the new hedge fund era - ncpers
TRANSCRIPT
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This confidential document is for informational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy any securities or partnership interests described herein. This document should be read in conjunction with and is qualified in its entirety by information appearing in the Confidential Private Placement Memorandum, which should be carefully reviewed before investing. This document is not an advertisement and is not intended for public use or distribution. The information contained in this report is confidential and proprietary in nature and may not be copied or used in any way or disclosed with individual, corporation, partnership or entity for any reason, except with express written permis-sion of Attalus Capital. Copyright 2009, Attalus Capital, L.P. The Attalus Capital, L.P. logo, product and services described herein are either trademarks or servicemarks of Attalus Capital, L.P. and may not be copied, imitated or used, in whole or part, without the written permission of Attalus Capital, L.P.
For additional information, log on to www.attaluscapital.com
THE NEW HEDGE FUND ERA
NCPERS 2009 Public Safety Employees Pension & Benefits ConferenceOctober 12, 2009
John P. BolesManaging Director
2
HEDGE FUND OVERVIEW
Bank Trust Departments Manage
Most Funds
1960’s
80% Bonds
Balanced Accounts
Legal Lists
ERISA: “Prudent Portfolio” Concept
Consultants
Refining of Strategy “Styles”
Rise of Indexing
Asset Classes Added
Broader Acceptance of
AlternativeInvestments
Endowments Add Hedge Funds
Most Funds Still “Long Only”
95% of Returns Still Come From
“Market” Returns
1970’s
60% Equities
Growth / Value
Small Cap
1980’s
International
High Yield
Real Estate
Private Equity
1990’s
Tech Boom
Higher Equity Allocation
2000’s
Tech “Bust”
Lower Expected Returns
Evolution of Institutional Investment Management
Institutions Add Significant Allocations to Hedge Funds
3
HEDGE FUND OVERVIEW
What is a Hedge Fund?•Hedge funds derived their name from adding short securities to traditional long-only portfolios, thus they are hedged or
protected to varying degrees against market declines.
•Thetermhedgefund,likethetermmutualfund,referstoaninvestmentstructure;itdoesnotdescribeaspecificinvestment approach.
•The hedge fund structure typically uses more complex investment strategies than traditional long-only portfolios. It is a form of active management that may utilize a wide range of tools to build and manage a portfolio.
•Hedgefundstypicallyfocusonafewspecificareaswithinvirtuallyallassetclassesandstrategies,including,stocks,bonds, commodities, currency and real estate. They may make extensive use of derivatives, like swaps, futures, and options.
•ThefirstacknowledgedhedgefundwasstartedbyAlfredJonesin1949.Hisgoalwastoreducemarketriskandfocuson security selection.
•Today,therearemorehedgefunds(about7,100*)thanUSstocks(approximately5,000**).
Hedgefund.net*Wilshire5000TotalMarketIndex**
4
RETURNS THIS DECADE
AttalusMulti-StrategyFund,Ltd.fundedasofFebruary1,2000.BeginningJanuary1,2005,netperformancepresentedisanasset-weightedcompositereturnofinvestorsinAttalusMulti-StrategyFund.Performanceiscumulativeandnetofallfeesandexpenses,andisauditedthroughDecember31,2008.S&P500IndexisanequityindexownedandmaintainedbyStandard&Poor’s,whosevalueiscalculatedasthefreefloat-weightedaverageofthesharepricesof500large-capcorporationslistedontheNYSEandNASDAQ.Pastperformanceisnotnecessarilyindicativeoffutureresults.
Returns this Decade (Feb. 2000- September 2009 Est.)
14.1%
8.1%
12.4%
-4.3%
-11.9%
-22.1%
28.7%
1.0%
10.9%
4.2%6.3%
11.1%11.0%8.0%
5.0%
-21.4%
19.2%
5.5%4.9%
10.9%15.8%
-37.0%
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
2000 2001 2002 2003 2004 2005 2006 2007 2008 YTD2009 DecadeAverage
Ret
urn
(%)
AttalusMulti-StrategyFund
S&P500TR
5
HEDGE FUNDS: A COMPELLING RISK-ADJUSTED INVESTMENT
AttalusMulti-StrategyFund,Ltd.fundedasofFebruary1,2000.BeginningJanuary1,2005,netperformancepresentedisanasset-weightedcompositereturnofinvestorsinAttalusMulti-StrategyFund.Performanceiscumulativeandnetofallfeesandexpenses,andisauditedthroughDecember31,2008.HFRIFundofFundsCompositeIndex(HedgeFundResearch,Inc.)istheaverageperformanceofover800fundoffunds.S&P500IndexisanequityindexownedandmaintainedbyStandard&Poor’s,whosevalueiscalculatedasthefreefloat-weightedaverageofthesharepricesof500large-capcorporationslistedontheNYSEandNASDAQ.BarclaysCapitalAggregateBondIndexisamarketcapitalization-weightedindex.MostU.S.tradedinvestmentgradebondsarerepresentedwhichincludeTreasurysecurities,Governmentagencybonds,mortgage-backedbonds,corporatebonds,andasmallpercentageofforeignbondstradedintheU.S.Pastperformanceisnotnecessarilyindicativeoffutureresults.
Risk/Return Characteristics (10-Year: Jan 1994-Dec 2003)Risk/Return Characteristics (Feb. 2000- Sept. 2009 Est.)
-6%
-4%
-2%
0%
2%
4%
6%
8%
10%
0% 2% 4% 6% 8% 10% 12% 14% 16% 18%Annualized Standard Deviation (Risk)
Ann
ualiz
ed C
ompo
und
Ret
urn
S&P 500 Index
Barclays Capital Agg. Index
T-BillsHFRI FoF: Composite Index
Attalus Multi-Strategy Fund
6
WHY PLAN SPONSORS USE HEDGE FUNDS
1. Diversification Benefits
2. Non-correlated Return Streams
3. Lower Volatility
4. Increased Opportunity
Direction of Investment “Evolution”
Increasing Investment Sophistication
Increasing Ability to Add Value
Cash Bonds Stocks AlternativesPrivate Equity
Real EstateHedge Funds
7
INVESTOR CONCERNS WITH HEDGE FUNDS
• Investment Risk - Loss of principal
• Operational Risk - Appropriate risk management tools, policies and procedures
• Fraud-Madoff
• Liquidity - Availability of cash to meet investor redemptions
• Transparency - Ability to monitor the hedge fund investments
• Cash Flows-Moneyflowinginto(2004-2006)andoutof(2008-2009)thesestrategies
• Expense-Feeschargedbyhedgefundsandfundoffunds
• Benchmark - Appropriate benchmark for performance comparison
• Minimal Regulation - Lack of government oversight and registration
• Leverage-Magnifiesbothreturnsandlosses
8
INVESTOR CONCERNS WITH HEDGE FUNDS INVESTMENT RISK
•DrawdownsofFundofFundsaresignificantlylessthanmarketindices
Cum
ulativeReturn(%
)
Feb.2000-Dec.2002
NASDAQ S&P500 AttalusMulti-StrategyFund
66.1%
34.3%
28.5%
Drawdown - any losing period during an investment record. In terms of time, a drawdown encompasses both the period frompeaktovalley(length)andtheperiodfromvalleybacktoitspeak(recovery).
Cum
ulativeReturn(%
)
June2007-September2009
NASDAQ S&P500 AttalusMulti-StrategyFund
17.7%27.1%
8.0%
9
INVESTOR CONCERNS ABOUT HEDGE FUNDS OPERATIONAL RISK
Operational Risk: the risk of the principal loss due to lack of appropriate risk management tools and operational procedures
The use of an integrated analysis to ensure that operations and risk management systems are appropriate given the strategy and the way securities are traded can substantially reduce the operational risk and the potential for large losses.
Strategy + Behavioral = Develop a clear understanding of hedge
fund performance characteristics
Operations + Risk Management = Ensure appropriate tools, policies and
procedures are in place given hedge fund strategy and performance characteristics
Comprehensive understanding of how hedge fund is structured
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INVESTOR CONCERNS ABOUT HEDGE FUNDS FRAUD
•Historyhasshownthattheestablishedhedgefundindustrydoesnothaveahigherrateoffraudthanotherindustriesinthe economy, however they tend to have highly publicized events.
