GLOBALARC Briefing Notes Boston 2010

Global ARC Boston
2010 Briefing Package
Dear Global ARC Boston Participant: We are at a critical juncture in the history of institutional and alternative investing. More than ever, the productive exchange of ideas requires a common baseline definition of the challenges facing investors and investment managers worldwide. To encourage the exchange of ideas during our panel sessions, Global ARC is pleased to furnish participants with the following set of briefing notes. These notes are designed to provide background, seed discussions and supply the audience with food for thought prior to and during each panel session. Global ARC would like to thank the Chartered Alternative Investment Analyst (CAIA) Association for assembling these notes. As you are aware, the CAIA Association is a longtime partner of Global ARC and shares our mission of encouraging dialogue and fostering the exchange of knowledge.
This Global ARC briefing is an initiative of the Chartered Alternative Investment Analyst (CAIA) Association, a global non-profit educational organization and sponsor of the CAIA designation. The CAIA Association has offices in the US, Europe and Asia, and maintains chapters in all of the worlds major financial centres. (www.caia.org)
About the CAIA Association

The Chartered Alternative Investment Analyst (CAIA) Association designation was launched in 2002 as a partnership between the alternative investment industry (Alternative Investment Management Association, AIMA) and academia (The Center for International Securities and Derivatives Markets, CISDM, at the University of Massachusetts). Based in Amherst, Massachusetts, with offices in London and Singapore, the non-profit CAIA Association now counts over 4,200 members in 70 countries around the globe. CAIA designees include financial advisors, hedge fund managers and marketers, consultants, lawyers, accountants, fund administrators, risk managers, regulators and major investors. The rigorous CAIA program is designed for self-study and comprised of two levels, both of which are offered every March and September. The CAIA program provides individuals with the core competencies required to create, manage, and monitor an institutional-quality portfolio consisting of both traditional and alternative investments. For more on the CAIA Association, visit CAIA.org.
Panel Briefing Notes

Institutional Investor Allocations to Alternatives
Background & Description
The investor perspective: what are the implications for institutional investors alternative asset allocation policies in a world in which 4-5% per annum investment returns across the conventional asset classes is the new long term norm? Panelists will discuss how they are coping in this low rate paradigm and how they might include alternatives in their portfolios to increase risk-adjusted returns.
Data Points Investors gravitate to alternatives

100% 75% 50% 25% 0%
3% 5% 3% 12% 13% 13% 31% 35% 33% 54% 3% 16% 35% 2% 18% 35% 3% 20% 35% 43%
Investors increasing alternatives allocations

45% 30% 15% 0% -15% -30% -45%
41% 51% 46%
45%
Cash
Alternatives
Fixed Income
Equities
Source: JP Morgan Alternative Asset Survey
6 months 3 years
Source: bfinance bi-annual Pension Fund Survey (2010) conducted May 2010
2009 (left three bars) and 2010 (right three bars) surveys show investors targets and allocations to alternatives are risingat the expense of equities.
Pension plans expect to increase allocations to virtually all alternatives (and fixed income) at the expense of their equities. (Chart shows difference in increase v. decrease.)
Hedge funds et al still attractive

8%
Endowments lead the way

Alternatives allocation 35% 30% 25% 20% 15% 10% 5% 0%
80%
60%
40% 20% 0%
8% 46%
8% 52%
61%
9% 9%
10% 16%
5% 17%
% planning to
% investing
Corporate fund
Public fund
Endowment/Foundation
From a smaller base, infrastructure should see phenomenal growth, while HFs, PE and RE continue to gain ground.
Endowments/foundations, early adopters of alternatives investing, show the way for public and corporate plans to allocate to non-traditional managers and asset classes.
2010 Chartered Alternative Investment Analyst Association
Click to edit MasterInvestor Allocations to Alternatives Institutional title style Key Trends & Recent Developments
Whereas once investment in hedge funds was the preserve of the super-wealthy, the industry is coming
to be dominated by investments from pension funds and insurance companies. Financial Times
Specifically, in 2009 the UKs Royal Mail upped its bet on UK and overseas equities through futures
contracts from 2.1 billion (in 2008) to 5.13 billionor almost 20% of the schemes AUMin a bid to reduce its estimated deficit of 10 billion. Some speculate if significant profits were made by this move. The Daily Telegraph
Potential Questions/Points of Debate

With an increase in popularity, will the institutionalization of alternatives, especially hedge funds, lessen
managers ability to go out on a limb and create unique and dynamic alpha?
Will there become two camps of investors? Those who derive alpha from their alternatives exposure and
those who eschew alternatives and are left with meager beta returns?
Is the time coming when investors will internalize alternatives strategieseither on their own or via inter-
investor investment schemes?
Further Research
Title (Year) The Impact of Alternative Investments on Private Colleges' Endowment Investment Returns (2010) Background Risk and University Endowment Funds (2010) Author(s) Donald Basch Main Thesis or Conclusion Evidence of 1999-09 shows alternatives increased performance of public college endowments, especially larger ones, although 2009 illustrated how one year could make alternatives look bad in the short run. Background (exogenous, non-tradable) risk levels of endowments affects their asset allocation vis--vis fixed income vs. alternatives whereby a one standard deviation increase in background risk increases fixed income allocation by circa 15% relative to the mean. Wealthier, highly selective universities hold riskier portfolios.
Stephen Dimmock
Participants Fan Hua

Managing Director of Asset Allocation and Strategy China Investment Corporation China
Michael Strachan
Chief Investment Officer Equisuper Australia
Christian Nistler
Chief Investment Officer Syngenta International AG Pension Switzerland
Moderator: Christopher Holt, Senior Advisor, Chartered Alternative Investment Analyst Association USA

Will Smaller Hedge Funds Continue to Outperform Larger Ones?
Smaller, nimbler hedge funds have traditionally offered the best performance for investors, but some analysts question whether the need for more comprehensive risk reporting and regulatory reports make disproportionately more strenuous cost demands on smaller managers, eroding their competitive advantage. Will the mid range manager with between half a billion and 3 billion dollars AUM constitute the new sweet spot: large enough to shoulder the regulatory burden whilst small enough to swiftly enter and exit markets?
Data Points Smaller managers exhibit outperformance

80 70 60 50 40 30 20 10 0 Cumulative performance
Larger funds give < risk-adjusted returns

Monthly risk-adjusted returns (%) 1 0.8 0.6 0.4 0.2 0.1 10 1000
Source: Teo (2009)
Smallest 20%
Largest 20%
Source: Teo (2009)
Assets (USD millions, log scale)
Study compared cumulative abnormal returns of smallest two percentiles of hedge funds and largest two percentiles of hedge funds.
Relationship between fund abnormal returnsestimated by Fung and Hsieh (2004) risk factorsand past assets. (Jan 94 to June 08, chart is reproduction of original)
Alpha peaks at the median

Per annum average excess return 12% 10% 8% 6% 4% 2%
More small fund alpha in certain strategies

Per annum average excess return 8% 6% 4% 2% 0%
0%
Single manager funds
FoHFs
Source: Shawky, Wang (2010) Source: Shawky, Wang (2010)
A study of excess return (alpha) on quintiles of managers from Jan 94 to Dec 08 revealed a sweet spot around the median for single manager funds, declining FoHF alpha.
Jan 94 to Dec 08 study shows excess alpha comparing largest & smallest quintiles varies by strategy. EMN, EM with largest discrepancy vs. Global Macro and Short Bias.
Click to Hedge Funds Continue to Outperform Larger Ones? Will Smaller edit Master title style Key Trends & Recent Developments
Registration with the US SEC and other regulatory bodies adds cost (either outsourced or in staffing) to
hedge funds that had been much leaner.

US legislation and political/economic climate are pushing proprietary desk traders from investment and
commercial banks to fledgling hedge funds.

Post-Madoff, many institutional investors and consultants are requiring services such as managed
accounts which may be prohibitively expensive for smaller funds to establish and maintain (both in cost and trading sophistication required).

