CFA Naik Presentation Conference 27 June 2011 Without Animation Web

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Hedge Funds: The Past, Hedge Funds: The Past,

The Present

and

The

Future?*The

Present

and

The

Future?*

Prof. Nara an Y. Naik

Hedge Fund Research Centre

London Business School

27 June 2011



Strategy

Buy and Hold Buy and Hold

Long On y Long On y

Trend Trend

Following Following

Alternative Investments Alternative Investments :* :*

Convergence Convergence

Trading Trading

Strategies Strategies

Location/

Long S ort Long S ort

Buy & Hold

Assets Classes

Location/Markets

Bonds Stocks Real Commodities Currencies Spreads Spreads Venture Venture

ong n y Tra t onal Investments:

Estate Capital Capital

* In addition to differences in flexibility, there are differences in Incentives and Regulation



Insi hts from

Research

What investors are

willing to pay 2/20 for

(or 3/30 for FoHFs)

β ‐ , ‐

Betas, and Exotic Betas

Traditional Betas

Page 3



performance prospects in future?

hedge funds

(as

businesses)

1. Hedge Fund is a composite of strategy and people (business model)

. e c o ce o s ra egy s epen en on r s ‐re urn c arac er s cs

and market environment

3. The choice

of

business

model

involves

other

considerations

4. Plenty of data and empirical evidence on past strategy

characteristics (hedge fund returns) but not much on business

characteristics (mostly qualitative data)—let’s start here

4



Capital

Structure

of

the

Industry

•Focus should be on hed e fund com anies not funds

Distribution of AUM versus Number of Firms

•According

to

HFR,

approximately

85%

of

the

capital

are

in

the

hands

of 15% of hedge fund companies

Q? Do investors place more emphasis on the company/manager (driver) or the strategy/fund (car)

•To answer this question, let’s take a closer look at the historical

5



Historical Performance pattern by AUM deciles

e man,

ung an

s e

• Each year end from 2000 to 2009, merge Barclays, CISDM, HFR, Lipper TASS. Group un s y irms, remove up icates, sum AUM or

each firm*

• or rms n o ec es ec e s sma es o rms

• Add Institutional Investor (“II

100”)

and

Absolute

Return

‐Alpha

(“AR

” . ‐

reporting firms, obtain returns from private sources

‐ ‐ , .

•

6

This is a complicated task and needs specialist Hedge Fund Database Management skills



Capital

formation

over

the

last

DecadeDistribution of AUM versus Number of Firms

Decile 2001 2002 2003 2004 2005 2006 2007 2008

1 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

2 0.10% 0.10% 0.10% 0.10% 0.00% 0.00% 0.00% 0.00%

. . . . . . . .

4 0.50% 0.40% 0.40% 0.40% 0.30% 0.30% 0.30% 0.30%

5 1.00% 0.80% 0.70% 0.70% 0.60% 0.50% 0.50% 0.50%

6 1.70% 1.30% 1.30% 1.30% 1.10% 0.90% 0.90% 1.00%

7 2.70% 2.30% 2.30% 2.50% 1.90% 1.60% 1.70% 1.80%

8 5.40% 4.30% 4.40% 4.80% 4.00% 3.30% 3.50% 3.50%

9 11.10% 9.60% 9.80% 10.20% 9.70% 8.30% 8.20% 8.20%

Dec10 & II100 77.10% 80.90% 80.70% 79.70% 82.10% 85.00% 84.70% 84.50%

Total AUM ($B) $380 $484 $645 $1,019 $1,241 $1,589 $2,226 $1,696

Number of Firms 1,023 1,146 1,312 1,552 1,902 1,877 2,145 2,267

7

Dec10 & II100-cut($M) $621 $606 $739 $1,034 $1,100 $1,210 $2,000 $1,100



Capital Structure of the Industry is even more

56.46%

53.90%

Distribution of AUM, Number of FirmsSource: HFR 2008 Industry Report

40.00%

50.00%

.

29.77%

20.00%

30.00%

5.45%

11.26%6.67% 9.11%

14.76%

0.00%

.

>5 Billion >1 Billion >500 M > 250 M >100 M < 100 M

. . ..

AUM by Firm as %-of Industry %-of Total # of Firms

8



Capital Structure of the IndustrySurvival Probabilities

Survivorship Formation

Decile 2001 2002 2003 2004 2005 2006 2007 2008

0 1 2 3 4 5 6 7

2 79% 66% 60% 55% 51% 42% 37%

3 84% 73% 64% 60% 55% 51% 47%

5 88% 80% 74% 69% 63% 59% 49%

6 91% 83% 80% 77% 72% 64% 56%

92% 88% 83% 77% 74% 71% 69%

8 93% 88% 82% 79% 74% 69% 63%

9 95% 90% 86% 81% 78% 74% 67%

9

Dec10 & II100 99% 98% 96% 94% 93% 92% 89%



Flagship Funds of the “Blue Chip” firms*

325%

275%

175%

225%

125%

T+3% HFRI Fund of Funds Composite Index

HFRI Fund Weighted Composite Index Tremont Hedge Fund Index

T10_2009 T10_2010

10* Source: Edleman, Fung and Hsieh (2010)



Alpha delivered by different AUM deciles over time

e man,

ung an

s e

• Each year end from 2000 to 2009, merge Barclays, CISDM, HFR, Lipper TASS. Group un s y irms, remove up icates, sum AUM or

each firm.

