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P R I M E B R O K E R A G E – S T R A T E G I C C O N T E N T G R O U P
2014 Year-End Hedge Fund Recap
John.Schlegel@morganstanley.com
Anne.McNerney@morganstanley.com
Vasileios.Prassas@morganstanley.com
Dec 16, 2014
The information contained herein is not intended to be, and does not constitute, advice from Morgan Stanley. Morgan Stanley is not your advisor (municipal, financial or any other kind of advisor) and is not acting in a fiduciary capacity. 1
This memorandum is not a product of Morgan Stanley’s Research Department and you should not regard it as a research report. For Institutional Use Only.
Unless otherwise indicated, aggregated information provided in this document is sourced from filtered Morgan Stanley & Co. U.S. Prime Brokerage data.
With only two weeks left in the year, we review some of the key changes that we saw in 2014. The bullets below provide a sense of topics covered. For those interested in a briefer version of the piece, see CliffsNotes on page 15. TIMELINE OF 2014 REVERSALS It was a year with a lot of shifts – we aggregate some of
the major reversals this year in our timeline below
PERFORMANCE Evaluating 2014 Performance
How Does 2014 Stack Up vs. Recent Years?
Worst Year Post-Crisis for Stock Picking Alpha
YoY Returns: Was There Mean Reversion or Consistency?
Exposures vs. Returns: Little Benefit from Higher Nets in ‘14
Negative First Half of December
LEVERAGE US Gross and Net Leverage Very Steady this Year
4Q14 Seasonal Effects & What to Expect in 1Q15
Europe and Asia Leverage
REGIONAL POSITIONING Positioning Themes that Dominated This Year
o US: Energy, Health Care, New Tech/Old Tech, Growth, Momentum, Value
o Europe: Cyclicals vs. Defensives, Sector Exposures, European Periphery, Individual Country Exposures
o Asia: Japan, China, Other Countries
APPENDIX CliffsNotes Version of 2014 HF Recap
YTD Performance By Strategy, Sector, & Region of Focus
Global Equity L/S Sector Appreciation & Contribution YTD
CURIOUS TO KNOW WHAT MADE 2014 SO DIFFICULT FOR HEDGE FUNDS?
2014: The Year of the _________ Reversal (Fill in t he Blank)
Source: Morgan Stanley Prime Brokerage, Bloomberg, HFR, Inc., eVestment, Investor letters collected by Morgan Stanley
This material is not a solicitation of any offer to buy or sell any security or other financial instrument or to participate in any trading strategy. This material was not prepared by the Morgan Stanley research department. Please refer to importantinformation and qualifications at the end of this material. The information contained herein does not constitute advice. Morgan Stanley is not acting as your advisor (municipal, financial, or otherwise) and is not acting in a fiduciary capacity.
1-Jan-14 1-Feb-14 1-Mar-14 1-Apr-14 1-May-14 1-Jun-14 1-Jul-14 1-Aug-14 1-Sep-14 1-Oct-14 1-Nov-14 1-Dec-14
Factor Rotation / New Tech Underperforms Old Tech b y 30%: Growth, Momentum, and Value all reversed course sharply in March and April catching funds offsides. HFs had significant long biases in high growth and high momentum names (both groups had L/S ratios > 3.2) while they had very low biases towards low growth or low momentum names (both had L/S ratios <1.2). As part of this, New Tech underperformed Old Tech by ~30% from early March to early May; in early March, the New Tech L/S ratio was 5.5, while the Old Tech L/S ratio was 0.7 (i.e. they were net short Old Tech)
80
90
100
110
120
Apr-13 Jul-13 Oct-13 Jan-14 Apr-14
Factor ReversalsUS Momentum (MSZZMOMO)US Growth (MSZZGRW)US Value (MSZZVAL)
China Rallies Sharply after PBoC Surprises with Rate Cut: While HFs have significant net exposure to China, about 80% of it lately has been in Tech and Cons Disc, with much of that in US-listed names, which have genearally fallen since the PBoC announcement. This means that most funds have missed out on much of the 20% rise in the local China stocks since late Nov
60
70
80
90
100
110
120
130
550
600
650
700
750
800
Jan-14 Apr-14 Jul-14 Oct-14
S&P Energy vs. Brent Crude YTD
Treasuries Rally as 10Yr Yield Drops over 40bps: Most expected rates would increase in '14 due to strengthening economy and tapering (MS Research estimate was for 3.5% 10Yr yield by end of '14)
2.5
2.7
2.9
3.1
Oct-13 Nov-13 Dec-13 Jan-14 Feb-14
US 10YR Yields
-45bps
Japanese Equities Hit Post-Crisis High at the End of '13 Before Dropping 14% at the start of '14: After a significant increase from Nov '12 to mid '13, net exposure to Japan was still near 4-Year highs heading into the selloff
13000
14000
15000
16000
17000
Sep-13 Nov-13 Jan-14
Nikkei 225
0.8
0.9
1.0
1.1
1.2
1.3
1.4
1.5
Apr-13 Jul-13 Oct-13 Jan-14 Apr-14
New Tech / Old Tech Relative Return
EM Rallies 9% from Lows: After 6 months of steady underperformance, EM equities rallied 9% from mid-Mar to mid-Apr while DM stagnated. Net exposure to EM was only at the 12th %-tile relative to the prior 7 years when EM started to rally
0.56
0.58
0.60
0.62
0.64
0.66
0.68
Sep-13 Nov-13 Jan-14 Mar-14 May-14
MSCI EM / MSCI World
Small Caps Underperform by 5% in July: After outperforming in '13, small caps underperformed throughout '14 with 5% of that coming in July. Equity HFs typically maintain relatively large exposure to small caps when compared to the market
-8%
-4%
0%
4%
8%
Jan-14 Mar-14 May-14 Jul-14
RTY vs. SPX YTD Return
-6%+9%
Energy Equities Fall >20% & Crude Drops >40%: Crude dropped >40% from mid-year highs, causing Energy equities to reverse from the second best performing sector in 1H14 (+13%) to the worst performing sector YTD by early Dec (-13%). Heading into the sell-off, Energy was the most long-biased N. America sector among L/S HFs. More broadly cyclicals underperformed defensives by a wide margin in Sep and Oct as L/S funds sold cyclicals in some of the largest magnitudes of the past 5 years
-40% Crude-20% Equities
Systematic Macro / CTAs Outperform While Event Lags: At the start of '13, only 2% of investors expected Sys. Macro / CTAs to be the best performing strategy in '14 (per MS Investor Survey). However, following sharp gains from Aug to Nov, the median Sys. Macro / CTA fund is up 13% YTD through Nov '14, outperforming all other strategies by a wide margin. The strategy has seen the largest redemptions over the past two years suggesting investors largely missed out. In contrast, Event Driven funds saw some of the largest inflows over the past 2 years, but are barely positive in '14 following 2H losses
-10%
0%
10%
20%
30%
Dec-11 Dec-12 Dec-13 Dec-14
Sys. Macro / CTA vs. Event Driven YTDReturns
+10%
102
106
110
114
118
122
14000
15000
16000
17000
18000
Sep-14 Oct-14 Nov-14 Dec-14
Nikkei 225 vs. USDJPY
2200
2400
2600
2800
3000
Sep-14 Oct-14 Nov-14 Dec-14
Shanghai Comp.
Japanese Equities Rally >10% and Yen Weakens Sharply on Surprise BoJ Action: Net Exposure to Japanese equities were at a 20-month low heading into the news at the end of Oct
+20%
S&P 500:1848 on 12/31/13
S&P 500:2002 on 12/12/14,+10.5% YTD including dividends
-30%
-14%
The information contained herein is not intended to be, and does not constitute, advice from Morgan Stanley. Morgan Stanley is not your advisor (municipal, financial or any other kind of advisor) and is not acting in a fiduciary capacity. 2
Performance
Evaluating 2014 Performance – Where Do We Stand?
