Download - Hedge Funds Presentation Apr 08
Speakers:Sabby Mionis CEO & CIO, C.M. Advisors Ltd.
Yannis ProcopisDeputy CIO, C.M. Advisors Ltd.
April 7, 2008
Introduction to Alternative Investments
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Contents
§ Alternative Investments
§ Hedge Funds§ What are Hedge Funds? § Hedge Funds History§ Myth and Reality§ Hedge Funds vs. Traditional Mutual Funds§ Hedge Funds Styles & Strategies§ Strategy Analysed: Merger Arbitrage§ Risk return Profile of Hedge Fund Styles§ Hedge Fund Performance§ Efficient Frontier Argument§ Investor Base
§ Funds of Hedge Funds§ What is required to select the best Hedge Fund?
§ Listed Funds of Hedge Funds
§ Conclusions
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Alternative Investments
Hedge FundsHedge Funds• Real Estate• Natural Resources• Private Equity
• Stocks• Bonds• Cash equivalents
Investment UniverseInvestment Universe
Alternative InvestmentsAlternative Investments Traditional InvestmentsTraditional Investments
Classic AlternativesClassic Alternatives Modern AlternativesModern Alternatives
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Ø A multitude of skill-based investment strategies with a broad range of risk and return objectives.
Ø A common element is the use of investment and risk management skills to seek absolute positive returns regardless of market direction through hedging, use of derivatives, use of leverage and frequent trading.
Ø A hedge fund is a private investment portfolio, usually structured as a limited partnership or an open-end investment vehicle, open to accredited investors, charging an incentive based fee, and managed by a general partner with every financial tool imaginable at his disposal.
What are Hedge Funds?
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Hedge Funds History
Ø History:Ø 1949 - Alfred Jones – First Hedge FundØ 1968 - 200 Hedge-FundsØ 2007 - 8000 Hedge FundsØ 2007 - $1.442 Trillion in Hedge Fund AssetsØ Representing an estimated 3% of all global assets
Ø Investing in Hedge Funds:Ø US and European Institutions currently placing 8%-15% in Hedge Funds Ø Majority use Funds of Funds or External Advisors for Hedge FundsØ Only 10% Manage Hedge Funds internallyØ Swiss Private Banks have 15%-25% allocation in Fund of Funds and
Hedge Funds for individual clients
Source: Goldman Sachs and Frank Russell
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Myth & Reality
This idea belongs to the past. Today, even retail clients can invest infunds of hedge funds.
Hedge funds are only for wealthy private investors.
There is no evidence that hedge funds are linked to stock market crises.Hedge funds only represent a very small amount of total investmentsworldwide.
Hedge funds are a main cause of market downturns andvolatility.
LTCM failure was related to a combination of human error, greed (leverage up to28x!) and inappropriate risk management techniques. Also, large investmentbanks sometimes provided unlimited leverage to LTCM, incorrectly assessing therisks embedded in its strategy.
The failure of LTCM was a failure of the market.
Hedge funds offer a valid alternative to traditional asset classes byallowing investors to optimize the risk/ return profile of their portfolios.
Hedge funds offer no economic added value.
Although true for many offshore hedge funds, numerous investmentmanagers are regulated by local authorities such as the SEC in the US andthe FSA in the UK.
Hedge funds are always unregulated investment vehicles.
Less than 30% of hedge fund managers employ a leverage effect greaterthan 2x.
Hedge funds use significant leverage.
Nowadays, most hedge funds provide detailed monthly reports due to thepressure from institutional investors.
Hedge funds lack transparency over their portfolios andorganization.
The primary objective of hedge funds is to preserve capital by reducingvolatility, which has historically been much higher on equity markets.
Hedge funds are very risky and highly volatile.
REALITYMYTH
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Hedge Funds vs. Traditional Mutual Funds
Hedge funds are incorporated in offshore jurisdictions whichsometimes lack specific regulations.
Investment vehicles are often domiciled in regulated jurisdictions.
Managers invest part or all of their own capital and hence bear thesame risks as their clients.
Regulations normally prohibit managers from investing in the samesecurities as their clients.
