of the fund is determined by summing the total value of each asset in the fund.
The value of each asset can be found by multiplying the number of shares of the asset by the
corresponding price of the asset. Dividing this total fund value by the number of shares in the
mutual fund will give the NAV for the fund.

The NAV is calculated at the end of each daily trading session, and thus reflects any adjustments
in value caused by (a) changes in value of the underlying assets, (b) dividend distributions of the
companies held, or (c) changes in ownership of the fund. This process of daily recalculation of
the NAV is called marking-to-market.

12. A mutual fund owns 400 shares of General Electric, currently trading at $16, and 400
shares of Microsoft, Inc., currently trading at $28. The fund has 1,000 shares outstanding.

a.What is the net asset value (NAV) of the fund?

NAV = (400 x $16 + 400 x $28)/1,000 = $17,600/1,000 = $17.60.

b. If investors expect the price of General Electric shares to increase to $20 and the price
of Microsoft shares to decrease to $20 by the end of the year, what is the expected
NAV at the end of the year?

Expected NAV = (400 x $20 + 400 x $20)/100 = $16,000/100 = $16.00, or a decline of

9.09 percent.

c.Assume that the expected price of the General Electric shares is realized at $20. What is
the maximum price decrease that can occur to the Microsoft shares to realize an end-of-
year NAV equal to the NAV estimated in (a)?

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(400 x $20)/1,000 + (400 x PM)/1,000 = $17.60, implies that PM = $24.00, a decrease of

$2.00.

13. What is the difference between open-end and closed-end mutual funds? Which type of fund
tends to be more specialized in asset selection? How does a closed-end fund provide
another source of return from which an investor may either gain or lose?

Open-end funds allow shares to be purchased and redeemed according to investor demand. The
NAV of open-ended funds is determined only by changes in the value of the assets owned. In
closed-end funds, the number of shares of the fund is fixed. If investors need to redeem their
shares, they sell them to another investor. Thus, the demand for the fund shares can provide
another source of return for the investors as the market price of the fund may exceed the NAV of
the fund. Closed-end funds, such as real estate investment trusts, tend to be more specialized.

14. Open-end fund A owns 165 shares of AT&T valued at $25 each and 50 shares of Toro
valued at $45 each. Closed-end fund B owns 75 shares of AT&T and 100 shares of Toro.
Each fund has 1,000 shares of stock outstanding.

a.What are the NAVs of both funds using these prices?

NAVopen-end = (165 x $25 + 50 x $45)/1,000 = $6.375.

NAVclosed-end = (75 x $25 + 100 x $45)/1,000 = $6.375.

b. Assume that in one month the price of AT&T stock has increased to $26.25 and the
price of Toro stock has decreased to $43.375. How do these changes impact the NAV
of both funds? If the funds were purchased at the NAV prices in (a) and sold at month
end, what would be the realized returns on the investments?

NAVopen-end = (165 x $26.25 + 50 x $43.375)/1,000 = $6.50.

Percentage change in NAV = ($6.50 - $6.375)/$6.375 = 1.96%.

NAVclosed-end = (75 x $26.25 + 100 x $43.375)/100 = $6.30625.

Percentage change in NAV = ($6.30625 - $6.375)/$6.375 = -1.08%.

c.Assume that another 165 shares of AT&T are added to fund A. The funds needed to buy
the new shares are obtained by selling 647 more shares in fund A. What is the effect on
fund A’s NAV if the stock prices remain unchanged from the original prices?

NAVopen-end = ((165 + 165) x $25 + 50 x $45)/(1,000 + 647) = $6.375.

Percentage change in NAV = $6.375 - $6.375)/$6.375 = 0.00%.

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15. What is the difference between a load fund and a no-load fund? Is the argument that load
funds are more closely managed and therefore have higher returns supported by the
evidence presented in Table 5-7?

A load fund charges an up-front fee that often is called a sales charge and is used as a
commission payment for sales representatives. These fees can be as high as 8.5 percent. A no-
load fund does not charge a sales fee, although a small annual fee can be charged to cover certain
administrative expenses. This small fee, which is called a 12b-1 fee, usually ranges between 0.25
and 0.35 percent of assets. According to the data in Table 5-7, the load funds have adjusted
returns that are decreased after the fee is removed. In each case the relative performance ranking
of the fund decreases after the load is subtracted.

