the sigma perspective luis a. seco president and ceo
TRANSCRIPT
Hedge fund investingThe Sigma Perspective
Luis A. Seco
President and CEO, Sigma Analysis & Management
Sigma Analysis & Management
The Fields Institute
222 College Street
Toronto, Ontario M5T 3J1
Agenda
History of a decade (1994-2004): myths and facts
Hedge Fund Indices: the likely mistake for 2005
The perspective on hedge fund investments
Conclusions
Sigma Analysis & Management
Marriage between business and academia: the RiskLab
Risk Management and Asset Management background
Founded in 1999 as an institutional advisor. In 2002 became manager for family offices. In 2004 it joined Quadrexx to bring a risk-controlled product to the retail market.
11 employees in Canada, US and UK.
Clients: Canadian banks and pension plans, US family offices, Insurance Companies and Pensions.
History of a decade: 1994-2004
CSFB Hedge Fund Index
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1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Interest rate vol Credit crunch Interest rate vol
The myth of 1998: Fixed income is bad”
CSFB Hedge Fund Index - Fixed Income 1998
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Facts (1998)
“Fixed Income arbitrage” suffered generalized losses: -8%
“equity hedged” obtained generalized gains: +13% (M.F. +20%)
A balanced hedge fund portfolio would have been OK in 1998.
Investors decide to avoid Fixed Income as a style.
The myth of 2003:“Hedge funds (equity hedged) are good”
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Dec-02 Jan-03 Feb-03 Mar-03 Apr-03 May-03 Jun-03 Jul-03 Aug-03 Sep-03 Oct-03 Nov-03 Dec-03
HFRI Convertible Arbitrage Index
HFRI Distressed Securities Index (Offshore)
HFRI Equity Hedge Index
HFRI Equity Market Neutral Index
HFRI Event-Driven Index
HFRI Fixed Income: Arbitrage Index
HFRI Fixed Income: Mortgage-Backed Index
HFRI Merger Arbitrage Index
HFRI Relative Value Arbitrage Index
Facts: 2003
Most hedge fund styles obtained great returns.
The style “equity hedge” came out on top: +17%.
Investors moved en-masse to this style for 2004, forgetting all others.
The myth of 2004: “hedge funds are bad”
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Dec-03 Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04 Jul-04 Aug-04
HFRI Convertible Arbitrage Index
HFRI Equity Hedge Index
HFRI Equity Market Neutral Index
HFRI Merger Arbitrage Index
The facts: 2004
“Equity hedge” lost, as a style, in 2004.
Many investors, who trusted this (the most common), lose confidence.
Speculation arises as to whether hedge funds continue to bring value to investors portfolios.
Myth and science in 2004
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Dec-03 Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04 Jul-04 Aug-04
HFRI Convertible Arbitrage Index
HFRI Distressed Securities Index (Offshore)
HFRI Equity Hedge Index
HFRI Equity Market Neutral Index
HFRI Event-Driven Index
HFRI Fixed Income: Arbitrage Index
HFRI Fixed Income: Mortgage-Backed Index
HFRI Merger Arbitrage Index
HFRI Relative Value Arbitrage Index
Many hedge fund strategies have performed poorly in 2004... but quite a few of them seem to be recovering, and some have not been affectedby the "bad times"at all.
Science: lessons from history
Hedge funds continue to provide diversifying returns.
One should never favor one style against another based on simplistic rear-looking arguments.
The main property of hedge funds is their low correlation: this should not be destroyed with directional bets or unfounded decisions.
Hedge Funds
Hedge Funds, unlike traditional investments, show little cohesion.
This is what makes them attractive: they add diversification.
Because of hedge fund diversity, a hedge fund index is going to fail to capture anything of interest; they are plain fund-of-funds
Differences with stock indices
Index constituence is a function of liquidity, operations, etc. not performance.
Unlike stock indices, investors don’t like their hedge funds to be included in hedge fund investable indices
Alpha and beta
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Dec-03 Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04 Jul-04 Aug-04
Sigma Convertible Arbitrage Subindex
HFRI Convertible Arbitrage Index
Even w ithin a strategy w hose index is performing poorly, returns can be remarkably diverse. The index may be an inaccurate indicator of w hat may be achievable w ithin the strategy.
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alpha
Indices in 2003
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Dec-03 Jan-04 Feb-04 Mar-04 Apr-04 May-04 Jun-04 Jul-04 Aug-04
CSFB-Tremont HFI Investible Hedge Fund
HFRXGL Index
S&P Hedge Fund Index
Index correlations
CSFB Hedge Investible Index 1.00MSCI Composite Equal-Weighed Index 0.47 1.00MSCI Composite Asset-Weighed Index 0.51 0.98 1.00S&P Hedge Fund Index 0.41 0.90 0.94 1.00Van Global Hedge Fund Index 0.80 0.48 0.51 0.41 1.00
What investors should keep in mind
Absence of correlation continues to be the best aspect of hedge fund investing.
Correlations change, and an investment should not be left to diversification exposure, which affects the portfolio in the most difficult times.
There are many mediocre hedge funds, but there are still many which are excellent.
Risks to avoid: distressed alignment
Equity vs Fixed Income CTA vs Fixed Income
Equity vs Fixed Income
Other risks
Style risk
Concentration
Valuation
Liquidity
Operational risk
Blow-up
Non-diversifiable
Non-diversifiable
Non-diversifiable
diversifiable
diversifiable
diversifiable
The Reference Portfolio
Identify the risks.
Get a target return.
Produce a risk tolerance.
Mathematize the simultaneous risk mitigation problem.
Do the math
Investment design
Get a low risk hedge fund foundation: modest return, minimal risk.
Performance independent of market events
Get proper liquidity for the underlying hedge funds
Lever on the low risk levels of the foundation to enhance returns