Key Areas In The Hedge Fund Industry in 2010

KEY AREAS IN THE HEDGE FUND INDUSTRY IN 2010

Daniel Capocci, PhD – CAIA [email protected] Luxembourg Educational Event APRIL 2010

mailto:[email protected]

Today’s objectiveDiscuss the hedge fund industry in 2010 and illustrate our views using updated information

1. Why a second edition?

2. Hedge Fund in 2010: some updated figures

3. Hedge Fund in 2010: strategies evolution

4. Hedge Fund in 2010: the consolidation of the industry

5. The future of the hedge fund industry

6. Conclusion

« Introduction aux hedge funds »

Why a second edition?

1. Why a second edition?The world of hedge fund changed dramatically between2003 & 2010

The industry grew rapidly between 2004 & 2007The industry has been strongly hurt by the financial crisisStar hedge fund managers emergedHedge fund strategies emerged/diedHedge funds became more standardNew regulations have been implemented (Europe)Performance stabilized in 2009

The industry is back but it is different…

1. Why a second edition?Categories Strategies Sub‐strategies

Non‐directional strategies

Market neutral

Equity market neutralStatistical arbitrage

Fixed income arbitrageMortgage‐backed securities

Convertible arbitrage

Event driven

Event drivenRisk arbitrage

Distressed securitiesSpecial situationsPIPE/regulation D

Activism

Arbitrage

Relative value arbitrageOption arbitrage

Closed‐end fund arbitrageVolatility arbitrage

Multi‐strategy arbitrage Multi‐strategy arbitrage

Other Asset based lendingOther

Directional strategies

Long/short equityDeveloped marketsEmerging markets

Global

Sector Sector

Credit High yield

Short selling Short selling

Long only (leveraged) Long Only (leveraged)

Macro Macro

Managed futures CTAShort term trader

Fund of funds Diversified Diversified

Niche Niche

Source; Introduction aux hedge funds, 2nd edition, Economica 2010

1. Structure of the second edition

Chapter 1: What is a Hedge Fund? (55 pages)

Chapter 2: Hedge Fund Characteristics (76 pages)

Chapter 3: Hedge Fund Strategies (226 pages)

Chapter 4: Hedge Fund Performance over Time (42 pages)

Chapter 5: Hedge Fund Regulation (27 pages)

Chapter 6: Hedge Fund, LTCM & recent Crisis (33 pages)

Chapter 7: Hedge Funds versus Mutual Funds (12 pages)

+ websites + index + glossary

1. What’s new?1st EDITION 2nd EDITION

CHAPTERS 6 chapters 7 chapters

PAGES 350 pages 550 pages

STRATEGIES PRESENTED IN DETAILS

17 22

EXAMPLES PER STRATEGY 1‐2 (25 in total) 2‐3 (> 40)

100% updated

100% from HF managers

HEDGE FUND REGULATION

11 countries broadly covered 14 countries in details

100% update analysis

HEDGE FUND & CRISIS / Including the subprime crisis

GRAPHS & SCHEMAS Around 75 graphs & schemas More than 150 graphs & schemas

Hedge Funds in 2010: updatedfigures

Where are we today?

0

500

1 000

1 500

2 000

2 500

0

2

4

6

8

10

12

88 90 92 94 96 98 00 02

Nombre Actifs

0

500

1 000

1 500

2 000

2 500

0

2

4

6

8

10

12

88 90 92 94 96 98 00 02 04 06 08

Nombre Actifs

In 2003 In 2010

2. Hedge Fund in 2010: some updatedfigures



Number of fundson 01/01/08

Funds exiting Funds enteringEstimated

attrition rate

All HFR funds 3221 894 170 28 %

Long short equity 1566 404 74 26 %

Relative value 702 259 46 37 %

Credit 215 71 11 33 %

Directional trading 599 119 30 20 %

Systematic funds 114 29 8 25 %

Others 25 12 1 48 %

Attrition rate: percentage of funds that stopped reporting


Roughly 30% of the funds stop to report


Hedge Fund domicile based on number of funds

Hedge Fund managers domicile

Offshore42 %

United-States33 %

Europe12 %

Asia10 %

Latin America 2%

Others1 %

New York36 %

USA ex-NY28 %

London18 %

Europe ex-

London8 %

Asia10 %



Hedge Fund investorsrepartition

US Hedge Fund investorsrepartition

United States50 %

Switzerland 20 %

Japan 5 %

Others25 %

Instit. investors

31%

Private investors

36%

Funds of funds18%

Others15%


Institutional investors continue to grow


Use of hedge funds by Institutional investors

Institutional investorsallocation to Hedge Funds

01020304050607080

2001 2003 2005 2007

0

2

4

6

8

10

12

2001 2003 2005 2007 2009



Based on number of funds Based on AUM

Event driven10 %

Distressed4 %

Risk arbitrage

2 %Macro6 %

CTA6 %

Long/short equity30 %Equity

market neutral

7 %

Equity non hedge

2 %

Emerging market

8 %

Sector7 %

Fixed income

8 %


2 %Autres

8 %Event driven

16 %

Distressed7 %

Risk arbitrage

3 %

Macro10 %CTA

10 %Long/short equity20 %

Equity market neutral

6 %

Equity non hedge

2 %

Emerging market

6 %

Sector6 %

Fixed income

7 %


1 %Autres

8 %



Performance of HF, bonds & equities during the worst20 months for equities over the last 20 years


