“Let every man divide his money into three parts, and invest one-third in land, a third in business, and a third let him keep in reserve.” - The Talmud, 1200 BC
Performance
The Greenwich Global Hedge Fund Index ("GGHFI") returned 2.21% in February, helped by a +7.2% return in the Futures Trading fund managers, and rebounding from January's -2.79% worst return since 2002. The S&P 500 and MSCI World Equity posted negative returns of -3.32% and -0.74%, respectively,
while the ASX 200 had a return of -1.4%. All hedge fund strategy groups ended the month with gains. Long-Short Equity Group strategies also benefited from choppy equity markets, gaining 1.3%. For the second month in a row, dedicated short sellers were the top performers in this group, gaining +4.12% on the month. Emerging markets rebounded a strong +4.4% after a January decline. The Market Neutral Group was the weakest but still managed to show an average return of +1.1%...more>>
| Greenwich Alternative Investments Hedge Fund Index |
|||||||||
Total Return |
3 Yr Annual |
5 Yr Annual |
|||||||
Index |
Feb 08 | Jan 08* |
YTD |
3 Month |
1 Year |
CAR |
STD |
CAR |
STD |
| Global Hedge Fund | 2.2% |
-2.8% |
-0.6% |
0.1% |
8.4% |
9.8% |
5.0% |
11.3% |
4.7% |
| Global Long/Short | 1.3% |
-4.5% |
-3.2% |
-2.6% |
5.8% |
9.9% |
6.5% |
12.5% |
6.3% |
| Global Market Neutral | 1.1% |
-1.4% |
-0.3% |
-0.1% |
5.2% |
7.8% |
3.0% |
8.3% |
2.7% |
| Emerging Markets | 4.4% |
-6.2% |
-2.1% |
-0.8% |
18.7% |
17.9% |
9.4% |
22.6% |
9.0% |
Benchmark |
Feb 08 | Jan 08* |
YTD |
3 Month |
1 Year |
CAR |
STD |
CAR |
STD |
| Lehman Bond Index | 0.1% |
1.7% |
1.8% |
2.1% |
7.3% |
5.2% |
2.8% |
4.5% |
3.6% |
| S&P 500 Index | -3.3% |
-6.0% |
-9.1% |
-9.8% |
-3.7% |
5.4% |
8.8% |
11.6% |
9.2% |
| MSCI World Index | -0.7% |
-7.7% |
-8.4% |
-9.7% |
-2.3% |
7.4% |
9.4% |
14.1% |
9.8% |
| ASX 200 | -1.4% |
-11 |
-12% |
-15% |
-2.2% |
13.6% |
11.8% |
19.0% |
10.4% |
| CAR= Cumulative Average Return, STD = Standard Deviation | Source: Greenwichai.com |
Markets
Sub Prime
The sub prime fall out continued in February, with prominent losers being quantitative equity funds such as Goldman Sachs' Global Alpha Fund and AQR with double digit losses. Asset Backed Securities (ABS) funds such as DB Zwirn & Co and Peloton Partners have been hardest hit. However, according to Investor's Alpha (Dec 2007/Jan 2008) magazine's Imogen Rose-Smith, John Paulson, founder of New York based Paulson & Co., made a fortune for himself and investors through a brilliantly timed short of sub prime mortgage lenders and the sub prime index. His Paulson Credit Opportunities Fund was up 590 percent in 2007.
Since the early 2000's we have seen a growth of ABS Funds as the asset backed securities markets have grown. Essentially these funds prospered by borrowing 80-95% against their assets, and made money by borrowing at LIBOR +50 bps and investing in ABS's at LIBOR +300 bps, thereby picking up an easy 250 bps. With this level of leverage and stable ABS prices, many of these funds posted low volatility, double digit returns.
In the last few years, before the current crisis, credit spreads have been tightening across all credit markets. As a response, many of these funds lowered the rating of their portfolios, investing in lower and lower credits to maintain their spreads over their borrowing rates. The investors were happy and the banks kept lending against them and the underlying risk went unnoticed by many.
What we are seeing now, however, is a re-rating of risk and subsequent de-leveraging across the board. After five years of decreasing volatility and credit spreads, both these are have increased again, very sharply. And as a result, many asset backed managers are getting hit with a triple whammy: as their assets are downgraded and credit spreads increase, their portfolio value is falling. At the same time, banks are demanding higher margins to lend and increasing the ‘haircuts' they demand against these assets to protect themselves. In many cases, the banks are forcing funds to sell these assets as the gearing ratios increase in response to lower prices and higher margin requirements and the funds are forced to sell into a market being sold into by everyone else.
