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    As a former Dean and appointed University Professor and Endowed Department Chair, Dr. David Edward Marcinko MBA was a NYSE broker and investment banker for a decade who was respected for his unique perspectives, balanced contrarian thinking and measured judgment to influence key decision makers in strategic education, health economics, finance, investing and public policy management.

    Dr. Marcinko is originally from Loyola University MD, Temple University in Philadelphia and the Milton S. Hershey Medical Center in PA; as well as Oglethorpe University and Emory University in Georgia, the Atlanta Hospital & Medical Center; Kellogg-Keller Graduate School of Business and Management in Chicago, and the Aachen City University Hospital, Koln-Germany. He became one of the most innovative global thought leaders in medical business entrepreneurship today by leveraging and adding value with strategies to grow revenues and EBITDA while reducing non-essential expenditures and improving dated operational in-efficiencies.

    Professor David Marcinko was a board certified surgical fellow, hospital medical staff President, public and population health advocate, and Chief Executive & Education Officer with more than 425 published papers; 5,150 op-ed pieces and over 135+ domestic / international presentations to his credit; including the top ten [10] biggest drug, DME and pharmaceutical companies and financial services firms in the nation. He is also a best-selling Amazon author with 30 published academic text books in four languages [National Institute of Health, Library of Congress and Library of Medicine].

    Dr. David E. Marcinko is past Editor-in-Chief of the prestigious “Journal of Health Care Finance”, and a former Certified Financial Planner® who was named “Health Economist of the Year” in 2010. He is a Federal and State court approved expert witness featured in hundreds of peer reviewed medical, business, economics trade journals and publications [AMA, ADA, APMA, AAOS, Physicians Practice, Investment Advisor, Physician’s Money Digest and MD News] etc.

    Later, Dr. Marcinko was a vital and recruited BOD  member of several innovative companies like Physicians Nexus, First Global Financial Advisors and the Physician Services Group Inc; as well as mentor and coach for Deloitte-Touche and other start-up firms in Silicon Valley, CA.

    As a state licensed life, P&C and health insurance agent; and dual SEC registered investment advisor and representative, Marcinko was Founding Dean of the fiduciary and niche focused CERTIFIED MEDICAL PLANNER® chartered professional designation education program; as well as Chief Editor of the three print format HEALTH DICTIONARY SERIES® and online Wiki Project.

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Hurdle Rates V. Highwater Marks V. Claw Back Provisions

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By Dr. David Edward Marcinko MBA CMP®

Many physicians and other investors — even those that meet net worth guidelines — are surprised to learn that there exists a $500 – 999 billion, or more, alternative investment industry that is not generally marketed to the public. Such alternative investments have also been known as hedge funds or private investment funds.

Unlike mutual funds, these alternative investments can be structured in a wide variety of ways. Because of the very same regulations discussed above, these funds cannot be advertised, but they are far from illegal or illicit.




In fact, physicians were among the most significant early investors in one of the last century’s most successful hedge funds. Mr. Warren Buffett, Chairman of Berkshire Hathaway, Inc. and a legendary investor got his start in 1957 running the Buffett Partnership, an alternative investment fund not open to the general public. Mr. Buffett’s first public appearance as a money manager was before a group of physicians in Omaha, Nebraska. Eleven decided to put some money with him. A few of these original investors followed him into Berkshire Hathaway, now among the most highly valued companies in the world.

The alternative investment, or hedge, funds of today are similar to the original Buffett Partnership in many ways. So, we will discuss several unique terms which potential investors should be aware.



Hurdle Rate

Hedge funds may feature a hurdle rate as part of the calculation of the fund manager’s performance incentive compensation. Also known as a “benchmark,” the hurdle rate is the amount, expressed in percentage points, an investor’s capital account must appreciate before the account becomes subject to a performance incentive fee. Potential medical investors should view the hurdle rate as a form of protection in context with other features of the fee arrangement.

The hurdle rate, which benchmarks a single year’s performance, may be considered mutually exclusive of any other year, or the hurdle rate may compound each year. The former case is more common. In the latter case, a portfolio manager failing to attain a hurdle rate in the first year will find the effective hurdle rate considerably higher during the second year.

Once a fund manager attains the hurdle rate for an investor, the medical investor’s capital account may be charged a performance incentive fee only on the performance above and beyond the hurdle rate. Alternatively, the account may be charged a performance fee for the entire level of performance, including the performance required to attain the hurdle rate. Other variations on the use of the hurdle rate exist, and are limited only by the contract signed between the fund manager and the investor. The hurdle rate is not generally a negotiating point, however.


