The future of the Hedge Fund Industry

Transcription

1 The future of the Hedge Fund Industry January 2009 Kostas Iordanidis Managing Director Head of Hedge Funds

2 Table of content What brought us here? Anatomy of the current financial crisis The Hedge fund industry under stress Fund of hedge funds: Myths and Reality Where do we go from here? Investment opportunities Conclusion Hedge Funds 2

3 What brought us here? Hedge Funds 3

4 The era of delusional complacency Financial innovation and disintermediation decreases systemic risk Credit ratings of structure products are reliable indicators of their riskiness Volatility across asset classes will remain permanently low Asset class risk premiums will remain permanently low Historical data sometimes short term are good predictors of the return and risk of prospective investments Emerging economies are decoupled from developed economies Market liquidity will remain abundant for ever Leverage can be used to permanently enhance returns Hedge Funds 4

5 The age of leverage Using leverage in investing is like driving a race car; You can adjust it and steer, but you need to know when to go all out and when you should not. But if you press on the pedal all the way all the time, you will just blow-up. Hedge Fund manager, February 2008 Hedge Funds 5

6 The age of bubbles Formation of a bubble: Kindleberger & Minsky Displacement: exogenous shock that creates unique profit opportunities Credit creation: liquidity boom driven by monetary expansion Euphoria: speculative buying New era of false beliefs Excessive leverage Underestimation of risks Emergence of swindlers Critical stage Financial Distress: Small number of investors take profit Forced deleveraging Revulsion: Panic selling of securities Hedge Funds 6

7 Anatomy of the current financial crisis Hedge Funds 7

8 Anatomy of the current financial crisis Financial system breakdown Monetary & banking system Shadow banking system: SIVs, conduits, hedge funds, private equity Markets collapse: equity, commodity, real estate, currency Crisis affecting the real economy, income, consumption, employment, corporate profitability Largest crisis since the Great depression Crisis is global in scale Crisis evolving at a breathtaking speed Hedge Funds 8

9 Leverage Using leverage in investing is like driving a race car; You can adjust it and steer, but you need to know when to go all out and when you should not. But if you press on the pedal all the way all the time, you will just blow-up. Hedge Fund manager, February 2008 Hedge Funds 9

10 Market liquidity vs. Funding liquidity Market liquidity: ability to raise cash by selling an asset - Bid/ask spread - Depth of market (size that can be sold without further price impact) - Horizon for price reversion (how long does it take for prices to bounce back) Funding liquidity: ability to raise cash by borrowing using an asset as collateral - Ability of a fund to meet margin calls - Level of the volatility of the asset - Risk of investor redemptions - Maturity mismatch between the fund s assets and liabilities Hedge Funds 10

11 Deleveraging spirals: Leverage and liquidity, the money of the mind Increased Demand for Liquidity Forced liquidation of positions Initial loss (trigger event) Financing difficulties for levered investors Price Impact Prices move away from their fundamental value Impact on funding liquidity Increase of margins Redemptions of investor assets Mark-to-market Losses on remaining positions Source: Brunnermeier and Pedersen (2007), Unigestion Hedge Funds 11

12 The hedge fund industry under stress Hedge Funds 12

13 Sources of Hedge Fund returns Hedge fund returns are a mixture of systematic risk premiums and alpha that are enhanced by leverage Liquidity risk premiums constitute a significant source of hedge fund returns Systematic risk premiums: Equity, Credit, High Yield, Emerging Markets, Bond Risk Premiums Mortgages (complexity), Conversion Premium, Volatility Alpha: Inefficiencies: Regulatory, supply/demand imbalances, limits to arbitrage Forecasting skill (rare) Hedge Funds 13

14 Do hedge fund managers deliver alpha? Source: Bridgewater Associates, Dec 2008 Hedge Funds 14

15 Hedge fund managers under stress Typical Haircut or Initial Margin (in %) Leverage and Cash Balances of Global Hedge Funds (in %) Source: IMF Global Financial Stability report, Oct 2008 Hedge Funds 15

16 Hedge fund deleveraging Hedge Fund Equity and Balance Sheet holdings Hedge Fund Inflows/Outflows ($US bn Annualised) Source: Bridgewater Associates, Dec 2008 Hedge Funds 16

17 Hedge funds assets: How low will they go? Source: Hedge Fund Alert, Jan 2009 Hedge Funds 17

18 Challenges and responses Deleveraging will continue due to client redemptions Reputation of hedge funds is turning for the worse Tighter regulation is inevitable: It will affect the entire shadow banking system Investors will demand: more transparency and disclosure better match of liquidity between assets and liabilities tighter terms in offering memorandums Importance of sound operations and standard industry practices is increasing Compensation structures will change to promote long-term behavior vs. short-term gains Use of leverage in generating returns will diminish as it becomes unavailable and costly and will affect certain hedge fund strategies more than others Hedge Funds 18

19 Fund of hedge funds: Myths and reality Hedge Funds 19

20 Fund of Hedge Funds: The trouble with false promises Selling proposition of delivering absolute returns with low volatility under all market environments has not worked Multiple layers of hidden leverage Structured products Leverage at the fund of funds level Role of FX hedging Large liquidity mismatches Questionable due diligence Unstable business models Hedge Funds 20

