Exploring Portable Alpha Strategies
- 01 hr 47 mins 12 secs
Portable alpha has been implemented across a range of strategies, both locally and internationally. Absa Multi Management and Absa Alternative Asset Management, recently hosted a webinar exploring Portable Alpha strategies. Speakers on the webinar included Absa’s Neville James and St John Bunkell, Jeleze Hattingh from Southchester Investment Managers and Michael Rhodes from Goldman Sachs Asset Management.
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Hello and thank you for joining us. As we explore a very important discussion on possible Alpha strategies um, Candy cuvee and on behalf of Absa Multi management and Abs Alternative asset management. Warm, welcome to you all now. For many years possible. Alpha has been used by insurance companies, corporate and investment managers. It's no wonder that over the years investors have gravitated to possible Alpha for multiple reasons. Undoubtedly there is a certain appeal to the concept in that it reconciles the need for higher returns while still offering many of the same advantages of passive investing. Well to discuss this and more. I'm excited to introduce our speaker lineup which includes upstairs neville James and singer Amb Uncle john is hurting from South Chester investment managers and Michael Rhodes from Goldman Sachs asset management. But before I introduce our first speaker, please do note that you can join the conversation by sending any questions you may have for speakers via the chat box. You can also email your questions to insights and absurd dot c o dot c a and we will tackle those questions through our position. Well, to kick off today's conversation, please join me in welcoming our first speaker, NEville James will ease up some multi management's chief investment officer. I'm NEville James and I'll be talking to you about affordable healthcare solutions and how they can add value to investors. First of all, I'm going to talk about the cyclicality of equity managers in their ability to outperform the LZ 40 or the JsC top 40 index. Looking back over time, we can see that most managers struggle to outperform the index of the rolling one year periods that has picked up lately in uh, April 2021 due to the current market volatility. But Other than that, over most periods, managers have struggled and this is also before fees. So when you add on manager fees, there's even less chance of an active manager performing the l. c. 14. If you look at longer periods, It's even more evident. And uh around about a 20% chance of a manager outperforming the old deportee over the rolling three year periods. This is a little bit of a busy chart but it's quite a lot of information. So each Box on a data point is the 25th to the 75th%ile of general equity funds. The black line in the middle of the boxes, the median and the top and the bottom whiskers show the 90th and the 10th%ile. The Red Line then shows the performance of the jazz. He put put see Jazzy Top 40 index. And you can see that over most periods you'd have to for most general equity funds about just holding the index over the railing and railing. Three year periods. Look at over 5-year periods, you can see that it's even worse. You have less chance of picking a manager that's gonna outperform. And uh, a lower probability. Looking again at rolling five year periods for each data point is a rolling five year period. You can see it, but they're beholding the index. You again would have done better than most general equity fund is just by holding the index. So it is quite a strong argument for holding a passive component. But then the next point on from that is uh, why are the managers performances since they are cyclical? So traditionally asset managers in South Africa Um, invest in pretty much the same investable stocks, which is about 160 stocks portfolios tend to over large, overlapping in their underlying positions. You can get some diversification but by exposing yourself in different investments trials, but investment styles really give you the same underlying stocks with just different ways. So you're not getting through diversification inside inequities. It's not to say that it's not better than no diversification. It certainly is, but um you're not getting maximum diversification. If you look at the diversification between value and momentum, which are really the two sort of predominant styles in the South African equity market, um The red line is the S and P South Africa Value Index and the platform, the momentum index And the gray line shows a 5050 split between the two. You can see that they pretty much offset each other the most grueling three year periods. So you're not really gaining a lot. But I was fine between those two. Um Investment styles. What is portable Alpha? The investment strategy that is predicated on the ability to separate the portfolio sources of L fair from its sources of data. The objective of portable Alpha is to add alpha from asset classes that are less efficiently priced, uh, such as fixed interest or hedge funds. And added to the beach of those asset classes that are more efficiently priced, such as local equities. The beetle can be sourced for little or no cost and Alpha sources can be completely independent of the B to point. But, and this is done using the relatives and the risk can be calibrated to suit investors return objectives, just showing you the mechanics of portable Alpha. So rather than traditional asset management, which you would purchase all the underlying securities of the top body index in the weightings of the top of the index if you wanted a passive exposure. So rather than doing that, Use your cash, collateral about 10% of your assets to buy exposure using derivatives to the LZ 40 And then you've got about 90% of your assets remaining, which you can then invest in alpha generating portfolios that How to add alpha to your overall strategy over and above the all the 40. So to give you a bit more of a practical example, we've got here after portfolio made up of income pens, absolute return bonds, private debt, infrastructure and African Eurobonds and that is then invested to achieve a return in excessive the cost of the swap being job a plus 0.8% per annum with the county, which you then pay across