5 th Annual PAPERS Fall Workshop Hedge Fund Investing

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1 5 th Annual PAPERS Fall Workshop Hedge Fund Investing James H. Grossman, Jr., CPA, CFA Managing Director of External Public Markets, Risk & Compliance

2 What are Hedge Funds? Private investment vehicles Defines its return profile as absolute return vs. benchmark oriented Strategies seek to exploit inefficiencies and complexities both within asset classes and between asset classes Managers can be both long and/or short financial instruments Compensation paid to managers consists of a base fee and a performance fee May utilize leverage 2

3 Hedge Funds Trade instruments available to all market participants Typically flexible and opportunistic Benefit from the ability to take both long and short positions 3

4 Types of Hedge Funds Equity Long/Short Event Driven Relative Value Tactical Trading 4

5 Equity Long/Short Industry Focus Regional Focus Short Bias Multi-Strategy 5

6 Event Driven Equity Focus Debt Focus Multi-Strategy 6

7 Relative Value Long/Short Credit Convertible Arbitrage Fixed Income Quantitative Strategies Multi-Strategy 7

8 Tactical Trading Global Macro Emerging Markets Macro Commodities CTAs Reinsurance Multi-Strategy 8

9 Hedge Fund Industry Universe (by number of firms) Industry estimates that there are between 4,000 and 5,000 hedge fund firms 5.26% 11.45% Assets under management 7.72% 9.31% 50.82% < $100 Million $100 to $250 Million $250 to $500 Million $500 M to $1 Billion $1 to $5 Billion > $5 Billion 15.44% Source: HFR Global Hedge Fund Industry Report, 2011 Q3 9

10 Hedge Fund Industry Universe (by firm assets under management) Industry estimates that hedge funds manage approximately $2 trillion 1.45% 2.39% 3.09% 5.34% Assets under management 62.74% 24.98% < $100 Million $100 to $250 Million $250 to $500 Million $500 M to $1 Billion $1 to $5 Billion > $5 Billion Source: HFR Global Hedge Fund Industry Report, 2011 Q3 10

11 Estimated Growth of HF Industry $2,500 (in billions) $2,000 $1,500 $1,000 $500 $- $(500) Q Source: HFR Global Hedge Fund Industry Report, 2011 Q3 Net Asset Flow Estimated Assets 11 Q2 2011

12 Hedge Fund Performance Cumulative Value of $100 Invested O ver 10yr Period Ending April $180 $160 $140 $120 $100 $80 $60 Apr-01 Oct-01 Apr-02 Oct-02 Apr-03 Oct-03 Apr-04 Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 M SCI W orld USD BarCap Gl Agg Bond HFRI FO F Composite Source: Aksia, LLC 12

13 Hedge Fund in a Portfolio Various Uses for Hedge Funds in a Portfolio Absolute return Equity substitute Fixed income substitute Portable alpha Important to understand nature of hedge fund Directional strategy Non-directional strategy 13

14 How to Invest in Hedge Funds Fund of Funds Commingled Fund Fund of One Separate Account 14

15 Hedge Fund Due Diligence Investment Review Operational Review Critical if investing in a fund structure 15

16 Hedge Fund Investment Review Investment Strategy Does strategy resonate with you Investment Team & Structure Strong personnel Key man risk Risk Management Process Strong risk controls 16

17 Hedge Fund Operational Review Operations and Infrastructure Independent calculation of net asset value? Regulatory and Compliance Private Placement Memorandum ADV Review Financial Statements 17

18 Private Placement Memorandum Base management fee and performance fees Standard of care Hurdle rate High water mark Side pockets Lock-up period Gates Liquidity Transparency Key man provision 18

19 Institutional Issues Headline Risk Leverage Liquidity 19

20 Should I Invest in Hedge Funds? Depends Do I have the expertise? Investment Operational Do I have the backing of my Trustees? Can I afford a consultant? Do I have a long enough time horizon? Can I handle the potential criticisms? Do I have access? 20

21 5 th Annual PAPERS Fall Workshop Hedge Fund Investing James H. Grossman, Jr., CPA, CFA Managing Director of External Public Markets, Risk & Compliance