Introduction to Hedge Funds - Data


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Lecture for the first module of Hedge Fund Elective E416 at London Business School, delivered on 3 May 2013

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Introduction to Hedge Funds - Data

  1. 1. Hedge Funds: DataDr Drago IndjicSunningdale Capitaldindjic@london.eduMay 2013
  2. 2. Data on Hedge Funds• Industry, but Regulated– Size and growth of “professional” funds• Business– Entrepreneurs and their ventures• Product: Funds– Data: reference, product, business andmarket data
  3. 3. Macro View• Size of AUM: $2.4 t (est. 2013Q1)• Exceeds pre-crisis peak (2007); >50%+ over low$1.3 tn (1Q09); inflows $15b; ~10k funds (1,108born vs 873 died (2011: 1,113 / 775), concentrated• ~ ETF products, top 3 SWF or <Blackrock $3.8t• The largest hedge funds are ~$132b SPDR ETF• Better businesses today• Consolidating value chain, more regulated• Survivors: 2008 crisis was an extraordinary yearfor managed futures strategy (+15%)
  4. 4. MBA View of Value Chain• Demand: “cheap Alpha”– End investors: direct and indirect sourcing• Intermediaries: FoHF ($650b in 2013Q1)– Imperfect market of “professional” funds; Off-shore fund services industry• Supply: start ups vs mature businesses– Hedge fund managers as innovators; nevertoo big to fail (LTCM; Pelaton)
  5. 5. Fin de siecle• Financial “repression” era– Hedge funds as exit strategy: “unbundling” ofbank’s proprietary trading desk– An employee (trader) has to become anentrepreneur, through a prime brokerageagreement and other services - includingraising his own funds, but business costsincreasing• EU AIFMD, Dodd-Frank, SEC etc
  6. 6. Regulation
  7. 7. Fund Management Company• Start-up, not a public listed corporate• Manager(s) = Founders-owners; micro-enterprise(think credit score); cash-flow sensitive; taxable• Careful structuring• Regulated entity and approved personnel• On-shore: (UK: FCA) authorised LLP (private LLPagreements); staff, systems, service contracts• Off-shore Ltd, corporate “substance” andgovernance, authorised (eg. Guernsey FSC)manages off-shore fund
  8. 8. Legal Documentation• People: Partnership agreement– Equity%: ownership, not salaried partners;control and economics• Fund manager: Articles of incorporation• Fund: private placing memorandum– Investment management agreement– Subscription forms (often “non US”)• Service agreements– Counterparties, directors, distributors …
  9. 9. Private Fund• Separate legal entity: off-shoreincorporated, controlled and audited• Governance (off-shore non-exec directors): non-voting investor shares: potential mismatch ofinvestor expectations and fund board powers• Tax benefits for international investors• Private placement• on-shore distribution: business model of 3rd partyfund marketers and fund of funds (pooled, open-ended fund vehicles)
  10. 10. Counterparties and Services• Prime broker– (+) Bank: securities lending and financing– (-) Most senior creditor: re-hypothecation(Lehman; MF Global)• Fund Administrator– NAV Calculator, registrar and transfer agent– Traditionally priced monthly, redemption lessoften• Auditor, lawyer, secretarial services …– Compliance, 3rd party marketing, IT …
  11. 11. Investors• Eligibility– KYC and AML client classification; direct orindirect (HNW, pension plans or FoF)– An investor domiciled in X buys units of funddomiciled in jurisdiction Y: who should paystaxes – and where?• Marketing and business strategy– Performance/flows: AUM may stay around$100m for a long time (eg. Molinero LLP)
  12. 12. Micro-Enterprises• Owner/Manager’s LLP– Staff <10: the largest are still SME!• Median “fund” AUM <$50m– Today less profitable then in the past; highercost of seed capital• Very few long-term survivors and “brands”– Most liquidated within 7 years– not unlike many other start-up businesses
  13. 13. Myths: Cashflow, Not “Blow Up”,($1,000)$0$1,000$2,000$3,000$4,000$5,000$6,000$7,000$8,000$9,000$0.0$10.0$20.0$30.0$40.0$50.0$60.0$70.0$80.0
  14. 14. Case Study: Leverage - Lower
