Den Danske Finansanalytikerforening Investing in Hedge Funds The

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Den Danske Finansanalytikerforening Investing in Hedge Funds – The Investor‘s Perspective March 18 2004

Den Danske Finansanalytikerforening Investing in Hedge Funds – The Investor‘s Perspective March 18 2004 Representative in Denmark: Denmark

About Harcourt Mission: Deliver superior investment solutions and products the context of hedge funds

About Harcourt Mission: Deliver superior investment solutions and products the context of hedge funds to institutional investors Locations: within 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 2

Agenda 1. Hedge funds – structural differences to traditional investing 2. Hedge fund investing

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

1. 1. What is a hedge fund? Common for all hedge funds is: •

1. 1. What is a hedge fund? Common for all hedge funds is: • 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 as in investment techniques (e. g. usage of derivatives/leverage) • Due to less restrictions – hedge funds are very heterogeneous 4

1. 2. Hedge funds from the portfolio manager perspective Hedge fund Management Traditional Management

1. 2. Hedge funds from the portfolio manager perspective 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 5

1. 3. Hedge funds from the investor perspective Hedge Funds Traditional funds Subscription terms

1. 3. Hedge funds from the investor perspective Hedge Funds Traditional funds Subscription terms Monthly/Quarterly Daily Legal structure Offshore / unregulated Onshore / regulated Min. investment USD 1 mln / 5 mln Low NAV Reporting (Weekly)/Monthly Daily Transparency Low High Fee structure 1 -2% Mgmt; 20% Perf 1. 5% Mgmt Main risk Manager Risk Market Risk 6

1. 4. Harcourt Hedge fund strategies classification used by Fixed Income Relative Value Directional

1. 4. Harcourt Hedge fund strategies classification used by Fixed Income Relative Value Directional Multiple Equities Relative Value Fixed Income Strategies: 1. Fixed Income Arbitrage 2. Mortgage-Backed Securities Arbitrage 3. Capital Structure Arbitrage Relative Value Equity Strategies: Directional Fixed Income Strategies: 4. High Yield 5. Distressed Securities 6. Emerging Markets Debt Directional Equity Strategies: 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. Convertible Arbitrage Reg D Private Convertibles Merger Arbitrage Index and Options Arbitrage Statistical Equity Arbitrage Fundamental Market Neutral Equity Long/Short US Equities Long/Short European Equities Long/Short Japanese Equities Long/Short Emerging Markets Long/Short Sectors Short-Biased Equities Mutual Fund Timers Futures, Currencies and Commodities Relative Value Futures and Commodities Strategies: 20. Commodities Arbitrage Directional Managed Futures and Currency Strategies: 21. Long Term Systematic Trading 22. Short Term Systematic Trading 23. Currency Trading 24. Discretionary Trading Multiple Strategies: 25. Macro Hedge Funds 26. Multi-Strategy Funds 27. Funds of Funds 7

Hedge Fund Strategies Globally Hedge Fund Manager Locations RV Equity 23% Directional FI 6%

Hedge Fund Strategies Globally Hedge Fund Manager Locations RV Equity 23% Directional FI 6% Long/Short Equity CTA 12% 55% Relative Value FI 4% Hedge Fund Domiciles Globally Evolution assets Evolutionof of assets invested into Hedge Fundsin HF’s In USD Bln CAGR 25% p. a. since 1980 Source: CSFB / TASS 8

Agenda 1. Hedge funds – structural differences to traditional investing 2. Hedge fund investing

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 9

2. 1. Why investing in hedge funds? Compared with traditional investment alternatives, hedge funds

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 10

2. 2. Why Hedge Funds? Hedge fund return vs stocks & bonds MSCI World

2. 2. Why Hedge Funds? Hedge fund return vs stocks & bonds MSCI World HFR Fo. HF JPM Global Bonds Source: HFR, JPM, MSCI 1994 -2004 11