We expect the first signs of abating sub prime problems will be when credit spreads stabilize. As the graph of the ABX index shows below, it is difficult to be sure when the credit spreads have hit bottom and stabilized.
 |
| Source: www.markit.com |
ABX Index
The notation is explained as follows: ABX stands for Asset Backed Index, HE for Home Equity, and AAA or AA is the rating, whilst the numbers 07-02 indicate it is for bonds issued in first half of 2007. The graph shows that since Aug 2007, AAA rated sub primes have declined from trading at about 95 cents in the dollar to about 57 cents, while AA rated ones have dropped from 88 cents in Aug 2007 to 22 cents now. Moreover, the spread between these rated bonds has increased from 7 bps to 36 bps. Even since January 2008, the spreads have widened by 6 bps. We can say, however, that even if the sub prime crisis has run its course, the knock-on effect continues to spread through the financial world to banks, insurers and other financial institutions.
Volatility
Volatility increased in markets with the bellwether S&P 500 volatility (vix) index at 26%, a level not seen since 2002 (see chart below). Volatility managers, who would be expected to prosper, have actually had a mixed record in this environment.
Volatility can bode well for fundamental stock pickers and opportunistic managers, who have been able to pick areas of good fundamental value being indiscriminately sold or who have been very nimble. However, the returns from such plays may take a few months to come to fruition.
 |
| Source: Bloomberg |
Sentiment
Uncertainty continues to surround U.S. equities and the Managers are now presenting a negative view on the S&P 500 for March, as 50% report a bearish position, vs. 36% neutral and 14% bullish. The U.S. Dollar mounted a strong rally the first week of February; however, this move was short lived as the Dollar traded sharply lower toward the end of the month. Accordingly, 50% of the Managers expect the Dollar to continue moving lower, vs. 29% unchanged and 21% higher. Finally U.S. Treasury 10-year prices saw a strong rally the last few days of the month; however, the Managers are presenting a divided outlook for March, as 43% are bearish, 21% neutral and 36% bullish.
Regulator Okays Hedge Index
According to the Financial Times, a second European regulator has approved an investable hedge fund index as an eligible asset for funds operating under the European Union's UCITS III banner, potentially allowing retail investors greater access to the fruits of the hedge fund industry.
FTfm,
the Financial Times weekly review of the investment industry,
reported recently that Ireland had approved Ucits funds based on the FTSE Hedge Global Index and the FTSE Hedge Momentum Index. Luxembourg has followed suit by approving the Greenwich Composite Investable Hedge Fund Index, which was launched by Connecticut-based Greenwich Alternative Investments in 2003.
The investable index is based on 51 hedge fund managers across 16 investment strategies, and is designed to track the performance of Greenwich 's non-investable global index, which features 2,700 managers.
Greenwich is currently working with several companies interested in creating products based on the index, with the first offerings expected to be launched this year...more>>
To learn more, contact VanMac.
Trends
CalPERS Commits US$1.4 billion to Hedge, Private Equity Funds
The $240 billion (all figures are USD) California Public Employees' Retirement System (CalPERS) has committed a total of $1.4 billion to five private equity funds and a hedge fund.
Last month, according to FinAlternatives.com, CalPERS committed $500 million to the Riverstone/Carlyle Global Energy & Power Fund IV; $442 million to Bridgepoint Europe IV fund; $200 million to the Resolute Fund II; $106 million to Carlyle Europe Technology Partners II and $100 million to Advent Japan Private Equity Fund.
The Advent Japan Private Equity Fund is the first dedicated vehicle raised by Advent International to invest in Japanese middle-market companies “requiring a high degree of operational change and strategic direction”, according to CalPERS. The fund also committed $100 million to the Marquee Fund, a multi-strategy hedge fund run by Evnine & Associates.
“The EvA multi-strategy product will utilise ‘learning and forgetting' algorithms to adjust strategy weights,” according to CalPERS.
Alternative Asset Allocation top-up of $150 billion now due.
With volatility in equity markets and other traditional assets continuing the move into alternative investments should be an easy decision. But why is this obvious diversification decision just not that simple?
VanMac Group's Scott MacDonald recently found that the current allocation to alternatives in Australian superannuation funds (as of March 2008) is only 6-8%. Compared with top-performing US endowment funds, such as Harvard, Princeton and Yale Universities which are currently allocating 18-20% of their total portfolios to absolute return or hedge funds, this doesn't make sense.
