Building Hedge Fund Portfolios Capable of Generating Absolute Return within Stressful Market Environments Presented to: October 20, 2011 Paul Lucek SSARIS Advisors, LLC SSARIS Advisors, LLC Wilton Corporate Centre Courtside Building, Suite 2C 187 Danbury Road Wilton, CT 06897 Investor Relations: (203)328-7200 Fax: (203)328-7299 Internet: www.ssaris.com email: info@ssaris.com
Introduction and Firm Summary Majority owned by State Street Global Alliance and minority owned by SSARIS Executive Management State Street Global Alliance is a wholly owned subsidiary of State Street Corporation Approximately $1.7 billon* in assets under management Clients include pensions, endowments, institutional and other types of investors $2.0 trillion* in assets under management The investment management division of State Street Corporation $21.5 trillion* in assets under custody (State Street Bank and Trust Company) Leading hedge fund service provider with front-to-back office administration and risk solutions * As of December 31, 2010. All values expressed in USD unless otherwise noted. This AUM includes the assets of the SPDR Gold Trust (approx. $58 billion as of December 31, 2010), for which State Street Global Markets, LLC, an affiliate of State Street Global Advisors, serves as the marketing agent. 2
Journal of Alternative Investments, 2004 3
Balancing Convergence & Divergence: Correlation is zero in normal circumstances Correlation turns negative in period of stress / crisis Opposite tail events coincide Combination yields more normal return distribution with less tail risk The information contained above is for illustrative purposes only. 4
Asset Class Diversification: Equities Fixed Income Currencies Commodities Convertible Arb Distressed Equity Hedge Equity Non-Hedge Market Neutral Event Driven Relative Value Arb Convertible Arb Distressed Event Driven Fixed Inc. Arbitrage Mortgage Backed Relative Value Arb Managed Futures / Global Macro / CTAs 5
Data sources: Hedge Fund Indices: Hedge Fund Research Inc. ( www.hedgefundresearch.com ) Benchmark portfolio (50% stocks / 50% bonds) Bloomberg S&P 500 Total Return Index Merrill Lynch 5-7 Year Constant Duration US Treasury Index CTA returns Bloomberg Barclay CTA Index CASAM / CISDM Asset Weighted CTA Index Time period is 21 years ( Jan 1990 through Dec 2010 ) 6
Benchmark 50 / 50 portfolio: Benchmark is: 50% S&P 500 Total Return Index 50% Merrill Lynch 5-7 Year Constant Duration US Treasury Index 7
Benchmark S&P 500 Total Return Index: 10.0 value of $1 invested (logarithmic scale) 1.0 1990: First Gulf war -14.67% 1998: Asian currency crisis / Russian debt default -15.35% 2000-2002: Tech bubble -44.71% 2008: Credit crisis -50.95% 0.1 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Bloomberg, L.P. 8
Benchmark: Merrill Lynch 5-7 yr Gov t Bond Index: 10.0 value of $1 invested (logarithmic scale) 1.0 1990: First Gulf war +4.83% 1998: Asian currency crisis / Russian debt default +3.19% 2000-2002: Tech bubble +26.68% 0.1 2008: Credit crisis +16.10% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Bloomberg, L.P. 9
Benchmark: 50%/50% S&P500 & ML Bond Index: 10.0 value of $1 invested (logarithmic scale) 1.0 1994: Fed rate hike -5.97% 1990: First Gulf war -7.00% 1998: Asian currency crisis / Russian debt default -6.04% 2000-2002: Tech bubble -14.36% 0.1 2008: Credit crisis -23.49% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Bloomberg, L.P. 10
Benchmark Performance Characteristics: (50%/50% S&P500 & ML Bond Index) PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS Jan 1990 through Dec 2010 8.22 % annualized return 7.85 % annualized standard deviation 1.05 return / risk ratio Maximum drawdown: -23.49 % (in 2008) Average drawdown: -2.60 % 11
Benchmark distribution of monthly returns: (50%/50% S&P500 & ML Bond Index) Benchmark distribution of monthly returns: PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS Jan 1990 through Dec 2010 60 50 40 Frequency 30 20 10 0-10% -9% -8% -7% -6% -5% -4% -3% -2% -1% 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% More -0.40 skewness Return Source: Bloomberg, L.P. 12
Data sources: Equity: Emerging Markets: Event driven: Relative value: HFRI Equity Hedge (Total) Index HFRI Equity Market Neutral Index HFRI Quantitative Directional HFRI Emerging Markets (Total) Index HFRI Event-Driven (Total) Index HFRI Distressed/Restructuring Index HFRI Merger Arbitrage Index HFRI Relative Value (Total) Index HFRI Fixed Income-Convertible Arbitrage Index HFRI Fixed Income-Corporate Index FOF: Macro: HFRI Fund of Funds Composite Index HFRI Macro (Total) Index HFRI Macro: Systematic Diversified Index CTA Macro: Barclay CTA Index CASAM/CISDM Asset Weighted CTA Index Benchmark: S&P500 TR Index / ML 5-7yr bond Index (50%/50%) 13
Hedge fund returns: 16.00% PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS Jan 1990 through Dec 2010 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other 14
