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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:
5
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
6
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
7
1.4. Hedge fund strategies classification used by Harcourt
Fixed Income Equities Futures, 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 Arbitrage8. Reg D Private Convertibles9. Merger Arbitrage10. Index and Options Arbitrage11. Statistical Equity Arbitrage12. Fundamental Market Neutral
Equity
Relative Value Futures and Commodities Strategies:20. Commodities Arbitrage
Directional
Directional Fixed Income Strategies:
4. High Yield5. Distressed Securities6. Emerging Markets
Debt
Directional Equity Strategies:
13. Long/Short US Equities14. Long/Short European Equities15. Long/Short Japanese Equities16. Long/Short Emerging Markets17. Long/Short Sectors18. Short-Biased Equities19. Mutual Fund Timers
Directional Managed Futures and Currency Strategies:21. Long Term Systematic Trading22. Short Term Systematic Trading23. Currency Trading24. Discretionary Trading
Multiple
Multiple Strategies:25. Macro Hedge Funds26. Multi-Strategy Funds27. Funds of Funds
8
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
9
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
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
12
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
Source: HFR, JPM, MSCI 1994-2003
13
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
Source: HFR, JPM, MSCI 1994-2003
Aun
nual
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
Source: HFR, JPM, MSCI 1994-2003
Aun
nual
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 DebtMacro
Short Sellers
CTAs
15
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 fundsAun
nual
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 BondsAun
nual
ized
Ret
urn
Source: HFR, JPM, MSCI 1994-2003Standard Deviation
JPM Global Bonds
MSCI World Equities
HFR Hedge Funds
Portfolio with hedge funds
17
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
Source: HFR, JPM, MSCI 1994-2002
18
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
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 keyQualitative 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 managementActive 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
23
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 och multi-manager approach?
4. Hedge funds as Alpha generators – what does that really mean?
5. Conclusions
4.
24
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!
25
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 och multi-manager approach?
4. Hedge funds as Alpha generators – what does that really mean?
5. Conclusions5.
26
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 Gangsted-Rasmussenpgr@privestor.dk
Niels Kaysernk@privestor.dk Pho. +45 45 82 45 87
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