IFM 2003 Geneva 2003 Alternative Strategies – Hedge Funds Geneva, February 2003
Hedge funds have no single definition but have unique characteristics: part of AIM (alternative investment management family and fastest growing segment) Low transparency Managing partners for investors as not Very little Low Barriers invest substantial to give away regulatory oversight, to Entry Typically structured own capital investment strategy as limited partnerships (not listed) Complex trading Usually use leverage strategy Low or negative to generate higher Usually structured correlation to stock Seek absolute returns but level in offshore banking and bond market returns varies depending on centres the fund Limited # of High initial Receive both Managers have investors investment plus lock- No advertising but management and high discretion (institutional and up period for initial incentive fees place funds privately high net-worth investment plus individuals) and conditions to redeem usually limited fund shares size 2
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Risks must be actively managed Risks Fallout Fraud when proper operational Clients bear significant risk as when things � � controls are not established go wrong with a hedge fund, an investor may lose everything Mark to market risk when illiquid � securities are purchased Major Losses include: � - Manhattan Investment Fund ($300 million) Human risk when the fund manager � bails out - LTCM ($3.6 billion) - Valrocane Limited ($700 million) Change of strategy risk when the � - Askin Capital ($420 million) manager does not stick to the original trading parameters - Argonaut Capital ($100 million) - Beacon Hill ($400 million) Size risk when a fund gets too big to be � effective (e.g. positions too large to move or the disappearance of arbitrage opportunities). HF Fund of Funds are Strategies are often neither market � designed to mitigate the neutral or arbitrage but simple long only (e.g. emerging market strategies) impact of such risk events and reduce portfolio Liquidity risk when a fund is � inappropriately capitalized volatility Strategy risk when hedge fund’s � strategy does not work 6
Despite the risks, the hedge fund market is growing rapidly worldwide on an extremely fragmented basis According to market estimates, the market size varies between $400-$500 billion assets under management. Due to the lack of transparency, these estimates offer only limited accuracy and may be over $600 billion. Although the market is much smaller than the $4.5 trillion mutual fund industry, it is still very sizable and growing faster. 90% is managed out of the United States with Europe growing rapidly. Roughly 25% of hedge funds are fund of funds. TASS Tremont, the AIMA and other sources estimate that the hedge fund market will continue to grow at 20%-25% per annum. The market is very fragmented with about half the funds making up 90% of total assets. The total number of Market Growth of Hedge Funds hedge funds is estimated between 500 AuM in USD billions 5,000 and 6,000. The 400 top 20 managers only 300 have a fraction of the global market share 200 100 Top Ten Funds 1. Moore capital mgt 8.0 bio 0 2. Farallon capital mgt 7.8 0 1 2 3 4 5 6 7 8 9 0 1 3. Andor capital mgt 7.5 9 9 9 9 9 9 9 9 9 9 0 0 9 9 9 9 9 9 9 9 9 9 0 0 1 1 1 1 1 1 1 1 1 1 2 2 4. Maverick capital 7.5 5. Citadel inv group 7.1 6. Angelo Gordon 7.0 Assets [USD billion] 7. Soros fund mgt 7.0 8. Pequot capital mgt 6.5 9. Och Ziff cap[ital mgt 6 Source: TASS: A prominent alternative manager offering market research 10. Renaissance tech corp 5.6 AIMA: Alternative Investment Management Association (as per financial news 30 June 2002) Hedge fund Associates Own estimates based on publicly available information 7
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There are several generic strategies for entering and/or growing the hedge fund (AIM) business Build Organically � White Label � Joint Venture � Merger � Acquisition � 9
Organic growth has the lowest chance of short-term impact unless a large scale business already exists Advantages Disadvantages Lead time to market Low financial exposure � � No track record Speed of initiation � � Lack of know-how Low influence on culture � � Dilution of bottom-line (investments in Minimal capital (no goodwill) � � infrastructure, marketing, human resources and other setup costs) White label: offer hedge funds managed by third parties Advantages Disadvantages Low financial exposure Profits shared � � Speed of initiation � Know-how transfer not very high � Low influence on culture � Reliance on third party risk controls � Minimal capital (no goodwill) � Lead time to market � Build on established track record � 10
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Key success factors and considerations for acquisitions Characteristics of the Target Firm Integration Success Criteria Acquisition Key Parameters � Short time from Strong CEO and management team � signing to Efficient infrastructure (systems and risk Friendly � closing control processes are key) transaction Compliance with all regulatory environment � registrations/authorisations Set up of Tax optimised legal structure autonomous � Solid performance track record business unit � Cultural Success and team driven culture � clashes to be Appropriate salary/incentive structure � managed Within budget constraints � Acquisition of Secondary Parameters � a digestible size Size of Assets Under Management � knowledge Geography transfer task � force Brand strength � Integration Distribution � plan needs to Overlapping businesses be established � New fund launch task force 13
Case Study: Man Group The Man Group has two distinct business units: Man Financial and Man Investment Products (80% of profits) Man Financial (1783) Man Investment Products (1983) Institutional Futures/Securities � Fund Managers & Strategies � Brokerage services for financial futures, energy, � AHL Diversified - Managed Futures � metals, foreign exchange, agricultural futures, Man-Balanced - Market Neutral Equities � global execution services, securities Man-Barnegat - Relative Value / Arbitrage � Investing (FI and currency) Man Futures Retail Clients Man-Drake - Equities Long / Short Investing � � Man-Glenwood - Multi-Strategy Investing 24-hour worldwide futures execution and clearing � � Man-Response - Short-term Futures Trading services, trading capabilities � Man-Vector - Managed Futures Full Cycle Trading � Managed Investments Division � Marin - Convertible Bond Arbitrage � Finds top managed futures and hedge fund � RMF Products and Strategies � products. Primary Fund Manager Details � Man Securities Retail Clients � AHL (Adam, Harding & Lueck ): largest manager, � Option order execution established in 1983, trades in more than 100 � global derivatives markets, from stock and bond futures to currencies, oil, gold and grain. Uses International Clients � systematic approach applying primarily trend- Services international private (non-US) clients. � following strategies. (Owned by Man Group since Products include futures, options, equities, CFDs 1987) � and foreign exchange. Man-Glenwood : does not manage investors' funds � Man Direct offers full service, advisory, execution- directly but allocates funds across a range of � only, and managed accounts strategies and selects between 80 to 100 specialised hedge fund managers expert in the Managed Futures Research utilisation of these strategies. (Owned by Man � Group) Database provides performance information on � RMF: a major European provider of alternative over 400 CTAs � investment strategies. Has a broadened range of investment management content, enhanced Clearing Services � strength in tailored solutions and access to other asset classes including private equity and high Online Trading Services yield; Focus on asset allocation � Acquisition reflects growing importance of FOF Managers 14
Case Study: Man Group Man’s profit structure has been redefined Profit Performance 1997-2003E 300 PBT and X-Items in GBP 250 200 150 Millions 100 50 0 1997 1998 1999 2001 2002 2003E -50 Profit Before Tax, Goodwill and X-Items Asset Management Brokerage NB: 99/00 excluded due to extraordinary loss and 15 months accounting. PBT excludes extraordinary items and goodwill Based on UK fiscal year 15
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