A fund charges a performance fee with a 6 percent hurdle rate, calculated in mutually exclusive manner. Dr. Lanouette, a radiologist investor places $100,000 with the fund. The first year’s performance is 5 percent. The investor therefore owes no performance fee during the first year because the portfolio manager did not attain the hurdle rate. During year two, the portfolio manager guides the fund to a 7 percent return. Because the hurdle rate is mutually exclusive of any other year, the portfolio manager has attained the 6 percent hurdle rate and is entitled to a performance fee.

Highwater Mark

Some funds feature a highwater mark provision, also known as a ”loss-carryforward” provision. As with the hurdle rate, potential investors should consider the highwater mark a form of protection. A high water mark is an amount equal to the greatest value of an investor’s capital account, adjusted for contributions and withdrawals. The high water mark ensures that the hedge fund manager charges a performance incentive fee only on the amount of appreciation over and above the highwater mark set at the time the performance fee was last charged. The current trend is for newer funds to feature this highwater mark, while older, larger funds may not feature it.


A fund charges a 20 percent performance fee with a highwater mark but no hurdle rate. Dr. Butala, a dentist investor contributes $100,000 to the fund. During the first year, the hedge fund manager grows that capital account to $110,000 and charges a 20 percent performance fee, or $2,000. The ending capital account balance and highwater mark is therefore $108,000. During year two, the account falls back to $100,000, but the highwater mark remains $108,000. During year three, in order for the manager to charge a performance fee, the manager must grow the capital account to a level above $108,000.

Clawback Provision

Rarely, a fund may provide investors with a clawback provision. This term, borrowed from the venture capital fund world, such provisions result in a refund to the investor of all or part of a previously charged performance fee if a certain level of performance is not attained in subsequent years. Such refunds in the face of poor or inadequate performance may not be legal in some states or under certain authorities.


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More on Options Trading

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Two business school students telling you how it is.

Options Trading (for Morons Like You).

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Physician-executives during options trade discussion!



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Financial Freedom through Commercial Real Estate Education and Investing

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A Viable Alternate Investment Class for Physicians?

By Dennis Bethel MD  www.nesteggrx.com

dennis-bethelI’ve worked as an Emergency Medicine Physician for over a decade now.

Most of that time, I’ve also been investing in real estate.

Real estate has been good to me and I’ve been asked to share my story with this ME-P


Not long after graduating from residency in 2002, I began investing in real estate.  I watched my father-in-law make some money in residential real estate (1 – 4 units), read some books, and jumped in feet first.  I purchased and rented out single family homes, a triplex, and multiple four-plexes (quads).  What I didn’t realize at the time was that I made two critical errors.

My First Mistake

The first mistake was that I purchased residential real estate when I should have gone bigger and purchased commercial multifamily.  I had limited resources and I thought bigger properties were out of my reach.  At that time, I had not heard of fractional investing.

My Second Mistake

The second error, that is inherent to residential real estate, is that I became a landlord.  At times I managed properties and at other times I employed a property manager and limited myself to managing the manager.  Regardless, I was putting in a significant amount of time at my unintended second career as a landlord without the desired compensation.

Not Scaleable

Since there are no economies of scale with residential real estate the cash flow is small and unpredictable.  I was on the long, hard path to financial freedom.  The rents from my properties would someday replace my income as a physician, however, that wasn’t going to happen until I paid off the mortgages completely.  Until then it was going to be too inconsistent and I would have to ride several market cycles including the very painful down-turns.


Unfortunately, chronic understaffing in the ER coupled with increased regulation and the rigors of shift-work had begun to catch up to me.  I was beginning to feel the effects of burnout.  I began to question whether I could make it 30 years.  I began to see earned-income as a trap in which you trade your valuable time for heavily-taxed income.

Then some devastating news, my wife tested positive for the BRCA (breast cancer) gene mutation.  That was a game changer.  I could no longer rest on my laurels, slowly burning out waiting for a comfortable retirement.  The future was uncertain, and I needed to ensure our wealth.  Come what may, I was determined that she would get the best health care money could buy.

I knew real estate was an incredible wealth building investment vehicle and my path to financial freedom.  In fact, 90% of the Forbes 400 (wealthiest people in the US) either made or retain their wealth in real estate.  While I was doing far better than my colleagues who invested in the stock market, I knew that I could do better.

My New Mission

I made it my mission to become an expert in real estate.  I read even more books as well as attended numerous conferences and seminars.  I invested heavily in my education, took advanced real estate investing classes, retained mentors, and developed networks.  I also grew my experience, buying and selling more properties.

I learned that although real estate won’t make you rich overnight, it needn’t take 30 years either.  I needed to transition out of residential real estate and go bigger into commercial multifamily.  I ultimately landed on multifamily, because shelter is a basic need.  People will give up their luxuries long before they give up the roof over their head.  The difference is that I now look for properties that are between 80 – 250 units.  These types of properties afford the investor true economies of scale that provide for predictable multisource income.  I invest in these properties fractionally, pooling my money with other like-minded investors.


