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Den Danske Finansanalytikerforening Investing in Hedge Funds – The Investor‘s Perspective March 18 2004. Representative in Denmark :. About Harcourt. Mission: Deliver superior investment solutions and products within the context of hedge funds to institutional investors
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Den Danske FinansanalytikerforeningInvesting in Hedge Funds – The Investor‘s PerspectiveMarch 18 2004 Representative in Denmark:
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 Re • Novartis Pension Fund • Hagströmer & Qviberg
Agenda • Hedge funds – structural differences to traditional investing • Hedge fund investing – what is the value added for the investor? • How to construct a hedge fund investment – single manager or fund of hedge fund approach? • Hedge funds as Alpha generators – what does that really mean? • Conclusions 1.
1.1. What is a hedge fund? Common for all hedge funds is: • The ambition to generate absolute returnsAbsolute 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 managersMore flexibility in what they invest in (such as asset classes) as well as in investment techniques (e.g. usage of derivatives/leverage) • Due to less restrictions – hedge funds are very heterogeneous
Hedge fund Management Traditional Management Inv. Restrictions None Numerous Return Objective Absolute return Relative return View on risk Loss of capital Deviation from index Investment method Buy long, sell short Buy long Incentive Reach return target Beat index Fee structure Mgmt + Perf Fees Management Fee Own assets invested Very common Very uncommon 1.2. Hedge funds from the portfolio manager perspective
Hedge Funds Traditional funds Subscription terms Monthly/Quarterly Daily Legal structure Offshore / unregulated Onshore / regulated Min. investment USD 1 mln / 5 mln Low (Weekly)/Monthly NAV Reporting Daily Transparency Low High Fee structure 1-2% Mgmt; 20% Perf 1.5% Mgmt Main risk Manager Risk Market Risk 1.3. Hedge funds from the investor perspective
Hedge Fund Strategies Globally Hedge Fund Manager Locations RV Equity 23% Directional FI Long/Short 6% Equity 55% CTA 12% Relative Value FI 4% Evolution of assets invested in HF’s Hedge Fund Domiciles Globally Evolution of assets invested into Hedge Funds In USD Bln CAGR 25% p.a. since 1980 Source: CSFB / TASS
Agenda • Hedge funds – structural differences to traditional investing • Hedge fund investing – what is the value added for the investor? • How to construct a hedge fund investment – single manager or fund of hedge fund approach? • Hedge funds as Alpha generators – what does that really mean? • Conclusions 2.
2.1. Why investing in hedge funds? Compared with traditional investment alternatives, hedge funds can offer three unique benefits for the investor: • Higher risk adjusted returns • Low correlation • Capital preservation in falling markets
2.2. Why Hedge Funds? Hedge fund return vs stocks & bonds MSCI World HFR FoHF JPM Global Bonds Source: HFR, JPM, MSCI 1994-2004
2.3. Historical risk adjusted returns – hedge funds vs bonds & stocks Source: HFR, JPM, MSCI 1994-2003
2.4. Why hedge funds? The Portfolio Perspective HFR Hedge Funds Aunnualized Return MSCI World Equities JPM Global Bonds Standard Deviation Source: HFR, JPM, MSCI 1994-2003
2.4. Why hedge funds? The Portfolio Perspective Long/Short Equities L/S Sector Specialists Distressed Debt Convertible Arbitrage Macro Merger Arbitrage HFR Hedge Funds Aunnualized Return MBS Arbitrage L/S Emerging Markets MN Equity Statistical Arbitrage High Yield MSCI World Equities JPM Global Bonds FI Arbitrage CTAs Short Sellers Standard Deviation Source: HFR, JPM, MSCI 1994-2003
1.6. Low correlation – Benefits from a portfolio perspective HFR Hedge Funds Aunnualized Return MSCI World Equities JPM Global Bonds Portfolio without hedge funds Standard Deviation Source: HFR, JPM, MSCI 1994-2003
1.6. Low correlation – Benefits from a portfolio perspective HFR Hedge Funds Aunnualized Return MSCI World Equities JPM Global Bonds JPM Global Bonds Portfolio with hedge funds Standard Deviation Source: HFR, JPM, MSCI 1994-2003
1.8. Preservation of capital – Bull vs Bear Markets Source: HFR, JPM, MSCI 1994-2002
Agenda • Hedge funds – structural differences to traditional investing • Hedge fund investing – what is the value added for the investor? • How to construct a hedge fund investment – single manager or fund of hedge fund approach? • Hedge funds as Alpha generators – what does that really mean? • Conclusions 3.
3.1. Be aware of the pitfalls of hedge funds! • Substantial manager risk due to less investment restrictions Style and strategy shifts Hedge funds may employ high degree of leverage Capacity issues Manager skill can vary in different types of markets • More complex investment conditions Higher fees Worse liquidity conditions Regulatory framework varies • Low transparencyReporting frequency Degree of portfolio transparency? • Challanges in finding and getting access to the best managers Global and intransparent industry Funds can be closed to new investors Minimum investments may be very high
3.2. Due to the high Manager Risk Due Diligence is key • Qualitative 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
3.3. Single Managers or Fund of Hedge Funds? Completely based on the investor’s investment objective: • Benefits of single manager investments No extra layer of fees Hedge fund selection at the investor’s own discretion No potential conflicts of interest Full transparency in the manager selection process • Benefits of fund of hedge fund investments Lower manager risk through diversification Professional selection of managers in each hedge fund category Professional active portfolio management Professional monitoring of managers Broad access to global supply of hedge funds May have prioritized access / transparency to otherwise closed funds Lower minimum investment requirement
3.3. Different investment approaches into hedge funds • Active vs passive money management • Active 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
Agenda • Hedge funds – structural differences to traditional investing • Hedge fund investing – what is the value added for the investor? • How to construct a hedge fund investment – single manager och multi-manager approach? • Hedge funds as Alpha generators – what does that really mean? • Conclusions 4.
Hedge Funds – Alpha or beta? Be educated in how hedge funds make their returns! Hedge fund returns = Traditional betas + alternative betas + structural alpha + skill alpha 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 Traditional betas = directional risk premia: -Stock market beta -Interest rate duration -Currencies -BARRA factors -Credit spreads Source: Harcourt
Agenda • Hedge funds – structural differences to traditional investing • Hedge fund investing – what is the value added for the investor? • How to construct a hedge fund investment – single manager och multi-manager approach? • Hedge funds as Alpha generators – what does that really mean? • Conclusions 5.
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 correlation Capital 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 management Hedge funds as overlay • Hedge fund returns are a function of not only alpha, but also to non- traditional investment risks.
Den Danske FinansanalytikerforeningThank you for your time and attention Contact: Pernille Gangsted-Rasmussen pgr@privestor.dk Niels Kayser nk@privestor.dk Pho. +45 45 82 45 87