0 K2 ADVISORS Fiduciary Investors Symposium October 2011 Confidential Presentation This presentation is provided to you on a confidential basis for informational purposes only and shall not constitute an offer to sell or a solicitation of an offer to buy an interest in any of the funds advised by K2 Advisors, L.L.C., K2/D&S Management Co., L.L.C., or their respective affiliates (“K2” or “K2 Advisors”). Such offer may only be made at the time a qualified offeree receives from K2 a Confidential Private Offering Memorandum describing the offer. This presentation may not be copied, loaned, or distributed to any other person without the consent of K2.
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K2 ADVISORS
Fiduciary Investors Symposium
October 2011
Confidential Presentation
This presentation is provided to you on a confidential basis for informational purposes only and shall not constitute an offer to sell or a solicitation of an offer to buy an interest in any of the funds advised by K2 Advisors, L.L.C., K2/D&S Management Co., L.L.C., or their respective affiliates (“K2” or “K2 Advisors”). Such offer may only be made at the time a qualified offeree receives from K2 a Confidential Private Offering Memorandum describing the offer. This presentation may not be copied, loaned, or distributed to any other person without the consent of K2.
Source: HFR, The Bank of New York Mellon and Casey Quirk.
14%
61%
Hedge Fund Industry AUM(Jan. 1990 – June 2011, billions)
Institutional Investors
Institutional Investors
2
Institutional Hedge Fund Investing
Pre and Post Global Financial Crisis
What has changed ?
3
Pre Global Financial Crisis
Investors Misperceptions
�Absolute return
�Zero beta i.e. the proliferation of portable alpha
�Presumed manager liquidity
�Misunderstood correlations
Cont’d...
4
Pre Global Financial Crisis
Investors Misperceptions
�Did not see crowded trades
�Ignored counterparty risk
�Operational due diligence taken for granted
�Transparency shortcomings
Cont’d...
5
Institutional Investors
�Benchmarks
– HFR Index
– Peers
– Cash +
�Institutions allocated 3-5% into alternatives
6
Institutional Investors
Equity
Fixed Income
Alternatives
Old Allocation Framework
60 / 40 Old School Paradigm
�Institutional investors’ asset allocations are evolving
7
Hedge Fund Weightings by Capitalization
Source: HFR Global Hedge Fund Report 2Q2011.
Equity Hedge
28.76%
Event-Driven
25.92%
Macro
20.50%
Relative Value
24.82%
Equity Hedge
37.07%
Event-Driven
9.75%
Macro39.30%
Relative Value13.88%
1990 2011
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Hedge Fund Returns
�Hedge Fund Indices have delivered significant outperformance
with lower draw downs compared to other indices
Source: HFR, S&P, Merrill Lynch and Bloomberg. Data from January 1990 through June 30, 2011. Annualized 8% return is representative of an actuarial return target for a hypothetical institutional investor. Past Performance is not indicative or guarantee of future results
-60%
-50%
-40%
-30%
-20%
-10%
0%
His
tori
cal
Dra
wd
ow
ns
HFRI Fund Weighted Composite Index
S&P 500 Total Return
Merrill Lynch High Yield Master II
Annualized 8% Return
Superior Capital
Preservation
0%
200%
400%
600%
800%
1000%
1200%
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Cu
mu
lati
ve R
etu
rns
1006%
491%
557%
Beta MarketExposure
9
Post Global Financial Crisis
�Counterparty risk is assessed and monitored
�Focus on operational concerns and controls
�Portfolio transparency is universally available
Cont’d...
10
Post Global Financial Crisis
�Implementation of risk systems enable investors to:
50/50 MSCI World and HFRI Equity Hedge Hypothetical NAV
MSCI World USD TR
Annual Return 3.36%
Annual Standard Deviation 15.59%
Annual Return 5.49%
Annual Standard Deviation 8.32%
M SC I Wo rld
M SC I Wo rld and H F R I Equity H edge
Source: Bloomberg and Hedge Fund Research. This performance data is the hypothetical performance of a model portfolio of indices. The model portfolio is not an actual portfolio, and the indices contained in the model portfolio are unmanaged, may not be investable, have no expenses and generally reflect reinvestment of dividends and
distributions. The performance information presented herein reflects the gross hypothetical performance returns of the model portfolio, but does not reflect the deduction of investment advisory fees and expenses that an investor would pay. Hypothetical performance information presented herein is not indicative or a guarantee of future results.
Barcap Agg Corp 50%, HFR Relative Value FI Corp 25%, HFR
Distressed/Restructure 25% Hypothetical NAV
BarCap US Aggregate Corporate TR
Annual Return 7.58%
Annual Standard Deviation 5.47%
Annual Return 8.93%
Annual Standard Deviation 4.80%
B arC ap U.S. C o rpo rate
B arC ap U.S. C o rp, H F R R V F I, H F R D istressed
Source: Bloomberg, Hedge Fund Research and Barclays Capital. This performance data is the hypothetical performance of a model portfolio of indices. The model portfolio is not an actual portfolio, and the indices contained in the model portfolio are unmanaged, may not be investable, have no expenses and generally reflect reinvestment of dividends and distributions. The performance information presented herein reflects the gross hypothetical performance returns of the model portfolio, but does not reflect the deduction of
investment advisory fees and expenses that an investor would pay. Hypothetical performance information presented herein is not indicative or a guarantee of future results.
