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EDHEC Funds of Hedge Funds Reporting Survey
Mathieu Vaissié
Press Conference, London February 17th
11
Contents
♦ Section 1: Introduction
♦ Section 2: The Specific Characteristics of Hedge Fund Performance
♦ Section 3: The Current Practices of Market Participants
♦ Section 4: Edhec Recommendations for Fund of Hedge Fund Reporting
♦ Section 5: Conclusion
2
Introduction
Section 1
33
Introduction: The FoHF Reporting Quagmire
♦ Why should FoHF reporting differ from Mutual Fund reporting?
Hedge fund strategies are more complex than traditional buy-and-holdstrategiesRelevant information has never been clearly defined
♦ Why is the question of FoHF reporting becoming so urgent?
FoHF manage USD 541bn and control over half of the hedge fund industry(Source: InvestHedge)
Most institutional investors gain exposure to hedge fund strategies throughFoHF
4
The Specific Characteristics of Hedge Fund Performance
Section 2
55
Extreme Risks
0.046.671.140.48Short Selling0.0067.493.73-1.38Relative Value0.00354.59.65-2.27Merger Arbitrage0.0017.911.490.93Global Macro0.0029.063.110.20Funds of Hedge Funds0.002829.4628.73-4.57Fixed Income Arbitrage0.00378.6210.18-2.12Event Driven0.193.370.490.46Equity Market Neutral0.381.940.860.05Equity Long Short0.00117.585.66-1.24Emerging Markets0.00303.269.20-1.84Distressed Securities0.870.29-0.080.13CTA0.0031.152.31-1.07Convertible Arbitrage
SignificanceBera-JarqueStatisticExc. KurtosisSkewness
Statistical Properties of Hedge Fund Strategies (from January 1997 through December 2004)
Hedge fund strategies show significant extreme risks
66
Key Drivers of Hedge Fund Performance
Hedge Fund Strategies’ Long-Term Exposures to Major Risk Factors (Panel A)
** Factor that became insignificant with the unsmoothing procedure* Factor that became significant with the unsmoothing procedure0.23-0.290.420.26-0.190.200.23CTA
0.21*-0.22-0.50-0.24**0.740.36-0.23-0.57-0.29Long/Short Equity
-0.75**0.560.36-0.59-0.41Distressed Securities
0.25-0.58-0.25-0.260.580.25-0.50-0.22Merger Arbitrage
**-0.55**0.26-0.21*Convertible Arbitrage
0.340.22-0.31-0.23-0.330.430.230.34-0.31Equity Market Neutral
Goldm
an Sachs C
omm
odity Index
US
dollar
T-Bill 3 m
onths
Historical V
olatility of the LGB
I
Lehman G
lobal Bond Index (LG
BI)
∆C
redit Risk
Credit R
isk
Yield Curve
S&
P 500 Index
∆S
mall C
ap versus Large Cap
Sm
all Cap versus Large C
ap
Value versus G
rowth
∆Im
plied Volatility (V
IX)
Implied V
olatility (VIX
)
UnconditionalCorrelationCoefficients (from January 1997 through December 2004)
Other FactorsBond FactorsEquity Factors
Hedge funds are exposed to a wide variety of risk factors
77
Key Drivers of Hedge Fund Performance
Hedge Fund Strategies’ Conditional Exposures to Major Risk Factors (Panel B)
Hedge funds’ risk factor exposures are non-linear
Significant Factor showing stable correlation with the style index
Insignificant Factor
-0.32-0.52CTA Global
-0.130.60Long/Short Equity
-0.330.56-0.72-0.21Distressed Securities
-0.220.59-0.67-0.21-0.420.09Merger Arbitrage
-0.650.06Convertible Arbitrage
Equity Market Neutral
HLHLHL
S&
P 500 return
Change in Im
plied volatility (V
IX)
Implied
volatility(V
IX)
ConditionalCorrelationCoefficients (from January 1997 throughDecember 2004)
Equity Factors
0.060.27
-0.77-0.08
-0.510.110.410.66
HLHLHL
Historicalvolatility
Bond
return
Change in C
reditSpread
Change in Term
Spread
Bond Factors
88
Key Drivers of Hedge Fund PerformanceHedge Fund Strategies’ Dynamic Exposures to Major Risk Factors (Panel C)
Hedge funds’ risk factor exposures are time-varying
-0.80
-0.60
-0.40
-0.20
0.00
0.20
0.40
0.60
0.80
1.00
Jan-
99
May
-99
Sep-
99
Jan-
00
May
-00
Sep-
00
Jan-
01
May
-01
Sep-
01
Jan-
02
May
-02
Sep-
02
Jan-
03
May
-03
Sep-
03
Jan-
04
May
-04
Sep-
04
CBOE SPX VOLATILITY VIX(NEW) - PRICEINDEXChange in VIX
Goldman Sachs CommodityIndex - PRICE INDEX
Term Spread
Credit Spread
Change in Term Spread
Change in Credit Spread
S&P 500 COMPOSITE - PRICE INDEX
Value minus Growth
Change in Value minus Growth
Small minus Large
Change in Small minus Large
ML T - BILL 3 MONTH ($)
US $ MAJOR CURRENCY MAR73=100 (FED) - EXCHANGE INDEX HISTORICAL VOLATILITY - LEHMAN USAGGREGATELEHMAN US AGGREGATE
24-month rolling window correlation coefficients of the Equity Market Neutral with risk factors (from January 1997 through December 2004)
9
The Current Practices of Market Participants
Section 3
1010
The Current Practices of Market Participants
Which indicators and information do European FoHF use for reporting to their clients?
