workshop hedge funds and sovereign wealth funds - morgan
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RESTRUCTURING FORUM
THE TRUTH ABOUT HEDGE FUNDS
PETER MORGANECO SECTION, EESC
BRUSSELS5 JULY 2010
AGENDA
• INVESTMENT COMMUNITY. • GLOBAL FUND MANAGEMENT• SEEKING ALPHA.• FACTS AND FIGURES• LONDON MARKETS• HEDGE FUND STRATEGIES• SUB‐PRIME GREECE• FSA ASSESSMENT• SUMMARY
Investment Community
• CIFM Conventional Institutional Fund ManagersPension Funds, Insurance Funds, Mutual Funds
• HNWI High Net Worth Individuals8.6 million individuals having investable assets> $1 m
• SWF Sovereign Wealth FundsSurplus funds of oil producing and Asian exporting
countries
• AIFM Alternative Investment Fund Managers
Hedge Funds, Private Equity, Venture Capital
Global Fund Management
Assets under management, $ trillion, 2007
2009
• CIFM Pension Funds
28.2
29.5
Mutual Funds
26.2
23.0Insurance funds
19.9
20.0
• HNWI High Net Worth Individuals 40.0
32.8
• SWF
Sovereign Wealth Funds
3.3
3.8• AIFM
Hedge Funds
2.3
1.6
Private Equity
2.0
2.6
Source: International Financial Services Ltd, May 2010
Seeking Alpha
• HF returns, volatility and risk vary enormously.• Many funds hedge against market downturn.• Many deliver non‐market correlated returns.• Many aim for consistency of returns and capital
preservation, rather than magnitude of returns.• Managers are experienced, disciplined, diligent and
highly specialised; they co‐invest with clients.• Performance incentives attract the best brains. • The Investment Community uses HF to minimize
overall portfolio volatility and enhance returns.
HF Sources of Capital
Facts and Figures 1
• 9,400 hedge funds world‐wide at December 2009.• About 5,000 Funds went out of business between
2000 and 2009 without any systemic risk or impact.• Funds are only a repository for cash and
investments.• Fund domicile: Cayman Islands 39%, Delaware 27%,
BVI 7%, Bermuda 5%, EU (Dublin and Luxembourg) 5%.
• Funds often operate in low tax environments but managers and investors taxed by domicile regime.
• Manager domicile: 68% US, 23% EU, 6% Asia.
HF Investors by Country of Origin
Facts and Figures 2
• Assets: NYC 41%, London 20% (75% of EU).• Average fees: 2% management, 20% performance.
• Approx 20 Prime Brokers provide global custody, securities lending, leverage financing, technology and sometimes, administration.
• About 40% Prime Brokerage based in London.
• London concentration of EU Hedge Funds linked to global importance of London equity, bond, currency and commodity markets.
London Markets 1
• Share of Global Equity Markets, 2009:
US 32%, Jap 7%, UK 6%, DE 3%.
• Foreign Equities Trading, 2009:London
17%, New York 31%, NASDAQ 41%.
• International Debt Securities
Market
2008: UK 29%, US 24%; 2009 UK 6%, US 30%.
• Conventional Investment Fund Assets, 2009
US 50%, UK 9%, Jap 6%, FR 6%, DE 3%.
• Hedge Fund Assets: US 41%, London 20% (75% of EU)
London Markets 2
• OTC Derivatives, 2007:UK 42.5%, US 23.9%, FRA 7.2%, GER 3.7%
• Exchange Traded Derivatives: 4 UK markets.
• Foreign Exchange 2009: UK 36%, US 14%, JAP 6%, SIN 6%.
• Commodities: 3 UK exchanges, 15% globally.
• Bullion: Largest global OTC market is London.
• Carbon and emissions trading: London is a leading centre.
Hedge Fund Strategies 1
Each of the 9,400 funds builds its unique strategy from a number of different elements:
• Style: global macro, equity hedge, event‐driven, relative value (arbitrage), managed futures
• Market:
equity, fixed income, commodity, currency• Instrument:
long/short, futures, options, swaps
• Exposure:
directional, market neutral• Sector:
emerging market, technology, healthcare etc.