the counter party bank. The counter body bank then pays you the all the 40 years stone and you left with the return of the OC 40 plus the excess return in by that Elsa portfolio over and above the job plus 0.8% Per Annum. Just looking through each of the components income funds would typically be the core holding within the portable for portfolio. It should are to perform job last .8 by investing in slightly during longer duration money market instruments as well as some credit rising liquidity for the portfolio for the handling of cash flows And the expected return. And this would be job plus when two jobs plus 2% per annum, absolute return bonds give you expose it to a longer duration global bonds. And by investing in this, you can expect a return of job plus three two jobs plus 3.5%. Private debt is an interesting one gives you access to higher yielding debt. They fully fully collateralised bilateral loan agreements Term to maturity usually 3-5 years and unlike ones there's no principal payment at maturity so therefore there's no duration effect on that principle. And the volatility is very low And for that low volatility you can get a return of Java, that's three to drive up this 4% infrastructure is another interesting one. It's been very topical lately with the The revisions to regulation 28 for the pension funds so that there's a huge need for private sector infrastructure funding and portable health allows investors allocate a portion of the access to infrastructure without changing their policy portfolio or script into gas allocation. The expected internal infrastructure will be about java plus 3.5 pajama plus four and then African eurobonds. Another interesting one. Um you're allowed to invest 10% in Africa over and above your 30% offshore limit and that provides additional diversification opportunities. Eurobonds are strangely enough, many usd denominated african debt instruments, although there are a few listed in euros. Yes, these era iris can be hedged out and the the interest rate can be headed over as well. So if you look at the African Eurobonds, you can expect a return of job plus eight two jobs plus 10 with that's unhedged and with hedging job plus five job plus six. And then you have your margin account which is your cash collateral which you hold for the better exposure that you're going to obtain through sops or futures. So the overall picture looks like this You have here in this example a alpha Portela that has an expected total average return of 3.3% above Jabbar. You paying job a plus 0.8 to the counter party bank And they're paying you the total return on the RC 40 in return. So your net total return is Bill C40 plus 2.2 doesn't quite add up. And the reason for that is because you And assuming no return on your margin accounts, you've got drive off for 3.3 on 90% of your assets. Uh Monica job a plus .8 on you, 100% of assets but still very nice educated java plus two point T. What you're really looking to achieve is consistency. So you can see in this example is far more months in which the Alfa that can be ported is positive than there are that that alpha is negative. There's the one big draw down in March 2020 which is obviously the COVID crisis which impacted badly on bonds and equity. So what you want by way of return profile, this is back tested returns Um going back 10 years. I'm not trying to sell the baptist returns too much. It's more to focus on the, um, profile that we expect from portable office, which is that consistent, long term incremental our performance. So we're not looking to shoot the lights out at any point and we're not looking to a catastrophic month at any point. If we look at the effective consistently beating the benchmark on a monthly basis, you can see the portable Alpha by nature because the sourcing is an offer from sources other than equities. It is, it's got more chance of after forming its benchmark on a monthly basis and that translates into better long term returns. So looking at each touches is a general equity portfolio from the Morning star database. And uh, you can see firstly that followed by Alpha is a lot more consistent on a monthly basis. And secondly that that monthly consistency results in There and most long term returns that are achievable over 10 year parents. It's interesting tonight that, well, that's all the equity managers Uh more likely to are performing a negative month in a positive month. In fact, if you look at 10-year periods on Morningstar, every single one of them does better in a negative month in a positive month. So part of my portfolio actually combined nicely with traditional managers in that it gives you that investment strategy that will outperform in a positive man more likely than in a negative month. And that provides some interesting diversification opportunities. Mhm. The relationship between tracking area and the performance is um tenuous at best, uh affordable Alpha is the training of about 2% which really is because the media is purchased by the derivative and has a really competitive long term returns. Whereas active managers who take on a lot of tracking area and a lot of risk relative to their benchmark, um don't necessarily generate generate returns that are commensurate with that risk. So this is just looking back again, that's the same graph I showed you earlier. UT Top 40 Index vs General Equity Funds. If I did speak between that and the portable Alpha, you can see the extent to which portable Alpha can enhance your performance over and above the the index to provide a and very competitive return. So it's mostly above 75th%ile and very often above the 90th%ile. Same story with the five year returns. This is the same in the same graph I said you earlier. Um And that's the enhancement, the portable. So you can see it has a significant enhancement over the index over the longer term and that's because of the consistency and the compounding positive returns. Mhm. What are the risks? Key risk is support for alfa portfolio must be well diversified. Uh The author portfolios need to be optimized to minimize the frequency and severity of the underperformance of the return target. So it's optimized based on the tail and not on volatility was voluntary if he did not pick up those sort of tailor events which provide