Using Alpha Hedge Fund Strategies FINAL - Verus top‐down expertise for designing portfolio...

SEPTEMBER 1, 2015

Using Hedge Fund Alpha Strategies to Improve Portfolio ConstructionShelly Heier & Jim Vos from Aksia, LLC

Why we favor hedge funds today

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1

2

3

4

5

6

7

8

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1988 1994 1999 2005 2010

Yield (%)

Japan 10 Yr Yield US 10 Yr Yield

September 1, 2015Verus Client Summit

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

2008 2010 2011 2013 2014

MSCI ACWI NR USD MSCI EAFE NR USD

S&P 500 TR USD MSCI EM NR USD

End of the 30-year bull market in bonds?

Cresting of six-year bull market in equities?

2

Sources: Bloomberg, MSCI, Standard & Poors

The role of hedge funds


Source: SEI Hedge Fund Investor Survey

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The low correlation promise

0% 10% 20% 30% 40% 50%

Ability to exploitmarket opportunities

Enhanced alpha generation

Decreased Volatility

Absolute Return

Diversification w/non‐correlated assets

What do hedge fund investors want?

September 1, 2015Verus Client Summit 4

Diminishing benefits?


Aggregate hedge fund correlation versus stocks and bonds

Source: Bloomberg, HFR, Barclays, MSCI, Verus. Equity returns represented by MSCI ACWI, while Bonds were represented by the Barclays Global Agg

(0.60)

(0.40)

(0.20)

‐

0.20

0.40

0.60

0.80

1.00

1997

1999

2001

2003

2005

2007

2009

2011

2013

Correlation

Correl ‐ EquitiesCorrel ‐ Bonds

(0.60)

(0.40)

(0.20)

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1997

1999

2001

2003

2005

2007

2009

2011

2013

Correlation

Correl ‐ Equities

Correl ‐ Bonds

HFRI FUND OF FUNDS COMPOSITE HFRI FUND WEIGHTED COMPOSITE

Diminishing benefits?


Aggregate hedge fund beta versus stocks and bonds

Source: Bloomberg, HFR, Barclays, MSCI, Verus. Equity returns represented by MSCI ACWI, while Bonds were represented by the Barclays Global Agg

(1.00)

(0.50)

‐

0.50

1.00

1997

1999

2001

2003

2005

2007

2009

2011

2013

Beta

Beta ‐ EquitiesBeta ‐ Bonds

(1.00)(0.80)(0.60)(0.40)(0.20)0.000.200.400.600.801.00

1997

1999

2001

2003

2005

2007

2009

2011

2013

Beta

Beta ‐ Equities Beta ‐ BondsLinear (Beta ‐ Equities) Linear (Beta ‐ Bonds)

HFRI FUND OF FUNDS COMPOSITE HFRI FUND WEIGHTED COMPOSITE

Disintegrating the aggregate

‐0.4 ‐0.2 0 0.2 0.4 0.6 0.8

Emerging MarketsEquity Hedge (Total)Event Driven (Total)

Relative Value ‐ Yield AlternativesEvent Driven ‐ Distressed

Relative Value ‐ Convertible ArbitrageMacro ‐ Systematic

Relative Value (Total)Macro (Total)

Event Driven ‐ Merger ArbitrageEquity Market Neutral

Relative Value ‐ Asset‐Backed

Beta to Fixed Income Beta to Equities


Benefits and diversification capacity vary by strategy

Source: Analysis uses MSCI ACWI and BC Global Agg. MSCI, Barclays, Bloomberg, HFRI, Verus. Data from January 1995 to June 2015.

Disintegrating the aggregate


Benefits and diversification capacity vary by strategy

Source: Analysis uses MSCI ACWI and BC Global Agg. MSCI, Barclays, Bloomberg, HFRI, Verus. Data from January 1995 to June 2015.

0 0.2 0.4 0.6 0.8 1

Relative Value ‐ Asset BackedEquity Market Neutral

Macro (Total)Macro ‐ Systematic

Relative Value ‐ Convertible ArbitrageRelative Value ‐ Yield AlternativesEvent Driven ‐ Merger Arbitrage

Event Driven ‐ DistressedRelative Value (Total)

Emerging MarketsEvent Driven (Total)Equity Hedge (Total)

Correlation to Bonds Correlation to Equities

Adding alpha

5% 0% 8% 14% 4%

5%

‐8%

0%

0%

‐2%

2010 2011 2012 2013 2014EEquity Hedge

Returns in Excess of Benchmark BetaReturns Attributable to Benchmark Beta


3% 0%4%

9%

2%

9%

‐3%

5%

4%

2%

2010 2011 2012 2013 2014EEvent Driven

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Barclays Capital Solutions study based on HFR returns

Source: Barclays Capital Solutions, January 2015 “What Lies Beneath: 2015 Global Hedge Fund Industry Trends and Allocation Outlook”http://www.barclayscommunications.com/CapSol_Publications/520593/WhatLiesBeneath_USL.pdf

Beta to S&P 500: 0.41 0.54 0.57 0.47 0.47 0.26 0.38 0.29 0.29 0.24

Hedge fund “beta”


Certain strategies rely on premia that are widely documented and understood…

Source: HFR, IndexIQ, Bloomberg, Verus

R² = 0.5964HF

RI ED: M

erger A

rbitrage Index

IQ ARB Merger Arbitrage Total Return Index

Finding alpha… and finding impact


StrategyReturn‐

Enhancing Risk ReductionNew Risk Factors

(Diversification)

Equity Strategies

Long‐Short Equity

Market Neutral

Short‐Biased

Macro Strategies

Global Macro

Managed Futures

ArbitrageStrategies

Event Driven

Convertible Arbitrage

Fixed Income Arbitrage

High Impact Moderate Impact Low Impact

4%

5%

6%

7%

8%

0% 2% 4% 6% 8% 10% 12% 14% 16% 18%

Annu

alize

d Re

turn

Annualized Volatility

The impact of hedge funds


Historical risk and return (1995-2015)

Source: Bloomberg, Barclays, MSCI, HFR, JP Morgan. Data from January 1995 to June 2015.

