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The value of intergenerational transfers within funded ... Presentation Transcript

  • 1. Hedge Funds: Examining the Potential Benefits and Risks of Hedge Fund Investing Robert Howie Shalin Bhagwan, Leon Beukes, Harjeet Cheema, Con Keating, Khurram Mirza, Ian Morley, Yasmin Saltuk
  • 2. Contents
    • Introduction
    • Literature Review
    • Investor Activity
    • Expected returns from hedge funds
    • Non-Investment Risks
    • Benchmarking Hedge Fund Investments
  • 3. What are hedge funds?
    • Not easy to define concisely
    • Large universe
    • Some are by no means “hedged”
    • Key characteristics
      • Heavily skill-based
      • Investment flexibility
      • May employ short-selling and use leverage
      • Focus on “absolute returns” or “cash plus”
  • 4. Other (non-defining) characteristics
      • Performance related fees
      • Less regulated
      • Less transparent
      • Small fund and organisation size
      • High minimum investment
      • Relatively illiquid
      • Fund manager co-invests with investors
    • Many hedge funds do not have these characteristics
  • 5. Academic Research
    • Several major academic groupings established
    • Variable quality of research, focusing on:
      • Distribution of hedge fund returns
      • Biases in hedge fund data
      • Understanding and modelling drivers of returns
  • 6. Survivorship Bias
    • Hedge fund data:
      • Diverse range of investment techniques, fairly large dispersion
      • Voluntary submission of data = selection bias
        • Most index providers only include data for a fund after it enters index
    • Estimated survivorship bias in hedge fund data:
      • Ackermann et al. (1999): negligible bias
      • Brown et al. (1999): c. 3% p.a.
      • Liang (2000): 2-3% p.a.
      • Fung et al. (2004): 2-3% p.a.
  • 7. Survivorship Bias
    • No studies measuring bias of fund of hedge fund indices
      • Substantially lower given the lower failure rate?
      • Similar to mutual fund universes?
        • Academic studies on survivorship bias in mutual fund data have estimated 0.2% - 1.4% p.a.
  • 8. Modelling Hedge Funds
    • Academic research confirms, without exception, that returns are non-normal
      • Standard mean/variance analysis is invalid
    • Calculated stability coefficient (1.67) questions existence of 2 nd moment
      • Multivariate regression possibly inappropriate
    • Modelling is non-trivial
      • Research is in its infancy
  • 9. Total Investment in Hedge Funds Source: HFR Industry Reports
  • 10. Institutional Allocations to Hedge Funds (2003) Source: HFR Industry Reports
  • 11. Institutional Share of Hedge Fund Capital Flows Source: HFR Industry Reports
  • 12. Product Offerings
    • Standard offerings
    • Structured products
      • Principal protected products
      • Leverage products
    • Potential role in “alpha transport” and “liability benchmark strategies”
  • 13. Expected returns from hedge funds
    • Simple model for hedge fund returns:
    • gross return = 67% (cash return) + 19% (equity return) + 14% (high yield return) + tracking error
    • Historical standard deviation of tracking error is 6.4%
      • With gross Information Ratio = 1.6
  • 14. Expected returns from hedge funds
    • If gross return is positive:
      • net return = (gross return – 1.3% p.a.) (1 - 19.3%)
    • If net return is positive:
      • net fund of fund return = (net return – 1% p.a.) (1 - 5%)
  • 15. Expected returns from fund of funds
  • 16. Impact of fees
    • If cash returns are 4.5% and gross IR = 1.6
      • Fees are 4.1% p.a. for fund + 1.5% for fund of funds
    • If gross IR is zero
      • Fees are 2.1% p.a. for fund + 1.1% for fund of funds
    • High gross IR required to generate attractive net of fee returns
  • 17. Hedge Fund Risks
    • Investment risks fairly well documented
    • Non-investment risks can be significant
      • Operational failings
      • At worst, fraud
    • Operational risks occur in
      • Manager
      • Fund
      • Third parties
  • 18. Evaluation of Operational Risk
    • Necessarily qualitative, covering
      • Background checks
      • Conflicts
      • Administration and trading
      • Pricing
      • Third parties
      • Legal structure and documentation
      • Reporting
    • Special skills needed
  • 19. Benchmarking
    • Measurement of value added should not constrain manager
    • Benchmark must represent neutral position of manager :
      • Stated objectives
      • Composite of market indices
      • Hedge fund indices
  • 20. Questions?