hedge fund return sources...fixed income arbitrage, reg d) spread risk, e.g. carry trades (global...
TRANSCRIPT
1
Hedge Fund Return Sources
Alternative Beta Strategies:
A new paradigm to the hedge fund industry
Dr. Lars Jaeger, Partner
Partners Group
2
III The two essential approaches
Table of contents
IV Core – Satellite portfolios: A new
paradigm to hedge fund investing
II Implications: Why hedge fund replication
is interesting
I Alpha versus Beta in hedge fund returns
3
The hedge fund return puzzle
There is a widely held belief that hedge funds earn their returns through the identification
of market “inefficiencies” and by superior investment selection, i.e. by producing “alpha”.
However … since hedge funds generally trade in the most efficient markets:
Is it really plausible that remaining inefficiencies in these markets can provide a steady
stream of alpha to the USD 1,500+ billion hedge fund industry?
Are hedge fund managers really so much smarter than traditional managers?
There must be another, hidden source of returns driving a significant part of the performance of many hedge fund strategies
There must be another, hidden source of returns driving a significant part of the performance of many hedge fund strategies
Alpha versus beta in hedge fund returns
2
4
Discovering the “atomic structure” of hedge fund returns
α
αε
αε β
ε
α
ββ
α
The model of an atom in 1895 The model of an atom according to modern quantum physics
α
β2β3
β7
β4
β1
β5
β6
α
α
α
α
α
α
α
α
α
α
The emerging model of hedge fund return sources
The model of returns in a hedge fund portfolio until today
ε
ε
β
Alpha versus beta in hedge fund returns
5
Understanding Hedge Fund Returns: A Simple Model
Hedge fundTraditional mutual fund
Hedge LeverageProclaimed alpha
“Alpha”
Market riskpremium
Levera
ged
pro
claim
ed
alp
ha
One of many investors’ most frequent mistakes is not looking deeper into a hedge fund’s proclaimed alpha.
Superior:- Security selection
- Market Timing
Equity Risk Premium
EmMa Risk Premium
Credit Risk Premium
Term Curve Risk Premium
Value Stocks Risk Premium
Small Cap Risk Premium
Liquidity Risk Premium
Short Vega Risk Premium
Complexity Risk Premium
Commodity Risk Premium
Currency Risk Premium
Event Risk Premium
Convergence Risk Premium
α
Alt-β
Mark
et-β
Alpha versus beta in hedge fund returns
6
Traditional Beta vs.Hedge Fund Beta (Alternative Beta)
Traditional Beta
Exposure to:
Broad equity market
Interest rates (duration)
Credit risk
Emerging markets
Hedge Fund Beta (Alternative Beta)
Exposure to:
Style factors, such as small cap vs. large cap, value vs. growth, momentum (Long/Short Equity, Equity Market Neutral)
Event risk (Merger Arbitrage)
Volatility (Convertible Arbitrage, Volatility Arbitrage)
Risks of commercial hedgers in futures markets (Managed Futures)
Liquidity risk (Distressed Securities, Fixed Income Arbitrage, Reg D)
Spread risk, e.g. carry trades (Global Macro)
Exposure to Hedge Fund Beta requires special investment techniques including short selling, leverage, and the use of derivatives. Thus, hedge funds have exclusive access to these Alternative Betas.
Alpha versus beta in hedge fund returns
3
7
Distinguish „alphas” and „betas” in hedge funds
Alpha and beta do not come separately.
Often hedge funds come with “phantom alphas” (i.e. beta is sold as alpha)
Phantom alphas are not persistent
Phantom alphas can even be related to unwanted and uncontrolled systematic risks
Unwanted and uncontrolled systematic risks often lead to DI-WORSE-IFICATION
History and common sense tells us:
The real risk from hedge funds comes from:
unwanted and unknown leveraged systematic risk
uncontrolled manager related risk (style drifts, faulty operations, fraud, etc.)