At the end of last year, we asked investors what they thought would be the best performing strategy in 2014. 98% of investors guessed wrong – only 2% said CTA / Trend Following strategies. The back half of this year has turned tables. CTA funds are slated to end at the top; Energy-focused funds continue their fall from mid-year highs; many are disappointed with Equity L/S, Event Driven, and Credit fund returns (which are within 70 bps of one another); and Disc Macro appears on track to finish its third consecutive year of difficult performance relative to other strategies. For more on performance dispersion statistics by strategy, see page 16 in appendix.
How Does 2014 Stack Up vs. Recent Years?
Given our perspective on Equity L/S, we spend the next several pages delving into the strategy’s returns and what impacted them this year. After 11 months, the median net return for Equity L/S funds is +2.7%. On an absolute basis, 2014 stands as the worst year of HF returns that we’ve seen post-crisis other than 2011. To beat the next closest year (2012), the median Eq L/S fund would have to be up more than 5% in Dec alone, and that’s unlikely given recent equity market moves. On a relative basis, it’s worth noting that hedge funds’ capture ratio this year isn’t too far off from ’12 figures.
Dispersion is also relatively in line with what we’ve seen over the past 4 years, though 2013’s levels were slightly more elevated (dispersion = difference between the 95
th and 5
th %-tile of returns).
Comparing Absolute and Relative Returns
Expectations for Top Performing Strategy in 2014 vs. Realized Results% of Respondents (From Our 4Q13 Investor Survey) Nov '14 YTD Median Net Return (%)
Source: Morgan Stanley Prime Brokerage, 4Q13 Investor Survey, Investor letters collected by Morgan Stanley Prime Brokerage
Note: The yellow bars above add up to 91% as there w ere several strategies not show n above, including "Commodities," "Fixed Income RV," "Structured Credit," and "Other."
The first three options each had less than 2% of respondents expecting them to be the top performing in '14. "Other" represented 4.5% of respondent answ ers.
40
26
11
7
3 21 1 0
2.7 3.0
0.2
(0.9)
3.4
13.0
2.3
3.6
0.5
-2
0
2
4
6
8
10
12
14
16
18
-5
0
5
10
15
20
25
30
35
40
45
Eq L/S EventDriven
DiscGlobal Macro
EmgMarkets
Multi-Strat
Sys Macro /CTA
Credit L/S Quant /Stat Arb
ConvertArb
% of Respondents Expecting Strategy to Be Best Performing in '14 (LS) Nov '14 YTD Median Net Return (RS)
Only 2% said Sys Macro / CTA
More than three-quarters of
investors chose Equity L/S,
Event, or Disc Macro
ABSOLUTE: Annual Net Return By Year RELATIVE: HF Return Relative to the MSCI AC WorldEquity L/S Annual Median Net Return (%) Capture Ratio (Equity L/S Median Net Return / MSCI AC World Return, %)
Source: Bloomberg, Morgan Stanley Prime Brokerage, Investor letters collected by Morgan Stanley Prime Brokerage
(14.3)
18.5
8.2
(4.9)
7.8
14.4
2.7
-20
-15
-10
-5
0
5
10
15
20
25
'08 '09 '10 '11 '12 '13 Nov '14YTD
34%
53%
63%
71%
47%
61%
39%
0%
20%
40%
60%
80%
100%
'08 '09 '10 '11 '12 '13 Nov '14YTD
% Upside in Up Yrs % Dow nside in Dow n Yrs
The information contained herein is not intended to be, and does not constitute, advice from Morgan Stanley. Morgan Stanley is not your advisor (municipal, financial or any other kind of advisor) and is not acting in a fiduciary capacity. 3
Dispersion Relatively In Line with Prior Four Years
Worst Year Post-Crisis for Stock Picking Alpha
Stock picking YTD in 2014 has been the most difficult of the past six years as the long side has been very challenging and while the short side has been additive, it hasn’t been enough to compensate for long underperformance. Mar & Apr of this year were particularly painful for funds as they saw a significant portion of HF alpha destroyed: those two months reduced the ’14 YTD Total Alpha figure (farthest right blue bar in left hand graph below) by more than 4 percentage points.
On the long side YTD, the lack of alpha can at least partly be explained by relatively large exposure to small caps, which have lagged YTD (in the US, the Russell 2000 is +0.24% YTD vs. S&P +10.48% through 12/12/14). In addition to this, underperformance in Info Tech, Cons Disc, and Telecom YTD have caused long portfolios to lag. In contrast, a bright spot for long portfolios is the +27% appreciation of Health Care longs through Nov, which contributed a lot to aggregate performance due to the sector’s relatively large weight.
On the short side, small cap exposure helped returns in a big way. In addition, Energy was the largest positive contributor as these shorts depreciated 23% YTD (which is good for short portfolios), while Energy longs barely detracted on a YTD basis. For more color on how sectors contributed to returns YTD, see page 17 in appendix.
All Funds Annual Dispersion By YearNet Return (%) Dispersion (Difference btw n 95th and 5th %-tile Returns, %)
Percentile 2008 2009 2010 2011 2012 2013 Nov '14 YTD
Average (12.3) 22.9 9.1 (3.5) 7.7 12.5 4.2
95% 21.5 77.8 27.4 13.9 27.4 40.2 21.5
75% 1.4 33.4 14.4 3.0 13.4 19.1 7.9
50% (11.3) 16.1 8.0 (2.3) 7.4 10.7 2.9
25% (26.5) 4.9 2.8 (9.6) 1.3 3.6 (1.1)
5% (49.1) (8.3) (5.3) (23.2) (8.6) (6.6) (9.1)
Count 956 952 765 984 997 939 470
Dispersion (95th - 5th) 70.6 86.1 32.7 37.2 36.0 46.9 30.6
Equity Long/Short Fundamental (Non-Quantitative)Net Return (%)
Percentile 2008 2009 2010 2011 2012 2013 Nov '14 YTD
Average (15.8) 23.7 9.0 (6.0) 8.6 16.5 3.8
95% 12.3 73.0 27.4 9.2 27.9 44.6 19.8
75% (2.9) 34.5 15.4 1.4 14.3 23.4 7.3
50% (14.3) 18.5 8.2 (4.9) 7.8 14.5 2.7
25% (29.1) 8.1 2.7 (11.5) 2.1 7.0 (1.1)
5% (52.1) (5.1) (5.9) (26.1) (6.4) (4.2) (8.0)
Count 447 419 396 390 480 487 287
Dispersion (95th - 5th) 64.3 78.2 33.3 35.3 34.3 48.8 27.9
Source: Morgan Stanley Prime Brokerage, Investor Letters Collected By Morgan Stanley Prime Brokerage
0
10
20
30
40
50
60
70
80
90
100
'08 '09 '10 '11 '12 '13 Nov '14YTD
All Funds Eq L/S
YTD Dispersion is relatively in
line w ith the prior 4 yrs
How Did Longs and Shorts Contribute Relative to the Last Several Years?Long, Short, and Total Alpha (%), Based on Equity L/S Global Positions vs. MSCI AC World Returns
Source: Bloomberg, Factset, Morgan Stanley Prime Brokerage
16.7
9.7
0.0
7.3
14.5
1.0
(4.9)(4.2)
4.6
2.5
(4.4)
2.3
11.8
5.5 4.6
9.8 10.1
3.4
(10)
(5)
0
5
10
15
20
'09 '10 '11 '12 '13 '14YTD
(Nov)
'09 '10 '11 '12 '13 '14YTD
(Nov)
'09 '10 '11 '12 '13 '14YTD
(Nov)
LONG Alpha(Longs ̶ MSCI)
SHORT Alpha(MSCI ̶ Shorts)
TOTAL Alpha(Longs ̶ Shorts)
Worst Yearof Alpha
Post-Crisis
TOTAL Alpha by Month (Longs - Shorts)
Source: Morgan Stanley Prime Brokerage, Bloomberg, Factset
-3%
-2%
-1%
0%
1%
2%
3%
Jan-1
0
May-
10
Sep-1
0
Jan-1
1
May-
11
Sep-1
1
Jan-1
2
May-
12
Sep-1
2
Jan-1
3
May-
13
Sep-1
3
Jan-1
4
May-
14
Sep-1
4
Longs - Shorts
Mar & Apr w ere Worst Months
of Past 5 Years
The information contained herein is not intended to be, and does not constitute, advice from Morgan Stanley. Morgan Stanley is not your advisor (municipal, financial or any other kind of advisor) and is not acting in a fiduciary capacity. 4
With this low amount of alpha in mind, where would we expect YTD returns to end up? In the below waterfall chart, we break down overall long and short performance and then account for market timing, costs, and fees. From this model, Equity L/S funds would only be up +1.9% through Nov, which is slightly below the median return based on investor letters of +2.7%.
