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- 1. s Why understanding hedge fund beta is important? Portable Alpha Asia 2006 Conference 25 – 27 April 2006, Conrad Hotel, Hong Kong
- 2. s This presentation and the analysis herein contains proprietary information and is not to be copied, reproduced, used, or divulged to any person in whole or in part without proper written authorization from an officer or director of Siemens AG. This information is the fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S property of Siemens AG and is subject to completion and amendment. The content of the presentation should not be interpreted as legal, tax, or investment Portable Alpha Asia 2006 advice. This document has been prepared by Siemens for discussion purposes only, based upon unaudited financial data. Siemens does not make any representation that the strategy will or is likely to achieve performance comparable to that shown. This document is not an offer to sell or a solicitation for the sale of a security nor shall there be any sale of security in any jurisdiction where such offer, solicitation, or sale would be unlawful. An investment in any of the products may involve a high degree of risk, including the risk of complete loss of an investment, and may only be made pursuant to final offering documents. Past performance of Siemens and / or any of its respective affiliates, employees, members, or principals is not indicative of future results and is no guarantee targeted performance will be achieved. Siemens is under no obligation to release to the public any revised financial data that reflect anticipated or unanticipated events or circumstances. This presentation does not claim to be all-inclusive or to contain all of the information that any particular party may desire. No representation or guarantee is made regarding the accuracy or completeness of any of the information contained herein. Any person in possession of this presentation agrees that all of the information contained herein is of a confidential nature. Furthermore, the same person will treat the information in a confidential manner and will not directly or indirectly, disclose, or permit agents or affiliates to disclose, any of such information without the prior written consent of Siemens. BY ACCEPTING THIS DOCUMENT YOU ACKNOWLEDGE THAT ALL OF THE INFORMATION HEREIN SHALL BE KEPT STRICTLY CONFIDENTIAL BY YOU. 2
- 3. s Agenda fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Why understanding hedge fund beta is important? Portable Alpha Asia 2006 Differentiating between hedge fund beta and traditional investment beta Are hedge funds just repacking beta and selling it as a pure alpha strategy? Replicating the hedge fund returns synthetically Why should investors pay for embedded beta? Conclusion 3
- 4. s Differentiating between hedge fund beta and traditional investment beta Yt = α + β * X t + ε t fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Traditional beta: Portable Alpha Asia 2006 Market Return Single Index Model Return Alpha = Skill = Residuals Market Risk Alpha Beta Agility Agility Hedge Market Return Pure „Agility“ Fund = Residuals Alpha Return Market Risk Yt = α + δ * At + β * X t + ε t Hedge Fund Beta: Yt = α + β1 * X 1 t + β 2 * X 2 t + β 3 * X 3 t + β 4 * X 4 t + L + β k * X k t + ε t APT Volatility Commodity Currency Credit ... Factors Risk Risk Risk Risk TBD* 4 *See Appendix A.
- 5. Portable Alpha Asia 2006 fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S An example Traditional beta Agility Beta Alpha Risk Factors Hedge fund beta s Source: CSFB, Siemens/fin4cast 5
- 6. s We need to understand what drives the hedge fund return Pure alpha requires a lot of maintenance. It comes from manager’s skills: fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Portable Alpha Asia 2006 technology and know how „Agility” is the ability to invest in ways not open to traditional investors: Beta Agility: derivatives, short-selling, no restrictions on consentration limits and credit ratings of investments Alpha Agility: complex trading rules (Model Risk, Momentum Risk), leverage Market beta is not a good reason to invest in hedge funds Pure alpha is desirable, not reliable and not replicable Agility is desirable, reliable and difficult to replicate Market beta is reliable, easily replicable, but not desirable 6
- 7. s Agenda fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Why understanding hedge fund beta is important? Portable Alpha Asia 2006 Differentiating between hedge fund beta and traditional investment beta Are hedge funds just repacking beta and selling it as a pure alpha strategy? Replicating the hedge fund returns synthetically Why should investors pay for embedded beta? Conclusion 7
- 8. s We need to translate the hedge funds returns into risk factors Principal Component Analysis (PCA) fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Portable Alpha Asia 2006 Conv_Arb Multi_Strat FI_Arb Event_D Equity_MN Global Emerging Macro Markets CSFB/T HFI Managed Long Short Futures Equity Dedicated Short 8 Source: CSFB, Reuters, Thomson Financial, Siemens/fin4cast *See Appendix B for 6 principal components.
