fiduciary investors symposium - october 2011 · pdf filefiduciary investors symposium october...

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K2 ADVISORS

Fiduciary Investors Symposium

October 2011

Confidential Presentation

This presentation is provided to you on a confidential basis for informational purposes only and shall not constitute an offer to sell or a solicitation of an offer to buy an interest in any of the funds advised by K2 Advisors, L.L.C., K2/D&S Management Co., L.L.C., or their respective affiliates (“K2” or “K2 Advisors”). Such offer may only be made at the time a qualified offeree receives from K2 a Confidential Private Offering Memorandum describing the offer. This presentation may not be copied, loaned, or distributed to any other person without the consent of K2.

1

$-

$250,000

$500,000

$750,000

$1,000,000

$1,250,000

$1,500,000

$1,750,000

$2,000,000

$2,250,000

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

YE

Evolution of Hedge Fund Investors

Source: HFR, The Bank of New York Mellon and Casey Quirk.

14%

61%

Hedge Fund Industry AUM(Jan. 1990 – June 2011, billions)

Institutional Investors


2

Institutional Hedge Fund Investing

Pre and Post Global Financial Crisis

What has changed ?

3

Pre Global Financial Crisis

Investors Misperceptions

�Absolute return

�Zero beta i.e. the proliferation of portable alpha

�Presumed manager liquidity

�Misunderstood correlations

Cont’d...

4

Pre Global Financial Crisis

Investors Misperceptions

�Did not see crowded trades

�Ignored counterparty risk

�Operational due diligence taken for granted

�Transparency shortcomings

Cont’d...

5


�Benchmarks

– HFR Index

– Peers

– Cash +

�Institutions allocated 3-5% into alternatives

6


Equity

Fixed Income

Alternatives

Old Allocation Framework

60 / 40 Old School Paradigm

�Institutional investors’ asset allocations are evolving

7

Hedge Fund Weightings by Capitalization

Source: HFR Global Hedge Fund Report 2Q2011.

Equity Hedge

28.76%

Event-Driven

25.92%

Macro

20.50%

Relative Value

24.82%

Equity Hedge

37.07%

Event-Driven

9.75%

Macro39.30%

Relative Value13.88%

1990 2011

8

Hedge Fund Returns

�Hedge Fund Indices have delivered significant outperformance

with lower draw downs compared to other indices

Source: HFR, S&P, Merrill Lynch and Bloomberg. Data from January 1990 through June 30, 2011. Annualized 8% return is representative of an actuarial return target for a hypothetical institutional investor. Past Performance is not indicative or guarantee of future results

-60%

-50%

-40%

-30%

-20%

-10%

0%

His

tori

cal

Dra

wd

ow

ns

HFRI Fund Weighted Composite Index

S&P 500 Total Return

Merrill Lynch High Yield Master II

Annualized 8% Return

Superior Capital

Preservation

0%

200%

400%

600%

800%

1000%

1200%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Cu

mu

lati

ve R

etu

rns

1006%

491%

557%

Beta MarketExposure

9

Post Global Financial Crisis

�Counterparty risk is assessed and monitored

�Focus on operational concerns and controls

�Portfolio transparency is universally available

Cont’d...

10

Post Global Financial Crisis

�Implementation of risk systems enable investors to:

– Measure manager and portfolio alphas and betas

– Risk assessment – VaR, CVaR and Stress Testing

– Measure correlations

– Measure portfolio liquidity

– Real-time portfolio monitoring

11

Transparency and Risk Systems

�Have changed the way institutions deploy / use

hedge funds

�Enable investors to measure market betas

12

Hedge Fund Investing Today

�Volatility management

�Managed beta / measured alpha

�Access non-traditional asset classes:

– Distressed

– M&A

– Structured credit

– Others Cont’d...

13


�Active vs. passive exposure – long / hedged

�Tail risk or zero correlating investments

�Managed betas:

– Global macro

– GTAA

14

Volatility Management

318.31

204.48

-

50

100

150

200

250

300

350

400

450

Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

50/50 MSCI World and HFRI Equity Hedge Hypothetical NAV

MSCI World USD TR

Annual Return 3.36%

Annual Standard Deviation 15.59%

Annual Return 5.49%


M SC I Wo rld

M SC I Wo rld and H F R I Equity H edge

Source: Bloomberg and Hedge Fund Research. This performance data is the hypothetical performance of a model portfolio of indices. The model portfolio is not an actual portfolio, and the indices contained in the model portfolio are unmanaged, may not be investable, have no expenses and generally reflect reinvestment of dividends and

distributions. The performance information presented herein reflects the gross hypothetical performance returns of the model portfolio, but does not reflect the deduction of investment advisory fees and expenses that an investor would pay. Hypothetical performance information presented herein is not indicative or a guarantee of future results.