YoY Returns – Was There Mean Reversion or Consistency?
Given some anecdotes, it may surprise some that we did NOT see mean reversion in returns from ’13 to ’14. Across Equity L/S funds, it appears that funds with stronger returns in ’13 tended to have better performance in ’14, but it’s certainly not a strong relationship (see left hand chart below). Top quartile performers in ’13 delivered median returns of 3.18% this year; whereas, bottom quartile performers in ’13 delivered median returns of only 79 bps YTD (the spread is wider when you look at averages). Turning to non-Equity L/S funds, the relationship between last year’s returns and this year’s performance is weak. While there is still a spread in ’14 returns between the best and worst performing funds in ’13, it’s less consistent.
Nov '14 Equity Long/Short Return Breakdown
Return/Cost/Fee (%)
Source: Bloomberg, FactSet, Morgan Stanley Prime Brokerage
Notes:
1) The figures included above are estimates based on Morgan Stanley Prime Brokerage data and are not directly based on what we receive in investor letters
2) Assumptions used in the waterfall chart above:
– Long and short exposures derived from average 2014 gross and net exposures as reported in global Equity L/S funds’ investor letters
– Long and short appreciation equal to global equity position appreciation of Equity L/S funds, as measured by MSPB
– Market timing return as measured by MSPB. Costs based on 1.5% annual cost of borrow, financing, and trading. Fees: Annual Management fee of 1.5%; Incentive Fee of 20%
7.9
(2.5)
5.5
(0.3)
(1.4)
3.8
(1.4)
(0.5)
1.9
6.8
3.1
0
2
4
6
8
10
12
Long Rtn(Gross)
Short Rtn(Gross)
Stock PickingReturn
MarketTiming
Costs (Brw,Fin, Trdg)
GrossReturn
Mgmt Fee IncentiveFee
NetReturn
MSCI ACWorld
Return
MSCI * AvgNet Exp
55% Short Exposure * 4.5% Short
Appreciation = -2.5% Short Return
46% Net Exposure* 6.8% Index
Return = 3.1%
101% Long Exposure * 7.9% Long
Appreciation = 7.9% Long Return
EQUITY L/S NON-EQUITY L/S
2014 vs. 2013 Net Returns (%, 2013 = X Axis; 2014 = Y Axis) 2014 vs. 2013 Net Returns (%, 2013 = X Axis; 2014 = Y Axis)
EQUITY L/S (Relative to Eq LS Funds) NON-EQUITY L/S (Relative to Non-Eq LS Funds)
2013 Quartiles Median Average Count Median Average Count 2013 Quartiles Median Average Count Median Average Count
4 (Best) 31.70 37.26 95 3.18 5.41 95 4 (Best) 19.46 24.81 77 3.11 3.23 76
3 20.00 19.58 95 2.20 2.16 95 3 10.60 10.49 77 2.80 4.31 77
2 12.13 11.79 95 2.56 2.94 95 2 4.77 4.67 77 2.82 4.66 77
1 (Worst) 2.09 (0.00) 95 0.79 1.33 95 1 (Worst) (2.94) (4.50) 77 1.38 1.99 76
Total 15.55 17.16 380 2.41 3.19 402 Total 7.20 8.87 308 2.81 3.55 312
Source: Morgan Stanley Prime Brokerage, Investor letters collected by Morgan Stanley Prime Brokerage
Note: 2014 Returns represent YTD figures through Oct or Nov of this year.
2013 Returns 2014 Returns 2013 Returns 2014 Returns
y = 0.1253x + 0.8094R² = 0.0451
-60
-40
-20
0
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80
-60 -30 0 30 60 90 120
y = 0.008x + 3.4826R² = 0.0001
-60
-40
-20
0
20
40
60
80
-60 -30 0 30 60 90 120
2013 Return
2013 Return
2014 Return
2014 Return
The information contained herein is not intended to be, and does not constitute, advice from Morgan Stanley. Morgan Stanley is not your advisor (municipal, financial or any other kind of advisor) and is not acting in a fiduciary capacity. 5
Recent Net Returns (For Americas-Based Funds Only) Dec '14 Cumulative Net Returns (For Americas-Based Funds Only)
MTD YTD Cumulative MTD Net Return (%)
Oct Nov Dec* Oct Nov Dec*
All Funds (Americas-Based)
Investor Letters Median -0.10% 1.00% N/A 2.03% 2.81% N/A
Proprietary MS Median 0.45% 0.89% -0.93% 2.96% 2.94% 1.85%
Equity L/S (Americas-Based)
Investor Letters Median 0.32% 1.00% N/A 1.87% 2.64% N/A
Proprietary MS Median 0.81% 1.10% -1.32% 2.29% 2.99% 1.28%
Event Driven (Americas-Based)
Investor Letters Median -3.43% N/A N/A 0.99% N/A N/A
Proprietary MS Median -0.88% 0.99% -0.69% 1.58% 1.99% 1.29%
Market Indices
S&P 500 TR 2.44% 2.69% -3.07% 10.99% 13.97% 10.48%
MSCI AC World 0.73% 1.74% -3.94% 4.99% 6.82% 2.61%
Russell 2000 6.59% 0.09% -1.72% 1.90% 1.99% 0.24%
*Nov Return as of 12/12/2014
Source: Morgan Stanley Prime Brokerage, Bloomberg, Investor letters collected by Morgan Stanley
Note: The YTD Proprietary MS estimate is derived by compounding the previous month’s YTD return from Investor Letters w ith the current month’s MTD Proprietary MS return. For the
most recent Event Driven YTD proprietary return, it is calculated by compounding the previous month’s YTD return from Investor Letters w ith the current month’s MTD proprietary MS
return. The prior month's YTD return can be biased upw ards as a result of early reporters historically having better performance than late reporters for the prior month. In turn, this
biases upw ard the MS Proprietary YTD estimate during the f irst several w eeks of the current month.
-3.5%
-3.0%
-2.5%
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
All Funds Equity L/S Event Driven SPXT
Exposures vs. Returns: Little Benefit From Higher Nets in 2014
Despite relatively high levels of consistency in exposures YoY (i.e. high net funds in 2013 were still high net in 2014 and vice versa), there was a much weaker link between net leverage and performance in 2014 than we saw in 2013. The most net long funds in 2013 (i.e. quartile 4) were up 21% last year, outperforming the lowest net funds by 9%. In 2014, however, the most net long funds are up 5.4% YTD, which is only a little better than the least net long funds, which are up 4.1% YTD.
Negative First Half of December
Since 1990, there have only been 3 years where we’ve seen negative HF returns in the month of Dec (’11, ’02, & ’94 looking at HFR data). Based on our Proprietary Estimate of intra-month returns, hedge funds are seeing a negative month through Dec 12
th with All Funds down 93 bps, Equity L/S down 1.32%, and Event Driven down 69 bps.
Equity L/S Net Leverage vs. Performance: Higher Net Funds Outperform in 2014, But by Much Less Than in 2014
2013 and 2014 Net Leverage Quartiles 2013 and 2014 Performance by Net Leverage Quartiles
Gross Leverage vs. Performance: Low Gross in 2014 Hurts Most
2013 and 2014 Gross Leverage Quartiles 2013 and 2014 Performance by Gross Leverage Quartiles
Source: Morgan Stanley Prime Brokerage, investor letters collected by Morgan Stanley, data as of Oct or Nov, 2014
Note: Based on Equity L/S Funds w ith a Global or N. America Focus only.