Investment in a fund of funds is a speculative investment, entails significant risk and should not be considered a complete investment program. An investment in a fund of funds provides for only limited liquidity and is suitable only for persons who can afford to lose the entire amount of their investment. There can be no assurance that the investment strategies employed by K2 or the managers of the investment entities in which K2 Funds invest will be successful.
The identification of attractive investment opportunities is difficult and involves a significant degree of uncertainty. Returns generated from the funds described in this presentation may not adequately compensate investors for the business and financial risks assumed. Investment in these types of funds is subject to those market risks common to entities investing in all types of securities, including market volatility. Also, certain trading techniques employed by the investment entities in which the funds described in this presentation invest, such as leverage and hedging, may increase the adverse impact to which the fund’s investment portfolio may be subject.
Hedge funds are not required to provide investors with periodic pricing or valuation and there is generally a lack of transparency as to the underlying assets. Investing in hedge funds may also involve tax consequences and a prospective investor should consult with a tax advisor before investing. Investors in funds of hedge funds will incur asset-based fees and expenses at the fund level and indirect fees, expenses and asset-based compensation of investment funds in which these funds invest.
DISCLAIMERS
This presentation shall not constitute an offer to sell or a solicitation of an offer to buy an interest in any of the funds advised by K2. Such offer may only be made at the time a qualified offeree (as determined by K2 and the applicable K2 Fund in their sole discretion) receives from K2 a Confidential Private Offering Memorandum describing an offering. This material does not constitute investment advice with respect to an investment in any security or other interest in any K2 Fund. Any information herein regarding K2 Funds should not be regarded as providing any assurance that any such K2 Fund will continue to have the features, attributes and qualities described herein as of any subsequent date and is not a guarantee of future results.
THIS MATERIAL DOES NOT CONTAIN ALL OF THE INFORMATION THAT IS MATERIAL TO A PROSPECTIVE INVESTOR IN ANY K2 FUND. AN INVESTOR CONSIDERING INVESTING IN A K2 FUND SHOULD CAREFULLY CONSIDER ALL OF THE TERMS GOVERNING AN INVESTMENT THEREIN INCLUDING INVESTMENT OBJECTIVES, RISKS, CHARGES AND EXPENSES, WHICH ARE CONTAINED IN ITS CONFIDENTIAL PRIVATE OFFERING MEMORANDUM. THE CONFIDENTIAL PRIVATE OFFERING MEMORANDUM OF SUCH FUND SHOULD BE CAREFULLY READ AND UNDERSTOOD BEFORE INVESTING.
This presentation has been approved with limitations for the purpose of Section 21 of the Financial Services and Market Act 2000, by K2 Advisors, Ltd., an affiliate of K2, which is authorized and regulated by the United Kingdom Financial Services Authority.
THIS PRESENTATION DOES NOT CONSTITUTE AN OFFER OR SOLICITATION BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED, OR TO ANY PERSON WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION.
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Definitions of Comparative Indices and Statistics
HFR Monthly Indices (HFR) are equally weighted performance indexes, utilized by numerous hedge fund managers as a benchmark for their own hedge funds. The HFR are broken down into four main strategies, each with multiple sub-strategies. All single-manager HFR Index constituents are included in the HFR Fund Weighted Composite, which accounts for over 2000 funds listed on the internal HFR Database.
HFRI EH: Equity Market Neutral Index Equity Market Neutral strategies employ sophisticated quantitative techniques of analyzing price data to ascertain information about future price movement and relationships between securities, select securities for purchase and sale. These can include both Factor-based and Statistical Arbitrage/Trading strategies
HFRI Relative Value Index Investment Managers who maintain positions in which the investment thesis is predicated on realization of a valuation discrepancy in the relationship between multiple securities. Managers employ a variety of fundamental and quantitative techniques to establish investment theses, and security types range broadly across equity, fixed income, derivative or other security types.
HFRI Macro Index Macro: Investment Managers which trade a broad range of strategies in which the investment process is predicated on movements in underlying economic variables and the impact these have on equity, fixed income, hard currency and commodity markets. Managers employ a variety of techniques, both discretionary and systematic analysis, combinations of top down and bottom up theses, quantitative and fundamental approaches and long and short term holding periods.
HFR Distressed/Restructuring Securities Index – Distressed Restructuring Strategies employ an investment process focused on corporate fixed income instruments, primarily on corporate credit instruments of companies trading at significant discounts to their value at issuance or obliged (par value) at maturity as a result of either formal bankruptcy proceeding or financial market perception of near term proceedings. Managers are typically actively involved with the management of these companies, frequently involved on creditors' committees in negotiating the exchange of securities for alternative obligations, either swaps of debt, equity or hybrid securities. Managers employ fundamental credit processes focused on valuation and asset coverage of securities of distressed firms; in most cases portfolio exposures are concentrated in instruments which are publicly traded, in some cases actively and in others under reduced liquidity but in general for which a reasonable public market exists. In contrast to Special Situations, Distressed Strategies employ primarily debt (greater than 60%) but also may maintain related equity exposure.