50% MSCI + 50% HFRI Equity Hedge

15

Volatility Management

638.55

487.47

-

100

200

300

400

500

600

700

Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10

Barcap Agg Corp 50%, HFR Relative Value FI Corp 25%, HFR

Distressed/Restructure 25% Hypothetical NAV

BarCap US Aggregate Corporate TR

Annual Return 7.58%


Annual Return 8.93%


B arC ap U.S. C o rpo rate

B arC ap U.S. C o rp, H F R R V F I, H F R D istressed

Source: Bloomberg, Hedge Fund Research and Barclays Capital. This performance data is the hypothetical performance of a model portfolio of indices. The model portfolio is not an actual portfolio, and the indices contained in the model portfolio are unmanaged, may not be investable, have no expenses and generally reflect reinvestment of dividends and distributions. The performance information presented herein reflects the gross hypothetical performance returns of the model portfolio, but does not reflect the deduction of

investment advisory fees and expenses that an investor would pay. Hypothetical performance information presented herein is not indicative or a guarantee of future results.

50% BarCap AGG + 25% HFR Relative Value + 25% HFR Distressed

16

Manager Beta and Alpha/Beta Separation

1. Beta of Example Static Manager to the S&P 500

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11

2. Alpha/Beta Separation of Example Static Manager to the S&P 500

-0.2

-0.1

0

0.1

0.2

0.3

0.4


Performance from Beta

Manager Performance

Cumulative Alpha


0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6



0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6


2. Alpha/Beta Separation of Example Static Manager to the S&P 500

-0.2

-0.1

0

0.1

0.2

0.3

0.4



Manager Performance

Cumulative Alpha

Source: Third party risk aggregators. For illustrative purposes only.

17

1. Beta of Example Dynamic Manager to the S&P 500

-1

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

1.2


2. Alpha/Beta Separation of Example Dynamic Manager to the S&P 500

-0.1

-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3



Manager Performance

Cumulative Alpha


-1

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

1.2



-1

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

1.2


2. Alpha/Beta Separation of Example Dynamic Manager to the S&P 500

-0.1

-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3



Manager Performance

Cumulative Alpha

Manager Beta and Alpha/Beta Separation

Source: Third party risk aggregators. For illustrative purposes only.

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Hedge Fund Correlations

Source: Third party risk aggregators and Bloomberg.

HFR Strategy MSCI World Index

1997 Asian

Flu (FX)

1998 Credit

Crunch

2001

Correction

2006 Energy

Sell-Off

2008

Lehman Fail

Post-Bailout

S&P 500 Index 0.98 3.33% -15.44% -19.67% -7.62% -36.91%

MSCI World Index 1.00 -2.30% -20.52% -15.37% -10.55% -34.58%

HFR Equity Hedge 0.86 -4.66% -12.61% -10.51% -7.16% -16.73%

HFR Event Driven 0.84 1.41% -8.31% -5.44% -3.64% -11.76%

HFR Fund of Funds 0.91 -0.88% -5.14% -4.64% -3.43% -9.90%

HFR Merger Arb 0.88 0.70% -3.78% -2.30% -1.20% -2.65%

HFR Rel Val 0.78 -0.05% -10.89% -3.12% -1.59% -12.22%

HFR Distressed 0.80 0.97% -6.77% -3.50% -2.43% -9.10%

HFR Convert Arb 0.82 -2.71% -19.47% -7.31% -4.68% -18.62%

HFR Yield Alternatives 0.86 -1.68% -11.88% -4.13% -2.35% -14.32%

HFR Eq Market Neutral 0.87 1.55% 0.81% -2.05% -1.16% -2.30%

HFR Macro 0.62 1.04% 2.03% -0.45% 0.07% -2.37%

Barclays Managed Futures 0.50 3.07% 21.18% 11.26% 7.47% 20.91%

Correlations Stress Tests

HFR Strategy MSCI World Index

1997 Asian

Flu (FX)

