Hedge Funds

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Introduction to hedge fund data at MBA level. 10th annual module at London Business School, E416 Hedge Funds

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Hedge Funds

  1. 1. Hedge Funds: Data Analysis Dr Drago Indjic dindjic@london.edu London Business School 9 May 2014
  2. 2. Data on Hedge Funds • Regulated “alternative” industry – “Ex-offshore“ size, growth – MBA/COO perspective • Entrepreneurial – Mostly small, private craftsman business • Product: (private) investment funds – Alternative investment strategies: reference, business and market data – Alpha gentrification
  3. 3. Macro View • Size of AUM: $2.7t (est. 2014Q1) • ~ ETF products, top 3 SWF or <Blackrock $4.4t • Exceeds pre-crisis peak (2007); >50%+ over low $1.3 tn (1Q09); inflows $26b (2013); ~10k funds; difficult “births”, extremely concentrated industry • $105b AQR vs $157b SPDR ETF • Better businesses today • Consolidated, more regulated value chain • “Survivors”: in 2008 managed futures strategies made +15% (then “underperformed”)
  4. 4. Not Mainstream - Yet • UK data: – 450 businesses (FCA) – Top 49: $480 bn AUM • “Liquid alternatives” – 1400 UCITS (HFR) – Not yet active ETFs • Scalability?
  5. 5. Basic Economics • Demand: (cheap) “Alpha” – End investors: direct and indirect sourcing, not yet “smart” indexing • Intermediaries: FoHF (1/3 of total AUM) – “professional” fund market imperfections; off- shore fund services industry • Supply: start ups vs mature businesses – Hedge fund managers as innovators; never too big to fail (LTCM; Pelaton)
  6. 6. 2010s • Financial “repression” – Hedge funds as the exit strategy: “unbundling” of bank’s proprietary trading desk – An employee/trader has to become an entrepreneur - including raising his own funds and funding the venture • EU AIFMD, US Dodd-Frank, etc – business costs, clearing fees etc increasing – Fear of start-ups and early stage investing
  7. 7. Demand and Distribution • Institutional investors – “Unconstrained” investors: direct or indirect • Pension funds – Strategic asset allocation (policy portfolio) • %alternatives (PE, RE); % HFs; %”strategies” • “Private” (HNW) vs emerging retail – “GACTA”: An investor domiciled in X buys units of fund domiciled in jurisdiction Y • KYC, AML client classification
  8. 8. Creating HF Exposure • Thriving • Direct, but advised: outsourced due diligence, non- discretionary • Managed Account Platforms • Extinct and endangered • FoHF: full outsourcing - consultant’s stronghold • Disappeared: Structured (capital protected) • 2010s: Emerging retail • Liquid Alternatives: UCITS and index products
  9. 9. Fund Management Company • Approved personnel in the regulated entity • On-shore, taxed: (UK: FCA) LLP (private LLP agreements); staff, systems, service contracts • Off-shore Ltd, manages off-shore fund: corporate “substance” and governance, off-shore authorised (eg. Guernsey FSC) • Start-up, not a listed company • True Hedge Fund: Manager(s) = Founders- owners; micro-enterprise (think credit score); cash- flow sensitive; taxable; Careful structuring
  10. 10. People (“professionals”) Note: your own BBG login: £1.5k/mth (quarterly billing, 6 months cancellation notice, rolling 2 yr lock-up)
  11. 11. Legals • People: Partnership agreement • Equity%: control and economics; designated partners(not salaried) • Fund management company • Articles of incorporation: fund governance issues • Investment management agreement with fund • Fund: private placing memorandum • Subscription forms (FATCA: often “non US”) • Service agreements • Counterparties, directors, distributors …
  12. 12. Service Agreements • Counterparties: Prime broker(s) – (+) Bank: securities custody, lending and financing – (-) Most senior creditor: re-hypothecation (Lehman; MF Global) • Fund Administrator – NAV Calculator, registrar and transfer, depositary bank etc • Auditor, legal, secretarial services … – Compliance, 3rd party marketing, IT …
  13. 13. Micro-Enterprises • Owner/Manager’s LLP – Staff <10: the largest are still SME! • Median “fund” AUM <$50m – Today less profitable then in the past; significantly higher cost of seed capital • Very few long-term survivors and “brands” – Most new funds liquidated within 5-7 years – not unlike many other start-ups or products
  14. 14. Voluntary Transparency • “Market research” databases • HFR, Lipper, Morningstar: not prices (NAVs): Lagged, non-verified performance estimates for fund share classes and fund “boiler plates” • “catalogues” of 1,000+ management companies by market research specialists – No standard identifiers • Self-selection and survivorship bias: the largest, the smallest and “defunct” funds excluded • No CUSIPs/LEI. Bloomberg etc blank; data is not for sale by fund administrators or brokers
  15. 15. The Allocation Problem • “Strategy allocation” (weight) • Fund “selection” (binary)
  16. 16. Alpha Needle or Rotten Apple?
