Hedge Fund Industry Quarterly Return Analysis and Outlook · 2008-12-11 · Quarterly Return Analysis and Outlook 4 Quartalsperformance HFRI Fund Weighted Composite Index 0 5 10 15
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Hedge Fund Industry
Quarterly Return Analysis and Outlook
Quarterly Return Analysis and Outlook 2
Agenda
Hedge Fund Industry - Quo Vadis?
Q3 2008 Returns
Outlook
Quarterly Return Analysis and Outlook 3
Paulson moves into recovery mode
By James Mackintosh in LondonSunday Sep 7 2008"THIS IS THE FIRST INDICATION [FROM MR PAULSON] OF A BELIEF THAT WE WEREANYWHERE WITHIN SIGHT OF THE MOMENT TO GO LONG," SAID ONE INVESTOR WHOWAS ON THE CALL.MR PAULSON WILL LAUNCH HIS RECOVERY FUND ON OCTOBER 1 AND - IN A MOVETHAT INVESTORS SAID COULD ATTRACT BILLIONS OF DOLLARS …
Hedge Funds in the press
„The hedge funds are not guilty for the financial crisis. They
are amongst the victims. Responsible for the crisis are
universal banks investing in US-mortgages,“ Hans Rudolf Merz,
Minister of Finance of Switzerland, 13th September 2008.
„Don‘t be surprised if policymakers need to close down markets for aweek or two in coming days,“ Nouriel Roubini professor at the Universityof New York, 20th October 2008.
Quarterly Return Analysis and Outlook 4
Quartalsperformance HFRI Fund Weighted Composite Index
0
5
10
15
20
25
30
35
-5.00% 0.00% 5.00% 10.00% 15.00%
-10.00% -5.00% 0.00% 5.00% 10.00%
Quartalsperformance zwischen x und y
An
zah
lQ
uart
ale
Q3 2008 in a historic perspective
Q3 1998: -8.80%
Q3 2008: -8.85%
• Losses in Q3 2008 are exceptional, but not beyond what we have seen in the past
• Last period with similar high losses: Q3 1998 (Russia crisis, LTCM)
Quarterly Performance of HFRI Fund Weighted Composite Index (1990 – Q3 2008)N
um
ber
of
qu
art
ers
Quarterly performance between x and y
Quarterly Return Analysis and Outlook 5
• Average leverage of the hedge fund industry at 2.5 : 1 (today)
• The riskier the strategy the lower the leverage
• Leverage financed trough: repo line, securities based lending , standard credit line, structuredfinancing instruments, derivates> different instruments, different risks and effects
• Reminder: Leverage end of 2007: Credit Suisse 32 : 1 ; UBS 64 : 1
0
1
2
3
4
5
6
7
8
9
No Leverage: Long Short Equity,
Distressed, Short Selling Funds
Low Leverage: Long Short Equity,
Long Short Credit, Merger
Arbitrage, Macro Funds
Moderate Leverage: Convertible
Arbitrage, Statistical Arbitrage,
CTA's, MBS Arbitrage Funds
High Leverage; Fixed Income
Arbitrage Funds
Leverage ≠ Leverage
Source: Harcourt database; FuW Nr. 22, 2008
Average Leverage Level of the different Investment Strategies (as of H2 08)
0 – 1 : 1
1 – 2 : 1
2 – 6 : 1
6 – 15 : 1
Quarterly Return Analysis and Outlook 6
• Almost worldwide banning of short selling of financials and partially insurance stocks; partiallyalready revoked
• Hedge fund industry to face more regulations, closer monitoring by regulators and greaterdistribution restrictions
• Industry is dependent on a solid financial system, transparency and confidence in counterparties
►Short term over regulation can stabilize markets; however governed regulation isneeded for mid term stabilization
Impacted by regulation and governmental actions
Overview of Regulating Short Selling
US Securities and ExchangeCommission
- Banned short selling in morethan 900 US financials
Ontario Securities Commission
- Banned short selling in 13financial securities
Financial Services Authority
- Banned short positions in 34financial stocks
BaFin
- Banned “naked” short selling in11 financial stocks Financial Services Agency
- No change (rules since 2002 inplace)
Securities and FuturesCommission
- No change
Australian Securities andInvestment Commission
- Total ban on short selling ofstocks.