  15. 15. Case Study: Fees - Lower• Clive Capital LLP, Europe’s biggest commodity hedge fund, will cutits fees after posting two consecutive years of losses, according to aletter sent to clients today.• Clive will start charging investors in its class Bshares a 2%/20% from April, down from2.5%/25%. The decision comes after clientwithdrawals and investment losses promptedAUM to shrink 46% to $1.95 billion.• Clive, which was founded by former Moore Capital ManagementLLC trader Chris Levett, slumped 8.8% last year after falling 9.9% in2011. Investors had been willing to pay a premium to Clive after itoutperformed rivals in previous years, gaining 44% in 2008, 17% in2009 and 20% in 2010 (Bloomberg, 8 February 2013)
  16. 16. Case: Liquidity - Better• With about three weeks before investors in SAC need to decide onwhether they are pulling their money out, Cohen is offering them aquicker way to in a bid to convince them to stick with him.• Investors will now be able to get back 50% of theirmoney in each of the last two quarters of the year, thefirm told investors. Initially, the firm would pay backwithdrawals spread out over four quarters. Then the firmhastened the payouts to one third of investors fundstakes per quarter and now it will be half per quarter.• This marks the second time in about two months that SAC hasadjusted its liquidity conditions. Outsiders money accounts for onlyabout $6 billion of the AUM, but Cohen appears to be trying to pacifyjittery clients who said in February that they wanted to pull out $1.7billion at the end of the first quarter (Reuters, 26 April 2013)
  17. 17. Data Sources• No standard security identifiers• Bloomberg etc screens are blank; data is not forsale by fund administrators or brokers• Specialist databases• Low quality: mainly “catalogues” of 1,000+management companies by market researchspecialists like HFR, Lipper, Morningstar• Lagged performance estimates for 20k+ fundshare classes and fund “boiler plates”• Self-selection and survivorship bias: the largest,the smallest and “defunct” funds excluded
  18. 18. Fundamental Data• Mostly private, lagged and age fast– Static reference data• Fund offering memorandum, counterparties– Business• Due diligence: staffing, references, accounts• “Skin in the game”: monitoring incentives, conflictsand sustainability– Portfolio• portfolio exposure and holdings (“Opera” standardaggregated), weekly NAV, investor letters ...
  19. 19. It Was Just One of Many Funds
  20. 20. Investment Strategies• What exactly is a strategy?– Lack of standard definitions – or indices -beyond labelling: stated in interviews andcase studies– Transparency: necessary, not sufficientcriteria• Lack of verification– Benchmarking and replication applications;contract law: Legal text vs legal evidence
  21. 21. Indicative “Strategies”• Danger: overpaying for Beta-like service• Not all “hedge” funds deploy hedgingstrategies; varies across universe and timeEquity Hedge38.52%Emerging Markets (Total)5.53%Distressed Securities2.74%Equity Market Neutral5.94%Equity Non-Hedge7.84%Event-Driven 7.28%FI: Arbitrage 2.78%FI: Convertible Bonds0.25%FI: Diversified 2.56%FI: High Yield 1.14%FI: MBS 1.37%Convertible Arbitrage3.70%Short Selling0.76%Sector (Total) 6.71%Macro 2.15%Market Timing 3.65%Merger Arbitrage 3.78%Regulation D 0.52%Relative Value Arbitrage2.77%Estimated Strategy Composition by # of Funds (exFOF) 2002
  22. 22. Indexes are Composites• “Broad” indexes are just (non-investable)peer groups• No reliable multi-source industry statistics• “average” performance, #hedge funds,#management companies; % Strategies,domiciles, counterparties; $AUM, flows, liquidity,age; micro data: #births/deaths …• Questionable Ranking• Statistical, operational or any other attributes intypical investment mandate search (infeasible!)
  23. 23. Index Performance• “non-investable” (HFRI) vs “investable”
  24. 24. Exposure• Extinct and endangered• Structured: capital protected – disappeared• FoHF: full outsourcing, consultant’s stronghold• Thriving• Advisors: outsourced due diligence• Managed Account Platforms• Direct: many endowments, pension funds• Emerging• UCITS and index products
  25. 25. Risk and Reward• Evaluate Total Hedge Fund Risk– Mostly business risk: contractual, SME, “keyman” LP’s “exit”, no EV, equity financed– Lesser portfolio and market risk (“hedged”)• Benefits– Unique risk/return profiles (units priced in goldor oil): not dependant on underlying assets– Negotiable investment terms, business co-ownership (PE-like); discovery of fair activemanagement “price”
  26. 26. Conclusion• Global political economy– “On-shoring”; private equity is excluded fromAIFMD– High frequency traders became new “badboys”• New passive / active boundaries– Active ETFs; “newcits”