risk and affordable alpha context. And the other major risk is counter pawnee bank risk. Um The swap mechanism really provides or exposes you to a lot of counter party bank risk so that counter party bank exposure needs to be diversified across the major banks in order to diversify that risk away. And that's it for me. Well, thanks for your time Naville. Without wasting any more time, I'd like to introduce our second speaker, jellies hatting jealous joins South Chester investment managers in 2020 as a portfolio manager. Hand is over 19 years of investment experience specializing fixed-income asset allocation and alternative investments universe. She started her career focusing on risk management and financial engineering within investment banks, working for institutions such as Yes, Absa Standard Bank Credit Suisse UK and Deloitte UK in 2000 and eight she returned from London and moved to the asset management industry, joining Allan Gray in Cape Town is the fixed interest trader. Chile's joined Element investment managers in 2010 as an investment analyst was appointed a portfolio manager on Elements multi asset funds in 2012 and then elected as an executive director in 2017 before she left for a sabbatical through East Africa. The majority of the funds that she had managed ranked in the top 10% of their respective categories over the preceding three years. While the multi asset high equity fund had just won the raging Bull award for top performance, jealous is both a c. F. A and C. M. T. Charter holder and also holds a master's degree in business, mathematics and information science Cialis. It's over to you. Thanks Candy and thanks for the opportunity to actually be part of this weapon. Also today we're talking about alpha strategies in a south african context. So the gender that we're going to quickly run through the next 10 minutes, it's just looking at the main case for portable alpha strategy. What happened in the 2003, space? We went from a darling to a villain and back. What can go wrong specifically on the alpha side of this whole strategy. Typical portable alpha strategies in South Africa and then a case study of the potential alpha strategy that one can include. Um, so to quickly run through it, I quite like using google trends just to give an idea of market sentiment. And if you look at the trends behind the word portable alpha And you can see in 2006 there was this massive, um, almost hype around Portugal alpha and comments flying around of you can put your alpha and eat it. And then obviously great financial crisis happened. And as for normal it went down into the doldrums and the comments started coming out like that portable alphas, like synthetic Russian roulette. So the question is, what went wrong and what can we do at the moment and why is it coming back? So we're going to try and address some of those those comments. So firstly, what is the main case for portable alpha strategy where we stand right now in the cycle? So as the previous speakers level is said already, the majority of active equity managers are really struggling to add Alpha. And if you look at the top portion of that slide, you can see that the number of funds actually outperforming the total return equity indices over any given month is fairly low. So there is an argument for passive versus active at this point in the cycle. But the problem with passive is that it will always underperformed the benchmark due to fees. So if you've got a target where you need to outperform the benchmark, you are by definition going to underperform if you just use a pure passive strategy. So then let's look at this affordable alpha strategy. Again, as NEville already explained, it's to allow investors to add a separate alpha component or our performance component, to a better yielding passive market investment. So we're going to talk a little bit later on in the presentation about how to do that. But for now I just been recruited as let's assume the target return is the all see the return of the L. C. As you beat. I return plus a 2% alpha. So you want to get index plus two, the author of the better component, you typically replicate by derivatives, whether it is all the futures options that return, swats etcetera. So we're gonna talk a lot more about that alpha component because that is where from south Chester viewpoint where our strength actually lies. So the excess return is generated on this strategy. If the alpha components return exceeds the cost that's associated with using the derivatives. So let's talk about that a little bit further firstly, what happened early in the 2000, 2000 to 2000 and 10 because in 2000 and three, portable alpha as a strategy was relatively unknown. And then as these things go, it started become trending and by 2000 and eight about 22% of the north american institutions had a portable alpha allocation and 45% were considering it. Now to put that in context. Currently there's a lot of research running around that about 25% of north american investors, Almost just the man on the street is already invested in Bitcoin. But we all know that the hype about Bitcoin at the moment and the number of articles and research going around. So you can imagine it's that same high Back in 2000 and 2008 where the comments were flying off, you can have your port, you can Porcher alpha and eat it. And then great financial crisis happened. And we started seeing the comments as you can see there on the screen of portal Alpha fails to deliver the goods. What went wrong? It falls out of favor the temptation of the strategies. So like anything else. The strategy got burned but it got burned because the correlation between your alpha and you beat our components went to zero and we're going to talk about what does that actually mean and how to prevent that. So firstly what went wrong correlations and drawdowns. So Alpha strategies should have very little correlation to your beetle component. That means that any draw downs is a beetle component should be offset by your Alpha. So let's think about what is that practically mean? It means that any drawdowns in the equity index in your passive component. Let's think of getting about 20 to 30% drawdown similar to even what we saw in March last year should be offset by alpha strategy that has got