2. 3. Historical risk adjusted returns – hedge funds vs bonds & stocks Source:

2. 3. Historical risk adjusted returns – hedge funds vs bonds & stocks Source: HFR, JPM, MSCI 1994 -2003 12

Aunnualized Return 2. 4. Why hedge funds? The Portfolio Perspective HFR Hedge Funds JPM

Aunnualized Return 2. 4. Why hedge funds? The Portfolio Perspective HFR Hedge Funds JPM Global Bonds MSCI World Equities Standard Deviation Source: HFR, JPM, MSCI 1994 -2003 13

2. 4. Why hedge funds? The Portfolio Perspective Aunnualized Return Long/Short Equities L/S Sector

2. 4. Why hedge funds? The Portfolio Perspective Aunnualized Return Long/Short Equities L/S Sector Specialists Distressed Debt Convertible Arbitrage Macro Merger Arbitrage HFR Hedge Funds MBS Arbitrage MN Equity Statistical Arbitrage High Yield JPM Global Bonds FI Arbitrage CTAs L/S Emerging Markets MSCI World Equities Short Sellers Standard Deviation Source: HFR, JPM, MSCI 1994 -2003 14

Aunnualized Return 1. 6. Low correlation – Benefits from a portfolio perspective HFR Hedge

Aunnualized Return 1. 6. Low correlation – Benefits from a portfolio perspective HFR Hedge Funds MSCI World Equities JPM Global Bonds Portfolio without hedge funds Standard Deviation Source: HFR, JPM, MSCI 1994 -2003 15

Aunnualized Return 1. 6. Low correlation – Benefits from a portfolio perspective HFR Hedge

Aunnualized Return 1. 6. Low correlation – Benefits from a portfolio perspective HFR Hedge Funds MSCI World Equities JPM Global Bonds Portfolio with hedge funds Standard Deviation Source: HFR, JPM, MSCI 1994 -2003 16

1. 8. Preservation of capital – Bull vs Bear Markets Source: HFR, JPM, MSCI

1. 8. Preservation of capital – Bull vs Bear Markets Source: HFR, JPM, MSCI 1994 -2002 17

Agenda 1. Hedge funds – structural differences to traditional investing 2. Hedge fund investing

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 18

3. 1. Be aware of the pitfalls of hedge funds! • Substantial manager risk

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 transparency Reporting 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 19

3. 2. Due to the high Manager Risk Due Diligence is key Qualitative due

3. 2. Due to the high Manager Risk Due Diligence is key Qualitative due diligence l l Competitive edge Background and experience Investment process Risk management Quantitative due diligence l l Peer group comparison Consistency of track record Rolling correlation Portfolio fit and style analysis Organizational due diligence l l Organization and legislative framework Infrastructure Primebroker(s), administrator and auditors Reference checks 20

3. 3. Single Managers or Fund of Hedge Funds? Completely based on the investor’s

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 21

3. 3. Ø Ø Different investment approaches into hedge funds Active vs passive money

3. 3. Ø Ø 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 22

Agenda 1. Hedge funds – structural differences to traditional investing 2. Hedge fund investing

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 23

Hedge Funds – Alpha or beta? Be educated in how hedge funds make their

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 Traditional betas = directional risk premia: Alternative betas = demand/supply premia: -Stock market beta -Interest rate duration -Currencies -BARRA factors -Credit spreads -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 24

Agenda 1. Hedge funds – structural differences to traditional investing 2. Hedge fund investing

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 25

4. Conclusions • Hedge funds has an absolute return objective therefore hedge funds are

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 nontraditional investment risks. 26

Den Danske Finansanalytikerforening Thank you for your time and attention Contact: Pernille Gangsted-Rasmussen pgr@privestor.

Den Danske Finansanalytikerforening Thank you for your time and attention Contact: Pernille Gangsted-Rasmussen pgr@privestor. dk Niels Kayser nk@privestor. dk Pho. +45 45 82 45 87