hedge fund indexing January 2010

Transcription

1 hedge fud idexig Jauary 2010

2 Emergig from oe of the most sigificat market dislocatios to date, hedge fuds as a whole successfully capitalized o opportuities i 2009, recoupig much of their 2008 losses ad producig their highest returs i a decade. Today, the ability of hedge fuds to provide access to a rage of ivestmet strategies which ca provide diversificatio eve i the face of sigificat market volatility has oce agai catapulted these strategies ito the spotlight, ad maagers cotiue to attract sigificat ad growig assets from istitutios ad high et worth ivestors. Yet, the potetial costs, risks ad performace icosistecies of direct hedge fud ad fud of hedge fud ivestig have prompted some to examie alterative methods of accessig these alterate retur streams. Passive ivestmet strategies have become well established i the traditioal asset maagemet area ad we believe the same will hold true i the hedge fud market. I fact, the core beefits offered by idexig ease of maagemet, capturig broad market performace, diversificatio, trasparecy ad cost efficiecy directly address may of the challeges facig hedge fud ivestors today. The cocept of hedge fud idexig, however, also raises iterestig questios: How does oe defie a hedge fud idex? How does oe defie hedge fud alpha? How relevat is the cocept of beta? Idexig also poses the sigificat challeges of capturig the performace of a marketplace where trasparecy ad cosistet iformatio flow ca be difficult to access ad where retur streams have bee drive, i part, by fuds that are ow closed to ew ivestmets. With the itroductio of idices such as the Credit Suisse / Tremot Hedge Fud Idices, we believe ivestors have gaied importat tools ad bechmarks to aalyze hedge fud performace. These bechmarks also marked the begiig of a importat evolutio i hedge fud ivestig: the opportuity to track broad market returs through idexig strategies. Lookig ahead, we believe these types of ivestmets will play a icreasigly importat role for ivestors implemetig core hedge fud allocatios. 2 Jauary 2010

3 Market Returs Idexig of the traditioal stock markets was cosidered a radical idea whe first itroduced by Vaguard s Jack Bogle i Today, the Vaguard 500 Idex Fud is oe of the largest fuds i the idustry. Oce viewed with skepticism by the ivestmet commuity, Bogle is ow cosidered a pioeer of moder ivestig. His visio helped create a viable ad sustaiable alterative to active maagemet, while offerig ivestors a effective way to implemet their asset allocatio models. I fact, traditioal idexig has become syoymous with such core ivestor beefits as costefficiecy, trasparecy, ad diversificatio, as well as providig the coveiece of a sigle etry poit to gai broad market exposure. As a result of Bogle s iovatio, traditioal equity ivestors ow have a wide variety of optios to choose from, icludig both active ad passive strategies. We believe the same tred may be occurrig i hedge fud allocatios, as ivestors seek differet ways to access hedge fud market exposure. The itroductio of broad market idices such as the Credit Suisse/Tremot Hedge Fud Idex has made it possible to ivest i a portfolio desiged to track the returs of the overall hedge fud market, icludig the performace of some closed fuds. This type of passive hedge fud ivestig offers a pool of direct hedge fud ivestmets that is maaged to track the returs of a overall hedge fud idex, such as the Credit Suisse/Tremot Hedge Fud Idex. This paper examies some of the key cosideratios for ivestors cotemplatig this type of approach as a meas of gaiig core hedge fud exposure. What Is a Hedge Fud Idex? Ivestors geerally use a idex as a barometer for a give market, idustry or asset class, providig a bechmark to track performace. However, ulike traditioal securities, such as large cap stocks, hedge fuds represet a wide rage of strategies that have bee categorized ito 10 uique sectors. A hedge fud idex attempts to capture the returs of the broad uiverse of hedge fuds ad establish a overall peergroup performace bechmark. Istitutioal ivestors ofte use a variety of bechmarks for measurig hedge fud performace. A commo method is to measure a fud s performace agaist a risk-free rate of retur, such as cash plus a certai umber of basis poits. A secod method is to measure a hedge fud s performace agaist the public equity markets. The itroductio of hedge fud idices offers a third way to aalyze returs measurig performace agaist a peer uiverse of other hedge fuds. This provides a useful startig poit for trackig alpha ad beta agaist the geeral hedge fud market. Why cosider hedge fud idexig? Ivestors typically seek out hedge fuds for their attractive risk-adjusted retur potetial ad a umber of hedge fud maagers have delivered attractive retur streams as well as geuie alpha. However, idetifyig these top maagers ca require a serious commitmet of time ad resources, largely because of lack of trasparecy i the idustry ad the diversity of tradig strategies. This resource ad time commitmet has helped fuel the popularity of multi-maager fud of hedge fuds strategies. These strategies offer the beefits of professioal maagemet ad diversificatio, although they also itroduce a additioal layer of fees. A fud of fuds strategy, however, does ot completely alleviate a ivestor s research requiremets. Istead, it simply trasfers the time ad effort spet aalyzig idividual hedge fud maagers to aalyzig fud of fud maagers. I additio, the added diversificatio which is a key beefit from a risk perspective dilutes the ability to add meaigful alpha. The tred, i fact, has bee a geeral The Evolutio of Hedge Fud Idexig 1949 Alfred Wislow Joes combies short sellig ad leverage to create the world s first moder hedge fud Jack Bogle itroduces the Vaguard 500 Idex Fud, the first log equity idex mutual fud for idividual ivestors The Credit Suisse/Tremot Hedge Fud Idex, the first asset-weighted, rules-based hedge fud idex, is lauched Credit Suisse creates a portfolio that is desiged to closely track the performace of the Credit Suisse / Tremot Hedge Fud Idex Credit Suisse / Tremot lauches the AllHedge Idex, a composite idex desiged to offer broad exposure to the ivestable hedge fud uiverse Credit Suisse maages over $1 billio i hedge fud idex-based portfolios. Jauary