- 9. s Let us have a close look at the returns of CSFB/Tremont Hedge Fund Index Model with Beta Agility, Model with Beta and Model with Beta Agility Beta T-Statistic Significance Beta T-Statistic Significance Beta T-Statistic Significance Alpha Agility and Pure fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Alpha Agility Alpha Commodity Risk 0.3303 3.2349 0.0020 Commodity Risk 0.2211 2.3716 0.0210 Pure Alpha 0.0738 0.4701 0.6420 Credit Risk -0.0355 -0.3157 0.7533 Credit Risk -0.0485 -0.4927 0.6241 Commodity Risk 0.2410 1.6106 0.1185 Portable Alpha Asia 2006 Currency Risk -0.2056 -1.9300 0.0583 Currency Risk -0.2031 -2.1428 0.0363 Credit Risk 0.1043 0.6836 0.4998 Emerging Market Risk 0.4078 3.2941 0.0016 Emerging Market Risk 0.2320 2.0081 0.0492 Currency Risk -0.2993 -1.8470 0.0753 Interest Rate Risk (short) -0.1566 -1.6451 0.1051 Interest Rate Risk (short) -0.1346 -1.6093 0.1129 Emerging Market Risk 0.4532 2.0792 0.0469 Interest Rate Risk (long) 0.0284 0.2352 0.8148 Interest Rate Risk (long) 0.0962 0.8881 0.3781 Interest Rate Risk (short) -0.0161 -0.1019 0.9196 Liquidity Risk 0.2178 2.1539 0.0352 Liquidity Risk 0.1451 1.5458 0.1275 Interest Rate Risk (long) 0.0406 0.1930 0.8484 Yield Curve Risk -0.1633 -1.6347 0.1073 Yield Curve Risk -0.0926 -1.0405 0.3024 Liquidity Risk 0.2482 1.6690 0.1063 Market Risk -0.2591 -1.8066 0.0758 Market Risk -0.1859 -1.4425 0.1545 Yield Curve Risk -0.1555 -0.9538 0.3483 Style Risk 0.1531 1.5825 0.1187 Style Risk 0.1102 1.2597 0.2128 Market Risk -0.0960 -0.4366 0.6658 Volatility Risk -0.2400 -1.6176 0.1109 Volatility Risk -0.2800 -2.1415 0.0364 Style Risk 0.1668 1.0569 0.2996 Model Risk -0.0022 -0.0175 0.9861 Volatility Risk -0.1787 -0.8711 0.3911 Momentum Risk 0.4136 3.4698 0.0010 Model Risk -0.1621 -0.9293 0.3607 Momentum Risk -0.0733 -0.4289 0.6713 R-squared 0.5041 R-squared 0.6316 R-squared 0.54277 Adjusted R-squared 0.4146 Adjusted R-squared 0.5505 Adjusted R-squared 0.33048 S.E. of regression 0.0077 S.E. of regression 0.0067 S.E. of regression 0.00611 Correlation 0.7100 Correlation 0.7947 Correlation 0.73673 Durbin-Watson stat 1.6143 Durbin-Watson stat 1.8638 Durbin-Watson stat 1.70051 F-statistic 5.6365 F-statistic 7.7817 F-statistic 2.55677 Prob(F-statistic) 0.0000 Prob(F-statistic) 0.0000 Prob(F-statistic) 0.01822 Source: CSFB, Reuters, Thomson Financial, Siemens/fin4cast Beta agility and alpha agility seem to be significant sources of hedge fund return, but is there any pure alpha? Pure alpha tends to be less a matter of pure skill, but more a matter of flexibility It is difficult to separate the alpha agility (flexibility) from the pure alpha (skill) 9
- 10. s Agenda fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Why understanding hedge fund beta is important? Portable Alpha Asia 2006 Differentiating between hedge fund beta and traditional investment beta Are hedge funds just repacking beta and selling it as a pure alpha strategy? Replicating the hedge fund returns synthetically Why should investors pay for embedded beta Conclusion 10
- 11. s Replicating the hedge fund returns synthetically fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S It was necessary to understand where the hedge fund returns Portable Alpha Asia 2006 came from in the past It is more important to understand what will drive the hedge fund returns in the future Building Autoregressive Models with exogenous Variables (ARX) to predict the future returns of: CSFB/Tremont Hedge Fund Index CSFB/Tremont Equity Long/Short Index (see Appendix D) CSFB/Tremont Emerging Market Index (see Appendix E) CSFB/Tremont Global Macro Index (see Appendix F) 11
