SEPTEMBER 1, 2015
Using Hedge Fund Alpha Strategies to Improve Portfolio ConstructionShelly Heier & Jim Vos from Aksia, LLC
Why we favor hedge funds today
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1988 1994 1999 2005 2010
Yield (%)
Japan 10 Yr Yield US 10 Yr Yield
September 1, 2015Verus Client Summit
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
2008 2010 2011 2013 2014
MSCI ACWI NR USD MSCI EAFE NR USD
S&P 500 TR USD MSCI EM NR USD
End of the 30-year bull market in bonds?
Cresting of six-year bull market in equities?
2
Sources: Bloomberg, MSCI, Standard & Poors
The role of hedge funds
September 1, 2015Verus Client Summit
Source: SEI Hedge Fund Investor Survey
3
The low correlation promise
0% 10% 20% 30% 40% 50%
Ability to exploitmarket opportunities
Enhanced alpha generation
Decreased Volatility
Absolute Return
Diversification w/non‐correlated assets
What do hedge fund investors want?
September 1, 2015Verus Client Summit 4
Diminishing benefits?
September 1, 2015Verus Client Summit 5
Aggregate hedge fund correlation versus stocks and bonds
Source: Bloomberg, HFR, Barclays, MSCI, Verus. Equity returns represented by MSCI ACWI, while Bonds were represented by the Barclays Global Agg
(0.60)
(0.40)
(0.20)
‐
0.20
0.40
0.60
0.80
1.00
1997
1999
2001
2003
2005
2007
2009
2011
2013
Correlation
Correl ‐ EquitiesCorrel ‐ Bonds
(0.60)
(0.40)
(0.20)
0.00
0.20
0.40
0.60
0.80
1.00
1.20
1997
1999
2001
2003
2005
2007
2009
2011
2013
Correlation
Correl ‐ Equities
Correl ‐ Bonds
HFRI FUND OF FUNDS COMPOSITE HFRI FUND WEIGHTED COMPOSITE
Diminishing benefits?
September 1, 2015Verus Client Summit 6
Aggregate hedge fund beta versus stocks and bonds
Source: Bloomberg, HFR, Barclays, MSCI, Verus. Equity returns represented by MSCI ACWI, while Bonds were represented by the Barclays Global Agg
(1.00)
(0.50)
‐
0.50
1.00
1997
1999
2001
2003
2005
2007
2009
2011
2013
Beta
Beta ‐ EquitiesBeta ‐ Bonds
(1.00)(0.80)(0.60)(0.40)(0.20)0.000.200.400.600.801.00
1997
1999
2001
2003
2005
2007
2009
2011
2013
Beta
Beta ‐ Equities Beta ‐ BondsLinear (Beta ‐ Equities) Linear (Beta ‐ Bonds)
HFRI FUND OF FUNDS COMPOSITE HFRI FUND WEIGHTED COMPOSITE
Disintegrating the aggregate
‐0.4 ‐0.2 0 0.2 0.4 0.6 0.8
Emerging MarketsEquity Hedge (Total)Event Driven (Total)
Relative Value ‐ Yield AlternativesEvent Driven ‐ Distressed
Relative Value ‐ Convertible ArbitrageMacro ‐ Systematic
Relative Value (Total)Macro (Total)
Event Driven ‐ Merger ArbitrageEquity Market Neutral
Relative Value ‐ Asset‐Backed
Beta to Fixed Income Beta to Equities
September 1, 2015Verus Client Summit 7
Benefits and diversification capacity vary by strategy
Source: Analysis uses MSCI ACWI and BC Global Agg. MSCI, Barclays, Bloomberg, HFRI, Verus. Data from January 1995 to June 2015.
Disintegrating the aggregate
September 1, 2015Verus Client Summit 8
Benefits and diversification capacity vary by strategy
Source: Analysis uses MSCI ACWI and BC Global Agg. MSCI, Barclays, Bloomberg, HFRI, Verus. Data from January 1995 to June 2015.
0 0.2 0.4 0.6 0.8 1
Relative Value ‐ Asset BackedEquity Market Neutral
Macro (Total)Macro ‐ Systematic
Relative Value ‐ Convertible ArbitrageRelative Value ‐ Yield AlternativesEvent Driven ‐ Merger Arbitrage
Event Driven ‐ DistressedRelative Value (Total)
Emerging MarketsEvent Driven (Total)Equity Hedge (Total)
Correlation to Bonds Correlation to Equities
Adding alpha
5% 0% 8% 14% 4%
5%
‐8%
0%
0%
‐2%
2010 2011 2012 2013 2014EEquity Hedge
Returns in Excess of Benchmark BetaReturns Attributable to Benchmark Beta
September 1, 2015Verus Client Summit
3% 0%4%
9%
2%
9%
‐3%
5%
4%
2%
2010 2011 2012 2013 2014EEvent Driven
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Barclays Capital Solutions study based on HFR returns
Source: Barclays Capital Solutions, January 2015 “What Lies Beneath: 2015 Global Hedge Fund Industry Trends and Allocation Outlook”http://www.barclayscommunications.com/CapSol_Publications/520593/WhatLiesBeneath_USL.pdf
Beta to S&P 500: 0.41 0.54 0.57 0.47 0.47 0.26 0.38 0.29 0.29 0.24
Hedge fund “beta”
September 1, 2015Verus Client Summit 10
Certain strategies rely on premia that are widely documented and understood…
Source: HFR, IndexIQ, Bloomberg, Verus
R² = 0.5964HF
RI ED: M
erger A
rbitrage Index
IQ ARB Merger Arbitrage Total Return Index
Finding alpha… and finding impact
September 1, 2015Verus Client Summit 11
StrategyReturn‐
Enhancing Risk ReductionNew Risk Factors
(Diversification)
Equity Strategies
Long‐Short Equity
Market Neutral
Short‐Biased
Macro Strategies
Global Macro
Managed Futures
ArbitrageStrategies
Event Driven
Convertible Arbitrage
Fixed Income Arbitrage
High Impact Moderate Impact Low Impact
4%
5%
6%
7%
8%
0% 2% 4% 6% 8% 10% 12% 14% 16% 18%
Annu
alize
d Re
turn
Annualized Volatility
The impact of hedge funds
September 1, 2015Verus Client Summit 12
Historical risk and return (1995-2015)
Source: Bloomberg, Barclays, MSCI, HFR, JP Morgan. Data from January 1995 to June 2015.