Securities andExchange Board ofIndia
- No change
Autorité desmarchés financiers
- Banned shortselling on financialand insurancestocks
Consob
- Shorters must havestock available frommoment orderplaced
Source: FT Research, September 24th 2008
Quarterly Return Analysis and Outlook 7
• Due to deleveraging effects (triggered by liquidity freeze of credit providers), and subsequently byinvestors redeeming assets, liquidity of hedge funds are scrutinized
• Suspending redemptions or gating a fund are legal measures of the fund manager in order toprotect investors and to allow for orderly liquidity adjustments
• However hedge funds are getting prepared for further liquidity squeeze and are hoping to managethe redemptions expected by investors
►Consequently some hedge fund strategies will become less liquid (Polarization; i.e.CTAs, Macro)
Liquidity crises
Subscriptions
84.59%
7.83% 3.02%
0.01%
4.55%
Weekly
Monthly
Quarterly
Annually
Other
Redemptions
2.50%
3.82%
9.51%
34.84%
49.32%
Source: HFRI Report Q2, July 2008
Liquidity Conditions within the Hedge Fund Industry (status quo)
17 September 2008 - David Walker
Hedge fund cash holdings at all-time highHedge funds have increased their cash assets to nearly one-third, one of theirhighest ever levels, the turbulent markets increase the possibility of redemptionsfrom the sector at the end of the year.
Quarterly Return Analysis and Outlook 8
The rules are changing….
Quarterly Return Analysis and Outlook 9
Less competition
• Hedge funds will no longer have to compete against powerful investment banks
• Industry consolidation: The number of hedge funds will decrease more than the assets since itwill be more difficult for small funds to exist
• Industry is heading for a period of deep structural change
►“Cleansing by fire” is positive for the hedge fund industry; more alpha opportunitiesbut less Alpha hunters
Hedge Fund Industry Consolidation
Source: HFR Report Q3 2008
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Q1
2008
Q2
2008
Q3
2008
Q4
2008
Q1
2009
Number of Hedge Funds Number of Fund of Hedge Funds
Quarterly Return Analysis and Outlook 10
0
500
1000
1500
2000
2500
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Q1
2008
Q2
2008
Q3
2008
Q4
2008
Q1
2009
AuM Hedge Fund Industry
Hedge Fund AuM development
Source: HFRI Industry Report 03/2008,
Asset decline as result of:• Closures due to underperformance• Obsolete (high leverage) strategies• Redemptions primarily from private investors and
structured products• General reluctance to invest in any low-liquidity vehicle
at the present time
Hedge Fund AuM Figures 1990 – 2008 and beyond
Quarterly Return Analysis and Outlook 11
Hedge Funds – Quo Vadis ?
Q1/Q2 – Phase of market uncertaintyQ3 – Phase of market
destabilization
Going Forward – Phase ofmarket opportunities
• Deleveraging• Fire Sale• Susp. Redemptions
• Systemic liquidity crisis• Global deleveraging• Counterparty risks• Regulatory changes• Neg. equity- / credit markets
• Increasing uncertainty• Widening of credit spreads• Banks run into liquidity issues• Increasing credit crunch
• Deleveraging over
• Hedge fundsbuilding cash
• Cleaning of thehedge fund industry
• Hedge fundpositioning for newopportunities
• Tight Regulations-50%
-40%
-30%
-20%
-10%
0%
10%
Jan-08 Feb-08 Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08
MSCI World Index USD JP Morgan Govt Bond Index USD HFRI Fund Weighted Composite Index
YT
DP
erf
orm
an
ce
2008
Quarterly Return Analysis and Outlook 12
Investment Opportunities on the raise
YTD default volume has surpassed FY ’06 and ‘07
• The opportunities in distressed debt, both incorporate credit and ABS, are increasing
Source: JP Morgan 2008; S&P LCD 2008
Source: Morgan Stanley, Industry View, Sept 2008
• Market players increasingly focus on distresseddebt opportunities
Distressed / Recovery Investing
Distressed is coming into the focus ofinvestors
Increasing Demand in Distressed Investing
Quarterly Return Analysis and Outlook 13
Outlook
• The liquidity crisis probably has hit its lows after massive interventions by governments andcentral banks around the world
• Deleveraging activities at the peak in October
• Until stability has returned to the markets capital preservation is key: fire sale activities leadto increased illiquidity of hedge funds and fund of hedge funds (new redemption terms,suspension of redemptions, gates, payment in kind)
• Going into next year we see markets presenting an extremely attractive investmentenvironment due to high inefficiency and therefore high opportunities
• Even entering a global recession we are convinced that hedge funds will be able to generatepositive returns as they have shown in previous cycles
►We believe that it will be a healthy cleansing although with some short term painfor all
Quarterly Return Analysis and Outlook 14
Dr. Hans Vontobel; Honorary Chairman of the Vontobel Group
„ This is in my professional careernow already the 7th baisse which Iundergo and it will pass, restassured.
