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Absolute Return Funds and Institutional Investors

abcd. Absolute Return Funds and Institutional Investors. Robert Howie 23 June 2003 The Caledonian Hilton Hotel, Edinburgh. Absolute Return: e.g. 10% p.a. Relative Return: e.g. MSCI World + 1% p.a. Think of “absolute return” strategies as “cash plus” Typically this means hedge funds

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Absolute Return Funds and Institutional Investors

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  1. abcd Absolute Return Funds and Institutional Investors Robert Howie 23 June 2003 The Caledonian Hilton Hotel, Edinburgh

  2. Absolute Return: e.g. 10% p.a. Relative Return: e.g. MSCI World + 1% p.a. Think of “absolute return” strategies as “cash plus” Typically this means hedge funds Agenda: Why some institutional investors are investing in these strategies, and others not What is happening in the hedge fund industry Some research into hedge fund returns Introduction

  3. Questionnaire on hedge fund investing to all Appointed Actuaries 38 responses (6 nil responses) 16% already had hedge fund investments 16% expected to make investments in next 3 years 31% would never invest in hedge funds Allocations very small and expected to stay so Survey of UK Life Insurers

  4. Hedge Fund Strategies Currently Utilised

  5. Hedge Fund Strategies Likely to be Utilised in Future

  6. Restrictions Preventing Hedge Fund Investments

  7. Attractive Attributes of Hedge Funds

  8. New funds no longer closing on launch Development of incubator/seeding programs for new funds Increase in the rate and number of closures Many failures caused by operational problems Others close because they fail to raise sufficient assets and become uneconomic New funds continue to launch Layoffs in traditional fund management and investment banks adding to pool of hedge fund managers Update on Hedge Fund Industry

  9. Institutional investors are used to position level transparency Hedge fund managers rarely supply this information to all investors Short positions are particularly protected Short positions have unlimited losses, and managers sometimes feel vulnerable to competitive exploitation Managers believe this is information is too sensitive Hedge Fund Transparency

  10. Investor Risk Committee of the International Association of Financial Engineers objectives for disclosure: Risk monitoring – no undue risks Risk aggregation – ability to use individual manager data to analyse portfolios of hedge funds Strategy drift monitoring – ability to determine whether manager is adhering to stated style Hedge Fund Transparency

  11. Many studies on explanatory models Hedge fund returns only partially explained by traditional linear models Option-like return payoffs Expect further research in this area Academic research on modelling hedge fund returns

  12. Heterogeneity of hedge funds

  13. Equity prices (S&P 500) Long Government Bond prices (Lehman Long Gov) Credit (Lehman Long Credit less Lehman Long Gov) Growth vs value (Russell 1000 Growth less Russell 1000 Value) US short rate (% move in 1 month interest rate) Implied volatility (% move in CBOE OEX Volatility Index) Regression Analysis of Hedge Fund Index Returns - Factors

  14. Many of the correlations fairly high Betas are generally lower (notable exception is credit) Many had a high correlation with equities (>0.6) Notably Equity Hedge and Event Driven Lower betas Many strategies exhibited strong correlation to credit Performed badly when credit deteriorated Most pronounced in the 1997 to 1999 period Incorporates the 1998 crash when credit spreads increased significantly Also some significant betas in this period Regression Analysis of Hedge Fund Index Returns – Main Results

  15. Many strategies have shown a high negative correlation to VIX Volatility Especially in the most recent time period 2000 to 2002 Particularly Equity Hedge and Event Driven Factor has very strong negative correlation to equity returns Regression Analysis of Hedge Fund Index Returns – Main Results

  16. UK Marketing Unlikely that marketing to retail investors will be allowed Market Impact Short-selling not discouraged, but increased transparency desirable Other Countries Mixture of approaches Sometimes driven by tax considerations Regulation of Hedge Funds

  17. Many investors choose to delegate Hedge fund selection and due diligence Portfolio construction Monitoring Fund of hedge fund managers bring Diversification Market access / capacity Improved liquidity Lower minimum investments Extra layer of fees Funds of Hedge Funds

  18. Limited role in hedge fund industry Unlikely to change Actuarial consulting firms focusing on funds of hedge funds Potentially important role advising on the strategic allocation to hedge funds More education needed? The role of actuaries

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