Hedge fund return / risk ratio: 2.50 PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS Jan 1990 through Dec 2010 2.00 1.50 1.00 0.50 0.00 Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other 15
Hedge fund correlations to benchmark: PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS Jan 1990 through Dec 2010 0.90 0.70 0.50 0.30 0.10-0.10 Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other 16
Hedge fund skewness of monthly returns: 0.75 0.50 0.25 0.00-0.25-0.50-0.75-1.00-1.25-1.50-1.75-2.00-2.25-2.50-2.75-3.00-3.25-3.50 PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS Jan 1990 through Dec 2010 Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other 17
Benchmark 50 / 50 portfolio vs. 45 / 45 / 10: Benchmark is: 50% S&P 500 Total Return Index 50% Merrill Lynch 5-7 Year Constant Duration US Treasury Index Comparison is to: 45% S&P 500 Total Return Index 45% Merrill Lynch 5-7 Year Constant Duration US Treasury Index 10% Hedge Fund Strategy 18
Annualized return relative to benchmark: 0.75% PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS Jan 1990 through Dec 2010 0.50% 0.25% 0.00% -0.25% Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other 19
Reduction in standard deviation vs. benchmark: 1.00% PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS Jan 1990 through Dec 2010 0.75% 0.50% 0.25% 0.00% -0.25% Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other 20
Increase in Return / Risk ratio vs. benchmark: 0.16 PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS Jan 1990 through Dec 2010 0.14 0.12 0.10 0.08 0.06 0.04 0.02 0.00 Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other 21
Maximum drawdown relative to benchmark: 4.00% PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS Jan 1990 through Dec 2010 3.00% 2.00% 1.00% 0.00% -1.00% -2.00% Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other 22
Average drawdown relative to benchmark: 0.70% PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS Jan 1990 through Dec 2010 0.60% 0.50% 0.40% 0.30% 0.20% 0.10% 0.00% -0.10% -0.20% -0.30% -0.40% Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other 23
Relative performance Aug-1990 to Sep-1990: 2.00% PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS 1.50% 1.00% 0.50% 0.00% -7.00% -0.50% -1.00% -1.50% Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other 24
Relative performance Jan-1994 to May-1994: PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS 1.20% 1.00% 0.80% 0.60% 0.40% 0.20% 0.00% -5.97% -0.20% -0.40% Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other 25
Relative performance Jul-1998 to Aug-1998: 1.50% PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS 1.00% 0.50% 0.00% -6.14% -0.50% -1.00% -1.50% -2.00% Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other 26
Relative performance Apr-2000 to Sep-2002: 4.00% PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS 3.00% 2.00% 1.00% 0.00% -14.36% -1.00% -2.00% Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other 27
Relative Performance in 2008: 4.00% PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS 3.00% 2.00% 1.00% 0.00% -13.89% -1.00% -2.00% Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other 28
Why do CTAs have such beneficial effects on tail risk? Early academic foundation Significant positive skewness characteristcs Unusually good performance in period of negative benchmark performance 29
Early Academic Foundation - 1983 Professor John K. Lintner of Harvard University The Potential Role of Managed Commodity-Financial Futures Accounts (and/or Funds) in Portfolios of Stocks and Bonds The improvements from holding an efficiently-selected portfolio of managed accounts or funds are so large, and the correlation between returns on the futures portfolios and those on the stock and bond portfolios are so low (sometimes even negative), that the return/risk tradeoffs provided by augmented portfolios clearly dominate the tradeoffs available from portfolio of stocks alone or from a portfolio of stocks and bonds. 30
Shift in skewness relative to benchmark: 20.00% PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS Jan 1990 through Dec 2010 15.00% 10.00% 5.00% 0.00% -5.00% -10.00% -15.00% -20.00% Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other 31
Performance during benchmark s lowest decile: 25% 20% 15% 10% 5% 0% -5% -10% -15% -20% -25% -30% -35% -40% -45% -50% -55% PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS Jan 1990 through Dec 2010 Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other 32
Managed Futures / CTA Strategies: Liquid Transparent Uncorrelated alpha (monthly, no lockups / gating) (managed accounts) (negatively correlated in periods of stress) 33