- 12. s Forecasting the returns of the CSFB/Tremont Hedge Fund Index fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Credit Risk Portable Alpha Asia 2006 Interest Rate Risk (US long) Emerging Market Risk Commodity Risk Interest Risk (EU long) Market Risk Momentum Risk Pure alpha 12 Source: Siemens/fin4cast
- 13. s What sources of return are more likely to drive the performance of CSFB/Tremont Hedge Fund Index in the future? fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Portable Alpha Asia 2006 Source: Siemens/fin4cast 13
- 14. s How the model did and what it expects for April 2006? fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Portable Alpha Asia 2006 Source: Siemens/fin4cast +0.73% Forecast for April 2006 14
- 15. s Agenda fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Why understanding hedge fund beta is important? Portable Alpha Asia 2006 Differentiating between hedge fund beta and traditional investment beta Are hedge funds just repacking beta and selling it as a pure alpha strategy? Replicating the hedge fund returns synthetically Why should investors pay for embedded beta? Conclusion 15
- 16. s Why should investors pay for embedded beta? Embedded beta could be divided into market beta and beta agility. fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Portable Alpha Asia 2006 Investors should be prepared to pay for pure alpha, alpha agility and beta agility, but not for market beta. Market beta is easy to replicate. Investors should buy it cheaper form the traditional managers. Although beta agility is replicable, few hedge fund managers are in a position to replicate it. Investors should be prepared to pay for alpha agility, which is difficult to replicate. Investors should pay for pure alpha, which comes from innovation, technology and know how and is not replicable. 16
- 17. s Agenda fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Why understanding hedge fund beta is important? Portable Alpha Asia 2006 Differentiating between hedge fund beta and traditional investment beta Are hedge funds just repacking beta and selling it as a pure alpha strategy? Replicating the hedge fund returns synthetically Why should investors pay for embedded beta? Conclusion 17
- 18. s Summary: Why understanding hedge fund beta is important? Traditional beta (single factor model) vs. hedge fund beta (multi factor model): fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S agility explains most of hedge fund returns Portable Alpha Asia 2006 Pure alpha is desirable, not reliable and not replicable Hedge Funds sell beta agility and alpha agility: Both seem to be significant sources of hedge fund returns Pure alpha tends to be less a matter of pure skill, but more a matter of flexibility Deep understanding of past hedge funds performance is not enough. We need a better grip on what will drive future hedge fund returns. alpha agility: momentum and trading model beta agility: emerging market factor, commodity factor, stock market factor Investors should pay for pure alpha and be prepared to pay for agility 18
