Presentation is loading. Please wait.

Presentation is loading. Please wait.

Independent specialists in tailor-made portfolios of hedge funds since 1989 International Asset Management Limited Managing Risk in a Fund of Hedge Funds.

Similar presentations


Presentation on theme: "Independent specialists in tailor-made portfolios of hedge funds since 1989 International Asset Management Limited Managing Risk in a Fund of Hedge Funds."— Presentation transcript:

1 Independent specialists in tailor-made portfolios of hedge funds since 1989 International Asset Management Limited Managing Risk in a Fund of Hedge Funds post 2008 – A personal perspective two years on Bernard Minsky Head of Portfolio Analysis and Risk Management June 2010

2 2 Agenda  A chronology – 2006 to 2010  Risk management before 2008  Our view in December 2008  Fifteen minutes of fame  Brave New World or Animal Farm  Not just about risk management  Concluding thoughts

3 3 A chronology – 2006 to 2010 JanFebJunAugSepDec 2007 Market Sub prime losses emerge Bear Stearns HF fail Quant equity losses Northern Rock bailed out by HMG IAM TCI writes to ABN AMRO Increase allocation to conviction picks Consortium buys ABN AMRO IAM Management start negotiating buy-out Jan-FebMarJulAugSepOct-DecDec 2008 Market Peloton and Carlyle hedge funds fail Bear Stearns bailed by JP Morgan/Fed Lehman bankruptcy, AIG, ML etc Market turmoil, liquidity strike Madoff fraud ‘exposed’ IAM FIRV managers under spotlight Employees buy- back from Fortis Enhanced risk management approved Portfolio losses and redemptions IAM never had Madoff exposure. JanMarAprOctDec 2009 Market Equity and credit markets turn positive AIFM draft published Galleon insider trading New Greek Govt austerity programme IAM Portfolio rotation programme starts Portfolios bearish Review risk aggregator products First significant new client portfolio Jan-AprAprMay 2010 Market Continuing fallout from Greece SEC sues Goldman Sachs EU bailout, Club Med risk IAM Start Risk Aggregation project Jan 2006IAM ABN AMRO buys IAM

4 4 IAM risk management before 2008 Strong due diligence programme Collegiate style of portfolio management Issues with approach  Never invested in fraud or operational blow ups  Tremendous network of contacts for reference checking  Conservative approach, true due diligence veto  Bespoke portfolios not comingled funds  Manager driven  Subjective approach to sizing  Lack of detailed risk exposure reporting by managers  Difficult to compare risk across managers even within a strategy  Under-use of background checking agencies  Research analysts assessed manager’s investment risk profile 

5 5 Our view in December 2008: Macro events Credit crisisPolicy shifts Event risks raise correlation levels dramatically  Financial system became too complex for its own good  When banks are in trouble we are all in trouble  2007’s year-end liquidity crisis did not reverse in January as many anticipated  Central banks concerned with inflation through early 2008 (not Fed)  Targeted changes to short-selling in July and September  Government providing capital to banks  Loose monetary policies  Credit crunch has spiraled into a widespread liquidity and confidence crisis  Question marks regarding bank solvency triggered further redemptions which has a knock-on effect

6 6 Our view in December 2008: Industry issues ShortingRedemption riskFinancing  Short selling regulatory changes  Pension fund stock lending shifts will cause the largest risk  “Short-termism” in the hedge fund investing community –Money classed as long term suddenly ‘hot’ –“Game Theoretic” pre-emptive redemptions  Madoff devastates remaining confidence in hedge funds credibility  Private bank redemptions expected to be much greater than institutional  Significant number of financial institutions reducing/withdrawing credit lines to funds  Trade financing that is offered will be more expensive  Longer duration trades financing will continue to be problematic  Reduced range of securities financed

7 7 Our view in December 2008: IAM challenges Manager selectionSlow to sell Long/Short managersDifficult to rotate in and out of strategies  High profile blowups avoided such as Madoff, Focus, Ospraie, Peloton, Carlyle  Several IAM managers performed poorly, but to a lesser extent  Sizing and asset allocation have been a negative factor  Slow to react to differing views amongst credit and equity managers  Increased risk outlook and reduced allocation but not by enough  Too many of our managers remained long bias or with high level of gross exposure  Had not converted a positive outlook on certain strategies to investable opportunities  Perceived lack of suitable managers in these strategies