16. What is a 12b-1 fee? Suppose you have a choice between a load fund with no annual 12b-1
fee and a no-load fund with a maximum 12b-1 fee. How would the length of your expected
investment horizon, or holding period, influence your choice between these two funds?

The 12b-1 fee is allowed by the SEC to provide assistance in covering administrative expenses
for no-load funds. Thus, in terms of fees and without consideration of time value issues, a 4.00
percent load would be equivalent to the 12b-1 fee for 16 years. This comparison would have to
be adjusted for change in the value of the funds assets over time, since the 12b-1 fee is
administered on an annual basis against the fund value at that time.

17. Suppose an individual invests $10,000 in a load mutual fund for two years. The load fee
entails an up-front commission charge of 4 percent of the amount invested and is deducted
from the original funds invested. In addition, annual fund operating expenses (or 12b-1
fees) are 0.85 percent. The annual fees are charged on the average net asset value invested
in the fund and are recorded at the end of each year. Investments in the fund return 5
percent each year paid on the last day of the year. If the investor reinvests the annual
returns paid on the investment, calculate the annual return on the mutual fund over the two-
year investment period.

Annual Return Calculation Based on Text Example 5-4:

Annualized load fee = 4%  2 years = 2.00%
Annual fund operating expense = 0.85%
Total annual cost = 2.85%  Annual return = 5.00% - 2.85% = 2.15%

Annual Return Calculation Based on Present Value of Investment:

Initial investment in the fund = $10,000
Front-end load of 4.00% = $400
Total investable funds = $9,600

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Investment value at end of year one = $9,600 x 1.05 = $10,080.00

Operating expenses based on average NAV = $9,840 x .0085 = $83.64
Net investable funds for year two = $9,996.36

Investment value at end of year two = $9,996.36 x 1.05 = $10,496.18

Operating expenses based on average NAV = $10,246.27 x .0085 = $87.09
Net investment at end of year two = $10,409.09

Average annual compound return:

$10,409.09 = $10,000(1 + g)2  g = 2.025%

18. Who are the primary regulators of the mutual fund industry? How do their regulatory goals
differ from those of other types of financial institutions?

The Securities and Exchange Commission (SEC) is the primary regulator of the mutual fund
industry. The SEC is not concerned with the administration of sound economic monetary policy,
which is part of the goal of the Federal Reserve System, but rather is primarily concerned with
the protection of investors from possible abuses by managers of mutual funds.

Several pieces of legislation have been enacted to clarify and assist this regulatory process.
Under the Securities Act of 1933, mutual funds must file a registration statement with the SEC
and abide by the rules established under the act for the distribution of prospectuses to investors.
The Securities Exchange Act of 1934 establishes antifraud provisions aimed at the accurate
transmission of information to prospective investors. The 1934 act also appointed the National
Association of Securities Dealers to supervise the distribution of mutual fund shares. The
Investment Advisors Act of 1940 regulates the activities of mutual fund advisors, and the
Investment Company Act establishes rules involving fees and charges. The Insider Trading and
Securities Fraud Enforcement Act of 1988 addresses issues of insider trading, and the Market
Reform Act of 1990 provides for the establishment of circuit breakers to halt trading in case of
severe market downturns. The National Securities Markets Improvement Act of 1996 exempts
mutual funds from the regulatory burden of state securities regulators. Finally, in March 2009,
the SEC adopted amendments to the form used by mutual funds to register under the Investment
Company Act of 1940 and to offer their securities under the Securities Act of 1933 in order to
enhance the disclosures that are provided to mutual fund investors. The amendments (first
proposed in November 2007) required key information to appear in plain English in a
standardized order at the front of the mutual fund statutory prospectus. The new amendment also
included a new option for satisfying prospectus delivery obligations with respect to mutual fund
securities under the Securities Act. Under the option, key information is sent or given to
investors in the form of a summary prospectus and the statutory prospectus is provided on an
Internet Web site. The improved disclosure framework was intended to provide investors with
information that is easier to use and more readily accessible, while retaining the comprehensive
quality of the information that was previously available.

