Transcript Asset Management - Universidade Nova de Lisboa

Asset Management
Lecture 18
Outline for today
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Hedge funds
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General introduction
Styles
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Statistical arbitrage
alpha transfer
Historical performance
Alphas and betas
Definition
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Investment approach
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Trade any type of security or financial instrument
Operate in any market anywhere in the world
Unrestricted short-selling and leverage
Pure management skill
Fees and liquidity
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Compensation
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Management fee 2% (NAV)
Performance fee 20%
High water marks
Limited liquidity (lock-ups)
Legal
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LLC in US or off-shore open-ended investment companies
Unregulated private investment vehicles for wealthy individuals and
institutional investors
Provide minimal information to investors
Industry Size
Styles
Strategies
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Directional
 Bets that one sector or another will
outperform other sectors
Non directional
 Exploit temporary misalignments in security
valuations
 Buys one type of security and sells another
 Strives to be market neutral
Classification
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Equity Long/Short investing consists of a core holding of long/short
equities depending on the outlook. Commonly employ leverage.
Equity Market Neutral investing seeks to profit by exploiting pricing
inefficiencies between related equity securities, neutralizing exposure to
market risk by combining long and short positions.
Convertible Arbitrage involves purchasing a portfolio of convertible
securities, generally convertible bonds, and hedging a portion of the
equity risk by selling short the underlying common stock.
Distressed Securities strategies invest in, and may sell short, the
securities of companies where the security's price has been, or is
expected to be, affected by a distressed situation. This may involve
reorganizations, bankruptcies, distressed sales and other corporate
restructurings.
Merger Arbitrage, sometimes called Risk Arbitrage, involves investment
in event-driven situations such as leveraged buy-outs, mergers and
hostile takeovers.
Classification
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Emerging Markets funds invest in securities of companies or the
sovereign debt of developing or "emerging" countries. "Emerging
Markets" include countries in Latin America, Eastern Europe, the former
Soviet Union, Africa and parts of Asia.
 Event-Driven is also known as "corporate life cycle" investing. This
involves investing in opportunities created by significant transactional
events, such as spin-offs, mergers and acquisitions, bankruptcy
reorganizations, recapitalizations and share buybacks.
 Fixed Income Arbitrage is a market neutral hedging strategy that seeks
to profit by exploiting pricing inefficiencies between related fixed income
securities while neutralizing exposure to interest rate risk.
 Relative Value Arbitrage attempts to take advantage of relative pricing
discrepancies between instruments including equities, debt, options and
futures. Managers may use mathematical, fundamental, or technical
analysis to determine mis-valuations.
Classification
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Macro involves investing by making leveraged bets on
anticipated price movements of stock markets, interest
rates, foreign exchange and physical commodities.
Involves allocating assets among investments by
switching into investments that appear to be
beginning an uptrend, and switching out of
investments that appear to be starting a downtrend.
Fund of Funds invest with multiple managers through
funds or managed accounts. The strategy designs a
diversified portfolio of managers with the objective of
significantly lowering the risk (volatility) of investing
with an individual manager.
Statistical Arbitrage
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Uses quantitative systems that seek out many
temporary misalignments in prices
Involves trading in hundreds of securities a day with
short holding periods
Pairs trading
 Pair up highly correlated companies with recent
pricing discrepancy
 Create a market-neutral position
Data mining
Alpha Transfer
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Separate asset allocation from security
selection
 Invest where you find alpha
Hedge the systematic risk to isolate its
alpha
Establish exposure to desired market
sectors by using passive indexes
Pure Play Example
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Manage a $1.5 million portfolio
Believe alpha is >0 and that the market is about to fall
Capture the alpha of 2% per month
rportfolio  rf   (rM  rf )  e  
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β = 1.20
S&P 500 Index is S0 = 1,440
α = .02
rf = .01
Hedge by selling S&P 500 futures contracts
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S&P 500 futures contracts: $250 each
Pure Play Example
Hedge Ratio =
$1,500, 000
x 1.20  5 Contracts
1, 440 x $250
The dollar value of your portfolio after 1 month:
$1,500, 000 x (1  rportfolio )  $1,500, 000 1  .01  1.20(rM  .01)  .02  e 
$1,527, 000  $1,800, 000 x rM  $1,500, 000 x e
The dollar proceeds from your futures position:
5 x $250 x ( F0  F1 )
Mark to market on 5 contracts sold
 $1, 250 x  S0 (1.01)  S1 
Substitute for futures prices from parity relationship
 $1, 250 x S0 1.01  (1  rM ) 
Because S1 = S0 (1  rM ) when no dividends are paid
 $1, 250 x  S0 (.01  rM ) 
Simplify
 $18, 000  $1,800, 000 x rM
Because S0 = 1,440
Hedged Proceeds = $1,545,000 +$1,500,000 x e
3% return
Non-systembatic risk
Historical Performance
Historical Performance
Hedge Fund Alpha
Hedge Funds
Spring 2008
17
Alfas and betas
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Measure fund performance using regression:
Beta measures how fund goes up and down with the
market
 i rmt measures the return due to market exposure
 i measures the excess return, due to manager talent
(or luck…)
 (i) measures the risk specific to the fund
(presumably diversifiable)
Alfas and Betas
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You should only pay fees for alpha, the rest you can
easily (and more cheaply) obtain with an ETF
To add an hedge fund to a portfolio, we need to know
how it correlates with the other assets
Unfortunately, it’s not so easy to measure alphas and
betas for hedge funds
 Asset illiquidity biases betas
 Time-varying or non-linear exposure of hedge fund
strategies
Hard to spot talent – short histories
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Typically hedge funds have histories shorter than 5
years
Uncertainty of mean return is
With 15% volatility, 5 year history, 90% confidence
interval for mean return is
To evaluate a manager, you need to understand the
economic story very well
 Risk premia – value, illiquidity, Market inefficiency –
why? what capacity?
 Competitive advantage of manager
Hard to spot talent – survivorship bias
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All hedge funds around seem to be exceptional… And,
in fact, all funds alive have had an exceptional
performance in the past
Hedge fund indices are based on self-reported
performance (with backfill)
 Only successful funds report, biasing the
performance of the index relative to the
performance of an investor who actually put money
in a cross section of funds
Survivorship bias in indices of the order of 3% per year
(Brown and Goetzmann)