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Vola
tility
Shar
pe R
atio
Perfo
rman
cere
lativ
e to
abe
nchm
ark
Styl
e an
alys
is
Sorti
no R
atio
VaR
est
imat
ion
Leve
rage
effe
ct
Con
ditio
nal
beta
s
No
answ
er
Source: Edhec European Alternative Multimanagement Practices Survey, 2003
1111
The Current Practices of Market Participants
Source: Edhec European Alternative Multimanagement Practices Survey, 2003
0%
10%
20%
30%
40%
50%
60%
Sha
rpe
Rat
io
Sor
tino
Rat
io
M2
or S
RAP R
atio
s
Dra
wdo
wn
Rat
io
Ret
urn/
VaR
Info
rmat
ion
Rat
io
Ret
urn
Sem
i-dev
iatio
n
Cor
rela
tion
Sta
ndar
d de
viat
ion
Bet
a
Alp
ha
Om
ega
B VaR
Very ImportantImportantNot very importantNot considered
Which Quantitative Indicators do you use when monitoring manager performance?
12
Edhec Recommendations for Fund of Hedge Fund Reporting
Section 4
1313
Profile of the Respondents
98 professionals spontaneously decided to take part in our examination of FoHF reporting.
These professionals work for major traditional and alternative institutions, representing over $1.1 trillion in assets under management.
FoHF Manager61%
Investor39% <$250 mn
34%
$250 mn to $1 bn 33%
$1 bn to $5 bn 21%
> $5 bn 12%
< 5 years 27%
5 to 15 years 51%
> 15 years 22%
1414
Granularity and Frequency
Do you see any acute issue as regards both the risk and return dimensions that could not be accounted for in a
monthly activity report?
27%30%
21%
67%63%
74%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
All Respondents FoHF Managers Investors
Yes No
♦EDHEC Position: Monthlyfrequency is appropriate for FoHF reporting
♦Fund managers (especiallythose managing small funds) are more demanding thaninvestors as regards reportingfrequency
1515
Granularity and Frequency
How should information ideally be aggregated in the monthly activity report?
67%
80%
55%
20%
14%
37%
4%
60%
90%
43%
13% 13%
33%
7%
79%
63%
74%
32%
16%
42%
0%0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Fund
Stra
tegy
Stra
tegy
Gro
up
Cur
renc
y
Cou
ntry
Asse
t Typ
e
Oth
er
All Respondents FoHF Managers Investors
♦EDHEC Position: there should bethree aggregation levels, namelyStrategy Group, Strategy and Fund. The degree of information granularityshould be suited to the aggregationlevel. We also suggest that thebreakdown by asset type and level of liquidity should be given at the strategy group level.
♦Caveat: beware of the data overkilleffect !
♦Investors are more demanding thanfund managers (especially thosemanaging small funds) as regards reporting granularity
1616
Return Analysis
♦EDHEC Position: Monthly andannual returns should be given at allaggregation levels. Historical returns, YTD or cumulative returns sinceinception should be reserved for strategy group and strategy levels.
♦Fund managers put much more emphasis on YTD than investors (i.e. important to very important for 97% vs 79%) and cumulative returns (i.e. important to very important for 80% vs 58%).
How important, in your opinion, is the history of monthly returns?
0%0%
24%
76%
Irrelevant Not Important Important Very Important
How important, in your opinion, is the history of annual returns?
2%6%
41%
51%
Irrelevant Not Important Important Very Important
1717
Return Analysis
♦EDHEC Position: Performance relative to an (appropriate) benchmark as well as performance conditional on equity andbond market conditions should bedisclosed at strategy group and strategylevels.
♦Performance at FoHF level should bedisclosed over 12/24/36/48/60 trailingmonths to ease the screening process for investors
♦Fund managers put much more emphasis on relative returns thaninvestors (i.e. important to very important for 80% vs 58%)
How important, in your opinion, are relative returns? (Managers)
17%
37%
43% 0%3%
Irrelevant Not Important Important Very Important No Answer
How important, in your opinion, are relative returns? (Investors)
0%
42%37%
21% 0%
Irrelevant Not Important Important Very Important No Answer
1818
Risk Analysis
♦EDHEC Position: riskindicators should span the wholespectrum of risk (i.e. normal, loss, extreme risks). This information should be disclosedat the strategy group andstrategy levels.