Usually monthly subscriptions and quarterly redemptions. Some fundsimpose lock-up periods as well as gates.
Investments are usually very liquid.
Fees based both on AUM and the fund’s absolute performance.Generally, fees are higher than the rest of the industry.
Fees based on the amount of the assets under management (AUM).
The manager is free to choose the investments and weightings at itsentire discretion.
In most cases the portfolio is fully invested.
Managers aim to achieve risk-adjusted absolute returns regardless ofmarket environment.
Managers aim to outperform a benchmark (seek relative returns),hence providing little protection in times of market downturns.
Performance is driven by investment style and the manager’s skillsPerformance is largely dictated by the direction of stock markets.
A wide range of financial instruments and investment techniques tochoose from, allowing to reduce risks and take advantage of pricinginefficiencies.
Limited access to sophisticated instruments and hedging techniquessuch as short-selling or derivatives trading owing to the restrictiveregulatory environment.
HEDGE FUNDSTRADITIONAL INVESTMENTS
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Hedge Funds are Here to Stay…
Source: Strategas
Hedge Fund AUM ($ US Bn) andNumber of Hedge Funds (’88-’08E, Van Hedge)
12000
8000
10000
6000
4000
2000
0
$1,800
$1,600
$600
$1,400
$1,200
$200
$1,000
$800
$0
$400
‘88 ‘94 ‘96 ‘06 ‘08‘98 ‘02 ‘04‘00‘90 ‘92
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Hedge Funds Styles & Strategies
ARBITRAGE STRATEGIESTRADING STRATEGIES
• Fixed Income • Convertible • Merger• Distressed Securities• Special Situations• Credit • Volatility• Carry• Mortgage
• Global Macro• Systematic
LONG/SHORT EQUITY STRATEGIES
• General• Sector Focus• Region Focus• Market Neutral• Short Bias
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Hedge Fund Strategies: Arbitrage
Ø Arbitrage: Arbitrage is the process of taking advantage of market mis-pricing between two related or highly correlated instruments. This management approach is highly technical and usually exploits a narrow market segment to which it brings liquidity and efficiency. Arbitrage returns are generally characterized by low volatility, and are neutral to market movements.
Ø Arbitrage Strategies:
§ Convertible Arbitrage
§ Merger Arbitrage
§ Fixed Income Arbitrage
§ Distressed Securities
§ Special Situations
§ Credit Arbitrage
§ Capital Structure
§ Volatility Arbitrage
§ Carry Trades
§ Mortgage Securities Arbitrage
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Hedge Fund Strategies: Long/Short Equity
Ø Long/Short Equity: This strategy focuses on equity managers who may trade both long and short in the US and international equity markets. These managers carry diversified portfolios and focus on long and short equity securities, in addition to matched pairs and the use of other financial instruments, including stock indices, options, bonds and cash equivalents, to increase flexibility and reduce the risk of capital loss. These managers usually favour a bottom-up approach and their portfolios, in general, will have a directional bias. These managers trade in large, medium and small cap stocks.
Ø Long/short Equity Strategies:
§ Market exposure: net long, net short, market neutral
§ Market capitalization focus
§ Geographical focus
§ Sector focus
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Hedge Fund Strategies: Trading
Ø Macro: The macro manager typically invests worldwide, without any limitations either in country allocations or in the types of assets or instruments traded (stocks, bonds, commodities, derivatives, currencies, etc.). The term “macro” comes from the fact that managers with this style typically seek to profit from anticipated changes in major macro-economic variables, and especially shifts in interest rates. This type of manager is also sometimes called ”macro discretionary” to reflect that the approach is opportunistic, and based on the manager’s own identification and evaluation of potential trades in any area of interest to them, rather than on a technical or system-based approach to identifying potential trades in a limited set of specific markets.
Ø Systematic Trading: The strategy involves the taking of positions in global financial markets based on a systematic approach where trade signals are generated from computer-based models. Managers attempt to add value through the use of various techniques such as identification of trends, or price patterns in order to take advantage of directional moves in markets including fixed income, equities, currencies and commodities. Most managers are mainly active in the derivatives markets, and therefore often referred to as CTAs (Commodity Trading Adviser) reflects the fact that futures and options markets were originally developed as a means of hedging positions in agricultural and other physical commodities.
