Den Danske Finansanalytikerforening Investing in Hedge Funds – The Investor‘s Perspective March...

Den Danske FinansanalytikerforeningDen Danske Finansanalytikerforening

Investing in Hedge Funds – Investing in Hedge Funds – The Investor‘s PerspectiveThe Investor‘s Perspective

March 18 2004March 18 2004

Representative Representative in Denmarkin Denmark:

2

About Harcourt

Mission: Deliver superior investment solutions and products within the context of hedge funds to institutional

investors

Locations: Zurich (Head office), New York, Geneva, Stockholm

Representative in DK: Privestor Fondsmægerlerselskab A/S

Founded: April 1997

Staff: 39

AUM: USD 1,57 Bln

Ownership: NIB Capital N.V.Management & Staff

Major Clients: Swiss ReNovartis Pension FundHagströmer & Qviberg

3

Agenda

1. Hedge funds – structural differences to traditional investing

2. Hedge fund investing – what is the value added for the investor?

3. How to construct a hedge fund investment – single manager or fund of hedge fund approach?

4. Hedge funds as Alpha generators – what does that really mean?

5. Conclusions

1.

4

• The ambition to generate absolute returns

Absolute returns means the focus to strive for positive returns in all market conditions and therefore to disregard from beating any index

• Hedge funds have less restrictions than traditional asset managers

More flexibility in what they invest in (such as asset classes) as well asin investment techniques (e.g. usage of derivatives/leverage)

• Due to less restrictions – hedge funds are very heterogeneous

1.1. What is a hedge fund?

Common for all hedge funds is:

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1.2. Hedge funds from the portfolio manager perspective

Hedge fund Management Traditional Management

Inv. Restrictions

Return Objective

Investment method

Incentive

Fee structure

Own assets invested

None Numerous

Absolute return Relative return

View on risk Loss of capital Deviation from index

Buy long, sell short Buy long

Reach return target Beat index

Mgmt + Perf Fees Management Fee

Very common Very uncommon

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1.3. Hedge funds from the investor perspective

Hedge Funds Traditional funds

Subscription terms

Legal structure

NAV Reporting

Transparency

Fee structure

Main risk

Monthly/Quarterly Daily

Offshore / unregulated Onshore / regulated

Min. investment USD 1 mln / 5 mln Low

(Weekly)/Monthly Daily

Low High

1-2% Mgmt; 20% Perf 1.5% Mgmt

Manager Risk Market Risk

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1.4. Hedge fund strategies classification used by Harcourt

Fixed Income EquitiesFutures, Currencies and

Commodities

Relative Value

Relative Value Fixed Income Strategies:

1. Fixed Income Arbitrage

2. Mortgage-Backed Securities Arbitrage

3. Capital Structure Arbitrage

Relative Value Equity Strategies:

7. Convertible Arbitrage

8. Reg D Private Convertibles

9. Merger Arbitrage

10. Index and Options Arbitrage

11. Statistical Equity Arbitrage

12. Fundamental Market Neutral Equity

Relative Value Futures and Commodities Strategies:

20. Commodities Arbitrage

Directional

Directional Fixed Income Strategies:

4. High Yield

5. Distressed Securities

6. Emerging Markets Debt

Directional Equity Strategies:

13. Long/Short US Equities

14. Long/Short European Equities

15. Long/Short Japanese Equities

16. Long/Short Emerging Markets

17. Long/Short Sectors

18. Short-Biased Equities

19. Mutual Fund Timers

Directional Managed Futures and Currency Strategies:

21. Long Term Systematic Trading

22. Short Term Systematic Trading

23. Currency Trading

24. Discretionary Trading

Multiple

Multiple Strategies:

25. Macro Hedge Funds

26. Multi-Strategy Funds

27. Funds of Funds

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RV Equity 23%

Directional FI 6%

CTA 12%

Relative Value FI 4%

Long/Short

Equity

55%

Hedge Fund Management Company Locations

Greater NY 45%

Other US 35%

Other Europe 3%

London 13%

Asia 4%

Hedge Fund Domiciles

US 33%

BVI 17%

Bermuda 11%

Cayman Islands 19%

Bahamas 7%

Channel Islands 2% Other 3%

Dublin 3% Luxembourg 3%

Netherlands Antilles 2%

Evolution of assets invested into Hedge Funds

In USD Bln

Hedge Fund Strategies Globally Hedge Fund Manager Locations

Hedge Fund Domiciles Globally Evolution of assets invested in HF’s

Source: CSFB / TASS

0

100

200

300

400

500

600

700

800

1949

1952

1955

1958

1961

1964

1967

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

CAGR 25% p.a. since 1980

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Agenda





5. Conclusions

2.

