The Benefits of Hedge Funds The First Seoul International Derivatives Securities Conference Thomas Schneeweis & Vassilis K...
Outline <ul><li>I. Introduction to Traditional and Alternative Investments </li></ul><ul><li>II. Benefits of Hedge Fund In...
I. Introduction to Traditional and Alternative Investments <ul><li>What Are Hedge Funds? </li></ul><ul><li>Hedge Fund Fact...
Introduction to Traditional & Alternative Investments Investment Alternatives Traditional Alternatives Modern Alternatives...
What is a Hedge Fund? <ul><li>Term “Hedge Fund” is a misnomer with little descriptive power </li></ul><ul><ul><li>1950’s: ...
What are Hedge Funds? <ul><li>Various Definitions </li></ul><ul><ul><li>A multitude of skill-based investment strategies w...
Hedge Fund Classifications <ul><li>Relative Value </li></ul><ul><ul><li>Market Neutral Equity (Long undervalued/short over...
Hedge Fund Facts <ul><li>Hedge funds are not riskier than traditional stock and bond investments </li></ul><ul><li>Not all...
Academic Evidence on  Traditional Asset Investment Performance <ul><li>Actively managed stocks and bond portfolios provide...
Little Evidence of Equity Fund Alpha (1996-2002)
Little Evidence of Diversification Benefits Across Stock Markets (1990-2002)
Academic Evidence on Hedge Funds <ul><li>Hedge funds and CTAs offer the potential for alpha (excess return relative to com...
Evidence of Hedge Funds in Providing Diversification Benefits Relative to Stocks and Bonds (1990-2002)
II. Benefits of Hedge Funds <ul><li>Why Hedge Funds? </li></ul><ul><li>Source of Hedge Fund Benefits </li></ul><ul><li>Ana...
<ul><li>Hedge funds represent a large and growing industry that offers investors an opportunity to diversify and to earn c...
Source of Hedge Fund Benefits <ul><li>Unique Return Opportunities </li></ul><ul><ul><li>Strategy based </li></ul></ul><ul>...
Hedge Fund Performance Indices <ul><li>Active manager based peer indices (similar to Morningstar or Lipper Mutual Fund Ind...
Hedge Funds: Return/Risk Performance
Hedge Funds Provide  Higher Return Compared to Traditional Assets
Hedge Funds Provide  Enhanced Return/Risk Performance
Hedge Fund Performance
Basis for Hedge Fund Performance
Tracking Factor Based Determinants of Hedge Fund Returns– US Case
European Hedge Fund: Factor Analysis – Tracking
Long/Short: Factor Analysis – Tracking
Tracking Style Based Determinants of Hedge Fund Returns US Case
Hedge Funds: Style Based Long Short Equity Tracking <ul><li>Tracking: Dow Jones Euro Stoxx 50, FTSE 100  </li></ul>
Asset Allocation: Active Asset Management <ul><li>Strategic Asset Replacement </li></ul><ul><li>Tactical Asset Management ...
Hedge Funds in Active Asset Allocation
Traditional Mean Variance Optimization with Hedge Funds Traditional Asset Classes Weights Sub Total U.S. 30 Day TBill TR 5...
Hedge Funds Replace Traditional Assets Change in Allocation
Hedge Funds Replace Traditional Assets  Change in Allocation
Hedge Fund Selection  Determined By Economic Forecast
Tactical Asset Allocation:  Hedge Fund Selection by Economic Forecast
Conclusions <ul><li>Risk and Return Analysis That Works for Traditional Assets Works for Hedge Fund Analysis. </li></ul><u...