Real estate is the only investment I know of in which the investor makes his or her money in four different ways.

  • Cash Flow (monthly, quarterly, or yearly distributions of net profits)
  • Appreciation (increasing value of the property as net operating income increases)
  • Tax Benefits (can result in little to no taxes on income and gains)
  • Principal Pay Down (Increased equity as the loan gets paid down by the residents)

Multisource income is an incredible benefit of multifamily commercial real estate investing.  In fact, in all of my commercial properties, I have been able to obtain double-digit returns year after year.  Making money and compounding those gains is what investing is all about.


real estate



While all investments have risk, the safety profile of multifamily commercial real estate is impressive.  Let’s compare it to business.  We’ve all heard that 9 out of every 10 businesses fail.  These failures are not just limited to small business.  Every year, many big businesses fail as well.  Names like Circuit City, Hostess, Borders, and Mervyns just to name a few.  Many other, well known, national brands teeter on the brink of insolvency.

In contrast, the commercial multifamily properties I invest in meet current Fannie Mae underwriting standards.  Nationally these properties have a paltry 1% – 2% foreclosure rate.  That rate is even lower in the best markets.  In the hands of a quality syndicator, in thriving markets, utilizing proven property management these properties are FAR safer than stocks for capital preservation, equity growth, and current income.

Additional safety measures include the use of non-recourse lending, the ability to insure against loss, and the use of sole purpose entity structures to eliminate any liability risk.

The “Conversation”

Switching from residential real estate to commercial has enabled me to provide for my family and has allowed me to work only part-time in the emergency department.  A few years ago, I walked into the physician lounge and overheard a conversation between two colleagues.  Both around 20 years my senior, were lamenting their inability to retire.  They had each invested heavily in the stock market without any diversification into real estate.  They bemoaned the fact that they had each worked 25 – 30 years in medicine and were nowhere close to retirement.  They wondered how I could afford to work so many fewer shifts than them with two young boys to raise.

An Eye-Opener

This interaction was eye-opening.  I was grateful for the decisions I had made but saddened by the fate of my 60 year old colleagues.  I’ve watched far too many of them push back retirement as the stock market and economic cycles ruined their plans.


I knew I could help.  I have recently started an educational website intended to demystify the subject of real estate investing.  My mission is to help physicians and other health care workers find financial freedom through real estate investing and education.

We also provide quality real estate investments for busy professionals looking to diversify a portion of their portfolio out of the stock market and into commercial multifamily real estate without having to become a landlord.  We do this by helping like-minded professionals pool their resources together to buy quality multimillion dollar assets as fractional investors.

I invite you to visit my website at www.nesteggrx.com and explore the content to learn more about real estate and see if it might be right for you.

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Physician’s Acquiring Real-Estate


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Physician’s Update on Dividend-Paying Stocks

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But Some Doctors Ask – Why All the Hype?

By David K. Luke MIM CMPcandidate [www.CertifiedMedicalPlanner.com]


In an effort to help the US economy recover, the Federal Reserve has lowered interest rates to historically low levels. Furthermore, the Fed has announced its intent to keep interest rates low until 2014. Classic income-producing investments such as savings accounts and certificates of deposit pay next to nothing.

Borrowing Good – Saving Bad!

Borrowers are being rewarded, but savers are being punished. Low interest rates may have spurred the economy somewhat, but they have been devastating for retired people who have a low tolerance for risk. Physicians, other investors and their advisors are turning toward alternatives that pay higher returns, but these vehicles necessarily carry more risk. Among these alternatives, some investors are considering the purchase of stocks that pay reliable dividends.


But, is this an appropriate strategy for mature doctors and similar retirees? What are the potential benefits and drawbacks?


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Understanding Absolute Investment Returns

Exploiting Market Inefficiencies

By J. Wayne Firebaugh CPA, CFP® CMP™

By Dr. David E. Marcinko MBA, CMP™

Source: www.HealthcareFinancials.com

This class of investments seeks to exploit market inefficiencies and generate positive returns regardless of broader market performance. Often, investments in this class are made through the use of hedge funds. Hedge funds will often employ leverage, short-selling, and arbitrage to take advantage of pricing distortions in their targeted strategy area.

Relation to Healthcare Endowments

When investing an endowment’s assets in this category, the physician director or money manager should be aware of fee structures that commonly include performance-related incentive fees, hurdle rates, and claw-back clauses. The endowment managers should also remember that these types of investments generally have much less transparency than other asset classes with which they may be more familiar.


Finally, since many of these investments are offered only to accredited investors, the physician or investment manager is often free to pursue much more aggressive strategies than would otherwise be pursued for retail or lay customers.