10

• Higher risk adjusted returns

• Low correlation

• Capital preservation in falling markets

2.1. Why investing in hedge funds?

Compared with traditional investment alternatives, hedge funds can offer three unique benefits for the investor:

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2.2. Why Hedge Funds? Hedge fund return vs stocks & bonds

0

50

100

150

200

250

300Ja

n-94

Jul-9

4

Jan-

95

Jul-9

5

Jan-

96

Jul-9

6

Jan-

97

Jul-9

7

Jan-

98

Jul-9

8

Jan-

99

Jul-9

9

Jan-

00

Jul-0

0

Jan-

01

Jul-0

1

Jan-

02

Jul-0

2

Jan-

03

Jul-0

3

Jan-

04

MSCI World

HFR FoHF

JPM Global BondsJPM Global Bonds

Source: HFR, JPM, MSCI 1994-2004

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2.3. Historical risk adjusted returns – hedge funds vs bonds & stocks

Ret 2003 Ret 2002 Ret 2001 Ret pa 1994-2003

Stdev pa Corr MSCI

HFR Funds of Funds 11.30% 1.09% 2.76% 7.48% 6.15% 0.56HFR Hedge Funds 19.94% -1.18% 4.62% 11.93% 7.45% 0.74CSFB/Tremont Hedge Funds

15.42% 3.05% 4.41% 11.11% 8.48% 0.48Emerging markets 40.57% 4.59% 10.49% 8.76% 15.45% 0.64Distressed securities 29.74% 5.39% 13.13% 11.93% 5.69% 0.50Sector specialists 27.34% -12.33% -4.90% 14.63% 15.53% 0.66Macro 22.22% 8.26% 6.89% 11.13% 7.71% 0.41Long/short equities 20.91% -4.38% 0.46% 15.61% 9.47% 0.70High yield 20.78% 7.46% 5.34% 7.33% 4.81% 0.48Fixed income arbitrage 9.17% 8.78% 4.74% 5.97% 4.21% -0.04Convertible arbitrage 8.97% 9.11% 13.34% 10.94% 3.54% 0.27Merger arbitrage 8.13% -0.81% 2.77% 10.76% 3.70% 0.48CTAs 7.97% 11.80% 0.83% 6.45% 8.50% -0.15MBS 6.80% 8.85% 21.37% 9.61% 4.89% 0.01Market neutral equity 2.45% 1.80% 6.69% 8.55% 3.28% 0.14Statistical arbitrage 2.25% -2.31% 1.67% 7.48% 3.98% 0.51Short-selling -21.66% 25.06% 8.79% 0.89% 23.21% -0.69MSCI World 30.82% -21.05% -17.84% 6.81% 14.82% 1.00JPM Global Bonds 14.53% 19.36% -0.78% 7.21% 6.30% 0.03


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0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0% 5% 10% 15% 20% 25%

MSCI World

Macro

Distressed

CV Arb

EM

Short Selling

Merger Arb

L/S Equity

Sector

JPM

Hedge Fund Index

MN Equity

FI Arb

MBS

CTAFI HY

Fund of Funds

2.4. Why hedge funds? The Portfolio Perspective

HFR Hedge Funds

JPM Global BondsMSCI World Equities


Au

nn

ual

ized

Ret

urn

Standard Deviation

14

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0% 5% 10% 15% 20% 25%

MSCI World

Macro

Distressed

CV Arb

EM

Short Selling

Merger Arb

L/S Equity

Sector

JPM

Hedge Fund Index

MN Equity

FI Arb

MBS

CTAFI HY

Fund of Funds

2.4. Why hedge funds? The Portfolio Perspective

HFR Hedge Funds

JPM Global BondsMSCI World Equities


Au

nn

ual

ized

Ret

urn

Standard Deviation

Long/Short Equities

L/S Emerging Markets

L/S Sector Specialists

Merger ArbitrageConvertible Arbitrage

MBS ArbitrageMN Equity

Statistical ArbitrageHigh Yield

FI Arbitrage

Distressed Debt

Macro

Short Sellers

CTAs

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0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0% 5% 10% 15% 20% 25%

