Bull & Bear 04/18 Investments, Markets & Regulation by EBS.Invest Research

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Dear Readers, As Spring Term 2018 is coming to an end, it is time for us to say goodbye. Most of the EBS.Invest e.V. members are leaving university over the summer to gain practical experience via internships. We will be coming back from Investment Banking, Consulting, Accounting, Auditing, Real Estate and even Marketing in fall. By then the freshmen will have arrived at EBS as well, hopefully maintaining the successful production and distribution of BULL&BEAR. Looking back, the EBS.Invest e.V. Research Team has achieved a lot with BULL & BEAR. We covered topics such as mergers & acquisitions, cryptocurrencies, initial coin offerings, Chinese investors in the German real estate market, smart home technology, tokenization of real estate investment trusts and debt capital market. Furthermore, the whole EBS.Invest association had the honor to visit the Main Incubator GmbH and the Frankfurt stock exchange. Moreover, we had the opportunity to see presentations and participate on workshops from the federal association of stock exchange associations at German universities (BVH), BKB Steuerberatungsgesellschaft Wirtschaftprüfungsgesellschaft, Prof. Dr. Hommel, Bank of America Merrill Lynch, Silverbear Capital, Active Ownership Capital, KPMG and last but not least Mentor Lane. With the last two editions of BULL&BEAR we reached over 8,500 viewers from over a dozen nations (As of April ’18). This includes students from all over the world but also representatives of Mazars, Deutsche Bank, Commerzbank, Morgan Stanley, KPMG, Nord LB, FS Invest, Source for Alpha, EY, SAP, UBS, Warth & Klein Grant Thornton, Bankhaus Metzler, Acatus, Berenberg, pwc, Freigeist Capital, BASF, Jefferies, Arthur D Little, Rothschild, AEW, Allianz, J.P. Morgan and many more. We owe this overwhelming success to the members of the EBS.Invest research team, who really made enormous effort, working for BULL&BEAR! Once again, we have to emphasize our gratitude to all contributors! Johan ten Doornkaat Gautam Kumar Head of Research at EBS.Invest e.V. Chief Responsibility for Bull&Bear View LinkedIn Profile

Head of Research at EBS.Invest e.V. Layout/ Composition, Editorial Supervision & Chief Responsibility for Bull&Bear View LinkedIn Profile

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Content I.

ESMA on Contracts for Difference Johan elaborates on the functionality of CFDs, raising awareness for current regulation efforts of European regulation authorities.

II.

The Benefits and Risks of Exchange Traded Funds Jan-Raphael and Tijen give a comprehensible explanation of ETFs and shed light on the pros and cons of such investment products.

III.

Real-life Sample for Exchange Traded Funds The ComStage MSCI World TRN UCITS ETF is analyzed by Felix and Kilian on an exemplary basis, not giving any investment recommendation.

IV.

Capital Asset Pricing Model Max, Benedikt and Pascal give an informative in-depth comment on CAPM, taking a look at the formula itself, its background and utility.

The Fascinating World of Hedge Funds The historical origin, the current state and a future outlook for Hedge Funds is given by Gautam.

VI.

What are Options? Finally, Philippe and Arsenij explain the purpose of option trading, going into detail about Call and Put options.

ESMA on Contracts for Difference Tying Down the Invisible Hand The concept of the invisible hand can be

CFDs are usually leveraged, since the mar-

traced back to the English economist Ad-

gin deposited by the investor only makes

am Smith (*1723, † 1790) and describes the

up for a small percentage of the overall

self-control of supply and demand on any

investment.

market. It implies that the market activity itself is the force that organizes and regulates markets in an optimal manner, as the individual market participant serves the societies best interest, by aiming at his very own need-satisfaction.