4 reversio to the mea i terms of fud of fuds performace with oly a hadful of the largest fud of hedge fuds outperformig the Credit Suisse/Tremot Hedge Fud Idex for the five-year period eded December 2009 (see Figure 1). Idexig provides istitutioal ivestors with the additioal beefit of helpig to maage the risks associated with idividual hedge fuds. By trackig a idex s returs, a idex-based portfolio should ot sigificatly uderperform the broad market. I additio, while idexig caot elimiate exposure risk, it does help maage it by maitaiig a high level of diversificatio. With a idexed portfolio, a ivestor buys the etire market, creatig safety i umbers. Should a idividual hedge fud experiece maagemet or tradig problems, the impact to the overall portfolio is diluted. A Cost-efficiet Alterative Beta Source Aother iterestig tred that adds credibility to idex-based hedge fud strategies is the emergece of alpha ad beta as core buildig blocks to maximize portfolio efficiecy. The itroductio of hedge fud idices has established a beta for the geeral hedge fud market, which has teded to be oly moderately correlated to the betas of traditioal equity ad fixed icome markets (see Table 1). Prior to the liquidity crisis (defied as the begiig of the drawdow for the hedge fud idustry which occurred i Jue 2008), average capture for hedge fuds teded to rise durig bull markets while dowside correlatio decreased durig bear markets, resultig i asymmetric payouts. Sice Jauary 2009, the hedge fud space has evolved from beig more directioal i ature to employig a rage of ivestmet strategies desiged to diversify away from traditioal market movemets. By effectively capturig it i a ivestmet vehicle, ivestors ca access oe of the primary beefits of hedge fuds: their attractive risk-adjusted retur potetial (see Figure 2). Idexig ca be a cost-efficiet way to access this alterative beta stream, satisfyig the iheret diversificatio eeds associated with most hedge fud madates. I additio, idexed portfolios offer this beta opportuity without the risk of sigificatly uderperformig the hedge fud market as a whole. Figure 1: Performace of the Largest Multi-Strategy Fuds of Fuds (Ja. 1, 2005 Dec. 31, 2009) The Credit Suisse/Tremot Hedge Fud Idex has historically offered returs similar to large multi-strategy fuds of fuds, with attractive volatility ad risk characteristics. Rak by Aualized Retur 12 Aualized Retur (%) Credit Suisse/Tremot Hedge Fud Idex Rak by Sharpe Ratio 2.0 Strog performace compared to largest multi-strategy fuds of fuds Largest Multi-Strategy Fuds of Fuds Aualized Retur (%) Attractive Sharpe Ratio compared to largest multi-strategy fuds of fuds Credit Suisse/Tremot Hedge Fud Idex Largest Multi-Strategy Fuds of Fuds Sources: Credit Suisse Tremot Idex LLC; Bloomberg. Fuds show based o publicly available iformatio. All data was obtaied from sources believed to be reliable. Credit Suisse does ot guaratee the accuracy of such data. This chart is for illustrative purposes oly. Idices are umaaged ad do ot reflect the deductio of accout fees ad expeses. Ivestors caot ivest directly i a idex. Past performace does ot guaratee future results. 4 Jauary 2010

