Gross exposure is the absolute sum of all positions, where the long and short positions are added together.
Net exposure is the sum of long positions, minus the value of short positions.
Short selling refers to the practice of borrowing an asset to sell today in exchange for cash, with the expectation that its price falls during the investment period before repurchasing the asset and returning it to the original owner (the lender). Short selling can be undertaken for various reasons, including to hedge specific sector risks or to manage a fund’s total market exposure. Short sales create leverage or gearing for the underlying fund, thereby amplifying investment performance.
Leverage is the use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment. Higher leverage can amplify investment returns, both on the upside and downside. Leverage includes the use of derivatives. Derivatives derive their value from the value of an underlying asset. The degree to which leverage may be employed within a hedge fund is limited by the investment mandate.
Volatility, also known as the standard deviation of the fund’s return, is a measure of how much a fund’s return varies from its average over time
Alpha is a term used in investing to describe a portfolio’s ability to beat the market return over some period of time. Alpha is often referred to as the “excess return” or “active return” on an investment and gauges the performance of an investment against a market index or benchmark that is considered to represent the market’s movement as a whole.
The Performance Fee is a variable fee that is dependent on the returns of the fund. In most instances there is a set participation rate, which is levied on the increase in net asset value (NAV), subject to the high water mark.
The High Water Mark
The High Water Mark (“HWM”) refers to the highest point in value that the participatory interest has reached. The high-water mark ensures that the fund manager does not get paid a performance fee for the same performance twice. If fund loses money over a period, we must first make back this performance deficit and ensure that the participatory interest exceeds the HWM before charging the investor a performance fee. The HWM is updated at each crystallisation point.