This is best explained by using an example: Usually CFDs on indices cost around EUR 1,00 per base point. Assuming the DAX would close at 10,000 base points per today, the cost of the derivative CFD would sum up to EUR 10,000. This is where the

But on the 27th of March 2018 the Euro-

margin comes into play: usually the margin

pean Securities and Markets Authority

rates are rather low, ranging from 0.33% to

(ESMA) published a press release, an-

50%. As margin rates below 10% are more

nouncing that it resolved to prune future

common, we will assume a margin rate of

CFD trading. What CFDs actually are and

2% for our DAX-CFD example. This would

what exactly the ESMA plans to restrict is

lead to a deposited margin of EUR 200,00,

ought to be condensed within this article.

which allows the investor to participate in

What are CFDs?

the value development of a EUR 10,000 worth investment. This relation means that

CFD is an abbreviation for “Contract for

the investment is leveraged 50 times (EUR

Difference”, which basically means that

10,000 divided by EUR 200,00).

investors close a contract, binding them to stand in for the underlying value’s difference between bid and sell price. The respective counterparty on the other hand, is obliged to pay the difference amount be-

This leverage is enabled by the broker, who funds the missing EUR 9,800. This means that the CFD leverage is actually ordinary debt capital.

tween entry price and the achieved profit

Furtherly it has to be noticed that the mar-

target in case the underlying value moves

gin rate moves along with the underlying

according to the investor’s expectations.

value, which may lead into the necessity of

a margin call, resolving in the financially

cleared if 50% of available cash is liable for

dangerous subsequent payment obliga-

investorâ&#x20AC;&#x2122;s margin duties

tion. This basically means that CFD investors may lose more money, than they initially invested. What does the ESMA think of CFDs? The European Securities and Markets Authority found out that 74 to 89% of European small CFD-investors make losses ranging from EUR 1,600 to EUR 29,000 on average. This makes the ESMA believe that there is a need for action to ensure investor protection.

- standardized loss limitations in form of a prohibition of negative account balances for small investors Final thoughts As small investors obviously seem to struggle with this kind of investment, it comes across wise to regulate these speculative vehicles. Nonetheless, regulation often seems like an easy way out, frequently providing a vivid breeding ground for market disruptions. Studies have shown

As the ESMA states that CFD are too com-

that regulatory and other governmental

plex, intransparent and risky, the authority

market interferences have had major

prescribed several restrictions, from which

negative impacts on past crises, as for ex-

the three most important are:

ample the involvement of US government

- leverage limits from 30:1 to 2:1 for small investor position on volatility underlyings, 10:1 for commodities (except gold) and stock indices, 5:1 for single stocks/ other securities and 2:1 for cryptocurrencies

(Fannie Mae & Freddie Mac) in the financial crisis from 2007 to 2008. Moreover, the effectiveness of financial regulations like equity capital requirements for banks and the deposit protection scheme, is debated among scholars. Finally, the discus-

- obliged margin-close-outs, meaning that

sion whether this kind of regulation is ap-

small investors accounts have to be

propriate remains to be settled.

Written by

Johan ten Doornkaat Head of Research at EBS.Invest e.V. Layout/ Composition, Editorial Supervision & Chief Responsibility for Bull&Bear View LinkedIn Profile

The Benefits and Risks of Exchange Traded Funds Exchange Traded Funds, commonly re-

Moreover, ETFs are purchased through a

ferred to as ETFs, are marketable securities

brokerage much like stocks. This differs

that are similar in nature to index funds.

from mutual funds because they are

They are often tied to an index, commodi-

bought directly from a fund company. ETFs

ty, or bond. The difference between ETFs

are tradable throughout the day, so many

and mutual funds, however, is that ETFs

people rely on arbitrage to take advantage

are traded on a stock exchange in the

of different prices for the same the fund.

same manner as a common stock. Like

They generally have lower costs than mu-

stocks, their prices change over the course

tual funds that may be tracking the same

of a day, and they can be bought and sold

index, but they can also fall victim to high-

just as easily. They are more liquid than

er trading fees. Commissions are paid to

mutual funds which means they are often

the broker every time an ETF share is

considered more desirable to investors

bought or sold, so if funds are being trad-

that are looking for more of a stock market

ed frequently, the cost benefit may be nul-

experience.

lified by the commissions.

ETFs are created and redeemed by author-

There are many ETFs. In fact, they out-

ized participants, which are usually banks

number mutual funds by quite a large

or investment firms. The authorized partic-

margin. This is due to the fact that there

ipant puts a portfolio together, consisting

are a wide variety of heavily focused ETFs

of the underlying assets that make up the

within many different sectors. Investors

ETF. These assets can include stock shares,

can purchase ETFs that follow only specifi-

bonds, futures, commodities, and a variety

cally industries, such as technology, alter-

of other items. Once the asset portfolio is

native energy, or any number of foreign

assembled, it is given to the fund in ex-

stocks. These specific ETFs are best utilized

change for ETF shares. In a similar fashion

for frequent trading rather than as a pri-

to creation, redemption happens with an

mary investment.

authorized participant returning shares to the fund. The fundâ&#x20AC;&#x2122;s holdings are public information and are released daily for the benefit of potential and current investors.