30% Stocks70% Bonds
60% Stocks20% Bonds20% HF
100% Bonds
100% Stocks
50% Stocks50% Bonds
70% Stocks30% Bonds
20% Stocks60% Bonds20% HF
40% Stocks40% Bonds20% HF
Seeking alpha: FOF or direct?
Key considerations include:
1. Unbiased top‐down expertise for designing portfolio strategy
2. Bottom‐up expertise for evaluating and selecting managers
3. Independent expertise for evaluation of operational risks of managers
4. Administrative bandwidth for portfolio implementation and maintenance
September 1, 2015Verus Client Summit 13
As much a governance decision as cost decision
Hedge funds are not without challenges
― Leverage― Counterparty― Operational― Headline― Regulatory
Complex Fees Risk Opaque
September 1, 2015Verus Client Summit 14
― Activism― Crowding― Short skill― High
frequency trading
― Secrecy― Hidden beta― Frequent
trading
― $$$
Verus Alternatives Investment Committee
Verus hedge fund research staff
Verus hedge fund solution
September 1, 2015Verus Client Summit 15
Investment due diligenceOperational due diligenceComprehensive modeling & analytics
Oversight, review, and monitoring
Risk‐based evaluation & analysisTailored portfolio designFormal focus list
Verus Portfolio Managers, Consultants & Clients
Portfolio design & client communication
Aksia professionals
9%36%55%
Total Staff 95
Research Staff 57
Average Assets Under Advisory Committed to Hedge Funds: $1,280* mm
Total Clients : Total Staff .7 : 1
Monitored Funds : Operational Due Diligence Staff 12 : 1
Monitored Funds : Investment Due Diligence Staff 8 : 1
* Data as of August 2015. This includes advisory clients only and represents a conservative estimate of the assets our clients have committed to allocating to hedge funds based on most recently available information. Number is not inclusive of clients who do not disclose hedge fund allocations to Aksia.
Verus Client SummitSeptember 1, 2015
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Research coverage
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Insight Reports1 ODD2 IDD3 Monitored4
Long/Short Equity 188 393 206 82
Event Driven 169 165 121 65
Relative Value 137 173 104 54
Tactical Trading 76 180 123 50
Multi‐Strategy 25 57 47 24
Hedge Funds 595 968 601 275
*Data as of August 20151. Figures represent investment programs on which an investment insight report has been completed.2. Figures represent investment programs on which operational due diligence has been performed. Both onshore and offshore funds of the same program count as one.3. Figures represent investment programs on which investment due diligence has been performed. Both onshore and offshore funds of the same program count as one.4. Figures shown represent total number of investment programs on which we perform ongoing monitoring. Both onshore and offshore funds of the same program count as one.
September 1, 2015Verus Client Summit
Strategy Team & Structure Risk
― History & background― Investment strategy
overview― Investment risks― Capital allocation― Research / inv. process― Firm and fund structure
― Key staff and dependencies― Staff turnover― Compensation structure― Alignment of interests― Firm ownership structure
― Risk management philosophy
― Risk management team― Asset liability / mismatch― Risk exposure, leverage
and financing― Quantitative risk analysis
Investment due diligence
18September 1, 2015Verus Client Summit
Operational due diligence
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Infrastructure & Operational Process
Regulatory, Compliance & Background Document Review
― Competence of key staff― Counterparty relationships― Independence of NAV― Review of trading systems― Cash management process
― Regulatory registrations― Compliance culture & approach― History of examinations by
regulator(s)― Background checks on key
employees― Historical violations ― Conflicts of interest
Specialist review of:― Financial statements― Offering Memo― Form ADV
September 1, 2015Verus Client Summit
Risk framework
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Risk Exposures
Risk / Return Profile
Risk‐Based Position Sizing
Public Holdings
Alpha Analysis
Factor Replication
Liquidity Mapping
Active Management Attribution
September 1, 2015Verus Client Summit
Why we favor hedge funds today
0
1
2
3
4
5
6
7
8
9
10
1988 1994 1999 2005 2010
Yield (%)
Japan 10 Yr Yield US 10 Yr Yield
September 1, 2015Verus Client Summit
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
2008 2010 2011 2013 2014
MSCI ACWI NR USD MSCI EAFE NR USD
S&P 500 TR USD MSCI EM NR USD
End of the 30-year bull market in bonds?
Cresting of six-year bull market in equities?
21
Sources: Bloomberg, MSCI, Standard & Poors
Questions?
September 1, 2015Verus Client Summit 22
Thank you
September 1, 2015Verus Client Summit 23
Every asset class has a role
September 1, 2015Verus Client Summit 24
RETURN ROLES DIVERSIFICATION & VOLATILITY ROLES
Benefit from GDP Growth
Earn Risk Premium
Produce Stable Income
Hedge Against Inflation
Low Absolute Volatility
Low Corr. To Other Assets
Reduce Portfolio Volatility
Public Equities
Fixed (Credit)
Hedge Funds(Perceived role)
MAGNITUDEHigh Med‐High Medium Low None