Hedge Fund Portfolio Soutions for Advisors

H E D G E F U N D S T R AT E G I E S

Long/Short Equity

Q1 / 2014

www.crysta...
Hedge Fund Portfolio Soutions for Advisors

Introduction

Long/Short Equity
Hedge Fund Strategy
The long/short equity stra...
Hedge Fund Portfolio Soutions for Advisors

What are

Long/Short
Equity Funds?
Long/short equity managers are active in eq...
Hedge Fund Portfolio Soutions for Advisors

Drivers of Returns
The returns of long/short equity managers are determined by...
Hedge Fund Portfolio Soutions for Advisors

The Advantages of

Long/Short Equity Funds
Better Risk-adjusted Returns than T...
Hedge Fund Portfolio Soutions for Advisors

Liquidity

Long/short equity managers are recognized for being one of the more...
Hedge Fund Portfolio Soutions for Advisors

IMPORTANT DISCLOSURE
This Document is for informational purposes only and is n...
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Long/Short Equity Hedge Fund Strategy Paper

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A white paper explaining the long/short equity hedge funds.

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Long/Short Equity Hedge Fund Strategy Paper

  1. 1. Hedge Fund Portfolio Soutions for Advisors H E D G E F U N D S T R AT E G I E S Long/Short Equity Q1 / 2014 www.crystalfunds.com Page 1
  2. 2. Hedge Fund Portfolio Soutions for Advisors Introduction Long/Short Equity Hedge Fund Strategy The long/short equity strategy is one of the more nimble hedge The long/short equity fund manager buys long positions in stocks fund strategies whereby managers seek opportunities across they believe will increase in value (“the long book”) and shorts global equity markets with the objective of outperforming tradi- positions which they feel will decrease or offer a suitable hedge tional markets over a given cycle. against certain market or sector risk (“the short book”). The concept behind the long/short equity strategy is simple: The combined portfolio creates enhanced opportunities for idio- investment research uncovers expected winners and losers syncratic (i.e. stock-specific) gains and reduces market risk as and the hedge fund enhances its potential return capabilities by the short holdings offset the long market exposure. taking a position in both. In all, long/short equity managers largely target equity-like re- Accordingly, one of the major advantages of the long/short eq- turns without the high volatility typically associated with long-only uity strategy is that the managers have the flexibility to express strategies in order to provide a higher compounded rate of return their views in opposite directions. over time. Q1 / 2014 www.crystalfunds.com Page 2
  3. 3. Hedge Fund Portfolio Soutions for Advisors What are Long/Short Equity Funds? Long/short equity managers are active in equity and equity Nonetheless, the objective of the fundamental long/short derivative securities in which they maintain both long and short manager is to uncover opportunities through deep bottoms- positions in order to generate returns. The managers aim to de- up analysis where they aim to identify the intrinsic value of a liver returns in excess of the broad equity markets while seeking company. to assume less risk in the process. The fundamental investment approach to long/short equity can Unlike traditional long-only equity managers, those that pursue also be exercised through a single portfolio manager approach the long/short equity strategy have the ability to use their “short where there is a sole risk-taker responsible for initiating and siz- book” to express a negative view on a stock or as a means to ing positions or within the context of a multi-manager, multi-strat- hedge market risk in periods of heightened volatility. egy structure, which has the potential to offer a more diversified As a result, long/short equity funds are generally able to sidestep return stream. large drawdowns and compound returns in a more attractive Alternatively, managers who utilize a quantitative approach to fashion than what is available in the long-only equity world. uncovering value in the long/short equity space tend to be broad- The universe of long/short equity hedge funds is quite broad with managers in the space implementing the strategy through er in nature and seek opportunities across all and any sector through the use of both fundamental and technical factors. a fundamental investment approach or by utilizing quantitative Finally, managers within the long/short equity strategy can fur- methods to arrive at investment decisions. ther distinguish themselves through the levels of gross and net In general, managers who employ a fundamental research approach can be specialists in certain sectors (e.g., technology, healthcare, financials, etc.) or sector agnostic and pursue a exposure that they are willing to assume, the average duration of their investment holding period, and the market capitalizations of targeted companies. more diversified approach. Q1 / 2014 www.crystalfunds.com Page 3