Some words of caution : Distinguish between alpha and beta
Alpha versus beta in hedge fund returns
8
Table of contents
III The two essential approaches
IV Core – Satellite portfolios: A new
paradigm to hedge fund investing
II Implications: Why hedge fund replication
is interesting
I Alpha versus Beta in hedge fund returns
9
Hedge Fund Alpha Is Diminishing …
Why hedge fund replication is interesting
Data source: HFR, Bloomberg. Calculation: Partners Group
Mo
nth
ly a
lph
a i
n p
erc
en
t
HFRI Index Replicating Factors
EH S&P 500 Russell 2000 BXM Buywrite Index AR(1)
ED S&P 500 Russell 2000 CS High Yield Index AR(1)
MA SMB Russell 3000 MERFX BXM Buywrite Index AR(1)
CA S&P 500Citigroup
Convertible IndexCS High Yield Index AR(1)
AR (1) = Autoregressive factor for tracking of stale pricing
MERFX = Merger fund index
SMB = Small minus Big (Small Cap Factor)
-0.2%
0.0%
0.2%
0.4%
0.6%
0.8%
1.0%
Jan
01
Apr 0
1
Jul 0
1
Okt 0
1
Jan 02
Apr 0
2
Jul 0
2
Okt 02
Jan
03
Apr 0
3
Jul 0
3
Okt 0
3
Jan 04
Apr 0
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Jul 0
4
Okt 04
Jan
05
Apr 0
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Jul 0
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Okt 0
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Jan 06
Apr 0
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Jul 0
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Okt 0
6
Jan 07
Apr 0
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Jul 0
7
Okt 0
7
Equity HedgeEvent DrivenMerger ArbitrageConvertible Arbitrage
The development of alpha (excess return over a rolling linear factor regression) over a 60 month time window for various strategies :
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Hedge fund returns: Yesterday, today and tomorrow
βeta = is a risk premia and a compensation for a risk taken
αlpha = is the result of a zero-sum game (one’s profit is another’s loss)
Average Hedge Fund Return Components over Time
0%
2%
4%
6%
8%
10%
12%
14%
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-19
99
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00
-2
00
7
20
08
-20
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Exp
ect
ed
retu
rn
α
Alt-β αAlt-β
Alt-β
α
(35%)
(35%)
(15%)
(60%)
(48%)
(42%)
M-β (10%) M-β (30%) M-β (25%)
Hedge fund return sources
11
The traditional “Balanced Portfolio” does not include other risk premia that have favorable diversification qualities and generate attractive alternative returns.
Hedge funds in a global portfolio
Traditional investors benefit only from a few risk premia (blue) available in the market and miss multiple other sources of return!
Investors can access other uncorrelated alternative “risk premia” and thus return sources through hedge funds.
The real benefits from hedge funds do not necessarily come from accessing today’s star trader, but from the persistent benefits of alternative risk premiaThe real benefits from hedge funds do not necessarily come from accessing
today’s star trader, but from the persistent benefits of alternative risk premia
Why hedge fund replication is interesting
Convergence riskEmMa risk
Credit risk
Term risk
Volatility risk
Commodity hedging risk
Duration (Bond) risk
Equity risk
FX Carry risk
Event risk
Value risk
Momentum risk
Convergence risk
Roll Yield risk
Complexity/efficiency risk
12
The Issue of Hedge Fund Fees
Why hedge fund replication is interesting
Hed
ge f
un
d f
ees
Pay a lot (and even more in thefuture) for true alpha skill unavailable anywhere else
Don‘t pay hedge fund fees for traditional beta exposure (even when a few short positions are thrown in for credibility)
Pay less for systematic exposure to alternative betas, but more than regular stock market beta as extra skills are required
Hedge fund fee structure does not discriminate between skill based performance (alpha) and risk factor compensation (beta)
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Fees I: How about saving the manager fee layer?
