Hedge FundsLecture 1: Overview
Ezra Zask
Yale University
September, 2005
Definition• Investment approach
– A sub-set of alternative investments that incorporate all investment strategies run with an orientation to producing primarily absolute returns using largely marketable securities.
– Strategies typically include short-selling and often include leverage– As a result, correlations with broader markets are expected to be modest to low.
• Legal Definition– Freedom from ICA (1940) controls on:
• Leverage• short-selling• cross-holding• 10% limits• incentive compensation• derivatives positions
– Limitations on:• number of U.S. investors (99 maximum)• solicitation of U.S. investors• public advertising and disclosure
Institutional Allocation
Allocation Methodology
Impediments to Investing
Institutional Assets
Institutional Share of Assets
Long Only Managers
Structured Products
Asset Class Allocation by Institutional Investors
Asset Class Percent Allocation
Equity 51%
Fixed Income 17%
Real Estate 4%
Hedge Funds 15%
Private Equity 3.2%
Venture Capital 3.5%
Natural Resources 3%
Source: NACUBO Endowment Study
Strategy Allocation
Strategy Assets ($bln) Percent Assets Number Funds
Long/Short Equity Hedge
282 35% 1148
Event Driven 38.6 18% 316
Other 40.7 9% 316
Fixed Income Arbitrage
38.6 166
Global Macro 32.6 8% 146
Emerging Markets 31.7 7% 168
Market Neutral 26.8 6% 212
Convertible Arbitrage
22.2 5% 124
Dedicated Short 1.2 -- 17
Source: Lipper/Tass
Hedge Fund Location
Location Percent Assets
Cayman Islands 35%
United States 32%
British Virgin Islands 8%
Bermuda 8%
Bahamas 4%
Luxembourg 3%
Asia 4%
S&P Hedge Fund Strategies
Strategy Definitions
Fixed Income Arbitrage
Convertible Arbitrage
Merger Arbitrage
Equity Market Neutral
Distressed Securities Strategy
Special Situations
Equity Long/Short
Managed Futures
Global Macro
Strategy PerformanceConve
rtible Arbitra
ge
Distressed
Securities
Emerging
Markets
Equity Hedge
Equity Market Neutra
l
Event-Driven
Fixed Incom
e Arbitra
ge
Fixed Incom
e Convt Bonds
Fund of
Funds
Macro Merger
Arbitrage
Market Ti
Relative
Value Arbitra
ge
Dec 1993 15.22 32.54 87.10 27.94 11.11 28.22 16.64 23.60 26.32 53.31 20.24 24.18 27.10
Dec 1994 -3.73 3.84 7.65 2.61 2.65 6.00 11.94 -0.62 -3.48 -4.30 8.88 3.49 4.00
Dec 1995 19.85 19.73 9.02 31.04 16.33 25.11 6.08 19.17 11.10 29.32 17.86 12.58 15.66
Dec 1996 14.56 20.77 35.69 21.75 14.20 24.84 11.89 18.24 14.39 9.32 16.61 13.47 14.49
Dec 1997 12.72 15.40 19.85 23.41 13.62 21.23 7.02 17.60 16.20 18.82 16.44 13.57 15.93
Dec 1998 7.77 -4.23 -36.39 15.98 8.30 1.70 -10.29 7.53 -5.11 6.19 7.23 24.82 2.81
Dec 1999 14.41 16.94 40.06 44.22 7.09 24.33 7.38 36.94 26.47 17.62 14.34 26.17 14.73
Dec 2000 14.50 2.78 -9.39 9.09 14.56 6.74 4.78 -11.17 4.07 1.97 18.04 11.79 14.43
Dec 2001 13.37 13.28 11.51 0.31 6.71 12.18 4.81 3.30 2.80 6.87 2.76 4.09 8.92
Dec 2002 9.07 5.28 -0.03 -4.71 0.98 -4.30 8.77 -13.07 1.01 7.42 -0.86 -3.26 5.42
Dec 2003 9.93 29.58 32.41 20.53 2.46 25.33 9.35 17.52 11.62 21.44 14.39 15.38 9.72
Dec 2004 0.97 18.21 16.92 7.66 4.63 14.23 5.15 8.60 6.39 4.72 3.51 3.68 5.03
Strategy Performance (2) Mean Return
(%)
Standard Deviation
(%)