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The Benefits of Hedge Funds

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The Benefits of Hedge Funds

  1. 1. The Benefits of Hedge Funds The First Seoul International Derivatives Securities Conference Thomas Schneeweis & Vassilis Karavas August 28, 2003
  2. 2. Outline <ul><li>I. Introduction to Traditional and Alternative Investments </li></ul><ul><li>II. Benefits of Hedge Fund Investment </li></ul><ul><li>III. Hedge Funds in Asset Allocation </li></ul>
  3. 3. I. Introduction to Traditional and Alternative Investments <ul><li>What Are Hedge Funds? </li></ul><ul><li>Hedge Fund Facts </li></ul><ul><li>Academic Evidence on Traditional Investment Performance </li></ul><ul><li>Academic Evidence on Hedge Fund Performance </li></ul>
  4. 4. Introduction to Traditional & Alternative Investments Investment Alternatives Traditional Alternatives Modern Alternatives Traditional Investments Private Equity Commodities Real Estate Hedge Funds Managed Futures Stocks Bonds
  5. 5. What is a Hedge Fund? <ul><li>Term “Hedge Fund” is a misnomer with little descriptive power </li></ul><ul><ul><li>1950’s: A.W. Jones Model </li></ul></ul><ul><ul><ul><li>-Long/Short U.S. equities </li></ul></ul></ul><ul><ul><ul><li>-Capture two opportunity sets while reducing overall market </li></ul></ul></ul><ul><ul><ul><li>exposure </li></ul></ul></ul><ul><ul><ul><li>-“Hedge Fund” term accurately reflected the underlying strategy </li></ul></ul></ul><ul><ul><li>2000’s: Generic reference to a private, commingled vehicle </li></ul></ul><ul><li>investing in marketable securities </li></ul><ul><ul><li>-Strategy characteristics vary widely </li></ul></ul><ul><ul><li>-Markets in which they participate vary widely </li></ul></ul><ul><ul><li>-Risk/return characteristics vary widely </li></ul></ul><ul><ul><li>-Common organizational and structural characteristics </li></ul></ul>
  6. 6. What are Hedge Funds? <ul><li>Various Definitions </li></ul><ul><ul><li>A multitude of skill-based investment strategies with a broad range of risk and return objectives. A common element is the use of investment and risk management skills to seek positive returns regardless of market direction. </li></ul></ul><ul><ul><li>A loosely regulated private pooled investment vehicle that can invest in both cash and derivative markets on a leveraged basis for the benefits of its investors. </li></ul></ul><ul><ul><li>A hedge fund is a private investment portfolio, usually structured as a limited partnership, open to accredited investors, charging an incentive based fee, and managed by a general partner with every financial tool imaginable at his disposal. </li></ul></ul>
  7. 7. Hedge Fund Classifications <ul><li>Relative Value </li></ul><ul><ul><li>Market Neutral Equity (Long undervalued/short overvalued stock) </li></ul></ul><ul><ul><li>Convertible Hedging (Long convertible. bonds/short stock) </li></ul></ul><ul><ul><li>Bond hedging (Yield curve arbitrage) </li></ul></ul><ul><li>Event Driven </li></ul><ul><ul><li>Corporate transactions and special situations </li></ul></ul><ul><ul><li>Deal Arbitrage (Long/short equity involved in corporate transactions) </li></ul></ul><ul><ul><li>Bankruptcy/Distressed (Long securities involved in financial distress) </li></ul></ul><ul><ul><li>Multi-strategy (Deal arbitrage and bankruptcy) </li></ul></ul><ul><li>Equity Hedge Funds </li></ul><ul><ul><li>Domestic Long (Long undervalued US equities) </li></ul></ul><ul><ul><li>Domestic Opportunity (Long/Short Equity (long bias)) </li></ul></ul><ul><li>Global Asset Allocators/Global Macro </li></ul><ul><ul><li>Systematic (trend-following or other quantitative analysis) </li></ul></ul><ul><ul><li>Discretionary (Long or short markets based on fundamental analysis) </li></ul></ul><ul><li>Short Sellers </li></ul>
  8. 8. Hedge Fund Facts <ul><li>Hedge funds are not riskier than traditional stock and bond investments </li></ul><ul><li>Not all hedge funds are highly levered </li></ul><ul><li>Most hedge funds trade in liquid and transparent markets </li></ul><ul><li>Hedge fund strategies have existed for decades </li></ul><ul><li>Hedge funds are not absolute return investments (e.g., make money in all markets) but do offer unique risk and return opportunities not available in traditional stock and bond markets. </li></ul>
  9. 9. Academic Evidence on Traditional Asset Investment Performance <ul><li>Actively managed stocks and bond portfolios provide little alpha (excess return relative to benchmarks) </li></ul><ul><li>With increased globalization, stock and bond investment provide limited diversification </li></ul>
  10. 10. Little Evidence of Equity Fund Alpha (1996-2002)
  11. 11. Little Evidence of Diversification Benefits Across Stock Markets (1990-2002)
  12. 12. Academic Evidence on Hedge Funds <ul><li>Hedge funds and CTAs offer the potential for alpha (excess return relative to common benchmarks such as equal risk S&P 500 or Lehman Bond Indices) </li></ul><ul><li>Hedge funds and CTAs offer the potential for diversification to existing stock or bond portfolios </li></ul><ul><li>Multi-factor models which describe return process for stocks and bonds also describe the return process for hedge funds </li></ul><ul><li>Modern methods of asset allocation used to deliver desired risk and return tradeoff for stocks or bonds can also be used for hedge funds </li></ul>
  13. 13. Evidence of Hedge Funds in Providing Diversification Benefits Relative to Stocks and Bonds (1990-2002)
  14. 14. II. Benefits of Hedge Funds <ul><li>Why Hedge Funds? </li></ul><ul><li>Source of Hedge Fund Benefits </li></ul><ul><li>Analysis of Hedge Fund Returns </li></ul>
  15. 15. <ul><li>Hedge funds represent a large and growing industry that offers investors an opportunity to diversify and to earn competitive returns with low to moderate volatility. </li></ul>Why Hedge Funds?