ETFs have many advantages. With a low cost of entry and easy, flexible trading, almost anybody can begin trading ETFs

without feeling inadequate in terms of

members that are required to service the

knowledge or financial capacity. They are

accounts like there are with mutual funds.

often more transparent than mutual funds

This reduction in managerial costs may not

and offer more customization due to the

always be beneficial in the case of frequent

wide range of funds available. In addition

trading, but for many people it works out

to these benefits, ETFs also provide great

in the long run. With ETFs, only authorized

opportunities for diversification as well as

participants

a number of tax benefits.

formation, so money is saved on monthly

Because ETFs are traded during the day, they are easy to manage and quick to buy

have

access

the

in-

statements and transfers that are generally required for standard funds.

or sell. Investors can move their money

A final benefit to consider is that of tax

around quickly and efficiently, and even

advantages. Investors involved with ETFs

though that is not always recommended,

only have to pay capital gains taxes on the

many people consider it an advantage

sale of the ETF. Compare this to a mutual

over mutual funds. Much like stocks, inves-

fund, where owners must pay capital gains

tors can engage in short selling by using

taxes over the course of the entire life of

the possibility to sell borrowed securities

the investment. As an added benefit, ETFs

and buy them back later at a better price

generally have lower capital gains taxes

when they have to be returned to the

than mutual funds in the first place, thanks

lender.

to differences in how they are organized.

Diversification is considered a major bene-

There are also some drawbacks to ETFs.

fit of ETFs, as they are traded on every as-

For people who are well-versed in trading

set class, currency, and commodity across

individual stocks, the costs of ETFs can end

the world. Investors can make the decision

up being higher in the long run. An ETF

to invest in currency, stocks, commodities,

has an advantage over mutual and index

or any more specific sectors that they de-

funds, but because there is no managerial

sire. This means that they can choose from

fee for trading stocks, an experienced

a variety of industries in which to invest on

trader may opt against the ETF. Similarly,

their own rather than relying on a fund

because stocks have slightly higher risk,

manager to make the picks. While this can

they can offer a higher yield on dividends

be more volatile, it can also lead to higher

than most ETFs are capable of. Because

returns that can be cashed out at a much

ETFs are tied to a wider market, the yields

faster pace.

tend to be lower than that of specific stock

Low cost of entry is a major selling point of

or group of stocks.

ETFs. Every fund has expenses, but be-

While many people benefit from the fact

cause mutual funds often have costs asso-

that pricing changes throughout the day

ciated with brokerage firms and client ser-

and that ETFs can be bought and sold in

vices, their costs can often be higher than

the same manner, it can be excessive for

one would expect. With ETFs, administra-

certain types of investors. Long-term in-

tive costs are reduced because there are

vestors or retirement investors would

generally no back-office fees or staff

probably not benefit much from the most-

ly quick time horizon of ETFs. Volatile pric-

They are extremely diverse and are created

ing may prove to be dangerous for those

within a wide range of industries and sec-

investors who donâ&#x20AC;&#x2122;t have the time to pay

tors, offering a decent tax benefit com-

attention to the ETF throughout the course

pared to traditional funds. However, there

of the day.

are risks associated with ETFs such as

To summarize ETFs are one of many ways for investors to make money and educate themselves on the inner workings and overall health of the market. Because they are generally low cost and easily traded, they can provide both new and experi-

higher costs than stocks and low dividends, as well as volatility that may hurt long-term investors. People who are interested in ETFs should consider these advantages and draw-backs before deciding to invest.

enced investors with a quick way to get into the market and supplement their income.

Written by

Jan-Raphael Gritzmacher

Tijen Demircan

Author for Bull&Bear

at EBS.Invest e.V.