Will the administrative burden facing emerging managers lead to a wholesale change in their business
model (e.g., outsourcing risk modeling and analytics)?

Certain investors demand minimum infrastructure (e.g., risk managers) . While this may be relatively
easily accommodated in a large fund company, can smaller funds do so and remain (as) economically viable?
How will new funds reach the critical mass required to have the infrastructure required (assuming they
really need it) and how might this affect performance?
Further Research
Title (Year) Author(s) Main Thesis or Conclusion
Liquidity Risk and the SizePerformance Relationship in the Hedge Fund Industry (2010)
Does Size Matter in the Hedge Fund Industry? (2009)
Hany A. Shawky, Ying Wang
When liquidity risk is accounted for: small, high liquidity risk hedge funds outperform large ones by an average of 9.5% p.a.; large, low liquidity risk FoHFs outperform small funds by an average of 8.4% p.a.
Smaller funds outperform larger ones by 3.65% due to significant diseconomies of scale including capacity constraints.
Melvyn Teo
Participants Deepak Gurnani

Managing Director and Head of Hedge Funds Investcorp USA
Dr. Arvind Raghunathan

Founder and Chief Executive Officer Roc Capital USA
Michael Karsch
Founding Partner and Chief Executive Officer Karsch Capital USA
Alexander Neszvecsko
Portfolio Manager European Patent Office Pension Germany Designated Investor Questioner
Jeff Tarrant
Co-Founder, CEO and CIO Protg Partners USA
Apurva Mehta
Director of Portfolio Investments The Julliard School USA Designated Investor Questioner

Outlook for High Yield and Asset Based Credit Markets
Has the extraordinary demand for yield in a near zero interest rate world distorted the credit markets? Has the breathing space provided to the high yield credit markets by the last two years of quantitative easing been wasted? Consequently, will the next two years see a dramatic increase in bankruptcies? With the demise of quantitative easing will hedge funds be able to position themselves as direct lenders to the small and mid-sized market?
Data Points MBS originations

Originations: (billions) $3,945 $2,920 $3,120 $2,980 $2,430 $1,500 $1,815 $320 100% (billions) 50% 0% Conv/Conf Subprime FHA/VA Alt-A Jumbo Home Equity
Source: Inside Mortgage Finance
Global high yield issuance

125.0 100.0 75.0 50.0 25.0 2007 2008 2009 2010 2007 2008 2009 2010 2007 2008 2009 2010 US Q1 Q2 Asia Pacific Q3 Europe Q4 (or full-year)
Source: Dealogic
The crucible of securitization, MBS origination, has cooled and now leans heavily on Conventional/Conforming papervis--vis subprime and Alt A a few years ago.
HY issuance in the US is roaring back (2009 total in 2Q10 alone), Asia Pacific is still similar to 2009 (although with less of a drop that year) and Europe is percolating.
HY down-upgrade + default
120% 100% 80% 60% 40% 20% 0% -20% 14% 12% 10% 8% 6% 4% 2% 0% $300 (billions) $200
Maturities pushed further out

$274 $156 $153 $133 $138 $131 $89 $92 $55 $58 $77 $64 $53 $15 $7 $13 $1 $250
$100
$-
(Downgrades-Upgrades)/Total Par
HY Defaults
High yield bonds

As of June 14, 2010
Institutional leveraged loans

Source: JPM
Source: Bank of America Merrill Lynch
A lagging indicator in the 2002 credit crunch, (downupgrades)/total par foretold rising and (continued) falling default rates in the recent global credit crisis.
After near-death experiences of late, 70% of issuance from 2Q09-2Q10 (inclusive) was earmarked for refinancing, extending maturities until at least 2013-14.
Click to edit Master Yield and Outlook for High title style Asset Based Credit Markets Key Trends & Recent Developments
After being whipsawed by horrible returns during 2008s credit crisis and a rally that boosted virtually
every credit security in 2009, more institutional investors are looking to reduce their long exposure to credit and protect their credit portfolios on the downside... its a good time to be looking at long/short credit. Pensions & Investments,
A large majority of the 2014 maturities are issues sold in 2007 in conjunction with LBO transactions,
which explains the growing proportion of speculative-grade borrowers with debt coming due. In fact, approximately 71% of the speculative-grade debt due in 2014 was issued in 2007 by 53 companies in headline-making LBOs. Standard & Poor's

Now that the global credit crisis is - we hope - behind us, what mispricings persist that managers can
exploit for out-sized profits?

How have the tools and strategies available to managers changed over the last three years? How might the contemplated implementation of QE2 (Quantitative Easing, part 2) in both the United
States and United Kingdom affect the ABS and high yield markets going forward? Will it differ from or align with that of the original program?
Further Research
Are Junk Bonds Junk? (2010)
Guangdi Gordon Chang

Adam Metzler
Junk bonds have higher Sharpe ratios than investment grade they are underpriced. Junk has higher returns in all economic states: fewer losses with default and higher returns without default.
Model risk, substantial but not catastrophic in first-generation (ABS) securities, proves dire with second-generation (CDO) ones due to cross-correlations not included in Gaussian factor models.
Model Risk and the Design of CDO Tranches (2010)
Participants Steve Shapiro

Founding Partner and Portfolio Manager GoldenTree USA
Anilesh Neil Ahuja

Chief Investment Officer Premium Point Investment USA
John M. Bader
Co-Chairman and Chief Investment Officer Halcyon Asset Management USA
Eni V. Panggabean
Head of Bureau and Directorate of Reserve Bank of Indonesia Indonesia Designated Investor Questioner
David Sherr
Founder and Managing Partner One William Street USA
Samuel Belk
Managing Director Dartmouth College Endowment USA Designated Investor Questioner

US Budget Deficit: Cases, Implications & Possible Solutions
Continued indefinitely in its current form, the US budget deficit threatens to undermine US credibility, and ultimately, through ever-increasing foreign borrowing, US power. Yet the current precarious state of the US economy may preclude immediate tax hikes and/or spending cuts for fear of exacerbating the other current deficit, that in jobs. How should the US manage the conflicting needs of the US budget and jobs deficit in the short to medium term? In the longer run, how should we reform the US tax system and US spending patterns to create a lasting resolution to the budget deficit?
Data Points US budget deficit projections

Actual Projections 10% 8% 6% 4% 2% 0%
Mandatory federal spending % of GDP

Actual Projected
500 0 -500 -1,000 -1,500 -2,000 -2,500
($billions)
Medicaid, CHIP & Exchange subsidies

Source: Congressional Budget Office, Heritage Foundation CHIP=Childrens Health Insurance Program
Medicare
Source: Congressional Budget Office
The CBO and White House see >$500 billion deficits for the next 20 years. CBO forecast is extended-baseline, not the more conservative alternative fiscal scenario.
Under the CBOs extended-baseline scenario, spending on Medicare, Medicaid and related health programs will reach 10% of GDP, about twice todays proportion.
Mind the gap

15% (% of GDP) 10%
4.8% 5.7% 7.9% 12.3%
US public-held debt as % of nominal GDP

50%
25%
5% 0% Actions begin in 2011 Actions begin in 2015 Actions begin in 2020 Actions begin in 2025
0%
Source: Congressional Budget Office
Source: US Government Accountability Office
Reductions in primary spending (excl interest payments) or increase in revenues needed to close the 25-year fiscal gap in the CBOs alternative fiscal scenario.
Public holdings of US debt are at levels not seen in 60 yearswhen the US was growing its way out of WWII debt.
US Click to edit Master Cases, Implications & Possible Solutions Budget Deficit: title style
Key Trends & Recent Developments
Budget deficit on pace to hit $1.47 trillion by fiscal year end September 30 ABC Only $387 billion of the $700 billion TARP budget was allocated. Recent estimates of the cost of the
program are only $29 billion (after much higher forecasted costs). New York Times
FOMC Chairman Ben Bernanke said recently that the US public finances are on an unstable path (Wall
Street Journal) while fund manager George Soros called for more stimulus, not a slashed deficit. Financial Times.
The IMF cut its US 2010 growth forecasts from 3.3% to 2.6%, 2011 from 2.9% to 2.3% Bloomberg

What will come of state budgets, such as that of California, if they cannot balance? Would the federal
government assist them as it has with other groups?

