skill based investing - january 2012

8/2/2019 Skill Based Investing - January 2012

1/34

Skill based investin

January 2012

Hedge funds and other alternative investments: a discussion

Adri Guha

January 2012 32

Confidential presentation materials. Not for unauthorized distribution. Reproduction without express written permission is strictly prohibited.


2/34


3/34

Table of Contents

Description and definitions 1

Skill based active management 3

Hedge funds 4

Manager analysis 8Attributes 8

Performance analysis 9

Comparative example 1 14

Comparative example 2 16

Terms analysis 18

Hed e fund strate ies 20

Classifications 20

Equity long-short 21

Credit-linked 22

Event-driven 23

Fixed income arbitrage 24

Volatility 25Tactical 26

Other 27

Financial crisis 28

January 2012 3434


4/34

Descri tion and definitions

Passive investments Characteristics

Asset classes of an asset allocation policy portfolio

Available as index funds or derivatives

Asset classes offer, in the long-term, an expected return premium forear ng e sys ema c r s o e asse c ass

Systematic returns and systematic risk

Minimal difference between the returns of the index fund or derivative onpaper and as an investment

January 2012 1


5/34


Passive investments Beta

= Correlation (between investment and stock index) *

Standard Deviation investment /

Standard Deviation (stock index)]

Origin in the Capital Asset Pricing Model

Measure of systematic risk

)( fmf RRRR +=

Meant to capture stable, long-term relationships

January 2012 2


6/34


Skill based active mana ement Al ha

)( fmf RRRR +=

= RRRR

Terminology from regression analysis

+= )( fmf RRRR

Measure of idiosyncratic risk and return

+= X

Ways to generate alpha

- Market timing

- Security selection

January 2012 3


7/34


Hed e funds Characteristics

Two important characteristics that consistently apply to hedge funds

- they are subject to minimal investment constraints

- they charge high fees

Hedge funds have the ability to invest in a wide range of securities, to hold

negative positions in securities through short sales or derivatives, and to

borrow or use other forms of leverage

Hedge funds charge fees that are much higher than those charged by most

other asset managers

January 2012 4


8/34


Hed e funds Skill based active mana ement

Given their investment flexibility, hedge funds can be constructed to

rovide a ure la on active mana ement or skill-based investin

Given their investment flexibility, hedge funds should be able to maximize

the profit opportunities available from skill-based investment opportunities

Given their flexibility and fee structure, hedge funds should attract the best

skill-based managers

January 2012 5


9/34


Hed e funds Inefficient source of assive returns

Given their fee structure, hedge funds provide an extremely inefficient

source of assive asset class returns

Index funds will dominate hedge funds as providers of passive asset class

returns

Index funds will dominate in terms of fees, costs, liquidity, and

transparency

January 2012 6


10/34


Hed e funds Source of skill based returns

Hedge funds should offer superior, consistent skill based returns from alpha

Sources of risk not specifically related to the generation ofalpha should be

minimized

e ge un s s ou no e a source o pass ve re urns

Alpha, not beta

January 2012 7


11/34

Mana er analysis

Attributes

Performance analysis

Returns analysis