106
135
162
194
109
144
164
212
100
150
200
250
1(Low Gross)
2 3 4(High Gross)
Median '13 Gross Average '13 Gross
Median '14 Gross Average '14 Gross
17
34
52
74
23
38
52
73
0
20
40
60
80
100
1(Low Net)
2 3 4(High Net)
Median '13 Net Average '13 Net
Median '14 Net Average '14 Net
16.4
13.0
15.9
20.4
1.4
4.5 4.3 3.6
0
5
10
15
20
25
1(Low Gross)
2 3 4(High Gross)
Median '13 Rtn Average '13 Rtn
Median '14 Rtn Average '14 Rtn
12.0
15.9 16.7
21.0
4.1
0.4
5.1 5.4
0
5
10
15
20
25
1(Low Net)
2 3 4(High Net)
Median '13 Rtn Average '13 Rtn
Median '14 Rtn Average '14 Rtn
The information contained herein is not intended to be, and does not constitute, advice from Morgan Stanley. Morgan Stanley is not your advisor (municipal, financial or any other kind of advisor) and is not acting in a fiduciary capacity. 6
Leverage
US Gross and Net Leverage Very Steady This Year
Looking at US Equity L/S leverage, gross remained elevated and nets generally hung around long-term averages this year. What’s been notable about US gross and net leverage in 2014 is how steady both measures have been. The bottom right chart below shows that 2014 saw the lowest level of gross leverage volatility and the 2
nd lowest level of net leverage volatility
since ’05. Like last year, median gross and net both remained in 10 percentage point ranges for the entirety of 2014. Given that funds were moving around exposures less over the last two years, returns weren’t impacted as much by poor market timing (which was a drag from ’09 to mid-’12).
US Equity L/S Gross and Net Leverage vs S&P 500
Exposure as % of Equity (5-day averages of daily medians) S&P 500
Source: Morgan Stanley Prime Brokerage, Data as of Dec 10, 2014
400
600
800
1000
1200
1400
1600
1800
2000
2200
0%
20%
40%
60%
80%
100%
120%
140%
160%
180%
200%
Gross - Delta Adjusted Net - Delta Adjusted SPX (RS)
US Gross Above Long Term Average; Nets Close to Long Term Average 2014 Has Had Lowest Level of Gross Leverage Volatility Since 2005
Gross Leverage Annual Average (%) Net Leverage Annual Average (%) Standard Deviation (%)
Source: Morgan Stanley Prime Brokerage Source: Morgan Stanley Prime Brokerage
Note: The averages referenced above are the annual averages of daily medians across all
US Equity Long/Short (non-Quantitative) accounts. 2014 Avg is from 1/1/14 through
12/8/14 and w ill continue to change as the year progresses.
Note: The 2014 average figure is from 1/1/14 through 12/8/14 and w ill continue to change
as the year progresses.
135
138
156
136135
145
148
152
157155
58
6467
43 42
53 53
48
5855
0
10
20
30
40
50
60
70
80
120
125
130
135
140
145
150
155
160
Gross Leverage Net Leverage
Average from '05 - '14 YTD
4.8
2.6
6.5
18.4
12.0
5.7 5.4
3.9
2.62.0
3.6 3.8
5.6
9.2
11.1
4.8
8.8
4.9
2.2 2.4
0
2
4
6
8
10
12
14
16
18
20
Gross Leverage Net Leverage
Average from '05 - '14 YTD
The information contained herein is not intended to be, and does not constitute, advice from Morgan Stanley. Morgan Stanley is not your advisor (municipal, financial or any other kind of advisor) and is not acting in a fiduciary capacity. 7
While US medians were very steady, there were two areas of leverage that saw volatility this year: 1) Lower Net Funds: After playing catch-up throughout 2013, lower net funds (i.e. the 25
th %-tile of net leverage) were
at post-2008 highs at the start of 2014 and declined to the lows of 2013 by early April 2) Higher Gross Funds (i.e the 75
th %-tile of gross) were relatively high throughout 2014, but saw large declines in Sep and
Oct before recovering a little
4Q14 Seasonal Effects and What to Expect in 1Q15
It’s worth looking at how changes in leverage this quarter compare to 4Qs in prior years. Relative to the S&P, median gross leverage has fallen in 4Q, which is typical of what we’ve seen in past years. Gross leverage has begun to tick up slightly more recently, but based on average historical changes, we’d expect gross to decline again in late Dec.
In the 4th
quarter, net leverage usually moves in line with changes in the S&P—you can see that the average difference (solid black line) is flat in the right hand chart in the graphs immediately below. This year, net has NOT rebounded nearly as quickly as the S&P since mid-Oct.
In terms of what we expect to see in 1Q, gross leverage generally tends to increase while nets tend to move with equity markets. Over the past 3 years, we’ve generally seen net leverage track lower relative to changes in the S&P. Historical 4Q Changes in US Equity L/S Gross and Net Leverage
US Equity L/S Gross Leverage Quartiles US Equity L/S Net Leverage Quartiles
Source: Morgan Stanley Prime Brokerage, Data as of Dec 12, 2014 Source: Morgan Stanley Prime Brokerage, Data as of Dec 12, 2014
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Median 75th Percentile 25th Percentile
100%
120%
140%
160%
180%
200%
220%
240%
Median 75th Percentile 25th Percentile
Change in Median GROSS Leverage Minus S&P 500 Returns Change in Median NET Leverage Minus S&P 500 Returns
Source: Morgan Stanley Prime Brokerage, Bloomberg, data as of Dec 10, 2014
Note: Data above reflects daily medians across all US Equity Long/Short (non-Quantitative) accounts
-20%
-15%
-10%
-5%
0%
5%
10%
10/1 10/8 10/15 10/22 10/29 11/5 11/12 11/19 11/26 12/3 12/10 12/17 12/24 12/31
2005 2006 20072009 2010 20112012 2013 2014Avg. '05-'13 (ex. '08)
2011
2012
2013
-15%
-10%
-5%
0%
5%
10%
10/1 10/8 10/15 10/22 10/29 11/5 11/12 11/19 11/26 12/3 12/10 12/17 12/24 12/31
2005 2006 20072009 2010 20112012 2013 2014Avg. '05-'13 (ex. '08)
2011
2012
2013
The information contained herein is not intended to be, and does not constitute, advice from Morgan Stanley. Morgan Stanley is not your advisor (municipal, financial or any other kind of advisor) and is not acting in a fiduciary capacity. 8
Europe and Asia Leverage
In Europe and Asia, there were notable leverage changes as well (please note that the below figures are based on funds that generally focus on Europe or Asia). In Europe, gross leverage was relatively steady this year until Nov’s steep increase; in contrast, nets have trended downward for much of 2014, dropping from 60% at the end of 2013 to a low of 30% in Oct ’14, and then rebounding more recently to the mid-30s. Similar to Europe, Asia net leverage was relatively high at the start of the year and bottomed in Oct before rebounding closer to historical averages. Gross leverage was fairly choppy and saw a large increase in Nov that appears to be fading now in Dec.
Regional Positioning
In this section, we touch broadly on sector exposures in each region and some of the major regional positioning shifts that dominated this year. Exposures are based on cash and swap equities.
o US: Energy, Health Care, New Tech/Old Tech, Growth, Momentum, Value o Europe: Cyclicals vs. Defensives, Sector Exposures, European Periphery, Individual Country Exposures o Asia: Japan, China, Other Countries
US EXPOSURES
It’s interesting to note that hedge funds started 2014 with elevated L/S ratios to sectors that generally underperformed in the first half of the year: what we mean by this is that sectors with high L/S ratios on 12/31/2013 (relative to their own historical levels) generally had worse returns in 1H14 (these included Cons Disc, Financials, Industrials, and Telecom). In contrast, sectors with low L/S ratios from their own historical perspective (Utilities, Info Tech, and Health Care) had stronger returns in 1H14.