Industry pundits earlier prognosticated the buy-ins of bank stock-holdings by federal stimulus programs
might be a boon for the Treasury (show a profit). Is this the caseand if so, when?
Maturing debt can be paid with new currency, but at what cost from inflation is this a viable option? How should cuts to social programs, that so many rely on, be made?
Further Research
Title (Year) Fiscal Policy in the United States: Automatic Stabilizers, Discretionary Fiscal Policy Actions, and the Economy (2010) Rebalancing the US Economy in a Postcrisis World (2010) Author(s) Glenn Follette, Byron Lutz Main Thesis or Conclusion During 2008-09, the combined effects of federal, state and local budgets on aggregate demand (from both discretionary actions and automatic stabilizers) may have lifted the level of GDP by 2.5% 2009. US currently has low private savings rates and a very large budget deficit with a cyclically depressed rate of investment. Corporate tax structure changes, reconsideration of capital controls, and further decline in real exchange rates could ameliorate a potentially very hard post-recession landing.
Barry Bosworth, Susan Collins
Participants
Participants Peter Orszag

Member, President Obamas Cabinet (2009-10) Director, Office of Management and Budget (2009-10) Director, Congressional Budget Office (2007-08) Senior Economist, President Clintons Council of Economic Advisors (1995-97) USA
Kris Kowal
Chief Investment Officer Fixed Income Du Pont Investment Management USA Designated Investor Questioner
Vicente Tuesta
Head of Research Prima Pension Peru Designated Investor Questioner

How Vulnerable Are We to a Sovereign Debt Avalanche?
Europe came precariously close to a chain of sovereign debt defaults in the spring of this year and economists agree the emergency measures taken failed to address the underlying debt problems; they merely postponed the day of reckoning. Our panellists will: offer their analysis of the likelihood of sovereign debts occurring at both the nation state level and (for the US) at the state and municipal level; discuss where such defaults may occur and their effects on global financial markets and various hedge fund strategies; and offer their recommendations on how institutional investors should be arranging their portfolios to mitigate against such risks.
Data Points US reliance on foreign holders higher

5 4 ($trillions) 3 2 1 0 400% 300% 200% 100% 0%
Comparing sovereigns
US securities foreign holders
of which Mainland China

Source: US Treasury
Debt/GDP
*Federal government
Debt/Revenue
Source: Eurostat, CBO, Morgan Stanley Research
Foreign holdings of US securities has increased 23% CAGR for 3 years ending June 2010. China percentage stalled at 37% in July 2009 and fell to its current 27%.
Although US debt/GDP is lowest (at 53%), its debt/ revenue (or debt/aggregate federal tax) is high (358%) higher than Greece (312%) and Ireland (248%).
French & German banks PIGS bond holdings

100% 80%
Estimates of government net worth

400% 0% -400% -800% -1200% -1600%
Rest of World
US ($3 billion) UK ($8 billion) France ($56 billion) Germany ($33 billion) (as % of GDP)
60%
40% 20%
0%
(Parenthetical values show capital impact associated with PIGS government bond holdings.) Source: Lloyds TSB, Bloomberg, BIS
Cost of Aging
Structural Deficit
Initial Debt Level
Source: EU Commission, Eurostat, CBO, IMF, Morgan Stanley Research
A Sept 10, 2010 report shows very high exposures of German and French banks to PIGS bonds. Combined capital impact of $89 billion could be quite a blow for both.
Based on admittedly rough assumptions, the picture of sovereigns net worth is particularly bleak on the right end of the scale.
Click to edit Master title style How Vulnerable Are We to a Sovereign Debt Avalanche? Key Trends & Recent Developments
Norway, perhaps investing to infinity, has taken a large position in Greek debtcounter to PIMCOs
view that Greece eventually restructures or defaults. Bloomberg

Ireland slammed media reports that IMF intervention was imminent based on a 25% deficit (including
bank bail-outs, only 10%, or 3 times the EU limit, ex bail-outs). Reuters

BIS data reports France has over 2x and 3x exposure to Greece and Portugal, respectively, than were
used in stress test. Lloyds TSB

Euro-region governments to repay 582 billion of debt in 2011, up from 521 billion in 2010. Bloomberg

In the spring, the PIIGS (Portugal, Italy, Ireland, Greece, Spain) were touted as primed for default and
austerity measures are currently taking hold in various forms. Will these emergency actions be enough?
Given the shaky sovereign debt in many (especially European) bank balance sheets, could sovereign be
the next hammer to fall on capital ratios?

How far might a sovereign credit contagion reach? Could Japan and the US fall victim as well? What role might China and other countries currency reserves have if sovereigns become distressed?
Further Research
Fiscal Deficits, Public Debt and Sovereign Bond Yields (2010)

Creditor Discrimination During Sovereign Debt Restructurings (2010)
Emanuele Baldacci, Manmohan S. Kumar

Aitor Erce, Javier Daz-Cassou
A fiscal deficit of 5% of GDP could raise long-term interest rates by 1% plus 20bps for each 1% over 5%50bps per 1% if adverse circumstances prevail.
If debt crisis follows a banking crisis, sovereigns tend to discriminate against non-residents; if domestic banking is sound, sovereigns discriminate against residents in a gamble for redemption strategy.
Participants
Derek Kaufman
Head of US and European Fixed Income Citadel USA
Takayuki Hirai
General Manager of Investments Bank of Tokyo and Mitsubishi UFJ Pension Fund Japan Designated Investor Questioner
Warren Wright
Chief Investment Officer DGAM Canada
Iker Zubizarreta
Finance Director Fondo Latinoamericano de Reservas Columbia Designated Investor Questioner
Victor Khosla
Founder and Senior Managing Partner Strategic Value Partners USA

What is the Outlook for Global Macro and CTA Strategies?
Over the last couple of years, the performance of stocks and commodities has been driven less by their individual characteristics than by wider political, economic and regulatory macro factors. Correlation of stocks in the S&P500, which averaged 27% in 2000-06, jumped to 80% in 2008 and now, in calmer markets, is still at an elevated 60% representing heights not seen since the Great Depression. Panelists will examine the continuance of this trend as well as which emerging political and socio-economic trends might profoundly impact investment returns in the coming years.
Data Points Macro and CTA Favored

Global Macro Rolling 6-month returns 60%
51% 36% 33% 29% 27% 26% 26% 23% 21%
Global Macro, long volatility

40% 30% 20% 10% 0% -10% -20% -30% -45% -30% -15% 0% 15% 30%
40%
20% 0%
MSCI World Index rolling 6-month returns

Source: Credit Suisse/Tremont Hedge Fund Index (replicated from source)
Source: Preqin
Recent survey shows European banks FoHF units put macro and CTA strategies in preferred top 5 going forward.
In times of market moves, Global Macro managers post higher returnsessentially, these (and CTA) managers are long volatility.
Global Macro continues to produce

2008: +4.83% 14,000 13,500 13,000 12,500 12,000 2009: +4.34% 2010*: +0.93% 25% 20% 15% 10% 5% 0%
Global Macro/CTA AUM
*to August 2010
Source: HFRI
Source: BarclayHedge
As markets tumbled and correlated, Global Macro managers were able to eke out positive returns over the last two yearsa rather exemplary feat.
AUM of Global Macro/CTA is middle-of-the-pack, Global Macro having less prominence than in the 1980s/90s when Soros, et al. made headlines; CTA having grown.
Click to edit Master title style What Is the Outlook for Global Macro and CTA Strategies? Key Trends & Recent Developments
The S&P500 and 10-year Treasury rates were 84% correlated in the 60 trading days through June 16
the highest reading since 1962. The 2000-07 bull market, when equity prices doubled, was presaged by a similar coefficient. Bloomberg
Hedge Fund Research reported macro managers returned average 2.16% to 3.65% gains in August,
against a 1.28% drop among directional equity strategies. The hedge fund industry as a whole rose a marginal 0.38% in August, bucking the 4.3% decline in the DJIA. Wall Street Journal

