Why SA Hedge Funds
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Transcript of Why SA Hedge Funds
Strictly private and confidentialFor discussion purposes only
Hedge Funds in South Africaby Peter Urbani
2
•What are Hedge Funds
•Where do Hedge Funds Belong
•What Returns should I expect
Why Hedge Funds
3
What is a Hedge• A hedge is a protective barrier, designed to mitigate or reduce the adverse effects
of something.
In the case of an actual hedge, they are designed to be windbreaks that protect fields and crops from strong winds
4
What are Hedge Funds• An extreme form of unconstrained active management that seek to generate
absolute returns by reducing downside risksCo
mpl
exity
High
Low Costs High
Equities
Index Funds
Cash
Hedge
Structured Products
Bonds
PASSIVE
ACTIVE
Balanced
5
Bi-Lateral (both sides) Symmetry (the same shape)
6
Normal Distribution Assumes Risk Symmetry
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
0.00%
500.00%
1000.00%
1500.00%
2000.00%
2500.00%
3000.00%
3500.00%
4000.00%
-6.00% -4.00% -2.00% 0.00% 2.00% 4.00% 6.00%
Normal
Upside ‘Risk’Downside ‘Risk’ =
7
But real returns often Asymmetric –ve Skewed
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
0.00%
500.00%
1000.00%
1500.00%
2000.00%
2500.00%
3000.00%
3500.00%
4000.00%
-6.00% -4.00% -2.00% 0.00% 2.00% 4.00% 6.00%
Neg- Skew Normal
Upside ‘Risk’Downside ‘Risk’ ≠
8
0.00%
500.00%
1000.00%
1500.00%
2000.00%
2500.00%
3000.00%
3500.00%
4000.00%
-6.00% -4.00% -2.00% 0.00% 2.00% 4.00% 6.00%
Normal Pos+ Skew
A hedged fund should by definition be Positively Skewed
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
Upside ‘Risk’Downside ‘Risk’ ≠
9
Equities versus Equities – Beta = 1.00, Alpha = 0%
If you buy Equities you are exposed to Pure Beta
-8.00%
-6.00%
-4.00%
-2.00%
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
-8.00% -6.00% -4.00% -2.00% 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00%
Pure
Bet
a
SA Equities
Best Fit Bi-variateCopula Lines
PiecewiseRegression
Linear Regression
ALPHA = 0.00%
ACTUAL
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
10
Equities versus Equities – Beta = 1.00, Alpha = 0%
When Markets go down you go down by the same amount
-8.00%
-6.00%
-4.00%
-2.00%
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
-8.00% -6.00% -4.00% -2.00% 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00%
Pure
Bet
a
SA Equities
Best Fit Bi-variateCopula Lines
PiecewiseRegression
Linear Regression
ALPHA = 0.00%
ACTUAL
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
11
Perfectly ‘Hedged’ Fund – Downside Beta = 0, Upside Beta = 1.0, Alpha = +1.21%
A Perfectly Hedged Fund would protect your downside
ASSUMEDJOINT NORMALDISTRIBUTIONSSYMMETRIC
-8.00%
-6.00%
-4.00%
-2.00%
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
-8.00% -6.00% -4.00% -2.00% 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00%
Perfe
ctly
Hed
ged
SA Equities
Best Fit Bi-variateCopula Lines
PiecewiseRegression
Linear Regression
ALPHA = 1.21%
THEORETICAL
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
12
Perfectly ‘Hedged’ Fund – Downside Beta = 0, Upside Beta = 1.0, Alpha = +1.21%
Which would by definition make its returns Asymmetric
ACTUAL JOINTDISTRIBUTIONSBY DEFINITIONASYMMETRIC
-8.00%
-6.00%
-4.00%
-2.00%
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
-8.00% -6.00% -4.00% -2.00% 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00%
Perfe
ctly
Hed
ged
SA Equities
Best Fit Bi-variateCopula Lines
PiecewiseRegression
Linear Regression
ALPHA = 1.21%
THEORETICAL
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
13
• Joint Normal Distribution assumption can under- or over- state both positive and negative risks and consequently tail risk and true correlation.