Average European Equity L/S Gross and Net Leverage
Gross Exp / Equity (%) Net Exp / Equity (%)
Source: Morgan Stanley Prime Brokerage, data as of Dec 12, 2014
Note: Leverage levels are defined as 5-day averages of daily averages and are delta-adjusted.
0%
20%
40%
60%
80%
100%
120%
100%
120%
140%
160%
180%
200%
220%
Europe Gross (LS) Europe Net (RS)
Median Asian Gross and Net Leverage
Gross Exp / Equity (%) Net Exp / Equity (%)
Source: Morgan Stanley Prime Brokerage, data as of Dec 12, 2014
Note: Leverage levels are defined as 5-day averages of daily medians and are delta-adjusted.
20%
30%
40%
50%
60%
70%
80%
90%
100%
110%
60%
70%
80%
90%
100%
110%
120%
130%
140%
150%
Asia Gross (LS) Asia Net (RS)
U.S. Sector Exposures
SectorCurrent
Level (%)
% Rank
Since '09
at 12/5/14
YTD
Change in
% Rank
Current
Level (%)
% Rank
Since '09
at 12/5/14
YTD Change
in % Rank
Current
Level (%)
% Rank
Since '09
at 12/5/14
YTD
Change in
% Rank
Cons Disc 18.2 89% -3% 5.7 70% -22% 1.9 57% -36%
Cons Stap 5.1 14% -24% 1.3 16% -38% 1.7 26% -26%
Energy 6.6 0% -1% 1.9 0% -40% 1.8 16% -65%
Financials 13.9 27% -46% 4.6 86% -14% 2.0 91% -9%
Health Care 13.4 98% 52% 4.6 98% 66% 2.0 58% 36%
Industrials 10.4 68% -15% 3.1 66% -29% 1.8 67% -25%
Info Tech 18.5 99% 71% 5.9 39% 31% 1.9 34% 26%
Materials 4.4 6% 4% 1.4 24% 12% 2.0 60% 26%
Telecom 1.7 5% -95% (0.3) 0% -100% 0.7 0% -98%
Utilities 1.5 12% -45% 0.2 64% 54% 1.3 76% 66%
ETF 6.3 27% 7% (3.6) 62% 25% 0.3 37% 34%
Source: Morgan Stanley Prime Brokerage, Data as of Dec 5, 2014
Note: Data is based on US cash and sw ap equity exposure across US clients only. The YTD Change in % Rank is in percentage points
Gross Exp as % of Gross Net Exp as % of Gross L/S Ratio
The information contained herein is not intended to be, and does not constitute, advice from Morgan Stanley. Morgan Stanley is not your advisor (municipal, financial or any other kind of advisor) and is not acting in a fiduciary capacity. 9
Energy: Hedge funds increased Energy exposures in the first half of the year as Energy equities rallied through June. As Crude Oil prices fell to multi-year lows during the second half of 2014, Energy stocks underperformed and HFs decreased gross and net exposures to the lowest levels of the past six years. Regarding Energy-focused fund performance, the median YTD return is -4.2% while the average is down -8.1%.
Health Care: Given strong performance of HC stocks over the past two years (best US sector YTD ’14, 2
nd best US sector in ’13),
HFs have steadily increased gross and net exposure such that both are near highs since ’09. Looking at Equity L/S performance YTD, Health Care-focused funds are the best sector-focused strategy with a median YTD return of 16.1% and average of 15.7%.
New Tech/Old Tech: Heading into 2014, funds increased New Tech exposures to all-time highs, while Old-Tech exposures were close to all-time lows (New Tech names outperformed in 2013 by a wide margin). However, this trend quickly reversed in 2014 as New Tech names underperformed by approximately 30% from March to May. As performance picked up in the second half of the year though, funds steadily increased exposure in both New and Old Tech.
U.S. Energy LONG & SHORT Exposures as % of Total Gross Exposure (%) U.S. Energy GROSS & NET Exposures as % of Total Gross Exposure (%)
Source: Morgan Stanley Prime Brokerage, U.S. data as of Dec 12, 2014
0
1
2
3
4
5
6
7
8
9Energy Long % Energy Short %
1
2
3
4
5
6
7
8
5
6
7
8
9
10
11
12Energy Gross % (LS) Energy Net % (RS)
U.S. Health Care LONG & SHORT Exposures as % of Total Gross Exposure (%) U.S. Health Care GROSS & NET Exposures as % of Total Gross Exposure (%)
Source: Morgan Stanley Prime Brokerage, U.S. data as of Dec 12, 2014
0
1
2
3
4
5
6
7
8
9
10HC Long % HC Short %
1
2
3
4
5
6
7
8
9
10
5
6
7
8
9
10
11
12
13
14
15HC Gross % (LS) HC Net % (RS)
Net Exposure to New Tech vs. Old Tech
Net Exposure as % of Global Net Exposure Net Exposure Difference
Source: Morgan Stanley Prime Brokerage, data as of Dec 9, 2014 Source: Morgan Stanley Prime Brokerage, data as of Dec 9, 2014
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
New Tech (MSXXNTCH Index) Old Tech (MSXXOTCH Index)
-6%
-4%
-2%
0%
2%
4%
6%
Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Difference (New Tech Net % - Old Tech Net %)
The information contained herein is not intended to be, and does not constitute, advice from Morgan Stanley. Morgan Stanley is not your advisor (municipal, financial or any other kind of advisor) and is not acting in a fiduciary capacity. 10
A similar story to New Tech is that of China Internet Names. There was a sizable increase in net exposure to these names as they rallied in both 2013 and early 2014, bringing nets to all time-highs; however, after hitting a high on March 6
th, China
Internet stocks came down ~30% through May 6th
. However, unlike New Tech, net exposure to China Internet names didn’t see large declines and rebounded quickly in the middle of the year to reach new highs in Sep.
Growth, Momentum, Value: In March and April 2014, selloffs in US growth and momentum caused significant volatility in many HF portfolios. From our vantage point, we saw exposure to high growth stocks reach an elevated level at the start of this year with long exposure over 3.5 times greater than short exposure (first left chart below). As high growth names sold off in March and April, we saw the long bias fall. However, the larger reduction in exposure actually occurred from Sep to Nov as the Growth L/S ratio fell to its lowest levels of the past 3 years.
In US value names, we have NOT seen an increased long bias this year, despite outperformance in March and April. In addition, the current Value L/S ratio of 1.5 is significantly lower than the Growth L/S ratio of 2.5. Exposure to high momentum names has also fallen to relatively low levels over the past two years. Finally, as performance of European factors appears to have been much less extreme this year than US factor performance, it’s worth mentioning that exposure to European factors appears to be quite different than what we see in the US.
Exposure to US-listed China Internet Names
Net Exposure as % of Global Net Exposure Long and Short Exposure as % of Global Gross
Source: Morgan Stanley Prime Brokerage, data as of Dec 9, 2014 Source: Morgan Stanley Prime Brokerage, data as of Dec 9, 2014
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Net as % of Global Net
0.0%
0.2%
0.4%
0.6%
0.8%
1.0%
1.2%
Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Long as % of Global Gross Short as % of Global Gross
US Growth Long Basket (MSQQUGRL Index)
Composite L/S Ratio Cumulative Relative Return
Source: Morgan Stanley Prime Brokerage, Bloomberg, data as of Dec 11, 2014
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
40%
2.0
2.2
2.4
2.6
2.8
3.0
3.2
3.4
3.6
3.8
Sep-1
1
Nov-
11
Jan-1
2
Mar-
12
May-
12
Jul-12
Sep-1
2
Nov-
12
Jan-1
3
Mar-
13
May-
13
Jul-13
Sep-1
3
Nov-
13
Jan-1
4
Mar-
14
May-
14
Jul-14
Sep-1
4
Nov-
14
MSQQUGRL L/S Ratio MSQQUGRL / SPX
EU Growth Long Basket (MSQQEGRL Index)
Composite L/S Ratio Cumulative Relative Return
Source: Morgan Stanley Prime Brokerage, Bloomberg, data as of Dec 11, 2014
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
1.4
1.6
1.8
2.0
2.2
2.4
2.6
2.8
3.0
3.2
3.4
Sep-1
1
Nov-
11
Jan-1
2
Mar-
12
May-
12
Jul-12
Sep-1
2
Nov-
12
Jan-1
3
Mar-
13
May-
13
Jul-13
Sep-1
3
Nov-
13
Jan-1
4
Mar-
14
May-
14
Jul-14
Sep-1
4
Nov-
14
MSQQEGRL L/S Ratio MSQQEGRL / SXXP
L/S ratio to high growth US names at 3-year low
Little reduction in China Internet despite challenging returns in Mar/Apr
The information contained herein is not intended to be, and does not constitute, advice from Morgan Stanley. Morgan Stanley is not your advisor (municipal, financial or any other kind of advisor) and is not acting in a fiduciary capacity. 11
Note: Factor exposures are based on exposures across all primarily fundamental (i.e. non-quantitative) strategies.