What are the key trends managers have capitalized on in 2010? Which ones, if any, are expected in
2011?
How can investors determine the efficacy of CTA or Global Macro modelsespecially given that the
former are typically quant(itative) in nature, whilst the latter may have more subjectivity in trade selection and scaling?
What has caused the surge in CTA AUM over the last decade, and will they rebound from the drop (from
being the ATM/cash withdrawal window strategy) seen over the last few years?
Further Research
Systematic Global Macro: Performance, Risk and Correlation Characteristics (2009)

The Fundamentals of Commodity Futures Returns (2008)
Peter Park, Oguz Tanrikulu, Guodong Wang

Gary Gorton, Fumio Hayashi, K. Geert Rouwenhorst
Portfolios with significant investments in Systematic Global Macro strategies have historically outperformed portfolios without allocations to Systematic Global Macro strategies.
Commodity price volatility is higher when inventories are low, leading to higher futures risk premiums as commercial hedgers take positions.
Participants Jean Philippe Bouchaud

Chairman and Chief Scientific Officer CFM France
Anthony OToole
Chief Financial Officer American Legacy Foundation USA Designated Investor Questioner
Patrick McMahon
Co-Founder and Co-Chief Investment Officer MKP Capital USA
Scott Hayman
Chief Investment Officer Oceanpath Canada Designated Investor Questioner
Luke Dixon
Portfolio Manager for Absolute Return Strategies Universities Superannuation Scheme United Kingdom
Moderator: Julie Winkler, Managing Director, CME Group USA


Investment Opportunities in West Africa
In May of this year, Global ARC London showcased a rousing speech from the worlds foremost development economist, Professor Paul Collier of Oxford University, in which he compellingly argued the economic case for investing in Africa. A distinguished panel, including, from Nigeria, His Excellency President Dr. Goodluck Jonathan and Nigerias Minister of Finance The Hon. Dr. Olusegun Aganga and, from Benin, His Excellency President Dr. Thomas Yayi Boni and Benins Minister of Finance The Hon. Idriss Daouda will afford investors a rare opportunity to meet key economic decision makers of two of Africas most dynamic governments.
Data Points Top 10 African nations: proved oil reserves

(billions of barrels) 45 30 15 16 18 24 28 33 34 9 10
Technology in Africa
400 70% 60% 50% 40% 30% 20% 10% 0% Number of subscribers (LHS) % population with cell phone coverage (RHS)
Global ranking
(millions)
36
39
Source: CIA World Factbook, 2009
300 200 100 0
Source: Acker, Mbiti (2010)
The aggregate of these 10 countries proved reserves (116 billion bbl) equals that of Iraq (#4 global ranking), and more than that of Venezuela, Kuwait or the UAE.
Cellular penetration has rapidly expanded, making it a hot investment opportunity and valuable component of infrastructure that will support further developments.
African economies: steady, heady growth

$1,600
$1,200 $800 $400 $6% 5% 4% 3% 2% 1% 0% -1%
Robust West African growth
Source: IMF; World Bank World Development Indicators; McKinsey Global Institute
Source: CIA Factbook
African nations CAGR of 4.9% from 2000-08 puts it among the fastest growing regions in the world. A rate much higher than the 2% CAGR of developed economies.
Comparing average GDP growth from 2007-09, larger West African countries (>$10 billion GDP) show good growth compared to BRIC and developed countries.
Click to edit Master title style Investment Opportunities in West Africa Key Trends & Recent Developments
As part of an emerging markets and increasingly frontier markets strategy, Africa has been attracting asset
inflows as investors turn away from lower growth developed markets towards regions with higher potential for growth. Pensions & Investments
Nigeria is now (July10) the #3 exporter of oil to the US, at 1.14 million bpd, or 11.4% of total US imports
up from 0.674 mbpd for YTD (July) 2009, supplanting Saudi Arabia and Venezuela. Similar movement in rankings occurred in US petroleum imports as well. USEIA
Perhaps in response to global conditions, members of the Economic Community of West African States
(ECOWAS) look to increase intra-regional trade. The Guardian Nigeria

Oil revenues for West African states such as Ghana provide a large measure of government revenue, and
are projected to increase over the next few years. afrol News

Some African nations have had a difficult transition from imperialism to democracy: has that past mainly
been ameliorated with the passage of time and creation of new, more benevolent governments?
Many regions have particular industry specializations, which can morph over time (Japan from making toys
and cheap electronics to luxury road sedans and LCDs). What is West Africas industry calling card presently and which industries are planned for development in the future?
How have West African nations financed the extraction of natural resources such as oil and minerals in the
past, and how do they plan to finance the same in the future in order to optimize growth and development and national and population wealth?
How has moving from a cash-crop economy in some West African countries allowed greater prosperity and
what might have been sacrificed in the process?

Which political and socio-economic obstacles have West African countries surmounted over the last few
years and which continue to existand how might they be overcome?

Which areas of investment have the best short, intermediate and long-term prospect for foreign investors? Which are West African nations predominant trading partners and how has the global financial crisis
affected the level of trade with these countries?
Participants His Excellency President Dr. Thomas Yayi Boni

President, The West African Development Bank (1994-2006) Chief Economic Advisor to the President, Republic of Benin (1992-1994) Republic of Benin
His Excellency President Dr. Goodluck Jonathan

Vice-President, Federal Republic of Nigeria (2007-2010) Governor, Bayelsa State (2005-2007) Federal Republic of Nigeria
Kurt Silberstein
Senior Portfolio Manager CalPERS USA Designated Investor Questioner

Emerging Markets Exposure: Via Hedge or Long-Only?
Institutional investors have dramatically ramped up their exposure to emerging markets over the last five years. However, some investors have questioned whether hedge fund strategies may be the ideal means of gaining such exposure as they feel that such strategies exacerbate the already high cost and opaqueness associated with such geographic markets. How informed are such criticisms of EM hedge funds? If an institutional investor does consider investing in an EM hedge fund, how must it augment its hedge fund due diligence checklist?
Data Points US Institutions active in EM

0% Endowment Plan Fund of Hedge Funds Family Office/Foundation Public Pension Funds Private Pension Funds Other
6%
5% 13% 19%
Hedge strategies preferred in EM

30%
29%
28%
10%
20%
0% Long-Short Equtiy Macro Distressed Securities Fund of Hedge Funds CTA Credit Event Driven Market Neutral
20%
40%
60%
51%
35% 30% 27% 24% 23% 23% 15%
Source: Preqin
Source: Preqin
A fairly wide gap exists between EM exposure of endowment plans and private pension fundssimilar to that of their use of hedge funds.
Long-short EM strategies top the list when US institutional investors were asked, in a July 2010 report, which hedge strategies they prefer in emerging markets.
HFRI EM Asia ex-Japan Index

10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0
EM Hedge Funds define efficient frontier

10% 8% 6% 4% 2% 0% -2% -4% -6% -8%
EM HFs Asia ex-Japan HFs LatAm HFs India Brazil China
Annual returns
Korea
Hong Kong MSCI Global S&P 500 MSCI EM Taiwan
Singapore
5%
10%
15% 20% Annual volatility
25%
30%
Source: HFRI
Source: Yahoo Finance, MSCI Barra, Eurekahedge
Moribund for the first half of the decade, Asian EM hedge managers leapt to life, dropped in 2008 and revived in 2009, recouping their losses.
From Jan 2000 Feb 2009, EM Hedge Funds displayed mean-variance dominance against EM, US and global indices as well as many EM country equity indices.
Click to edit Master title style Emerging Markets Exposure: Via Hedge or Long-Only? Key Trends & Recent Developments
As the July 2010 Preqin survey shows that of US investors with a preference for EM:
17% have a preference for EM hedge funds The most favored investment approach is direct (over FoHF or a mixture of direct and FoHF) Average overall allocation to hedge funds for US investors allocating to EM is 19%
August 2010: in 1H10, AUM of EM hedge funds fell $3.2 billion to $95 billion, perhaps because investors
prefer fixed income to equities presently and Russia and most Asian markets are equity-focused. Latin American and Middle East hedge funds continue to attract investments, though. Wall Street Journal

Given the degree of opacity in emerging markets, is it advisable to add another layer of the same by
investing in an EM hedge fund?