It is important within these times toremain an optimist and to takeadvantage of the currentenvironment for ones ownbenefits..”
Quarterly Return Analysis and Outlook 15
Agenda
Hedge Fund Industry - Quo Vadis?
Q3 2008 Returns
Outlook
Quarterly Return Analysis and Outlook 16
YTD Sep 2008 vs YTD Oct 2008
1.49%
-17.99%
-39.75%
-34.03%-35.11%
-43.97%
-67.14%
-51.33%
-38.79%
-11.61%-9.52%
-25.58%
-20.57% -21.13%
-26.44%
-56.40%
-27.59%-29.77%
3.82%
-8.01%
2.31%
-27.59%
-0.09%
-19.61%
-70%
-60%
-50%
-40%
-30%
-20%
-10%
0%
10%
HFRX Global
HF Index
(investable,
gross)
CSFB/Tremont
HF Index
(investable,
gross)
MSCI World
(USD)
S&P 500 NASDAQ
Composit
Nikkei (JPY) Shanghai
Shenzen Index
MSCI Latam MSCI Europe
(EUR)
JP Morgan
Global Bond
Index (USD)
Swiss Bond
Index (CHF)
DJ AIG
Commodity
Index
Quarterly Return Analysis and Outlook 17
Q3 2008 – Hedge funds struggle, but still provide a buffer in a „forcedtransactions“ and fear driven market
Ret Q3 2008 Ret Q22008
FTSEhx (investable, net) -8.59% HFRI Fund of FundsComposite Index (non-investable, net) 1.90%
HFRI Fundof Funds Composite Index(non-investable, net) -9.63% HFRXGlobal Hedge Fund Index (investable, gross) 1.80%
HFRXGlobal Hedge Fund Index (investable, gross) -10.68% CSFB/Tremont HFs (investable, gross) 1.41%
CSFB/Tremont HFs (investable, gross) -10.70% FTSEhx (investable, net) -2.13%
Short-Selling 3.94% CTAs 3.70%
MBS Arbitrage 0.64% Fixed Income Arbitrage 3.40%
CTAs -1.54% Equity Market Neutral 2.68%
Merger Arbitrage -2.77% MBS Arbitrage 2.58%
Macro -4.22% Macro 2.40%
Fixed Income Arbitrage -5.06% Long/Short Equity 2.32%
Equity Market Neutral -5.36% RelativeValue Arbitrage 1.99%
RelativeValue Arbitrage -5.90% Distressed Securities 1.14%
DistressedSecurities -7.32% Short-Selling 1.04%
Event Driven -7.82% Merger Arbitrage 0.88%
Long/Short Equity -12.12% Event Driven 0.86%
Convertible Arbitrage -14.74% EmergingMarkets 0.27%
Emerging Markets -16.83% Convertible Arbitrage -0.24%
JPM Global Bonds 1.93% JPM Global Bonds -0.65%
MSCI World -15.72% MSCI World -2.45%
ComparisonbetweentheSecondandThirdquarter 2008
Quarterly Return Analysis and Outlook 18
Extreme uncertainty
Q32008 YTD 2007Retpa
2000-2008
Retpa
1994-2008
Stdevpa
2000-2008
CorrMSCI
2000-2008CSFB/TremontHFs(investable, gross) -10.70% -11.51% 7.42% 5.81% n/a 4.44% 0.47
HFRXGlobalHedgeFundIndex(investable,gross) -10.68% -11.61% 4.23% 6.48% n/a 6.37% 0.78HFRIFundofFundsCompositeIndex(non-investable,net) -9.63% -11.82% 10.25% 4.66% 6.55% 5.25% 0.54
Short-selling 3.94% 14.23% 4.72% 7.08% 2.00% 19.46% -0.70
CTAs -1.54% 8.73% 8.16% 6.35% 6.19% 7.33% -0.11
