1. Is the grass greener on the other side of the hedge (fund)?
NEW ZEALAND | Investment Briefing 2016
Is the grass greener on the other side of the hedge (fund)?
Bill Muysken, Chief Investment Officer, Alternatives

2. What we’ll cover… The duration connection
Recent hedge fund performance
How disappointing has it really been?
The mystery of hedge funds
Where do their returns come from?
Multi-asset funds
Are they a better solution?

3. The duration connection

4. The duration connection discount rate change and effective duration for selected assets from to year end-2015
Change in Discount Rate
Effective duration
Private Equity
-1.5% 31
30-year JGB
-1.8% 29
30-year Bund
-2.8% 27
Venture Capital 23
30-year Gilt
-2.1% 22
S&P 500 21
30-year US Treasury
MSCI EAFE
-1.0% 19
MSCI Emerging
+0.8%
MSCI US REIT
-1.6%
Private Real Estate
-2.9% 17
HFRI Index (“Alts”) 2
S&P/GSCI reduced Energy Index 1
Cash
-3.0%
Source: GMO

5. Recent hedge fund performance
How disappointing has it really been?

6. asness: Did Hedge Funds Disappoint?
MAYBE, BUT NOT FOR THE REASONS YOU OFTEN HEAR ABOUT
Returns: 2009 Through August 2016
S&P 500
Hedge Funds
Hedge Funds – S&P 500
2009
26%
19%
-7%
2010
15%
11%
-4%
2011 2%
-6%
2012
16% 7%
-9%
2013
32% 9%
-23%
2014
14% 4%
-10%
2015 1%
-1%
-2%
2016 YTD 8%
-0%
-8%
Sources: AQR, Credit Suisse Hedge Fund Index, and HFRI. “Hedge Funds” are an average of the Credit Suisse Hedge Fund Index and the HFRI Fund-Weighted Hedge Fund Index, both of which are net of fees. Past performance is not a guarantee of future performance.

7. Asness: Did Hedge Funds Disappoint?
THE CORRECT COMPARISON
You can think of their returns as (using historical beta):
Hedge funds = alpha * S&P noise
Returns: 2009 Through August 2016
S&P 500
Hedge Funds
Hedge Funds – S&P 500
2009
26%
19%
-7%
2010
15%
11%
-4%
2011 2%
-6%
2012
16% 7%
-9%
2013
32% 9%
-23%
2014
14% 4%
-10%
2015 1%
-1%
-2%
2016 YTD 8%
-0%
-8%
Hedge Funds – 0.36 * S&P 500
+10%
+5%
-5%
+1%
-2%
-1%
-3%
Better, but still anemic
Sources: AQR, Credit Suisse Hedge Fund Index, and HFRI. Results are similar using the MSCI World index. Regression based on January 1994 through August 2016 using overlapping, rolling annual (excess over T-bills) returns. “Hedge Funds” are an average of the Credit Suisse Hedge Fund Index and the HFRI Fund-Weighted Hedge Fund Index, both of which are net of fees. The right column uses excess of cash data. Past performance is not a guarantee of future performance.

8. Analysing hedge fund returns taking the asness approach further
Data series versus MSCI World
HFRI Fund of Funds Composite Index
Equity beta
0.31
Portfolio 1
0.24
7.0%
4.0%
1.6%
-2.1%
2.0%
HFRI FoF: Market Defensive Index.4
Portfolio 2
0.04
0.11
-1.6%
0.0%
3.8%
1.7%
6.1%
-3.0%
1.0%
Residual alphas for 12 mths to:
30 June 2013
30 June 2014
30 June 2015
30 June 2016
0.9%
1.3%
-4.9%
4 years to 30 Jun 16 (pa)
-0.4%

9. The mystery of hedge funds
Where do their returns come from?

10. The mystery of hedge funds where do the returns come from?
Traditional beta?
Traditional alpha?
Alternative risk premia?
Are they really smarter than long-only managers? Or do they just think they are?