• ns u ona nves or an so u e e urn‐ p a

BDC”) surveys of hedge fund firms to Deciles 9 and 10.

, decile‐portfolios for 1 year, re‐sort at the end of each year.

‐ , Hsieh,

Naik

and

Ramadorai

(JoF 2008)

• ‐

11

…..



Alpha Statistics (Deciles 1 to II100 firms)

12



0.840.88

0.80 0.81 0.80 0.78 0 78

1.00

0.71

0.26

0.710.75

0.39

0.73

0.55

0.69

0.76

0.69

0.610.65

0.74.

0.75 0.74

0.27

0.40

0.60

0.80

0 0

0.07

(0.13)

(0.40)

(0.20)

0.00

.

C

o r r e l a t i o n t o S & P 5

(0.89)(1.00)

(0.80)

(0.60)

e l v e t l a d

E q u i t y H

e d

E H : E n e r g y / B a s i c M a t e r i a l s

E H : E q M r k t N t r l

E H : Q u a n t D r c t n

E H : S h o r t B i a s

E H : T e c h / H C

E v e n t - D r i v e

E D : D i s t r e

s s e

E D : M e r g

A r

E D : P r v t e / R e

g D

M a c r

M a c r o : S y s

D i

R e l a t i v e V

a l u

R V : F I - A s s e t B a c k e

R V : F I - C o n v A r

R V : F I - C o r

R V : M u l t i - S t r a

R V : Y i e l d A l t s

F u n d W e i g h t e d C

o m

F O F C o m

E m r g n g M r k t s ( T o

t a l )

E M : A s i a e x - J a p a n

E M : G l o b a

E M : L a t A

E M : R u s s i

B a r c l a y s G o v t / C r d t A g g B o n

13

Source: HFR



Hedge fund Return Pattern is Consistent with having

‐

Performance of Indexes from June 2007 till May 2011

14

CMINST-1500



How have different Alternative Beta

Re licators done

durin

this

time?Performance of Select Replicators from June 2007 till May 2011

15

CMINST-1500



Looks like Alpha is delivered by very large firms (Blue Chip firms) and

the emerging managers (small firms or Incubators)*

The mid‐decile firms do not seem to deliver an al ha on avera e.

Data

seems

to

recommend

a

Bar‐

bell

strategy

Go for Blue Chip, Institutional Quality HF Managers and Emerging

Managers. In the middle, go for managers who deliver Alpha (relative

liquid, cheap, transparent and without any operational risk

16

cons stent w t ggrawa an or on . aut on: p a ecays over t me



can a one‐size fits all model work?

• Hedge Fund

is

a

vehicle

in

which

many

different

players

interact

whose objectives are not always in perfect alignment

• o r o o ec s ons are r ven y e nves men a v sor

management company)

• The financing

of

the

business

involves

prime

brokers

(lenders)

and

res ua c a man s nves ors

• Legal structure of the vehicle affects the behavior of third‐party

service providers—custodians, administrators, auditors etc.

• All of

the

above

businesses

have

been

evolving,

and

face

different

regulatory challenges

17



• What is being Regulated? The management company, the fund vehicles,

counterparties, others? Any of the above? All of the above?

• The industry has been consolidating into “Mega Asset Management

compan es – we are ta ng a out names, not .

• Systemic Risk,

if

any,

is

driven

by

the

actions

of

a

few

firms.

• Investor clientele—institutional (separate accounts, managed accounts, less

dependent on comingled vehicles); comingled vehicles (UCIT III); much less

• Counterparty risks—custodian services (consolidation),

accountin administrative services technolo PRIME BROKERS BANKERS

18



• Leverage is like a drug—where should the lion’s share of legislation fall?

Against drug users, drug dealers, or drug manufacturers? —probably all

three but

you

can’t

have

one

‐size

(one

‐rule)

that

fits

all

• t ta es two to ango: — everage over ose or a en ng pract ces

• Need to

have

a

clear,

clean

set

of

guidelines

out

of

FINREG

(shadow

or

,

• Unintended consequences—excessive or poorly guided regulation; pushing

“ ” ,

become too

big

(to

fail?)

• Can we ever avoid Enron Bernie Madoff? Eliminatin fraud is not that

19

different from eliminating greed— Good Luck!

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CFA Naik Presentation Conference 27 June 2011 Without Animation Web

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