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Strategy Analysed: Merger Arbitrage
Ø Introduction
The strategy involves the purchase and sale of securities of M&A participants and generally involves purchasing shares of a target company and selling short shares in the acquiring company (if not a cash deal).
Ø Where is the Arbitrage?
After a company announces an intent to acquire another, the price of the target company's stock predictably goes up, although usually not to the full offering price. This spread exists because of the risk of the deal not closing on time or at all. Before a transaction can be completed, shareholders of both companies must vote to approve the deal and industry regulators and competition authorities must signal their acceptance.
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Strategy Analysed: Merger Arbitrage (cont.)
Ø Why does the spread exist?
§ Time Value of Money
§ Risk of a Deal Break
§ Deal Flow
§ Capital Employed
§ Liquidity
§ Macroeconomic & Market Risk
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Strategy Analysed: Merger Arbitrage (cont.)
Ø Types of Transactions
§ Cash deals. Long the target company. As deal break concern increases there is market risk which can be hedged with options.
§ Stock for Stock
Ø Expected Returns
§ Generally merger arbitrage seeks annual returns of 10%-15% with low volatility. This will depend on leverage.
§ Returns on the upside are capped by the spread, whereas they are not limited on the downside. Payoff resembles the short put option profile.
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Strategy Analysed: Merger Arbitrage (cont.)
Ø Investment Process
§ Announcement of Transaction
§ Assessment/ Evaluation
Bottom up analysis. Review deal terms, strategic forces, fundamental attractiveness of deal to participants
Effects of new events and information
Legal/ anti-trust/ regulatory review
§ Investment Decision / Evaluate Likelihood of deal completing
§ Portfolio building
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Strategy Analysed: Merger Arbitrage (cont.)
Ø Example: AOL/Time Warner – A Stock for Stock Deal
In January 2000, Time Warner Inc. (TWX), the largest media company in the worldstunned the market when it announced that it had agreed to be acquired by AOL. Atthe time TWX’s revenues were 6 times greater than AOL’s.
AOL / TIME Transaction Summary
Transaction: AOL buys Time Warner
Deal Announced: January 10, 2000
Terms: 1.5 AOL shares / TWX share
Expected Completion: 3Q 2000
Actual Completion: January 12, 2001
Regulatory Risk: High
Premium: 73.9%
Deal Type: Friendly stock swap
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Strategy Analysed: Merger Arbitrage (cont.)
Ø Example: AOL/Time Warner – A Stock for Stock Deal
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Strategy Analysed: Merger Arbitrage (cont.)
Ø Example: AOL/Time Warner – A Stock for Stock Deal
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Strategy Analysed: Merger Arbitrage (cont.)
Ø Example: AOL/Time Warner – Payoff(the stocks of both companies fell by nearly 50% in the same period)
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Strategy Analysed: Merger Arbitrage (cont.)
Ø Risks
§ Deal-Break Risk (can hedge with put options on the target company if spread allows)
Macroeconomic / market risk. Reduced attractiveness of the deal (can hedge with put options on the market)
§ Liquidity
§ Deal Flow & Capital Employed
§ Duration
Ø Risk Management
§ Diversification & position weighting
§ Independence of factors influencing deals
§ Duration limit
§ Market Cap
§ Stop Losses
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Strategy Analysed: Merger Arbitrage (cont.)
Ø Success Factors
§ Agility. Timing is very important.
§ Experience in information processing. Investment banking background is very useful.
§ Diverse analytical resources needed to perform various analyses from company valuations to legal assessments.
§ Trading skills. As new information becomes available trading around positions may be necessary.
§ Risk Management
§ Low Transaction Costs
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Strategy Analysed: Merger Arbitrage (cont.)
Ø Findings
§ Simple concept but becomes complex in practice.
§ Stable returns not dependent on market moves.
§ Ability of manager to process information and evaluate the probability of a deal-break is paramount.
Ø Different Versions
§ In the 1980s merger arbitrage typically involved going into unannounced deals, companies thought to be transaction candidates. This however is highly speculative and more risky.