EUROPE EXPOSURES
Sector Exposures: There were a number of notable changes in European sector exposures, which mostly reflected declining net exposure to cyclical sectors (Industrials and Materials led) and increased net exposure to defensive sectors (Health Care and Utilities, in particular). In the chart below, the ratio of net exposure to cyclicals vs. defensives (blue line) fell to 5-year lows in late ’14.
US Value Long Basket (MSQQUVLL Index)
Composite L/S Ratio Cumulative Relative Return
Source: Morgan Stanley Prime Brokerage, Bloomberg, data as of Dec 11, 2014
-15%
-10%
-5%
0%
5%
10%
15%
20%
1.2
1.4
1.6
1.8
2.0
2.2
2.4
2.6
2.8
Sep-1
1
Nov-
11
Jan-1
2
Mar-
12
May-
12
Jul-12
Sep-1
2
Nov-
12
Jan-1
3
Mar-
13
May-
13
Jul-13
Sep-1
3
Nov-
13
Jan-1
4
Mar-
14
May-
14
Jul-14
Sep-1
4
Nov-
14
MSQQUVLL L/S Ratio MSQQUVLL / SPX
EU Value Long Basket (MSQQEVLL Index)
Composite L/S Ratio Cumulative Relative Return
Source: Morgan Stanley Prime Brokerage, Bloomberg, data as of Dec 11, 2014
-10%
-8%
-6%
-4%
-2%
0%
2%
4%
6%
8%
10%
0.8
0.9
1.0
1.1
1.2
1.3
1.4
1.5
1.6
1.7
Sep-1
1
Nov-
11
Jan-1
2
Mar-
12
May-
12
Jul-12
Sep-1
2
Nov-
12
Jan-1
3
Mar-
13
May-
13
Jul-13
Sep-1
3
Nov-
13
Jan-1
4
Mar-
14
May-
14
Jul-14
Sep-1
4
Nov-
14
MSQQEVLL L/S Ratio MSQQEVLL / SXXP
US Momentum Long Basket (MSQQUMOL Index)
Composite L/S Ratio Cumulative Relative Return
Source: Morgan Stanley Prime Brokerage, Bloomberg, data as of Dec 11, 2014
-5%
0%
5%
10%
15%
20%
25%
30%
35%
1.8
2.0
2.2
2.4
2.6
2.8
3.0
3.2
3.4
3.6
3.8
Sep-1
1
Nov-
11
Jan-1
2
Mar-
12
May-
12
Jul-12
Sep-1
2
Nov-
12
Jan-1
3
Mar-
13
May-
13
Jul-13
Sep-1
3
Nov-
13
Jan-1
4
Mar-
14
May-
14
Jul-14
Sep-1
4
Nov-
14
MSQQUMOL L/S Ratio MSQQUMOL / SPX
EU Momentum Long Basket (MSQQEMOL Index)
Composite L/S Ratio Cumulative Relative Return
Source: Morgan Stanley Prime Brokerage, Bloomberg, data as of Dec 11, 2014
-10%
-5%
0%
5%
10%
15%
20%
25%
1.8
2.3
2.8
3.3
3.8
4.3
Sep-1
1
Nov-
11
Jan-1
2
Mar-
12
May-
12
Jul-12
Sep-1
2
Nov-
12
Jan-1
3
Mar-
13
May-
13
Jul-13
Sep-1
3
Nov-
13
Jan-1
4
Mar-
14
May-
14
Jul-14
Sep-1
4
Nov-
14
MSQQEMOL L/S Ratio MSQQEMOL / SXXP
Europe Cyclicals vs. Defensives: Net Exposure as % of Total Gross Exposure
Source: Morgan Stanley Prime Brokerage, data as of Dec 5, 2014
Cyclicals = Cons Disc, Energy, Industrials, Materials Defensives = Cons Stap, Health Care, Telecom, Utilities
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
0
5
10
15
20
25
Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14
Cyclicals Defensives Ratio (RHS)
L/S ratio to US Value continues to fall
L/S ratio to European Value generally rose in ‘14
European Momentum exp.
near lows
EU Cyc/ Defensives Ratio fell to 5-year lows in late ’14
The information contained herein is not intended to be, and does not constitute, advice from Morgan Stanley. Morgan Stanley is not your advisor (municipal, financial or any other kind of advisor) and is not acting in a fiduciary capacity. 12
At the individual sector level, Industrials net exposure was at a high at the start of the year, but fell from the 96th
%-tile to the 50
th %-tile of historical exposures over the course of the year. Energy exposure was already at a low, but fell to even more net
short levels toward the end of the year. In contrast, Health Care net exposure reached new highs in 2014, but fell a little in 4Q.
Net exposure to European Financials as a whole remained relatively steady throughout 2014 (see light orange line in left-most chart above). In particular, Eurozone Banks were occasional topics of interest throughout 2014; however, despite volatility in returns, we saw HF net exposure go from net short from ’10 – ’13 to a modest net long by mid-’14 and remain steady in 2H14.
Europe Sector Exposures
SectorCurrent
Level (%)
% Rank
Since '10
at 12/5/14
YTD
Change in
% Rank
Current
Level (%)
% Rank
Since '10
at 12/5/14
YTD Change
in % Rank
Current
Level (%)
% Rank
Since '10
at 12/5/14
YTD
Change in
% Rank
Cons Disc 17.4 99% 27% 6.0 70% -10% 2.1 53% -21%
Cons Stap 6.4 5% -41% (0.7) 5% 5% 0.8 5% 4%
Energy 5.2 4% 0% (0.8) 0% -1% 0.7 0% -1%
Financials 17.6 85% 6% 5.5 92% -3% 1.9 89% -5%
Health Care 11.6 100% 78% 5.4 93% 36% 2.7 88% 16%
Industrials 17.5 12% -84% 5.5 50% -46% 1.9 59% -32%
Info Tech 8.0 37% -49% (0.1) 31% -40% 1.0 32% -37%
Materials 6.2 16% 12% 0.9 11% -29% 1.3 12% -48%
Telecom 4.7 79% -22% 2.3 81% -17% 2.9 78% -4%
Utilities 2.5 10% -12% 0.4 79% 29% 1.4 86% 36%
ETF 2.9 63% 60% (0.8) 98% 20% 0.6 100% 57%
Source: Morgan Stanley Prime Brokerage, Data as of Dec 5, 2014
Note: Data is based on Europe cash and sw ap equity exposure across global clients. The YTD Change in % Rank is in percentage points
Gross Exp as % of Gross Net Exp as % of Gross L/S Ratio
Europe Sector NET Exposures as % of Total Gross Exposure (%)
Source: Morgan Stanley Prime Brokerage, data as of Dec 5, 2014
(2.0)
(1.0)
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
Energy Indus Mat
(2.0)
(1.0)
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
CS HC Tel Util
(4.0)
(2.0)
0.0
2.0
4.0
6.0
8.0
10.0
CD Fin IT
2014 2014 2014
EZ Banks Gross as % of Global Gross EZ Banks Net as % of Global Net
Source: Morgan Stanley Prime Brokerage, data as of Dec 5, 2014
-2.5%
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
2.0%
0.0%
0.2%
0.4%
0.6%
0.8%
1.0%
1.2%
1.4%
1.6%
1.8%
1/1/2010 1/1/2011 1/1/2012 1/1/2013 1/1/2014
EZ Banks Gross as % of Global Gross EZ Banks Net as % of Global Net
Euro Stoxx Banks (SX7E Index)
Source: Bloomberg, data as of Dec 12, 2014
50
70
90
110
130
150
170
190
210
230
250
1/4/2010 1/4/2011 1/4/2012 1/4/2013 1/4/2014
The information contained herein is not intended to be, and does not constitute, advice from Morgan Stanley. Morgan Stanley is not your advisor (municipal, financial or any other kind of advisor) and is not acting in a fiduciary capacity. 13
European Periphery: Another shift we saw in 2014 was increased interest in peripheral countries. Indeed, the combined net exposure to Greece, Ireland, Italy, Portugal, and Spain more than tripled from its start of year levels and has remained near highs despite choppiness in returns over the second half of the year.