MBSarbitrage 0.64% 2.36% 1.11% 7.60% 8.71% 3.61% 0.16
Macro -4.22% 2.06% 11.11% 7.99% 9.73% 5.65% 0.28
JPMGlobal Bonds -0.24% 1.61% 6.94% 6.07% 7.03% 2.83% -0.30
Marketneutralequity -5.36% -3.00% 5.29% 5.09% 7.16% 3.10% 0.13
Mergerarbitrage -2.77% -3.65% 7.05% 6.23% 9.12% 3.63% 0.57
Relativevaluearbitrage -5.90% -7.25% 8.94% 7.09% 8.71% 3.19% 0.53
Fixedincomecorporateindex -5.06% -8.00% -0.74% 5.87% 6.64% 4.14% 0.50
Distressedsecurities -7.32% -9.92% 5.08% 9.83% 10.58% 5.16% 0.56
Eventdriven -7.82% -10.29% 6.61% 8.07% 11.53% 6.24% 0.75
Long/shortequity -12.12% -15.45% 10.48% 9.74% 5.67% 7.80% 0.55
Convertiblearbitrage -14.74% -20.25% 5.33% 4.23% 6.80% 5.92% 0.37
Emergingmarkets -16.83% -22.58% 24.92% 10.82% 9.78% 11.38% 0.78
MSCIWorld -15.72% -25.63% 7.10% -2.08% 4.72% 14.12% 1.00
Quarterly Return Analysis and Outlook 19
Illiquidity visualised
80
90
100
110
120
130
140
Jan08 Feb08 Mar08 Apr08 May08 Jun08 Jul08 Aug08 Sep08 Oct08
Oxam
/Am
plit
ude/H
FR
X(r
ebased
to100)
50
100
150
200
250
300
350
400
450
500
550
VIX
and
OIL
/Lib
or
(rebased
to100)
MN QuantST SystHFRX Global HFVIXOIS/Libor
Quarterly Return Analysis and Outlook 20
0
50
100
150
200
250
300
350
400
01Aug08 08Aug08 15Aug08 22Aug08 29Aug08 05Sep08 12Sep08 19Sep08 26Sep08 03Oct08 10Oct08 17Oct08 24Oct08 31Oct08
OIS
/LIB
OR
Sp
read
(bp
s)
US Government Interventions (31/10/08)
FDIC guarantee ofsenior debt of financialinstitutions. Non interestbearing depositaccounts fully insured
Capital purchaseprogram: $250bln in pref.shares of banks
$180bln expansion toswap lines
Fed lends $85bln to AIG
Fed would provideunlimited $liquidity tofinancial institutions andswaps
TARP Passed:$700bln
CPFF: $50bln
Fed, ECB, BoE: cut by 50bps
Increase in TAF: 25 to$75bln for Oct 6. 2fwd TAF totalling150bln in Nov.Increase in swapauthorisation limitswith other CBs from$290bln to $620blnMoney Market Mutual Fund
Liquidity Facility: $75bln
Fannie/Freddiebailout: $200bln
PDCF & TSLF: broadeningcollateral accepted. IncreaseTSLF by $25bln
Lehman collapse
US OIS/Libor
Source: Bloomberg - Harcourt – federalreserve.gov
Swap lines withBrazil, Mexico,Korea andSingapore
Money MarketInvestorFunding Facility
Quarterly Return Analysis and Outlook 21
European Interventions (31/10/08)
France: EUR360bln
• EUR320bln loan guarantees for new debt issuance• EUR40bln for stakes in troubled banks
• Conditions imposed on pay and bonuses• France invests EUR10.5bn in the six largest banks
Germany: EUR500bln
• EUR70bln to rebuild bank balance sheets, EUR20bln to cover potentialcredit guarantee and EUR10bln to acquire troubled assets