  4. 4. Hedge Fund Portfolio Soutions for Advisors Drivers of Returns The returns of long/short equity managers are determined by source of alpha would seek out individual names deemed to be the skill of the manager and their ability to successfully navigate overvalued in the sector and subsequently implement a short the market. By and large, long/short equity managers rely on position with the goal of producing a return that outperforms the their stock picking expertise and hedging ability to generate index and, thereby, enhances the manager’s spread. returns. Consequently, the ability to extract alpha on the short side re- Success within the space generally hinges on the ability to cor- quires a particular skillset and is the hallmark of a leading long/ rectly predict companies that will outperform the market while short equity manager. also discerning the underperformers and shorting them. While an overriding factor, stock selection is not the sole driver The difference between the returns of the long and short hold- of long-term returns for long/short equity managers. Managers ings is referred to as a “spread” and managers who are able to pursuing the long/short equity strategy have the ability to aug- maximize a positive spread offer a more attractive return profile. ment returns by actively managing the levels of gross and net The ability of long/short equity managers to deliver a positive exposure in the portfolio. spread is largely related to how they utilize their short portfo- Gross exposure is defined as the long portfolio plus the absolute lio. A long/short equity manager who mostly employs market value of the short portfolio whereas net exposure equals the dif- hedges in their short portfolio is not taking full advantage of the ference between the long portfolio and the short portfolio. opportunity to extract double alpha. A long/short equity manager who has the foresight to reduce For instance, at the most basic level, a manager that estab- exposure levels before a market correction is able to protect lishes a short position in an ETF related to U.S. regional banks investor capital and offer an attractive means to long term cap- to hedge a long holding in the sector is largely focused on at- ital appreciation. Conversely, managers who seek to expose tempting to reduce sector risks in the name in order to isolate themselves to more market directionality would increase their company specific factors as a source of return. Alternatively, a exposures. long/short equity manager who views their short portfolio as a Q1 / 2014 www.crystalfunds.com Page 4
  5. 5. Hedge Fund Portfolio Soutions for Advisors The Advantages of Long/Short Equity Funds Better Risk-adjusted Returns than Traditional Equity Portfolios Over the past 10 years, long/short equity strategy hedge funds have been able to outperform the S&P 500 with significantly less volatility. As illustrated in the chart below, the CS Equity Long/Short HF Index delivered over 100 basis points of outperformance with a standard deviation of 7.84% versus 14.50% for the S&P 500. This translates into a Sharpe Ratio of 0.78 for the CS Long/Short Equity HF Index compared to 0.41 for the S&P 500. Annualized ROR 7.67% Std. Deviation 7.84% Cumulative Value 222.62 199.66 66.92% -21.97% 14.50% 6.59% % Months Positive Max Drawdown 63.85% -52.56% Sharpe Ratio Correl to S&P 500 Sortino 0.37 0.78 0.81 0.41 Credit Suisse Long/Short Equity HF Index 0.12 NA Jan. 2003 – Oct. 2013 S&P 500 Index Potential downside protection in major downturns It is important to note that long/short equity managers generally run with a low-to-moderate amount of net exposure to equity markets. As a CS Equity Long/Short Performance Index Differential Period S&P 500 Q4-2008 -22.55% -7.47% 15.08% periods when equity markets faced significant headwinds, the strategy Q3-2002 -17.63% -2.43% 15.20% has been able to offer considerable downside protection. Q3-2001 -14.98% -1.84% 13.14% Q3-2011 -14.33% -9.80% 4.53% Long/Short HF Index has historically outperformed the S&P 500 by an Q2-2002 -13.74% 0.14% 13.87% average of 9.54% during the 10 worst quarters for the equity markets Q1-2001 -12.12% -4.87% 7.25% as long/short equity funds returned on average -4.37% versus -13.91% Q2-2010 -11.86% -5.84% 6.02% result of operating a hedged portfolio, long/short equity managers typically have not fully participated in runaway bull markets. However, in For instance, as demonstrated in the table to the right, the CS Equity for the S&P 500. Q1-2009 -11.67% 0.32% 11.99% This ability to offer protection during equity market downturns has Q3-1998 -10.30% -7.80% 2.50% resulted in more attractive risk-adjusted returns and a superior cumula- Q1-2008 -9.93% -4.09% 5.84% Average -13.91% -4.37% 9.54% tive growth for the strategy. Q1 / 2014 www.crystalfunds.com Page 5