  17. 17. Fund Labeling • What exactly is an investment strategy? – 1980s descriptive taxonomies: no standards beyond labelling: elicited by interviews and case studies; exposures vary across assets universe and over time • Lack of verification – Transparency: necessary, not sufficient criteria; Silver bullet: pre-trade controls • Danger: overpaying for Beta-like service
  18. 18. Indicative “Strategies” • Not all “hedge” funds deploy hedging strategies Equity Hedge 38.52% Emerging Markets (Total) 5.53% Distressed Securities 2.74% Equity Market Neutral 5.94% Equity Non-Hedge 7.84% Event-Driven 7.28% FI: Arbitrage 2.78% FI: Convertible Bonds 0.25% FI: Diversified 2.56% FI: High Yield 1.14% FI: MBS 1.37% Convertible Arbitrage 3.70% Short Selling 0.76%Sector (Total) 6.71% Macro 2.15% Market Timing 3.65% Merger Arbitrage 3.78% Regulation D 0.52% Relative Value Arbitrage 2.77% Strategies by # of Funds (ex FOF) 2002
  19. 19. Fund “Stars” and “Awards” • Hedge Fund Review Americas 2014: NYC, July 24th ”Hedge funds reporting to the BarclayHedge database are automatically entered in the performance categories. All other managers are encouraged to download and complete an entry form ... (and) also invited to enter the qualitative categories, which reward achievements in product development, innovation and client service” “This year the awards also recognise best bespoke FoHF provider and best advisory team from a fund of funds” “The hedge fund investment process relies on more than just numbers and the evaluation process recognises this”
  20. 20. What about “index(es)”?
  21. 21. Transparency • Full position transparency (to institutions) • “The exit rights of hedge fund investors put hedge fund managers on a much shorter leash than managers of public corporations and other types of investment funds”
  22. 22. Business Data • Mostly private, lagged and age fast – Static reference data • Fund offering memorandum, counterparties – Business • Due diligence: staffing, references, accounts – Portfolio • Classic: investor letters, weekly NAVs, portfolio exposure and holdings: “Opera” standard • Real-time: HedgeMark
  23. 23. Risk/Reward • Evaluate Total Hedge Fund Risk – Mostly business risk: contractual, SME, “key man” (“exit” - no EV), equity financed – Lesser portfolio and market risk (“hedged”) • Benefits – Unique profiles (NAV in gold or oil): not dependant on underlying assets (Betas) – Negotiable; business co-ownership (PE-like); – Alpha supply/demand => price?
  24. 24. Cash-flow vs Systemic Risk • Small funds: Tyranny of TER – (+) Performance/flows/age – (-) AUM <$100m for a long time • Mega funds: FCA “systemic” – Top 49: 64x NAV Gross Notional Exposure; $210tn turnover (inc STIR) ($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
  25. 25. Investment “Game” • Minimum required AUM to consider fund • “high %AUM is the partner’s capital”, “stamp of approval from a respected seeder” • Average investment size
  26. 26. (Re-)Pricing “Alpha”
  27. 27. Liquid Alternatives
  28. 28. “Game” • COO/CFO – http://cooconnect.com/ • Role Play • The investment manager • The product sponsor (setting up the fund) • The distributor • Business longevity
  29. 29. CA#100037 • Deep Asset Management, M&A, Risk Control and Market experience  Chief Executive Officer - Jon Oyvind Eriksen ─ 15 years of international CEO experience. Executed several M&A opportunities.  Chief Risk officer - Sanjay Agarwal ─ 7 years of International and emerging markets M&A risk control experience with 8 years of corporate treasury experience. Chartered Certified Accountant in UK and India.  Chief Financial Officer - Livia Popa ─ 7 years of Hedge Fund financial controller experience. Specialist in acquisition analysis.  Client Relationship Manager - Mike Huang ─ Product specialist with Halbis, a leading global asset management company. 3 years of sales and marketing experience in structured products with HSBC.  Head of Research - Stefan Slowinski ─ 8 years Equity Research experience with SG. 2 years M&A experience at Salomon Brothers.  Head of Trading - Jun Lin ─ Futures trading specialist, 5 years experience of trading experience. 32 The Alpha Team – Absolute Return M&A specialists Group 5 Jun Lin 05/05/2009 Sanjay Agarwal Jon Oyvind Eriksen Livia Popa Mike Huang Stefan Slowinski
  30. 30. Conclusion • Global political economy – “Re-regulation” • New investment contracting and passive / active boundaries – Aligned interests – Separation of funds and managers (limits fund investors’ right to claim management companies’ residual earnings or “profits”) – ETFs
  31. 31. References • “FoHF face fight for cash with consultants”, Reuters, April 28, 2014 • “HFR Q1 2014 in Review”, HFR Webcast 663 809 923, 23 April 2014 • “Going Mainstream: Developments and Opportunities for Hedge Fund Managers in the ’40 Act Space”, Barclays Prime Services, April 2014 • 12th Deutsche Bank's Alternative Investment 2014 Survey • http://springboardtm.files.wordpress.com/2014/03/deutsche-twelfth-annual- ai-survey.pdf • No need for any protection in 2014? The worst strategy: tail hedge, 3rd: CTA) • The top 50 HF firms have been in business for an average of 22 years. The average age of the founders of the top 50 funds is 54

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