• In2006,1,192(21%)publiclytradedcompaniescommittedsomeformoffraud*
•In2006,600(10%)mutualfundcompaniesweresanctionedbytheSECforlatetrading
•Thereareabout7,100hedgefunds
» In2008therewerelessthan100casesoffraud(>2%)
» In2006therewerelessthan20casesoffraud(>1%)
•Enronin2002wasthebiggestcorporatefraudat$56billion
- Others notable frauds include Adelphia and WorldCom
•Madoffwasthebiggestinvestment industry fraud, but...
- Madoffwasnotahedgefund,itwassupposedlyalong-onlytradingstrategy - MadoffwasregisteredwiththeNASDandSECasabroker-dealerandinvestmentadvisor - MadoffunderwentseveralexaminationsbytheSECandNASD
•Fraudcanbemitigatedthroughactiveresearch/protocols
“Frauds”definedas:SECsanctionsforback-datedstockoptions,SECrequiredrestatementsofearningsorrevenues,and/orcriminalindictmentsofseniorofficers.Source:Glass,Lewis&Co.,InstitutionalShareholderServices(ISS)studyin2006.
*
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INVESTOR CONCERNS WITH HEDGE FUNDS LIQUIDITY
• In the spectrum of investments from public markets to private equity, hedge funds tend to fall in the middle in terms of liquidity
•Why hedge funds have lock-ups
- Investmentsoftenhavealongtimehorizontorealizegains(distressed)
- Protect investors from the manager becoming a forced seller at the bottom of a market decline to meet redemptions
Public Markets Hedge FundsPrivate Equity /
Real Estate
High Liquidity Little / No Liquidity
12
INVESTOR CONCERNS WITH HEDGE FUNDS TRANSPARENCY
• Why hedge funds are reluctant to provide full disclosure
- Providingthemostuptodateportfolioinformationcouldcompromisecertaininvestments(shortselling)bywidedisseminationandthereforehurtinvestors’returns
• PortfolioRiskMonitoring
- Information provided by hedge funds and their prime brokers / administrators can allow an investor to monitor diversificationandriskstatistics(leverage,exposures,VaR,liquidity,etc.)onafrequentbasis
- Mosthedgefundoffundsprovidecomprehensivemonthlyportfolioreportingandstatistics
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0 2000 4000 6000 8000 10000 12000
Top10TraditionalMoneyManagers
Total HedgeFundsInvested
INVESTOR CONCERNS WITH HEDGE FUNDS CASH INFLOWS
•Hedge funds are a form of active management, not an asset class
•Movingfromtraditionalmanagerstohedgefundsshouldbeviewedassimplyachangeinmanagers
•Totalhedgefundassetscontinuetobesignificantlylessthantheamountinvestedintraditionalmoneymanagers
Hedge Fund Investment Relatively Small
Dollars in Billions
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INVESTOR CONCERNS WITH HEDGE FUNDS EXPENSE
•An asset management fee plus an incentive fee is not unique to hedge funds. Real estate and private equity both have similar incentive fee structures
•The incentive fee structure aligns the interest of the managers with investors, as opposed to traditional asset management which provides incentives for asset gathering instead of performance
•Hedge fund managers frequently have a high percentage of their own net worth in the funds they manage, further aligning incentives
• Alpha is viewed as being expensive - Consideratraditionalfixedincomemanagerthathassuccessfullyproduced1%peryearabovebenchmarkover
afullmarketcycle(thetop20%oftheuniverse).A0.40%annualmanagementfeeis40%ofthevalueadded.Asmallcapequitymanagerwitha2%alphaanda1%managementfeeisacostof50%ofthevalueadded.
15
INVESTOR CONCERNS WITH HEDGE FUNDS BENCHMARK
• Hedgefundsencompasscomplexstrategiesonaglobalbasis,therefore,itisdifficulttobenchmarkreturns
- Within the fund of funds index, some of the funds are multi-strategy, some are composed solely of long-short funds
• Tremendous spread of return characteristics within similar strategies
- Discrepancies exist within almost all of the hedge fund indices
•Other issues with the current benchmarks
- An inherent survivor bias in the numbers
- Lack of reporting by newer funds, closed funds, smaller funds and poor / top performing funds
•Hedge funds focus on delivering consistent positive returns instead of “market relative” returns
16
INVESTOR CONCERNS WITH HEDGE FUNDS MINIMAL REGULATION
• Fewhedgefundsareregisteredinvestmentadvisors,butmostHedgeFundofFundsareregistered
- 1940Actexemptionlimitsclientsto“qualifiedinvestors”
- Institutionsmusthaveaminimumof$20millioninassets
- Regulationsprohibit“advertising”sofundscanonlydiscusstheirinvestmentswith“qualifiedinvestors”
• SEC regulation:
- Willallowpublicaccesstobasicfirminformation–doesnotprovide“transparency”
- WillsubjecthedgefundstoperiodicinspectionbyFINRA
- Will not necessarily mitigate fraud or reduce risk
- Will add a layer of cost and complexity to hedge fund management
17
INVESTOR CONCERNS WITH HEDGE FUNDS LEVERAGE
• Hedge funds borrow money when the return will exceed the cost of funding
- Gainsandlossescanbesignificantlymagnified
- Almost all home owners use leverage
- Banks:Likefixedincomehedgefundsusing20:1leverage(5%capital)
• Leverage needs to be appropriate given the particular hedge fund strategy
- ConvertibleArbitrageistypically2to3times
- FixedIncomeArbitrageishighlylevered
•Leverage needs to be monitored
- Leverage presents a major risk factor
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HOW PLAN SPONSORS USE HEDGE FUNDS
• Specific allocation
- Lowcorrelationstotraditionalequityandfixedincomemarkets
- Allocationscancomefromequityorfixedincome,oracombinationofboth,forplansseekingacombinationofreturn enhancement and risk reduction
• Multi-Strategy Fund used as either a fixed income substitute or complement
- Hedge fund returns have been very attractive over many different market cycles
- Standard deviation typically materially less than equity
- Interest rates on bonds are currently very low
• Equity Long/Short funds added to equity pool
- Seekgreaterdiversificationduetoawiderrangeoftoolsbeingavailabletomitigaterisk
- Equitylong/shortcorrelationisapproximately0.8%totheS&P500Index(February2000-August2009)*
• Portable Alpha Strategy
- Usedasanimplementationstrategywithinanassetclasspolicyallocation
- Portablealphaisusuallyclassifiedasan“EnhancedIndex”strategyforeitherstockorbondindexes
Equitylong/shortisrepresentedbytheHFRIEquityHedgeIndex(HedgeFundResearch,Inc.),whichistheaverageperformanceofover500long/shortfunds.*
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HEDGE FUND OF FUNDS DIVERSIFICATION
Regulation D ConvertibleArbitrage Options
Busted
High Yield
InvestmentGrade
Credit
Credit
Trading
Gamma
Approach
Coupon
High Yield
MortgageArbitrage
FixedIncomeArbitrage
FixedIncome StatisticalArbitrage
Emerging Markets
Asia
Europe
NorthAmerica
Small Cap
MidCap
Large Cap
Opportunistic
Value
Growth
Momentum
IndustryFocused
Diverse
Long Bias
Varied
MarketNeutral
TradingOriented
Quant/Modeling
Research
MarketCap Style Sector ExposureGeography Process
Systematic / Fundamental
Discretionary
GlobalMacro
Commodity
Short TermSystematic
Long TermTrendFollowing
CTA
Currency
Equity
Diversified
Currency
EmergingMarkets
FixedIncome
Relative Value Long/Short Tactical Trading
Cap StructureArbitrage
Long TermEquity
Closed EndFundArbitrage
SpecialSituations
MergerArbitrage
Trade Claims
Bank Debt
High Yield
Distressed
Liquidations
Event Driven
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HEDGE FUND STRATEGIES
• Fundsbuylongsecuritiesexpectedtoincreaseinvalueandsellshortsecurities expected to decrease in value
• Fundshaveabilitytoinvestmentacross,orspecializein,individualregions,industries, sectors and market capitalization
• Market Risk–Activetradersperformbetterinvolatilemarkets,whilevalue/fundamental funds perform well in trending markets
• Liquidity Risk–Activelytradedpublicsecurities,veryliquid• Instrument Risk–Subjecttoeconomic/marketdynamics• Leverage–Relativelylow(0-3times)
• Business Risk–Requiresamodestlevelofinfrastructure,amongotherthings
Long-Short Equity• Convertiblearbitragefundsgenerateprofitsbyidentifyingpricing
disparities between convertible bonds and their underlying equities • Fundsconstructlongportfoliosofconvertiblebondsandhedgetheposition
by selling short the underlying stock of each bond• Market Risk–Performswellinvolatilemarkets
• Liquidity Risk–Variesbasedonbondcategory• Instrument Risk–Complex,optionalityintheunderlyingbondandinverse
relationship to interest rates• Leverage–Canbemoderatetohigh(2-10)times
• Business Risk–Requirescertainlevelofinfrastructure,amongotherthings
Relative Value / Convertible Arbitrage
• Fundsinvestinfirmsinvolvedinmergersorotherspecialsituations,whichalteranentity’sfinancialstructure.Investsinannounceddeals.