• EUR400bln to guarantee bank debt• Commerzbank taps program for EUR8.2bn
Spain: EUR100bln • Guarantee in new debt issued by banks• Govt to buy bank shares
Italy: EUR20bln • Govt insists Unicredit is only bank needing recapitalisation
Austria: EUR 100bln • EUR85bln in guarantees and EUR15bln in capital
Netherlands: EUR200bln• EUR200bln in interbank lending
• EUR20bln fund to recapitalise banks• Government takes stakes in Fortis and ING
Source: Bloomberg - FT
Quarterly Return Analysis and Outlook 22
Increased activities in existing programs
0
20
40
60
80
100
120
140
160
Dec07 Jan08 Feb08 Mar08 Apr08 May08 Jun08 Jul08 Aug08 Sep08
0
10000
20000
30000
40000
50000
60000
70000
80000
Mar08 Apr08 May08 Jun08 Jul08 Aug08 Sep08
Schedule 1
Schedule 2
Term Auction Facility (in Blns) Term Securities Lending Facility (in Mlns)
Coordinated Global response to the crisiswith the US, UK and EU applying:
• Liquidity operations
• Political Guarantee of deposits
• Bank recapitalisation
• Interest Rate Cuts
TSLF:
• Schedule 1: All collateral eligible for tri-party repurchase agreements arrangedby the Open Market Trading Desk
• Schedule 2: All Schedule 1 collateral. IGCorporates, munis, MBS and ABS
Source: Bloomberg - Harcourt - Bloomberg
Quarterly Return Analysis and Outlook 23
2.5
3
3.5
4
4.5
5
5.5
01Jul08 15Jul08 29Jul08 12Aug08 26Aug08 09Sep08 23Sep08 07Oct08 21Oct08
Bank Of Toky o MiBank Of AmericaBarclay sChaseCitiCSDBHBOSHSBCLloy dsNorinchukinRanbobankRBCRBSUBSWestLB
The Result so far…
3M Libor
3M Libor/Euribor ECB O/N Deposits (in Blns)
• Letting Lehman fall was a mistake
• Interbank market has started tonormalise after government guarantees
• Not everyone will be getting the liquidity:A1/P1 vs. A2/P2
Lehman collapse
Source: Bloomberg - Harcourt - Bloomberg
2
2.5
3
3.5
4
4.5
5
Jan08 Feb08 Mar08 Apr08 May08 Jun08 Jul08 Aug08 Sep08 Oct08
US
4
4.2
4.4
4.6
4.8
5
5.2
5.4
5.6
EU
US
EU
0
50
100
150
200
250
300
Jan99 Jan00 Jan01 Jan02 Jan03 Jan04 Jan05 Jan06 Jan07 Jan08
Quarterly Return Analysis and Outlook 24
Government Interventions
• Letting Lehman collapse was a mistake: commercial paper market and money
market funds froze up, leading to an elevation in the level of the crisis
• Key players will be rescued from now on but other mistakes can still be expected
• Things will get better but it will take time! Liquidity has improved in the interbank
market but not in the credit market
• The printing press will be run long enough to rebuild financial institutions... Those
actions have long term consequences
Quarterly Return Analysis and Outlook 25
Agenda
Hedge Fund Industry - Quo Vadis?