Quality of returns analysis:- s -a us e re urns

- Alpha content

- Downside analysis

Terms analysis:- Liquidity

- Fees

January 2012 8


12/34

Mana er analysis

Performance anal sis Historical mana er returns

Comparativehistorical

Manager Equity Oriented L/S Equity

Period: Oct 2002 to Sep 2010

Annualized Monthly Returns

Period Standard Sharpe

individual

manager

performance

Manager/Benchmark 1Y Return 5Y Return Return Deviation Ratio

Manager 1.7% 8.3% 6.5% 8.7% 0.5

Altvest Long ShortEquity Index

7.1% 5.1% 8.1% 7.8% 0.8

HFR Equity Hedge

Index6.6 4.1 7.1 8.7 0.6

Tremont Long Short

Equity Index5.8 6.0 8.2 7.8 0.8

Average 6.5 5.1 7.8 8.1 0.7

US 1M T-Bill 0.1% 2.3% 2.0% 0.5% N/A

Barclays Aggregate 7.9 6.1 5.3 3.8 0.9

SSB Non-US WGBI 4.9 7.5 8.2 8.8 0.7

Merrill High Yield 17.3 8.9 11.2 11.3 0.8

Russell 1000 Value 10.2 1.3 8.1 16.3 0.4

Russell 1000 Growth 13.8 3.7 7.7 15.9 0.4

January 2012 9

Russell 2000 15.6 4.3 11.3 20.7 0.4

MSCI World Ex-USA 6.0 4.7 11.7 18.5 0.5


13/34

Mana er analysis

Performance anal sis Factor-based risk and return attribution

Factor analysisis applied to

R Square Period Standard Correl vs. Beta vs. Factor t Return Risk*

Investment Class 0.29 Return Deviation Portfolio Portfolio Weighting Statistics Attribution Attribution

Manager 6.5% 8.7% 1.00 1.00 -0.54 -- 6.5% 100.0%

Alpha -- -- -- -- -- 1.70 4.8 70.3

and precisely

attribute both

risk and return

- 2.0 0.5 0.00 -0.01 -- -- 2.0 -2.5

Barclays Aggregate 5.3 3.8 -0.19 -0.42 -0.34 -1.14 -1.1 2.8

SSB Non-US WGBI 8.2 8.8 -0.06 -0.06 -0.11 -0.80 -0.7 0.6

Merrill High Yield 11.2 11.3 -0.03 -0.02 -0.09 -0.76 -0.8 0.4

Russell 1000 Value 8.1 16.3 -0.11 -0.06 -0.62 -3.88 -3.7 14.1Russell 1000 Growth 7.7 15.9 -0.03 -0.02 -0.03 -0.23 -0.2 0.2

Russell 2000 11.3 20.7 -0.06 -0.03 0.03 0.32 0.3 -0.5

MSCI World Ex-

USA11.7 18.5 0.10 0.05 0.60 5.02 5.9 14.6

January 2012 10

* Normalized


14/34

Mana er analysis

Performance anal sis Drawdown and eriod anal sis

Drawdownanalysis and

Historical Statistics ManagerTwelve months ending

Period 5Year 1Year Sep-09 Sep-08 Sep-07 Sep-06Compounded Return 62.9% 47.8% 1.4% 17.6% 1.0% 12.4% 9.2%

Maximum Drawdown -7.4% -7.4% -5.1% -3.4% -7.1% -5.1% -7.4%

important

dimensions of

manager

From May-06 May-06 May-10 Mar-09 Jan-08 Jul-07 May-06

To Dec-06 Dec-06 Sep-10 May-09 Jun-08 End of Period End of PeriodLength of Drawdown 8 8 5 3 6 3 5

Trough to Recovery 6 6 1 1 2 No Recovery No RecoveryMonthly Average Return 0.5% 0.7% 0.1% 1.4% 0.1% 1.0% 0.8%

Monthly Standard Deviation 2.5% 3.0% 2.3% 3.2% 3.6% 2.6% 3.2%Best Month 7.7% 7.7% 5.8% 6.6% 6.8% 4.2% 7.7%

performanceorst ont - . - . - . - . . - . - .Skewness 0.22 0.13 1.24 0.14 0.27 -1.14 0.23Serial Correlation -0.10 -0.09 -0.11 -0.02 -0.22 -0.26 0.02

Ann. Avg. Alpha + Residual Return 4.8% 6.3% 8.8% 14.9% 2.7% 2.7% 2.6%

Annualized Slope 0.1%

Average Monthly Alpha 0.4%

8.0% Average RegressionAvera e A l ha +Alpha Analysis (monthly)

-2.0%

0.0%

2.0%

4.0%

6.0%

Apr-01 Sep-02 Jan-04 May-05 Oct-06 Feb-08 Jul-09 Nov-10

Alpha Line

Residual

January 2012 11

-6.0%

-4.0%


15/34

Mana er analysis

Performance anal sis Outlier anal sis

Worst and bestmonthly returns

Correlation and BetaAnalysis

US 1M

T-Bill

Barclays

Aggregate

SSB Non-

US WGBI

Merrill

High Yield

Russell

1000 Value

Russell

1000

Growth

Russell

2000

MSCI

World Ex-

USA

allow detailed

investigation

into outlying

- .

-0.10

0.63

-0.06

-0.05

0.26

er o . - . - . - . - . - . .