6.6% - 14.2%4.4% - 10.9%FoF Return Net of Fees0.2% - 0.9%Performance Fee FoF (10% above US LIBOR)
1.0%Management Fee FoF (1%)6.6% - 14.2%5.6% - 12.8%Hedge Fund Return Net of Fees
1.2% - 2.5%1.4% – 3.2%Performance Fee HF (20%) / PG ABS (15%)1.25%2.0%Management Fee HF (2%) / PG ABS (1.25%)
9% - 18%9% - 18%Hedge Fund Return Gross of FeesPG ABSFoF
Total fee savings potential: 220 bps – 330 bps p.a.
Share of Return Payed Off to Investor
0%
10%
20%
30%
40%
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60%
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90%
4% 6% 8% 10%
12%
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20%
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24%
26%
28%
30%
Gross of Fees Return
FoF
PG ABS
Why hedge fund replication is interesting
14
Fees II: Do you really need to pay asymmetric performance fee in fund of funds?
The ABS performance fee is only paid on the netted performance. In contrast, for a portfolio of hedge funds the performance is not netted.
Total fee savings potential: 40 bps – 80 bps p.a.
Gross Performance Hedge Fund 1
ABS:After 15% performance fees
Net Performance combined:After 20% performance fees
Gross Performance Hedge Fund 2
- 6%
+12%+9.6%
- 6%
+3.6%== +5.1%
Why hedge fund replication is interesting
15
Fees III: How can you avoid to pay prime brokers excess leverage financing fees
ABS typically employ instruments like futures and options that allow exposure to the desired market with only a fractional size of the underlying cash. Therefore cash can be employed several times.
Total fee savings potential: 40 bps – 80 bps p.a.
HF A
Traditional Fund of funds:
No access to excess cash
Exp
osu
re
required collateral
excess cash
External borrowing
Average Exposure of Fund of funds
…
Hedge Fund Bpays Libor +45 bpsfor leverage
Hedge Fund A receives Libor -35 bps for excess cash
HF B HF n
ABSABSLeverage without external borrowing
Why hedge fund replication is interesting
6
16
Table of contents
III The two essential approaches
IV Core – Satellite portfolios: A new
paradigm to hedge fund investing
II Implications: Why hedge fund replication
is interesting
I Alpha versus Beta in hedge fund returns
17
Modeling Alternative Beta:Two Different Approaches
Identify FactorsReplication throughgeneric (linear) risk
exposure (Replicating Factor Strategies - RFS)
A. Top down: Linear Regression Approach (RFS)
B. Bottom up: Non-linear rule-based Approach (AltBeta Strategies)
Identify Risk Premia
Identify various HedgeFund Risk Premia by
analyzing the industry
Well known ideas
Identified Risk Premiabacked by academic
research
InvestWith rule-based
approach like Hedge Funds do
InvestDirect exposure
to explaining factors
The two essential approaches
18
1. The Top Down Approach - Linear regressions
We compare the performance of the factor model to the performance of the hedge fund strategy indices (HFRI, HFRX, S&P, where available).
The “replicating factor strategy” (in the following referred to as “RFS”) returns are simply calculated based on the factor returns times the factor weights. The latter were obtained based on a rolling regression analysis of a five year window, i.e. no in-sample optimization.
Superior:-Security selection
-Market Timing
Equity Risk Premium
EmMa Risk Premium
Credit Risk Premium
Term Curve Risk Premium
Value Stocks Risk Premium
Small Cap Risk Premium
Liquidity Risk Premium
Short Vega Risk Premium
Complexity Risk Premium
Commodity Risk Premium
Currency Risk Premium
Event Risk Premium
Convergence Risk Premium
Hedge Fund
α
β
Re = α + Σ (βi* Fi)
The two essential approaches
7
19
Replicating Factor Strategies applied
Results of the regression using the HFR event driven index as a dependent variable:
Data: HFR, Bloomberg. Calculation: Partners Group
Comparison of the replicated strategy (factors above)with the HFR event driven
correlation: 93%
Wouldn‘t it be great if we could separate the return components and compensate them specifically and accordingly?