Select Europe Country Exposures: Among the larger countries within Europe, gross exposures saw some increases during the first four months of ’14 before heading lower throughout the rest of the year. While at least part of this may likely be explained by outperformance of US equities, especially when adjusted for currency effects, the falling gross exposure suggests that the “robust” opportunity set that many expected from Europe this year has yet to come to fruition. On the net side, 2014 generally saw a continuation of trends that started in 2013, i.e. lower net exposure to UK, Switzerland, Germany and increased net exposure to France, Italy, and Spain.
EU Periphery: HF Net Exposure and Weight in MSCI AC World
Source: Morgan Stanley Prime Brokerage, Bloomberg, data as of Dec 5, 2014
Note: EU Periphery includes Greece, Ireland, Italy, Portugal, Spain
-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
6.0%
Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14
Difference EU Periphery Share of Net Exp. EU Periphery Wgt in MXWD
Gross as % of Global Gross Net as % of Global Net
Source: Morgan Stanley Prime Brokerage, data as of Dec 12, 2014 Source: Morgan Stanley Prime Brokerage, data as of Dec 12, 2014
0.0%
1.0%
2.0%
3.0%
4.0%
5.0%
6.0%
1/1/2010 1/1/2011 1/1/2012 1/1/2013 1/1/2014
France Germany Italy
Spain Switzerland United Kingdom
-2.0%
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
1/1/2010 1/1/2011 1/1/2012 1/1/2013 1/1/2014
France Germany Italy
Spain Switzerland United Kingdom
The information contained herein is not intended to be, and does not constitute, advice from Morgan Stanley. Morgan Stanley is not your advisor (municipal, financial or any other kind of advisor) and is not acting in a fiduciary capacity. 14
ASIA EXPOSURES
Japan (left chart below): Japan caused challenges for many managers as net exposure was at multi-year highs heading into the 14% selloff in Jan. After HFs sold Japan throughout the first few months of the year, net exposure remained low and was at 20-month lows heading into the surprise BoJ announcement at the end of Oct. Since then, net exposure has ticked marginally higher, but there’s still room for it to move further given it was nearly twice as high last year.
China (right chart below): Towards the end of 2014, China has become even more topical as local markets have ripped higher—the Shanghai Composite is up 20% in 4 weeks from late Nov to early Dec. Throughout 2014, we saw net exposure to China increase and the high level data would suggest that HFs participated in the rally; however, until recently, there was little exposure to sectors like Financials and Industrials, which have been among the best performers in 4Q. While HF exposures in China remain dominated by Tech and Cons Disc, outside these sectors, net exposure has recently increased to 4-year highs.
Select Additional Asia Country Exposures: Aside from Japan and China, we have generally seen increased gross exposure across other Asian countries; however, only India has seen a dramatic increase in net exposure. While there was an initial run up in exposures heading into the election of Modi in May, net exposures have risen another ~20% from the end of Aug to early Dec to the high end of their 5-year range.
Japan Net Exposures as % of Global Net Nikkei 225
Source: Morgan Stanley Prime Brokerage, data as of Dec 5, 2014
6000
8000
10000
12000
14000
16000
18000
20000
0%
2%
4%
6%
8%
10%
12%
14%
16%
Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14
Japan Net as % of Global Net Exposure NKY Index
China Net Exp vs. MSCI AC Weight (%)
Source: Bloomberg, Morgan Stanley Prime Brokerage, data as of Dec 5, 2014
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
1/1/2010 1/1/2011 1/1/2012 1/1/2013 1/1/2014
China Net as % of Total Net
China MSCI AC Wgt
China Net (ex. Cons Disc & Tech) as % of Total Net
Gross as % of Global Gross
Source: Morgan Stanley Prime Brokerage, data as of Dec 5, 2014
0.0%
0.2%
0.4%
0.6%
0.8%
1.0%
1.2%
1.4%
1.6%
1.8%
1/1/2010 1/1/2011 1/1/2012 1/1/2013 1/1/2014
Australia India Korea Taiwan
Net as % of Global Net
Source: Morgan Stanley Prime Brokerage, data as of Dec 5, 2014
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
1/1/2010 1/1/2011 1/1/2012 1/1/2013 1/1/2014
Australia India Korea Taiwan
The information contained herein is not intended to be, and does not constitute, advice from Morgan Stanley. Morgan Stanley is not your advisor (municipal, financial or any other kind of advisor) and is not acting in a fiduciary capacity. 15
APPENDIX
CliffsNotes Version of 2014 HF Recap (all bolded phrases throughout report)
PERFORMANCE
At the end of last year, we asked investors what they thought would be the best performing strategy in 2014. 98% of investors guessed wrong – only 2% said CTA / Trend Following strategies
On a relative basis, it’s worth noting that hedge funds’ capture ratio this year isn’t too far off from ’12 figures
Long side has been very challenging
Mar & Apr of this year were particularly painful for funds
A bright spot for long portfolios is the +27% appreciation of Health Care longs through Nov
On the short side, small cap exposure helped returns in a big way
With this low amount of alpha in mind, where would we expect YTD Equity L/S returns to be? From our model, up +1.9%
We did NOT see mean reversion in returns from ’13 to ’14. Across Equity L/S funds, it appears that funds with stronger returns in ’13 tended to have better performance in ’14, but it’s certainly not a strong relationship
Turning to non-Equity L/S funds, the relationship between last year’s returns and this year’s performance is weak
There was a much weaker link between net leverage and performance in 2014 than we saw in 2013
Hedge funds are seeing a negative month through Dec 12th
LEVERAGE
What’s been notable about US gross and net leverage in 2014 is how steady both measures have been
After playing catch-up throughout 2013, lower net funds (i.e. the 25th
%-tile of net leverage) were at post-2008 highs at the start of 2014 and declined to the lows of 2013 by early April
In the 4th
quarter, net leverage usually moves in line with changes in the S&P… This year, net has NOT rebounded nearly as quickly as the S&P since mid-Oct
European nets have trended downward for much of 2014, dropping from 60% at the end of ’13 to a low of 30% in Oct ’14
Asia net leverage was relatively high at the start of the year and bottomed in Oct
REGIONAL POSITIONING US:
Hedge funds started 2014 with elevated L/S ratios to sectors that generally underperformed in the first half of the year
Energy stocks underperformed and HFs decreased gross and net exposures to the lowest levels of the past six years
Health Care: HFs have steadily increased gross and net exposure such that both are near highs since ’09