Building HF portfolios capable of generating absolute return within stressful market environments: Balance convergent and divergent investing approaches. Avoid mean-variance optimizations (and optimizations in general). Be careful of correlations that increase during crisis events. Consider portfolio skewness (try to minimize tail risk, coincidental drawdowns). There are multiple pathways to building the desired portfolio. 34
One possible portfolio: Equity exposure : S&P 500 Index HFRI Market Neutral Index Fixed Income exposure: Merrill Lynch 5 7 year US Treasury Index HFRI Relative Value Index Divergent exposure CASAM / CISDM Asset Weighted CTA Index The information contained above is for illustrative purposes only. 35
One possible portfolio: Equity exposure : S&P 500 Index 15 % HFRI Market Neutral Index 25 % Fixed Income exposure: Merrill Lynch 5 7 year US Treasury Index 20 % HFRI Relative Value Index 20 % Divergent exposure CASAM / CISDM Asset Weighted CTA Index 20% The information contained above is for illustrative purposes only. 36
Sample portfolio vs. benchmark: value of $1 invested 7.0 6.0 5.0 4.0 Sample Benchmark portfolio Ann. return: 8.22% 8.95% Ann. Stdev.: 7.85% 3.81% Ret./Risk ratio: 1.05 2.35 Max drawdown: -23.49% -9.94% Avg. drawdown: -2.60% -0.53% Skewness: -0.4006 0.0135 3.0 2.0 1.0 0.0 +5.47% 1994: Fed rate hike +7.76% 1990: First Gulf war 2000-2002: Tech bubble +22.34% 1998: Asian currency crisis +3.86% 2008: Credit crisis +15.09% 1990 1991 1992 1993 1994 1995 1996 1997 1998 The information contained above is for illustrative purposes only. Hypothetical returns are based upon estimates and reflect subjective judgments and assumptions. These results were achieved by means of a mathematical formula and do not reflect the effect of unforeseen economic and market factors on decision-making. The hypothetical returns are not necessarily indicative of future performance, which could differ substantially. 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 37
Disclaimers: HFRI Indexes are not investable (but HFRX history is much shorter). Model performance results have inherent limitations. The allocations presented involve substantial strategy concentrations. 38
Thank You
Important Disclosures: Sample benchmarks sample portfolio return streams represent model performance. Model performance does not represent the profit or loss resulting from actual trades. Rather, this model performance was generated by applying different investment allocations to various indices (the Sample Benchmark ), and then combining the Sample Benchmark with the return stream of various indexes. Model performance results have inherent limitations, such as being prepared with the benefit of hindsight. In addition, model trading does not involve financial risk and no model trading record can completely account for the impact of financial risk in actual trading. For example, the ability to withstand losses or to adhere to a particular trading program in spite of trading losses are material points that can adversely affect actual trading results. There are numerous other factors related to the markets in general or to the implementation of any specific trading program that cannot be fully accounted for in the preparation of model performance results and all of which can adversely affect actual trading results. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN. This document is being provided per your request. No offer of any interest in any product will be made in any jurisdiction in which offer, solicitation or sale is not authorized, or to any person to whom it is unlawful to make such offer, solicitation or sale. This document expresses the views of SSARIS Advisors, LLC only through the date of the last performance reporting period shown regarding the Strategy and the views are subject to change based on market or other conditions. The opinions expressed are for general information only and are not intended to provide specific advice or recommendations but rather, a basis from which strategies can be built, taking into account the specific objectives of each portfolio, in terms of return, time horizon, and risk constraints, as well as diverging investment perspectives and assumptions. All material has been obtained from sources believed to be reliable, but its accuracy and completeness are not guaranteed. No current or prospective client should assume that future performance will be profitable, or equal to the performance results reflected in any of the benchmarks or indices shown. All the historical benchmark and index performance results shown are provided exclusively for comparison purposes only, so as to provide general comparative information to assist an individual client or prospective client in determining whether the performance of a SSARIS Strategy meets, or continues to meet their investment objective(s). It should not be assumed that the SSARIS Strategy holdings will correspond directly, or indirectly, to the comparative benchmarks or indices shown. 40