21 Financial Weapons of mass destruction: Collateralized Financial Obligations 3x to 4x leveraged investment to a Fund of Hedge Funds (FoHF) FoHF volatility is low (4% to 6%) over a long history Historical drawdowns are far smaller than the equity market Product sold as a structured note (fees) FoHF uses 20% to 30% leverage to invest in hedge fund managers Underlying hedge fund managers use leverage that varies widely depending on the strategy to invest in companies that use significant operating leverage Hedge Funds 21

22 Challenges for fund of hedge funds The industry will consolidate dramatically, perhaps as much as 70% of the players will go out of business Fund of hedge funds will have to adjust their business model to focus more to institutions and less to private clients and structure products European focused players will probably suffer more than US focused ones as they rely more heavily on private clients The role of Due Diligence will be scrutinized by investors going forward As hedge fund managers continue to impose gates, create side pockets and suspend redemptions, fund of hedge funds will inevitably be forced to restrict liquidity as well Hedge Funds 22

23 Where do we go from here? Investment opportunities Hedge Funds 23

24 Why investing in hedge funds today? Despite the significant problems of the industry NOT all hedge funds are the same Dispersion of returns across hedge fund strategies has been extremely wide Even more important, within each strategy the dispersion or manager returns is at the widest Systematic Risk Premiums have been restored and although can widen further, they offer attractive returns in the medium term Alpha opportunities have increased Inefficiencies are abundant across asset classes (regulation, forced selling) Competition has decreased as capital is less available and proprietary trading by investment banks has been significantly reduced Identification of alpha easier Fake alpha exposed Crisis is the best testing ground for identifying manager skill Hedge Funds 24

25 Most attractive opportunities for 2009 Liquid strategies will continue to profit from the current environment Tactical Trading: Global Macro, CTAs, Discretionary Commodity traders Leverage is not an issue for such strategies as it is primarily provided by exchange traded derivatives Client redemptions are not a problem Distressed cycle will be extremely profitable for cash rich investors Best opportunity in the industry: Buy high quality performing assets from distressed sellers at distressed prices (Super Senior Mortgages, Leveraged Loans, Convertible Bonds?) Highly illiquid No leverage required as opportunities are extremely compelling Long lock ups to stabilize investor base Hedge Funds 25

26 Conclusion Hedge Funds 26

27 Why we don t learn what we don t learn? Was the current financial crisis predictable? Markets are far riskier than playing Russian roulette with a revolver with a thousand chambers At least with Russian roulette we know the odds In financial markets we do not observe the barrel of reality Humans are shortsighted and incapable of learning from history If I had lived through the Great depression I would have been in a better position to understand events, John Meriwether, LTCM Hedge Funds 27

28 What the future holds? There are two kinds of forecasters: those who don t know, and those who don t know they don t know. John Kenneth Galbraith A man who knows and knows that he knows is a sage, follow him A man who knows but knows not that he knows is asleep, awaken him A man who knows not and knows that he knows not is a seeker, teach him A man who knows not and knows not that he knows not is a fool, shun him Chinese proverb Hedge Funds 28

29 Important information This presentation is provided to you on a confidential basis solely and may not be published or reproduced in whole or in part and may not be delivered to any person without the prior consent of Unigestion. It does not purport to be complete and is qualified in its entirety by reference to the more detailed discussions to take place with Unigestion. Unigestion has the ability in its sole discretion to change the strategies described herein. This presentation comprises elements of our investment philosophy and does not constitute an offer to sell or a solicitation to subscribe in the strategies described or alluded to herein which may be construed as high risk and not readily realizable investments which may experience substantial and sudden loss, including total loss of investment. Investors may not get back the amount they invest. These materials should only be considered current as of the date of publication without regard to the date on which you may access the information. Unigestion maintains the right to delete or modify information without prior notice. Data and graphical information herein are for information only. No separate verification has been made as to the accuracy or completeness of these data which may have been derived from third party sources. As a result, no representations are made by Unigestion as regards the information contained herein. KIO/OMA/VFE Hedge Funds 29

30 Contacts Kostas Iordanidis Managing Director, Head of Hedge Funds Tel : +41 (22) kiordanidis@unigestion.com GENEVA 1) UNIGESTION SA 8C avenue de Champel CP 387 CH-1211 Genève 12 LONDON 2) UNIGESTION (UK) Ltd 105 Piccadilly UK-London W1J 7NJ NEW YORK UNIGESTION (US) Ltd Plaza 10 Harborside Financial Center Suite 203 Jersey City, NJ USA PARIS 3) UNIGESTION ASSET MANAGEMENT (France) SA 12 avenue Matignon F Paris SINGAPORE UNIGESTION ASIA Pte Ltd 152 Beach Road Suite #23-05/06 The Gateway East Singapore Singapore GUERNSEY 4) UNIGESTION (Guernsey) Ltd Farnley House La Charroterie St. Peter Port Guernsey, GY1 1EJ Channel Islands 1) Supervised by the Swiss Financial Market Supervisory Authority (FINMA). 2) Authorised and regulated by the Financial Services Authority (FSA). Registered in England and Wales N ) Supervised by L Autorité des Marchés Financiers (AMF). 4) Regulated by the Guernsey Financial Services Commission (GFSC).