Good news: Fairly simple to calculate and invest!
Factor Beta/Alpha t-stat Adj. R-squared
S&P 500 21.3% 9.84 82.6%Russell Spread (Small - Large) 20.0% 9.36 CS High Yield 27.0% 5.52 AR (1) 20.7% 4.83
Constant (=Alpha) 0.4% 4.62
-5%
-4%
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
Jan 0
0
Jan 0
1
Jan 0
2
Jan 0
3
Jan 0
4
Jan 0
5
Jan 0
6RFS
RFS
The two essential approaches
20
Trading RFS: Two Examples
Reference: L. Jaeger et al., “Modeling and Benchmarking of Hedge Funds: Can passive hedge fund strategies deliver?”, Journal of Alternative Investment, Winter 2005
Good replication Less good replicationLong/Short Equity Distressed
RFS worksRFS does not work as well
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105
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RFS HFRX DS
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-07
RFS HFRX EH
The two essential approaches
21
Why Do RFS Not Always Work?
RFS
HF return
retu
rn o
f hed
ge
fund s
trat
egy
return of systematic risk factor (size of risk premium)
RFS are linear approximations of hedge fund returns. They do not consider non-linear payout profiles inherent in hedge fund strategies!
1. No nonlinearity 2. Backward looking
RFS is backward looking: In contrast to hedge fund managers who base their decisions on current data, RFS adjusts exposures with a significant time lag. This can be problematic in a fast changing environment!
Limitations of RFS
Wouldn‘t it be great if we could separate the return components and compensate them specifically and accordingly?
Bad news: RFS is not suitable to describe hedge fund returns in all market environments.
It mostly captures the part of hedge fund returns that investors find least attractive
3. Mostly equity exposure
RFS models and incorporates mostly the equity exposure of hedge funds, i.e. specifically that part that is least attractive to investors.
S&P 500
700
800
900
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1300
1400
1500
1600
8.28.99 8.27.00 8.27.01 8.27.02 8.27.03 8.26.04 8.26.05 8.26.06 8.26.07
The two essential approaches
8
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B. Bottom up rule-based approach:the PG AltBeta model
Hedge FundsHedge Funds
Managed Futures(CTA)
Managed Futures(CTA)
Systematic - Technical(Trend Follower)
Systematic - Technical(Trend Follower)
Event-DrivenEvent-DrivenEquity HedgedEquity Hedged
Short SellersShort Sellers
ConvertibleArbitrage
ConvertibleArbitrage
Fixed IncomeArbitrage
Fixed IncomeArbitrage
Equity Market Neutral(Statistical Arbitrage)
Equity Market Neutral(Statistical Arbitrage)
Risk Arbitrage(Merger & Acquisition)
Risk Arbitrage(Merger & Acquisition)
Distressed Securities/High Yield
Distressed Securities/High Yield
Regulation D(Convertible Debenture)
Regulation D(Convertible Debenture)
Long/ShortEquities
Long/ShortEquities
Equity MarketTimer
Equity MarketTimer
Discretionary - Active(Fundamental/Spread)Discretionary - Active(Fundamental/Spread)
Relative ValueRelative Value
Derivative ArbitrageDerivative Arbitrage
Global Asset Allocator(Global Macro)
Global Asset Allocator(Global Macro)
OpportunisticOpportunistic
Systematic - Technical(Counter Trend)
Systematic - Technical(Counter Trend)
Special Situations(Spin-off, etc.)
Special Situations(Spin-off, etc.) Carry StrategiesCarry Strategies
++Observable hedge fund strategies
Supporting academic research
Hedge fund investment techniques
Alternative Beta Strategies(AltBeta)
Wouldn‘t it be great if we could separate the return components and compensate them specifically and accordingly?