• If the manager expects a merger to occur, it will purchase the stock of the target company and short sell the stock of the acquiring entity as a hedge
• Market Risk–VolumeofM&Aactivityiscyclicalandattractiveinstablemarkets
• Liquidity Risk–Moderate• Instrument Risk–Dealspecific.Ifthedealiscalledoff,spreadswill
widen• Leverage –Canbehigh(0-5times)
• Business Risk–Tendstorequiresignificantinfrastructureinvestmentforaccesstodealflowinformation,amongotherthings
Event Driven / Merger Arbitrage• Fundsmaketoplevelcallsonthedirectionofvariousinstrumentsincluding
interest rates, currencies, commodities, and equities on a global market basis.
• Leverage and derivatives used to enhance positions• Market Risk–Subjecttomanagersdirectionalcallsoninterestrates,
currencies, etc.
• Liquidity Risk–Dependsonmarketbeingtraded(e.g,Russiancurrencyvs.oilfutures)
• Instrument Risk–Varies,includesfutures,derivatives,etc.• Leverage–Canbehigh(over10times)
• Business Risk–Significantinvestmentinresources,possibilityoflargemargin calls requires well capitalized structure, among other things
Tactical Trading / Global Macro
21
HEDGE FUND IMPLEMENTATION DIRECT VS. FUND OF FUNDS
•Provides plan sponsor greater control over strategy/style allocation decisions
•Ability to select what individual hedge funds to invest in
•Size/rebalance hedge fund positions to achieve desired risk and return expectations
•Potential for lower fees than investing in hedge fund of funds
Direct Hedge Funds
•Requires large asset base to build an adequately diversifiedportfolio
• Initial due diligence and ongoing monitoring requires significantinvestmentexpertiseandinternalstaffing
•Cost of hiring specialized consultant
• Initial contribution is highly illiquid due to lock ups
•Ongoingstrategyreallocationsaredifficultduetolongredemptionnotificationperiods
•PotentialforMadofforAmaranth-legalissuesaremore“direct”
Disadvantages
Advantages
• Instantstrategy/stylediversification
•Professionally managed portfolio
•Access to top performing hedge funds that may be closed to new investors
•Cashflowbenefitsofinvestinginpooledvehiclethatenhanceplansponsor’sabilitytorebalance
Hedge Fund of Funds
•Cost of hedge fund of funds manager
•Less control over strategy/style allocation decisions and hedge fund position sizing
Disadvantages
Advantages
22
HEDGE FUND OF FUNDS STRUCTURE
INVESTOR
Custodian
HedgeFundAdministrators
FundofFundsAdministrator Hedge Fund of Funds
Hedge Fund 2
Prime Broker 2
Hedge Fund 3
Prime Broker 3
Hedge Fund 1
Prime Broker 1
Hedge Fund 4
A hedge fund of funds invests in a portfolio of underlying hedge funds in order to achieve a desired risk / return objective
- Hedgefundsmaintainmultipleprimebrokerrelationshipsforcompetitivefinancingandtradeexecution.
- Hedgefundadministratorsactasthehedgefundbackofficetoverifypricing,netassetvaluations,andauditedaccounting records.
- Hedge fund of funds invest in hedge funds and establish relationships with their underlying prime brokers for ongoing risk management.
- Fundoffundsadministratorsfacilitatenetassetvaluationsandclientreporting.
- Acustodianbankisutilizedtosafeguardandreportonallcashflows.
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HEDGE FUND OF FUNDS INVESTMENT PROCESS
Portfolio ConstructionFinancialmarketanalysis
Hedge fund style projections
Risk management
Correlation analysis
Active ManagementStrategy allocationFundselection
Risk management
Risk management
Performance expectations
Sustainable competitive advantage
Integrated Hedge Fund Analysis
24
RISK MANAGEMENT FOR HEDGE FUNDS IS CRITICAL
• Why?
- Due to wide range of usable tools and instruments
- Lock-ups and liquidity constraints limit transparency, rebalancing, and withdrawals
- Lack of transparency
• How?
- Behavioral analysis in both normal and abnormal markets
- Identificationofpotentialoutperformanceandunderperformance
• Quantitative:correlations,sensitivityanalysisusingunderlyinginstruments
• Qualitative:behavioralanalysis,infrastructure
- Active management is key
- Constant contact with underlying funds
• Increases transparency
- Ensure funds adhere to strategy and risk limits
• Stop loss, exposures, etc.
25
WHY PLAN SPONSORS USE HEDGE FUND OF FUNDS?
• Achieveimmediatediversificationbenefitsandloweroverallplanvolatility
• Large universe of hedge funds
- Over 7,000 funds with complex global trading strategies and tools
• Greater oversight requirements
- Information not publicly available
- Diversificationbenefitssupportgreaternumberoffunds
• Capitalize on specialized due diligence skills
- Portfolio management team with direct experience in the underlying strategies and instruments
- Relationships and networks
• Leverage infrastructure
- Monitoringandriskmanagement
- Accounting and performance reporting
26
HEDGE FUND OF FUNDS GOALS AND INVESTOR EXPECTATIONS
Hedge Fund of Fund’s Goals:
• Provide more stable and consistent positive returns than the markets
• Provide returns equal to or above most actuarial assumptions
Rational Investors should expect that Hedge Fund of Funds:
• Will lag the market, when markets are doing extremely well
• Willdobetterthanthemarket,whenmarketsareflatordoingpoorly
• Will have positive returns more frequently than the markets
• Hedge funds are not loss-proof, nor are they “magic bullets”; they will have negative months and quarters, but the frequency and magnitude of the losses will be far less than the markets
• Will use more complex and non-traditional strategies than traditional portfolios
• Will be less liquid and less transparent than traditional portfolios
• Will have higher fees than traditional portfolios
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WHAT TO LOOK FOR HEDGE FUND OF FUNDS
Direct experience with underlying strategies and instruments to properly assess portfolio during normal and abnormal markets
ManagerSelection
DoestheHedgeFundofFundshave a seasoned investment team?
5
Returns should be disclosed net of both underlying hedge fund and fund of funds fees
FirmStructure
Are the returns net of all fees?3
Employee owned with client focus and not owned by a larger entity with possible competing interest or agenda
FirmStructure
Is the fund free of conflicts of interest?
2
Risk management needs to be “hands-on” and actionable to address changes in equity markets, interest rates, credit rates etc.
Portfolio Construction
Are there risk management tools to support institutional investors?
7
Portfolio Construction
ManagerSelection
FirmStructure
FirmStructure
Category
Nimbleinvestmentteamscanquicklyputmoneytowork, seek next opportunity and provide “value-added”
Deep information flow leading to a fuller understanding of positions/strategies and ability to identify top performing funds
The fund of funds team should be properly structured to analyze all of the hedge fund’s components for a proper fit
Registered Investment Advisor under the SEC, QualifiedProfessionalAssetManagerunderERISA
Rationale
Is there active management, available capacity and attribution?