Normal versus Positively Skewed Distributions
-2.00%
-1.28%
-0.56%
0.16%
0.88%
1.60%
2.32%
3.04%
3.76%
0.0000
0.0200
0.0400
0.0600
0.0800
0.1000
0.1200
0.1400
0.1600
0.1800
-4.0
0%
-3.6
8%
-3.3
6%
-3.0
4%
-2.7
2%
-2.4
0%
-2.0
8%
-1.7
6%
-1.4
4%
-1.1
2%
-0.8
0%
-0.4
8%
-0.1
6%
0.16
%
0.48
%
0.80
%
1.12
%
1.44
%
1.76
%
2.08
%
2.40
%
2.72
%
3.04
%
3.36
%
3.68
%
4.00
%
Test Fund
Bad
0.1600-0.18000.1400-0.16000.1200-0.14000.1000-0.12000.0800-0.10000.0600-0.08000.0400-0.06000.0200-0.04000.0000-0.0200
-3.00% -2.04% -1.08% -0.12% 0.84% 1.80% 2.76% 3.72% 4.68%0.0000
0.0200
0.0400
0.0600
0.0800
0.1000
0.1200
0.1400
0.1600
-4.00%
-3.20%
-2.40%
-1.60%
-0.80%
0.00%
0.80%
1.60%2.40%
3.20%4.00%
Good
Bad
0.1400-0.16000.1200-0.14000.1000-0.12000.0800-0.10000.0600-0.08000.0400-0.06000.0200-0.04000.0000-0.0200
14
-8.00%
-6.00%
-4.00%
-2.00%
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
-8.00% -6.00% -4.00% -2.00% 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00%
Perfe
ct H
edge
SA Equities
Best Fit Bi-variateCopula Lines
PiecewiseRegression
Linear Regression
Perfect Hedge Fund – Downside Beta = 0.30, Upside Beta = 0.70, Alpha = +1.50%
A Perfect Hedge Fund would give you alpha of around 1.50%
ALPHA = 1.50%
THEORETICAL
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
15
-8.00%
-6.00%
-4.00%
-2.00%
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
-8.00% -6.00% -4.00% -2.00% 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00%
Med
ian
LS H
edge
Fund
SA Equities
Best Fit Bi-variateCopula Lines
PiecewiseRegression
Linear Regression
Actual LS Hedge Fund – Downside Beta = 0.14, Upside Beta = 0.20, Alpha = +0.70%
Actual Hedge Funds have delivered about half of that
ALPHA = 0.70%
ACTUAL
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
16
-8.00%
-6.00%
-4.00%
-2.00%
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
-8.00% -6.00% -4.00% -2.00% 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00%
Top
Qua
rtile
LS H
edge
Fund
SA Equities
Best Fit Bi-variateCopula Lines
PiecewiseRegression
Linear Regression
Top 25% LS Hedge Fund – Downside Beta = 0.12, Upside Beta = 0.32, Alpha = +1.70%
But Top Quartile Funds have delivered more
ALPHA = 1.70%ACTUAL
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
17
-8.00%
-6.00%
-4.00%
-2.00%
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
-8.00% -6.00% -4.00% -2.00% 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00%
Top
Deci
le LS
Hed
ge Fu
nd
SA Equities
Best Fit Bi-variateCopula Lines
PiecewiseRegression
Linear Regression
Top 10% LS Hedge Fund – Downside Beta = 0.06, Upside Beta = 0.45, Alpha = +2.95%
And Top Decile Funds have delivered twice as much
ALPHA = 2.95%ACTUAL
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
18
-8.00%
-6.00%
-4.00%
-2.00%
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
-8.00% -6.00% -4.00% -2.00% 0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00%
Botto
m D
ecile
LS H
edge
Fund
SA Equities
Best Fit Bi-variateCopula Lines
PiecewiseRegression
Linear Regression
Worst 10% LS Hedge Fund – Downside Beta = 0.36, Upside Beta = 0.13, Alpha = -1.36%
While Bottom Decile Funds have not done as badly
ALPHA = -1.36%THIS IS WHAT YOUDON’T WANT TO SEEHIGHER 4TH QUADRANT TAIL DEPENDENCE
ACTUAL
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
19
Impact of Asymmetry on Risk Metrics - Actual
-15.00% -10.00% -5.00% 0.00% 5.00% 10.00% 15.00% 20.00%
Best Fit and Assumed Normal Distributions for Pure Beta
Best Fit Fund PDF (Normal)
Assumed Normal Fund PDF (Normal)
-2.00% -1.00% 0.00% 1.00% 2.00% 3.00% 4.00%
Best Fit and Assumed Normal Distributions for Median LS Hedge Fund