  16. 16. Source of Hedge Fund Benefits <ul><li>Unique Return Opportunities </li></ul><ul><ul><li>Strategy based </li></ul></ul><ul><ul><li>Manager based </li></ul></ul><ul><li>Unique Diversification Opportunities (use wider range of instruments </li></ul><ul><li>Different sources of return (long and short investing, concentrated asset positions) </li></ul>
  17. 17. Hedge Fund Performance Indices <ul><li>Active manager based peer indices (similar to Morningstar or Lipper Mutual Fund Indices) </li></ul><ul><ul><li>EACM </li></ul></ul><ul><ul><li>CSFB/Tremont </li></ul></ul><ul><ul><li>HFR </li></ul></ul><ul><ul><li>CISDM </li></ul></ul><ul><ul><li>MSCI </li></ul></ul><ul><ul><li>S&P </li></ul></ul><ul><ul><li>Zurich </li></ul></ul><ul><ul><li>Note: Academic research has shown that use of different indices may show different levels of risk and return benefits but basic conclusions are the same regardless of performance index used. </li></ul></ul>
  18. 18. Hedge Funds: Return/Risk Performance
  19. 19. Hedge Funds Provide Higher Return Compared to Traditional Assets
  20. 20. Hedge Funds Provide Enhanced Return/Risk Performance
  21. 21. Hedge Fund Performance
  22. 22. Basis for Hedge Fund Performance
  23. 23. Tracking Factor Based Determinants of Hedge Fund Returns– US Case
  24. 24. European Hedge Fund: Factor Analysis – Tracking
  25. 25. Long/Short: Factor Analysis – Tracking
  26. 26. Tracking Style Based Determinants of Hedge Fund Returns US Case
  27. 27. Hedge Funds: Style Based Long Short Equity Tracking <ul><li>Tracking: Dow Jones Euro Stoxx 50, FTSE 100 </li></ul>
  28. 28. Asset Allocation: Active Asset Management <ul><li>Strategic Asset Replacement </li></ul><ul><li>Tactical Asset Management </li></ul>
  29. 29. Hedge Funds in Active Asset Allocation
  30. 30. Traditional Mean Variance Optimization with Hedge Funds Traditional Asset Classes Weights Sub Total U.S. 30 Day TBill TR 5.0% SB 1 Yr On-The-Run Treasury TR 5.0% 10% SB 3-7 Yr Treasury TR 5.0% SB 10+ Yr Treasury TR 10.0% SB Hi-Yld TR 5.0% SB AAA/AA Corp TR 10.0% 30% Russell 1000 TR 40.0% Russell 2000 TR 10.0% 50% MSCI EAFE TR 5.0% MSCI Emerging Market Free USD 5.0% 10%
  31. 31. Hedge Funds Replace Traditional Assets Change in Allocation
  32. 32. Hedge Funds Replace Traditional Assets Change in Allocation
  33. 33. Hedge Fund Selection Determined By Economic Forecast
  34. 34. Tactical Asset Allocation: Hedge Fund Selection by Economic Forecast
  35. 35. Conclusions <ul><li>Risk and Return Analysis That Works for Traditional Assets Works for Hedge Fund Analysis. </li></ul><ul><li>Hedge Funds and CTAs Provide Risk And Return Opportunities Consistent With Their Exposure To Various Market Opportunities as well as Trader Skill. </li></ul><ul><li>Modern Methods Of Asset Allocation That are Used To Determine Source of Return To Stocks and Bonds Can Be Used To Determine Source of Returns to Hedge Funds. </li></ul>

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