8 8 Our view in December 2008: A changed industry Less crowdingSimplicity of strategyLess leverage  Fewer risk takers in the industry  Fewer funds  Simple equity long/short, trading, event driven, credit arbitrage have the greatest opportunities going forward;  Small Relative Value funds ( { "@context": "http://schema.org", "@type": "ImageObject", "contentUrl": "http://images.slideplayer.com/13/3749442/slides/slide_8.jpg", "name": "8 Our view in December 2008: A changed industry Less crowdingSimplicity of strategyLess leverage  Fewer risk takers in the industry  Fewer funds  Simple equity long/short, trading, event driven, credit arbitrage have the greatest opportunities going forward;  Small Relative Value funds (

9 9 Our view in December 2008 – IAM Response Macro eventsIndustry issuesIAM challengesChanged industry Development at IAM  Developed strategy forecasting process  Emphasised top-down asset allocation Renewed focus on:  Redemption risk  Counterparty risk  New Corporate Governance  Portfolio management process review  Consolidation of names  Risk budgeting New opportunities:  CTA basket  Macro  Equity Long/Short  Long/Short Credit and Distressed

10 10 Fifteen minutes of fame Nobody thanks you for saying yes… …but they know who to blame if it goes wrong  Risk management in bright focus  Conflicts in responsibility for manager liaison and risk management  Everybody second guesses… with hindsight, but we did make mistakes  Bespoke portfolios sheltered from “Game Theoretic” redemptions  Strong operational due diligence meant no Madoff A chance to make changes  Managers becoming more transparent  Framework for quantitative approach already in place  Profile of good risk control procedures raised to highest level  Every client and prospect wants to meet the risk team

11 11 Brave New World or Animal Farm  Rewrote Risk Policy for new board to approve  Founded Risk and Compliance Committee as sub-committee of the Board  Changed reporting line for Head of Due Diligence  Introduced quantitative risk budgeting process  Subscribe to risk aggregation service, and background checking service  Revamped monitoring of existing managers to align with governance change  Overcoming scepticism within the firm  Finding resources to produce the analyses  Gaining manager support to increase portfolio transparency  Allowing portfolio managers to manage, yet  Justifying the controls as markets ease and avoiding pro-cyclicality

12 12 New risk budgeting process ObjectiveApproachOutput  To quantify worst-case losses without diversification considerations  To set allocation limits for each underlying manager  To ensure PMC decisions are made in a risk aware framework  Use up-to-date readily available data from managers: i.e. exposure; maximum drawdown, portfolio concentration  Each fund is rated according to how it reacts to a battery of stresses, and measured across four factors: 1.Directionality 2.Concentration 3.Leverage 4.Liquidity  The risk budget framework assigns a maximum allocation (as a % of the portfolio) to each approved manager  Risk budgets are mandatory and rules for managing breaches are in the firm’s policies  Risk budgets are specific to mandated portfolio risk tolerance

13 13 Risk budgets Manager 1. Credit Fund 2. Event Driven Fund 3. Equity Market Neutral 4. Long- Biased Equity Fund 5. Macro Fund 6. Short-term CTA 7. Generic CTA Market Risk Test (%)0.59.03.012.828.24.77.6 Concentration Test (%)4.94.52.02.80.0 8.9 Leverage Test (%)10.04.33.13.632.13.65.0 Historic Max Drawdown (%) x 67%1.22.52.321.55.46.717.2 Liquidity Rating2311111 Worst Case Loss (%)12.513.53.121.532.16.717.2 Low Risk Appetite (%)4.03.716.12.31.67.52.9 Medium Risk Appetite (%)6.05.624.23.52.311.24.4 High Risk Appetite (%)8.07.432.34.63.114.95.8 Example – Proposed Allocation in a High Risk Portfolio (3–8% min/max allocation) 4.5483164 Source: IAM. Portfolio Construction Optimal strategy weights Approved manager suitability Portfolio Management Committee approval Rigorous testing through IAM Software

14 14 Downside risk measurement rather than dispersion measurement Co-drawdown is the probability of the column fund suffering a loss at the same time a row fund suffers a loss. Source: IAM. Correlation Co-Drawdown

