Hedge funds and how to communicate with them

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2 Hedge funds and how to communicate with them DIRF dag 2007: IR udfordringer 2008 Claus Heimann Larsen

3 Kaupthing Bank an overview Kaupthing Bank is a Northern European bank offering integrated financial services to companies, institutional investors and individuals. These services incl corporate banking, investment banking, capital markets services, asset management and wealth management for private banking clients. The Bank operates in ten countries, incl Nordic countries, UK and US. In Denmark, Kaupthing Bank operates under the name FIH Erhvervsbank. In recent years, Kaupthing Bank has been among the fastest growing financial groups in Europe. The aim of this growth is to further enhance the Bank s ability to provide comprehensive services to it s client base in the UK, the Nordic countries and elsewhere in Northern Europe. Employees 30 June 07 Iceland 1,150 UK 735 Sweden 350 Denmark 332 Luxembourg ¹ 189 Finland 98 Norway 83 Faroe Islands 23 US 9 Investment Banking Capital Markets Treasury Banking AM & PB Total 2,

4 Hedge funds - fastest growing asset class In 2006, approximately 7500 hedge funds held assets of U$ 1.4 trillion worldwide, up from U$ 185bn in ,600,000 8,000 1,400,000 1,200,000 Estimated Assets Estimated # of Funds 7,000 6,000 Millions U$ 1,000, , , , ,000 0 Source: Hedge Fund Research, Inc HFR, 2007, Q Q Q Q ,000 4,000 3,000 2,000 1,000 0 Number 4

5 Why bother? Hedge fund' relative proportion of global asset under management is estimated to <10% Lets assume hedge funds turns on average 6 x their asset under management (including derivatives, gearing etc) compared to long funds (pension funds, mutual funds and insurance companies) which turns an guesstimated 0.5x asset under management. Trading volume/size (assuming hedge funds accounts for 8% of AUM): Long funds: 92 x 0.5 = 46 Hedge funds: 8 x 6.0 = 48 The market impact from hedge funds is many times greater than their absolute size 5

6 Dialog with a hedge funds can be intensive Hedge funds Traditional asset management Return target Absolute return Relative return Definition of risk Loss Negative deviation from benchmark index Principlesourceofreturn Skill Mainly the market but also portfolio composition Investment methodology Buy long, sell short.,limited market risk (in theory!) Buy long. Mainly market risk Definition of success Absolute return, high risk adjusted return, low correlation (beta) Outperform benchmark index Incentive system Performance fee. A substantial proportion of a hedge fund manager s capital is typical invested in the fund Fixed fee 6

7 Investment styles Event Event driven driven Convertible arbitrage Growth investor Index Index tracker Investor Value Value investor Benchmarking Management changes Macro Macro 7

8 Evolution of hedge funds Composition of hedge funds by mid-1990s Composition of hedge funds by 2006 Macro 71.1% Equity Hedge 5.3% Event Driven 3.8% Fixed Income 3.3 Distressed securities 2.4% Equity market neutral 1.7% Equity non-hedge 0.6% Merger arbitrage 0.6% Convertible arbitrage 0.5% Emerging markets 0.4% Equity Hedge 31.0% Event Driven 15.0% Relative value arb 14.6% Macro 11.1% Fixed Income 8.5% Sector 5.8% Emerging markets 5.1% Distressed securities 5.0% Equity non-hedge 4.8% Convertible arbitrage 4.3% Equity market neutral 2.9% Merger arbitrage 2.1% Source: Hedge Fund Research, Inc HFR, 2007, 8

9 Implication for IR... The number of equity related investment styles have grown substantially. Recent trends have been Activists: U$ c60bn (5%) of the hedge funds have an dedicated activist approach. Event driven hedge funds: Fuelled by the significant increase in corporate activity such as M&A, takeover, buyouts etc These types of investment strategies do put more pressure on corporates and IR departments 9

10 ...More hard work In the quest for higher equity returns, hedge funds tends to take fewer but larger bets in individual stocks. This normally increases the work load for the IR departments: Investors do more in-depth research/homework. As IR you will know the difference More interaction with management and/or the board Demand for board representation. Something we have seen few examples of here in Denmark so far Coordinated hedge funds control => the wolf pack approach 10

11 The We don't want to meet hedge funds attitude... Arguments for not meeting hedge funds: But think again: They are short sighted and create much volatility There is a reason why the hedge fund wants to meet...any stories you don't know about They don't know our industry well enough They can be large shareholders They are only interested in short selling Hedge funds can also be long term owners It can be unpleasant and hedge funds only focus on next quarter 11

12 ...can be a mistake One of the first high profile activist cases in continental Europe was Deutsche Boerse' attempt to acquire London Stock Exchange CEO Werner G. Seifert from Deutsche Boerse said* on the first contact with Chris Horn from The Children's Investment Fund: He was quiet rude and Mr Seifert chose to ignore him. *) From the book: Invasion der Heuschrecken by Werner G Seifert, March

13 Summary Hedge funds continue to be the fastest growing asset class......with a wider range of investment styles Incentive systems attract strong individuals Growing breed both in terms of fragmentation and investment styles This points in one direction: More work for IR departments 13

14 The IR' 10 commitments 1. I am aware of current investment themes 2. I know of the important accounting issues and how the company relates or differs 3. I understand the dynamics in our industry and keep track on the peer group 4. I know of how investors calculate their return and valuation metrics 5. I am on top of capital structure issues and the cost of debt/equity 6. I have learned about the universe of hedge funds and investment styles 7. I understand the agenda before investor meetings 8. I have a number of pre-made presentations which fit different investors 9. I spend time with investors & brokers, which keeps me up to date 10.I know more about the company and industry fundamentals than investors 14

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