In this article, he examines how Australian Super Fund managers can select high quality partnerships and pursue value adding strategies – and reweight their asset allocations to take advantage of movements in the global finance industry...more>>
Fund Flows
The highly-publicized problems in the sub-prime mortgage market, and its high-profile hedge fund victims, have not dampened investor enthusiasm for hedge funds. Global Hedge Fund assets stand at US$2.48Tr as at June 2007 representing an annual growth rate of 38%. Investors added $2.5 billion to hedge funds in January and $2.3 billion in December, according to TrimTabs and BarclayHedge.
Property Derivatives
Managers are exploring new strategies such as property derivatives funds. Property derivatives funds take advantage of previously unexploited inefficiencies in global property markets as property derivatives enable investors to hedge the returns of the physical market for the first time. These strategies generally seek to identify and exploit relative value opportunities between different property markets, sectors and instruments and have no relation to sub prime market. To learn more, contact VanMac.
Hedge Fund Replication
Hedge Fund replication continues to attract assets as vehicles for “alternative beta”. There is much research in the area, with the broad conclusion being that Hedge Fund replication strategies are limited in their ability to access the performance of hedge funds. Some institutional investors are using HF replication as a way of obtaining alternative beta, which is then complemented by alternative alpha. To learn more, contact VanMac.
Crisis Funds
New strategies called crisis funds are also raising money. As the name implies, these funds expect to post its best returns during market crises, such as the looming U.S. recession and upcoming elections, with lower and possibly negative returns in benign and bullish times. To learn more, contact VanMac.
130/30 Funds
130/30 or short extension funds continue to be launched by a number of firms, but the jury is still out on their performance. Generally they have struggled with the volatility caused by the sub prime fall out. Standard and Poors has recently launched the S&P 500 130/30 Index and Pro Shares are planning the launch of a 130/30 ETF. The S&P index pairs a 100% long position in the S&P 500 with a 30/30 alpha-seeking basket. That alpha-seeking basket takes thirty 1% long positions in stocks ranked 5-stars by S&P's analyst team and thirty 1% short positions in stocks ranked 1-star.
To learn more, contact VanMac.
Portable Alpha
Portable alpha funds will be where the next wave of investment will take place. Briefly, portable alpha strategies are based on investing in two assets, a passive exposure to conventional assets by way of an index, gained through leverage. This beta exposure is complemented by an exposure to an alpha source such as hedge funds. A survey by Edhec, the French business School, finds new approaches such as portable alpha (used by 21 per cent of survey respondents) and completeness portfolios (used by 9 per cent of survey respondents) are under-utilized by asset managers...more>>
General
Copulas
An interesting paper on Copula-Based Models for Financial Time Series was recently published by Andrew Patton of the Oxford-Man institute. Essentially, Copula theory overcomes the simplifying and incorrect assumption of multivariate normality of the joint distribution of the assets returns. As many studies have shown, in finance, the normality is rarely an adequate assumption. There is much evidence that asset returns are more highly correlated during volatile markets and during market downturns. A copula produces a multi-variate joint distribution combining the marginal distributions and the dependence between the variables...more>>
Learning from other people's mistakes
The Peloton story is of two ex-Goldman Partners Ron Beller and Geoff Grant, who set up an Asset Backed Securities (ABS) fund in 2006 and subsequently raised almost US$2bn. The partners correctly foresaw the sub prime problem and shorted the lowest rated issues, thereby returning over 80% for investors in 2007, helped by an estimated 5-6 times gearing levels. This year, they tried to time the sub prime market again, this time going long Alt-A securities, which are among the top rated issues, only to see them fall a further 15%, and decimating their capital base. The lesson is not so much on the pitfalls of market timing combined with leverage, but that of avoiding single strategy funds, especially if they are investing in a single market and not diversified, focusing on clearly enunciated and repeatable investment strategies and a long track record, rather than focusing on the latest judgment calls of one or two individuals.
Green Hedge Funds
With interest in green and socially responsible investing continuing to grow, green hedge funds are starting to attract interest – and are seeing strong returns in an area that is not overcrowded or dominated by large players.
Green hedge funds use strategies involving equities that only invest in green businesses, carbon trading, renewable energy credit trading, ethanol trading and emissions trading. Like other hedge funds, they earn returns for investors through risk arbitrage and variations of long-term value and short-term momentum growth plays. For example, some funds are investing in projects that cut emissions of greenhouse gases in order to earn cheap emissions credits that could be worth much more in the future.
According to Peter Fusaro, co-author of “Energy and Environmental Hedge Funds”, emissions markets and clean energy projects are a logical next step for hedge funds that have profited hugely on energy markets in the past...more>>
For the diary
ASFA 2008, the premier superannuation industry conference event will be held offshore this year, in Auckland , New Zealand from 12-14 November. Registrations for this year's event, themed Reaching New Heights, will commence on 1 April...more>>