♦Investors are more concernedby risk than fund managers, especially as regards extremerisks (e.g. very important for 42% vs 3% as regards Style VaR or for 25% vs 3% for B-VaR)
How important, in your opinion, are the following extreme risk indicators?
4%7%
0%
10%
13%
5%
12%
17%
5%
35%
43%
21%
39%
43%
32% 31%
37%
21%
39%
32%
37% 37% 37%35%
32%
18%
3%
42%
4%
0%
11%12%
3%
26%
4% 3%5%
10%
7%
16%
10%
7%
16%
37%
43%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
All
Res
pond
ents
FoH
FM
anag
ers
Inve
stor
s
All
Res
pond
ents
FoH
FM
anag
ers
Inve
stor
s
All
Res
pond
ents
FoH
FM
anag
ers
Inve
stor
s
Style-VaR Cornish-Fisher VaR Beyond VaR
Irrelevant Not Important Important Very Important No Answer
1919
Risk-adjusted Return Analysis
How important, in your opinion, are the following risk-adjusted performance indicators?♦EDHEC Position: Risk-adjustedperformance indicators shouldaccount for the different definitionsof risk (e.g. Sharpe, Sortino, Calmar, Omega ratios) and bedisclosed at the Strategy Group and Strategy levels.
♦Results of the performance attribution process should beintegrated in the reporting
♦Investors are more interested in alternative ratios (i.e. veryimportant for 32% vs 17%) and theresults of the performance attribution process (i.e. veryimportant for 63% vs 43%) thanfund managers
4% 3%5%
2% 3%0%
6% 7% 5%
18%20%
16%
20%23%
16%
31% 30% 32%
43%40%
47%45%
37%
58%
40%
16%
35%37%
32%29%
16%
22%
17%
0% 0% 0%
4%
0%
11% 10%7%
16%
31%
37%
32%
0%
10%
20%
30%
40%
50%
60%
70%
All
Res
pond
ents
FoH
FM
anag
ers
Inve
stor
s
All
Res
pond
ents
FoH
FM
anag
ers
Inve
stor
s
All
Res
pond
ents
FoH
FM
anag
ers
Inve
stor
s
Sharpe ratio Sortino ratio Omega ratio
Irrelevant Not Important Important Very Important No Answer
2020
Beta and Correlation Analysis
How important, in your opinion, are static and dynamic style/factor analysis?♦EDHEC Position: static/dynamicstyle as well as unconditional/conditional factor analysis should bedisclosed at the FoHF level
♦Factor analysis at Strategy Group and Strategy levels should also beperformed to integrate a riskattribution process into the reporting
♦Investors are more interested in style analysis (e.g. very important for 37% vs 20%), factor analysis (e.g.important to very important for 85% vs 56%), and conditional exposures to risk factors (e.g. very important for 58% vs 20%) than fund managers (especially those running small funds)
4%7%
0%
6% 7% 5% 4%7%
0%
14%17%
11% 10%
17%
0%
18%
30%
0%
47% 47% 47%45%
53%
32%
39%
43%
32%
27%
20%
37%35%
20%
58%
29%
13%
53%
8%10%
5% 4% 3%5%
10%7%
16%
0%
10%
20%
30%
40%
50%
60%
70%
All
Res
pond
ents
FoH
FM
anag
ers
Inve
stor
s
All
Res
pond
ents
FoH
FM
anag
ers
Inve
stor
s
All
Res
pond
ents
FoH
FM
anag
ers
Inve
stor
s
Static and dynamic styleanalysis
Static factor analysis Dynamic factor analysis
Irrelevant Not Important Important Very Important No Answer
21
Conclusion
Section 5
2222
Conclusion: Light at the End of the Tunnel?
♦Market participants’ practices are still strongly influenced by those observed in the traditional world
♦However:
On the one hand, there is a broad consensus among investors and fund managers on the definition of relevant information
On the other hand, market participants’ practices are evolving and converging towards academic recommendations
♦FoHF should inform investors on:
The level of return and risk
The nature of risk
The results are encouraging, but good intentions now have to be followed by concrete changes in practices!
2323
References
•Edhec, 2003, Edhec European Alternative Multimanagement Practices Survey
•Edhec, 2005, Edhec Funds of Hedge Funds Reporting Survey
2424
Contact
Edhec Risk and Asset Management Research Centre393-400 promenade des AnglaisBP 3116F- 06202 Nice Cedex 3FRANCE
Tel.: +33 (0)4 93 18 78 24Fax: +33 (0)4 93 83 08 10
e-mail: [email protected]: http://www.edhec-risk.com
