Hedge. Living on the. ASKING the RIGHT QUESTIONS. INTELLIGENCE is NOT about having all the ANSWERS, RYAN BAILEY

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1 Living on the Hedge. RYAN BAILEY Board Member, Texas Hedge Fund Association INTELLIGENCE is NOT about having all the ANSWERS, but ASKING the RIGHT QUESTIONS - Some Brilliant Person 1

2 Agenda Is it worthwhile for $500M+ Pensions and Endowments to invest in Hedge Funds? Background + Why do we Invest? Are Hedge Funds an Asset Class? Manager Assessment Qualitative and Quantitative Overview Implementation Concerns What s important to consider? Just invest in public equity? YTD Macro Barclays Agg Small Cap Small Cap Barclays Agg Small Cap Small Cap S&P 500 Market Neutral Small Cap S&P % 5.2% 27.2% 26.9% 7.8% 16.3% 38.8% 13.7% 4.5% 21.3% 8.7% Equity L/S Global Bond S&P 500 S&P 500 Global Bond S&P 500 S&P 500 S&P 500 S&P % 4.8% 26.5% 15.1% 5.6% 16.0% 32.4% 11.4% 1.4% 12.0% 6.8% Comp Macro Relative Value Barclays Agg Equity L/S 11.0% 4.7% 23.0% 12.5% 3.8% 12.5% 22.1% 6.0% 1.1% 10.6% 5.0% Relative Value Market Neutral Equity L/S Relative Value S&P 500 Relative Value Equity L/S Macro Barclays Agg Small Cap 10.0% -3.0% 22.3% 12.5% 2.1% 9.7% 14.5% 5.8% 0.5% 9.2% 5.0% Global Bond Relative Value Relative Value Relative Value Macro Relative Value Global Bond 9.5% -17.3% 20.3% 11.5% 0.8% 6.5% 13.4% 5.3% 0.4% 7.7% 4.5% Equity L/S Equity L/S Small Cap Relative Value Equity L/S 8.7% -18.7% 20.3% 8.9% -0.5% 4.7% 9.6% 4.9% 0.2% 5.5% 3.5% Barclays Agg Macro Relative Value 7.0% -20.8% 18.6% 8.5% -0.7% 4.4% 7.5% 4.3% -0.2% 5.4% 3.3% Comp Global Bond Barclays Agg Market Neutral Global Bond Market Neutral Equity L/S Equity L/S Barclays Agg Relative Value 6.0% -24.3% 6.9% 6.5% -1.5% 4.3% 6.4% 3.6% -0.2% 2.6% 2.5% Market Neutral Equity L/S Macro Global Bond Barclays Agg Macro Market Neutral Market Neutral Barclays Agg 5.7% -26.4% 6.9% 5.5% -2.0% 4.2% 0.1% 3.2% -2.8% 2.2% 2.3% S&P 500 Small Cap Barclays Agg Macro Small Cap Market Neutral Barclays Agg Global Bond Global Bond Market Neutral 5.5% -33.8% 5.9% 3.2% -4.2% 3.1% -2.0% 2.6% -3.2% 2.1% 0.7% Small Cap S&P 500 Market Neutral Market Neutral Equity L/S Macro Global Bond Global Bond Small Cap Macro Macro -1.6% -37.0% -1.7% 2.5% -4.3% -1.3% -2.6% 0.6% -4.4% 1.0% 0.2% 2

3 By the numbers: what are other investors thinking? Source: Preqin Investor Outlook: Alternative Assets 1H How did we get here? 1990 $39M 1996 $257M 2003 $820M 2010 $1,917M 2017 $3,210M New to Institutional investors, lower risk vs. equities, toe hold allocations of 1-5%, max Hedge Funds viewed as an asset class ( marketable alternatives ) As comfort level increases, allocations move from 5% to up to 25% Large in flows, muted returns, some reducing exposure without thought to initial thesis Source: SEC.gov and Hedge Fund Research, Inc. *2017 through first quarter as of 3/31/

4 Why do we invest? σ Equity-like returns, bondlike volatility σ Growth Engines σ Tail/Macroeconomic Risk Hedging σ Portfolio Diversification NOT an Asset Class asset class [as-et klahs] noun A group of securities that exhibits similar characteristics, behaves similarly in the market place, and is subject to the same laws/regulations Ask: How does this manager impact my portfolio? 4

5 Evaluating Managers Appraising Hedge Fund Managers goes beyond Return Volatility Evaluating Managers Appraising Hedge Fund Managers goes beyond Return Volatility But also considers other merits... Skew Kurtosis 5

6 That skew and Kurtosis Market Neutral L/S Equity Short-Biased Stocks Global Macro CTA Managed Futures Risk Arbitrage Credit Arbitrage Convertible Arbitrage Qualitative Evaluation People Process 4Ps + Philosophy Performance OPPORTUNITY SET EDGE ROLE IN PORTFOLIO 6

7 Quantitative Evaluation When measuring quantitatively consider how the manager changes your distribution. For example: Merger Arbitrage Negatively skewed σ Increased frequency of higher (i.e., above average) returns σ Higher mean return σ Tail risk increased Implementation Concerns 1 Fund Size: The Enemy of Returns 2 LP Allocation Constraints 7

8 #1: Fund size Historically, Fund size vs. returns trade off But there are notable exceptions Source: Economist, ETFGI, Hedge Fund Research. #2: LP constraints Limited Partners bound by IPS restrictions 20% Typical maximum % of a given fund stipulated in IPS $400 million bite size Smallest fund would be a $2bn fund Hedge Fund * Assuming managers for diversification, 10% Hedge Fund allocation, questions should be ask for $40-$80bn Investor 8

9 Questions. 9

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