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But, can we [anyone] exploit market inefficiencies? Is the market efficient or inefficient? What about Modern Portfolio Theory [MPT] or the Arbitrage Pricing Model? Did we really learn anything from the market crash of 2008?

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Physician’s Acquiring Real-Estate

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Innovative Funding in Difficult Times

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Real estate can be acquired by physician-investors, even in these difficult times, in many different ways. For example, through direct purchase, participation in a real estate partnership vehicle with other investors [such as general partnerships, limited partnerships, various corporate entities, and, in most states, limited liability companies (LLCs), and investments in real estate securities such as Real Estate Investment Trusts (REITs).

Section 1031

Real estate also can be acquired through tax-deferred exchanges under Section 1031 of the IRS Code, in which a client “trades” one investment property for another, deferring the taxes due on the sale of the exchanged property. This allows the doctor to reinvest “pre-tax” dollars in another real estate investment, potentially benefiting from appreciation on the larger investment. The physician may also exchange one larger property into two or several smaller properties and pay tax consequences on each one as those properties are sold as cash is needed.

Tax and Risk Management

The way a physician takes ownership of real estate will affect the tax treatment of income and profit. For example, having an LLC-owned investment property will provide him/her with the same protection from individual liability as a corporation, while allowing him/her to have much more favorable tax treatment. Real estate can be bought directly by purchasing it in the following manners:

1. Paying cash,

2. Paying a cash down payment and acquiring a loan,

3. Paying cash to the seller who is financing, or

4. Financing the purchase by using either new real estate financing, seller financing, or credit borrowing when a lender is willing to loan solely on the strength of, and the financial statement of, the borrower, or a combination of these.

Trading and Secured Loans

Real estate also can be acquired by trading other valuable assets, sometimes in combination with financing. A client can obtain interests in real estate by making loans on real estate assets that are secured by a deed of trust or a mortgage. Another method is to invest as a participating lender. In such an instance the borrower needs to agree to provide equity kickers or participation in cash flow whereby the lender (doctor) can benefit directly from the real estate performance.fp-book21

Equity Participation Plans

With an equity participation, the physician-investor can profit or gain from the sale of the property, sometimes in a preferential manner (i.e., the money the doctor loaned is returned, with interest, and a predetermined percentage or portion of the gain is given to the owner/borrower before distribution of the sales proceeds). Similarly, the doctor can participate in annual cash flow, giving a fixed or a fluctuating amount depending on the performance of the investment. As a lender, many of the benefits of ownership of real estate are not available to the MD, but the doctor should have a security interest in the property and no direct responsibility for operation of the real estate investment. Also, if possible, the borrower should provide additional guarantees of performance. The borrower could do this by providing additional security, such as the deeds of trust on the borrower’s house, other real-estate, and the acquired property; bank letters of credit; or guarantees of performance from people other than the party to whom the money is originally loaned.archway


If a physician-investor is considering acquiring or lending on real estate, s/he should check with his professional advisors, including accountants and attorneys, before proceeding. The doctor’s attorney should review any contracts or agreements before the client signs anything. The physician also will need a due diligence review to ascertain both the relative values of the real estate on which money is being loaned and the borrower’s track record and background.


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What is a Market-Neutral Fund?

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Market Neutral Funds Demystified

[A Special Report]

[By Dimitri Sogoloff; MD, MBA]


It’s hard to believe that just 20 years ago, physician investors had only two primary asset classes from which to choose: U.S. equities and U.S. bonds.

Today, the marketplace offers a daunting array of investment choices. Rapid market globalization, technology advancements and investor sophistication have spawned a host of new asset classes, from the mundane to the mysterious.

Even neophyte medical investors can now buy and sell international equities, emerging market debt, mortgage securities, commodities, derivatives, indexes and currencies, offering infinitely more opportunities to make, or lose, money.

Amidst this ongoing proliferation, a unique asset class has emerged, one that is complex, non-traditional and not easily understood like stocks or bonds. It does, however, offer one invaluable advantage; its returns are virtually uncorrelated with any other asset class. When this asset class is introduced into a traditional investment portfolio, a wonderful thing occurs; the risk-return profile of the overall portfolio improves dramatically.

This asset class is known as a Market-Neutral strategy. The reason few medical professionals have heard of market neutral strategies is that most of them are offered by private investment partnerships otherwise known as hedge funds.

To the uninitiated, “hedge fund” means risky, volatile or speculative. With a market-neutral strategy however, just the opposite is true. Funds utilizing market-neutral strategies typically emphasize the disciplined use of investment and risk control processes. As a result, they have consistently generated returns that display both low volatility and a low correlation with traditional equity or fixed income markets. 