-20%

-15%

-10%

-5%

0%

5%

10-2

008

08-1

998

09-2

008

09-2

002

09-1

990

02-2

009

08-1

990

09-2

001

01-2

009

02-2

001

07-2

002

06-2

008

01-2

008

08-1

997

03-2

001

11-2

008

06-1

991

11-2

000

06-2

002

03-1

990

Moy

enne

Actions mondiales Obligations mondiales Hedge fund global

The HF index offered a positive performance 11 months (12 for bonds)

The average performance for the stock index is -9% against0.4% for bonds and -2.4% for HF.

$100 000 invested duringthese 20 months in the indices (impossible practically) would have resulted in $13 680 for shares, $108 610 for bonds and $59 900 for HF


Performance of HF, bonds & equities during the worst20 months for bonds over the last 20 years


The HF index offered a positive performance 11 months (7 for equities)

The average performance for the bond index is -1.6% against -2.1% for equities and -0.2% for HF

$100 000 invested duringthese 20 months in the indices (impossible practically) would have resulted in $71 200 for bonds, 61 290 for equities and 95 100 for HF

-20%

-15%

-10%

-5%

0%

5%

10%

07-2

003

04-2

004

03-1

994

10-2

008

02-1

999

02-1

994

02-1

996

03-2

002

09-1

994

11-2

001

01-1

992

09-2

008

08-1

990

10-1

992

01-1

990

03-1

997

09-2

005

03-2

006

10-2

003

12-1

996

Moy

enne

Obligations mondiales Actions mondiales Hedge fund global


Performance of HF, bonds & equities during the worst20 months for hedge funds over the last 20 years


The equity index was negative20 times but the bond index was up 13 times

The average performance for the HF index is -3.2% against -7% for equities and -0.5% for bonds

$100 000 invested duringthese 20 months in the indices (impossible practically) would have resulted in $50 560 for HF, 21320 for equities and 95 000 for bonds

-20%

-15%

-10%

-5%

0%

5%

10%

07-2

003

04-2

004

03-1

994

10-2

008

02-1

999

02-1

994

02-1

996

03-2

002

09-1

994

11-2

001

01-1

992

09-2

008

08-1

990

10-1

992

01-1

990

03-1

997

09-2

005

03-2

006

10-2

003

12-1

996

Moy

enne

Obligations mondiales Actions mondiales Hedge fund global

Hedge Fund in 2010: hedge fundstrategies

What changed or what is changing?

3. Hedge Fund in 2010: strategyrepartition

The hedge fund industry evolves quickly and the strategy repartition has always evolved dramatically

1970ies: long/short funds

1980ies: macro funds

1990ies: mix (long/short, macro & new strategies)

1999- early 2000ies: end of very large macro, real long/short,

CTA, CB arb, etc.

Starting 2005: long biased funds, emerging markets, less liquid

strategies (private investments, asset based lending, distressed,

event driven)

3. Hedge Fund in 2010: strategyrepartition

Since 2005, many new strategies became available: the more exotic, the more attractive

In terms of products, of markets and of tools used

Hedge fund investors focused more on returns & the background of hedge fund selector was too often light on technicals to understand the real risks.

Less liquid strategies became commonThe frontier between hedge funds and private equity funds disappeared

After the crisis, most hedge fund managers went back to basics and they are more focused

In 2010, hedge fund selectors should go deeper in the understanding of the strategies

3. Hedge Fund in 2010: new strategies


Equity non hedge

Wine investing (and other commodities)

Asset based lending

Closed-end fundarbitrage

Master Limited Partnership

Activism

Electricity trading

Trade finance

PIPE

Long/short

Event driven

Convertible Arbitrage

Equity market neutral

Fixed income arbitrageMulti-strategy

Funds of funds

Climate-related fundsSector

Short selling

Emerging Markets

High Yield

Macro

CTA

3. Hedge Fund in 2010: strategies more complex than many thinks

CreditInterest rates

FIXED INCOME ARBITRAGE

Spread trade

Curve trade

Correlation

Volatility

Spread betweencountries Relative value Long/short

Capital structure

Bonds/ CDS

Curvetrades Inter-currency

arbitrage

New issuances

Basis trading

CDS

Various maturities




Inputs Outputs

Interest rate curve

Credit spreads

Share price

Stock volatility

Currency

Dividend policy

Structure of the bond

Delta

Gamma

Theta

Vega

Sensitivity tocredit

Sensitivity to interestrates



Merger & acquisitions

Distressedcompanies

PIPE Activists

Event driven

Other specialsituations



Other specialsituations

Balance sheetrestructuring

Shares buyback

Recapitalisation refinancing

LBOs

Exchange listing

Deconsolidation

Partial sale New regulation

Reorganisation

Rating changeGovernmentprivatisation



Asset BasedLending

Transactions sourcesSpecialized agentInternal origin

Intangible Tangible non fixed Tangible fixed

<------------------------ Follow up of the collateral ------------------------Very frequent Spaced out Very spaced out