- 19. s Appendix A: Considered (Hidden) Risk Factors of Hedge Funds Market Risk: S&P 500 fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Commodity Risk: Dow Jones AIG Commodity Index Portable Alpha Asia 2006 Credit Risk: Spread (Yield M.L. US Corp BBB Bonds – Yield M.L. US Corp. AAA Bonds) Emerging Market Risk: JPMorgan EMBI+ Composite FX Risk: NYBOT US Dollar Index Style Risk: Spread (S&P 500 – Russell 2000) Interest Rate Risk: US Treasury Bill 90 day (short), Euro Bund (long EU), US T-Note 10y (long US) Volatility Risk: VIX Index (implicit volatility of S&P 100 options) Yield Curv Risk: Spred (US 30 year Treasury Bond – US Tresury Bill 90 day) Liquidity Risk: NYSE Traded Volume Model Risk: fin4cast Global Macro Diversified Futures Index I Momentum Risk: Autoregressive Term Source: Reuters, Thomson Financial, Siemens/fin4cast 19
- 20. s Appendix B: Principal Component Analyses fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Portable Alpha Asia 2006 Source: CSFB, Reuters, Thomson Financial, Siemens/fin4cast 20
- 21. s Appendix C: Descriptive Statistics and Correlation Matrix Equity Fixed Long Convertible CSFB Hedge Dedicated Emerging Event Global Managed Multi Descriptive Statistics Market Income Short Arbitrage Fund Index Short Market Driven Macro Futures Strategy fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Neutral Arbitrage Equity Mean 0.78% 0.61% -0.16% 1.52% 0.48% 0.75% 0.45% 0.72% 0.31% 0.78% 0.70% Median 0.85% 0.61% -0.48% 1.98% 0.43% 0.82% 0.56% 0.50% 0.39% 0.45% 0.71% Portable Alpha Asia 2006 Maximum 3.40% 2.72% 10.89% 7.34% 2.39% 2.71% 2.97% 4.36% 10.31% 9.20% 4.86% Minimum -2.36% -1.09% -13.56% -5.06% -0.49% -1.76% -2.21% -1.77% -7.99% -8.71% -1.54% Std. Dev. 0.011 0.008 0.045 0.026 0.005 0.009 0.010 0.012 0.029 0.038 0.010 Skewness -0.14 0.24 -0.10 -0.31 1.05 -0.25 -0.41 0.47 0.40 -0.20 0.79 Kurtosis 3.07 2.91 3.44 2.75 4.63 3.45 3.42 3.10 5.81 2.77 5.72 Autocorrelation 1st Order 0.55 0.10 0.13 0.07 0.18 0.26 0.19 0.20 0.00 0.10 0.24 Jarque-Bera 0.2354 0.7093 0.6950 1.3361 21.2498 1.3784 25.7536 2.6895 25.5599 0.6553 29.7101 Probability 0.8889 0.7014 0.7065 0.5127 0.0000 0.5020 0.2759 0.2606 0.0000 0.7206 0.0000 Observations 72 72 72 72 72 72 72 72 72 72 72 Equity Fixed Long Convertible CSFB Hedge Dedicated Emerging Event Global Managed Multi Correlation Matrix Market Income Short Arbitrage Fund Index Short Market Driven Macro Futures Strategy Neutral Arbitrage Equity Convertible Arbitrage 1.00 0.41 1.00 CSFB Hedge Fund Index -0.22 -0.45 1.00 Dedicated Short 0.20 0.51 -0.60 1.00 Emerging Market 0.31 -0.05 -0.10 0.00 1.00 Equity Market Neutral 0.48 0.59 -0.59 0.61 0.02 1.00 Event Driven 0.39 0.25 -0.03 0.12 0.13 0.35 1.00 Fixed Income Arbitrage 0.27 0.39 0.17 -0.06 -0.04 0.09 0.17 1.00 Global Macro -0.02 0.68 -0.64 0.52 -0.18 0.37 0.00 -0.07 1.00 Long Short Equity 0.05 0.47 0.14 -0.14 -0.08 -0.05 -0.21 0.38 -0.03 1.00 Managed Futures 0.60 0.61 -0.52 0.54 0.15 0.64 0.42 0.06 0.40 -0.08 1.00 Multi Strategy Period: 31 January 2000 - 31 January 2006 Source: CSFB/Tremont, Siemens/fin4cast 21
- 22. s Appendix D: Forecasting Model for CSFB/Tremont Long Short Equity Index fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Credit Risk Portable Alpha Asia 2006 Yield Curve Risk Emerging Market Risk Commodity Risk Interest Risk (EU long) Market Risk Momentum Risk Pure alpha 22 Source: Siemens/fin4cast
- 23. s Appendix D: What sources of return are more likely to drive the performance of CSFB/Tremont Equity Long/Short Index in the future? fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Portable Alpha Asia 2006 23 Source: Siemens/fin4cast
- 24. s Appendix D: How the model did and what it expects for April 2006? fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Portable Alpha Asia 2006 Source: Siemens/fin4cast +0.61% Forecast for April 2006 24