Definition of Market-Neutral

All market-neutral funds share a common objective: to achieve positive returns regardless of market direction. Of course, they are not without risk; these funds can and do lose money. But a key to their performance is that it is independent of the behavior of the markets at large, and this feature can add tremendous value to the rest of a portfolio.

A typical market-neutral strategy focuses on the spread relationship between related securities, which is what makes them virtually independent of underlying debt or equity markets. When two related securities are mispriced in relation to one another, the disparity will eventually disappear as the result of some external event. This event is called convergence and may take the form of a bond maturity, completion of a merger, option exercise, or simply a market recognizing the inefficiency and eliminating it through supply and demand.

Here’s how it might work

When two companies announce a merger, there is an intended future convergence, when the shares of both companies will converge and become one. At the time of the announcement, there is typically a trading spread between two shares. A shrewd trader, seeing the probability of the successful merger, will simultaneously buy the relatively cheaper share and sell short the relatively more expensive share, thus locking in the future gain.

Another example of convergence would be the relationship between a convertible bond and its underlying stock. At the time of convergence, such as bond maturity, the two securities will be at parity. However, the market forces of supply and demand make the bond underpriced relative to the underlying stock. This mispricing will disappear upon convergence, so simultaneously buying the convertible bond and selling short an equivalent amount of underlying stock, locks in the relative spread between the two.  

Yet another example would be two bonds of the same company – one junior and one senior. For various reasons, the senior bond may become cheaper relative to the junior bond and thus display a temporary inefficiency that would disappear once arbitrageurs bought the cheaper bond and sold the more expensive bond.

While these examples involve different types of securities, scenarios and market factors, they are all examples of a market-neutral strategy. Locking a spread between two related securities and waiting for the convergence to take place is a great way to make money without ever taking a view on the direction of the market.

How large are these spreads, you may ask? Typically, they are tiny. The markets are not quite fully efficient, but they are efficient enough to not allow large price discrepancies to occur.

In order to make a meaningful profit, a market-neutral fund manager needs sophisticated technology to help identify opportunities, the agility to rapidly seize those opportunities, and have adequate financing resources to conduct hundreds of transactions annually.  

Brief Description of Strategies

The universe of market-neutral strategies is vast, spanning virtually every asset class, country and market sector. The spectrum varies in risk from highly volatile to ultra conservative. Some market-neutral strategies are more volatile than risky low-cap equity strategies, while others offer better stability than U.S Treasuries.

One unifying factor across this vast ocean of seemingly disparate strategies is that they all attempt to take advantage of a relative mispricing between various securities, and all offer a high degree of “market neutrality,” that is, a low correlation with underlying markets.

[A] Convertible Arbitrage

Convertible arbitrage is the oldest market-neutral strategy. Designed to capitalize on the relative mispricing between a convertible security (e.g. convertible bond or preferred stock) and the underlying equity, convertible arbitrage was employed as early as the 1950s.

Since then, convertible arbitrage has evolved into a sophisticated, model-intensive strategy, designed to capture the difference between the income earned by a convertible security (which is held long) and the dividend of the underlying stock (which is sold short). The resulting net positive income of the hedged position is independent of any market fluctuations. The trick is to assemble a portfolio wherein the long and short positions, responding to equity fluctuations, interest rate shifts, credit spreads and other market events offset each other.  

A convertible arbitrage strategy involves taking long positions in convertible securities and hedging those positions by selling short the underlying common stock. A manager will, in an effort to capitalize on relative pricing inefficiencies, purchase long positions in convertible securities, generally convertible bonds, convertible preferred stock or warrants, and hedge a portion of the equity risk by selling short the underlying common stock. Timing may be linked to a specific event relative to the underlying company, or a belief that a relative mispricing exists between the corresponding securities.

Convertible securities and warrants are priced as a function of the price of the underlying stock, expected future volatility of returns, risk free interest rates, call provisions, supply and demand for specific issues and, in the case of convertible bonds, the issue-specific corporate/Treasury yield spread.

Thus, there is ample room for relative misvaluations. Because a large part of this strategy’s gain is generated by cash flow, it is a relatively low-risk strategy. 

[B] Fixed-Income Arbitrage

Fixed-income arbitrage managers seek to exploit pricing inefficiencies across global markets.

Examples of these anomalies would be arbitrage between similar bonds of the same company, pricing inefficiencies of asset-backed securities and yield curve arbitrage (price differentials between government bonds of different maturities). Because the prices of fixed-income instruments are based on interest rates, expected cash flows, credit spreads, and related factors, fixed-income arbitrageurs use sophisticated quantitative models to identify pricing discrepancies.

Similarly to convertible arbitrageurs, fixed-income arbitrageurs rely on investors less sophisticated than themselves to misprice a complex security.