1998 Credit

Crunch

2001

Correction

2006 Energy

Sell-Off

2008

Lehman Fail

Post-Bailout

S&P 500 Index 0.98 3.33% -15.44% -19.67% -7.62% -36.91%

MSCI World Index 1.00 -2.30% -20.52% -15.37% -10.55% -34.58%

HFR Equity Hedge 0.86 -4.66% -12.61% -10.51% -7.16% -16.73%

HFR Event Driven 0.84 1.41% -8.31% -5.44% -3.64% -11.76%

HFR Fund of Funds 0.91 -0.88% -5.14% -4.64% -3.43% -9.90%

HFR Merger Arb 0.88 0.70% -3.78% -2.30% -1.20% -2.65%

HFR Rel Val 0.78 -0.05% -10.89% -3.12% -1.59% -12.22%

HFR Distressed 0.80 0.97% -6.77% -3.50% -2.43% -9.10%

HFR Convert Arb 0.82 -2.71% -19.47% -7.31% -4.68% -18.62%

HFR Yield Alternatives 0.86 -1.68% -11.88% -4.13% -2.35% -14.32%

HFR Eq Market Neutral 0.87 1.55% 0.81% -2.05% -1.16% -2.30%

HFR Macro 0.62 1.04% 2.03% -0.45% 0.07% -2.37%

Barclays Managed Futures 0.50 3.07% 21.18% 11.26% 7.47% 20.91%

Correlations Stress Tests

Tail Risk Management

19


$ 1 Billion Sample Portfolio

Asset Class Allocation Decision

DomesticEquity

$350 mm35%

CorporateCredit

$150 mm15%

TreasuryBonds

$100 mm10%

SovereignDebt

$50 mm5%

InternationalEquity

$200 mm20%

Alternatives

$100 mm10%

PassiveBeta

Allocation20%

Hedge FundLong/ShortAllocation

15%

PassiveBeta

Allocation5%

Hedge FundLong/ShortAllocation

15%

PassiveBeta

Allocation5%

CreditLong/ShortAllocation

10%

PassiveBeta

Allocation8%

ActiveAlpha

Allocation2%

PassiveBeta

Allocation5%

ActiveAlpha

Allocation0%

PassiveBeta

Allocation0%

Macro/CTAAllocation

10%

Beta Completion

Overlay

Beta Completion

Overlay

Beta Completion

Overlay

Beta Completion

Overlay

Beta Completion

Overlay

Beta = 1.00 Beta = 1.00 Beta = 1.00 Beta = 1.00 Beta = 1.00 Beta = 1.00

Beta = 0.50 Beta = 0.45 Beta = 0.50 Beta = 0.05 Beta = 0.10 Beta = 0

Commodities

$50 mm5%

PassiveBeta

Allocation2.5%

ActiveAlpha

Allocation2.5%

Beta Completion

Overlay

Beta = 1.00

Beta = 0.25

Optional

20

Resources Needed to Invest in Hedge Funds Today

�Experienced staff

– Research

– Operational due diligence

– Risk

– Legal

– Portfolio construction

Cont’d...

21

Resources Needed

�Build an investment process

�IT, Accounting, Risk Systems, Information

Management, Data

�Travel

22

Choose Your Partner According To Your Needs

DirectHedge FOF

AdvisoryPartner

Specialists/Consultants Consultant

Hedge FOFCustom

Fund

Hedge FOFCommingled

ResearchReports

FEES RISING FEES DECLINING

23

Choose Your Partner According to Your Needs

�Knowledge transfer

�Fiduciary (responsible party)

�Portfolio construction

�Strategy expertise

�Manager sourcing

Cont’d...

24


�Research due diligence

�Operational due diligence

�Fund / investment structuring

�Legal

�Manager / portfolio monitoring

Cont’d...

25


�Risk measurement / reporting

�Performance measurement

26

Q & A

27

Important Disclosures and Disclaimers

RISK CONSIDERATIONS

Investment in a fund of funds is a speculative investment, entails significant risk and should not be considered a complete investment program. An investment in a fund of funds provides for only limited liquidity and is suitable only for persons who can afford to lose the entire amount of their investment. There can be no assurance that the investment strategies employed by K2 or the managers of the investment entities in which K2 Funds invest will be successful.

The identification of attractive investment opportunities is difficult and involves a significant degree of uncertainty. Returns generated from the funds described in this presentation may not adequately compensate investors for the business and financial risks assumed. Investment in these types of funds is subject to those market risks common to entities investing in all types of securities, including market volatility. Also, certain trading techniques employed by the investment entities in which the funds described in this presentation invest, such as leverage and hedging, may increase the adverse impact to which the fund’s investment portfolio may be subject.

