HEDGE FUNDS & ABSOLUTE RETURN STRATEGIES IN A LONG-TERM PORTFOLIO.

Transcription

1 HEDGE FUNDS & ABSOLUTE RETURN STRATEGIES IN A LONG-TERM PORTFOLIO

2 61% of hedge fund assets are held by institutional investors Source: Preqin February 2011 Hedge Funds Manager Survey Current developments in the hedge funds and institutional space Hedge Fund Industry AUM ($ Billions) $2,500 $2,000 $1,500 $1,000 $500 $ , st Qtr ,361 1,713 2,137 1,458 1,554 1,694 1,768 1,806 2nd Qtr 2011 Proportion of Assets (in %) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 39% 60% 54% 26% 7% 14% Global Capital Global Pension Funds Other Bonds Equities Source: BarclayHedge Source: Credit Suisse Investment Strategies and Solutions 2

3 Liquidity, Transparency, and Downside Risk Control & Management have become paramount concerns of investors, governments and corporate management Diversification helps but that does not mean a well-diversified basket of stocks are as safe in the long run. If they were safe in the long-run: they wouldn t command a risk premium longer-term put options (a.k.a. insurance) on stocks with a floor rising at the riskless rate would be cheaper than their shorter-term counterparts Absolute return strategies deserve a closer look in the modern capital allocation program 3

4 Based on Historical Returns From Jan 2002 to Aug 2011 Source: Bloomberg Regime State Probability (in %) Feb-88 Feb-89 Feb-90 Latin Eastern America Europe China India µ1 Annualized Returns in State σ1 Volatility in State µ2 Annualized Returns in State σ2 Volatility in State π1 Probability of State π2 Probability of State p12 Probability of Transition - State 1 to State p21 Probability of Transition - State 2 to State p11 Probability of Remaining in State p22 Probability of Remaining in State Feb-91 Feb-92 Feb-93 Feb-94 Feb-95 Feb-96 Asia Latin America Eastern Europe China India Feb-97 Emerging equity market returns exhibit contemporaneous shifts in volatility regimes Feb-98 Feb-99 Feb-00 Feb-01 Feb-02 Feb-03 Feb-04 Feb-05 CORRELATIONS (Jan Dec 2001) SPX MXFEJ MXCN MXIN SPX MXFEJ MXCN MXIN CORRELATIONS (Jan Aug 2011) SPX MXFEJ MXCN MXIN SPX MXFEJ MXCN MXIN EMERGING MARKETS CANNOT BE ENTIRELY CHARACTERIZED BY THEIR FIRST TWO MOMENTS 4

5 Ageing population and changing demographics in Japan, Hong Kong, Singapore and other parts of Asia. Declining support ratios As a consequence, expect compressed equity risk premiums and disappointing long-only equity returns An attendant issue: the development of cutting-edge financial solutions to meet investment and retirement planning needs Hedge funds, alternative investments, principal-protected and/or inflation-linked investment products, equity-indexed guaranteed life annuities (a.k.a. ratchet or click funds), etc. 5

6 Return-seeking (well-diversified) portfolio: Equities, hedge funds, portable alpha, commodities, real estate, private equity Matching (or hedging ) portfolio: Fixed income, laddered bond portfolios (including active management, high yield, EM debt) Interest rate and inflation total return swaps Equities Real estate Hedge funds Private equity Portable alpha Fixed Income TR Swaps Forwards + Futures Options Return Seeking Downside Protection = Insurance (Risky Portfolio) Matching (Asset-Liability Management) DOWNSIDE PROTECTION (Insurance) PERFORMANCE + RISK REDUCTION = DIVERSIFICATION, ASSET-LIABILITY MANAGEMENT AND RISK MANAGEMENT VIA FINANCIAL ENGINEERING 6

7 Source: Bloomberg Skewed to the right LOW CORRELATIONS TO TRADITIONAL ASSET CLASSES & POSITIVE SKEW RESULTED IN HIGH INCREMENTAL RETURNS FOR LOW MARGINAL RISKS 7

8 On a historical basis, an allocation to hedge funds would have yielded significantly higher returns from: Jan 2002 until now (multiple market cycles) Aug 2008 until now (Global Financial Crisis) Optimal allocation to hedge funds: The less dependent or correlated the assets, the more the potential gains from diversification Addition of uncorrelated assets with high information ratios results in significant expected return enhancement, thus enhancing portfolio risk-adjusted returns Introduction of alternative strategies improves the portfolio s potential return per unit of risk even at low overall portfolio risk levels (Sharpe ratio) Source: Bloomberg 8

9 Investors should seek hedge fund managers who have: Deep experience in portfolio management and a culture of continuous innovative research Robust security selection models tested under live performance, historical backtests, and Monte Carlo simulations, covering multiple economic environments Systematic and consistent, yet unconstrained, investment process that applies experience and model analytics to all relevant markets, asset classes, and opportunities Disciplined portfolio construction and downside risk management Flexible modeling capable of meeting specific client needs 9