[C] Equity Market-Neutral Arbitrage

This strategy attempts to offset equity risk by holding long and short equity positions. Ideally, these positions are related to each other, as in holding a basket of S&P500 stocks and selling S&P500 futures against the basket. If the manager, presumably through stock-picking skill, is able to assemble a basket cheaper than the index, a market-neutral gain will be realized.

A related strategy is identifying a closed-end mutual fund trading at a significant discount to its net asset value. Purchasing shares of the fund gains access to a portfolio of securities valued significantly higher. In order to capture this mispricing, one needs only to sell short every holding in the fund’s portfolio and then force (by means of a proxy fight, perhaps) conversion of the fund from a closed-end to an open-end (creating convergence).

Sounds easy, right?

In considering equity market-neutral, you must be careful to differentiate between true market-neutral strategies (where long and short positions are related) and the recently popular long/short equity strategies.

In a long/short strategy, the manager is essentially a stock-picker, hopefully purchasing stocks expected to go up, and selling short stocks expected to depreciate. While the dollar value of long and short positions may be equivalent, there is often little relationship between the two, and the risk of both bets going the wrong way is always present.

[D] Merger Arbitrage (a.k.a. Risk Arbitrage)

Merger arbitrage, while a subset of a larger strategy called event-driven arbitrage, represents a sufficient portion of the market-neutral universe to warrant separate discussion.

Merger arbitrage earned a bad reputation in the 1980s when Ivan Boesky and others like him came to regard insider trading as a valid investment strategy. That notwithstanding, merger arbitrage is a respected stratagey, and when executed properly, can be highly profitable. It bets on the outcomes of mergers, takeovers and other corporate events involving two stocks which may become one.

A textbook example was the acquisition of SDL Inc (SDLI), by JDS Uniphase Corp (JDSU). On July 10, 2000 JDSU announced its intent to acquire SDLI by offering to exchange 3.8 shares of its own shares for one share of SDLI.

At that time, the JDSU shares traded at $101 and SDLI at $320.5. It was apparent that there was almost 20 percent profit to be realized if the deal went through (3.8 JDSU shares at $101 are worth $383 while SDLI was worth just $320.5). This apparent mispricing reflected the market’s expectation about the deal’s outcome. Since the deal was subject to the approval of the U.S. Justice Department and shareholders, there was some doubt about its successful completion. Risk arbitrageurs who did their homework and properly estimated the probability of success bought shares of SDLI and simultaneously sold short shares of JDSU on a 3.8 to 1 ratio, thus locking in the future profit.

Convergence took place about eight months later, in February 2001, when the deal was finally approved and the two stocks began trading at exact parity, eliminating the mispricing and allowing arbitrageurs to realize a profit. 

Merger Arbitrage, also known as risk arbitrage, involves investing in securities of companies that are the subject of some form of extraordinary corporate transaction, including acquisition or merger proposals, exchange offers, cash tender offers and leveraged buy-outs. These transactions will generally involve the exchange of securities for cash, other securities or a combination of cash and other securities.

Typically, a manager purchases the stock of a company being acquired or merging with another company, and sells short the stock of the acquiring company. A manager engaged in merger arbitrage transactions will derive profit (or loss) by realizing the price differential between the price of the securities purchased and the value ultimately realized when the deal is consummated. The success of this strategy usually is dependent upon the proposed merger, tender offer or exchange offer being consummated.  

When a tender or exchange offer or a proposal for a merger is publicly announced, the offer price or the value of the securities of the acquiring company to be received is typically greater than the current market price of the securities of the target company.

Normally, the stock of an acquisition target appreciates while the acquiring company’s stock decreases in value. If a manager determines that it is probable that the transaction will be consummated, it may purchase shares of the target company and in most instances, sell short the stock of the acquiring company. Managers may employ the use of equity options as a low-risk alternative to the outright purchase or sale of common stock. Many managers will hedge against market risk by purchasing S&P put options or put option spreads. 

[E] Event-Driven Arbitrage

Funds often use event-driven arbitrage to augment their primary market-neutral strategy. Generally, any convergence which is produced by a future corporate event would fall into this category.

Accordingly, Event-Driven investment strategies or “corporate life cycle investing” involves investments in opportunities created by significant transactional events, such as spin-offs, mergers and acquisitions, liquidations, reorganizations, bankruptcies, recapitalizations and share buybacks and other extraordinary corporate transactions.

Event-Driven strategies involve attempting to predict the outcome of a particular transaction as well as the optimal time at which to commit capital to it. The uncertainty about the outcome of these events creates investment opportunities for managers who can correctly anticipate their outcomes.