PG AltBeta marries in-depth industry experience, academic risk premiaresearch and hedge fund investment technique
G:\Products\Hedge Funds\PG Alternative Beta Strategies\Presentations\2008\04 2008 – Partners Group Alternative Beta Strategies
The two essential approaches
23
2. The risk premium based approach – Bottom up
Instead of replicating of hedge fund indices gain direct exposure to individual hedge fund risk premia, i.e. alternative betas
Various risk premia in the global capital markets (alternative Betas) are the “atoms” of hedge fund returns. Note: Returns in single hedge fund strategy sectors are often already a composition of various risk premia
Modeling and investing in hedge fund risk premiums (i.e. alternative betas) requires alternative investment techniques (see before). Simple asset class exposures cannot do the job of extracting alternative betas.
Therefore, extracting alternative betas requires the definition and implementation of rule based trading strategies. We refer to these as “Alternative Beta Strategies”. Examples include trend following, spread trading and option strategies
The definition and extraction of alternative beta strategies is not a pure job of mathematical optimization. It also requires sound understanding of hedge funds themselves. Note: A fund of funds perspective can be extremely helpful here.
The two essential approaches
24
Bottom up - Rule-based Approach:Example I
Earning the “commodity hedging demand premium”: Involves taking the opposite position of commercial hedgers transferring their natural price risks.
Source: Bloomberg (SGFII <Index>, CISDM)See also L. Jaeger et al in “The sGFI – A case study”, Journal of Alternative Investments, Summer 2002.
Return: 11.8% p.a.Volatility: 11.5% p.a.
Return: 10.0% p.a.Volatility: 11.5% p.a.
* volatility adjusted for the SGFII volatility
Rule-based strategy:Trend following on 25 most liquid US futures markets. Positive momentum leads to long positionegative momentum leads to short position.
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SGFII
CISDM Systematic*
The two essential approaches
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Bottom up - Rule-based Approach:Example II
Rule-based strategy:Involves buying stocks and selling simultaneously (covered) call options.
Source: Bloomberg
Involves selling down-side protection to equity investors
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BXM Index
Tremont Long/Short IndexReturn: 4.5% p.a.Volatility: 9.2% p.a.
Return: 5.0% p.a.Volatility: 9.8% p.a.
The two essential approaches
26
Bottom up - Rule-based Approach:Example III
Rule-based strategy:Borrow from low yielding currencies, invest in high yielding currencies
Source: Bloomberg
Performance of the Deutsche Bank Carry IndexExcess Return (over risk free): 2.7% p.a.Volatility: 6.3% p.a.
95100105110115120125130135140
The two essential approaches
27
Integration of alternative risk premia: a simple example
How alternative risk premium play together – a simple example
Combination of trend following (SGFII), “buy-write” (BXM), and credit strategy
(CSFB HY index), equally weighted
Performance
Annualized Return: 7.7% p.a.
Annualized Volatility: 5.7% p.a.
Maximum Drawdown: -13.1%
Source: Bloomberg, CBOT
Performance
Annualized Return: 9.7% p.a.
Annualized Volatility: 5.4% p.a.
Maximum Drawdown: -9.8%
The two essential approaches
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S&P500TR HFR Composite HFR FoF Trilogy
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History of Alternative Beta Strategies
The two essential approaches
1997: Publication of “Empirical Characteristics of Dynamic Trading Strategies: The case of hedge Funds” by Fung Hsieh
2003:
Introduction of the term “alternative beta” by Fung et al. in “The Risk in Hedge Fund Strategies: Alternative Alphas and Alternative Betas”, in L. Jaeger (ed): “The new generation of Risk management for Private Equity and HF Investments”.