11. The mystery of hedge funds so what is the special sauce?
There are many different types of hedge funds, and their returns come from lots of different sources
What makes them different is their ability to capture additional sources of return that traditional long-only managers are unable to access because of the restrictions imposed by their mandates
Many of these return sources owe their very existence to the impact of mandate restrictions applying to long-only managers
To win the game you don’t need to be the smartest person in the room
you just need to find a game where the other players are held back in some way

12. A simplified example small stock abc
Small Stock ABC is so small it has a zero weight in the index
20% of active long-only and hedge fund managers think its going to double
20% of the long-only managers take a 2% overweight position
20% of the hedge fund managers take a 6% long position (taking triple the active risk)
But the other 80% think it’s going to halve
80% of the active long-only managers don’t hold it
80% of the hedge fund managers take a 6% short position
Small Stock ABC announces some adverse developments, and the stock halves
It turns out that the majority (80%) of both active long only and hedge fund managers were right about ABC
but only the hedge funds were able to take advantage of that

13. A simplified example so how did it all work out?
The active long-only managers were 0.4% overweight ABC on average
So as a group they lost 0.2% on the stock when it halved
The hedge fund managers were 3.6% short ABC on average
So as a group they made 1.8% on average when it halved
The active long-only managers lost money, not because most of them were wrong, but because of the long-only constraint
and this allowed the hedge funds to make money at their expense
NOTE: to clear the market in the above example you would need to have $9 invested in active long-only funds for every $1 invested in long/short equity funds

14. what other advantages do they have?
Hedge fund versus active long-only
Active long-only managers tend to have a structural bias to be overweight small/midcap stocks and underweight the larger stocks
Active long-only managers need to have views on all of the big stocks

15. Hedge fund versus active long-only
ARE THEY WORTH IT?
Hedge funds typically run 2 to 4 times as much active risk than long-only funds
The return per unit of active risk should be higher for hedge funds than for equally skilled active long-only managers (before allowing for fees)
But hedge funds have lower capacity than active long-only strategies

16. Does it really happen in practice? a real life case Study
MANAGER “X” runs a… 
Long-only global equity strategy, and… 
a Market Neutral Long/Short version of the same strategy.
Driven by the same quantitative alpha signals…
…so a baseline for a fair comparison between the two strategies.

17. DOES IT REALLY HAPPEN IN PRACTICE? Manager X – 71 months to 31 aug 16
Excess
return
before fees
% pa
Active
risk before fees %
Excess return per unit of active risk before fees
Excess return net of fees
Active risk net of fees
Excess return per unit of active risk net of fees
Long only
global equity
-0.8
4.0
-0.2
-1.4
-0.3
Market neutral hedge fund
11.0
10.8
1.0
7.1
9.3
0.8

18. Outlook for hedge fund returns so what could spoil it?
Too much money flowing into
hedge funds
Continuation of the trend from active long-only active to passive

19. Are they a better solution?
Multi-asset funds
Are they a better solution?

20. Multi-asset funds (dgf’s) are they a better solution?
Fees are materially lower than for hedge funds
Many carry considerable equity market beta
The remainder are essentially a hybrid between an active long-only strategy and a single manager hedge fund

21. Multi-asset funds (DGF’s) are they a better solution?
Data series
DGF 1
DGF 2
DGF 3
DGF 4
DGF 5
DGF 6
DGF 7
DGF 8
DGF 9
DGF 10
DGF 11
Equity beta
0.34
0.38
0.37
0.57
0.50
0.07
0.18
0.30
0.28
Average
0.35
0.0 Hf
port 1 2
0.24
0.11
2.0
1.7
Residual alphas over 4 years to 30 Jun 16 (% p.a.)
0.3
-1.1
-0.3
-1.5
-3.0
0.0
0.8
2.7
1.4
0.2

22. In summary Beware the Duration Effect when interest rates go up
Hedge fund performance has been better than the headlines might suggest
The mystery of where hedge fund returns come from has been solved
Multi-asset funds only make sense for investors who have fee budget constraints

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