KCS Fund Strategies Inc. Disciplined Fund of Hedge Funds Portfolio Management Contemporary Perspectives on Hedge Fund Investing CFA Victoria – February

KCS Fund Strategies Inc.Disciplined Fund of Hedge Funds Portfolio Management

Contemporary Perspectives on Hedge Fund Investing

CFA Victoria – February 21st, 2007

Page 2

Agenda

Why add hedge funds to a portfolio?

Why take a portfolio approach?

What are the merits of low volatility hedge funds?

Is an equity investing framework useful?

Page 3

What is a Hedge Fund?

Page 4

DescriptionWhat is a Hedge Fund?

Similar to mutual fund Professionally managed pool of assets Specified objectives

Investors typically must be qualified or accredited

Short positions/hedging allowed Leverage Position concentration Lower liquidity Trading strategy ≠ investment strategy

Page 5

Hedge Fund Strategies

1. Equity Long/Short2. Equity Market Neutral3. Dedicated Short Bias4. Emerging Markets5. Convertible Arbitrage6. Fixed Income Arbitrage7. Event Driven

Merger Arbitrage Distressed

8. Global Macro 9. Managed Futures / CTA10. Multi-Strategy


Page 6

Hypothetical Convergence/Divergence Pairs Trade

50

60

70

80

90

100

110

Pri

ce

Asset 1 Asset 2

Trade Completed

Trade Initiated

Trade Completed

Trade Initiated


Typical Hedge Fund Trade

Page 7

Typical Hedge Fund Trading ModelWhat is a Hedge Fund?

A convergence hypothesis underlies the trading model of most hedge fund managers

Trading models are analogous to business models for private or public companies

Evaluation of likelihood of success is similar: Focus on quality, track record of managers Ensure strategy is well articulated Look for sustainable competitive advantages

Page 8

Why add Hedge Funds to a Portfolio?

Page 9

Stability of Returns & Outperformance


Growth of $100 since February 1997*

75

100

125

150

175

200

225

250

Feb-97 Feb-98 Feb-99 Feb-00 Feb-01 Feb-02 Feb-03 Feb-04 Feb-05 Feb-06

Tremont Index HFR FoF Index TSX Index S&P 500 Index Scotia Bond Index

Page 10

High Return per Unit of Risk

CSFB/Tremont Indices vs. Traditional Assets – Since February 1997

9.8%

7.2%

9.0%7.1%

15.2%16.3%

0%

5%

10%

15%

20%

Tremont Hedge Fund Index S&P 500 TSX

Returns

Standard Deviation


Page 11

Diversification Benefits

Correlations – Since February 1997

CSFB/Tremont S&P 500 TSX

S&P 500 0.43

TSX 0.62 0.79

Scotia Bond Index 0.12 -0.02 0.05


Page 12

Drawdown & Recovery Drawdown

Period of negative returns from peak to trough

Hedge Fund Indices Less severe and faster recovery

Other Metrics - Since February 1997

% PositiveMonths

Maximum Drawdown

Months to Recover

/ % Yet to Recover

S&P 500 60.5% -46.28% 52 / 6.55%TSX 61.3% -45.05% 38 / none

Scotia Bond Index 69.7% -11.19% 9 / noneHFRI Conservative FoF Index (HFRI CFI) 77.3% -6.62% 6 / none

CSFB/Tremont Index 71.4% -13.81% 12 / none


Page 13

The Need for a Portfolio Approach

Page 14

26.27%

83.18%

55.59%

16.40%

0

10

20

30

40

50

60

70

80

90

BCE Nortel Kinross TSX

Annualized Standard Deviation of Various Equities

Benefits of Portfolio ApproachNeed for a Portfolio Approach

Page 15

Benefits of Portfolio ApproachNeed for a Portfolio Approach

13.72%12.44%

7.82%5.81%

0%

5%

10%

15%

20%

25%

30%

10 Largest Canadian

Hedge Funds

Annualized Standard Deviations of Hedge Funds

10 Largest Global

Hedge Funds

CSFB/TremontHedge Fund

Index

HFRI Fund of Funds

Index

Page 16

Risk of One Stock vs One Hedge FundNeed for a Portfolio Approach

BCE - February 1997 to December 2006

0%

5%

10%

15%

20%

25%

30%

35%

40%

50%40%30%20%10%0%-10%-20%-30%-40%

Representative Canadian Hedge Fund - February 1997 to December 2006

0%

5%

10%

15%

20%

25%

30%

35%

40%

50%40%30%20%10%0%-10%-20%-30%-40%

Page 17

Risk of non-“Blue Chip” stocks

Some extreme returns exceed scale and are lumped at +/- 50%

Nortel Networks Corp. - February 1997 to December 2006

0%

5%

10%

15%

20%

25%

30%

35%

40%

50%40%30%20%10%0%-10%-20%-30%-40%

Kinross Gold Corp - February 1997 to December 2006

0%

5%

10%

15%

20%

25%

30%

35%

40%

50%40%30%20%10%0%-10%-20%-30%-40%

Need for a Portfolio Approach

Page 18

Risk of Hedge Fund Index vs Equity IndexS&P 500 Index - February 1997 to December 2006