Partners Group (PG) research published; “Hedge Fund Return sources” topic on annual PG round tables
Decision to launch replicating beta hedge fund strategies; Launch of ABS quant team
2004:
Extensive research at PG of making risk premia models investable
October: Inception of PGAS Green Vega Cell; starting point of ABS track record
2005:
End of 2005: First institutional interest in hedge fund replication
2006:
Tremendous institutional interest in hedge fund replication
November: FT article triggers wave of discussion of hedge fund replication in the global financial industry
Asset base of PG ABS program up to 580 Mio. USD
Partners Group launches its first core-satellite products
2007:
Asset base of PG ABS program exceeds 800 Mio. USD
Strategy set expanded to 40 strategies
2008:
Launch of “passive” fund of alternative betas
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Alternative Beta: The real benefits of hedge funds
Dilemma for many hedge fund replicators: There is a lot of equity beta in current hedge fund returns. But: Clients want absolute and uncorrelated returns.
The large pack of currently available hedge fund replicators has chosen to follow a very simple path: Why not giving up on alternative beta and model hedge funds with traditional beta only?
This actually proved reasonably successful in the last four years (which is exactly the period most providers chose to display when they show their back-tested performance to attract investors) but would have failed miserably in the bear market from March 2000 to March 2003 - a period when hedge funds as an aggregate made money despite heavy losses in the equity markets.
More sophisticated investors would probably agree that this is not an acceptable concept to generate hedge fund exposure as it does not provide what investors want from hedge funds.
Alternative beta (risk premia beyond traditional equity (and bond) beta) can serve as a great diversifier and is ultimately the strongest rational to invest in hedge funds.
The two essential approaches
30
Alternative Beta kept up with equity beta in the bull market 2003-2007
Performance of a risk weighted average of simplified alternative beta returns compared to the Merrill Lynch factor model as a good proxy for the “equity component” in hedge fund return.
Alternative Beta factors: Deutsche Bank Carry Index, CDX High Yield Index, CRB Commodity Index, Value versus Growth Spread, Small cap versus large cap spread, BXM covered call writing (BXM Index- 0.5*SPX Index), the Merger Arbitrage Fund (MERFX Index), and the spread between emerging market equity returns and developed equity markets (MSCI Emerging Markets – MSCI World)
Source for ML factor model: Bloomberg, PG calculation prior to 2003
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ML Factor Index
Average Alternative Beta*
2003-2007YTD
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Average Alternative Beta*
ML Factor Index
The two essential approaches
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The real benefits of Alternative Beta over the full investment cycle
Alternative Beta factors: Deutsche Bank Carry Index, CDX High Yield Index, CRB Commodity Index, Value versus Growth Spread, Small cap versus large cap spread, BXM covered call writing (BXM Index- 0.5*SPX Index), the Merger Arbitrage Fund (MERFX Index), and the spread between emerging market equity returns and developed equity markets (MSCI Emerging Markets – MSCI World)
Source for ML factor model: Bloomberg, PG calculation prior to 2003
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28.0
2.0
7
30.0
4.0
7
30.0
6.0
7
31.0
8.0
7
31.1
0.0
7
31.1
2.0
7
ML Factors Average Alternative Beta*
The two essential approaches
32
Rolling correlation (60 days) of the risk weighted average of alternative beta returns to the MSCI World Equity Index are much lower than the 90-100% correlation regression based models display.