Does the investment team have a broad alternatives network?
Is the firm structured appropriately?
Can fiduciary responsibility be properly delegated?
Requirement
4
8
6
1
NY
Direct experience with underlying strategies and instruments to properly assess portfolio during normal and abnormal markets
ManagerSelection
DoestheHedgeFundofFundshave a seasoned investment team?
5
Returns should be disclosed net of both underlying hedge fund and fund of funds fees
FirmStructure
Are the returns net of all fees?3
Employee owned with client focus and not owned by a larger entity with possible competing interest or agenda
FirmStructure
Is the fund free of conflicts of interest?
2
Risk management needs to be “hands-on” and actionable to address changes in equity markets, interest rates, credit rates etc.
Portfolio Construction
Are there risk management tools to support institutional investors?
7
Portfolio Construction
ManagerSelection
FirmStructure
FirmStructure
Category
Nimbleinvestmentteamscanquicklyputmoneytowork, seek next opportunity and provide “value-added”
Deep information flow leading to a fuller understanding of positions/strategies and ability to identify top performing funds
The fund of funds team should be properly structured to analyze all of the hedge fund’s components for a proper fit
Registered Investment Advisor under the SEC, QualifiedProfessionalAssetManagerunderERISA
Rationale
Is there active management, available capacity and attribution?
Does the investment team have a broad alternatives network?
Is the firm structured appropriately?
Can fiduciary responsibility be properly delegated?
Requirement
4
8
6
1
NY
28
ATTALUS CAPITAL FIRM OVERVIEW
Performance is cumulative and net of all fees and expenses, and is audited through December 31, 2008. Past performance is not necessarily indicative of future results.
• Foundedin1998tomeettheneedsofinstitutionalinvestors
•ManagingHedgeFundofFundsandEnhancedIndexProducts
• Independent,employeeownedfirmwithnoconflictsofinterest
•100%institutional,withover130clientsandapproximately$2.6billioninassetsundermanagement
• 31memberteamwithover170yearsofcombinedresearchexperience
•RegisteredInvestmentAdvisorundertheSEC’sUSInvestmentAdvisorsActof1940
•QualifiedProfessionalAssetManagerunderERISA
•6.0%annualizednetreturn
•5.1%standarddeviation
•78%positivemonthlyperformance(91outof116months)
Attalus Multi-Strategy Fund - Consistent Positive Growth
Oversight
Organization
29
-6%
-4%
-2%
0%
2%
4%
6%
8%
0% 3% 6% 9% 12% 15% 18%$500
$750
$1,000
$1,250
$1,500
$1,750
$2,000
$2,250
Risk / Return Characteristics Since InceptionFebruary1,2000– September30,2009(Est.)
Annualized Standard Deviation (Risk)
Annu
aliz
ed N
et R
etur
n
Attalus Multi-Strategy Fund
Barclays Capital Aggregate Bond Index
T-BillHFRIFundofFundsCompositeIndex
S&P500Index
2/00
8/00
2/01
8/01
2/02
8/02
2/03
8/03
2/04
8/04 2/05
8/05
2/06
8/06
2/07
8/07
2/08
8/08
2/09
9/09
Growth of $1,000February1,2000– September30,2009(Est.)
Attalus Multi-Strategy Fund
BCA Index HFRIFoFIndex
S&P500Index
ATTALUS MULTI-STRATEGY FUND PERFORMANCE
AttalusMulti-StrategyFund,Ltd.fundedasofFebruary1,2000.BeginningJanuary1,2005,netperformancepresentedisanasset-weightedcompositereturnofinvestorsinAttalusMulti-StrategyFund.Performanceiscumulativeandnetofallfeesandexpenses,andisauditedthroughDecember31,2008.HFRIFundofFundsCompositeIndex(HedgeFundResearch,Inc.)istheaverageperformanceofover800fundoffunds.S&P500IndexisanequityindexownedandmaintainedbyStandard&Poor’s,whosevalueiscalculatedasthefreefloat-weightedaverageofthesharepricesof500large-capcorporationslistedontheNYSEandNASDAQ.BarclaysCapitalAggregateBondIndexisamarketcapitalization-weightedindex.MostU.S.tradedinvestmentgradebondsarerepresentedwhichincludeTreasurysecurities,Governmentagencybonds,mortgage-backedbonds,corporatebonds,andasmallpercentageofforeignbondstradedintheU.S.Pastperformanceisnotnecessarilyindicativeoffutureresults.
StatisticalAnalysis(sinceinceptionFeb.2000-Sept.2009Est.) Asof9/30/09Est. YTD-2009 2008 2007 2006 2005
Attalus HFRI S&P500 BCA T-Bill Annualized Return 11.06% -21.42% 12.40% 11.00% 5.05%Cumulative Return 76.02% 43.28% -9.90% 85.00% 31.71% Standard Deviation - 9.6% 4.2% 4.0% 3.6%Annualized Return 6.02% 3.79% -1.07% 6.57% 2.89% SharpeRatio(3%) - -2.54 2.24 1.99 0.57Standard Deviation 5.1% 5.8% 16.2% 3.8% 0.5% CorrelationtoS&P - 0.66 0.52 0.60 0.48SharpeRatio(3%) 0.59 0.14 -0.25 0.93 - Correlation to BCA - 0.26 -0.42 -0.33 -0.21%PositiveQuarters 87% 76% 55% 76% 100%Correlation with Attalus 0.84 0.40 0.08 0.17 Asof9/30/09Est. 1-Year 3-Year 5-Year 7-Year Since Inc.
Annualized Return 0.69% 0.72% 3.48% 4.90% 6.02%Standard Deviation 8.5% 8.0% 6.7% 5.8% 5.1%SharpeRatio(3%) (0.27) (0.29) 0.07 0.33 0.59CorrelationtoS&P 0.56 0.55 0.56 0.49 0.40Correlation to BCA 0.11 0.11 0.02 0.07 0.08
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FIRM STRUCTURE
*Fullbiographiesareavailableuponrequest*
CLIENT SERVICEJohnBoles
INVESTMENTSPatEgan,CFA
Pat Egan, CFA President & CIO
OPERATIONSNickNusbaum,CPA
LEGAL / COMPLIANCEDan Kim, Esq.
RELATIVE VALUE TACTICAL TRADINGEVENT DRIVEN LONG - SHORT QUANTITATIVE ANALYSIS
GeremyConnor(PM)
KevinLyons(Analyst)
DarshanGusani(Analyst)
PaulMirabello(Analyst)
PatEgan,CFA(PM)
RossFridy,CFA(Sr.Analyst)
KevinStreeper,CPA(Sr.Analyst)
MarcAntosy,CFA(Analyst)
MichelleEgan,CFA(PM)
AnnaLui,CFA,CAIA(PM)
ShahidKhan(Analyst)
AndrewEimer(Analyst)
BobSerhus(PM)
RobertFu,CFA(Sr.Analyst)
ShahidKhan(Analyst)
JudyKhuntaweetep(Analyst)
David Chenyao, Ph.D. (Sr.Analyst)
RobertHowley(Analyst)
Sai Krishnakumar (SoftwareEng.)
Associate
Note:Eachinvestmentteammemberislistedunderthestrategytheyprimarilyfocuson,buteachalso serves as a generalist, performing due diligence and ongoing monitoring across all strategies.
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INVESTMENTS
PATRICK C. EGAN, CFA - Founder, Chief Investment Officer 25 Years Investment Experience
Pat serves as Chief Executive and Chief Investment Officer overseeing all portfolio management and investments. Prior to founding Attalus Capital in 1998, Pat was responsible for developing the institutional investment management business for Federated Investors. Prior to this, Pat was portfolio manager and founder of MAIDA Partners. After graduating as a Palmer Scholar (top 5%) from the Wharton Business School, Pat joined Greenwich Associates where he advised institutional investment managers on strategy and assisted plan sponsors on investment policy and asset allocation. Prior to this, he traded fixed income instruments with Kidder, Peabody & Company. Pat began his investment career in 1984 as an options trader at the SBS Group in Philadelphia.