As such, Event-Driven trading embraces merger arbitrage, distressed securities and special situations investing. Event-Driven managers do not generally rely on market direction for results; however, major market declines, which would cause transactions to be repriced or break, may have a negative impact on the strategy. 

Event-driven strategies are research-intensive, requiring a manager to do extensive fundamental research to assess the probability of a certain corporate event, and in some cases, to take an active role in determining the event’s outcome. 

Risk and Reward Characteristics

To help understand market-neutral performance and risk, let’s take a look at the distribution of returns of individual strategies and compare it to that of traditional asset classes.

 Table 1:  Average Return / Volatility of Market Neutral Strategies And Selected Traditional Asset Classes 


Strategy Average Return Annualized Volatility
Convertible Arbitrage 11.95% 3.57%
Fixed Income Arbitrage 8.33% 4.90%
Equity Market-Neutral 11.62% 4.95%
Merger Arbitrage 13.29% 3.51%
Relative Value Arbitrage 15.69% 4.31%
   Traditional Asset Classes:    
S&P 500 12.62% 13.72%
MSCI World 8.57% 13.05%
High Grade U.S. Corp. Bonds 7.26% 3.73%
World Government Bonds 5.91% 5.96%

The most important observation about this chart is that the Market Neutral funds exhibits considerably lower risk than most traditional asset classes.

While market-neutral strategies vary greatly and involve all types of securities, the risk-adjusted returns are amazingly stable across all strategies. The annualized volatility – a standard measure of performance risk – varies between 3.5 and 5 percent, comparable to a conservative fixed-income strategy.     

Another interesting statistics is the correlation between Market Neutral strategies and traditional asset classes and traditional asset classes

Table 2: Correlation between Market Neutral Strategies and Traditional Asset Classes


Asset Class/Strategy S&P500 MSCI World GovBonds CorpBonds

The correlation of all market neutral strategies to traditional assets is quite low, or negative in some cases. This suggests that these strategies would indeed play a useful role in the ultimate goal of efficient portfolio diversification.

To test the “market neutrality” of these strategies, we asked, “How well, on average, did these strategies perform during bad, as well as good, market months?”

It turns out, in good times and bad, these strategies displayed consistent solid performance. From 12/31/91, in months when S&P 500 was down, the average down month was 3.03 percent. Market Neutral strategies performed as follows:


Strategy Average Monthly Return
Convertible Arbitrage + 0.65%
Fixed Income Arbitrage + 0.50%
Equity Market-Neutral + 1.19%
Merger Arbitrage + 0.88%
Relative Value Arbitrage + 0.81%

In months when S&P 500 was up, the average up month was +3.24 percent.  Market Neutral strategies performed as follows:


Strategy Average Monthly Return
Convertible Arbitrage +1.17%
Fixed Income Arbitrage +1.20%
Equity Market-Neutral +1.37%
Merger Arbitrage +0.60%
Relative Value Arbitrage +1.25%

Clearly, a compelling picture emerges. While these strategies, on average, underperform during good times, they show a positive average return during both good and bad markets.

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Inclusion of Market-Neutral in a Long-term Investment Portfolio

A critical concern for any medical investor considering a foray into a new asset class is how it will alter the long-term risk/reward profile of the overall portfolio. To better understand this, we constructed several hypothetical portfolios consisting of traditional asset classes:

·  US Treasuries (Salomon Treasury Index 10yrs+)

·  High Grade Corporate Bonds  (Salomon Investment Grade Index)

·  Speculative Grade Corporate Bonds  (High Yield Index)

·  US Blue chip equities  (Dow Jones Industrial Average)

·  US mid-cap equities  (S&P 400 Midcap Index)

·  US small-cap equities (S&P 600 Smallcap Index)

Portfolios varied in the level of risk from 100 percent U.S Treasuries (least risky) to 100 percent small-cap equities (most risky), and are ranked from 1 to 10, 1 representing the least risky portfolio.Each portfolio was analyzed on a Risk/Return basis using monthly return data since December 1991. The results are shown in Chart 1.Predictably, the least risky portfolio produced the smallest return, while the riskiest produced the highest return. This is perfectly understandable – you would expect to be compensated for taking a higher level of risk.

Chart 1: Risk/Return characteristics of traditional portfolios vs. Market Neutral strategies 

Clearly, the risk-return picture offered by Market Neutral strategies is much more compelling (lower risk, higher return) than that offered by portfolios of traditional assets. What happens if we introduce these market-neutral strategies into traditional portfolios? Let’s take 20 percent of the traditional investments in our portfolio and reinvest them in market-neutral strategies.