5 The Role of Idexed Strategies i a Portfolio As a coveiet, cost-effective etry poit to hedge fud ivestig, a idexed portfolio has may advatages. Direct ivestmet i hedge fuds or fuds of hedge fuds ca require sigificat research ad moitorig capabilities. Idexig elimiates the eed for these iteral capabilities, sice the portfolio tracks the broad hedge fud market. As a result, idexig is ofte a more accessible approach for a wider rage of istitutioal ivestors icludig small ad midsize pesios, edowmets ad foudatios. For ivestors who already ow several hedge fuds or fuds of hedge fuds, a idexed portfolio ca provide a simplified core holdig. A idexed portfolio offers hedge fud market beta, while idividual hedge fuds selected aroud this core offerig (which are sometimes referred to as the satellite ivestmets of a core/ satellite portfolio) may be used to gai maager-specific or strategy-specific alpha. I cotrast, the overlap of idividual fuds i a portfolio of multiple fuds of hedge fuds ca miimize diversificatio, resultig i what may be simply a high-cost quasi-idex i terms of aggregate returs. Figure 2: Idexig to Capture Attractive Returs Over the Log Term (Ja. 1, 1994 Dec. 31, 2009) Hedge fud idices ca produce attractive returs durig bull markets, while preservig capital i bear markets. Cumulative Retur (%) LTCM Collapse (Jul. Sep. 1998) Risk-adjusted Retur Risk-adjusted Retur Asia Currecy Crisis (Aug. Oct. 1997) Collapse of Stock Market Bubble (Feb Mar. 2003) Risk-adjusted Retur Liquidity Crisis (Ju Feb. 2009) Risk-adjusted Retur Risk-adjusted Retur Bull Market Rally (Apr Oct. 2007) Post Liquidity Crisis (Mar Ogoig) Risk-adjusted Retur Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Credit Suisse/Tremot Hedge Fud Idex S&P 500 TOPIX MSCI World DJ Euro Stoxx Barclays Capital Global Aggregate Sources: Credit Suisse Tremot Idex LLC; Bloomberg. All data was obtaied from sources believed to be reliable. Credit Suisse does ot guaratee the accuracy of such data. This chart is for illustrative purposes oly. Idices are umaaged ad do ot reflect the deductio of accout fees ad expeses. Ivestors caot ivest directly i a idex. Risk-adjusted retur measures retur per uit of stadard deviatio. A higher figure reflects better risk-adjusted performace. Past performace does ot guaratee future results. Jauary

6 Effectively Capturig Idex Returs As with ay idex-based strategy, miimizig trackig error (the volatility of the retur differeces betwee a portfolio s actual performace ad the idex it tracks) is a importat cosideratio. Whe trackig the MSCI World Idex, for example, a traditioal equity idex maager would likely ivest i a optimized samplig of compaies i the idex, rather tha tryig to purchase every sigle compay represeted. Portfolio optimizatio allows the maager to match a idex s returs without ivestig i compaies whose stocks may be difficult to access or trade due to govermet regulatios, market cap costraits or other limitatios. Similarly, a hedge fud idex s returs ca be matched through optimizatio techiques. However, creatig a idexed portfolio of hedge fuds requires payig careful attetio to the specific challeges of ivestig i the hedge fud market, such as hedge fud liquidity, lack of trasparecy ad fud capacity costraits. The output from the optimizatio process must be carefully evaluated by a experieced portfolio maagemet team to balace the various challeges while buildig the optimal portfolio. Table 1: Low Correlatios Whe Most Needed Bear market (Jauary 1, 2000 to March 31, 2003) Hedge fuds experieced low correlatio to global equity markets, preservig assets i the dow market period. Credit Suisse/Tremot Hedge Fud Idex Credit Suisse/Tremot Hedge Fud Idex 1.00 S&P 500 Total Retur Idex MCSI World Idex (USD) S&P 500 Total Retur Idex MSCI World Idex (USD) Bull Market Rally (April 1, 2003 to October 31, 2007) Correlatio to the global equity markets rose i correspodece to the bull market tred experieced i the equity markets helpig to icrease upside capture. Credit Suisse/Tremot Hedge Fud Idex Credit Suisse/Tremot Hedge Fud Idex 1.00 S&P 500 Total Retur Idex MCSI World Idex (USD) S&P 500 Total Retur Idex MSCI World Idex (USD) Liquidity Crisis (Jue 1, 2008 to February 28, 2009) Hedge fuds bega to decouple from the broad markets, resultig i decreased dowside correlatio. Despite sigificat losses, hedge fuds fared better tha broad equity idices overall by limitig drawdows ad maitaiig cosiderably less volatility. Credit Suisse/Tremot Hedge Fud Idex Credit Suisse/Tremot Hedge Fud Idex 1.00 S&P 500 Total Retur Idex MCSI World Idex (USD) S&P 500 Total Retur Idex MSCI World Idex (USD) Post Liquidity Crisis (March 1, 2009 to December 31, 2009) Correlatios i the post liquidity crisis eviromet have remaied relatively low, providig for diversificatio from traditioal market movemets. Credit Suisse/Tremot Hedge Fud Idex Credit Suisse/Tremot Hedge Fud Idex 1.00 S&P 500 Total Retur Idex MCSI World Idex (USD) S&P 500 Total Retur Idex MSCI World Idex (USD) Sources: Credit Suisse Tremot Idex LLC; Bloomberg. All data was obtaied from sources believed to be reliable. Credit Suisse does ot guaratee the accuracy of such data. This chart is for illustrative purposes oly. Idices are umaaged ad do ot reflect the deductio of accout fees ad expeses. Ivestors caot ivest directly i a idex. Past performace does ot guaratee future results. Hedge Fud Ivestmet Optios Today, as the hedge fud market cotiues to evolve, ivestors have a broader selectio whe examiig appropriate ivestmet vehicles. While the actual structures may vary amog idividual maagers, here are some typical characteristics that ivestors are likely to fid i the marketplace today. Sigle Maager Fud of Fuds Idex Trackig Portfolio A sigle fud maager s tradig strategy A actively maaged portfolio of multiple hedge fud maagers A diversified portfolio of hedge fuds maaged utilizig a quatitative ivestmet model with a qualitative refiemet process to track a o-ivestable idex s returs Fees Maagemet fee ad performace fee Additioal maagemet fee ad performace fee Additioal maagemet fee o performace fee Tradig Active Active Passive 6 Jauary 2010