Pat is a CFA charterholder and member of the CFA Institute and the Financial Analysts of Philadelphia Association. He has a Master of Business Administration, from the Wharton Business School and a Bachelor of Arts in Economics from the University of Pennsylvania, magna cum laude.
MICHELLE C. EGAN, CFA – Founding Partner, Deputy Chief Investment Officer 17 Years Investment Experience
Michelle serves as Deputy Chief Investment Officer, and was instrumental in the founding of Attalus Capital. Since joining full time in 2000, Michelle focuses on executing and managing of the firm’s portfolio allocation process and research efforts. Prior to joining Attalus, Michelle was a portfolio manager with Chartwell Investment Partners, where she co-managed $1 billion in small cap growth assets for institutional clients and participated in Zeke LP, a long/short hedge fund. Prior to this, Michelle worked with Delaware Investment Advisors as a securities analyst on small and mid-cap growth products. Prior to this, Michelle was a consultant with The Boston Consulting Group in New York, where she specialized in Financial Services strategy consulting. She began her investment career in 1992.
Michelle is a CFA charterholder and member of the CFA Institute and the Financial Analysts of Philadelphia Association. Michelle has a Master of Business Administration from The Wharton School, a Bachelor of Science in Economics from the Wharton School, magna cum laude, and a Bachelor of Arts from the University of Pennsylvania, East Asian Studies, magna cum laude. She is conversant in Japanese and German.
L. ROBERT SERHUS – Managing Director, Director of Research 22 Years Investment Experience
Bob focuses on executing and managing of the firm’s portfolio allocation process and research efforts. Prior to joining Attalus in 2006, Bob was the Chief Investment Officer and Head of Portfolio Management at Julius Baer Investment Management, Inc. There he managed a $2 billion fund of hedge funds portfolio, encompassing seventy-five hedge funds and more than thirty different hedge fund styles. Prior to this, he was the associate director of research at Alpha Investments, where his responsibilities included investment research, risk management and hedge fund due diligence across a broad array of strategies. Prior to this, Bob served as a managing director at SCS Investments managing a multi-strategy fund of hedge funds. In addition, he worked as a risk manager for J.P Morgan, and began his investment career in 1987 as a financial analyst for Pepsi-Cola, Inc.
Bob has a Master of Business Administration from the University of Florida, Hough Graduate School of Business with a major in Finance and a Bachelor of Science from the University of Florida with a major in Management.
32
INVESTMENTS (CONTINUED)
M. ANNA LUI, CAIA, CFA, FRM – Director, Portfolio Manager 12 Years Investment ExperienceAnna is involved in portfolio management and is responsible for conducting investment and operational research. Prior to joining Attalus in 2000, Anna was a consultant with Oliver, Wyman & Company in New York. There she specialized in the financial services industry. Her responsibilities included profitability enhancement engagements, risk management initiatives, financial modeling and best practice benchmarking. Her clients included insurers, investment banks, and development banks in the US and Canada. She began her investment career in 1997.
Anna is a CFA charterholder, member of the CFA Institute and the Financial Analysts of Philadelphia Association. She is a holder of the right to use the Chartered Alternative Investment Analyst designation as well as the Financial Risk Manager designation with the Global Association of Risk Professionals. Anna has a dual degree from The Wharton School and Moore School of the University of Pennsylvania - Bachelor of Science in Economics and Bachelor of Science in Engineering with majors in Finance and Electrical Engineering and a minor in Mathematics, magna cum laude. She is fluent in Chinese.
GEREMY CONNOR – Director, Portfolio Manager 10 Years Investment ExperienceGeremy is involved in portfolio management and is responsible for conducting investment and operational research. Prior to joining Attalus in 2005, Geremy was an investment analyst for Lehman Brothers Neuberger Berman Wealth Management. There he completed performance and risk analyses as a member of their fund of hedge funds investment team and performed due diligence on hedge fund managers. Prior to this, from 2001 to 2003, he was a hedge fund consultant and risk analyst for National Economic Research Associates. Geremy began his investment career in 1999 as a financial analyst with Credit Suisse First Boston.
Geremy has a Master of Business Administration from the Harvard Business School and a Bachelor of Arts in Economics from Princeton University. He is proficient in French.
ROSS A. FRIDY, CFA – Manager, Senior Analyst 10 Years Investment ExperienceRoss is responsible for conducting investment and operational research. Prior to joining Attalus in 2004, Ross was an investment consultant for Presidio Financial Partners. There he focused on the selection and evaluation of traditional and alternative investment managers and developed asset allocation strategies for high net worth individuals. Prior to this, Ross was a mutual fund and custody accountant for the Investor’s Bank & Trust Company, beginning his investment career in 1999.
Ross is a CFA charterholder and member of the CFA Institute and the Financial Analysts of Philadelphia Association. He has a Bachelor of Science from the University of Vermont with a concentration in Finance.
33
INVESTMENTS (CONTINUED)
DAVID CHENYAO, Ph.D. – Manager, Senior Analyst 16 Years Investment ExperienceDavid is responsible for conducting investment and operational research. Prior to joining Attalus in 2008, David was the head of risk management and quantitative research for the internal fund of hedge funds group at Royal Bank of Canada. There David developed and built their risk management and quantitative analysis infrastructure. Prior to this, from 2003 to 2005, David served in a similar capacity at Coast Asset Management, a fund of hedge funds, in Los Angeles. Prior to this, from 2001 to 2003, David was employed as a senior investment analyst in Morgan Stanley’s fund of hedge funds group. Prior to this, David worked at Knight Trading, as a senior quantitative analyst, and for the New York Stock Exchange as a senior business analyst.
David has a Doctor of Philosophy and Master of Arts in Econometrics,/Statistics from the State University of New York, Stony Brook, and a Master of Science and Bachelor of Science in Aeronautics from the University of Science and Technology of China.
KEVIN B. STREEPER, CPA – Manager, Senior Analyst 11 Years Investment ExperienceKevin is responsible for conducting investment and operational research. Prior to joining Attalus in 2007, Kevin was an Equity Research Analyst for Susquehanna Capital Group. There he conducted sector and stock analysis for Susquehanna’s proprietary trading group and evaluated investments through analysis of company filings, forecasts and valuation. Kevin was also an associate with Susquehanna Financial Group’s Equity Research Department, where he served as a member of the firm’s application and enterprise software team. Prior to this, he was a fund controller and tax supervisor for Tiger Management, a global hedge fund. There he focused on the accounting and tax reporting for the funds managed by Tiger Management. Prior to this, Kevin was also a senior tax analyst at Eisner LLP, and began his career as a tax analyst for McCabe Heidrich & Wong.
Kevin is a Certified Public Accountant and has a Master of Business Administration from the University of Maryland with a major in Finance and a Bachelor of Science in Business Administration from Bucknell University with a major in Accounting.
ROBERT Z. FU, CFA – Manager, Senior Analyst 6 Years Investment ExperienceRobert is responsible for conducting investment and operational research. Prior to joining Attalus in 2008, Robert was a portfolio manager and quantitative analyst at Martello Investment Management. There he was responsible for building portfolios of global macro hedge funds, conducting due diligence on prospective and existing hedge funds, and client communications. Prior to this, Robert held various engineering and product development positions at Kimberly Clark Corporation.
Robert is a CFA charterholder and member of the CFA Institute. He has a Master of Business Administration from the University of Chicago Graduate School of Business, and a Bachelor of Science in Electrical Engineering and Mathematics from the University of Arizona. He is fluent in Mandarin.
(IN ADDITION TO EIGHT ANALYSTS AND ONE ASSOCIATE)
34
CLIENT SERVICE
JOHN P. BOLES – Managing Director 25 Years ExperienceJohn is responsible for overseeing client service, business development and consultant relations at Attalus Capital. Prior to joining Attalus in 2002, he spent two years as a director of sales for Measurisk, an independent provider of advanced analytics for capital market entrants in alternatives. There, he was directly responsible for institutional business development and hedge fund of funds. Prior to this, from 1988 to 1998, John was a vice president with Bankers Trust Global Institutional Services and Asset Consulting. He began his career with Price Waterhouse in 1984.