Increased New Tech exposures to all-time highs, while Old-Tech exposures were close to all-time lows… New Tech names underperformed by approximately 30% from March to May
A similar story to New Tech is that of China Internet Names… unlike New Tech, net exposure to China Internet names didn’t see large declines and rebounded quickly in the middle of the year to reach new highs in Sep
In March and April 2014, selloffs in US growth and momentum caused significant volatility in many HF portfolios
The larger reduction in exposure actually occurred from Sep to Nov as the Growth L/S ratio fell to its lowest levels of the past 3 years
In US value names, we have NOT seen an increased long bias this year EUROPE:
Exposure to European factors appears to be quite different than what we see in the US
European sectors: ratio of net exposure to cyclicals vs. defensives (blue line) fell to 5-year lows in late ’14
European Industrials was at a high at the start of the year, but fell from the 96th
%-tile to the 50th
%-tile of historical exposures
Eurozone Banks…HF net exposure go from net short in 2010-2013 to a modest net long by mid-year
Combined net exposure to Greece, Ireland, Italy, Portugal, and Spain more than tripled from its start of year levels
The falling gross exposure suggests that the “robust” opportunity set that many expected from Europe this year has yet to come to fruition
ASIA:
Japan: net exposure was at multi-year highs heading into the 14% selloff in Jan
China: until recently, there was little exposure to sectors like Financials and Industrials, which have been among the best performers in 4Q
India has seen a dramatic increase in net exposure
The information contained herein is not intended to be, and does not constitute, advice from Morgan Stanley. Morgan Stanley is not your advisor (municipal, financial or any other kind of advisor) and is not acting in a fiduciary capacity. 16
YTD Performance By Strategy, Sector, and Region of Investment Focus
Nov 2014 YTD Net Performance
Percentiles
Strategy/Region Median Average 5% 25% 50% 75% 95% # Funds
All Funds 2.93 4.17 (9.09) (1.10) 2.93 7.87 21.49 470
Convertible Arbitrage 0.49 3.21 (2.06) 0.14 0.49 3.32 13.05 9
Credit 2.33 0.96 (10.91) (1.55) 2.33 3.70 6.45 24
Equity Long/Short 2.67 3.83 (8.04) (1.12) 2.67 7.27 19.82 287
Event Driven 2.96 3.78 (7.80) (0.69) 2.96 7.24 19.44 15
Macro/Discretionary 0.20 2.29 (7.41) (5.51) 0.20 7.62 16.57 26
Multi-Strategy 3.43 4.28 (0.98) 0.15 3.43 6.49 12.49 23
Quant Equity 3.60 3.11 (7.02) (1.37) 3.60 7.32 12.55 13
Systematic Macro 13.04 11.40 (16.82) 2.95 13.04 22.30 33.53 37
Energy (4.17) (8.10) (33.29) (9.99) (4.17) 0.07 5.93 12
Financials 2.00 (0.31) (12.11) (5.84) 2.00 5.18 8.15 10
Health Care 16.10 15.68 0.00 9.21 16.10 19.81 30.63 18
Tech/TMT 2.49 4.53 (8.30) (1.83) 2.49 9.23 25.46 20
Emerging Markets (0.91) (0.19) (8.41) (5.33) (0.91) 4.29 9.71 44
Europe 4.15 5.72 (4.65) 1.07 4.15 8.40 22.40 36
Global 3.32 4.81 (10.76) (0.76) 3.32 8.99 24.57 209
North America 3.60 4.19 (5.36) 0.49 3.60 7.67 17.73 65
All Asia Funds 2.53 4.89 (7.90) (1.17) 2.53 7.16 19.04 75
Asia ex Japan 5.00 9.47 (1.88) 2.21 5.00 12.39 39.81 27
Asia inc Japan 1.60 2.39 (8.91) (2.25) 1.60 5.98 17.94 27
Japan (0.33) 2.24 (5.52) (1.50) (0.33) 6.60 17.16 21
North America 3.17 3.89 (9.89) (1.52) 3.17 8.48 20.49 256
Europe 2.85 5.05 (7.54) (0.55) 2.85 8.17 25.76 136
Asia 3.75 6.12 (5.33) 0.57 3.75 7.47 19.16 50
Latin America (1.08) (1.88) (11.33) (5.69) (1.08) 2.69 6.70 27
Source: Morgan Stanley Prime Brokerage, Investor letters collected by Morgan Stanley as of Dec 12, 2014
Notes:
1) The sector-focused returns are for Equity L/S fund only. Energy includes funds that have a sector focus on either Energy and/or Natural Resources
2) The Asia (ex Japan) sample includes all Asia focused funds excluding those that are Japan or Asia inc. Japan focused
3) Strategies/Regions w ith Less than 10 Funds in the current sample are highlighted in yellow
Fir
m
Lo
cati
on
Secto
rR
eg
ion
of
Fo
cu
sS
trate
gy
The information contained herein is not intended to be, and does not constitute, advice from Morgan Stanley. Morgan Stanley is not your advisor (municipal, financial or any other kind of advisor) and is not acting in a fiduciary capacity. 17
Nov 2014 YTD Global Equity L/S Appreciation and Contribution (Equity L/S Funds Only)
Nov 2014 YTD Global Equity L/S Appreciation and Contribution (Equity L/S Funds Only)
We Often Look At Equity L/S Returns…
By Treating Long and Short Appreciation Separately As If Each Side Were Its Own Portfolio
Long Minus Short APPRECIATION (%) Long Appreciation (%) Short Appreciation (%) MSCI AC World (%)
Below, We Look At What Has Contributed Most to Portfolios YTD…
By Tak ing Into Account Sector Performance, HF Exposure to Each Sector, and Long and Short Side Leverage
Long Minus Short CONTRIBUTION (%) Long Contribution (%) Short Contribution (%) MSCI AC World (%)
Source: Bloomberg, FactSet, Morgan Stanley Prime Brokerage, Data as of Nov 30, 2014
Notes:
1) The above analysis is based on a broad sample of the largest holdings w ith Morgan Stanley Prime Brokerage. Securities include all global single-name equities and ETFs
3) Short appreciation greater than 0% indicates losses in that sector
2) Long and short sector contribution measures how much each sector has contributed to YTD performance, by accounting for a) sector returns, b) HFs' exposure
to each sector relative to the broader market, and c) the amount of leverage being used on both the long and short side
5.5
(1.8)
(0.1)
14.3
4.9
0.6
12.3
(1.6)
6.8
27.1
14.7
7.9
-30 -20 -10 0 10 20 30
ETF
Tel
CD
Util
Fin
Mat
CS
Engy
Ind
HC
IT
Total
4.8
4.5
15.2
5.6
9.4
(10.8)
1.9
21.6
17.6
6.7
-30 -20 -10 0 10 20 30
ETF
Tel
CD
Util
Fin
Mat
CS
Engy
Ind
HC
IT
Total
6.9
9.6
1.3
20.3
9.3
(10.1)
2.7
(23.0)
3.0
20.1
6.0
4.5
-30 -20 -10 0 10 20 30
ETF
Tel
CD
Util
Fin
Mat
CS
Engy
Ind
HC
IT
Total
(1.4)
(11.3)
(1.4)
(5.9)
(4.4)
10.7
9.7
21.4
3.8
7.0
8.7
3.4
-30 -20 -10 0 10 20 30
ETF
Tel
CD
Util
Fin
Mat
CS
Engy
Ind
HC
IT
Total
0.0
(0.1)
0.0
0.1
0.8
0.0
0.6
(0.0)
1.0
2.6
2.6
7.9
-2 0 2 4 6 8
ETF
Tel
CD
Util
Fin
Mat
CS
Engy
Ind
HC
IT
Total
0.2
0.5
0.5
1.2
(0.2)
0.9
(1.0)
0.2
2.2
2.2
6.7
-2 0 2 4 6 8
ETF
Tel
CD
Util
Fin
Mat
CS
Engy
Ind
HC
IT
Total
(0.5)
(0.2)
(0.2)
(0.1)
(0.7)
0.3
(0.1)
0.7
(0.2)
(0.8)
(0.6)
(2.5)
-6 -4 -2 0 2 4
ETF
Tel
CD
Util
Fin
Mat
CS
Engy
Ind
HC
IT
Total
(0.4)
(0.3)
(0.2)
(0.0)
0.1
0.3
0.5
0.7
0.8
1.8
2.0
5.5
-2 0 2 4 6 8
ETF
Tel
CD
Util
Fin
Mat
CS
Engy
Ind
HC
IT
Total
The information contained herein is not intended to be, and does not constitute, advice from Morgan Stanley. Morgan Stanley is not your advisor (municipal, financial or any other kind of advisor) and is not acting in a fiduciary capacity. 18
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