0%

5%

10%

15%

20%

25%

30%

35%

40%

50%40%30%20%10%0%-10%-20%-30%-40%

Credit Suisse / Tremont Hedge Fund Index - February 1997 to December 2006

0%

5%

10%

15%

20%

25%

30%

35%

40%

50%40%30%20%10%0%-10%-20%-30%-40%


Page 19

Risk of Hedge Fund Index vs Equity Index


TSX Index - February 1997 to December 2006

0%

5%

10%

15%

20%

25%

30%

35%

40%

50%40%30%20%10%0%-10%-20%-30%-40%

Scotia Capital Universe Bond Total Return Index - February 1997 to December 2006

0%

5%

10%

15%

20%

25%

30%

35%

40%

50%40%30%20%10%0%-10%-20%-30%-40%

Page 20

The Merits of Low Volatility Hedge Funds

Page 21

Hedge Fund Strategy Risk Profiles

Hedge Fund Strategies to the left are less volatile and have higher return per unit of risk (i.e. standard deviation).

Merits of Low Volatility Hedge Funds

CSFB/Tremont Risk/Return - Since February 1997 - Annualized

9.9% 9.8%

5.4%9.0%

10.7%11.9% 12.4%

7.1%9.6%

-1.5%

2.7% 3.6% 3.8% 4.8% 5.9%9.4% 10.7%

11.9% 15.0%

17.8%

-5%

0%

5%

10%

15%

20%

Equity MarketNeutral

Multi Strategy

Fixed IncomeArbitrage

ConvertibleArbitrage

Event Driven

Global Macro

Long / ShortEquity

ManagedFutures / CTA

EmergingMarkets

DedicatedShort Bias

TremontReturnsTremont StdDeviation

Page 22

Hedge Fund Strategy Betas

Hedge Fund Strategies to the left have lower beta (i.e. sensitivity) to the S&P 500.

CSFB/Tremont Strategy Betas vs. S&P 500 - Since February 1997

0.07 0.04 -0.01 0.040.21

0.10

0.40

-0.13

0.54

-0.91

-1.0

-0.5

0.0

0.5

1.0


Multi Strategy



Event Driven

Global Macro

Long / ShortEquity


EmergingMarkets

DedicatedShort Bias

Merits of Low Volatility Hedge Funds

Page 23

Best Diversification includes Global HFs Globally $1.5 Trillion with 8,000 managers Canada approx. $60 Billion with 70+ managers (Canada

Hedge Watch)

As of December, 2006

Scotia HF Index

CSFB/Tremont Index

27 Managers Strategies 341 Managers

39 Funds 410 Funds 56 % Equity L/S 28 % 11 % Multi -Strategy 11 % 10 % Market Neutral 4 % 9 % Event Driven 24 % 2 % Managed Futures 5 % 2 % Fixed Income 8 % 3 % Global Macro 11 % 0 % Emerging Markets 4 % 2 % Convertible Arbitrage 2 % 2 % Dedicated Short Bias 1 %

3 % Other 2 %


Page 24

Applying an

‘Equity Investing Framework’

to Hedge Funds

Page 25

U.S. Value Stock Selection ProcessQuantitative Screens Price-to-book Price-to-earnings Dividend-Yield Create ‘Short list’

‘Short list’

10,000+ US equities

Diversified Mutual Fund

Quantitative Screens

Bottom Up Analysis

Qualitative Analysis Bottom-up company review Core competencies and competitive

advantages Industry position

Diversified Portfolio Reduces risk Manager monitors holdings

Applying an ‘Equity Investing Framework’

Page 26

Hedge Fund Selection ProcessQuantitative Screens Understand drivers of returns Assessment of risks Consistency of results with stated strategy Quantitative fit with overall portfolio

‘Short list’

8,000+ US and International hedge funds

Diversified Portfolio of Hedge Funds

Quantitative Screens

Bottom Up Analysis

Qualitative Assessment Bottom-up manager review Core competencies and competitive

advantages Qualitative fit with overall portfolio Nature and extent of risk controlsDiversified Portfolio Reduces risk Manager monitors holdings


Page 27

Demands of Hedge Fund Investing Successful hedge fund investing requires:

Expertise in analyzing trading strategies as businesses Entry and exit discipline Time commitment Sufficient size of investment to allow diversification

Need more than a single manager multi-strategy

Decide between: Self manage Outsource

Custom portfolio Funds of hedge funds

Combination


Page 28

KCS Approach

Page 29

Investment Strategy Based on

10 years Hedge Fund Investing experience AIMA Award-winning Research Proprietary Analytics Focus on risk reduction

Objectives Low volatility Low correlations with traditional assets Tax-preferred deferred capital gains ‘Equity-like’ returns with ‘bond-like’ volatility

Strategy Levered low-volatility

KCS Approach

Page 30

HF Strategy Risk Profiles & the ACRF

Notes: Weights are as at December 30, 2006. All risk/return measures are since February, 1997, and have been annualized.