The change is dramatic: the new portfolios (denoted 1a through 10a) offer significantly less risk for the same return. The riskiest portfolio, for instance (number 10) offered 20 percent less risk for a similar return of a new portfolio containing market-neutral strategies (number 10a).   
Chart 2:  Result of inclusion of 20% of Market Neutral strategies in traditional portfolios 

This is quite a difference.  Everything else being equal, anyone would choose the new, “improved” portfolios over the traditional ones.

How to invest

The mutual fund world does not offer a great choice of market neutral strategies. 

Currently, there are only a handful of good mutual funds that label themselves market-neutral (AXA Rosenberg Market Netural fund and Calamos Market Neutral fund are two examples).

Mutual fund offerings are slim due to excessive regulations imposed by the SEC with respect to short selling and leverage, and consequently these funds lack flexibility in constructing truly hedged portfolios. The dearth of market-neutral offerings among mutual funds is offset by a vast array of choices in the hedge fund universe. Approximately 400 market-neutral funds, managing $60 billion, represent roughly 25% of all hedge funds.

Therefore, further focus will relate to the hedge fund universe, rather than the limited number of market-neutral mutual funds.

Direct investing in a market-neutral hedge fund is restricted to qualifying individuals who must meet high net worth and/or income requirements, and institutional investors, such as corporations, qualifying pension plans, endowments, foundations, banks, insurance companies, etc.

This does not mean that retail investors cannot get access to hedge fund exposure. Various private banking institutions offer funds of funds with exposure to hedge funds. Maaket-neutral funds are nontraditional investments. They are part of a larger subset of strategies known as alternative investments, and there is nothing traditional in the way doctors invest in them.

Hedge funds are private partnerships, which gives them maximum flexibility in constructing and managing portfolios, but also requires medical investors to do a little extra work.

[A] Lockup Periods

One of the main differences between mutual funds and hedge funds is liquidity. Market-neutral strategies have less liquidity than traditional portfolios. Quarterly redemption policies with 45- or 60-days notice are common. Many funds allow redemptions only once a year and some also have lock-up periods. In addition, few of these funds pay dividends or make distributions. These investments should be regarded strictly as long-term strategies.

[B] Managerial Risks

Success of a market-neutral strategy depends much less on the market direction than on the manager’s skill in identifying arbitrage opportunities and capitalizing on them.

Thus, there is significantly more risk with the manager than with the market. It’s vital for investors to understand a manager’s style and to monitor any deviations from it due to growth, personnel changes, bad decisions, or other factors.

[C] Fees

If you are accustomed to mutual fund fees, brace yourself; market-neutral investing does not come cheap.

Typical management fees range from 1 to 2 percent per year, plus a performance fee averaging 20 percent of net profits. Most managers have a “high watermark” provision; they cannot collect the performance fees until investors recoup any previous losses. Look for this provision in the funds’ prospectus and avoid any fund that lacks it. Even with higher fees, market-neutral investing is superior to most traditional mutual fund investing on a risk-adjusted return basis.

[D] Transparency

Mutual funds report their positions to the public regularly. This is not the case with market-neutral hedge funds. Full transparency could jeopardize accumulation of a specific position. It also generates front running: buying or selling securities before the fund is able to do so. While you should not expect to see individual portfolio positions, many hedge fund managers do provide a certain level of transparency by indicating their geographical or sector exposures, level of leverage and extent of hedging.

It does take a bit of education to understand these numbers, but the effort is definitely worthwhile. 

[E] Taxation

The issue of hedge fund taxation is quite complex and is often dependent on the fund and the personal situation of the investor. Advice from a competent accountant, specialized financial advisor, tax attorney with relevant experience is worthwhile. The bottom line is that investing in market-neutral funds is not a tax-planning exercise and it will not minimize your taxes.

On the other hand, it should not generate any more or fewer taxes than if you invested in more traditional funds.

From the medical investor’s perspective, the principal advantages of market-neutral investing are attractive risk-adjusted returns and enhanced diversification.

Ten years of data indicate that market-neutral portfolios have produced risk-adjusted returns superior to traditional investments. In addition, the correlation between the returns of market-neutral funds and traditional asset classes has been historically negligible.

Adding exposure of market-neutral return strategies to the asset mix within a consistent, long-term investment program offers a medical investor the opportunity to improve overall returns, as well as achieving some protection against negative market movements.

Now, after all of the above, has your impression of hedge funds in general or MN funds in particular, changed?


Asset class weighting in traditional portfolios:
Portfolio US Treasuries US High Grade Corp Bonds US Low Grade Corp Bonds Large Cap Stocks Mid Cap Stocks Small Cap Stocks
1 50% 50%        
2   50% 50%      
3 10% 30% 50% 40%    
4   50%   50%    
5   10% 10% 50% 30%  
6     10% 50% 20% 20%
7     10% 30% 20% 40%
8       20% 20% 60%
9         20% 80%
10           100%



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