Starving the Black SwanWhy Invest in Hedge Funds (after all that has happened). Presented by George Evans Global Head of Business Development GlobeOp Financial Services
Today’s Hedge Fund Landscape. Confidence is Back.• Despite continued economic uncertainty, hedge funds are still on the upswing, delivering solid performance for global investors.• The hedge fund industry worldwide now controls total assets worth $2.02 trillion as of April, 2011, greater than what the industry held prior to the credit crisis (Hedge Fund Research, 2011)• Year-over-year assets in hedge funds in 2011 are up by $102 billion over the first quarter of 2010.• In the post-Madoff era, regulatory scrutiny has intensified and will likely expand.• Institutions – such as corporate pension plans, family offices, endowments and foundations – have become major participants, expanding the core investor base beyond wealthy individuals.
Paradigm Shift: Institutions allocate more capital to hedge funds. 2008 to 2010 Projected next 12 to 18 months
What kind of investment strategies do you want?• Pension funds are facing the prospect of an exponential increase in withdrawals from retiring subscribers -- despite the shrinking value of their asset base.• In this scenario, hedge funds provide a powerful tool for effective liability hedging.• The specter of inflation has increased the appetite for capital preservation among endowments and foundations – and these investors have targeted rates of return that can’t be achieved with today’s low-yielding bonds.• Global alternatives like real-estate, infrastructure bonds and natural resources offer all types of hedge investors the potential for diverse anticipated returns and high earnings quality.
Pension Funds: Unfunded liabilities / hedge fund strategiesType of Security 2004 2005 2006 2007 2008 2009US Equities 0.4363 0.4322 0.4172 0.3957 0.3378 0.3299Non-US Equities 0.1497 0.1534 0.1743 0.1848 0.1802 0.188US Fixed Income 0.2769 0.2757 0.2648 0.2629 0.2528 0.2486Non-US Fixed Income 0.0116 0.0114 0.0087 0.0085 0.0143 0.009US Real Estate 0.0396 0.0434 0.052 0.0553 0.0647 0.0524Private Equity 0.0429 0.0432 0.0454 0.0499 0.0715 0.0659Hedge Funds 0.0002 0.0013 0.0089 0.0082 0.0115 0.0238Funding Ratio 0.825 0.8454 0.8618 0.9336 0.7831 0.5832 "Portfolio Allocation for Public Pension Funds" by George Pennacchi and Mahdi Rastad in Journal of Pension Economics and Finance, April 2011, http://bit.ly/iVkaCk
How has the governance of hedge funds improved?• Hedge funds are responding to the changed environment: Nearly half (46%) of funds have enacted a risk management system consistent with the expectations of boards of trustees or legislative mandates. (Preqin 2011)• Administrators have become central in helping investors to meet the need for transparency and integrity in hedge fund governance.• Investor demands and transparency/reporting requirements continue to increase rapidly
Why it’s a good idea to invest in Hedge Funds today• Hedge fund managers typically invest their own money in the fund they manage, which helps align their interests with investors.• Hedge funds typically have the resources and research to find and evaluate the best options across multiple categories and strategies.• Industry has been secured against operational risk.• Investment strategies of hedge funds have been customized for institutional investors.
the black swan• Operational risks predominate, with an average of 15 hedge funds collapsing each year on average (Edhec’s Risk and Asset Management Center, 2005)• 2002 CAPCO study found 41% of hedge fund failures are due to misrepresentation, 30% involved misappropriation of monies• 14% due to trading outside accepted boundaries and 6% due to inadequate or faulty technology.
How to Starve the Black Swan Nine Best Practices1 Know the marks of a 4 Nip fraud in the bud 7 Pay-for-performancecredible administrator Reconcile data from all sources-- Measure and evaluateCheck their standards – at least prime-brokers, counter-parties and performance of managers inSAS 70 Type II. Preferably ISAE exchanges both the short and long term and3402, SSAE 16 certifications ensure commensurate fees2 Identify risk “landmines” 5 Transparency 8 Monitor counterparty riskValue-at-Risk, Extreme risks, Communicate in real-time with Include prime brokers, valuationconsistency with memorandum reporting via a Web interface agents, auditors and other partners3 Pay attention to key metrics 6 Eliminate conflicts of interest 9 Guarantee IT data integritySnapshots of NAV are available Independently verify price data for and backupevery day to support evaluation unlisted assets and disclose Plan for business continuity andand decision making sources disaster recovery for all IT systems