HFR RV: Fixed Income-Convertible Arbitrage Index – Convertible Arbitrage includes strategies in which the investment thesis is predicated on realization of a spread between related instruments in which one or multiple components of the spread is a convertible fixed income instrument. Strategies employ an investment process designed to isolate attractive opportunities between the price of a convertible security and the price of a non-convertible security, typically of the same issuer. Convertible arbitrage positions maintain characteristic sensitivities to credit quality the issuer, implied and realized volatility of the underlying instruments, levels of interest rates and the valuation of the issuer’s equity, among other more general market and idiosyncratic sensitivities.
HFRI ED: Merger Arbitrage Index Merger Arbitrage strategies which employ an investment process primarily focused on opportunities in equity and equity related instruments of companies which are currently engaged in a corporate transaction. Merger Arbitrage involves primarily announced transactions, typically with limited or no exposure to situations which pre-, post-date or situations in which no formal announcement is expected to occur.
HFR Equity Hedge Index is a strategy that maintains positions both long and short in primarily equity and equity derivative securities. A wide variety of investment processes can be employed to arrive at an investment decision, including both quantitative and fundamental techniques; strategies can be broadly diversified or narrowly focused on specific sectors and can range broadly in terms of levels of net exposure, leverage employed, holding period, concentrations of market capitalizations and valuation ranges of typical portfolios. Equity Hedge managers would typically maintain at least 50%, and may in some cases be substantially entirely invested in equities, both long and short.
HFR Event Driven Index –Investment Managers who maintain positions in companies currently or prospectively involved in corporate transactions of a wide variety including but not limited to mergers, restructurings, financial distress, tender offers, shareholder buybacks, debt exchanges, security issuance or other capital structure adjustments. Security types can range from most senior in the capital structure to most junior or subordinated, and frequently involve additional derivative securities. Event Driven exposure includes a combination of sensitivities to equity markets, credit markets and idiosyncratic, company specific developments. Investment theses are typically predicated on fundamental characteristics (as opposed to quantitative), with the realization of the thesis predicated on a specific development exogenous to the existing capital structure.
HFRI Fund of Funds Composite Index 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. The Fund of Funds manager has discretion in choosing which strategies to invest in for the portfolio. A manager may allocate funds to numerous managers within a single strategy, or with numerous managers in multiple strategies.
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Definitions of Comparative Indices and Statistics
Barclays US Managed Futures Industry BTOP 50 The BTop 50 Index seeks to replicate the overall composition of the managed futures industry with regard to trading style and overall market exposure. The BTop 50 employs a top-down approach in selecting its constituents. The largest investable trading advisor programs, as measured by assets under management, are selected for inclusion in the BTop 50. In each calendar year the selected trading advisor programs represent, in aggregate, no less than 50% of the investable assets of the Barclay CTA Universe. The Index begins in January 1990 with a starting value of 1000.
BarCap U.S. Long Corporate TR Index Unhedged USD - The U.S. Corporate Index is a broad-based benchmark that measures the investment grade, fixed-rate, taxable, corporate bond market. It includes USD-denominated securities publicly issued by U.S. and non U.S. industrial, utility, and financial issuers that meet specified maturity, liquidity, and quality requirements. Securities in the index roll up to the U.S. Credit and U.S. Aggregate Indices. The U.S. Corporate Index was launched on January 1, 1973. Modified Adj. Duration: (˜12)
MSCI World Index USD The MSCI World Index is a capitalization weighted index that monitors the performance of stocks from around the world.
Average Annualized Return – Annualized geometric average return comprised of compounded monthly returns
Alpha - A mathematical value indicating an investment's excess return relative to a benchmark. Measures a manager's value added relative to a passive strategy, independent of the market movement.
Beta – The slope of the regression line and represents the expected change in the Fund’s return for a 1 percent change in the comparison Index. Beta is considered to be a measure of the Fund’s risk relative to the comparison index.
Correlation - The degree of interaction between the Fund’s return and that of the comparison Index. The correlation coefficient, expressed as a value between +1 and –1, indicates the strength and direction of the linear relationship between Fund’s returns and the returns of the index.
Standard Deviation - Annualized arithmetic standard deviation is a measure of dispersion indicating the degree to which each monthly return clusters about the mean return. Standard deviation is calculated based upon monthly returns, net of all fees and expenses, and annualized by multiplying by the square root of 12 (approximately 3.46).
Value-at-Risk (or “VaR”) - VaR is a statistical measure of risk that estimates the downside loss potential of a portfolio. More precisely, the 95% 1-month VaR is the loss one would not expect to exceed over a 1-month period with 95% probability
Estimated Performance-to-VaR – The ratio of actual return to predicted VaR over the same period.