Q3 2008 Returns
Outlook
Quarterly Return Analysis and Outlook 26
Historical perspective (1)
Source: Fortune Jan 1970
Quarterly Return Analysis and Outlook 27
Historical perspective (2)
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
-24 -21 -18 -15 -12 -9 -6 -3 0 3 6 9 12 15 18 21 24
Months before / after Sep-1998 / Sep-2008
Cu
mu
lati
ve
Re
turn
s
Sep-1996 to Sep-2000 Sep-2006 to Sep-2008
Quarterly Return Analysis and Outlook 28
… a partial explanation
Liquidity Risk Factor
0.9
1
1.1
1.2
1.3
1.4
1.5
Mar-
94
Sep
-94
Mar-
95
Sep
-95
Mar-
96
Sep
-96
Mar-
97
Sep
-97
Mar-
98
Sep
-98
Mar-
99
Sep
-99
Mar-
00
Sep
-00
Mar-
01
Sep
-01
Mar-
02
Sep
-02
Mar-
03
Sep
-03
Mar-
04
Sep
-04
Mar-
05
Sep
-05
Mar-
06
Sep
-06
Mar-
07
Sep
-07
Mar-
08
Sep
-08
Source: George Chacko
Quarterly Return Analysis and Outlook 29
Outlook summary
Style Strategy Outlook next 3 ms Outlook next 12 ms Outlook 2009
Relative Value Fixed Income Fixed Income Arbitrage -- 0 0ABS/MBS 0 0 0ABL - 0 0
Directional Fixed Income Long/Short Credit -- + ++Distressed Securities -- + ++EM Debt -- 0 0
Relative Value Equity Multi-Strategy -- 0 +Event Driven -- - 0Convertible Arbitrage -- 0 +Structured Equity-Linked -- - 0Market Neutral Equity -- + ++Volatility Arbitrage + + +
Directional Equity L/S US Equities -- + ++L/S European Equities -- 0 +L/S Japanese Equities - + +L/S Emerging Markets -- 0 0Short Sellers + 0 0
Commodities RV Energy + ++ ++Directional Energy - + +Agriculturals + ++ ++Metals + + +Power 0 + +Shipping + + +Precious Metals 0 ++ ++
Multiple LT Trendfollowing CTAs + + +ST Systematic CTAs ++ + +Global Macro + + +
Quarterly Return Analysis and Outlook 30
Disclaimer
An investment in an alternative investment carries substantial risks. The nature
and extent of some of these risks differ from traditional investments in stocks and
bonds. There can be no assurance that the advice or information provided above
will lead to superior performance. In particular, the performance of an alternative
investment may vary substantially over time. Investors bear the risk of losing all
or part of their investment and thus should carefully consider the appropriateness
of such investments for their portfolio. While the information contained in this
document has been obtained from sources deemed reliable, no representation is
made as to its accuracy or completeness, and it should not be relied on as such.
Past performance is not necessarily indicative of future performance.
Quarterly Return Analysis and Outlook 31
Contact
Harcourt InvestmentConsulting AGStampfenbachstrasse 488006 ZurichSwitzerlandP: +41 44 365 1000F: +41 44 365 1001www.harcourt.ch
Harcourt InvestmentConsulting SARue de l'Université 41205 GenèveSwitzerlandP: +41 22 592 8580F: +41 22 592 8599www.harcourt.ch/geneva
To access Harcourt research and educational material please visit:www.harcourt.ch
Harcourt InvestmentConsulting ABNorrlandsgatan, Box 7046SE-10386 StockholmSwedenP: +46 8 611 0670F: +46 8 611 0671www.harcourt.se
Harcourt AlternativeInvestments (US) LLC712 Fifth Avenue, 28th FloorNew York, NY 10019United States of AmericaP: +1 212 371 4340F: +1 212 371 4342www.harcourtalternative.com
Harcourt AlternativeInvestments (HK) LtdSuites 2004-2006Jardine House1 Connaught Place CentralHong Kong, ChinaP: +852 3655 3900F: +852 3655 3939www.harcourt.hk
Harcourt InvestmentsSGIIC SASerrano, 26, 6 Planta28001 MadridSpainP: +34 91 598 3680F: +34 91 556 7493www.harcourt.es
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