  6. 6. Hedge Fund Portfolio Soutions for Advisors Liquidity Long/short equity managers are recognized for being one of the more liquid hedge fund strategies as they predominantly operate in deep and liquid trading markets. This liquidity generally allows long/short equity managers the ability to quickly adjust exposure levels in order to exploit opportunities or swiftly de-risk the portfolio to sidestep market volatility. Conclusion Long/short equity managers have been able to use their flexibility to deliver returns that exceed those available in long-only equity markets and with significantly less volatility. long-only managers which typically follow the turbulent path of the overall markets. These long/short hedge funds use their ability to express a negative view on a particular stock, sector or market— along with timely shifts to portfolio exposure levels—to offer The performance of long/short equity funds is driven by manag- enhanced downside protection and the ability to compound er skill and the ability to navigate equity markets as compared to returns in a more attractive fashion. Using CrystalTools© to Evaluate L/S Equity Funds Advisors should consider using CrystalTools© before investing in any strategy or in any individual fund. CrystalAnalyticsTM – to obtain a better CrystalResearchTM – to gain a better qual- CrystalPortfoliosTM – to run a simulation quantitative understanding of the fund’s itative assessment of the manager. Learn of pro-forma returns to better understand historical characteristics and individual about their trading strategy, review their li- the historical performance of a portfolio as return profile: quidity and provide an overall assessment well as the effect of adding and removing of the institutionality of a manager. funds. Below are a few examples of some of the analytics that CrystalTools© offers. Monthly Returns - can be used to review the fund’s annualized net returns, risk adjusted returns and individual performance during particular months. For example, advisors can review performance during the worst periods for equity markets and hedge funds, as described above. Returns Histogram – reviewing the returns histogram will provide the advisor with a better visual understanding of the consistency of the fund’s returns. Drawdowns – allows the advisor to review the fund’s largest drawdown periods on a twelve month and thirty six month basis. Q1 / 2014 www.crystalfunds.com Page 6
  7. 7. Hedge Fund Portfolio Soutions for Advisors IMPORTANT DISCLOSURE This Document is for informational purposes only and is not an offer to sell or the solicitation of an offer to buy an interest in any of the Funds managed or advised by Crystal Capital Partners, LLC (“Crystal”). This document contains only summary information about the Funds and is qualified in its entirety by, and should be read in conjunction with, the more detailed information contained in the Offering Memorandum for each Fund. The interests in the Fund have not been registered with the SEC under the Securities Act, or under the securities laws of any state of the United States or under the securities laws of any other jurisdiction, and the Funds have not been registered as an investment company under the Investment Company Act of 1940, as amended, and are being offered and sold in reliance on exemptions from the registration requirements of such laws. The information contained in this Document has been prepared to assist interested parties in making their own evaluation of the opportunity and does not purport to be complete or to contain all of the information that a prospective investor might consider important in connection with an investment in the Fund. In all cases, interested parties should conduct their own investigation and analysis of the Fund, the data set forth in this Document and such other data as they may consider relevant to an investment decision. The information contained in this Document does not constitute legal, tax, accounting, regulatory or investment advice, and persons considering an investment in the Fund should consult their own legal and financial advisors with respect to the application of United States securities, tax or other laws and accounting and regulatory provisions to their particular, as well as any consequences arising under the laws of any other jurisdiction. The liquidity schedule constitutes the “best available” liquidity as of the date hereof. The liquidity terms described are for a particular exposure. From time to time, the Fund and/or the Outside Portfolio Manager may offer different liquidity terms. “Best available” liquidity assumes availability when soft lock terms are applicable. The pro forma results are based on simulated or hypothetical performance results that have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. Also, because these trades have not actually been executed, these results may have under-or over-compensated