View LinkedIn Profile

Real-life Sample for Exchange Traded Funds

Since the benefits and the risks of ETFâ&#x20AC;&#x2122;s

However, as already known from the pre-

have been elaborated in the previous arti-

vious article, it is of great importance to

cle, a more detailed view on an example

also look at other general facts about the

ETF (ComStage MSCI World TRN UCITS

ETF itself. As it can be seen in the chosen

ETF (ETF110)) should give a better under-

ComStage ETF, the replication method of

standing of the topic. The ETF will be pre-

the Fund is synthetic and so an unfunded

sented on firstly its investment strategy

swap. The strategy risk of the ETF is, as in

and its statistics.

most ETFâ&#x20AC;&#x2122;s, long-only. Although the ETF is located in Luxembourg (a tax simple coun-

The investment strategy of the ETF is

try) the currency of the fund is in USD$,

based on a high variety within its portfolio.

and so it also carries a certain currency

The MSCI World Index has access to 23

risk, as USD is not stable. The fund volatili-

different industrial countries with a total of

ty is rather high with 10.5%, as the volatili-

1654 titles in January 2017. Due to the

ty is an indicator for price fluctuation in

great number of titles included in the port-

the past investors prefer that it has a low

folio, it has an overall low susceptibility to

percentage. As the last fact, the ComStage

changes in the market. The earnings which

ETF is not equally weighted, since the per-

are achieved in the ETF are reinvested. The

centage of the assets differ.

total expense ratio of the ETF is 0.2% with a total fund volume of 1.254 million euros.

Interesting about this ETF are the active

Out of the view of an investor, the total

sectors in which it mostly invested. Their

expense ratio should be as low as possible

most significant sector is, with 21.16%, the

because it measures the total cost of a

Consumable & Consumer Goods closely

fund to the investor. Since it was founded

followed by Banking & Financial services

in 2008, the ETF increased by around 200%

with 17.97%, as well as IT with 17.04%.

and had a positive growth rate in each

Other smaller active sectors in which the

year. In the last three years the ever-

ETF invested are for example the Industry

increasing rates looked like this: In 2015

& Transportation comp., Pharma & Bio-

the ETF increased by 10,57%, in 2016 it

tech, and Oil, Gas & Metals with a total of

increased by 10,56% and last year in 2017

27.55%. The remaining active sectors have

it increased by 7.51%.

a too small percentage to be mentioned.

Source: https://www.finanz en.net/etf/comsta ge_msci_world_trn _ucits_etf

Finally, it is crucial to look at the invest-

As a conclusion, it can be said that the

ment in percentage in each country. The

ComStage MSCI World TRN UCITS ETF

ComStage ETF has its biggest investments

(ETF110) is a very interesting ETF as its

in the USA with 59.24%. The second big-

investments

gest country is Japan with 9.01% followed

We, as authors, hope that by taking the

by Great Britain in place three with 6.51%.

ComStage ETF as an example, the topic

are

widely

spread.

â&#x20AC;&#x153;ETFâ&#x20AC;? itself became clearer and easier to understand.

Written by

Felix Heyd

Kilian Enders

Author for Bull&Bear

at EBS.Invest e.V.

View LinkedIn Profile

Capital Asset Pricing Model The Capital Asset Pricing Model (CAPM) is a widely used financial tool that was developed by William F. Sharpe, John Lintner, Jan Mossin and Jack L. Treynor independently in the 1960s. Sharpe won the Nobel Price of Economics in 1990 for his discovery. The CAPM is based on the portfolio theory that was developed by Markowitz in 1952. Features & Functions The CAPM is a single factor economic model that is used to determine an appropriate rate of return of a single asset. That way, it is possible to evaluate whether it makes sense to add a certain asset in order to construct a well-diversified portfolio. It is also possible to evaluate the rate of return of whole portfolios using the model.

Assumptions The model is based on certain assumptions. Investors act rational and risk averse, they aim to maximize economic utilities and aim to diversify across numerous investments. Investors are not able to influence market prices, are able to lend and borrow money at a risk-free rate of interest and have access to the same information. There are no transaction costs and all assets are perfectly divisible and liquid. It acknowledges systematic risk, often called market risk. Market risk cannot be eliminated by diversification. An example for such risks are natural disasters or regulatory policies by the government that influence the whole market as opposed to only individual assets. The idiosyncratic risk on the other hand can be reduced through

One function this model serves is provid-

a well-diversified portfolio. The systematic

ing a benchmark for the rate of return

risk is usually represented by the quantity

when evaluating future investments. It is

beta (β). If a portfolio has a Beta of 1.25 in

possible to predict whether a forecast for a

relation to the S&P 500 Index, it is 25%

stock is higher or lower than its “fair” re-

more volatile than the S&P 500 Index.