CSFB/Tremont Weights vs. Current ACR Basket Weights

5.1% 9.9% 6.2%2.7%

23.1%

10.9%

29.6%

5.1% 7.0%0.5%

11.3%

40.8%

11.2% 11.9%6.3% 9.7%

2.5% 0.0% 0.0% 0.0%0%

10%

20%

30%

40%

50%

Equity Market Multi Strategy



Event Driven

Global Macro

Long / ShortEquity


EmergingMarkets

DedicatedShort Bias

TremontWeightsACR BasketWeights

CSFB/Tremont Risk vs. Current ACR Basket Risk - Annualized

2.7% 3.6% 3.8% 4.8% 5.9%

9.4%10.7%

11.9%15.0%

17.8%

2.3%2.8%

4.4%2.1%

6.0% 3.4% 5.9%

0.0% 0.0% 0.0%0%

5%

10%

15%

20%


MultiStrategy



Event Driven

Global Macro

Long / ShortEquity


EmergingMarkets

DedicatedShort Bias

Tremont Std. Dev’nACR BasketStd Dev’n

KCS Approach

Page 31

Performance

+ 15.7% for 2006

Ranked #1 Fund of Funds in 2006 on

Canadian Hedge Watch

Page 32

KCS ACR Fund Performance

Fund Name for December Q1 Q2 Q3 1 Month 3 Months 6 Months YTDKCS Absolute Core Return Fund 10.56 0.067 -1.75 1.34 6.04 4.24 15.7Man Multi-Strategy (Canada) Fund Class F U$ 0.54 2.63 -6.22 12.67Arrow Focus Fund Class F2 11.92 -3.68 -2.02 2.24 6.28 4.13 12.25Arrow Global Long/Short Fund Class F 9.71 -3.69 -1.38 2.33 7.3 5.82 11.81Arrow Multi-Strategy Fund Class G U$ Class F 8.39 -0.69 -1.93 2.23 5.53 3.49 11.4Mac Alternative Strategies Class O 3.84 -0.19 2.23 2.26 5.02 7.36 11.27TA3 - Mesirow 'O' US$ 2.77 1.67 0.69 1.7 3.9 4.61 9.31Tremont Core Diversified Fund U$ Class O 3.44 0.54 1.12 1.45 3.86 5.03 9.23Pro-Hedge Elite Fund Class F 8.96 -4.9 -3.25 1.32 4.8 3.94 7.7TA3 - Safeguard US$ 2.14 1.03 0.04 1.48 3.24 3.28 6.57Pro-Hedge Capital Preservation Fund Class F 3.05 0.27 0.48 0.29 1.29 1.77 6.41Arrow Enhanced Income Fund Class F 2.09 1.71 -0.9 1.12 2.45 1.95 5.86Pro-Hedge Capital Preservation PLUS Class F 4.12 -1.03 -0.78 0.1 1 0.22 5.33TA3 - Hybrid 'F' C$ 2.21 -1.65 -1.58 3.42 5.74 4.08 4.62Quadrexx Market Neutral Performance Fund Series F 7.44 -0.67 -2.75 0.49 0.47 -2.3 4.27Pro-Hedge Capital Preservation USD Class A 2.69 -0.08 0.16 0.2 0.99 1.16 4.18Horizons Diversified Fund 2.96 -1.3 -1.97 3.36 3.92 1.87 3.51Tremont Capital Opportunity Trust 3.22 -1.38 -3.2 0.37 -1.09 -5.83 1.49Abria Diversified Arbitrage Trust Class O $US 3.26 3.36 0.67 0.86 -6.02 -5.39 0.98Pescara Fund of Funds U$ 2.09 1.03 -7.06 -9.1 -12.56 -18.74 -16.19Abria XL Trust Class O U$ 0.00 -19.89HRS Absolute Return Trust 4.52 -0.42 0.42 3.06 3.67 1.92 8.19Stanton Diversified Strat LP - Class A C$ 151 0.00 1.82 -6.11

* For Internal Use Only - from www.canadianhedgewatch.com

Page 33

Questions and comments?

Page 34

This presentation is confidential. The contents are not to be reproduced or distributed to the public or the press. Securities legislation may prohibit such distribution. This presentation is a summary only and should be used in conjunction with the detailed information in the Confidential Offering Memorandum. The information contained in this presentation is believed to be reliable, but is not guaranteed as to its accuracy or completeness. This presentation is for information purposes only and does not constitute an offer to sell or a solicitation to buy the securities referred to herein. No securities commission or similar regulatory authority has reviewed this document or has in any way passed on the merits of the securities describe and any representation to the contrary is an offence.

Historical performance is not a guarantee future results. KCS Fund Strategies Inc. recommends consulting appropriate investment and financial advisors when considering any investment decision.

KCS Fund Strategies Inc.

2150 – 555 West Hastings Street

Vancouver, British Columbia

V6B 4N6

Ph: 604-730-0729 x 225www.kcsfunds.com

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KCS Fund Strategies Inc. Disciplined Fund of Hedge Funds Portfolio Management Contemporary Perspectives on Hedge Fund Investing CFA Victoria – February