Hedge funds are not required to provide investors with periodic pricing or valuation and there is generally a lack of transparency as to the underlying assets. Investing in hedge funds may also involve tax consequences and a prospective investor should consult with a tax advisor before investing. Investors in funds of hedge funds will incur asset-based fees and expenses at the fund level and indirect fees, expenses and asset-based compensation of investment funds in which these funds invest.

DISCLAIMERS

This presentation shall not constitute an offer to sell or a solicitation of an offer to buy an interest in any of the funds advised by K2. Such offer may only be made at the time a qualified offeree (as determined by K2 and the applicable K2 Fund in their sole discretion) receives from K2 a Confidential Private Offering Memorandum describing an offering. This material does not constitute investment advice with respect to an investment in any security or other interest in any K2 Fund. Any information herein regarding K2 Funds should not be regarded as providing any assurance that any such K2 Fund will continue to have the features, attributes and qualities described herein as of any subsequent date and is not a guarantee of future results.

THIS MATERIAL DOES NOT CONTAIN ALL OF THE INFORMATION THAT IS MATERIAL TO A PROSPECTIVE INVESTOR IN ANY K2 FUND. AN INVESTOR CONSIDERING INVESTING IN A K2 FUND SHOULD CAREFULLY CONSIDER ALL OF THE TERMS GOVERNING AN INVESTMENT THEREIN INCLUDING INVESTMENT OBJECTIVES, RISKS, CHARGES AND EXPENSES, WHICH ARE CONTAINED IN ITS CONFIDENTIAL PRIVATE OFFERING MEMORANDUM. THE CONFIDENTIAL PRIVATE OFFERING MEMORANDUM OF SUCH FUND SHOULD BE CAREFULLY READ AND UNDERSTOOD BEFORE INVESTING.

This presentation has been approved with limitations for the purpose of Section 21 of the Financial Services and Market Act 2000, by K2 Advisors, Ltd., an affiliate of K2, which is authorized and regulated by the United Kingdom Financial Services Authority.

THIS PRESENTATION DOES NOT CONSTITUTE AN OFFER OR SOLICITATION BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED, OR TO ANY PERSON WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION.

28

Definitions of Comparative Indices and Statistics

HFR Monthly Indices (HFR) are equally weighted performance indexes, utilized by numerous hedge fund managers as a benchmark for their own hedge funds. The HFR are broken down into four main strategies, each with multiple sub-strategies. All single-manager HFR Index constituents are included in the HFR Fund Weighted Composite, which accounts for over 2000 funds listed on the internal HFR Database.

HFRI EH: Equity Market Neutral Index Equity Market Neutral strategies employ sophisticated quantitative techniques of analyzing price data to ascertain information about future price movement and relationships between securities, select securities for purchase and sale. These can include both Factor-based and Statistical Arbitrage/Trading strategies

HFRI Relative Value Index Investment Managers who maintain positions in which the investment thesis is predicated on realization of a valuation discrepancy in the relationship between multiple securities. Managers employ a variety of fundamental and quantitative techniques to establish investment theses, and security types range broadly across equity, fixed income, derivative or other security types.

HFRI Macro Index Macro: Investment Managers which trade a broad range of strategies in which the investment process is predicated on movements in underlying economic variables and the impact these have on equity, fixed income, hard currency and commodity markets. Managers employ a variety of techniques, both discretionary and systematic analysis, combinations of top down and bottom up theses, quantitative and fundamental approaches and long and short term holding periods.

HFR Distressed/Restructuring Securities Index – Distressed Restructuring Strategies employ an investment process focused on corporate fixed income instruments, primarily on corporate credit instruments of companies trading at significant discounts to their value at issuance or obliged (par value) at maturity as a result of either formal bankruptcy proceeding or financial market perception of near term proceedings. Managers are typically actively involved with the management of these companies, frequently involved on creditors' committees in negotiating the exchange of securities for alternative obligations, either swaps of debt, equity or hybrid securities. Managers employ fundamental credit processes focused on valuation and asset coverage of securities of distressed firms; in most cases portfolio exposures are concentrated in instruments which are publicly traded, in some cases actively and in others under reduced liquidity but in general for which a reasonable public market exists. In contrast to Special Situations, Distressed Strategies employ primarily debt (greater than 60%) but also may maintain related equity exposure.

HFR RV: Fixed Income-Convertible Arbitrage Index – Convertible Arbitrage includes strategies in which the investment thesis is predicated on realization of a spread between related instruments in which one or multiple components of the spread is a convertible fixed income instrument. Strategies employ an investment process designed to isolate attractive opportunities between the price of a convertible security and the price of a non-convertible security, typically of the same issuer. Convertible arbitrage positions maintain characteristic sensitivities to credit quality the issuer, implied and realized volatility of the underlying instruments, levels of interest rates and the valuation of the issuer’s equity, among other more general market and idiosyncratic sensitivities.