15 15 Not just about risk management New Board makes its mark  New governance structure introduced  Emphasis needed for clear definition of philosophy, style and processes  Confirmed commitment to Bespoke Portfolio product  Semi-annual review of progress with CEO Improves portfolio management process  More use of top-down strategy analysis  Portfolio Manager responsibility allocated to committee members  Better quantitative tools and better use made of them  Investment Committee member linked to each manager relationship

16 16 Enhancing portfolio construction Strategic Asset Allocation Manager Selection and Risk Budgeting Portfolio Optimisation Portfolio Scenarios Simulations Rigorous Testing Process Forecasting and Analysis Maximum allocation for a given risk appetite Challenges allocation Evaluate performance and risk characteristics and validate allocations Portfolio Construction Optimal strategy weights Approved manager suitability Portfolio Management Committee approval Rigorous testing through IAM Software

17 17 Backtests and forecasts Historical backtest Simulated forecast Future views and confidence Neutral NegativePositive Mixed Stress test Manager contribution All-weather manager Contribution to Positive Months Contribution to Negative Months Bell-weather manager

18 18 Concluding thoughts  Was this an Ancient Greek Tragedy? -Hubris, Nemesis and Catharsis  Or a painful learning experience? -Bespoke portfolios work -Keynes was right about the long term -Liquidity, transparency and simplicity -Process, process and process  Maintain your own equilibrium -Have a thick skin, but admit your failings -Be part of the solution not the problem -Stand up for what you believe

19 19 This document was prepared by IAM, a company authorised and regulated by the Financial Services Authority (FSA). The information contained herein is not for distribution and does not constitute or form part of any offer, recommendation or invitation to participate in any product. It does not take into account the investment objectives, financial situation and particular needs of any investor. Any investor or prospective investor should consider whether such investment is appropriate to their particular investment needs and financial circumstances and consult the offering memoranda of the product which are available upon request. Past performance is no indication or guarantee of future performance. The value of investments may fluctuate and prospective investors may not recover the full amount initially invested. The products described herein are not subject to approval or regulation by the FSA and as such the Financial Services Compensation Scheme will generally not apply. This document has been prepared by IAM on information available to them and has not been independently verified. Accordingly, no representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information contained in this document. No liability whatsoever is accepted for any loss arising from any use of this document or its contents. This document is being supplied to you on the basis that you are an entity of a type falling within one of the approved categories described in the Financial Services and Markets Act 2000 and is being supplied to you solely for your information and may not be reproduced, redistributed or passed on to any other person or published, in whole or in part, for any purpose. By accepting receipt of this document, you agree to be bound by the limitations set out above. IAM uses data from the following sources: Bloomberg, EurekaHedge, Hedge Fund Research Inc., Morgan Stanley Capital International Inc., Morningstar, IAM and the relevant Administrators. International Asset Management Ltd, 7 Clifford Street, London, W1S 2FT Tel: +44 (0) 20 7734 8488 Fax: +44 (0) 20 7287 7129 Please contact: Jamison Skelli-Cohen (jskelli-cohen@iam.uk.com) or Sue Kim (skim@iam.uk.com) IAM Research (LLC), 540 Madison Avenue, Suite 18B, New York, NY 10022 Tel: +1 (212) 826 1845 Fax: +1 (212) 980 2708 Please contact: Amanda Dippel (adippel@iam.uk.com) International Asset Management Ltd (UK) Norden Filial, Strandvägen 7A, 4tr, S-114 56 Stockholm Tel: +46 (0) 8 586 334 70 Fax: +46 (0) 8 660 65 89 Please contact: Henric Malmqvist (hmalmqvist@iam.uk.com) International Asset Management Ltd, Sucursal en España, c/ Almagro, 25 (2 izq), 28010 Madrid Tel: +34 (91) 391 5096 Fax: +44 (0) 20 7287 7129 (London Office) Please contact: Marivi Lorente (mlorente@iam.uk.com) International Asset Management Limited (IAM) – Legal Disclaimer


Download ppt "Independent specialists in tailor-made portfolios of hedge funds since 1989 International Asset Management Limited Managing Risk in a Fund of Hedge Funds."

Similar presentations


Ads by Google