Best Fit Fund PDF (J ohnson (Lognormal))
Assumed Normal Fund PDF (Normal)
Hedge Funds’Equities
20
• Hedge Funds are complimentary assets
Where do Hedge Funds Belong
SA Equities
SA BondsSA Cash
SA Property
SA Hedge
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00% 18.00%
Retu
rns (
Annu
al)
Volatility (Annual)
SA Domestic Asset Classes
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
21
Efficient Frontier without Hedge Funds allowed
• Hedge Funds are complimentary assets
SA Equities
SA BondsSA Cash
SA Property
SA Hedge
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00% 18.00%
Retu
rns (
Annu
al)
Volatility (Annual)
Efficient Frontier Without Hedge Funds
Efficient Frontier Without Hedge Funds ( Normal )
Optimal Without Hedge Funds ( Normal ) Vol = 9.09%
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
22
Efficient Frontier with Hedge Funds allowed
• Frontier with Hedge Funds moves to the left – reducing volatility
SA Equities
SA BondsSA Cash
SA Property
SA Hedge
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00% 18.00%
Retu
rns (
Annu
al)
Volatility (Annual)
Efficient Frontier With Hedge Funds
Efficient Frontier With Hedge Funds ( Normal )
Optimal With Hedge Funds ( Normal ) Vol = 2.76%
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
23
Hedge Funds are Risk Diversifiers
• Adding Hedge Funds to your portfolio will reduce its volatility
SA Equities
SA BondsSA Cash
SA Property
SA Hedge
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00% 18.00%
Retu
rns (
Annu
al)
Volatility (Annual)
Efficient Frontier With and Without Hedge Funds
Efficient Frontier Without Hedge Funds ( Normal )
Efficient Frontier With Hedge Funds ( Normal )
Optimal With Hedge Funds ( Normal ) Vol = 2.76%
Optimal Without Hedge Funds ( Normal ) Vol = 9.09%
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
24
Including Hedge Funds leads to better Risk Adjusted Returns
SA Equities
SA BondsSA Cash
SA Property
SA Hedge
0.00%
0.20%
0.40%
0.60%
0.80%
1.00%
1.20%
1.40%
1.60%
-9.00%-8.00%-7.00%-6.00%-5.00%-4.00%-3.00%-2.00%-1.00%0.00%1.00%
Retu
rns (
Mon
thly)
Modified Value at Risk ( VaR )
Mean Modified Value at Risk (VaR) (Monthly) Frontier
Efficient Frontier Without Hedge Funds ( Normal )
Efficient Frontier With Hedge Funds ( Normal )
Optimal Without Hedge Funds ( Normal ) VaR @ ( 99.00% ) = -5.12%
Optimal With Hedge Funds ( Normal ) VaR @ ( 99.00% ) = -1.00%
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
• Hedge Funds are risk diversifiers
25
• Hedge Funds are complimentary assets
Unconstrained Optimal Portfolio mainly in Hedge Funds
26
• Hedge Funds are complimentary assets
But many SA investors subject to Reg 28 Constraints
27
Reg 28 (Prudential Limit) Constrained Efficient Frontiers
• Even with Hedge Funds limited to 10% of your portfolio they still shift the frontier
SA Equities
SA BondsSA Cash
SA Property
SA Hedge
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00% 18.00%
Retu
rns (
Annu
al)
Volatility (Annual)
Reg 28 Constrained Frontiers With and Without Hedge Funds
Efficient Frontier Without Hedge Funds ( Normal )
Efficient Frontier With Hedge Funds ( Normal )
Optimal With Hedge Funds ( Normal ) Vol = 7.84%
Optimal Without Hedge Funds ( Normal ) Vol = 8.60%
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
28
Impact of Asymmetry on Efficient Frontiers
• Even with Hedge Funds limited to 10% of your portfolio they still shift the frontier
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
SA Equities
SA BondsSA Cash
SA Property
SA Hedge
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00% 18.00%