Alternative beta correlation are far more beneficial
-0.4
-0.2
0
0.2
0.4
0.6
0.8
1
10.0
4.0
3
10.0
6.0
3
10.0
8.0
3
10.1
0.0
3
10.1
2.0
3
10.0
2.0
4
10.0
4.0
4
10.0
6.0
4
10.0
8.0
4
10.1
0.0
4
10.1
2.0
4
10.0
2.0
5
10.0
4.0
5
10.0
6.0
5
10.0
8.0
5
10.1
0.0
5
10.1
2.0
5
10.0
2.0
6
10.0
4.0
6
10.0
6.0
6
10.0
8.0
6
10.1
0.0
6
10.1
2.0
6
10.0
2.0
7
10.0
4.0
7
10.0
6.0
7
10.0
8.0
7
10.1
0.0
7
10.1
2.0
7
Average Correlation of Alternative Beta Factors to MSCI World ML Factors
The two essential approaches
33
Two portfolios of alternative betas: Performance target parameters
AltBeta - Green Vega (goal: approximate global hedge fund industry)
Fee schedule: 1.25% management fee, 15% performance fee
Net performance Target: Libor plus 400-600,
Volatility Target: 6-8%
Long term sensitivity to equity markets: Beta of 0.5
AltBeta - Black Vega (passive allocation:
equally balanced across alternative risk premia)
Fee schedule: 1.25% management fee flat
Net performance Target Libor plus 200-400
Volatility Target: 4-6%
Long term sensitivity to equity markets: Beta of 0.2
The two essential approaches
12
34
Two portfolios of alternative betas: Asset Allocation
Long/Short I
Long/Short III
Event DrivenFixed Income
Arbitrage I
Merger Arbitrage
ILS
Volatility Arbitrage
CTA
Carry
GTAA
Min Var
Deep Value
Long/Short II
Fixed Income Arbitrage I
Long/Short I
Long/Short III
Event Driven
Fixed Income Arbitrage I
Merger ArbitrageILS
Volatility Arbitrage
CTA
Carry
GTAA
Min Var
Deep Value
Fixed Income Arbitrage I
Long/Short II
Green Vega (active HF industry proxy) Black Vega (equally weighted risk budgets)
The two essential approaches
35
Two portfolios of alternative betas: Net performance
95
100
105
110
115
120
125
130
135
140
145
150
Feb
04
Apr
04
Jun
04
Au
g 0
4
Okt
04
Dez
04
Feb
05
Apr
05
Jun
05
Au
g 0
5
Okt
05
Dez
05
Feb
06
Apr
06
Jun
06
Au
g 0
6
Okt
06
Dez
06
Feb
07
Apr
07
Jun
07
Au
g 0
7
Okt
07
Dez
07
Feb
08
Apr
08
HFR Composite HFR FoF
Black Vega (risk equally-weighted) Green Vega (active HF Industry tracker)
The two essential approaches
36
Table of contents
III The two essential approaches
IV Core – Satellite portfolios: A new
paradigm to hedge fund investing
II Implications: Why hedge fund replication
is interesting
I Alpha versus Beta in hedge fund returns
13
37
The Core - Satellite Investment Approach
Core - Satellite Approach
Limitations of the replicating approach
Some hedge fund strategies (such as Distressed Securities, Activist Event Driven) do not lend themselves as much to successful replication because they rely, by their very nature, more on skill/know-how or special market access rather than systematic exposure (e.g. variable bias, highly opportunistic or highly selective).
There are managers in any strategy that have demonstrated an ability to generate alpha over time also after taking into account the systematic risk exposure biases of their strategy.
Such hedge fund strategies can offer significant diversification benefits to ABS, thereby improving the overall risk/return properties of a combined portfolio.
38
So what does that mean for multi-strategy multi-manager portfolios?
Equity Risk Premium
EmMa Risk Premium
Credit Risk Premium
Term Curve Risk Premium
Value Stocks Risk Premium
Small Cap Risk Premium
Liquidity Risk Premium
Short Vega Risk Premium
Complexity Risk Premium
Commodity Risk Premium
Currency Risk Premium
Event Risk Premium
Convergence Risk Premium
Alt-β
Market-β
Separate inexpensive Alternative Beta and skill-based Hedge Funds
ε
ε β
ε
ββ
β2β3
β7
β4
β1
β5
β6
The emerging model of hedge fund return sources
The model of returns in a hedge fund portfolio until yesterday
ε
ε
β
α α
α
α
αα
α
αα
α α
αβ
β
β
β
ββ
α
β
Similar to the long only investment industry, employ a Core–Satellite approach for hedge fund investing!