very little correlation to the equity markets. But what you can see there, and I've actually highlighted in red during the financial crisis, your conservative hedge fund of funds, which is basically your alpha component. That was used in a lot of these strategies. They lost 19% on average versus you'll be to your equity market, losing 37%. Now you can look at that and said still our performance of close between the scene. Your problem is if you lose it during the same period, then you've got a liquidity crisis that is actually compounding the negative returns. So what, how do you mitigate it? You look to find it or you target alpha components with a low beat, uh, correlation and a fairly restrained drawdown history. Okay, so keep all of these points in blue or green. I don't know what color that is. Just keep that in mind in terms of how do you subject your alpha to vote the second point market volatility and liquidity? So you beat our component. As I explained, you usually use derivatives behind that and those are exposed to daily market movements. So let's assume you're using uh, all the future to basically capture the beater component or the passive index return as to all the drops three times will rise three times you've got daily margin calls on that specific position. So you should keep a portion of your of your strategy of your fund as a cash reserve to cover those margin calls. Because the moment that your cash reserve is exhausted, your alpha strategy must be liquidated to come to the call. And that is what happened during 2008. So when you're conservative hedge funds lost 19% at the same time that the index lost 37%,, Some of those hedge funds had to be liquidated in order to cover the marginal, which means now you're locking in a loss for component that was supposed to give you almost a correlation free or very low correlation, positive written. All of that being said, you want to target alpha component with a high level of liquidity so that if you have to sell it in the worst case scenario that you can actually get out of that position without having to pay a mass affinity, right, what else should investors be cognizant of? Obviously your alpha generation should be consistent and replicable. That means it must be a proven strategy with salary teachers throughout market cycles. So whether you've got it basically, if oscillating or flat market cycle upwards trending downwards streaming, it should consistently outperform the cost of funding your beat up component or the cost of cash. So one has to be cognizant of doubling up on risk and your hidden effects of the gearing. And that specifically talks to targeting Alpha managers with a consistent return and a very transparent investment strategy because if you don't know what they're doing, you don't know whether you are doubling up on risk, whether you're taking additional gearing risk or whether this strategy will outperform throughout the cycle because that is essentially what you want. And the last point is excessive fees because usually a portable Alpha strategy carry a fairly high fee structure because you're expecting the investment Manager to add the alpha component, active component of our performance. So any excess returns can very easily be eroded by excessive performance fees. Specifically, if those performance reviews are against very low benchmarks. So again, target Alpha strategy or Alpha manager that's got a transparent fee structure so that you know what you're on the hook for. They're obviously a number of other things to also be cognizant of. But I think we're going to focus on those four points throughout this presentation. So let's look at it simplistically. If you want to build 100 million rand portable Alpha strategy, like I said, you can use different directives to do that. In this case, we're going to buy 161 multi futures, Which is gonna give us about 100% effective exposure to the top 40 index. We're going to pay down 7.7 million rand margin initial margin for that. Keep additional 22% in cash so that we can cover up to 2022% drawdown level and then we're gonna talk about that remainder that 70% that we can now invest into alpha strategies. So again this strategy will outperform the benchmark if your alpha strategies return is larger than the cost of the derivatives plus the feet and bear that in mind because the feed component is one that actually turns around at the end and and you wrote your your it is. So let's just quickly look at it graphically so you can either go 100% passive equity. But like I said, you're always underperform the index you defeat. You can next step is to have your Almost your beater component. So this goes like to show you you need 8% of cash to buy 100% of all their futures and you've got 92% for cash and your cash buffer and alpha. So let's take it a step further out of that, 92%, is going into a cash reserve. We can talk about the 70% into alpha and the last part of boxes basically showing you typical at Alpha strategies in South Africa, similar in a global context. But we're specifically going to talk about the South African context. So you've got enhanced money market or income funds, absolute return strategies, unlisted credit and infrastructure project. We actually go long duration, you've got risk, premium or long short strategies and then lastly numerous other types of hedge funds and that is where we're gonna end up. I'm going to give you an example of a hedge fund that actually complies with all of these points. So let's quickly just touch on each of these categories, on the enhanced an income fund or money market fund portion where you basically take you 70% allocation and just put it into an enhanced income fund. The problem is that there is not sufficient alpha generation and I'll show that to you in a second on the absolute return strategy part. There you need to be very cognizant of potentially doubling up on rescue to ask allocation decisions. So where there's again already equity component within say, a C B I plus four type fund or a repo plus four type fund. There's already equity component. So your correlation to beat up is going to be higher than what most property you will be comfortable with if there is any drawdown on the enlisted credit or the infrastructure project funding