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
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? 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 YTD Macro Barclays Agg Small Cap Small Cap Barclays Agg Small Cap Small Cap S&P 500 Market Neutral Small Cap S&P 500 11.4% 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 500 11.4% 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
By the numbers: what are other investors thinking? Source: Preqin Investor Outlook: Alternative Assets 1H 2017. 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 3/31/2017. 3
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
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
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
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
#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 10-20 managers for diversification, 10% Hedge Fund allocation, questions should be ask for $40-$80bn Investor 8
Questions. 9