hedge fund industry quarterly return analysis and outlook · 2008-12-11 · quarterly return...

Hedge Fund Industry

Quarterly Return Analysis and Outlook

Quarterly Return Analysis and Outlook 2

Agenda

Hedge Fund Industry - Quo Vadis?

Q3 2008 Returns

Outlook


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.


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


• 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


• 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


• 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.


The rules are changing….


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


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


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


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


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


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..”


Agenda


Q3 2008 Returns

Outlook


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


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


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


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


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


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


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


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


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


Agenda


Q3 2008 Returns

Outlook


Historical perspective (1)

Source: Fortune Jan 1970


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


… 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


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 + + +


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.


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

hedge fund industry quarterly return analysis and outlook · 2008-12-11 · quarterly return...

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