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19. What is a hedge fund and how is it different from a mutual fund?

Hedge funds are a type of investment pool in that they solicit funds from (wealthy) individuals
and other investors (e.g., commercial banks) and invest these funds on their behalf. Hedge funds
are similar to mutual funds in that they both are pooled investment vehicles that accept investors’
money and generally invest these funds on a collective basis. Hedge funds, however, are not
technically mutual funds in that they are not required to register with the SEC. Thus, they are
subject to virtually no regulator oversight and generally take significant risk. Hedge funds are
also not subject to the numerous regulations that apply to mutual funds for the protection of
individuals such as regulations requiring a certain degree of liquidity, regulations requiring that
mutual fund shares be redeemable at any time, regulations protecting against conflicts of interest,
regulations to assure fairness in the pricing of funds shares, disclosure regulations, and
regulations limiting the use of leverage. Further, hedge funds do not have to disclose their
activities to third parties. Thus, offer a high degree of privacy for their investors. Hedge funds
offered in the U.S. avoid regulations by limiting the number of investors to less than 100
individuals (below that required for SEC registration), who must be deemed “accredited
investors.” To be accredited, an investor must have a net worth of over $1 million or have an
annual income of at least $200,000 ($300,000 if married). These stiff financial requirements
allow hedge funds to avoid regulation under the theory that individuals with such wealth should
be able to evaluate the risk and return on their investments. According to the SEC, these types of
investors should be expected to make more informed decisions and take on higher levels of risk.

20. What are the different categories of hedge funds?

Most hedge funds are highly specialized, relying on the specific expertise of the fund manager(s)
to produce a profit. Hedge fund managers follow a variety of investment strategies, some of
which use leverage and derivatives, others use more conservative strategies and involve little or
no leverage. Generally, hedge funds are set up with specific parameters so investors can forecast
a risk-return profile. Figure 5-4 shows the general categories of hedge funds by risk
classification.

“More risk” funds are the most aggressive and may produce profits in many types of market
environments. Funds in this group are classified by objectives such as: aggressive growth,
emerging markets, macro, market timing, and short selling. Aggressive growth funds invest in
equities expected to experience acceleration in growth of earnings per share. Generally, high
price-to-earnings ratios, low or no dividend companies are included. These funds hedge by
shorting equities where earnings disappointment is expected or by shorting stock indexes.
Emerging market funds invest in equity or debt securities of emerging markets which tend to
have higher inflation and volatile growth. Macro funds aim to profit form changes in global
economies, typically brought about by shifts in government policy which impact interest rates.
These funds include investments in equities, bonds, currencies and commodities. They use
leverage and derivatives to accentuate the impact of market moves. Market timing funds allocate
asset among different asset classes depending on the manager’s view of the economic or market

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outlook. Thus, portfolio emphasis may swing widely between assets classes. Unpredictability of
market movements and the difficulty of timing entry and exit from markets adds significant risk
to this strategy. Short selling funds sell securities in anticipation of being able to buy them back
in the future at a lower price based on the manager’s assessment of the overvaluation of the
securities or in anticipation of earnings disappointments.

“Moderate risk” funds are more traditional funds, similar to mutual funds, with only a portion of
the portfolio being hedged. Funds in this group are classified by objectives such as: distressed
securities, fund of funds, opportunistic, multi strategy, and special situations. Distressed
securities funds buy equity, debt or trade claims at deep discounts of companies in or facing
bankruptcy or reorganization. Profits opportunities come from the market’s lack of
understanding of the true value of these deep discount securities and from the fact that the
majority of institutional investor cannot own below investment grade securities. Fund of funds
mix hedge funds and other pooled investment vehicles. This blending of different strategies and
asset classes aims to provide a more stable long term investment return than any of the individual
funds. Returns and risk can be controlled by the mix of underlying strategies and funds. Capital
preservation is generally an important consideration for these funds. Opportunistic funds change
their investment strategy as opportunities arise to profit form events such as IPOs, sudden price
changes resulting from a disappointing earnings announcement, and hostile takeover bids. These
funds may utilize several investing styles at any point in time. and are not restricted to any
particular investment approach or asset class. Multi strategy funds take a diversified investment
approach by implementing various strategies simultaneously to realize short and long term gains.
This style of investment allows the manager to overweight or underweight different strategies to
best capitalize on current investment opportunities. Special situation funds invest in event driven
situations such as mergers, hostile takeovers, reoganizations, or leveraged buyouts. These funds
may undertake simultaneous purchases of stock in companies being acquired, and the sale of
stock in its bidder, hoping to profit from the spread between the current market price an the final
purchase price of the company.

