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One of my lectures given in June 2012 at E416 Hedge Fund Elective at London Business School
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Liquidity Risk and Alternative Beta Products
Dr Drago Indjic
London Business School
June 2012
,
What is Risk Then?
• Not just variance– Risk “off/on”
• Correlation• Beta• Loss of capital• Liquidity• Access to capital (“return of capital”)
– May 2012: Treasuries and Bunds
Downside Risk
• Hedged, more agile strategies outperform: smaller losses, lower variance
• Long-only, buy and hold strategies are riskier
Hedge Fund Exposure
• Funds of hedge funds (“Alpha”)– Best “Alpha” is still most often packaged in
form of private funds: illiquid, fees loaded• Index replicators (“Beta”)
– Passive alternatives: “alternative Beta”, commoditised and liquid (ETF)
• ►Separate Alpha and Beta components– mean vs tail; fair liquidity premium
Reminder: 2008 Performance
• A hedge fund strategy on the top – as in May 2012
Indirect Cost of “Alpha”
• Monthly redemptions, 45 days notice• Quarterly, 65 bd, 12 month Lockup• Quarterly, 120d, 20% gate• Quarterly, 60d OR Monthly 35d @ 2%• 1y hard Lockup, 2.5y soft lockup @ 6%,
1/3 per year, 2/3 @ 6% with 20% gate• …• Anniversaries, side pockets, side letters!
Liquidity of funds0
20
40
60
80
Managed Futures
Duration
Co
un
t
0 31 60 90 120 150 180
05
10
15
Fixed Income: Mortgage-Backed
Duration
Co
un
t
0 60 130 210 390
•
Decoupled and disproportional to market liquidity
FoHF Liabilities
• Duration of liabilities is structurally mismatched – works in “normal” conditions
02
00
40
0
Fund of Funds
Duration
Co
un
t
0 90 215 360 498 750
0%
20%
40%
60%
80%
100%
Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12
S Fund (MP=100%, GI=0%) - Redemption
S Fund (MP=0%, GI=0%) - Redemption
S Fund (MP=0%, GI=100%) - Redemption
S Fund (MP=100%, GI=0%) - Still at risk
S Fund (MP=0%, GI=0%) - Still at risk
S Fund (MP=0%, GI=100%) - Still at risk
FoHF “Run”: Liquidity Crisis
Alpha vs Beta Agency
• Fund of hedge funds are still required– Best managers are packaged as hedge funds– Inc. regulation, accessibility, monitoring ....
• But they failed in 2008 and 2011– Blocked assets by mismanaging liquidity:
gated, suspended redemptions, restructured ...– Sold Beta at Alpha price: questionable
performance attribution– Industry AUM reduced by 1/3 or more
Service Provider Brands
• PB– >50%: J.P. Morgan and Goldman Sachs – Administrators: BNY Mellon, GlobeOp and
Citigroup gained share
June 22nd
• Replication today• Hedge fund industry today• Indexation risk and benefits• “New Normal” (Jan 2011) • Stress and response• Mind your tail and momentum
New Products and Markets
• Single strategy replicators – Equity L/S, CTA, CB– Reverse (short) index replication– Tail protection products
• Secondary markets– Collateral management
Yet Another UCITS
HFR (1Q 2012)
• Births: 304– level not reached since 4Q2007
• Deaths: 232 – the highest since 240 in 1Q10– “FOF continued to experience a contraction”
64 closing while 34 launched; 4th consecutive quarter of decline in number”
• Fees rose slightly – Avg 1.63%/17.75%
Index XYZ?
The “New Normal”
“(HFR 1Q12) Hedge fund performance dispersion increased over 4Q11, with the top decile of all hedge funds averaging a gain of over 20%, while the bottom decile of all funds declined by 28% on average.
Rear View
May 2012 Performance
Risk On/Off, HFT Style
Portfolio De-Construction
New Dawn
Tail Risk Products
Modern Performance Charts
(Un)Managed Account Platform
Leverage
Watch Out
Emerging World
Not a Game
Year 1
Shipping Performance
• Navigate in the high seas of illiquidity
NB. Risk, optimisation et al quant tools irrelevant; even OpRisk considerations
Fees
Liquidity
BetaHF
Capacity
Counterparty