1. Hedge Funds Lecture 1: Overview Ezra Zask Yale University September, 2005

2. Definition Investment approach –A sub-set of alternative investments that incorporate all investment strategies run with an orientation to producing primarily absolute returns using largely marketable securities. –Strategies typically include short-selling and often include leverage –As a result, correlations with broader markets are expected to be modest to low. Legal Definition –Freedom from ICA (1940) controls on: Leverage short-selling cross-holding 10% limits incentive compensation derivatives positions –Limitations on: number of U.S. investors (99 maximum) solicitation of U.S. investors public advertising and disclosure

3. Institutional Allocation

4. Allocation Methodology

5. Impediments to Investing

6. Institutional Assets

7. Institutional Share of Assets

8. Long Only Managers

9. Structured Products

10. Asset Class Allocation by Institutional Investors Asset ClassPercent Allocation Equity51% Fixed Income17% Real Estate4% Hedge Funds15% Private Equity3.2% Venture Capital3.5% Natural Resources3% Source: NACUBO Endowment Study

11. Strategy Allocation StrategyAssets ($bln)Percent AssetsNumber Funds Long/Short Equity Hedge 28235%1148 Event Driven38.618%316 Other40.79%316 Fixed Income Arbitrage 38.6166 Global Macro32.68%146 Emerging Markets31.77%168 Market Neutral26.86%212 Convertible Arbitrage 22.25%124 Dedicated Short1.2--17 Source: Lipper/Tass

12. Hedge Fund Location LocationPercent Assets Cayman Islands35% United States32% British Virgin Islands8% Bermuda8% Bahamas4% Luxembourg3% Asia4%

13. S&P Hedge Fund Strategies

14. Strategy Definitions

15. Fixed Income Arbitrage

16. Convertible Arbitrage

17. Merger Arbitrage

18. Equity Market Neutral

19. Distressed Securities Strategy

20. Special Situations

21. Equity Long/Short

22. Managed Futures

23. Global Macro

24. Strategy Performance Conve rtible Arbitra ge Distre ssed Securi ties Emerg ing Market s Equity Hedge Equity Market Neutra l Event- Driven Fixed Incom e Arbitra ge Fixed Incom e Convt Bonds Fund of Funds MacroMerge r Arbitra ge Market Ti Relativ e Value Arbitra ge Dec 199315.2232.5487.1027.9411.1128.2216.6423.6026.3253.3120.2424.1827.10 Dec 1994-3.733.847.652.612.656.0011.94-0.62-3.48-4.308.883.494.00 Dec 199519.8519.739.0231.0416.3325.116.0819.1711.1029.3217.8612.5815.66 Dec 199614.5620.7735.6921.7514.2024.8411.8918.2414.399.3216.6113.4714.49 Dec 199712.7215.4019.8523.4113.6221.237.0217.6016.2018.8216.4413.5715.93 Dec 19987.77-4.23-36.3915.988.301.70-10.297.53-5.116.197.2324.822.81 Dec 199914.4116.9440.0644.227.0924.337.3836.9426.4717.6214.3426.1714.73 Dec 200014.502.78-9.399.0914.566.744.78-11.174.071.9718.0411.7914.43 Dec 200113.3713.2811.510.316.7112.184.813.302.806.872.764.098.92 Dec 20029.075.28-0.03-4.710.98-4.308.77-13.071.017.42-0.86-3.265.42 Dec 20039.9329.5832.4120.532.4625.339.3517.5211.6221.4414.3915.389.72 Dec 20040.9718.2116.927.664.6314.235.158.606.394.723.513.685.03

25. Strategy Performance (2) Mean Return (%) Standard Deviation (%) Sharpe RatioSkewnessKurtosisAlphaBeta HFRI Convertible Arbitrage TR10.536.561.6341-1.13491.13890.09630.0863 HFRI Distressed Securities TR14.0210.991.3205-0.0382-0.55060.11930.2043 HFRI Emerging Markets Global TR14.3130.230.59110.64702.13990.15240.2087 HFRI Equity Hedge TR15.8614.271.16680.2938-0.35620.09720.5501 HFRI Equity Market Neutral TR8.435.321.60880.0563-1.50660.07070.1172 HFRI Event-Driven TR14.9810.921.4171-0.5234-1.12540.10910.3615 HFRI Fixed Income Arbitrage TR6.776.491.0732-1.59444.73970.0770-0.0587 HFRI Fixed Income Convt Bonds TR9.7414.520.7328-0.1235-0.19720.03690.5515 HFRI Fund of Funds TR8.8710.380.89760.4218-0.62670.06710.2066 HFRI Macro TR13.5215.410.93371.54812.98390.10630.2987 HFRI Market Timing TR12.149.361.33500.0168-0.83270.08710.3003 HFRI Merger Arbitrage TR11.417.041.6514-0.5811-1.12590.09080.2017 HFRI Relative Value Arbitrage TR11.336.931.66160.78860.87550.10450.0847

26. Style Risk Return

27. Style Correlations 1/1994-6/2005 Style Correlations Distressed Emerging Markets Equity Market neutralEvenMultiFixed Income MacroHF IndexFuturesFoF Distressed Index10.58230.3630.93570.75090.31170.31610.5796-0.12670.661 Emerging Markets Index0.582310.24640.66530.66650.27510.4190.6535-0.09910.7399 Equity Market Neutral Index0.3630.246410.39180.36580.11330.20980.33640.12310.4441 Event Driven Index0.93570.66530.391810.93170.38810.38240.6691-0.17410.7577 Multi-Strategy Index0.75090.66650.36580.931710.42890.42790.6878-0.19480.7616 Fixed Income Arbitrage Index0.31170.27510.11330.38810.428910.45410.4476-0.06850.426 Global Macro Index0.31610.4190.20980.38240.42790.454110.85870.24450.6453 Hedge Fund Index0.57960.65350.33640.66910.68780.44760.858710.12640.9082 Managed Futures Index-0.1267-0.09910.1231-0.1741-0.1948-0.06850.24450.126410.1171 Fund of Funds0.6610.73990.44410.75770.76160.4260.64530.90820.11711

28. CISDM Style Beta Analysis S&P 500Small CapS&P VolatilityImplied Vol Change in Implied Vol Yield Curve Slope Credit Risk Premium 10 Year Swap Spread Equity HedgeMMMHMMHM Relative Value Arbitra geMHHLMMHM Global MacroMHMLMMMM Fund of FundsMMMHMMHM Equity Market NeutralMMMMMLMM Convertible Arbitra geMHHLMLMH Fixed Income: Arbitra geMMHLMHMM

29. Hedge Fund Alpha