John has a Bachelor of Business Administration from Pace University with a major in Accounting. He is an accomplished marathon runner with seventeen races to date. John currently serves on the Advisory Board of the Institutional Investor Hedge Fund Institutional Forum.
DAVID A. RUSSELL, CFA – Managing Director 37 Years ExperienceDavid is responsible for developing and enhancing our relationships with institutional clients, in addition to communicating the firm’s investment strategy to clients and investment consultants. Prior to joining Attalus in 2006, David was a principal and senior consultant at Ennis, Knupp and Associates in Chicago, where he was co-head of the alternative investment research group. Prior to this, he served as a senior consultant at Capital Resource Advisors, responsible for both the Philadelphia and San Francisco offices. Prior to this, David was a vice president at Prudential Securities, where he headed Prudential’s Investment Management Consulting and Research Division. David began his career in the trust department of a large regional bank based in eastern Pennsylvania.
David is a CFA charterholder and member of the CFA Institute and the Financial Analysts Society of Philadelphia. He has a Master of Business Administration with a major in Finance and a Bachelor of Arts from Kutztown University. He currently serves on the Investment Committee of The Good Shepherd Home and Rehabilitation Hospital. He is also a member of the Board of Directors of the Lutheran Theological Seminary at Gettysburg and a Trustee and Chair of the Investment Committee of the Seminary’s Endowment Foundation. David served as a director of The Evangelical Lutheran Church in America’s Board of Pensions from 1991 to 1997 and the National Easter Seal Society from 1987 to 2000.
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CLIENT SERVICE (CONTINUED)
RONALD T. ERNST – Director 21 Years ExperienceRon is responsible for developing and enhancing our relationships with institutional clients. He coordinates the firm’s resources in order to provide proactive, superior client service. Prior to joining Attalus in 2009, Ron was head of pension sales and client service at EAM Partners, where he promoted the firm’s products to public and private pension plan sponsors. Prior to this, from 2003 to 2008, Ron was managing director of institutional sales and client service for Highland Capital Management, primarily focusing on the firm’s largest relationships. Prior to this, from 1999 to 2003, Ron was a principal at Vaughan, Nelson, Scarborough & McCullough, where he served as director of institutional sales and client service. From 1990 to 1999, Ron served as managing director at Bankers Trust Company. Prior to this, Ron worked at Texas Commerce Bank from 1988 to 1990.
Ron has a Bachelor of Business Administration in Finance and Economics from University of Houston.
STEPHEN R. SIMPKIN – Director 10 Years ExperienceStephen is responsible for developing and enhancing our relationships with institutional clients. He coordinates the firm’s resources in order to provide proactive, superior client service. Prior to joining Attalus in 2009, Stephen was vice president of business development and client service at Lazard Asset Management, where he was directly responsible for building and maintaining consulting and plan sponsor relationships. Prior to this, Stephen was vice president of institutional sales and marketing for Massachusetts Financial Services (MFS), primarily focusing on relationships in the western United States. Prior to this, from 1998 to 2000, he worked as a financial consultant for Salomon Smith Barney/Citigroup. An accomplished golfer, Stephen was head golf professional at Pinheiros Altos Golf Club and Resort in Quinta do Lago, Portugal from 1993 to 1997. In addition, he competed on the Japanese and European PGA Tours from 1990 to 1992.
Stephen has a Bachelor of Arts in History from University of California, Los Angeles. He is a member of The Olympic Club in San Francisco and an honorary member of Loch Lomond Golf Club in Scotland.
(IN ADDITION TO TWO ASSOCIATES)
36
OPERATIONS/TECHNOLOGY
NICHOLAS NUSBAUM, CPA – Senior Financial Officer 14 Years ExperienceNick is responsible for managing the fund operations team and overall tax and accounting for Attalus Capital. Prior to joining Attalus in 2008, Nick was the chief financial officer and chief compliance officer at Gamma Capital Advisors, where he managed the back office team, prepared all fund documents and financial statements, and oversaw human resource functions. Prior to this, Nick spent six years with Ernst & Young in Philadelphia as a senior audit manager and internationally in both Sydney, Australia and Grand Cayman as an audit manager. There he provided audit and advisory business services to Ernst & Young’s financial services clients. Nick began his career as an audit supervisor at Kuntz, Lesher, Siegrist & Martini LLP.
Nick is a Certified Public Accountant and has a Bachelor of Science in Accounting from Elizabethtown College.
(IN ADDITION TO FIVE ASSOCIATES)
DANIEL S. KIM – Managing Director, Corporate Counsel & Chief Compliance Officer 11 Years Experience Dan is responsible for managing all legal and compliance matters related to Attalus Capital. Prior to joining Attalus in 2007, Dan was general counsel, chief compliance officer and director at Hyperion Brookfield Asset Management, Inc., where he managed all legal and compliance matters related to registered investment advisors in addition to registered investment companies, real estate investment trusts, hedge funds and collateralized debt obligations. Prior to this, Dan was assistant general counsel, compliance officer and assistant vice president at Oak Hill Capital Management, Inc. and Oak Hill Advisors, LP, where he assisted in managing legal matters related to leveraged buyout, high yield and distressed funds. Prior to this, Dan worked at Arkin Kaplan & Cohen LLP in New York and previously held a position as a trader at Norwest Bank, Investment and Trust.
Dan has a Juris Doctor from Brooklyn Law School, a Master of Arts in East Asian Relations from Yonsei University: Graduate School of International Studies, and a Bachelor of Arts in Political Science from Macalester College.
LEGAL/COMPLIANCE
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GLOSSARY OF HEDGE FUND TERMS
Alpha: Alpha of a fund measures the degree to which the return is not attributable to the performance of the market. This excess return measures the ability of a fund manager to add value through active portfolio management, and not merely participate in a market up trend. Statistically, Alpha is the Y intercept of a regression line.
Alternative Investments: Alternative investments are professionally managed assets that have a low correlation to traditional public markets. This low correlationcreatessignificantportfoliobenefitsthroughdiversification(riskreduction)andreturnenhancement.Alternativeinvestmentsseektocapitalizeonmarketinefficiencies,whileneutralizingtheoveralldirectionofthecapitalmarketsandinterestrates. Alternative investments utilize techniques and instruments that are unavailable to traditional investment approaches and may invest in either listed or unlisted companies or securities. Alternative investments include hedge funds, private equity, real estate, oil and gas, and timber.
Annualized Return: Annualizedreturn(alsocalledcompoundannualrateofreturn)isatime-weightedmeasureofinvestmentreturn(asopposedtothedollar-weightedmeasureofIRR).Time-weightedreturniscalculatedbyaveragingtheindividualholdingperiodreturnsanddoesnotconsiderthetimingofcashflowsintoandoutofthefund.AttalusCapitalcalculatesannualizedreturnbytakingthegeometricmeanofmonthlyreturnsandannualizingittoa12-monthperiod.AccordingtotheAssociationforInvestmentManagementandResearch(AIMR),time-weightedgeometricmeanshouldbeusedtomeasurepastperformance.
Benchmark: A benchmark is an index that serves as a standard against which a portfolio can be measured. Some common benchmarks are theS&P500Index(forequity),theRussell2000Index(forsmallcapitalizationsecurities),theNASDAQComposite(fortechnologystocks),andtheBarclaysCapitalAggregateIndex(forbonds).Abenchmarkisgenerally,butnotnecessarily,areadilyavailablemarket index. It can also be created from a combination of market indices.
Beta: Betameasuresthevolatilityofaninvestmentrelativetoaspecificbenchmark.Itgenerallydescribesthesensitivityoftheinvestmenttobroadmarketmovements.Forexample,inequities,thestockmarketisassignedaBetaof1.AninvestmentwithaBetaof1.1isexpectedtoperformbetterthanthebenchmarkby10%inarisingmarket,andworsethanthebenchmarkby10%inadecliningmarket. If an investment has a negative Beta, its price moves inversely with the market. Thus, a Beta neutral portfolio should be relatively insensitive to market movements. Statistically, Beta is the slope of a regression line.