Correlation 5Year -0.02 -0.34 -0.18 -0.05 0.03 -0.03 0.13

1Year 0.22 -0.37 0.17 0.70 0.68 0.64 0.72

Period -0.01 -0.42 -0.06 -0.02 -0.02 -0.03 0.05

Beta 5Year -0.43 -0.95 -0.21 -0.04 0.02 -0.01 0.06

1Year 101.12 -0.95 0.13 0.83 0.27 0.20 0.28

performanceWorst and BestPerforming Months

Manager US 1M

T-Bill

Barclays

Aggregate

SSB Non-

US WGBI

Merrill

High Yield

Russell

1000 Value

-4.0%

-2.5

Russell

1000

Growth

Russell

2000

MSCI

World Ex-

USA

Jan-08 -5.9% 0.2% 1.7% 4.0% -1.4% -7.8% -6.8% -9.0%

Ma -06 -5.4 0.4 -0.1 2.3 -0.1 -3.4 -5.6 -3.8

1.18.8

3.9

1.4%

-9.6

6.2

Aug-07 -5.0 0.4 1.2 1.6 1.1 1.6 2.3 -1.4Apr-03 -3.5 0.1 0.8 1.4 5.8 7.4 9.5 9.6

Sep-09 -3.2 0.0 1.1 2.7 6.0 4.3 5.8 4.1

Mar-06 7.7% 0.4% -1.0% -1.2% 0.6% 1.5% 4.8% 3.2%

Jun-08 6.8 0.2 -0.1 0.4 -2.7 -7.2 -7.7 -7.8

May-09 6.6 0.0 0.7 4.6 7.1 5.0 3.0 12.6

January 2012 12

7.8

-17.3

Sep-10 5.8 0.0 0.1 3.3 3.0 10.6 12.5 9.6

Oct-08 5.3 0.0 -2.4 -2.5 -16.3 -17.6 -20.8 -20.8


16/34

Mana er analysis

Performance anal sis Quartile anal sis

Quartile Analysis of Index Returns (from

worst to best, monthly) I II III IV

ManagerAverage Return 1.2% 0.8% 0.6% -0.4%

Standard Deviation 2.7 2.7 2.4 2.1

Barclays AggregateAverage Return -1.0 0.2 0.8 1.7

Worst-to-bestquartile

. . . .

ManagerAverage Return 0.6% 1.0% 0.2% 0.4%


SSB Non-US WGBIAverage Return -2.5 -0.2 1.6 3.9




vera e Return -2.7 0.7 1.5 4.2

index returns

versus the

managererr g e




Russell 1000 ValueAverage Return -5.5 0.1 2.1 5.9




provide

additional

intuition

Russell 1000 GrowthAverage Return -5.2 -0.3 2.2 5.8




Russell 2000Average Return -7.1 0.0 3.2 7.7


Average Return 0.0% 0.0% 1.1% 1.1%

January 2012


MSCI World Ex-USAAverage Return -5.7 -0.1 2.9 6.8


13


17/34

Mana er analysis

Com arative exam le 1 Historical mana er returns

Manager 1 hasa Sharpe ratio


Period: Oct 2002 to Sep 2010


Period Standard Sharpe .Manager/Benchmark 1Y Return 5Y Return Return Deviation Ratio

Manager 1 4.2% 9.1% 9.0% 6.4% 1.1


7.1% 5.1% 8.1% 7.8% 0.8

HFR Equity Hedge

Index11.6 9.5 14.7 12.2 1.0

Tremont Long Short

Equity Index5.8 6.0 8.2 7.8 0.8

Average 8.2 6.9 10.3 9.3 0.9

US 1M T-Bill 0.1% 2.3% 2.0% 0.5% N/A


SSB Non-US WGBI 4.9 7.5 8.2 8.8 0.7


Russell 1000 Value 10.2 1.3 8.1 16.3 0.4

January 2012 14

. . . . .