Superior:- Security selection
- Market Timingα
Core-satellite approach
39
Complement PG ABS with Alpha Producing Managers
Exp
ecte
d r
eturn
of
core
/ s
atel
lite
pro
gra
m
Expected alpha generatedby selected HF managers
A core/satellite approach combines the generic exposure to hedge fund returns with significant alpha returns by satellite managers
4%-8%
2%-4%
Rangeof
Alpha
Average Performance of hedge fund industry as represented e.g. by average FoFs or “investable” hedge fund index
Outperformance of ABS due to a) lower feesb) favorable cross-financing
(notional)
1%-5%
Core - Satellite Approach
14
40
Summary and Conclusion
1. Hedge funds generate returns primarily through risk premia, and in addition also by exploiting inefficiencies in imperfect markets.
2. The concept of Alternative Beta Strategies goes further than factor based replication techniques in that it explicitly accounts for the non-linear dependency structure of hedge fund returns. It thus offers a valid, theoretically more sound, and cheaper alternative to the currently offered hedge fund index products.
3. Alternative Beta Strategies are based on a proven theoretical framework and have a proven track record more than three years.
4. Alpha and Beta do not come separate but in an uncontrolled and perhaps undesired (and cost-inefficient) combination. As in traditional investing a “core -satellite“ approach solves this.
5. A core - satellite approach to hedge fund investing emerges naturally:
cost efficient exposure to hedge fund (“alternative”) Betas with ABS as the core.
select Alpha generating managers as satellites.
Summary
41
Contacts
This material has been prepared solely for purposes of illustration and discussion. Under no circumstances should the information contained herein be used or considered as an offer to sell, or solicitation of an offer to buy any security. The information contained herein is confidential and may not be reproduced or circulated in whole or in part. The information is in summary form for convenience of presentation, it is not complete and it should not be relied upon as such. All information, including performance information, has been prepared in good faith; however Partners Group makes no representation or warranty express or implied, as to the accuracy or completeness of the information, and nothing herein shall be relied upon as a promise or representation as to past or future performance. This material may include information that is based, in part or in full, on hypothetical assumptions, models and/or other analysis of Partners Group (which may not necessarily be described herein), no representation or warranty is made as to the reasonableness of any such assumptions, models or analysis. The information set forth herein was gathered from various sources which Partners Group believes, but does not guarantee, to be reliable. Unless stated otherwise, any opinions expressed herein are current as of the date hereof and are subject to change at any time.
Dr. Lars Jaeger
Partners GroupZugerstrasse 576341 Baar-Zug
SwitzerlandT: +41 41 768 85 02F: +41 41 768 85 58
ZUG SAN FRANCISCO NEW YORK LONDON GUERNSEY LUXEMBOURG SINGAPORE BEIJING TOKYO SYDNEY
42
Disclaimer
This material has been prepared solely for purposes of illustration and discussion. Under no circumstances should the information contained herein be used or considered as an offer to sell, or solicitation of an offer to buy any security. Any security offering is subject to certain investor eligibility criteria as detailed in the applicable offering documents. The information contained herein is confidential and may not be reproduced or circulated in whole or in part. The information is in summary form for convenience of presentation, it is not complete and it should not be relied upon as such. All information, including performance information, has been prepared in good faith; however Partners Group makes no representation or warranty express or implied, as to the accuracy or completeness of the information, and nothing herein shall be relied upon as a promise or representation as to past or future performance. This material may include information that is based, in part or in full, on hypothetical assumptions, models and/or other analysis of Partners Group (which may not necessarily be described herein), no representation or warranty is made as to the reasonableness of any such assumptions, models or analysis. The information set forth herein was gathered from various sources which Partners Group believes, but does not guarantee, to be reliable. Unless stated otherwise, any opinions expressed herein are current as of the date hereof and are subject to change at any time.