side, Yes, you can get a great return in a very nice guilt. Pick up your risk these liquidity risk. If you need to accept these strategies prior to maturity, there's usually either no by on the other side or you're gonna have to pay a fairly significant penalty to get out of it. So the coverage of the liquidity risk, because it's usually a very long duration position that you find on the risk premium side risk premium. Also different words for typical long short strategies where managers try to add Alpha by buying the shares that they think without performance selling the shares. And I think we're underperform to be market neutral, but still had alpha explosion. There's a lot of hidden correlation that will actually show you there. And then lastly, you look at different other types of hedge funds and we specifically going to talk about fixed income hedge funds there. The thing to be cognizant of is volatility because you don't really think it's going to be volatile. And secondly, understanding the investment strategy behind it. Yeah, its first started and say, what should you targeted level of Alpha B for alpha strategy? In this case we want to target a total portfolio return of beetle plus 2% whatever beat us Whether it is the L. c. top 14 etc. And just for the sake of argument, assume the cost of funding the derivative site or the better side is equal to people can be driver, it can be anything else. But for now let's assume it's equal to repo And let's assume that the average cash, which is the average money market fund return over the past five years gave us repo plus 50.9%. So that's for the 22% liquidity or cash buffer that we're keeping. Our alpha strategy needs to give you report plus 4% in order to get to portfolio alpha net of fees and then the portfolios only charging 1% fee fee structure to that of 2%. Okay, so we're looking for strategies that can outperform reaper plus for consistently three times. Firstly, I talked about income funds or enhance income funds not providing sufficient pickup. So if you look there in the little red box, I've highlighted the percentage of Multi asset income funds that have outperformed this repo plus 4% level Over on a year by year by year basis. I haven't annualized it because I specifically want to show how difficult it is to choose the right manager. You've got 10% of the funds are performing in 2024% in 2019, etc. So the amount of excess alpha that a typical enhanced income fund can generate Will most probably not be sufficient to actually get to your targeted beat up plus 2%. We go and we look at risk premium funds. Now, this is specifically looking at all the long short equity hedge funds in South Africa and the data is from where she is Africa, then it actually looks a bit better. There's about 25% of the funds that have outperformed the target of repo plus 4% over the past three years on a rolling and last basis. If you look at it on a year by year basis, 2020 and 2019 was quite good. But 2018, as you can see the percentage of funds outperforming repo plus four, It was only 9% of the funds. So firstly, you've got survivors should buys that's inside of this, of the data set. And secondly, again, you need to choose your fund correctly. But again, over here, it looks better. You can basically have 25% chance of choosing the right the right fund with the right amount of research that went into your fund selection. So what is the bigger risk behind your risk premium funds? And that's inside 15 firstly, there is a lot more volatility in order to get that our performance, as you can see, we're using standard deviation is a measure of risk on the on the X axis and then analyze performance on the Y axis for performance over the past three years to the end effect. And the majority of the funds in the two orange dots are your two equity benchmarks, your walls in your top 40 type return indices and then horizontal, you can see where we pay plus 4% is. So you want to ideally be in the top left quadrant of that graph. And you can see there's 123456 months that are actually be over the last three years. But looking at those funds and actually looking at all the funds and vitality. The main thing that you need to be cognizant of is the correlation with your benchmark. In this case, I actually looked at the correlation with the S. C. Top 40 total return index across all of those 32 funds and it ranges between 320.13 and 0.9. So just then as you can see the top, the correlation between the all the and the top 40 is about One time. So that is one for one. You want to ideally like I said, have a very low correlation to your feet are component. So the risk was going too long. Short equity hedge fund is that your correlation is let's call it sufficient more than 15. As you can see the medium 1.6 ad which means if there's an equity drawdown in the bitter component, you're gonna have a similar drawdown yourself component. It's not necessarily what you ideally would like to see. So the follow up questions then obviously if long short equity hedge funds are not the ideal answer our fixed income H funds anything better. So there you can see the 12 different fixed income hedge funds. Um, so these are single manager fixed-income hedge funds that are currently available. And some of them have got zero correlation, which is basically what you actually want in the type of the portable Alpha strategy. But still some of these fixed income funds, if you look at number fund three from 5.9 11 and 12 Oh, basically sitting on a .5 times correlation. So again, you think there are no, there's no correlation between yourself and your beauty component. But the correlation is the thing that keeps us from the market darling to the synthetic Russian roulette. So I'm specific specifically going to talk a little bit about fund one later on. But what you need to be wary of on the fixed income hedge fund side is that not all fixed income management are the same. So they all run different types of strategies. And this is where it's so important to understand the strategy that the manager is using to make sure it's replicable but also to understand how it will perform through the cycle. What I've done here is just plot the 12 different hedge funds, fixed-income hedge funds and the month of performance over time over