Russell 2000 15.6 4.3 11.3 20.7 0.4

MSCI World Ex-USA 6.0 4.7 11.7 18.5 0.5


18/34

Mana er analysis

Com arative exam le 1 Factor-based risk and return attribution

75% of risk and69% of returns



Manager 1 9.0% 6.4% 1.00 1.00 0.09 -- 9.0% 100.0%

Alpha -- -- -- -- -- 2.90 6.2 75.0

attributed to

alpha

US 1M T-B 2.0 0.5 0.07 0.89 -- -- 2.0 0.5

Barclays Aggregate 5.3 3.8 0.18 0.29 -0.04 -0.20 -0.1 -0.5

SSB Non-US WGBI 8.2 8.8 0.33 0.23 0.13 1.28 0.8 5.8

Merrill High Yield 11.2 11.3 0.04 0.02 -0.07 -0.80 -0.6 -0.4

Russell 1000 Value 8.1 16.3 0.17 0.07 0.29 2.42 1.8 13.2Russell 1000 Growth 7.7 15.9 0.03 0.01 -0.27 -2.39 -1.6 -1.7

Russell 2000 11.3 20.7 0.04 0.01 -0.10 -1.33 -1.0 -1.1

MSCI World Ex-

USA11.7 18.5 0.21 0.07 0.15 1.65 1.5 9.1

January 2012 15

* Normalized


19/34

Mana er analysis

Com arative exam le 2 Historical mana er returns

Manager 2, incomparison, has


Period: May 2004 to Sep 2010


Period Standard Sharpe

less than half of

Manager 1

Manager/Benchmark 1Y Return 5Y Return Return Deviation Ratio

Manager 2 9.9% 10.4% 13.1% 21.3% 0.5


7.1% 5.1% 6.5% 8.4% 0.5

HFR Equity Hedge

Index11.6 9.5 11.5 13.0 0.7

Tremont Long Short

Equity Index5.8 6.0 7.0 8.5 0.6

Average 8.2 6.9 8.3 9.9 0.6

US 1M T-Bill 0.1% 2.3% 2.2% 0.5% N/A


SSB Non-US WGBI 4.9 7.5 7.1 8.6 0.6


Russell 1000 Value 10.2 1.3 4.2 16.9 0.1

Russell 1000 Growth 13.8 3.7 4.3 16.4 0.1

January 2012 16

Russell 2000 15.6 4.3 6.6 21.4 0.2

MSCI World Ex-USA 6.0 4.7 8.0 19.5 0.3


20/34

Mana er analysis

Com arative exam le 2 Factor-based risk and return attribution

Only 25% of itsrisk and return



Manager 2 13.1% 21.3% 1.00 1.00 0.77 -- 13.1% 100.0%

Alpha -- -- -- -- -- 0.71 3.3 25.1

alpha- 2.2 0.5 0.03 1.10 -- -- 2.2 -2.3

Barclays Aggregate 5.7 3.5 0.15 0.87 0.14 0.26 0.5 0.3

SSB Non-US WGBI 7.1 8.6 0.31 0.75 -0.15 -0.66 -0.7 -1.8

Merrill High Yield 8.7 12.1 0.62 1.09 0.16 0.86 1.0 5.7

Russell 1000 Value 4.2 16.9 0.56 0.70 -1.01 -4.02 -2.0 -43.0Russell 1000 Growth 4.3 16.4 0.63 0.82 0.19 0.78 0.4 9.3

Russell 2000 6.6 21.4 0.52 0.52 -0.11 -0.60 -0.5 -5.5

MSCI World Ex-

USA8.0 19.5 0.79 0.86 1.54 7.98 8.8 112.2

January 2012 17

* Normalized


21/34

Mana er analysis

Terms anal sis Hed e funds

Liquidity

-

- Notice period

- Lock-ups (soft or hard)

- Gates individual or fund-level

Fees

- Management fees: amount

- Performance fees: amount, hurdle and frequency of charge- High water-marks

January 2012 18


22/34

Mana er analysis

Terms anal sis Private e uit

Liquidity

-

- Harvesting period

- Extensions

Fees

- Management fees: amount and committed capital

- Performance fees: amount, preferred return, catch-up, and cash-

ow payment sequence

January 2012 19


23/34

Hed e fund strate ies

Classifications

Equity long-short

Credit-linked

Event-driven

Fixed income arbitrage

Volatility

Tactical

January 2012 20


24/34


E uit Lon -Short Exam les

Multi-sector or sector focused

Market-neutral, sector neutral

Quantitative market neutral

Statistical arbitrage

January 2012 21


25/34


Credit-linked Exam les

Long-short credit

Capital structure arbitrage

Cash vs CDS

Direct lending

January 2012 22


26/34


Event-driven Exam les

Risk-arbitrage

Distressed including control situations

Corporate actions

- genuine capital structure rationalization

- asset-side restructurings through asset divestitures, spin-offs, and split-offs- efficiency-enhancing restructuring at the operating level

