Running Header:A New Hedge Fund Case Study Solution

Factors generating inefficiencies in the Market

The structure of the market is incomplete and imperfect, which makes it prone to failures. The factors responsible for generating the inefficiencies in the market could be attributed to the price mechanism, where it would fault to account for the cost incurred and benefit generated in purchasing or selling the security, which would result in the markets inability to produce a supply of securities that were socially optimal. Furthermore, other reasons are such as; environmental concerns, positive and negative externalizes, under provision to merit securities, over provision of demerits securities, lack of public goods and monopolization. Moreover, the market inefficiencies could be caused by human nature where greed and fear had dominated the market in which good news lead the price to increase whereas, bad news decrease the price. It can also be attributed to the fact that, principle investment is done through funds, where significant amount of money is placed in the market by the agent acting in the interest of the owners. However, their incentive could differ from the principle. Furthermore, the institutionalization of investment is a phenomenon, which could be held accountable for the market inefficiencies as it had increased the level of influence among the principle and agents divisional relationship. In addition to this, it can be determined after analyzing the factor that the market structure is imperfect and is filled with shortfalls and there is no such thing as a perfect market or perfect competition. Hence, the market would remain volatile and at times, irrational as long as the corporate structure of the industries is maintained.

Other smart investor’s exploitation of opportunity and the types of risks, constraints faced

The ability of the investor to avail the opportunities present to them generated by market inefficiencies depend on their perception. Some investors look from high risk investments in the hopes that it would generate high rewards, whereas, other investors avoid risky investment out of fear and diversify their investment portfolio to gain from pool investments in various securities. The primary constraint faced by these investors is their own physiology and perception that limits their investing ability as well as this limits their capacity to earn higher earnings. However, the risk faced by these type of investors is similar to the risk faced by other potential investors. The risks include, price risk, systematic risk, unsystematic risk, inflation risk and market risk. Hence, these constraints and risks could prevent these type of investors from successfully exploiting these opportunities.

Common Investors ability to exploit opportunity

The opportunities generated from market inefficiencies are available to all investors in the market. However, due to the lack of knowledge and experience of the common investor, it might be difficult for them to exploit the opportunities. As the common investor lacks the relevant knowledge regarding the market and the constraints faced by it, they would not be able to assess the potential factors for the variation in stock prices. Furthermore, they lack the amount of investment required to successfully exploit the opportunity. Moreover, they lack the connections with institutional investors to gain market related information necessary to forecast the market trends.

Strategic Evidence

The equity hedge strategy had barred successful results for other hedge funds. As it can be seen from a company namely, Manpower group Inc., a hedge fund employing equity hedge strategy and gaining profit from the divergences in the performance of various stocks. Furthermore, it had aimed to exploit the opportunity by taking long and short term positions in equities that are deemed to be undervalued or overvalued. On the other hand, by using equity hedge strategy it had reduced its market risk.

Additionally, another example can be considered, where the fund has 70% of its funds invested in long stocks and 30% in short stocks. However, the net exposure of the equity market is to 40% (long stock percentage minus short stock percentage). Furthermore, it would not be utilizing leverage its gross exposure would be 100%. If the fund manager increases the long stock position in the fund to 80% while its short stock would remain at 30%, then its leverage would be 10%………


Share This