turn in consideration of its risk. The CAPM

Other factors are the expected return of

also suits perfectly for comparing whether

the market and the expected return of a

different assets are under- or overvalued. If

theoretical risk-free asset. The CAPM fea-

the expected return is higher than what

tures zero transaction costs in order to get

the CAPM suggests, the asset under con-

rid of all idiosyncratic risk. This way, the

sideration is likely to be undervalued.

cost of equity capital is only determined by

This model can help determine the value of assets that have not been “priced in” by the market, such as new shares available through initial public offerings. This approach can also be applied when considering the amount of return investors will demand when the company introduces new projects.

beta. Market Portfolio When we sum up the portfolios of all individual investors with these assumptions, they will exactly mirror the entire wealth of the economy. This is called the market portfolio. The proportion of each stock is determined by the value of a stock (Price

per share * number of shares outstanding)

The CAPM equation:

divided by the sum of the market value of all stocks. If the Daimler stock for example makes up 1% of every individual portfolio, it makes up 1% of the market portfolio.

Expected Return of individual asset equals risk free rate of interest + sensitivity of the expected asset returns to the expected market returns of asset i *(expected return of market - Return of risk free asset) Security Market Line The Security Market Line (SML) is used to display the relation of expected return and systematic risk (beta). This is supposed to indicate how the market

Security Market Line

must price individual securities in relation to the extent of their security risk. That way, the SML enables the calculation of a reward-to-risk ratio for individual securities in relation to the ratio of the over-all market. If a Security does not lie on the SML, the CAPM does not hold for any calculations of an asset, since investors will get compensated for more or less than the systematic risk. Capital Market Line The Capital Market Line depicts the rates of return for efficient portfolios subject to the risk level for a market portfolio and the risk-free rate of return. The CML is If a company is not included in the optimal portfolio, the demand will be zero and the price will decrease. This way, the stock becomes more attractive to investors in comparison to other stocks. Ultimately, the company will reach a price where it will be included into the optimal portfolio again. These kinds of price adjustments are therefore the reason that every asset is included in the market portfolio.

created by sketching a tangent line from the intercept point of the efficient frontier to the place where the expected return of an asset equals the risk-free rate of return. The CML is superior to the efficient frontier as it considers the return of a risk-free asset in the market portfolio. It is necessary to acknowledge that the market will operate at the tangency of CML and the portfolio frontier of risky assets.

The efficient frontier represents all optimal

return the model calculates. However, the

portfolios with the highest expected re-

model gives a first approach for the re-

turn, including only risky assets. If a portfo-

quired expected return of the asset. CAPM

lio offers a lower expected return, but the

takes systematic risk into account, which is

same level of risk as other portfolios, it is

often ignored in other return models, such

considered suboptimal.

as the dividend discount model (DDM),

Pros, Cons and Alternatives

but should be taken into account. CAPM is simple and easy to calculate and in combi-

Despite failing multiple empirical tests, the

nation with other financial tools, it is im-

CAPM remains popular and well known

portant in order to support or discard pos-

due to its simplicity and utility. The accura-

sible investment options. The most com-

cy is deemed acceptable for important

mon alternative is the Arbitrage Pricing

applications. The main deficit of the CAPM

Theory (APT). As opposed to the CAPM,

is, that it relies on many unrealistic as-

the APT features multiple factors, including

sumptions. The risk-free rate derived from

non-company factors. This makes it harder

the U.S. treasury bill, is exposed to daily

to use, as users of the APT model must

changes in interest rates, which imple-

analytically determine relevant factors that

ments volatility. Secondly, the return on

might affect the assetâ&#x20AC;&#x2122;s return. Investors

the market is backwards-looking and may

may want to use the CAPM to determine

not be representative for future develop-

the expected theoretical appropriate rate

ments. Ultimately, investors are not able to

of return as it is a one-factor model and is

borrow or lend money at a risk-free rate,

thus easier to use.

which increases the minimum required

Written by

Max Opoczynski

Benedikt Kiefer

Author for Bull&Bear

at EBS.Invest e.V.