January 2012 23


27/34


Fixed Income arbitra e Exam les

Sovereign spreads

Swap spreads

Off-the-run vs on-the-run

Curve trades

January 2012 24


28/34


Volatilit Exam les

Volatility arbitrage (skew and calendar)

Long gamma

Dispersion trades

Convertible arbitrage

January 2012 25


29/34


Tactical Exam les

Macro

Trend-following

Tactical asset allocation

January 2012 26


30/34


Other Exam les

Emerging markets

Commodities

Multi-strategy

Other

January 2012 27


31/34

Financial crisis

Alternative investments Ex eriences and lessons

Performance:

Better than broad market indices, cumulative return from April 2008 March 2009:

- HFRX Equal Weighted Strategies Index -20% vs S&P 500 -38%

Hedge funds:

Leverage: amount and terms

Liquidity:- sset an un eve - qu ty

- Gates, suspensions and side-pockets- Secondary market liquidity avenues

Fees:

- - -

- High watermark and modified high watermark- Claw-backs

Private equity:

January 2012 28

qu y an cap a ca s


32/34

Financial crisis

Alternative investments O ortunities from the crisis

Whole loans RMBS

Residential mortgages Regulatory capital

arbitrage

Bank capital Corporate debt Dislocated leveraged

loans

Corporate restructuring

Out of court restructurin

Dislocated convertibles

Bankruptcy and workouts Restructured debt into

equity

Middle market Emerging market

Commercial mortgages opportunities distressed assets

Whole loans CMBS

Highly selectiveemerging market

distressed debt assets

Dislocated secondaryloans

Rescue financing Opportunistic corporate

January 2012 29

lending


33/34

Firm Profile

Firm Profile

Advanced Portfolio Management (APM) is a specialty asset management company that constructs and manages

customized portfolios of hedge funds and other financial instruments for endowments, foundations, pension funds,

insurance companies, and other financial institutions in North America, Europe, and Asia.

Each APM product is designed to complement, enhance, and complete an existing asset allocation and investment

portfolio. All products are managed to realize the clients unique investment objectives and risk parameters. APM

products are currently utilized as active management overlays, alpha transport programs, completion funds, and

stand-alone multi-manager hedge fund investments.

APM's investment process integrates experienced qualitative investment judgment with rigorous analyticalstructure. The rofessionals at APM have over 100 ears of combined investment and ca ital markets ex erience

providing a comprehensive understanding of the potential profit opportunities and the accompanying risks of

active investing.

To complement this experience and judgment, APM has constructed a state-of-the-art analytical platform which

comprises: (i) manager-level risk and return attribution analysis and risk budgeting, (ii) non-linear Monte Carlo

simulation processes driven by forward-looking expectations of return and risk, and (iii) portfolio optimization

and rebalancin in a shortfall risk framework..

By integrating experienced qualitative insights with robust analytical methods, APM delivers superior risk-adjusted returns with negligible correlation or beta to the major market factors or benchmarks. APM is a

Registered Investment Advisor with the US Securities and Exchange Commission (SEC).

January 2012 30


34/34

Skill based investin

Advanced Portfolio Management LLC1330 Avenue of the Americas, 36th FloorNew York, New York 10019

+1 212 838 4700

[email protected]

Past performance is not indicative of future results. The performance data in this presentation is unaudited and has been computed by APM based on unaudited figures.The data set forth in this presentation is based on information from sources believed to be reliable but has not been independently verified. Performance is shown net ofall fees and expenses, including investment expenses, and professional fees. The index information is included merely to show the general trend in markets in the periodsindicated and is not intended to imply that the portfolio was similar to the indices either in composition or element of risk. This document does not constitute an offer for

January 2012 31

sale of interests which may be made only by means of a private placement memorandum to investors satisfying the applicable investor eligibility criteria. This documentcontains confidential information which is not for unauthorized reproduction or distribution. Reproduction or distribution without express written permission is strictly

prohibited. Copyright 2012 by Advanced Portfolio Management LLC. All rights reserved.

skill based investing - january 2012

Documents