HFRI ED: Merger Arbitrage Index Merger Arbitrage strategies which employ an investment process primarily focused on opportunities in equity and equity related instruments of companies which are currently engaged in a corporate transaction. Merger Arbitrage involves primarily announced transactions, typically with limited or no exposure to situations which pre-, post-date or situations in which no formal announcement is expected to occur.

HFR Equity Hedge Index is a strategy that maintains positions both long and short in primarily equity and equity derivative securities. A wide variety of investment processes can be employed to arrive at an investment decision, including both quantitative and fundamental techniques; strategies can be broadly diversified or narrowly focused on specific sectors and can range broadly in terms of levels of net exposure, leverage employed, holding period, concentrations of market capitalizations and valuation ranges of typical portfolios. Equity Hedge managers would typically maintain at least 50%, and may in some cases be substantially entirely invested in equities, both long and short.

HFR Event Driven Index –Investment Managers who maintain positions in companies currently or prospectively involved in corporate transactions of a wide variety including but not limited to mergers, restructurings, financial distress, tender offers, shareholder buybacks, debt exchanges, security issuance or other capital structure adjustments. Security types can range from most senior in the capital structure to most junior or subordinated, and frequently involve additional derivative securities. Event Driven exposure includes a combination of sensitivities to equity markets, credit markets and idiosyncratic, company specific developments. Investment theses are typically predicated on fundamental characteristics (as opposed to quantitative), with the realization of the thesis predicated on a specific development exogenous to the existing capital structure.

HFRI Fund of Funds Composite Index Fund of Funds invest with multiple managers through funds or managed accounts. The strategy designs a diversified portfolio of managers with the objective of significantly lowering the risk (volatility) of investing with an individual manager. The Fund of Funds manager has discretion in choosing which strategies to invest in for the portfolio. A manager may allocate funds to numerous managers within a single strategy, or with numerous managers in multiple strategies.

29

Definitions of Comparative Indices and Statistics

Barclays US Managed Futures Industry BTOP 50 The BTop 50 Index seeks to replicate the overall composition of the managed futures industry with regard to trading style and overall market exposure. The BTop 50 employs a top-down approach in selecting its constituents. The largest investable trading advisor programs, as measured by assets under management, are selected for inclusion in the BTop 50. In each calendar year the selected trading advisor programs represent, in aggregate, no less than 50% of the investable assets of the Barclay CTA Universe. The Index begins in January 1990 with a starting value of 1000.

BarCap U.S. Long Corporate TR Index Unhedged USD - The U.S. Corporate Index is a broad-based benchmark that measures the investment grade, fixed-rate, taxable, corporate bond market. It includes USD-denominated securities publicly issued by U.S. and non U.S. industrial, utility, and financial issuers that meet specified maturity, liquidity, and quality requirements. Securities in the index roll up to the U.S. Credit and U.S. Aggregate Indices. The U.S. Corporate Index was launched on January 1, 1973. Modified Adj. Duration: (˜12)

MSCI World Index USD The MSCI World Index is a capitalization weighted index that monitors the performance of stocks from around the world.

Average Annualized Return – Annualized geometric average return comprised of compounded monthly returns

Alpha - A mathematical value indicating an investment's excess return relative to a benchmark. Measures a manager's value added relative to a passive strategy, independent of the market movement.

Beta – The slope of the regression line and represents the expected change in the Fund’s return for a 1 percent change in the comparison Index. Beta is considered to be a measure of the Fund’s risk relative to the comparison index.

Correlation - The degree of interaction between the Fund’s return and that of the comparison Index. The correlation coefficient, expressed as a value between +1 and –1, indicates the strength and direction of the linear relationship between Fund’s returns and the returns of the index.

Standard Deviation - Annualized arithmetic standard deviation is a measure of dispersion indicating the degree to which each monthly return clusters about the mean return. Standard deviation is calculated based upon monthly returns, net of all fees and expenses, and annualized by multiplying by the square root of 12 (approximately 3.46).

Value-at-Risk (or “VaR”) - VaR is a statistical measure of risk that estimates the downside loss potential of a portfolio. More precisely, the 95% 1-month VaR is the loss one would not expect to exceed over a 1-month period with 95% probability

Estimated Performance-to-VaR – The ratio of actual return to predicted VaR over the same period.

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