7 Credit Suisse Idex Trackig Portfolio Costructio Process Because some fuds i the Credit Suisse / Tremot Hedge Fud Idex are closed to ew ivestmets, quatitative procedures form a foudatio for Credit Suisse s portfolio selectio process, which is desiged to miimize trackig error to the actual idex s returs. The selectio process begis by idetifyig a portfolio uiverse. The Credit Suisse/Tremot Hedge Fud Idex cosists of 10 sectors, ad a uique covariace matrix is used to build the prelimiary portfolio for each of these sectors. A post-optimizatio aalysis follows that icludes quatitative measures such as back-testig, sesitivity aalysis, risk/retur ad correlatio aalysis o the optimized results. The selectio process combies the optimized strategy solutios ito a multi-sector portfolio, based o the weights of the Credit Suisse/Tremot Hedge Fud Idex. The portfolio is cotiuously reviewed ad moitored, with tradig of the uderlyig hedge fuds as frequetly as each fud s liquidity allows. New additios to the idex, chages i maager assets uder maagemet ad strategy reclassificatios ca trigger a rebalacig of positios. Broad Hedge Fud Idex Selectio Costraits Ope/Closed Liquidity cosideratios Miimum ivestmet Portfolio Uiverse Covertible Arbitrage Emergig Markets Equity Market Neutral Evet Drive Fixed Icome Arbitrage Global Macro Log/Short Equity Maaged Futures Multi- Strategy Optimizatio Covariace matrix Trackig error miimizatio Relative weight costraits Quatitative Aalysis Performace/Risk cotributio aalysis Correlatio/Cluster aalysis Outlier aalysis Maager style drift Qualitative Refiemet Operatioal due diligece* Outflow moitorig Sigificat orgaizatioal chages Apply Broad Idex Sector Weights Fial Portfolio * Fuds that costitute 0.5% or more of the portfolio are targeted for due diligece. Coclusio Historically, hedge fuds have gaied favor with ivestors for their ability to deliver positive returs ucorrelated to those of other asset classes. As a result, addig hedge fud exposure to a overall portfolio allocatio may icrease the efficiet frotier of may traditioal portfolios. Growig treds i the hedge fud marketplace have cotiued to build a compellig case for idex-based portfolios as a viable optio for gaiig core exposure to the asset class. Ideed, these ivestmet vehicles ca provide effective exposure to the low correlatios of the broad hedge fud market ad they also directly address may of the issues facig hedge fud ivestors dimiished alpha opportuities, complexity, cost efficiecy, diversificatio, trasparecy ad simplified reportig. Because of this, we believe idex-based portfolios will become icreasigly importat to ivestors cosiderig hedge fud strategies. As with ay idex-based portfolio, selectio of the appropriate bechmark requires careful cosideratio. Performace will be sigificatly impacted if the idex is ot truly represetative of the hedge fud uiverse, ad some hedge fud idices have specific challeges ad otable drawbacks i effectively represetig the overall hedge fud market. I additio, effectively deliverig the retur streams of a hedge fud idex through a ivestable portfolio (with a acceptable level of trackig error) requires a complex ivestmet platform drive by robust aalytical tools ad sophisticated proprietary systems. For ivestors cosiderig a passive approach to hedge fud ivestig, it is crucial to idetify a idex maager with a prove process for miimizig trackig error ad deliverig reliable market returs. Both of these challeges, however, are straightforward ad ca be overcome. As the hedge fud market cotiues to mature ad evolve, we believe idexbased strategies will cotiue to gai mometum i the marketplace, offerig ivestors aother viable tool to cosider whe buildig their hedge fud portfolio allocatios. Jauary

