* High Watermark

The highest peak in value that an investment fund/account has reached. This term is often used in the context of fund manager compensation, which is performance based.

The high watermark ensures that the manager does not get paid large sums for poor performance. So if the manager loses money over a period, he or she must get the fund above the high watermark before receiving a performance bonus. For example, say after reaching its peak a fund loses $100,000 in year one, and then makes $250,000 in year two. The manager therefore not only reached the high watermark but exceeded it by $150,000 ($250,000 - $100,000), which is the amount on which the manager gets paid the bonus.

Related words: Crystallize; Equalization; Performance fees

* Side Pocket

A type of account used in hedge funds to separate illiquid assets from other more liquid investments. Once an investment enters a side pocket account, only the present participants in the hedge fund will be entitled to a share of it. Future investors will not receive a share of the proceeds in the event the asset's returns get realized.

Investors who leave the hedge fund will still receive a share of the side pocket's value when it gets realized. Usually only the most illiquid assets, such as delisted shares of a company, receive this type of treatment, because holding illiquid assets in a standard hedge fund portfolio can cause a great deal of complexity when investors liquidate their position. Overall, side pocket accounts resemble single asset private equity funds in structure.

* “Quant” investing

What is quantitative or “quant” investing? In short, it is where mathematical models rather than manager’s discretion make investment decisions.

What do quant managers do apart from running sophisticated computer programs? An analogy with cars may help here. No matter how sophisticated a car, it still needs a driver and sometimes a mechanic. The driver must know when to brake and when to accelerate. Quant managers provide both functions – they control risks as well as fix things such as data errors when they occur. Most importantly, every car needs to be designed and engineered in the first place – the most important part of a quant manager’s job.

In the case of a good quant, it should get better!” Ignore established and successful quants at your peril. However, behind any computer program there is always a human brain. Investing in a quant approach is the best way to profit from human ingenuity but without the danger of human error.

Detail: Why quant?

* Cardboard collateral

“Cardboard collateral” refers to illiquid securities and investments that are deposited as collateral by hedge funds with prime brokers and, in the first instance, not given a “haircut” commensurate with the nature of the instrument and the inability to gain a price or to sell it.

In the opening phases of the sub-prime/credit crisis, prime brokers were forced to revalue downwards the value of illiquid instruments they held, resulting in margin calls and drops in hedge fund AUMs.

* Categorise gatekeepers

A gatekeeper can be defined as anyone who is responsible for selecting, screening and eventually allocating capital on behalf of others. Many gatekeepers exhibit similar qualities in the way they view and evaluate hedge fund investments and this has led to categorise gatekeepers as follows:

1. The Good
– forward thinking, sophisticated and independent thinkers.

2. The Bad
– unsophisticated, alarmists and having a tendency to generalise.

3. The Ugly
– sophisticated, crowd followers and often victims of their large size.

* A simple explanation from Wikipedia

An alternative investment is regarded as an investment product other than traditional investments such as stocks, bonds, money markets, and/or cash.

As the definition of Institutional Investor magazine's Alternative Investment Newsletter indicates, alternative investments include commodities, financial derivatives, hedge strategies (or absolute return strategies), real estate, and private equity, as well as venture capital. They are supposed to have very low correlation with traditional investment products. However, this definition may not be suitable due to a fast-changing investment environment and should be reconsidered over time.

Some alternative investment managers, such as hedge funds, cannot advertise or announce their performance under U.S. and European law. Most hedge funds or private-equity groups accept investments from only high-net-worth individuals or institutions.

Although many hedge funds cannot advertise, accredited investors, in accordance with Rule 501a of Regulation D of the U.S. Securities Act of 1933, can access the BarclayHedge databases of 6,400 hedge funds and download fund information, including AUM, contact information, and full performance data since inception.