In some countries, such as India, so-called long-only managers use many of the same tools of hedge
funds (e.g., futures and options, arbitrage strategies) and hedge managers are limited in some of their methods (e.g., short-selling). With this blurry distinction, which is the better option?
Is there a risk that EM regulators might shut down hedge funds and allow only mutual funds in the future?
Further Research
Title (Year) Market Volatility and Hedge Fund Returns in Emerging Markets (2010) Author(s) Bolong Cao, Shamila A. Jayasuriya Main Thesis or Conclusion EM hedge fund returns are not affected by stock or bond market volatility, are typically passive investments and show very little ability to produce excess alpha. They also have a high turnover rate.
New Evidence on Value Investing in Emerging Markets (2010)

Time-Varying Performance of International Mutual Funds (2010)
Zhipeng Yan, Yan Zhao

Harry J. Turtle, Chengping Zhang
A value investing-based system of long/short positions based on an EM countrys GDP, price-earnings and dividend yield can be very profitable.
EM mutual funds provide strongly positive and significant state dependent alphas when the idiosyncratic volatility of emerging markets is small. However, ignoring timevarying volatility could misstate mutual fund metrics.
Participants Kurt Silberstein

Senior Portfolio Manager CalPERS USA
Mark Dow
Senior Portfolio Manager Pharo Management United Kingdom
Dr. Karim Abdel-Motaal

Co-Head of Emerging Markets GLG United Kingdom

Diversification vs. Diworsification: High Conviction Managers
Do the last three years prove that in periods of turbulence that diversification is actually diworsification? Does the future belong to more concentrated, high conviction managers? The old cure for extreme events was simple diversification: spreading your bets among a broad array of asset classes. But the financial crisis showed that asset allocation isnt always reliable when markets tumble in unison. Diversification works most of the time, but when it doesnt work those times really kill you. Wall Street Journal
Data Points Fund managers beat by their bogeys

80%
60% 40% 20% 0%
17% 52% 39% 27% 69% 58%
Correlation of S&P500 constituents to index

80% 60%
40%
20% 0%
*YTD June 21, 2010
Source: Compustat, Goldman Sachs Global ECS Research
Source: Barclays Capital, Morningstar
Only about one quarters of mutual fund managers beat their benchmark by about half-way into 2010even moreso than in 2008/09 when markets were crashing.
Getting non-correlated returns in S&P500 equities is more difficult than beforeit takes a high conviction manager to differentiate from the crowd.
12 10 8 6 4 2 0 -2
Optimal number of portfolio assets

25 20
Excess benefits of diversification

# of positions where excess benefit = 0 VaR ES Std Dev
15
10 5 0 0.7 1 2 3 9 10 11 12 29 30 31 Investor RRA (Relative Risk Aversion)
Without short-selling constraint
Source: Melkumian (2009)
Standard Deviation
* Calculated at 0.001 probability
VaR*
Expected Shortfall*
With short-selling constraint
Source: Hyung, De Vries (2010)
As RRA increases, more is allocated to risk-free bonds, but even at low risk-aversion levels (<4) the optimal number of assets is below 25.
Diversification benefits fall quickly re higher moment risks than lower; portfolio construction in a fat-tail environ by safety first investors necessitates focused portfolios.
Click to edit vs. Diworsification: High Conviction Managers DiversificationMaster title style Key Trends & Recent Developments
In 1998, LTCM delved outside of its core relative value trades, among other actions, which gave the aura
of diversification, only to see correlations spike when Russia defaulted. In August 2007, Global Alpha, AQR, PDT, Renaissance Technologies and others found that each of these quant funds had diversified into the same crowded trades (financed with the same, cheap Japanese interest rates).
Over the last few months, U.S. small-cap stocks, emerging-markets, commodities, and real-estate trusts
are trading more in step with the S&P 500, on a price basis, than they have ever beenwhich contradicts modern portfolio theorys mantra of diversification as a means of volatility dampening. In 2008 almost everything correlated downward while now everything seems to correlate upward. Market Watch

Is being a high conviction manager enough? If one is in the same trade as others, then diversification
benefits can be lost as prices fall and liquidity evaporates. How can managers differentiate themselves?
What is the definition of a high conviction manager: focused on one or few industries, countries, investment
themes? Is there a preferred number of stocks or proportion of constituent company market cap?
What risks do high conviction managers attract and what risks do they shed or ameliorate?
Further Research
Title (Year) Do Arbitrageurs Really Avoid High Idiosyncratic Risk Stocks? (2010) Author(s) Itzhak BenDavid, Denys Glushkov, Rabih Moussawi Main Thesis or Conclusion Small, undiversified hedge funds are more likely to own high idiosyncratic risk stocks; hedge funds earn higher returns from investing in high idiosyncratic stocks than low.
Create better diversified highconviction equity portfolios using the Portfolio Diversification Index (2010)
Diversification in the Hedge Fund Industry (2010)
Dominiek Creze, Laurens Swinkels

Hany Shawky, Na Dai, Douglas Cumming Hyung, De Vries
Using the PDI portfolio construction algorithm results in well-diversified high-conviction equity portfolios.
Sector/asset class diversification outperforms style diversification. Geographical diversification does not significantly impact hedge fund performance. If a safety first investor cares about downside risk and is cognizant of fat tails, optimal portfolio sizes are smaller than traditional correlation based diversification analysis suggests.
The Downside Risk of Heavy Tails Induces Low Diversification (2010)
Participants Kathryn Crecelius

Chief Investment Officer Johns Hopkins University Endowment USA
Jim Higgins
Founder, CEO and CIO Sorin Capital Management USA
Moderator: Karen Fang, Managing Director, Bank of America USA


What Is the Most Effective Means of Protecting from Fat Tails?
The Great Recession has forced investors to dramatically reappraise the probability of fat tail risk, and with this the amount of time and resources that they deploy to protect against it. How do we avoid simply putting in place a tail risk protection system that protects against a 2008 shock but fails to protect against future types? Is it possible to cheaply embed negative correlation into the portfolio through tactical asset allocation? Do off-theshelf derivative products provide sufficient protection for most institutional investors, or does the extra protection afforded by customised products justify the extra time and expense involved?
Data Points Tail risk and volatility

3% 2% 1% 0% Probability of drawdowns over 30% 80% 60% 40% 20% 15% vol: 2% 0%
Implied vs. realized volatility
30% vol: 16%
30% Volatility
15% Volatility
Source: Brockhouse Cooper
VIX
Realized Volatility
Source: Standard and Poors
Using a normal distribution, doubling volatility to 30% increases the probability of a 30% drawdown eight fold. Higher kurtosis distributions would be more pronounced.
Realized volatility is usually lower than implied vol (VIX) except in certain spike scenariosand, as one can see, both are time-varying and not particularly predictable.
S&P500 distribution is non-normal

500 450 400 350 300 250 200 150 100 50 0 Frequency Normal Frequency
Source: Bloomberg, Barclays Capital
Cost of 1-year 15% OTM SPX puts

12% 10% 8%
6%
4% 2% 0%
OTM=out of the money, SPX=S&P500
Source: Bloomberg, Barclays Capital
1-year periods for the last 60 years, plotted against a normal distribution illustrates the markets tendency to crowd at the mean and have significant down-years.
Since the credit crisis, the cost of insurance has skyrocketed and continues to be higher than previously. (Datapoints as at exercise dates)
Click to Most Effective Means of Protecting from Fat Tails? What Is theedit Master title style Key Trends & Recent Developments
In the 1970s/80s, investors delta-hedged listed options with their associated path dependency and non-
linear decay. In the 1990s, OTC-traded variance swaps made pricing simpler and precluded potentially messy trading programs. In the last decade, listed VIX futures and options became the preferred route to trade volatility (instead of variance).
Current major models of tail risk hedging include: rolling various tenors and levels of OTM index option,
hedging with futures positions and choosing opportunistic hedges based on scenario/contingency analysis.