the last three years. And in the red block you can basically see what happened during the What we call the liquidity crisis in March and April last year. You can call it COVID crisis and give it a bunch of different names. But you can see that a number of the funds actually had massive 15% drawdowns and then 50% our performances as well. So if you look at it on an annualized basis, it looks great. But your level of volatility is extremely high. And if you have to liquidate any of these positions whilst there's a drawdown in place to create our components, marketing market margin calls, then you can sit with a little bit of problem because you're going to lock in potentially lock in some of those rounds. So you want to focus on the fund that's got relatively high performance with relatively low volatility. So again, similar to the previous slides, you've got your analyze performance of the one access standard, deviations measure of risk and the other one. You can see the Orange start rehab plus four over the last three years. And I'm specifically going to talk about the green one. The Southwest is smart escalated president qualified investor hedge fund and it's a massive longman because that's where the abc actually expects us to call the thing. We just call it smart. So our Smart Fund was launched in 2017. The benchmarks report plus 4% and you can basically trade or liquidators fund on a monthly basis. But what I want you to look at is that analyzed number since inception of 13% return over the last three and a bit years versus your 9.7% which was repo plus 4% already. So for each Canada here, you can see the out performance. So we're looking at consistent out performance and you're also looking at replicable our performance. So why is smart according to me, a good Alpha strategy to potentially include and again, I'm using this as an example of how to think about, let's call it your fund composition firstly, it's got a conservative, low volatility strategy where the performance is not linked to underlying emotion or directional trading, which means it remains consistently throughout interest rate cycles or throughout market cycles. It's got a transparent yet money market strategy. So you know what you're getting, where the relative usage is only used used to hedge risk out. Okay, so you know what you find, they said, focus on liquidity risk management, coupled with underlying very good quality credit risk management. You can see the consistent returns coming through since inception. And we're also not charging air performances. Again, you know what you're gonna get. And lastly, there's a low correlation of basically zero and .02 with all the end of the top 43rd return industries over the last three years. So you can know that you performance will basically move in a different way. So if we look at the monthly performances inception again, you can see it, it's fairly consistent, averaging about 1% per month. And we all know what happened to the interest rate markets in 2000 and 17, 18 and 19, essentially flat and as boring as watching paint drive 2000 and three, it was busy and we're slowly starting to come to school less volatile environment, but it's still a very uncertain environment. Having said all of that, we still believe this is a very good potential component into a smart alpha or portable alpha strategy. And I'm gonna close off with the conclusion, conclusion of choosing your alpha components, Y Z. There's definitely applies for portable alpha as a strategy again in the investor universe, but it's all about not falling into the same pitfalls that basically drew the Russian relate or synthetic Russian roulette guns out in the 2008 historical performance. So a little bit low beat up relation And uh, let's call it a fairly no drawdown history. Look at high levels of liquidity, which also talks about credit risk and credit exposure. If you are going into income type funds or income type, fixed income huge funds, look at consistent returns regardless of the market cycle because you want to have that low correlation with your opportunities and lastly transparent investment strategies and three structures. And we believe that if you put those for almost requirements together, that you can still actively add a lot of potential Portugal Alpha to any type of strategy and that is it from my side. Thank you. Thank you very much. Well, thanks jellies now, just a reminder that our speakers are available to answer as many of the burning questions that you may have today. So do you please send through your questions by the chat box or you can email us at insights at absa dot c o dot C A. Moving on, our next speaker is Sinjin bunker, who is the head of Ops alternative asset management. Now, Sinjin has over 20 years experience in the financial services industry, mostly in the alternative asset management space. Over the last 10 years, his focus has specifically been in the equity portfolio and Fechter investing space. However, his broad product experience includes the management of passive portfolios, derivatives structuring and hedging. Alpha transport, hedge funds, fixed income and credit management. He has a keen interest in machine learning, artificial intelligence and fintech as it pertains to integration within the financial markets. Sinjin, welcome. Thanks very much for the introduction. Wonderful to have you all with us today. Obviously time is is quite a precious resource at the moment and we certainly appreciate yours. Um It's been a really interesting ride doing this research with the multi manager um and we think that the the work that's come what is really fascinating and it's uh fantastic for us to share this with you today. I've done a fairly concise presentation. Um so I'm gonna run through it, you know, relatively quickly. I'm sure we we will, you know, certainly be through in the allocated time. I'm gonna touch a little bit on the definitions of alpha and beta. Look very specifically then at the construction of the portable alpha, you know, how we look at, at making sure that we allocate both to the B two component and alpha component um and how we manage that from a practical perspective. Um I think it's then quite important just to look at an acid asset allocation perspective in terms of where you would