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Hedge Fund Presentation
Prepared/or
Antioch University
June 6, 2002
Phil C. Shaffer C.I.M.A
Consulting Group Director
Smith Barney
Jennifer L. Kossow
Financial Consultant
Smith Barney
Hedge Fund Presentation
Agenda
-Historical Perspective
-Hedge Fund Overview
-Strategy Definition and Example
-Asset Allocation Recommendation
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Historical Perspective
A.W. Jones took two speculative tools, short sales and
leverage, and merged them into a conservative investing
system
Jones designed his system to maximize stock selection and
minimize market direction
Although Jones valued stock picking over market timing, hj?
increased or decreased the net market exposure of his
portfolio based on his estimation of the strength of the
market
Since the market generally rose, Jones was generally
long”
‘net
Traditional Characteristics
Traditional Investment Process
•Primary determinant of return is the market (Beta)
•Attempt to provide an incremental return versus a
benchmark (Alpha)
•Publicly traded securities
•Long only investment policy
•Leverage not included in the process
•Asset based fee structure
•Compensation increases through asset growth
Hedge Fund Characteristics
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Hedge Fund Investment Process
•Primary determinant of return is manager skill
•Use investment and risk management tools to seek positive returns
regardless of market direction
•Traditional asset classes plus alternative classes
•Balance long and short positions to obtain market neutrality
•Leverage may be utilized to enhance return potential, however it is not a
necessary component of hedge fund investing
•Performance based fee structure
•Compensation increases through higher absolute returns
Subject
Structure
Fees
Marketing
Transparency
Liquidity
Traditional vs. Hedge
Determinant of Return
Performance
Tools
Strategy
Traditional Equity Investments
ICA 1940
Assets under management
Yes
Yes
Yes
Market (Beta)
Benchmark
Lone cash, rebalance
Value, growth, sector. International
Hedge Funds •ssfy*
Unregistered Acc UL {jdkdi £r\ft£or~
AUM and incentive Tee
Limited
Limited and/or Depends
Limited
Manager Skill
Absolute return
Long, short, net exposure, concentration,
Leverage
Multiple strategies and styles
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What is Long / Short Equity?
Long example:
– Buy 100 shares of IBM at $96
-Sell 100 shares at $100
– Profit = $4 per share
Short example:
– Sell short 100 shares of IBM at $100
– Buy back 100 shares at $96
– Profit = $4 per share
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Strategies – Long/Short Hedging
Strong Fundamental analysis
• Go long position identified to outperform —
• Go short position identified to underperform-
– Long CitiGroup @ $50 Short Chase @ $40
– Market goes up
• Citigroup @ $60 =
• Chase @$45
• Net of Total Transaction =
– Market Goes Down
• CitiGroup at $45
• Chase at $30
• Net of Total Transaction =
– Can have net exposure to the market
3
$10 Gain
$5 Loss
$5 Gain
$5 Loss
$10 Gain
$5 Gain
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Strategies – Event Driven
Distressed securities
– Investing/Trading in equities, bonds or claims of
companies emerging from Bankruptcy and/or
Reorganization
– Managers usually actively involved In restructuring
process
Merger Arbitrage
– Position in acquired and acquirer (Short Acquirer and
long Acquired)
– Analysis focused on timing/successful completion of
merger
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Advantages/Disadvantages
Advantages of Hedge Funds:
• Attractive risk-adjusted returns
• Low correlation with traditional equity and fixed-
income
• Access to the best and brightest investment talent
• Alignment of interests
Disadvantages of Hedge Funds: . •
• Leverage, short selling, derivatives •=?> Cjf^oH^, JAAMJ-U. p>,
• High fees relative to traditional management
• Reduced Liquidity Lot*L-u_p h^Ufe,
• Limited access to transactions and/or holdings detail
• UBIT – Unrelated Business Income Tax
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The Fund to Funds Approach
Benefits of a Fund-of-Funds Approach:
Diversification:
– Use of 15-20 different managers; index fund approach
– Low or negative correlation among individual managers
– Improved transparency