With the recent increased cost of option-based insurance, are there as effective and/or cheaper to
implement methods that investors might prefer in todays environment?

How might investors (or their consultants/advisors) be able to choose the best method of tail risk hedging
and the associated levels of passive/active or choice of outlooks and hedging tools available?
Should tail-hedging strategies be implemented as an alpha engine or as a true hedge? If as a hedge, then
hedging all market exposure or on an opportunistic basis against overlay or AI-only exposures?
Further Research
Title (Year) Why Did the Crisis of 2008 Happen? (2010) Author(s) N.N. Taleb Main Thesis or Conclusion Fat (negative) tails are an artifact of the current financial, academic and governmental system and only a radical re-invent might lead to their amelioration.
We Dont Quite Know What We are talking About When We Talk About Volatility (2007)
D.G. Goldstein & N.N. Taleb
Finance professionals underestimate normal distribution events by 25%fat-tailed events by a shocking 90%.
Participants Brian Pennington

Chief Risk Officer GoldenTree USA
Harvey Toor
Chief Risk Officer Abu Dhabi Investment Council Abu Dhabi Designated Investor Questioner
Deepak Gurnani
Michal Zajac
Head of Risk Management National Bank of Slovakia Slovakia Designated Investor Questioner
Dr. Ronan OConnor

Head of Risk Management & Asset Allocation National Treasury Management Agency Ireland

Where Does the Future of Funds of Funds Lie?
How should a 2010 due diligence fund of funds checklist differ from that of 2007? Is liquidity management even more important than manager selection in the creation of an institutional-quality FoF? Will customization and niche strategies provide the keys to a successful future for the FoHFs industry? Or, will FoFs morph into a more advisory role, focused on assisting institutional investor clients as they construct inhouse, diversified direct hedge fund portfolioswithout the FoF actually managing the money?
Data Points AUM still under HWM

$800
(billions)
Year moved from FoF to Direct

10% 10%
$600 $400 $200 $1990-1999 2000-2007

Source: Hedge Fund Research Inc.
80%
2008-2010
Source: Prequin
Thanks to markets and Bernie Madoff, 2008 was a blow to FoHFs. Markets have rebounded in some sectors, but FoF AUM continues to languish.
July 2010 survey shows that of those institutional investors who go direct for hedge fund exposure, 80% did so in the last three years vs. 20% for 18 years prior.
Investors choose FoF and Direct

Diversification Purposes Lack of In-House Expertise Increased Transparency
Lower Fees More Control Over Investments More In-House Resources
Source: Prequin
Pros and Cons

0% 25% 50% 75%
66% 40% 33% 60% 54% 13%
Source: Preqin
Funds of Hedge Funds Only
34%
35%
Direct Only Funds of Hedge Funds and Direct
Reasons to use FoF
31%
Reasons to go direct
July 2010 survey indicates roughly one-third split between global institutional investors going direct, using FoF exclusively or using a combination of approaches.
Institutions use FoFs to get up-and-running quickly without headcount, but some find that after they gain knowledge theyd rather reduce fees and gain more control.
Click to edit Master the style Where Does title Future of Funds of Funds Lie? Key Trends & Recent Developments
Of those investors who went direct in the last few years, some retained their FoHF companies, but on a
retainer/advisory level. One FoHFs reports up to 70% of its AUA is in the form of advisory contracts with institutional investors vs. in-house managed funds or managed accounts.
In the years ahead, funds of funds are likely to see pension fund inflows grow... USD 250 billion of
pension fund money is expected to flow in over the next three years. The Financial Times, 11th July 2010
Smaller European FoHFs are expected to close or merge in the near future. Reuters

If the new model of FoHFs is advisory and not (higher margin) asset management, how might some
companies attract and retain talent?

Which might be better for the investor over the long term: a dedicated asset management team at a FoHF
or a consultant-type relationship where the portfolio is managed in concert with in-house staff?
If FoHFs move into consultancy, would the best business plan be to specialize in one area, such as
operational due diligence or asset allocation, or to offer holistic packages for clients?
Further Research
Title (Year) Do Funds of Hedge Funds Really Add Value? (2010) A Random Walk by Fund of Funds Managers? (2010) Author(s) Serge Darolles, Mathieu Vaissi Frans De Roon, Jinqiang Guo, Jenke ter Horst Main Thesis or Conclusion FoHF add value in the areas of strategic asset allocation (sticking to an allocation during difficult times) and in fundpicking. Tactical AA, however, is neutral to negative. FoHF invested HFs are larger in size; a longer operational history and higher average initial investment; and are more likely to hire an auditor and use a HWM. Their managers have more investment experience, and have a greater proportion of CFA charterholders. Using a nave strategy of investing in (up to six) topperforming FoHF from the year previous can beats benchmark FoHF indices.
Selecting Prior Years Top Fund of Hedge Funds as This Years Choice (2010)
Greg Gregoriou, Razvan Pascalau
Participants Gregory Doyle

Chief Investment Officer Kruger Corporate Pension Canada
Cheryl Alston
Executive Director & Chief Investment Officer Employees Retirement Fund of the City of Dallas USA Designated Investor Questioner
Stephen Harper
Founder and Chief Executive Officer Strathmore Capital United Kingdom
Moderator: Gary Enos, Executive Vice President, State Street USA


Operational Due Diligence: Best Practices
Operational due diligence includes assessing hedge funds financing and counterparty risks and establishing consistent valuation and audit procedures. Given the limited size of most investment divisions, what proportion of the due diligence process can realistically be carried out in-house and what proportion by external consultants and advisors?
Data Points Fewer funds, perhaps fewer headaches

100% 80% 60% 40% 20% 0% 2006 2008 2009 2010
Hedge fund due diligence timeframe

100% 80% 60% 40% 20% 0% 2008 >1 year 7-12 months 2009 3-6 months 2010 <3 months
120+ 40-60
100-120 20-40
80-100 0-20
60-80
Source: 2010 Deutsche Bank Alternative Investment Survey
Source: 2010 Deutsche Bank Alternative Investment Survey
Investors have pared the number of hedge funds they invest in. Fewer funds means more attention from staff per fundand more due diligence, including operational.
Investor due diligence is becoming bar-belled with a greater proportion taking under 3 months and over 6 months compared to 2009.
It looks good to have a clean desk

Do improvements in operations/automation have a positive impact on the ability to attract investors?
Ways that hedge funds are improving

0% 50%
69%
100%
33%
Reduce counterpary risk Yes No 67% Improve reporting/transparency Secure independent valuations/accounting
38%
33%
Source: 2010 Hedge Fund Operational Challenges Research Greenwich Associates & Omgeo
Source: 2010 Hedge Fund Operational Challenges Research Greenwich Associates & Omgeo
The majority of surveyed hedge fund managers believe that investors prefer funds with efficient and organized operations and trading systems.
Hedge funds have started to spruce up their operations, the most prevalent being reducing counterparty risk (e.g., via collateral management) but also in pricing.
Click toOperational Due Diligence: Best Practices edit Master title style Key Trends & Recent Developments
A 2003 Capco white paper revealed >50% of hedge fund failures were due to identifiable operational
problems: expanding due diligence and monitoring processes to understand back-office capabilities can make a big difference in preventing or avoiding these failures. 90% of investors said operational due diligence was a top priority, says a 2010 survey by Rothstein Kass. Financial Times
Key drivers of recent FoHF mergers and acquisitions is operational due diligence and scaleinvestors,
left wanting when major, respected FoHFs were found to be invested in Madoff and other frauds, demand more up-front and on-going research on invested funds. Dow Jones