38
GLOSSARY OF HEDGE FUND TERMS
Convertible Arbitrage Strategy: Convertiblearbitrageisoneoftherelativevaluehedgefundstrategies.Managersconstructlongportfoliosofconvertiblebondsand hedge these positions by selling short the underlying stock of each bond. Some managers also hedge interest rate exposures. Convertiblearbitragemanagersgenerateprofitsbyidentifyingpricingdisparitiesbetweenconvertiblebondsandtheirunderlyingequities.
Convertible Bond: Convertiblebondsarebonds,whichcanbeconvertedintoafixednumberofsharesofthesamecompany’sstock.Theyarehybridsecurities that have features of both a bond and a stock. Generally, the price of the convertible bond will decline less than the underlyingstockinafallingequitymarket(asthebondishigherinthecompany’scapitalstructure),andmirrortheincreaseinthestock price in a rising market.
Correlation: Correlationmeasuresthedegreeoflinearassociationbetweentwodatastreams.Itisastatisticalmeasure,whichrangesfrom-1to1.Acorrelationof1meansthetwodatastreamsareperfectlyandpositivelycorrelated.Acorrelationof-1meansthetwodatastreams are perfectly and negatively correlated. A correlation of zero means there is no association between the two data streams.
Distressed Strategy: Distressed strategy is one of the event driven hedge fund strategies. Distressed securities managers invest in securities of companiesthatareexperiencingfinancialoroperationaldifficulties.Traditionaldistressedmanagerspurchasethebankdebtorhigh yield of a distressed entity pre-bankruptcy at a discount, anticipating a successful reorganization and the emergence of a strongerentity,producingsignificantreturns,asthecompanyisabletobuildwithouttheburdenofdebt.Inadditiontothistraditionalapproach, some emerged managers actively trade, purchasing and shorting securities, including common stock and warrants, turning the portfolio holdings on a more regular basis.
Diversification: Diversificationisthecreationofaninvestmentportfoliowithmultiplepositionstoreducetheadverseimpactofalossinanyoneposition.Diversificationcanbeimplementedonmanylevels.Investmentmanagersnormallydiversifytheirholdingsacrosspositions, industries, geographies, strategies, and instruments to reduce exposure to risks. At Attalus Capital, we diversify our fund offundsportfoliostothesub-strategyleveltoachievetruediversificationandavoidregressiontomeanreturn.
Drawdown: A drawdown is any losing period during an investment record. In terms of time, a drawdown encompasses both the period from peaktovalley(length)andtheperiodfromthevalleybacktoitspeak(recovery).
39
GLOSSARY OF HEDGE FUND TERMS
Enhanced Index: An enhanced index is an indexing strategy whose objective is to provide a core exposure to a predetermined benchmark index, and to enhance its return over that benchmark. Attalus Capital offers enhanced index products on any readily available benchmark, suchastheS&P500IndexandtheBarclaysCapitalAggregateBondIndex.Theenhancedstrategyprovidesacoreexposuretothebenchmarkusingfutures,andenhancesthereturnbytransferringalphafromtheAttalusMulti-StrategyFund,whichhaslowcorrelation to traditional markets and low performance volatility. It also maintains tracking error within a tight range around the investors’desiredtarget.
Equity Hedge Strategy: Equityhedgeisoneoftheequitylong-shorthedgefundstrategies.Managerscombinealongportfoliowiththeshortsaleofstocks.Portfolios may range from net short to net long, depending on market conditions. The dollar amount, Beta or industry exposure ofthetwosidesdoesnotnecessarilymatch.Mostmanagersusetheshortpositionsasbothahedgeandreturngenerator.Conservativefundsusuallymitigatemarketriskbymaintainingnetexposurebetweenzeroand50%.Aggressivefundsmaycapturereturnsbyexceeding100%exposureand,insomeinstances;theymaymaintainahighnetshortexposure.
Equity Long-Short Strategy: Equitylong-shortisahedgefundstrategy.Managerspurchasestockstheyexpecttoriseandshortsellstockstheyexpecttofall.Portfoliosmayrangefromnetshorttonetlong.Returnsonthesestrategiesdependonthemanager’sskillatpickingstocks,bothlongandshort.Majorvariationsofthestrategiesareequitymarketneutral,equityhedgeandequitynon-hedge.Somemanagersalsofocusonaspecificindustryorgeography.
Equity Market Neutral Strategy: Equitymarketneutralisoneoftheequitylong-shorthedgefundstrategies.Managersofthisstrategymatchtheamountofsecurities they hold both long and short by dollar amount or Beta adjusted, thus they are neutral to the market. Some managers also match the long and short exposures within each industry sector to further mitigate market risk. An example of this strategy is to build a portfolio of long positions in the strongest companies in several industries, and sell an equal dollar amount of securities in companies that show signs of weakness in corresponding industries.
Equity Non-Hedge Strategy: Equitynon-hedgeisoneoftheequitylong-shorthedgefundstrategies.Fundsofthisstrategyarepredominatelylongequitiesalthoughtheyhavetheabilitytohedgewithshortpositions.Themanager’smajorfocusispickingstocksonthelongside,andwillonly opportunistically short sell individual stocks.
40
GLOSSARY OF HEDGE FUND TERMS
Event Driven Strategy: Managersofeventdrivenstrategiesinvestinsituationswiththeexpectationthataneartermeventwillactasacatalystchangingthemarket’sperceptionofacompany,therebyincreasingordecreasingthevalueofitsdebtorequity.Theseextraordinarycorporateeventsinclude,butarenotlimitedto,bankruptcies,financialrestructurings,mergers,acquisitionsandspin-offofadivisionor subsidiary. There are three major types of event driven strategies: merger arbitrage, distressed securities , and general event driven strategies that invest in a mix of the extraordinary events.
Fixed Income Arbitrage Strategy: Fixedincomearbitrageisoneoftherelativevaluehedgefundstrategies.Managerstakeoffsettinglongandshortpositionsinrelatedfixedincomesecuritieswhosevaluesaremathematicallyorhistoricallyinterrelatedbutarebelievedtobetemporarilydislocated.Fixedincomearbitragemanagersgenerateprofitswhentheskewedrelationshipbetweenthesecuritiesreturnstothe expected range. The differences between these related securities are usually small, therefore, managers generally employ significantleveragetoenhancereturns.
Fund of Funds: A fund of funds is a privately organized, pooled investment vehicle that invests in multiple funds, as opposed to direct investing. The fund of funds approach enables investors to diversify across instruments, strategies, and markets with a lower investment requirement, and to tap into professional investment expertise in accessing the quality of funds.
Global Macro Strategy: Globalmacroisoneoftheoldesthedgefundstrategies.Managersofthisstrategygenerallyemployatopdownglobalapproachto investing, which concentrates on forecasting how global macroeconomic and political situations affect the valuations of financialinstruments.Managersgenerateprofitsbyidentifyingextremeprice-to-valuedisparitiesinstockmarkets,interestrates,commodities,foreignexchangeratesorotherfinancialinstrumentsandmakingleveragedbetsonthepricemovementsthattheyanticipateinthesemarkets.Theartofmacroinvestingisdeterminingwhenaprocesshasbeenstretchedtoitsinflectionpointandwhen to become involved in its trend back to normality.
Hedge Fund: The term hedge fund, like mutual fund, refers to an investment structure and not an investment approach. A hedge fund is a privately organized, pooled investment vehicle that invests primarily in publicly traded securities and derivatives (whereas a mutual fundisapublicinvestmentcompany).ItisexemptfrombeingpubliclyregisteredwiththeSecuritiesandExchangeCommission(SEC)andisallowedtoundertakeawiderangeofinvestmentapproaches.HedgefundsmuststillcomplywithSECantifraud
(continued on next page)
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GLOSSARY OF HEDGE FUND TERMS
Hedge Fund (continued): provisions, satisfy certain disclosure obligations, and are only available to accredited investors. Hedge funds, unlike mutual funds, usually charge an asset-based fee and an incentive-based fee, and offer less liquidity. Since hedge funds are private entities and eachhedgefundmanagerhasauniqueinvestmentapproach,theclassificationofhedgefundstrategiesvaries.AttalusCapitalclassifieshedgefundstrategiesintofourbroadcategories:relativevalue,eventdriven,equitylong-shortandtacticaltradingstrategies.