Sharpe Ratio Skewness Kurtosis Alpha Beta
HFRI Convertible Arbitrage TR 10.53 6.56 1.6341 -1.1349 1.1389 0.0963 0.0863
HFRI Distressed Securities TR 14.02 10.99 1.3205 -0.0382 -0.5506 0.1193 0.2043
HFRI Emerging Markets Global TR 14.31 30.23 0.5911 0.6470 2.1399 0.1524 0.2087
HFRI Equity Hedge TR 15.86 14.27 1.1668 0.2938 -0.3562 0.0972 0.5501
HFRI Equity Market Neutral TR 8.43 5.32 1.6088 0.0563 -1.5066 0.0707 0.1172
HFRI Event-Driven TR 14.98 10.92 1.4171 -0.5234 -1.1254 0.1091 0.3615
HFRI Fixed Income Arbitrage TR 6.77 6.49 1.0732 -1.5944 4.7397 0.0770 -0.0587
HFRI Fixed Income Convt Bonds TR 9.74 14.52 0.7328 -0.1235 -0.1972 0.0369 0.5515
HFRI Fund of Funds TR 8.87 10.38 0.8976 0.4218 -0.6267 0.0671 0.2066
HFRI Macro TR 13.52 15.41 0.9337 1.5481 2.9839 0.1063 0.2987
HFRI Market Timing TR 12.14 9.36 1.3350 0.0168 -0.8327 0.0871 0.3003
HFRI Merger Arbitrage TR 11.41 7.04 1.6514 -0.5811 -1.1259 0.0908 0.2017
HFRI Relative Value Arbitrage TR 11.33 6.93 1.6616 0.7886 0.8755 0.1045 0.0847
Style Risk Return
Ris k (STD)
Return (A M)Ja nu a ry 1990 - Jun e 2005Risk vs. Return
2.0% 19.0%3.0% 4.0% 5.0% 6.0% 7.0% 8.0% 9.0% 10.0% 11.0% 12.0% 13.0% 14.0% 15.0% 16.0% 17.0% 18.0%
-2.0%
16.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
7.0%
8.0%
9.0%
10.0%
11.0%
12.0%
13.0%
14.0%
15.0%
CSFB/Tremont Convertible A rbitrage Index
CSFB/Tremont Dedicated Short Bias Index
CSFB/Tremont Emerging Markets Index
CSFB/Tremont Equity Market Neutral Index
CSFB/Tremont Event Driven Index
CSFB/Tremont Fix ed Income A rbitrage Index
CSFB/Tremont Global Macro Index
CSFB/Tremont Long/Short Equity Index
CSFB/Tremont Managed Futures Index
CSFB/Tremont Hedge Fund Index
TA SS Fund of Funds Universe A verage
Style Correlations 1/1994-6/2005
Style Correlations
Distressed EmergingMarkets
EquityMarketneutral Even Multi Fixed Income Macro HF Index Futures FoF
Distressed Index 1 0.5823 0.363 0.9357 0.7509 0.3117 0.3161 0.5796 -0.1267 0.661
Emerging Markets Index 0.5823 1 0.2464 0.6653 0.6665 0.2751 0.419 0.6535 -0.0991 0.7399
Equity Market Neutral Index 0.363 0.2464 1 0.3918 0.3658 0.1133 0.2098 0.3364 0.1231 0.4441
Event Driven Index 0.9357 0.6653 0.3918 1 0.9317 0.3881 0.3824 0.6691 -0.1741 0.7577
Multi-Strategy Index 0.7509 0.6665 0.3658 0.9317 1 0.4289 0.4279 0.6878 -0.1948 0.7616
Fixed Income Arbitrage Index 0.3117 0.2751 0.1133 0.3881 0.4289 1 0.4541 0.4476 -0.0685 0.426
Global Macro Index 0.3161 0.419 0.2098 0.3824 0.4279 0.4541 1 0.8587 0.2445 0.6453
Hedge Fund Index 0.5796 0.6535 0.3364 0.6691 0.6878 0.4476 0.8587 1 0.1264 0.9082
Managed Futures Index -0.1267 -0.0991 0.1231 -0.1741 -0.1948 -0.0685 0.2445 0.1264 1 0.1171
Fund of Funds 0.661 0.7399 0.4441 0.7577 0.7616 0.426 0.6453 0.9082 0.1171 1
CISDM Style Beta Analysis
S&P 500 Small Cap S&P Volatility Implied VolChange in Implied
VolYield Curve
SlopeCredit Risk
Premium10 Year Swap
Spread
Equity Hedge M M M H M M H M
Relative Value Arbitrage M H H L M M H M
Global Macro M H M L M M M M
Fund of Funds M M M H M M H M
Equity Market Neutral M M M M M L M M
Convertible Arbitrage M H H L M L M H
Fixed Income: Arbitrage M M H L M H M M
Hedge Fund Alpha
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