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IBBC CAPITAL ACADEMY / 2027

Look through a hedge fund’s net exposure

Independent IBBC Capital draft content for self-study. Not affiliated with or endorsed by CFA Institute. New lessons await subject-matter review. No CFA designation or official PSM credit is awarded.

Learning goals

  • Calculate the long-short return on beginning NAV.
  • Explain why 250% of NAV applies to this case.
  • Identify the case-specific assumption or failure mode before taking action.

Draft · approximately 30 minutes, excluding further revision.

Shared case and decision context

A long-short fund has long exposure 150 and short exposure 100 on NAV 100. The longs gain 4% and shorts’ underlying prices gain 2%. Ignore financing, fees and rebalancing. Short borrow can be recalled.

Economic or professional mechanism

Net exposure summarizes directional amounts while gross exposure indicates total positions, but neither alone measures factor, liquidity or tail risk. Equity long-short, relative-value, event-driven and macro strategies earn returns through different mechanisms and can share hidden common exposures. A small net position can coexist with leverage and substantial gross losses.

Apply, challenge and communicate

Long gains are 6 and short losses 2, giving 4% of NAV. Gross exposure is 250%, net 50%. Investigate borrow cost, short squeezes, redemption terms and financing margin. An attractive historical Sharpe ratio can be distorted by illiquidity, smoothing, survivorship and nonlinear option-like payoffs.

Hedge-fund strategies expose different event, spread and tail risks

Merger arbitrage often buys a target and may short an acquirer; a deal break can produce a discontinuous loss. Distressed strategies require analysis of claim priority, reorganization and recovery, not merely a high quoted yield. Convertible arbitrage may combine a long bond with a delta hedge, retaining credit, volatility, borrow and funding risk; fixed-income relative value can be highly levered despite low daily spread volatility.

Global macro takes directional or relative views on rates, currencies and other macro assets; managed futures can exploit trends but lose in whipsaws. Specialist strategies may focus on insurance-linked risk, volatility or niche credit with distinctive event and model risk. Fund-of-funds and multi-strategy structures diversify implementation but add fees, transparency and common-liquidity concerns; multiple manager names do not guarantee independent exposures.

Portfolio fit depends on stress covariance, liquidity, fees and nonlinear risk rather than a low historical correlation alone. Suppose traditional asset volatility 10%, hedge allocation volatility 8%, correlation 0.25, andweights 80%/20%. Variance=.8²×.1²+.2²×.08²+2×.8×.2×.1×.08×.25=.007296; volatility 8.5417%. A crisis correlation increase or gated redemptions can overturn the apparent diversification.

Formula and assumptions

Net return=(long exposure*rLong−short exposure*rShort)/NAV

Case analysis with explicit assumptions

  1. A long-short fund has long exposure 150 and short exposure 100 on NAV 100. The longs gain 4% and shorts’ underlying prices gain 2%. Ignore financing, fees and rebalancing. Short borrow can be recalled.
  2. Method: Net return=(long exposure*rLong−short exposure*rShort)/NAV
  3. Case result: 4.00%. Long gains are 6 and short losses 2, giving 4% of NAV. Gross exposure is 250%, net 50%. Investigate borrow cost, short squeezes, redemption terms and financing margin. An attractive historical Sharpe ratio can be distorted by illiquidity, smoothing, survivorship and nonlinear option-like payoffs.

Errors to catch

  • Do not replace the stated assumptions with an unstated shortcut. Reconcile units, timing and the claim being valued or duty being assessed.
  • No margin calls is not a defensible conclusion for these case facts.

Original knowledge check

Answer every question before checking. Review explanations after submitting; retry starts a new attempt.

Sources and coverage status

These original lessons are drafts. Public outlines are used to check scope; the official learning-outcome text and proprietary question banks are not reproduced here. Follow the source for exam-year requirements and updates.