- 25. s Appendix E: Forecasting Model for CSFB/Tremont Emerging Market Index Credit Risk fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Yield Curve Risk Portable Alpha Asia 2006 Emerging Market Risk Commodity Risk Interest Risk (EU long) Market Risk Momentum Risk Pure alpha Source: Siemens/fin4cast 25
- 26. s Appendix D: What sources of return are more likely to drive the performance of CSFB/Tremont Emerging Market Index in the future? fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Portable Alpha Asia 2006 Source: Siemens/fin4cast 26
- 27. s Appendix D: How the model did and what it expects for April 2006? fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Portable Alpha Asia 2006 Source: Siemens/fin4cast -0.63% Forecast for April 2006 27
- 28. s Appendix D: Forecasting Model for CSFB/Tremont Global Macro Index Credit Risk fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Yield Curve Risk Portable Alpha Asia 2006 Emerging Market Risk Commodity Risk Interest Risk (EU long) Market Risk Momentum Risk Pure alpha Source: Siemens/fin4cast 28
- 29. Portable Alpha Asia 2006 fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Appendix D: ARX Model for CSFB/Tremont Global Macro Index s Source: Siemens/fin4cast 29
- 30. s Appendix D: How the model did and what it expects for April 2006? fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S Portable Alpha Asia 2006 Source: Siemens/fin4cast -0.02% Forecast for April 2006 30
- 31. s Biographies Dr. Miroslav Mitev Siemens AG Österreich Siemens IT Solutions and Services fin4cast Q U A N T I T A T I V E I N V E S T M E N T S T R A T E G I E S PSE/fin4cast Phone: +43 (0) 51707 46253 Fax: +43 (0) 51707 56465 Mobile: +43 (0) 676 9050903 Email: miroslav.mitev@siemens.com Dr Miroslav Mitev is a managing director and head of quantitative research and strategy development at Siemens/fin4cast. Dr Mitev is responsible for the development of innovative, systematic long-short investment strategies for institutional investors world wide based on Siemens/fin4cast technology. After joining Siemens in 2001 Dr Mitev successfully formed a qualified team of 25 professionals which is continuously developing the Siemens/fin4cast Technology and building mathematical forecasting models for a variety of financial instruments like currency futures, commodity futures, stock index futures, bond futures, single stocks and hedge fund indices. Dr Mitev is in charge of the Siemens/fin4cast’s research cooperation with various universities and is actively involved in the scientific management of numerous master thesis and dissertations. Dr Mitev is a regular speaker at international conventions on liability driven investing, asset management, hedge funds, portable alpha, advanced quantitative studies, algo-trading and system research. Dr Mitev’s research is published on a regular basis in international journals and presented on international scientific conferences. Prior to joining Siemens Dr Mitev was at CA IB, the Investment Bank of Bank Austria Group, where he was in charge of the quantitative research of the securities research division. Dr Mitev received a Master of Economics and Business Administration with main focus on Investment Banking and Capital Markets. Dr Mitev also received a PhD in Economics with main focus on Finance and Econometrics. 31

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