“Moderate risk” funds are more traditional funds, similar to mutual funds, with only a portion of
the portfolio being hedged. Funds in this group are classified by objectives such as: income,
market neutral – arbitrage, market neutral - securities hedging, and value. Income funds invest
with the primary focus on yield or current income rather than solely on capital gains. These
funds use leverage to buy bonds and some fixed income derivatives, profiting from principal
appreciation and interest income. Market neutral – arbitrage funds attempt to hedge market risk
by taking offsetting positions, often in different securities of the same issuer, e.g., long
convertible bonds and short the firm’s equity. Their focus is on obtaining returns with low or no
correlation to both the equity and bond markets. Market neutral - securities hedging funds invest
equally in long and short equity portfolios in particular market sectors. Market risk is reduced but
effective stock analysis is critical to obtaining a profit. These funds use leverage to magnify their
returns. They also sometimes use market index futures to hedge systematic risk. Value funds
invest in securities perceived to be selling at deep discounts relative to their intrinsic values.
Securities include those that may be out of favor or underfollowed by analysts.

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21. What types of fees do mutual funds charge?

Hedge fund managers generally charge two type of fees: management fees and performance fees.
As with mutual funds, the management fee is computed as a percentage of the total assets under
management and typically run between 1.5 to 2.0 percent. Performance fees are unique to hedge
funds. Performance fees give the fund manager a share of any positive returns on a hedge fund.
The average performance fee on hedge funds is approximately 20 percent but varies widely. For
example, Steven Cohen’s SAC Capital Partners charges a performance fee of 50 percent.
Performance fees are paid to the hedge fund manager before returns are paid to the funds
investors. Hedge funds often specify a “hurdle” rate, which is a minimum annualized
performance benchmark that must be realized before a performance fee can be assessed. Further,
a “high water mark” is usually used for hedge funds in which the manager does not receive a
performance fee unless the value of the fund exceeds the highest net asset value it has previously
achieved. High water marks are used to link the fund manager’s incentives more closely to those
of the fund investors and to reduce the manager’s incentive to increase the risk of trades.

22. What is the difference between domestic hedge funds and offshore hedge funds?
Describe the advantages of offshore hedge funds over domestic hedge funds.

Hedge funds that are organized in the U.S. are designated as domestic hedge funds. These funds
require investors to pay income taxes on all earnings from the hedge fund. Funds located outside
of the U.S. and structured under foreign laws are designated as offshore hedge funds. Many
offshore financial centers encourage hedge funds to locate in their countries. The major centers
include the Cayman Islands, Bermuda, Dublin, and Luxembourg. /the Cayman Islands is
estimated to be the location of approximately 75 percent of all hedge funds. Offshore hedge
funds are regulated in that they must obey the rules of the host country. However, the rules in
most of these countries are not generally burdensome and provide anonymity to fund investors.
Further, offshore hedge funds are not subject to U.S. income taxes on distributions of profit or to
U.S. estate taxes on funds shares. Europe is the fastest growing area for offshore hedge funds,
with total assets managed of $743 billion.

When compared to domestic hedge funds, offshore hedge funds have been found to trade more
intensely than domestic funds, due to the zero or lower capital gains tax for offshore funds.
Further, offshore hedge funds tend to engage less often in positive feedback trading (rushing to
buy when the market is booming and rushing to sell when the market is declining) than domestic
hedge funds. Finally, offshore hedge funds have been found to herd (mimic each other’s
behavior when trading while ignoring information about the fundamentals of valuation) less than
domestic hedge funds. Many hedge fund managers maintain both domestic and offshore hedge
funds. Given the needs of their client investors, hedge fund managers want to have both types of
funds so as to attract all types of investors.

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