HEDGE FUNDS AND AUTOMOBILES AN OVERVIEW PETER MULDOWNEY SENIOR VICE PRESIDENT, INSTITUTIONAL STRATEGY CONNOR, CLARK & LUNN FINANCIAL GROUP
CHALLENGING THE BAD RAP HIGHER FEES TRANSPARENCY COMPLEXITY 3
HEDGE FUNDS BY NUMBERS $3.22tn Assets Under Management 7,500+ Rest of World Hedge Fund Managers Asia-Pacific Europe $3.22tn Hedge Fund Assets By Region North America 5,100+ Institutional Investors Source: Preqin, HFR and secondary sources ; 2016 4
HEDGE FUND DEFINED Underlying philosophy of hedge fund investing is that the skill of the manager, rather than the return of the market is the key determinant of how they will perform. Source: Pensions and Lifetime Savings Association, UK 5
BETA Return from investing in the market No special skill required Accessible at very low cost 6
ALPHA Return you earn due to skill Active management is a zero sum game Alpha is more expensive 7
IMPACT OF SHORT CONSTRAINTS 13% 16% Stocks 10% X 5% Y 3% -5% Z Expected Return Volatility Corr (X,Y,Z) Correlation X Y Z X 1.0 0.2 0.3 Y 0.2 1.0 0.1 Z 0.3 0.1 1.0 Source: Goldman Sachs Strategic Role For Hedge Funds 8
IMPACT OF SHORT CONSTRAINTS CONSTRAINED ASSET MIX No Shorting X Y Z 0% 29% 71% Expected Return 6.5% 4.7% Volatility UNCONSTRAINED ASSET MIX Shorting X Y Z -20% 21% 99% Expected Return 8.0% 4.7% Volatility Source: Goldman Sachs Strategic Role For Hedge Funds 9
HEDGE FUND STRATEGIES RELATIVE VALUE EVENT DRIVEN LONG SHORT TACTICAL TRADING Convertible Arbitrage Merger Arbitrage Geography Managed Futures Equity Arbitrage Special Situations Industry Global Macro Fixed Income Arbitrage Distressed Debt Style 10
HEDGE FUND ASSETS STRATEGY INVESTOR Tactical Trading Relative Value Insurance Company Other Public Pension Long Short 2015 Event Driven Asset Manager Endowment & Foundation 2015 Private Pension Sovereign Wealth Fund Percentage of Assets By Strategy Percentage of Assets By Investor Type Source: HFR and Preqin ($1bn Investor Club Breakdown) 11
HEDGE FUND ROLES DIVERSIFIER Significant alpha Significant or some alternative beta Little or no traditional beta SUBSTITUTE Combination of alternative and traditional beta and alpha 12
HEDGE FUND STRATEGIES RELATIVE VALUE EVENT DRIVEN LONG SHORT TRADING Equity Market Neutral Merger Arbitrage Fundamental Macro DIVERSIFIER SUBSTITUTE Source: Lyxor Research, HFRI Total Indices and CC&L Financial Group 13
HEDGE FUND STRATEGIES DISTRIBUTION OF MONTHLY RETURNS 90 RELATIVE VALUE 80 70 60 Equity Market Neutral 50 40 30 20 DIVERSIFIER SUBSTITUTE 10 0-15% -10% -5% 0% 5% 10% 15% Equity Market Neutral Index MSCI World Index (USD) Source: Lyxor Research, HFRI Total Indices and CC&L Financial Group 15
HEDGE FUND STRATEGIES LONG SHORT Fundamental DIVERSIFIER SUBSTITUTE DISTRIBUTION OF MONTHLY RETURNS 90 80 70 60 50 40 30 20 10 0-15% -10% -5% 0% 5% 10% 15% Long Short (EH) Index MSCI World Index (USD) Source: Lyxor Research, HFRI Total Indices and CC&L Financial Group 16
HEDGE FUND STRATEGIES DISTRIBUTION OF MONTHLY RETURNS 90 80 70 60 50 40 30 20 10 0-15% -10% -5% 0% 5% 10% 15% Macro Index MSCI World Index (USD) TRADING Macro DIVERSIFIER SUBSTITUTE Source: Lyxor Research, HFRI Total Indices and CC&L Financial Group 17