Retu
rns (
Annu
al)
Volatility (Annual)
Mean Modified Frontiers With and Without Hedge Funds
Efficient Frontier Without Hedge Funds ( Modified )
Efficient Frontier With Hedge Funds ( Modified )
Optimal With Hedge Funds ( Modified ) Vol = 7.25%
Optimal Without Hedge Funds ( Modified ) Vol = 7.82%
29
Impact of Asymmetry on Efficient Frontiers
• Standard Mean Variance ( Normal ) Frontier does not capture asymmetry
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
SA Equities
SA BondsSA Cash
SA Property
SA Hedge
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00% 18.00%
Retu
rns (
Annu
al)
Volatility (Annual)
Normal Frontier provides innacurate allocation advice
Efficient Frontier With Hedge Funds ( Normal )
Efficient Frontier With Hedge Funds ( Modified )
Optimal With Hedge Funds ( Modified ) Vol = 7.25%
Optimal With Hedge Funds ( Normal ) Vol = 7.84%
30
Asymmetry causes Correlation and Vols to be Different
31
Impact of Asymmetry on Efficient Frontiers
• Standard Mean Variance ( Normal ) Frontier does not capture asymmetry
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
SA Equities
SA BondsSA Cash
SA Property
SA Hedge
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00% 18.00%
Retu
rns (
Annu
al)
Volatility (Annual)
Normal Frontier provides innacurate allocation advice
Efficient Frontier With Hedge Funds ( Normal )
Efficient Frontier With Hedge Funds ( Modified )
Optimal With Hedge Funds ( Modified ) Vol = 7.25%
Optimal With Hedge Funds ( Normal ) Vol = 7.84%
32
Impact of Asymmetry on Hedge Fund Efficient Frontiers
• Standard Mean Variance ( Normal ) Frontier does not capture asymmetry
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
BI Fixed Income
BI LS Conservative
BI LS Aggressive
BI Commodities
BI Structured Finance
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
0.00% 2.00% 4.00% 6.00% 8.00% 10.00% 12.00% 14.00% 16.00% 18.00%
Retu
rns (
Annu
al)
Volatility (Annual)
Normal Frontier provides suboptimal allocation advice
Efficient Frontier With Hedge Funds ( Normal )
Efficient Frontier With Hedge Funds ( Modified )
Optimal With Hedge Funds ( Modified ) Vol = 1.44%
Optimal With Hedge Funds ( Normal ) Vol = 1.62%
33
Normal ( Mean Variance ) and Modified Optimal Allocations
12.99%
30.00%
13.80%
10.97%
2.24%
30.00%
Optimal Porfolio Weights ( Normal )
BI Fixed Income BI LS Conservative BI LS Aggressive
BI Commodities BI Structured Finance BI Other
0.00%
30.00%
30.00%4.47%
5.53%
30.00%
Optimal Porfolio Weights ( Modified )
BI Fixed Income BI LS Conservative BI LS Aggressive
BI Commodities BI Structured Finance BI Other
34
( Normal ) and ( Modified ) Correlation and Vols
35
Giving much better Risk Adjusted Stats
• Standard Mean Variance ( Normal ) Frontier does not capture asymmetry
Source: Blue Ink Investments, Data from 1 Jan 2011 to 31 Dec 2015
BI Fixed Income
BI LS Conservative
BI LS Aggressive
BI Commodities
BI Structured Finance
BI Other
0.00%
0.20%
0.40%
0.60%
0.80%
1.00%
1.20%
1.40%
-8.00%-7.00%-6.00%-5.00%-4.00%-3.00%-2.00%-1.00%0.00%1.00%
Retu
rns (
Mon
thly)
Modified Value at Risk ( VaR )
Mean Modified Value at Risk (VaR) (Monthly) Frontier
Efficient Frontier With Hedge Funds ( Normal )
Efficient Frontier With Hedge Funds ( Modified )
Optimal With Hedge Funds ( Normal ) VaR @ ( 99.99% ) = -0.98%
Optimal With Hedge Funds ( Modified ) VaR @ ( 99.99% ) = -0.46%
36
Looking after other people’s money requires both Defensive (Risk Management) and Offensive ( Selection ) skills
37
Hedge Funds should be a key part of your defense
• Including Hedge Funds in your portfolio can help limit downside risks