Which might be a better model for efficient use of operational due diligence resources: each investor
having its own team; investors clubbing to share specialized groups; or a credit rating model where a third-party agency or corporation provides ratings on funds?
Should investor/plan trustees/senior managers be held accountable for (operational) due diligence
gaffsin the spirit of Sarbanes-Oxley? Would that increase the duty of care required and delivered?
Should governments mandate minimum due diligence thresholds, or rely on market forces?
Further Research
Title (Year) Trust and Delegation (2010) Author(s) Stephen Brown William Goetzmann, Bing Liang, Christopher Schwarz Main Thesis or Conclusion Operational risk does not seem to be a material concern for investors. Due diligence is often follows impressive performance and, had issues been uncovered, could have improved returns.
Hedge Fund Investing: Identification of Potential 'Blow-Up' Managers (2008)

Hedge Fund Operational Due Diligence: The Madoff Effect (2010)
Mohsen Mazaheri
There are identifiable characteristics of hedge fund culture, business model, and senior management psychological profile that conduce to excessive risk and blow-up magnitude losses.
Post-Madoff, due diligence increasingly focuses on: cash controls, quality and length of relationship with service providers and transparency and reporting.
Jason Scharfman
Participants Kate Murtagh

Managing Director Harvard Management Company USA
Dominic Blais
Portfolio Manager for Public Assets Canadian Medical Protective Association Canada Designated Investor Questioner
Elizabeth Hewitt
Senior Investment Officer The Robert Wood Johnson Foundation USA
Moderator: Gary Enos, Executive Vice President, State Street USA


Choosing a Managed Accounts Platform
How do you choose the managed account platform that best satisfies your organizations needs? Managed accounts definitely reduce the risk of fraud and provide investors increasingly detailed information on which to measure risk. Some managers do not offer them for a variety of reasons including fear of front-running (their trades)whether justified or not.
The question for investors sometimes is: are managed accounts the only way to get what they want?
Data Points Events of 2008 exposed flaws

10% 47% 39% 48% 4% 15% 28% Improved transparency Improved liquidity 11% Validation of assets Ability to impose guidelines/ restrictions 19% 16% 13% 13% 0% 5% 10% 15% 20%
2010 Deutsche Bank Alternative Investment Survey
Top four reasons for managed accounts
2009
More likely Less likely No difference
2010
Already use MA
Source: 2009/2010 Deutsche Bank Alternative Investment Survey
Question posed to investors: Will you be more or less likely to make a proportion of your investments through managed accounts in the future?
Top reasons concern measurement and control. Runnerups: no gating, sole investor/no commingling, independent valuation/NAV, more frequent valuation/NAV.
Terms investors would like improved

Transparency at fund level Lock-up period Redemption frequency Performance fee Redemption fee Management fee
26% 11% 42% 37% 37% 53%
Allocations to managed accounts

3% 7% 7%
47%
3%
None 0-10% 53% 10-20% 20-30% 30-40% >40%
27% 60%
Source: Preqin
Other
0%
20%
40%
2010 Deutsche Bank Alternative Investment Survey
September 2010 survey shows that although 42% of investors agree transparency has improved over the last 12 months, 53% would like to see more data.
Question: what is the total allocation to managed accounts as a percentage of your total hedge fund portfolio?
Click to edit Master titleManaged Accounts Platform Choosing a style Key Advantages
Position transparency Ownership of underlying investments (including
Key Disadvantages
Monitoring requirements and dependence upon
managed account platform manager

Complex trade execution and order execution
shareholder activities such as proxy voting and potential board representation)

Increased liquidity Possible to alter investment guidelines Reduced risks to: Misappropriation Misrepresentation and incorrect pricing Trading outside of the operating mandate Managed account platform manager may be
system forced on manager

Unequal treatment of investors Increased costs Conflicts of interest (e.g., kickbacks) Decreased transparency with regard to: AUM of manager Reliability of true track record because: Manager may perform differently
another set of eyes watching the portfolio and risk metrics

May be possible to shut down or reverse
under idiosyncratic mandate

Difficult to calculate performance of
heterogeneous account mandates

Compiled from Swiss Analytics and EDHEC
particularly egregious trades

How much data might be appropriate for certain classes of investors (e.g., plan sponsors of varying size,
consultants, family offices, fund of funds)?

Which investor types would get the most from a managed account? How can risk metrics from managed accounts be used most effectively? How can investors access best managers through managed accounts?
Is it appropriate to raise money for a fund with stated and transparent terms and then raise more through
managed accounts that might have differing terms?

Which strategies or types of managers are best suited to a managed account environment? In what circumstances might a managed account have a gate imposed or side-pocket created? At what AUM level do managers typically offer managed accounts? What metrics (quantitative or
qualitative) might a manager use to create one for lower than its stated minimum amount?
Participants Christopher Vogt

Portfolio Manager Hedge Funds Allstate Insurance Corporation USA
Nathanal Benzaken
Managing Director Lyxor Asset Management USA
Deepak Gurnani
Dan McDonald
Portfolio Manager Ontario Teachers Pension Plan Canada
Moderator: George Sullivan, Executive Vice President and Global Head of AI Services, State Street USA

Financial Sector Reform, Dodd-Frank and the Volcker Rule
The events of the last few years have rent asunder much of the previously sacrosanct notions of banking and finance in the US, and the world. Following the carnage, US and other legislators have devised new, ostensibly more appropriate and effective, statues designed to prevent a re-enactment of recent history. What are these laws and how do they affect banking and finance going forward? Do they provide the protection sought, how so, and for how long?
Data Points US banking is big(ger) business

30% 25% 20% 15% 10% 5% 0%
1955-1965 1966-1975 1976-1985 1986-1995 1996-2005
More stringent prudential standards

75% 50% 25% 0%
Credit market instruments/GDP (RHS) Financial sector share of US corporate profits (LHS) Finance share of GDP (LHS)
Source: Pilippon (2007), Haver Analytics, Gluskin Sheff
Bankings share of GDP and the ratio of credit instruments vs. GDP almost doubled from 1955 to 2005. Perhaps laws enacted in the 1930s and 40s need to be updated.
The Volcker Rule

Banking entities cannot engage in proprietary trading (including through a hedge fund or PE subsidiary). Exemptions transactions due to underwriting/market-making in certain government securities. Compliance period divestures to be completed in about three or four years, perhaps as many as nine. Ownership restriction cannot own hedge or PE fund, except for bona fide fiduciary or investments advisory services for clients. Ownership cannot exceed 3% of the fund (after one year) and aggregate equity stakes cannot exceed 3% of Tier 1 capital and stakes will be deducted from assets and tangible equity (levered commensurate with leverage level of the relevant fund). Source: Fein (2010)
Banks and Non-bank Financial Companies (NFCs) are subject to: Liquidity requirements exact levels not specified Risk management requirements Requirement for risk committee - enterprise-wide risk management including independent directors and one with relevant risk experience Stress tests annual and semi-annual tests Examinations and reports both by request and pro-actively from the institutions. Limits on concentration and credit exposures <25% exposure to non-affiliated companies. Enhanced public disclosures concerning risk profile, capital adequacy, and risk management capabilities thereof. Limits on short-term debt includes off-balance sheet exposures. Leverage limits debt/equity no greater than 15:1. Off-balance sheet activities all off-balance sheet holdings, transactions and guarantees incorporated in financial statements and ratios. Enforcement extreme penalties for noncompliance if primary regulator quiet for 60 days. Resolution plans writing of a living will. Early remedy of financial distress Intermediate holding companies Limits on transactions with affiliates Limitations on activities including mergers and product lines; could lead to divestment. Acquisition of banks 5% threshold for approval Prior review of acquisitions to limit industry concentration risks. Prohibition against management interlocks
Source: Fein (2010)
Click to Sector Reform, Dodd-Frank and the Volcker Rule Financial edit Master title style Key Trends & Recent Developments
Major swap counterparties (MSCs) would face increased scrutiny and potentially higher costs if regulated
under the Dodd-Frank Act, but CFTC Chairman Gary Gensler and SEC Chairman Mary Schapiro agree the number of MSCs would be very small. The Wall Street Journal
The SEC plans on implementing Say on Pay rule (one of 100 from the Dodd-Frank Act) in the next few
weeks. Market Watch