30% Stocks70% Bonds

60% Stocks20% Bonds20% HF

100% Bonds

100% Stocks

50% Stocks50% Bonds

70% Stocks30% Bonds



Seeking alpha: FOF or direct?

Key considerations include:

1. Unbiased top‐down expertise for designing portfolio strategy

2. Bottom‐up expertise for evaluating and selecting managers

3. Independent expertise for evaluation of operational risks of managers

4. Administrative bandwidth for portfolio implementation and maintenance


As much a governance decision as cost decision

Hedge funds are not without challenges

― Leverage― Counterparty― Operational― Headline― Regulatory

Complex Fees Risk Opaque


― Activism― Crowding― Short skill― High

frequency trading

― Secrecy― Hidden beta― Frequent

trading

― $$$

Verus Alternatives Investment Committee

Verus hedge fund research staff

Verus hedge fund solution


Investment due diligenceOperational due diligenceComprehensive modeling & analytics

Oversight, review, and monitoring

Risk‐based evaluation & analysisTailored portfolio designFormal focus list

Verus Portfolio Managers, Consultants & Clients

Portfolio design & client communication

Aksia professionals

9%36%55%

Total Staff 95

Research Staff 57

Average Assets Under Advisory Committed to Hedge Funds: $1,280* mm

Total Clients : Total Staff .7 : 1

Monitored Funds : Operational Due Diligence Staff 12 : 1

Monitored Funds : Investment Due Diligence Staff 8 : 1

* Data as of August 2015. This includes advisory clients only and represents a conservative estimate of the assets our clients have committed to allocating to hedge funds based on most recently available information. Number is not inclusive of clients who do not disclose hedge fund allocations to Aksia.

Verus Client SummitSeptember 1, 2015

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Research coverage

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Insight Reports1 ODD2 IDD3 Monitored4

Long/Short Equity 188 393 206 82

Event Driven 169 165 121 65

Relative Value 137 173 104 54

Tactical Trading 76 180 123 50

Multi‐Strategy 25 57 47 24

Hedge Funds 595 968 601 275

*Data as of August 20151. Figures represent investment programs on which an investment insight report has been completed.2. Figures represent investment programs on which operational due diligence has been performed. Both onshore and offshore funds of the same program count as one.3. Figures represent investment programs on which investment due diligence has been performed. Both onshore and offshore funds of the same program count as one.4. Figures shown represent total number of investment programs on which we perform ongoing monitoring. Both onshore and offshore funds of the same program count as one.


Strategy Team & Structure Risk

― History & background― Investment strategy

overview― Investment risks― Capital allocation― Research / inv. process― Firm and fund structure

― Key staff and dependencies― Staff turnover― Compensation structure― Alignment of interests― Firm ownership structure

― Risk management philosophy

― Risk management team― Asset liability / mismatch― Risk exposure, leverage

and financing― Quantitative risk analysis

Investment due diligence

18September 1, 2015Verus Client Summit

Operational due diligence

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Infrastructure & Operational Process

Regulatory, Compliance & Background Document Review

― Competence of key staff― Counterparty relationships― Independence of NAV― Review of trading systems― Cash management process

― Regulatory registrations― Compliance culture & approach― History of examinations by

regulator(s)― Background checks on key

employees― Historical violations ― Conflicts of interest

Specialist review of:― Financial statements― Offering Memo― Form ADV


Risk framework

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Risk Exposures

Risk / Return Profile

Risk‐Based Position Sizing

Public Holdings

Alpha Analysis

Factor Replication

Liquidity Mapping

Active Management Attribution


Why we favor hedge funds today

0

1

2

3

4

5

6

7

8

9

10

1988 1994 1999 2005 2010

Yield (%)

Japan 10 Yr Yield US 10 Yr Yield


$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

2008 2010 2011 2013 2014

MSCI ACWI NR USD MSCI EAFE NR USD

S&P 500 TR USD MSCI EM NR USD

End of the 30-year bull market in bonds?

Cresting of six-year bull market in equities?

21

Sources: Bloomberg, MSCI, Standard & Poors

Questions?


Thank you


Every asset class has a role


RETURN ROLES DIVERSIFICATION & VOLATILITY ROLES

Benefit from GDP Growth

Earn Risk Premium

Produce Stable Income

Hedge Against Inflation

Low Absolute Volatility

Low Corr. To Other Assets

Reduce Portfolio Volatility

Public Equities

Fixed (Credit)

Hedge Funds(Perceived role)

MAGNITUDEHigh Med‐High Medium Low None

Using Alpha Hedge Fund Strategies FINAL - Verus top‐down expertise for designing portfolio...

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