View LinkedIn Profile

With the help of Pascal JĂ¤ger Author for Bull&Bear at EBS.Invest e.V. View LinkedIn Profile

The Fascinating World of

Hedge Funds

When it comes to fascinating topics in

Secondly, as hedge funds are relatively

finance, hedge funds are indeed one such

unregulated compared to mutual funds,

domain. In 1949, Mr. Alfred Winslow, who

hedge funds can invest in broader range of

was working for Fortune magazine, decid-

securities. While there are many hedge

ed to start his own investment fund to

funds that do invest in traditional securi-

raise $100,000 of which $40,000 was his

ties, such as stocks, bonds, commodities

own money. Jones limited the number of

and real estate, they are best known for

investors to 99 and used the concept of

using more sophisticated (and risky) in-

leverage and short selling as the two main

vestments and techniques.

investment strategies. As a result, Jones was able to generate bigger returns. However, the distinguishing feature of his fund was that the performance of his fund had little correlation with the performance of economy. Even when the economy was not doing well, the investors in Jones’ fund were “hedged” against the risk. Hedge funds didn’t become mainstream until 1960s when Warren Buffet and George Soros launched their own funds using Jones’ strategy. Before we delve into the market performance of hedge funds and its outlook for 2018, lets first understand what a hedge fund is.

Thirdly, hedge funds typically use “longshort” strategies, which invest in some balance of long positions (which means buying stocks) and short positions (which means selling stocks with borrowed money, then buying them back later when their price has, ideally fallen). Additionally, many hedge funds also invest in “derivatives,” (future & options) which are contracts to buy or sell another security at a specified price. Many hedge funds also use an investment technique called leverage, which is essentially investing with borrowed money—a strategy that could significantly increase return potential, but also creates greater risk of loss. In fact, the name “hedge fund”

A hedge fund is mostly targeted towards

is derived from the fact that hedge funds

the wealthy investors and is regarded as a

often seek to increase gains, and offset

private investment fund. A hedge fund can

losses, by hedging their investments using

be thought of as an investment vehicle like

a variety of sophisticated methods, includ-

mutual funds but the distinction between

ing leverage.

the two lies in the securities they invest in and to which customer segment they target.

When it comes to liquidity, hedge funds are typically not as liquid as mutual funds, meaning it is more difficult to sell your

Firstly, hedge funds are not currently regu-

shares. Mutual funds have a per-share

lated by the US SEC (Securities and Ex-

price (called a net asset value) that is cal-

change Commission) but mutual funds are.

culated each day, so you could sell your

However, in the future we may have regu-

shares at any time. Most hedge funds, in

lations on hedge funds as well.

contrast, seek to generate returns over a specific period called a “lockup period,”

during which investors cannot sell their

gained +8.7 percent in 2017, the strongest

shares. Private equity funds, which are sim-

calendar year return since 2013. Driven by

ilar to hedge funds, are even more illiquid

an active M&A environment, the HFRI

as they tend to invest in startup compa-

Event-Driven (total) Index produced a +7.7

nies, so investors can be locked in for

percent return for the year, led by a +11.9

years.

percent gain from the HFRI ED: Special

Considering the compensation spectrum, hedge fund managers are typically compensated differently from mutual fund managers. Mutual fund managers are paid fees regardless of their funds’ performance. Hedge fund managers, in contrast, receive a percentage of the returns they earn for investors, in addition to earning a “management fee”, typically in the range

Situations Index. Fixed income-based Relative Value Arbitrage (RVA) strategies received $1.3 billion of net inflows in 4Q17, increasing total RVA capital to $840 billion. RVA inflows were led by $2.2 billion of new capital invested into RVA: Corporate funds, which was partially offset by outflows of $1.7 billion from RVA: Multi-Strategy funds.

of 1% to 4% of the net asset value of the

The fourth quarter inflow helped to pare

fund. This feature of hedge funds is ap-

the FY17 outflow of $5.6 billion from RVA

pealing to investors who are frustrated

strategies, of which $5.4 billion occurred in

when they must pay fees to a poorly per-

1Q17. The HFRI Relative Value (Total) In-

forming mutual fund manager. On the

dex gained +5.1 percent for 2017, as US

down side, this compensation structure

interest rates remained relatively stable

could lead hedge fund managers to invest

throughout the year and a new Chairman

aggressively to achieve higher returns —

of the US Federal Reserve Bank was ap-

increasing investor risk.

pointed. Macro funds received $660 million of net inflows in 4Q17, increasing the FY17 inflow to $10.8 billion, which led all

The performance of hedge funds conclud-

hedge fund strategies. Total Macro AUM

ed 2017 with the strongest capital inflows

(Assets Under Management) ended the

since second quarter of 2015, driving total

year at $599 billion, an all-time high. Sub-

assets to new record. Compared to the

strategy inflows for the year were led by

performance in 2003, 2017 marked the

quantitative trend following CTA funds,

first year without any monthly decline.

which received $9.8 billion of new capital,

Compared to 2016, total hedge fund in-

and Currency strategies, which collected

dustry capital increased by $59 billion to

over $5.1 billion.