MSCI World

Macro

Distressed

CV Arb

EM

Short Selling

Merger Arb

L/S Equity

Sector

JPM

Hedge Fund Index

MN Equity

FI Arb

MBS

CTAFI HY

Fund of Funds

1.6. Low correlation – Benefits from a portfolio perspective

JPM Global Bonds

MSCI World Equities

HFR Hedge Funds

Portfolio without hedge fundsAu

nn

ual

ized

Ret

urn

Source: HFR, JPM, MSCI 1994-2003Standard Deviation

16

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0% 5% 10% 15% 20% 25%

MSCI World

Macro

Distressed

CV Arb

EM

Short Selling

Merger Arb

L/S Equity

Sector

JPM

Hedge Fund Index

MN Equity

FI Arb

MBS

CTAFI HY

Fund of Funds

1.6. Low correlation – Benefits from a portfolio perspective

JPM Global BondsAu

nn

ual

ized

Ret

urn

Source: HFR, JPM, MSCI 1994-2003Standard Deviation

JPM Global Bonds

MSCI World Equities

HFR Hedge Funds

Portfolio with hedge funds

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8.6%

14.2%12.7%

6.6%

20.5%

12.5%

16.0%18.3%

17.1%

5.6%4.4%

1.9% 1.7%3.7%

6.2%

-2.0%

-25.0%

-18.4%

-26.5%-24.0%

8.8%6.7%

-40%

-30%

-20%

-10%

0%

10%

20%

HFR Fund ofFunds Index

HFRComposite

Index

CSFB/TremontHF Index

CTAs HFRLong/Short

Equity Index

MSCI World(USD)

S&P 500 NASDAQComposite

SPI (CHF) JP MorganGlobal BondIndex (USD)

Pictet (CHF)

Light colors: 1994-2000

Dark colours: 2001-2002

1.8. Preservation of capital – Bull vs Bear Markets


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Agenda





5. Conclusions

3.

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3.1. Be aware of the pitfalls of hedge funds!

• Substantial manager risk due to less investment restrictionsStyle and strategy shifts Hedge funds may employ high degree of leverage Capacity issuesManager skill can vary in different types of markets

• More complex investment conditionsHigher feesWorse liquidity conditionsRegulatory framework varies

• Low transparencyReporting frequencyDegree of portfolio transparency?

• Challanges in finding and getting access to the best managersGlobal and intransparent industryFunds can be closed to new investorsMinimum investments may be very high

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3.2. Due to the high Manager Risk Due Diligence is key

Qualitative due diligence Competitive edge Background and experience Investment process Risk management

Quantitative due diligence Peer group comparison Consistency of track record Rolling correlation Portfolio fit and style analysis

Organizational due diligence Organization and legislative framework Infrastructure Primebroker(s), administrator and auditors Reference checks

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3.3. Single Managers or Fund of Hedge Funds?

• Benefits of single manager investmentsNo extra layer of feesHedge fund selection at the investor’s own discretion

No potential conflicts of interestFull transparency in the manager selection process

• Benefits of fund of hedge fund investmentsLower manager risk through diversificationProfessional selection of managers in each hedge fund categoryProfessional active portfolio management Professional monitoring of managers Broad access to global supply of hedge fundsMay have prioritized access / transparency to otherwise closed fundsLower minimum investment requirement

Completely based on the investor’s investment objective:

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Active vs passive money management

Active money management = hedge funds

Passive money management = index products

Hedge Fund Overlay – Core / Satellite approach

Core portfolio = traditional investments

Satellite portfolio = A) Single hedge funds B) Fund of hedge funds C) Core-Satellite with single & fund of

funds

3.3. Different investment approaches into hedge funds

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Agenda



3. How to construct a hedge fund investment – single manager och multi-manager approach?


5. Conclusions

4.

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Hedge Funds – Alpha or beta?

Hedge fund returns =

Traditional betas + alternative betas + structural alpha + skill alpha

Traditional betas = directional risk premia:

-Stock market beta-Interest rate duration-Currencies-BARRA factors-Credit spreads

Alternative betas = demand/supply premia:

-Liquidity-Volatility-Correlations-Merger deal failure-Complexity-FI spread conversion

Structural alpha = free option due to less restrictions:-Regulatory constraints-Speed-Size-Market timing-Flow-Trend-following

Skill alpha =Only few really skilled managers

Source: Harcourt

Be educated in how hedge funds make their returns!

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Agenda



3. How to construct a hedge fund investment – single manager och multi-manager approach?


5. Conclusions5.

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4. Conclusions

• Hedge funds has an absolute return objective therefore hedge funds are very heterogeneous

• Hedge funds offers an attractive return profile: High risk adjusted returns

Low correlationCapital preservation in falling markets

• Since hedge funds are heterogeneous, the investor must perform a thourough due diligence prior to, and during the life of the investment

• The investor can look at hedge funds as:Active vs passive capital managementHedge funds as overlay

• Hedge fund returns are a function of not only alpha, but also to non- traditional investment risks.

Den Danske FinansanalytikerforeningDen Danske Finansanalytikerforening

Thank you for your time and attention Thank you for your time and attention

Contact:

Pernille [email protected]

Niels Kayser

[email protected] Pho. +45 45 82 45 87

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