optimally allocate your excess return component when considering an alternative asset class. Um So that's something we'll we'll just touch on very briefly. Um and then critically some of the aspects, in terms of how we go about actually generating the consistent and un correlated alpha um is really key to the success. Um and you know, sensibility of the portable alpha construct as a whole. So we'll run through just the A. M. Process in terms of how we approach the alpha generation component. Um And then we also look to go through one or two examples of the types of building blocks that we can utilize in the alpha space to give access to the un correlated alpha component. I think if we think carefully about Alfred Vita and Vita has actually been around for a very long time. Uh, jones index, specifically in the equity side was initially conceived in the late 18 hundreds. But interestingly enough, the architects of the better consideration or beat measure are really the newspaper journalists Who worked for the Dow Jones Publishing space in the late 1800s. So a lot of our original expectations and a lot of what we rely on today, even for Geeta was originally conceived and developed within the journalistic with the journalism space. Even the Nikkei 2-5 benchmark still belongs to the Nikkei newspaper in Japan. It was only in 1932 that the active market or the active business was really considered or conceived. And that's really with Benjamin Graham's seminar work in securities analysis. Um, and that really was the result of legislation laid down by the sec to make sure that companies reported their annual financial statements or annually reported financial statements on an ongoing basis to make sure that investors at least had a chance in understanding what the various companies were doing. Um, and so that really builds to industries, both the asset management industry from an active perspective or from evaluation fundamental perspective as well as also the auditing profession. Um, and not a lot, um, there wasn't a lot of developments in the Beater space until the 19 seventies and depending who you speak to. Either Blackrock vanguard who opposed the really large, um, you know, passive managers in today's consideration Managing at least kind of $7 or $8 trillion dollars between the two of them. Um, certainly black crops, you know, claimed to have bought the businesses that was started by Wells Fargo managing a passive portfolio for the suitcase company Samsonite that they claim was started in 1973, but generally it's it's it's considered that vanguard were the first to the, to the market with Jack Bogle's development of the, of the passive industry. Um and they really have been the forerunners in terms of generating meta components. Um In the 1980s, we started to see the introduction of allocations to different types of beaters. Most notably Bar Rosenberg, who's both the infamous and kind of quite famous quantitative analyst developed what he termed by on a meter, which is the forerunner of what we understand a smart meter today. Um He was, he's well known for the barrier system which was sold to M. S. C. I. In the, in the 19 nineties. Um, and he himself was um excluded or banned for life from the, from the industry as a result of, you know, kind of hiding an area that he made in one of his calculations from investors. Um, I was wanted in the 1990s. Then pretty much developed. The might be destructive comparing value managers to um, to value constructs rather than market capital weighted constructs. And that then really started the debates between, uh, you know, the skill set consideration of active managers versus the specific risk that they were taking. And so alpha, as we understand it today, even though it's a measure of excess return and most easily or, or simply seen as excess return about better, um, really is considered in this day and age, either a skill set component or risk differentiation, um, beat to beat so largely in this day and age is is is now almost free. It's a commoditized industry. Um There are entities in THE US where if you, if you sign up as a bank account, you get a, you know, gold credit card access to an airport launch and as a free component, also access to better. I think just in terms of the, the portable healthcare component, it really is an attempt would really at its call separates the beta and alpha components into two specific. Um, I'm correlated pieces. Uh typically your unfunded Vita is a derivative sized instrument that you that you get, you get via a bank, principally the bank in the back end will hedge themselves by lending off their Treasury desk. They will charge a pickup, usually about 60 basis points and then pick up and range in the market between kind of 45 basis points and 85 basis points, But on average is pretty stable at about 60 basis points above the risk free rate. Um and will then use that capital that they borrowed off their Treasury desk to hedge themselves by buying the underlying asset class. Typically in equity space, we look at the more liquid embassies uh and so that tends to be the top 40 and 6 40 those, you know, much easier to manage than the all share benchmarks um and currently am manage about 20 billion in otc total return swaps and forwards across multiple beetle classes, including both local and international equity, as well as local fixed income and inflation instruments. In terms of the remaining components or the cash component that is within your portfolio, um You will earn the job rates on that and then you need to invest in veils alpha drivers that will generate additional return over above that benchmark. And I think once we combined with these components from an alpha perspective you are long Jabbar plus 3% From a pita perspective, you are short your funding rate which is Jabbar plus about 60 basis points and you are long wherever your specific beat a total return component is, Which typically then leads you to a better total return of your funding, costs less your alpha in this case a better total return of about 2.4% um underlying one of this is from an operational perspective, obviously there's a significant capability required in the cash management component because we need to margin both otc derivative component as well as potentially