$3.21 trillion. Investors allocated $6.9 billion of new capital to hedge funds in 4Q17, the highest quarterly inflows since 2Q15, bringing total 2017 inflows to $9.8 billion.

The HFRI Macro (Total) Index climbed +2.2 percent in 2017, led by a +5.3 percent gain from the HFRI Macro: Multi-Strategy Index. Equity Hedge (EH), the industry’s largest

December marked the fourteenth con-

strategy area, experienced outflows over

secutive monthly advance of the HFRI

the quarter, as investors pared equity beta

Fund Weighted Composite Index®, which

exposure on strong gains in both direct

equity markets and EH hedge funds. Inves-

new US Federal Reserve Chairman, strong

tors redeemed $2.0 billion from EH funds

M&A activities in healthcare & technology

in fourth quarter, bringing the FY17 out-

sector as well as in media and governance.

flow to $5.4 billion, though total EH AUM

Two more factors that will play a crucial

increased to $939 billion because of strong

role in the hedge fund industry will be the

performance gains.

US policies on infrastructure and taxes and

For the year, EH sub-strategy inflows were led by Multi-Strategy and Quantitative

the transformative impact of blockchain technology.

Directional funds, each of which received $7.1 billion of net investor capital, but these were offset by outflows of $13.6 billion from Fundamental Value and $9.2 billion from Fundamental Growth funds. The HFRI Equity Hedge (Total) Index topped all main strategies with a +13.5 percent return in 2017, while the HFRI EH: Fundamental Growth led all sub strategies with a gain of +19.5 percent. The HFRI Emerging Markets (Total) Index surged +20.1 percent in 2017, led by the HFRI India and HFRI China indices, which gained +36.9 and +32.2 percent, respectively. Flows by firm size for 2017 were led by managers with less than $1 billion, as these received $7.4 billion of new capital,

Written by

while the industryâ&#x20AC;&#x2122;s largest managers, those with greater than $5 billion AUM, received $6.3 billion of inflows. Investors withdrew a net $3.9 billion from firms managing between $1 billion to $5 billion. In a nutshell, 2017 can be regarded as a historic year in the hedge fund industry that included advancements in core and emerging

industries.

The

performance

gains were also consistent with the evolution of risk parity, cryptocurrencies and blockchain. When it comes to the outlook towards 2018, it can be said that 2018 presents new challenges and opportunities especially with regards to appointment of

Gautam Kumar Head of Research at EBS.Invest e.V. Chief Responsibility for Bull&Bear View LinkedIn Profile

What are Options? Options are a great instrument for inves-

sometimes followed by a disappointment,

tors to manage risks and stay flexible at

because options are also useful for long-

every level. They are great for every inves-

term buy-and-hold investors.

tor´s portfolio, but before buying them you shall know their definition, their purpose,

Option Trading: Purpose

the reason of their popularity and where to

Most of investors are attracted to option

start.

trading by many reasons, such as:

Options are contracts with pre-negotiated

■

initial outlay than buying the stock.

prices and certain dates which allow you to buy or sell a stock. Most common amount

■ ■

price without the obligation to buy.

asset outright, for example: Buy or sell shares of a stock at an agreed-upon

price

(the

“strike

price”) for a limited period. ■

Sell the contract to another investor.

■

Let the option contract expire and walk away without further financial obligation.