• Method:
discretionary or systematic/quantitative• Diversification:
multi‐manager,‐strategy, ‐fund, ‐
market
Hedge Fund Strategies 2
The four main strategy groups are based on the investment style and have their own risk and return characteristics.
• Global macro funds attempt to anticipate global macroeconomic events, generally using all markets and
instruments to generate a return.
• Equity Hedge funds
make hedged investments with exposure to the equity market.
• Event‐driven
funds
exploit pricing inefficiencies caused by anticipated specific corporate events (special situations).
• Relative value funds exploit pricing inefficiencies between related assets that are mispriced (arbitrage).
Hedge Fund Strategies 3
• Global macro: discretionary or systematic; trend or counter trend; commodities, currencies, equities.
• Equity hedge:
long/short, short bias, growth, value, sector specific, quantitative directional.
• Event driven: distressed, merger, special situations, activist, private equity.
These are the activities which directly impact enterprise.• Relative value: arbitrage, especially fixed income: sovereign
debt, corporate bonds, convertibles.• Fund of Funds: Conservative, diversified, defensive, strategic.
‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐• Emergence of computer based Algorithmic trading and High
Frequency trading.
Hedge Fund Strategies 4
• Macro Funds: The best known exponent is George Soros.• Equity Hedge:
Alfred Winslow Jones created the first HF.
It used a long/short equity hedge scheme. $10,000 invested in 1949 grew to $480,000 by 1968.
• Event Driven: HF played a decisive role in the acquisition of Cadbury by Kraft. An activist HF provoked the break
up of ABN Amro.• Algorithmic: Renaissance Technologies Millenium
fund
made 39% p.a. profit from 1989 to 2006.• High Frequency Trading: 73% of New York equity
trading is carried out by 2% of market traders.
Sub‐Prime Greece
• Greece has been in default for half its existence as a nation.
• June 1992: Bonds issued at 8.25%; spread +228 bp;
deficit 11.5% GDP; debt to GDP 110%; S&P: BBB;
onerous debt Ts & Cs, bonds governed by US/UK law.
• June 2008: Bonds issued at 4.625%; spread +113 bp;
deficit 5% GDP; debt to GDP 98%; S&P: A; debt Ts & Cs relaxed, debt mainly governed by Greek law.
• Sub‐prime analogy: “Trashy debt is alchemised to gold through manipulations driven by a political agenda”.
• An EU enquiry into the trade in Greek bond related Credit Default Swaps has apparently found no fault.
FSA Assessment, Feb 2010
• Examined: 50 hedge funds, £
300 billion assets, 20% global industry plus 14 investment banks (prime brokers).
• Concluded: HF do not pose a systemic risk.• HF do not pose a potentially destabilising credit counter party
risk: ‐
maximum bank lending to one HF: $500m
‐
maximum borrowing from all banks by one HF: $1billion.‐
average borrowing: 202% of equity.
• Maturity transformation results positive.• Prime brokers hold excess collateral. • HF presence too small to threaten the system. • In most asset classes, HF < 3% of market, < 1% EU equities.
Summary
• Impact of Hedge Funds on Enterprise confined to:Event driven: distressed, merger, special situations,
activist, private equity.• Impact can be positive or negative. • PE type reporting appropriate for social issues.
‐‐‐‐‐‐‐‐‐‐‐‐‐‐‐• Hedge funds pose little threat to financial system.• Short selling is a legitimate strategy• FSA/IOSCO type reporting provides transparency
• Impact of Hedge Funds on Enterprise confined to:
Event driven: distressed, merger, special situations, activist, private equity.
• Impact can be positive or negative.
• Short selling is a legitimate strategy
• PE type reporting appropriate for employment issues.
• Company Law issues need further consideration.
• Hedge funds pose no systemic risk to financial system.
• Sophisticated investors do not need consumer protection