for the impact, if any, of certain market factors, such as lack of liquidity. Simulated or hypothetical trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve profits or losses similar to these being shown. THE PRO FORMA COMPOSITE PERFORMANCE RECORD IS HYPOTHETICAL AND THESE TRADING ADVISORS HAVE NOT TRADED TOGETHER IN THE MANNER SHOWN IN THE COMPOSITE. HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY MULTI-ADVISOR MANAGED ACCOUNT OR POOL WILL OR IS LIKELY TO ACHIEVE A COMPOSITE PERFORMANCE RECORD SIMILAR TO THAT SHOWN. IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN A HYPOTHETICAL COMPOSITE PERFORMANCE RECORD AND THE ACTUAL RECORD SUBSEQUENTLY ACHIEVED. ONE OF THE LIMITATIONS OF A HYPOTHETICAL COMPOSITE PERFORMANCE RECORD IS THAT DECISIONS RELATING TO THE SELECTION OF TRADING ADVISORS AND THE ALLOCATION OF ASSETS AMONG THOSE TRADING ADVISORS WERE MADE WITH THE BENEFIT OF HINDSIGHT BASED UPON THE HISTORICAL RATES OF RETURN OF THE SELECTED TRADING ADVISORS. THEREFORE, COMPOSITE PERFORMANCE RECORDS INVARIABLY SHOW POSITIVE RATES OF RETURN. ANOTHER INHERENT LIMITATION ON THESE RESULTS IS THAT THE ALLOCATION DECISIONS REFLECTED IN THE PERFORMANCE RECORD WERE NOT MADE UNDER ACTUAL MARKET CONDITIONS AND, THEREFORE, CANNOT COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FURTHERMORE, THE COMPOSITE PERFORMANCE RECORD MAY BE DISTORTED BECAUSE THE ALLOCATION OF ASSETS CHANGES FROM TIME TO TIME AND THESE ADJUSTMENTS ARE NOT REFLECTED IN THE COMPOSITE. The Fund and/or the Fund Manager use several sources of information to support the analysis in this Document, including information provided by investment managers, third party databases, and other public and non-public sources. The Fund and/or the Fund Manager will make commercially reasonable efforts to ensure the reliability of the information, but make no warranty as to the accuracy, completeness or suitability of the information. Such information is further subject to the qualifications and limitations contained in the Terms of Use Agreement and the Disclaimer made part of each fund report. The interests in the Fund are speculative, illiquid, involve substantial risk, and are a suitable investment only for a limited portion of an investor’s portfolio. Investors could lose all or substantially all of their investment in the Fund. Neither the delivery of this Document nor any offers or sales hereunder shall create an implication that there has been no change since the date of this Document or the Offering Memorandum in the matters disclosed herein. Before you decide to invest, read the entire Offering Memorandum for the specific fund of interest carefully, and in particular, consider the “Risk Factor” section. If you, or your advisors, have questions concerning the operations, you should contact the Fund Manager at the address or phone number included in the Offering Memorandum. None of the directors, officers, employees or advisers of Crystal or its affiliates or any other person makes any promise, guarantee, representation or warranty (expressed or implied) to any person as to the fairness, accuracy or completeness of this Document or the information contained herein, or of any other information, materials or opinions, whether written or oral, that have been, or may be, prepared or furnished by any of those companies, including, without limitation, economic or financial projections, if any, or risk evaluations. The recipient acknowledges and agrees that all of the information contained herein is confidential, and if the recipient has previously accepted this Document, signed or agreed to Crystal’s Terms of Use Agreement or Non-Disclosure Agreement, is subject thereto. Without limiting the generality of the foregoing: (1) the recipient will not reproduce this Document, in whole or in part; (2) if the recipient does not wish to pursue this matter or is not an “Accredited Investor” within the meaning of Rule 501(a) under the Securities Act of 1933 and/or a “Qualified Purchaser” as such term is defined in the Investment Company Act of 1940, as amended and (the “Securities Act”), it must return this Document to Crystal, as soon as practicable, together with any other materials relating to the Fund, which the recipient may have received, or must destroy this Document and such other materials as soon as practicable and, in each case, must destroy, as soon as practicable, all copies of analyses, compilations, studies or other documents prepared by it in connection with any information in this Document or such other materials. Please see the Help Section of the website (? Icon) for additional disclosures and definitions of certain terms and comparison indices. Crystal Capital Partners, LLC 1111 Kane Concourse, Suite 404 Bay Harbor Islands, FL 33154 T. (305) 868 - 1500 F. (305) 868 - 1595 www.crystalfunds.com Q1 / 2014 www.crystalfunds.com Page 7

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