There is an opinion that options are an instrument for investors with commitment issues. Of course, it is possible, if an investor is interested in speculating with shorttime movements and trading contracts with an expectance of profit, which is

An option protects investors from downside risk by locking in the

are alternatives to buying or shorting the

■

An option buys an investor time to see how things play out.

are 100 shares of the stock per contract. They allow you a variety of actions, which

Buying an option requires a smaller

An investor, who is sure that the stock price of a company is going to rise, will probably use a so-called “call-option”, which is a contract with a right to purchase shares of a certain company at a specified price later. In case of maturing an investor gets a better price for buying the stock compared to the open market, otherwise his losses are limited to the price of contract. A possible financial loss on stock positions in investor’s portfolio can also be limited. If an investor is worried about short-term volatility wiping out his investment gains, he will try to sell several shares at a prede-

termined price, which is a result of buying

option would be offset by the losses in-

„put” options.

curred on the stock. So, buying a put option on a stock, which an investor does not

Call Options

own, is more reasonable.

Having a right to buy a stock from an investor, who sold you the call option at a specific price on or before a specified date is a key advantage of a call option: an option comes with terms such as a strike price and the expiration date. Let´s imagine an investor buys a call option on a firm X with a possibility to buy an option for $35 (the strike price) until the second Thursday in November (the expiration date): in case of a rise of a value of firm X over the strike price before the expiration date, an investor can buy it under its market price, exercise it, or even sell it to other investors for a profit.

These examples are very important for basic understanding of options. One must understand that buying an option gives him a right but not an obligation to buy a stock. If it is of one´s interest, he would do nothing with the option until the expiration date and the option would become worthless meaning that one would use 100% of his investment. Second, an option is merely a contract that deals with an underlying asset: that´s why they are called derivatives. The underlying asset will typically be a stock or stock index, but options are actively traded on all sorts of financial securities such as bonds, foreign curren-

In case the firm X stays below the strike

cies, commodities, and even other deriva-

price, your options won´t be attractive for

tives.

other investors, because no one would want to pay for an allowance to overpay for a stock.

The most widely used method of explaining this is via the housing industry.

Put Options In case of a put option the only big difference to a call option is that you buy a right to sell a stock. The terms strike price and expiration date also play a role at those options: an investor buys a put option for $6 on the Firm Y and has a time limit of three weeks to sell it. If the firm Y falls before the expiration date, an investor will have a possibility to sell it for a higher price than its market price or sell it to another investor for a profit. investor owns is a legitimate, but not profhedging

strategy,

There is an apartment you dream of, but it´s unaffordable as you can´t spend $100,00 on it, which is its current price. However, you don´t give up and contact the owner of an apartment willing to create a contract for your right to buy this apartment within next 6 months for $110,000(considering the rising cost of housing). The owner is smart and wants you to pay him $5,000 as a “downpayment” or a premium in case you change your mind and never show up again.

Buying a put option on a stock that an itable

Another Example:

because

the

amount of money coming from the put

There are two possible outcomes with an apartment of your dream within the next 6 months, even though the price of an apartment for you is already negotiated:

the market value of an apartment can rise

you profit. If the stock's value crashes, all

to $200,000. For you itÂ´s still $110,000, so

you've lost is your premium.

the rest is your profit or your savings. The second outcome is the price drop to $80,000, but since you have the right to buy it and not the obligation, you can forget about your contract with the owner and lose your $5,000 premium. Conclusion:

Options make it possible for day traders to continue to buy or sell shares as often as possible, if they desire, which is a possible profit that can appear many times over from stock price movements. There are many strategies day traders can construct and apply to options trading depending

When you buy an option, you get the right, but not the obligation, to buy the related stock at a future date, but at a price you specify now. If the stock's market value rises above your agreed-upon price,

on whether the security is likely to rise, fall, or be in a stable holding pattern. It is up to them which level of risk they tolerate and this is what makes option trading one of the most exciting possibilities available on the market.

Written by

Philippe Braum

Arsenij Geld

Author for Bull&Bear

at EBS.Invest e.V.

Thank you very much for reading our third edition, this time about Investment, Markets and Regulation! One last time, we hope it was as exciting to read as it was for us to create. If you have any concerns, questions, business inquiries or further food for thoughts feel most invited to contact us.

Thanks to this edition’s team: Jan-Raphael Gritzmacher, Tijen Demircan, Felix Heyd, Kilian Enders, Max Opoczynski, Pascal Jäger, Benedikt Kiefer, Philippe Braum, Arsenij Geld and Heads of Research (Gautam Kumar & Johan ten Doornkaat) Layout/ Composition & Editorial Supervision: Johan ten Doornkaat Chief Responsibility: Gautam Kumar, Johan ten Doornkaat

Cover Page Design Annisa Qurratu'Ain