§ Doing the Reverse: shorting target companies believing the deal will break.
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Risk
Ret
urn
Arbitrage
Long/Short Equity
Trading
Risk/Return Profile of Hedge Fund Styles
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Hedge Fund Performance (1994-Feb 2008)
- Low Volatility - Stable Returns- Protection of Capital in Difficult Markets
Source: CSFB Tremont, Pertrac
Gro
wth
of
$100
0
50
100
150
200
250
300
350
400
450
500
Dec
-93
Jun-
94
Dec
-94
Jun-
95
Dec
-95
Jun-
96
Dec
-96
Jun-
97
Dec
-97
Jun-
98
Dec
-98
Jun-
99
Dec
-99
Jun-
00
Dec
-00
Jun-
01
Dec
-01
Jun-
02
Dec
-02
Jun-
03
Dec
-03
Jun-
04
Dec
-04
Jun-
05
Dec
-05
Jun-
06
Dec
-06
Jun-
07
Dec
-07
CSFB-Tremont MSCI World SSB Corporate
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Risk and Return of Portfolios of Stocks, Bonds and Hedge funds
0%
2%
4%
6%
8%
10%
12%
0% 2% 4% 6% 8% 10% 12% 14% 16%
100% stocks
100% hedge funds
100% bonds
Por
tfolio
Ann
ualiz
ed R
etur
n
Portfolio Annualized Volatility
50% hedge funds25% stocks25% bonds
50% stocks50% bonds
70% stocks30% bonds
Adding hedge funds to portfolio of stocks and bonds increases return and reduces volatility*
*Following indices are used: MSCI World Index (stocks), SSB World Government Bond index (bonds) and CSFB Tremont index (hedge funds)
Efficient Frontier Argument
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Investor Base
Ø Funds of Funds – Multi Strategy / Single Strategy70% of total global assets allocated to Hedge Funds are deployed by Funds of Funds which give access
to retail investors
Ø Listed Funds of FundsA growing trend with 30 funds listed in London through which even a tiny investor can participate
Ø Structured Products: Capital Protection, Leverage
Ø High Net Worth Individuals
Ø Institutions: Private Banks, Insurance Companies, Pension Funds, Endowments, etc.
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Ø Superior Returns, Low Volatility
Ø Low correlation with traditional market indices
Ø Diversification
Ø Access to Closed Hedge Funds
Ø Better Liquidity Terms
Ø Flexibility of Investment Structures
Ø Expert Due Diligence and Selection Process
Benefits of Funds of Hedge Funds
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Ø CMA methodically narrows the list of potential investment candidates to a short-list of well-researched investment ideas
[Full Due Diligence][20 (5.6%)
[First Checks][37 (11%)
Investment85
Report 1: initial due diligence80% of opportunities screened
Initial review of investment candidates500-600 hedge funds per year
bottom-up and top-down sourced
Hedge Fund Universe
Capital Introduction
20%
News Flow20%
Proprietary Database10%
Industry Network50%
Screening/Idea Generation:
Report 2: Full due diligence20% of Report 1 Stage
OFFSITE ONSITE
OngoingMonitoring
Portfolio Management
Inception
RiskManagement
RebalancingRedemption
Maturity
What is required to select the best hedge funds?
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Ø Only listed Funds of Funds approved by the Greek Capital MarketsCommission
Ø Public listing provides daily liquidity for investors
Ø High level of transparency
Ø Access to an alternative asset class not widely open to small investors
Ø Multiple currency share classes: USD, GBP, and EUR
Ø No Minimum Investment Requirement
Ø Attractive Fee Structure
Ø Access to permanent capital facilitates investment in hedge funds with longer lock-ups
Benefits of Listed Funds of Hedge Funds
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Conclusions
Ø Hedge Funds, an alternative asset class
Ø Tremendous growth of the Hedge Fund industry over the years and especially recently
Ø Wide range of strategies with different risk/return profiles
Ø Hedge Funds enhance the risk/return profile of an investment portfolio
Ø Funds of Funds are the main source of capital for Hedge Funds
Ø Hedge Funds now available to all investors through Funds of Funds and Listed Funds of Funds