HEDGE FUND STRATEGIES DISTRIBUTION OF HEDGE FUND INDEX RETURNS 90 80 70 60 50 40 30 20 10 0-10% -8% -6% -4% -2% 0% 2% 4% 6% 8% 10% Long Short Index Equity Market Neutral Index Macro Index Source: Lyxor Research, HFRI Total Indices and CC&L Financial Group 18
LONG-TERM MERITS RISK AND RETURN 15% 15 YEARS ENDING DECEMBER 31, 2016 12% Return 9% 6% 3% Relative Value Index Macro Index Event-Driven Index Long Short (Equity Hedge) Index S&P500 Index (USD) MSCI World Index (USD) 0% 2% 4% 6% 8% 10% 12% 14% 16% Volatility Source: HFRI Total Indices and Thomson Reuters 19
SHORTER-TERM CHALLENGES RISK AND RETURN Return 15% 12% 9% 6% 3% Relative Value Index Event-Driven Index 5 YEARS ENDING DECEMBER 31, 2016 Long Short Index S&P500 Index (USD) MSCI World Index (USD) Macro Index 0% 2% 4% 6% 8% 10% 12% 14% 16% Volatility Source: HFRI Total Indices and Thomson Reuters 20
SMALL IS BETTER A CANADIAN PERSPECTIVE RISK AND RETURN 5 YEARS ENDING DECEMBER 31, 2016 24 Long Short Fund (CAD) 20 16 MSCI World Index (CAD) Return 12 8 Relative Value Fund (CAD) MSCI World Index (USD) 4 0 HFR Relative Value Index HFR Long Short Index 2 4 6 8 10 12 Volatility * Net pf fee returns CC&L Investment Management Source: Thomson Reuters and CC&L Financial Group 21
CASE FOR US EQUITY OVERLAY MEDIAN ROLLING 4-YEAR ADDED VALUE VS. S&P 500 INDEX Outperformance is cyclical 5% 4% 3% 2% 1% Low added value even in good times 0% -1% -2% -3% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Peer Group 50th Percentile Source: Morningstar 22
US EQUITY OVERLAY EXAMPLE SYNTHETIC S&P 500 Index Futures $100 PHYSICAL Market Neutral $50 Cash Margin $50 S&P 500 Index + 50% Market Neutral Return* *Assuming cash financing is equal to cash return Source: CC&L Financial Group 23
US EQUITY OVERLAY EXAMPLE US EQUITY OVERLAY 5% ROLLING 4-YEAR ADDED VALUE VS. S&P 500 INDEX 4% 3% 2% 1% 0% -1% -2% -3% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Peer Group 50th Percentile 100% SP500 Index + 50% HFRI EMN Index Source: Morningstar, HFR and CC&L Financial Group 24
CASE FOR FIXED INCOME OVERLAY 20% FTSE TMX Canada Universe Bond Yield FTSE TMX Canada Universe Bond 10-Year Return Yield predicts return 16% 12% 8% 4% 0% 1979 1983 1987 1991 1995 1999 2003 2007 2011 2015 3% Fixed Income Median Rolling 4-Year Added Value 2% Limited added value 1% 0% -1% Source: Thomson Reuters, evestment, and CC&L Financial Group -2% -3% 2004 2006 2007 2008 2009 2010 2011 2013 2014 2015 2016 50th percentile 25
FIXED INCOME OVERLAY EXAMPLE UNIVERSE BOND OVERLAY FUND FTSE TMX Universe Bond Index Fund Active Fixed Income 70% 30% Synthetic Fixed Income & 30% Physical Market Neutral Fund 2% p.a. expected return* 4% p.a. expected return** *Estimated 10 year return for the FTSE TMX Universe Bond Index **Benchmark of FTSE TMX Universe Bond Index + 2%p.as.t Source: Thomson Reuters and CC&L Financial Group 26
POTENTIAL ALPHA BENEFIT Return Successful Alpha +1.0% 75/25 50/50 30/70 Note: Assumed returns; Equity 6% and bonds 2% Risk (Volatility) 28
OVERLAY HISTORICAL EXPERIENCE 10% UNIVERSE BOND OVERLAY FUND ROLLING 4-YEAR ADDED VALUE VS. UNIVERSE BOND INDEX 8% 50 th Percentile Long-Only Active* Overlay Bond Fund* 6% 4% 2% 0% 2010 2011 2012 2013 2014 2015 2016 Source: Thomson Reuters and CC&L Financial Group; * Gross returns 29
ROLE FOR HEDGE FUNDS DIVERSIFIER SUBSTITUTE OVERLAY Regrets 30
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