8 Cotact Iformatio: Credit Suisse Tremot Idex LLC Eleve Madiso Aveue New York, NY Uited States Bloomberg: CTHI <GO> Reuters: CSFBHEDGE Importat Legal Iformatio This material has bee prepared by Credit Suisse Tremot Idex LLC ( Credit Suisse ) o the basis of publicly available iformatio, iterally developed data ad other third party sources believed to be reliable. Credit Suisse has ot sought to idepedetly verify iformatio obtaied from public ad third party sources ad makes o represetatios or warraties as to accuracy, completeess or reliability of such iformatio. All opiios ad views costitute judgmets as of the date of writig without regard to the date o which the reader may receive or access the iformatio, ad are subject to chage at ay time without otice ad with o obligatio to update. This material is for iformatioal ad illustrative purposes oly ad is iteded solely for the iformatio of those to whom it is distributed by Credit Suisse. No part of this material may be reproduced or retrasmitted i ay maer without the prior writte permissio of Credit Suisse. Credit Suisse does ot represet, warrat or guaratee that this iformatio is suitable for ay ivestmet purpose ad it should ot be used as a basis for ivestmet decisios. Past performace does ot guaratee or idicate future results. This material should ot be viewed as a curret or past recommedatio or a solicitatio of a offer to buy or sell ay securities or ivestmet products or to adopt ay ivestmet strategy. The reader should ot assume that ay ivestmets i compaies, securities, sectors, strategies ad/or markets idetified or described herei were or will be profitable ad o represetatio is made that ay ivestor will or is likely to achieve results comparable to those show or will make ay profit or will be able to avoid icurrig substatial losses. This iformatioal report does ot costitute research ad may ot be used or relied upo i coectio with ay offer or sale of a security or hedge fud or fud of hedge fuds. Performace differeces for certai ivestors may occur due to various factors, icludig timig of ivestmet ad eligibility to participate i ew issues. Ivestmet retur will fluctuate ad may be volatile, especially over short time horizos. Ivestig etails risks, icludig possible loss of some or all of the ivestor's pricipal. The ivestmet views ad market opiios/aalyses expressed herei may ot reflect those of Credit Suisse Group as a whole ad differet views may be expressed based o differet ivestmet styles, objectives, views or philosophies. To the extet that these materials cotai statemets about the future, such statemets are forward lookig ad subject to a umber of risks ad ucertaities. Ivestmets i hedge fuds are speculative ad ivolve a high degree of risk. Hedge fuds may exhibit volatility ad ivestors may lose all or substatially all of their ivestmet. A hedge fud maager typically cotrols tradig of the fud ad the use of a sigle advisor s tradig program may result i a lack of diversificatio. Hedge fuds also may use leverage ad trade o foreig markets, which may carry additioal risks. Ivestmets i illiquid securities or other illiquid assets ad the use of short sales, optios, leverage, futures, swaps, ad other derivative istrumets may create special risks ad substatially icrease the impact of adverse price movemets. Hedge fuds typically charge higher fees tha may other types of ivestmets, which ca offset tradig profits, if ay. Iterests i hedge fuds may be subject to limitatios o trasferability. Hedge fuds are illiquid ad o secodary market for iterests typically exists or is likely to develop. The icetive fee may create a icetive for the hedge fud maager to make ivestmets that are riskier tha it would otherwise make. The charts, tables ad graphs cotaied i this documet are ot iteded to be used to assist the reader i determiig which securities to buy or sell or whe to buy or sell securities. Bechmarks are used solely for purposes of compariso ad the compariso does ot mea that there will ecessarily be a correlatio betwee the returs described herei ad the bechmarks. There are limitatios i usig fiacial idices for compariso purposes because, amog other reasos, such idices may have differet volatility, diversificatio, credit ad other material characteristics (such as umber or type of istrumet or security). Copyright 2010, Credit Suisse Group AG ad/or its affiliates. All rights reserved. CSTHI-WP-0410