Access to Closed or High-Minimum Funds
Improved Liquidity:
– 90-day versus “lock ups ” of i-3 years
• Monthly/quarterly withdrawal rights
Additional Research Staff:
– General Partner provides expertise in manager selection
– Added layer of due diligence and oversight
Single Reporting Relationship
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Fund to Fund Manager Selection
When investing in hedge funds, the following criteria should be considered:
A well-established firm
An absolute return philosophy
An understandable strategy
A track record which displays the success of the strategy currently being
employed
General partners who have a significant portion of their own personal
wealth invested in the fund they are managing
Reasonable levels of transparency
Reasonable terms and standard fees
Fee Structure for Hedge Funds
| Fee Structure:
Alternative investments operate with a performance-based fee
structure:
Management fee of 0.75% – 2.00%
‘ * Incentive fee generally pays managers 10-20% of
&W^ ‘ ^”-“”investment profits
tS^”^ “^ ‘ High-Water Marks, Hurdle Rates or Preference Returns
Key Factors:
• Managers prosper by delivering investment performance
• Alignment of manager and investor interests
Asset Allocation Analysis
Preparedfor
Antioch University
June 6, 2002
Phil C. Shaffer C.I.M.A
Consulting Group Director
Smith Barney
Jennifer L. Kossow
Financial Consultant
Smith Barney
18
Benchmark Studies
– 617 Institutions
Asset Allocation Trends
Colleges & Universities
– Antioch in line with peer group
– With the exception of the allocation to Alternatives
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bometiic equities 47%
Intern it ionil ttpities
Alternative investments 19%
Equity Tout 79% 79% 79% 74% 76% n% 72% 69% 71% 66% 65% 0%
Fixed income 20%
Short-term neurit tet/cash
19%
2%
19%
2%
21%
3%
23% 25%
3%
27%
1%
27%
4%
27%
2%
29%
5%
33% 30%
0’» s%
30%
7%
Filed Income 21% 21% 21% 24% 24% 18% 28% 31% 29% 34% ‘ 35% 35% 37%
I00%| 100% 100%| 100%
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100% 100% 100%| 100% 100% 100% 100% 100% 100% PORTFOLIO TOTAL
19
i Asset Allocation Trends
C^-TVUv-ef^wJi^_^_id– Colleges & Universities
Benchmark Studies – Detail of Alternatives
– 617 Institutions
– With the exception of the allocation to Alternatives
35% 44% 38% 51%
Venture Capital 15% 20% 20% 10%
Private Equity 19% 18% 13% 11%
8%
11%
1%
Equily Real Estate 20% 12% 22% 26% 22% 17%
Energy & Natural Resources 10%
International Private Equity
‘Equity Total
1%
100%
_4%
2%
100%
5% 1%
2%
100%
1%
100%
1%
0%
100%
0%
0%
100%
20
10
Asset Allocation
Including Hedge Funds
SS.PSO0
Russell 1000 Veluo
Russell 1000 Growth
Russell 2000 Value
Russell 2000 Growth
Traditional US. Equity
900%
14.00%
5.00%
13,00%
13.00%
54.00%
9.00%
14.00%
5.00%
12.00%
11.00%
51.00%
9.00%
14.00%
5.00%
10.00%
10.00%
4840%
8.00%
14.00%
5.00%
9.00%
9.00%
45.00%
aoo%
13.00%
5.00%
8.00%
8.00%
42X0%
8.00%
8.00%
39X0%
MS SAFE
US Emerging Ukt Free
Traditional NonU.S. Equity
10.00%
1.00%
11X0%
1000% I 10.00% 10.00% 10.00% 10.00%
1.00% 1.00%
11.00% | 11.00%
1.00% 1.00%
11X0% 11.00% 11X0%
1.00%
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Hedge Fund (HFR Blendod) 0.00%
TotalWtemattva OJXWW
5.00% 10.00% 15.00% 20.00% I 25.00%
@8J
TOTAL FIXED* CASH
35.00%
35.00%
J
TOTAL PORTFOUO | 100X0%
–
I t
33.00%
33.00%
31.00%
3100%
29.00% 1 27.00%
29X0% j 27X0%
25.00%
25X0%
100X0% | 100X0% I 100X0% | 100X0% | 100X0% j
21
Ten Years of History
Asset Allocation
Including Hedge Funds
EXPECTED ROR
1 Yov Bast Case
1 Year Worst Caso
3 Year Best CMS
SYoar Worst Case
S Ysar Bast Caso
SYoar Worst Caso
10 Year Boat Caso
10YoarWorstCaao
12.00%
34.90%
-720%
24.70%
0.50%
21.70%
250%
ia7o%
5.50%
?
—
r 12.10%
34.00%
-6.30%
2420%
1.10%
2140%
3.40%
18X0%
SSXfh
1 Year
3 Year
5 Year
10Yoar
ProbibHttv of* NeoauVo R
11X0%
2.00%
0.40%
0.00%
10.6%
15%
05%
0.0%
1220%
3320%
-5.60%
024%
1.50%
21.10%
3X0%
18.40%
620%
12.30%
32.40%
-4.80%
23.50%
‘ 200%
20X0%
450%
1820%
650%
1240%
31.60%
-4.10%
23.10%
250%
20.60%
4.60%
18.10%
6X0%
12X0% |
31.00%
-3X0%
22X0%
290%
20.40%
5.00%
18X0%
7.10%
etuffl
9.6%
12%
02%
0.0%
85%
0.9%
0.1%
0.0%
75%
0.6%
0.1%
0.0%
6.6%
0.5%
0.0%
0.0%
Probability otAcheMnaj 10% Return
1Yoar
SYoar
SYoar
10Yoar
5720%
62.40%
65.60%
71.70%
59.0%
63.7%
67.4%
73X%
585%
64.7%
66.7%
755%
595%
66.1%
70.4%
775%
602%
67.3%
71.9%
79.4%
61.0%
68.6%
73.4%
812%
22