High Water Mark: HighwatermarkindicatesthehighestpreviousNAV(netassetvalue)ofaportfolioatspecifiedperiodicmeasurementdates,e.g.,calendar quarter ends. A manager receives a performance fee only when the portfolio value exceeds its previous high. A high water markpolicypreventsamanagerfromtakingabonusforgoodperformanceinagivenperiodwithoutfirstrecoveringanyearlierabsolute losses.
Incentive Fee: See performance fee.
Information Ratio: Informationratioisthealpha(annualizedexcessinvestmentreturnoverbenchmark)dividedbythetrackingerror(annualizedstandarddeviationofalpha).Thismeasurerelatesthemagnitudeandconsistencyofwhichaninvestmentoutperformeditsbenchmark. The higher the information ratio the better.
Leverage: Leverage is the practice of borrowing to add to an investment position when one believes the return from the position will exceed thecostofborrowing.Afundisleveragedwhenitsnetinvestmentamount(grosslong-grossshort)exceedsthatoftheinvestmentcapital.Certainhedgefundstrategies,e.g.fixedincomearbitrage,aremoreleveragedthanotherstocapturethemarginalreturns.Leverage can increase returns, but it also increases risk and volatility.
Liquidity: Liquidityreferstothetimeperiodsforwhichinvestorsmayredeemtheirinvestments.Forexample,monthlyliquidityindicatesthatan investor can withdraw his or her investments at the end of each month. Hedge fund investors must also factor in lockup and noticeperiodsforliquidity.Noticeperiodsforhedgefundstypicallyrangefromthirtytoninetydays.
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GLOSSARY OF HEDGE FUND TERMS
Lockup: A lockup period is an initial period during which an investment cannot be redeemed or become subject to the standard liquidity provisions. The length of lockup period ranges from manager to manager. Hedge funds typically have a lockup period of one year.
Long Position: Alongpositionmeansowninganinvestment.Forexample,aportfolioofstockscanbereferredtoasalongportfolio.
Management Fee: Managementfeeisanasset-basedfeechargedbyaninvestmentmanagerformanagingafund.Managementfeesofhedgefundsandprivateequityaretypically1-2%perannum,chargedmonthlyorquarterly.
Market Exposure: Marketexposureistheamountoftheportfoliothatisexposedtomarketrisk,asitisnothedgedbyanoffsettingposition.Marketexposure of an equity portfolio is generally the gross long exposure minus the gross short exposure.
Market Inefficiency: Marketinefficiencyreferstopricingdisparitiescausedbyalackofinformationaboutamarketorcompany,orbyadistortionoftheinformationthatisavailable.Asmarketinefficiencyincreases,itincreasesamanager’sopportunitytoaddvaluethroughactiveportfoliomanagement.Alternativeinvestmentmarkets(e.g.hedgefundsandprivateequity)arelessefficientthantraditionalinvestmentmarkets(e.g.stocksandbonds).
Merger Arbitrage Strategy: Mergerarbitrage(alsocalledriskarbitrage)isoneoftheeventdrivenhedgefundstrategies.Managersofthisstrategyinvestincompanies that are being acquired or are involved in a merger or acquisition. They only invest in announced deals and do not try to anticipate possible mergers. When a merger or acquisition is announced, the price being offered for the company to be acquired isgenerallyhigherthanthecurrenttradingpriceofthatcompany’sstock.Therefore,ifamanagerexpectsamergertooccur,itwillpurchase the stock of the target company and short sell the stock of the acquiring entity as a hedge. However, if a manager expects themergertofallthrough,itwillshortsellthestockofthetargetcompanyandpurchasesharesoftheacquiringcompany.Mergerarbitragemanagerstakepositionsonbothsidesofthetradetoactasahedgeagainstmarketrisks.Profitsaregeneratedbycorrectly anticipating the outcome of the mergers or acquisitions.
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GLOSSARY OF HEDGE FUND TERMS
Multi-strategy: Multi-strategyisadirecthedgefundandnotafundoffundsstrategy.Managersofthisstrategyemployadiversifiedportfoliowithvariousinvestmentapproaches.Forexample,amulti-strategymanagermayhaveaportfoliowithconvertiblearbitrage,mergerarbitrage,andfixedincomearbitragepositions.Themanagercanoverorunder-weightdifferentstrategiestobestcapitalizeoncurrent investment opportunities.
Performance Fee: Performancefee(alsocalledincentivefee)isanincentive-basedfee,whichgivesaninvestmentmanagerapercentageoftheprofitsearnedbythefund.Performancefeesofhedgefundsrangefrom10-30%,butarenormally20%ofannualprofit.Performance fees are usually subject to high water marks.
Regression Analysis: Regression analysis is a statistical technique for estimating the linear relationship between a dependent variable, and one or more independentvariables.R-squared(alsocalledcoefficientofdetermination)indicatesthedegreeoflinearassociationbetweenthedependentvariableandtheindependentvariable(s).R-squaredrangesfrom0to1,with0beingnocorrelationand1beingperfectcorrelation.
Relative Value Strategy: Relative value is a hedge fund strategy. Returns of this strategy are not dependent on the general direction of market movements; relativevaluemanagersseektoprofitfromthemispricingofrelatedsecurities.Thisstrategyutilizesquantitativeandqualitativeanalysistoidentifysecuritiesorspreadsbetweensecuritiesthatdeviatefromtheirfairvalueand/orhistoricalnorms.Majorexamplesofrelativevaluestrategiesareconvertiblearbitrage,fixedincomearbitrageandstatisticalarbitragestrategies.
Risk Arbitrage Strategy: See merger arbitrage strategy.
Sharpe Ratio: Sharpe ratio is the measure of return earned per unit of risk. It is calculated by the incremental return of an investment over the risk-freeratedividedbythestandarddeviationofthereturns.The3-monthU.S.Treasurybillor5%istypicallyusedastherisk-freerate. The higher the Sharpe ratio the better.
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GLOSSARY OF HEDGE FUND TERMS
Short Selling: Shortsalesreferstothesellingofaninvestmentthatisnotowned.Forexample,manyhedgefundsshortsellstocksthattheydonot own. It can be accomplished by borrowing the stock from a brokerage company and then selling it on the open market. When it comes time for the manager to close out the position, he or she will purchase the stock and return it to the lender. Collateral is requiredtomakesuretherearesufficientfundsavailableforthepurchase.Withshortselling,fundmanagersareabletomakemoney when a security drops in price.
Standard Deviation: Standarddeviationmeasuresthedispersionofreturnsaroundtheirmean(oraverage).Thehigherthestandarddeviation,thehigher the volatility of the investment returns. Thus, standard deviation is often used as a measure of investment risk.
Statistical Arbitrage Strategy: Statisticalarbitrageisoneoftherelativevaluehedgefundstrategies.Managersofthisstrategyconstructportfoliosthatconsistof approximately equal dollar amounts of offsetting long and short equity positions. Some managers also extend the neutrality to match Beta, industry, and market capitalization on both sides. Statistical arbitrage managers use sophisticated models to select stocks.Thus,profitsarederivedfromtheabilityoftheirmodelstopicklongandshortequitypositions,regardlessofmarketdirection.
Tactical Trading Strategy: Tactical Trading is a hedge fund strategy. It covers both global macro and CTA managers. Tactical trading is based primarily on macroeconomicshiftsandtrends,aswellastechnicalandmomentumindicatorssuchascapitalflowsandpricing.Tacticaltraders,whom can employ either a discretionary or systematic approach to investing in stocks, bonds, currencies and commodities, identify market trends and turning points and capitalize on movements by taking concentrated positions.
Tracking Error: In an indexing strategy, tracking error is the standard deviation of the difference between the performance of the benchmark and the replicating portfolio. Thus, tracking error can be used to measure the volatility of the alpha over the benchmark.
Transparency: Theabilityforinvestorstomeasureandevaluateaggregateriskexposuresandstatisticsacrosshedgefundstrategies.Underlyingpositiondataiskeptconfidentialinordertoprotectinvestors.