BofA already sacking prop traders to comply with Volcker Rule. Zacks Investment Research Application of Dodd-Frank is progressing and will lead to changed dynamics in US banking. NY Times
Further Research
Title (Year) Dodd-Frank Act: Implications for Securities Activities of Banks and Their Affiliates (2010) Dodd-Frank and Board Governance: New PoliticalLegal Risks to Monetary Policy and Business Judgments? (2010) Author(s) Melanie Fein Main Thesis or Conclusion Summary of key provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act that will affect securities activities of banks and their affiliates. Increasing the accountability of boards in corporations and the Federal Reserve System may compromise business judgments and monetary policy and reviews considerable evidence that, while governance reforms like Dodd-Frank often promise increased productivity, their implementation can empower one set of interests (e.g., shareholders, borrowers) to gain from others losses (e.g., bondholders, lenders). The financial services industry to devise new products means the Volcker proposals may be circumvented. The real and more challenging task is to devise regulatory responses based on an understanding of how an evolving and multifaceted, interconnected system actually functions.
Dino Falaschetti, Fred Karlinsky, Richard Fidei
Under the Volcker Rule (2010)
Ted Harding
Noted Participants Professor Laurence Kotlikoff

William Fairfield Warren Professor, Boston University Senior Economist, President Reagans Council of Economic Advisors (1981-1982) USA
Paul Volcker
Chairman, President Obamas Economic Recovery Advisory Board Chairman of the Board of Governors, Federal Reserve (1997-1987) USA
Professor Raghuram Rajan

2003 Fisher Black Prize winner Eric J. Gleacher Distinguished Service Professor of Finance, University of Chicagos Booth School of Business Chief Economist, The IMF (2003-2007) USA
Chris Paolino
Head of Hedge Fund Investments The Hartford Insurance Management Company USA
Larry Powell
Deputy Chief Investment Officer Utah Retirement System USA

The Great Debate: Inflation or Deflation?
Economists seem torn between worrying about the inflationary risks embedded in excessive stimulus spending and the deflationary risks carried by a premature curtailment of stimulus spending. Our two teams of panellistsone inflation team and one deflation teamwill debate whether deflation or inflation poses the greater imminent threat to the recovery of the world economy.
Data Points M2 spiked in 2008, CPI swooned

125 120 115 110
10-year TIPS yields at all-time low, again

5%
4%
3% 2% 1% M2 CPI
Source: U.S. Federal Reserve, U.S. Bureau of Labor Statistics
105
100
0%
Source: US Treasury
Jan 2010 = 100
Long term (1959-2010) M2 and CPI correlation is 97% but in last 2 and 5 years (to July 2010), correlation is zero with M2 rising over 5% p.a. and inflation of zero and 2%, resp.
Recent record-low 10-year TIPS yields indicates investors are concerned about inflation (and bidding up prices) and not willing to risk a surprise spike in CPI.
Median CPI a harbinger of disinflation

6% 3% 0% -3%
TRJ/CRB shows muted price movement

500 450 400 350 300 250 200 150 100
CPI-All Items
CPI-Core
Median CPI*
Source: Cleveland FRB Source: Thomson Reuters | Jefferies
Cleveland FRB and Ohio State Universitys Median CPI (50% and 25% more accurate than All Items CPI and Core CPI, respectively) points to falling prices in the short term.
The Commodity Research Board index shows commodity prices spiked in 2008 (mostly due to oils rise and fall) and have been quite tame for the last 15 months.
Click to edit Master title style Inflation or Deflation? The Great Debate: Key Trends & Recent Developments
In September, Fairfax Financial Holdings Ltd. purchased $21.5-billion notional value (roughly its total AUM)
of US inflation floorsan OTC derivative that pays if CPI slips below a certain level. Conversely, PIMCO has sold $8.1-billion of inflation floors over the prior six monthseffectively assuming the other side of the deflation bet. Both trades are believed to be 10-year, 2% CPI contracts. Globe and Mail
FOMC statement after September 21st meeting resulted in no change: With substantial resource slack
continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time before rising to levels the Committee considers consistent with its mandate. Wall Street Journal

Will the dramatic increase in the monetary base (M2) lead to inflation, or did it simply counter the
oppressive tightening of loan standards around the globe? What should central banks focus on?
Where is gold in the debate? Is it an inflation bellweather, or does it have a momentum of its own due to
demand pressures from many investor groups?

Which would be more destructive to investor portfolio values: inflation or deflation? Is there a way to hedge against both inflation and deflation without incurring oppressive risk or costs?
Further Research
Title (Year) Why Does the Treasury Issue TIPS? (2010) Inflation Hedging, Asset Allocation and the Investment Horizon (2010) The Long Horizon Benefits of Traditional and New Real Assets in the Institutional Portfolio (2010) Author(s) Matthias Fleckenstein, Francis Longstaff, Hanno Lustig Benedikt Fleishmann, Christian Rehring, Steffan Sebastian George Martin Main Thesis or Conclusion Contrary to classical asset pricing theory, the Treasury is leaving money on the table by issuing TIPS instead of traditional paper. The inflation-hedging efficacy of equities, cash, bonds and real estate vary between short, medium & long term horizons. Real or nominal target investors asset allocation should differ. Equities are neither a good long term nor short term inflation hedge. Only TIPS, commodities, timber and farmland hedge in both timeframes.
Participants Marco Ruiz

Head of Foreign Reserves Central Bank of Columbia (Banco la Republica de Columbia) Columbia
Mark Attanasio
Director of Hedge Fund Investments General Motors Asset Management USA
Ravo Vanags
Member of the Board and Head of Market Operations Central Bank of Latvia (Latvijas Banka) Latvia
Steve Algert
Director of Hedge Fund Investments The J. Paul Getty Trust USA

GLOBALARC Briefing Notes Boston 2010

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Global ARC Boston

2010 Briefing Package

About the CAIA Association

Panel Briefing Notes

Data Points Investors gravitate to alternatives

Investors increasing alternatives allocations

41% 51% 46%

Source: JP Morgan Alternative Asset Survey

Hedge funds et al still attractive

Endowments lead the way

Potential Questions/Points of Debate

investor investment schemes?

Participants Fan Hua

Panel Briefing Notes

Data Points Smaller managers exhibit outperformance

Larger funds give < risk-adjusted returns

Assets (USD millions, log scale)

Alpha peaks at the median

More small fund alpha in certain strategies

Single manager funds

hedge funds that had been much leaner.

commercial banks to fledgling hedge funds.

Potential Questions/Points of Debate

model (e.g., outsourcing risk modeling and analytics)?

really need it) and how might this affect performance?

Hany A. Shawky, Ying Wang

Participants Deepak Gurnani

Dr. Arvind Raghunathan

Panel Briefing Notes

Data Points MBS originations

Global high yield issuance

Maturities pushed further out

High yield bonds

Institutional leveraged loans

Source: Bank of America Merrill Lynch

Potential Questions/Points of Debate

exploit for out-sized profits?

Are Junk Bonds Junk? (2010)

Guangdi Gordon Chang

Model Risk and the Design of CDO Tranches (2010)

Participants Steve Shapiro

Anilesh Neil Ahuja

Panel Briefing Notes

Data Points US budget deficit projections

Mandatory federal spending % of GDP

500 0 -500 -1,000 -1,500 -2,000 -2,500

Medicaid, CHIP & Exchange subsidies

Source: Congressional Budget Office

Mind the gap

US public-held debt as % of nominal GDP

Source: Congressional Budget Office

Source: US Government Accountability Office

Potential Questions/Points of Debate

government assist them as it has with other groups?

Barry Bosworth, Susan Collins

Participants Peter Orszag

Panel Briefing Notes

Data Points US reliance on foreign holders higher

US securities foreign holders

of which Mainland China

French & German banks PIGS bond holdings

Estimates of government net worth

Initial Debt Level