Intellectualrights

Life-insurance

Land

Real estate

Forest

Droitintellectuel

Plane

TrainRawcommodities Boat

Merchandises

Machinery

Orders Shopping center

Cash to receive

Securities

Documents describing the transaction

Long termcontracts


Trade finance Real estate financing

Life insurance

Auto loansConsumer finance

Entité d’investissement

Producteur

Courtier Spécialisé

Revendeur

Fonds ABL

Produits

CashAvance

Produits pré-vendus

Autres intervenants


Actif immobilier

Emprunteur

Fonds ABL

Financement Intérêtet

capital

Collatéral


Détenteur de police

d’assurance

Fonds ABL

CashIntermédiaire

Cash

Polices d’assurance

Polices d’assurance

Entité d’investissementAssureur Prêteur original

Fonds ABL

Prime

Assurance

Intérêts et capital

Prêt


Collatéral :véhicules

Fonds ABL

VéhiculesIntérêts et capital

Vente des prêts

Emprunteurs peu solvables

Financement

Société de financement

Vendeur de voitures

3. Hedge Fund in 2010: hedge fund & private equityMany hedge funds invested during the private phase & several private equity players shortened the life of the funds

FOUNDER PRIVATE INVESTMENT

PRIVATE INVESTMENT PUBLIC INVESTMENT

LIFE OF A COMPANYPrice

Time

PrivateEquity Fund

LISTED SECURITIES

IPO

Hedge fund


Consolidation of the hedge fundindustry

How is the industry consolidating?

4. Consolidation of the hedge fundindustry

Before the crisis, not only original but also small funds (in terms of assets) became attractive because of the competition between hedge fund investors.

After the crisis, investors look for:Funds that went through the crisisFunds that are giving enough transparencyFunds that (looks like) have(ing) the capacity to make stables returns and manage liquidity…avoid fraud and liquidity issues

Large established funds closed for years opened to investors and got the main inflows


The new talents cannot raise assets to reach the minimum size to grow furtherMany funds made significant losses in 2008 and are still far from high watermark

Many managers/traders join the large hedge fund groups

A significant part of the new assets comes frominstitutional investors that loose confidence in banks and classic asset management companies but the needinstitutionalized funds

Is it the end of the « entrepreneur of finance »?

The industry is splitting with a few hundreds big ones and the other ones


< USD20m38 %

$20m to $50m20 %

$50m to $100m12 %

$100m to $200m10 %

$200m to $500m10 %

$500m to $1 000m5 %

$1 000m to $2 000m

2 %

>2 000m3 %


In number of funds


Assets in billions of dollars

Number of funds

Assets in the bucket billions

in Percentage of the industry

20 10 200 14%10 25 250 17%5 50 250 17%1 100 100 7%

NA 185 800 55%

Assets in millions of dollars

Number of funds

Assets in the bucket in billions

Percentage of the industry

70 9 315 650 45%


In assets under management

3. Consolidation of the hedge fundindustry: why?

Because of the institutionalization of the large fundsNo exposure to unwanted risks like operational risks(operational DDQ + quantitative analysis)

Reconciliation

External events

FraudPeople

managementChange of

infrastructure

Computer problem

Electricitybreakdown

Valuation or execution

OPERATIONAL RISK


3. Consolidation of the hedge fundindustry: why?Repartition of hedge fund

failuresRepartition of operational

failures

Source; Introduction aux hedge funds, 2nd edition, Economica 2010 – originally from Capco

The future of hedge fundinvesting

The easy part?


Source : Alternative Investment Solutions, International Financial Services London based on Watson Wyatt, Merrill Lynch/Capgemini, BCG, World Federation of Exchanges, BIS.

0102030405060708090100

W… P… T…


My (published) view in 2007 was…

USA

Europe

Asia

East Europe & Russia

Latin America

Africa

ConsolidationCatch upEmergence Start



For the future, 3 phases were possible

USA

Europe

Asie

ConsolidationCatch up

Rapid growth

Persistent consolidation

Des-interest


Conclusion

Almost done…

6. ConclusionThe industry is back on track but it is different and willcontinue to evolve rapidly.

In 2010, hedge fund selector should know more than the basics of every strategy even if many managers went back to basics.

Larger established funds opened to investors after the crisis and they are getting the main inflows

The short to medium term future of the industry is probably persistent consolidation

Q&A

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Key Areas In The Hedge Fund Industry in 2010

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