margin some of the alka components that we expose ourselves to in the excess return peace, I think it's important to think about and and kind of thing quite carefully about the allocation to hedge fund assets. I mean principally this is a, this is a hedge fund assets as you do have a good component. Um even though some of these assets have constructed with the right underlying cover assets, can he ran and are run? And we have certainly run these in the sister space, in the traditional, longer only space really, in terms of getting access to access return Alfa, it really needs to be run in the hedge fund space. Um And I guess if you think about as a typical allocator of risk where you're allocating to various asset classes and principally equities and fixed income asset classes, um where would the best utility be in terms of the excess return that you receive as a result of investing in the hedge fund space? And so very simply here we look at two very basic portfolios, one with 50% equity, 35% bonds, and then 15% portable alpha, Where we give equity total return plus 2.4 um which covers the funding cost component. And we compare that to a 50% 35% bonds, 50% traditional cash, which gives a step three plus 3% excess return. And we can see that consistently, really basically consistently, there's there's our performance over and above the cash allocation, which is is how things have been traditionally allocated versus whether you allocate things into the equity space. Um I guess one thing to note specifically is that clearly the excess return components in the office spaces is obviously not or can be volatile and depending on the actual underlying process, can be extremely volatile um and certainly as volatile as equity markets. Uh And so it makes sense from a long term um strategic asset allocation perspective to potentially allocate this to an equity building block component, rather than into a fixed income or cash building block content. Again, we want to look at very un correlated alpha components are relative to the active equity. I think also from a female perspective, I mean, it's often said fee reduction is the purest form of alpha. Um and so we need to think very carefully about what philo charging on these assets, um and to make sure that they're consistent through time to have a sensible fee that doesn't eat up or significantly impact the alpha generation capability. Um And then again, a lot of the work done by Michael from the Goldman Sachs side is to rethink and have a look at the risk allocation components into the hedge fund piece. Um and I think some of the work that we've seen, and you know, Michael present on the hedge fund peter side is, is really significant. And it really shows the relationship between return and risk that one takes, and certainly the relationship between the risk taken and the return generated really is the one component that seems to be borne out in the, you know, in the financial space. Clearly different investors have different requirements. Some investors may have, um, you know, liquidity components or liquidity requirements that are longer term, um, so a lot of the capital that we manage for the pension fund industry and in the 20 billion that we manage from the better perspective, that of a component is in quite a liquid credit portfolios. But because it's a long term tactical allocation from a pension fund perspective, the there isn't nearly as much requirement from a liquidity perspective. Certainly investors like, you know, ensure assurance companies who have long term liabilities, you know, that 20 to 30 years out may have a very different view on retail investors, who's, who's saving needs are significantly shorter from a maturity perspective than the institutional space. Also, taxation is a critical consideration. Um, if you think that a large component of your assets are being actually exposed to income, because from a, from a hedge fund perspective, most of those are in the fixed income space. Um, and if you're a retail investor, that that can potentially impact your specific returns, and there are ways of dealing with that in ways of, of making sure that we optimize the taxation on the specific funds, just in terms of the investment process that we as a group would look at, I think this is a kind of a four tiered approach. I think the first component is to really understand what it is, what the strategy or thesis or biases that we are exposing ourselves to in order to generate that help to. Um this can range certainly from kind of fundamental macroeconomic factors uh to behavioral factors, Um certainly there are various liquidity and credit premium components that you're going to be exposed to. Um and then obviously from a risk premium perspective, a lot of specific risk premiums that are beginning to, or they have become very popular in the last 20 years. That one can expose themselves to that on over time to give excess return above market capitalized weighted benchmarks. I think specifically these processes typically needs to be defined. Well, we find based on solid academic research um and clearly replicable across multiple jurisdictions. From that perspective, I think a back test is a significantly useful tool. They're clearly on the potential criticisms and problems with back test and they need to be done extremely cautiously as the famous danish philosopher Soren Kierkegaard said the we as humans tend to understand the world backwards but obviously have to live the world forwards and we live our lives forwards. Um and so the back test really allows us one to make sure we get a solid understanding of how the strategy and process works. It allows us to include, you know, some, some unique complexities that may be specific to the South african, the South african environment or landscape. Um and it also then allows us to really try and optimize the process with the use of various quantitative, you know, both statistical quantitative tools and you know, we obviously have embraced very kind of firmly within that the use of machine learning and artificial intelligence. The third component is various qualitative factors that are very difficult to back test. These include GSG components, what you would do from a policy perspective, interaction with you know, management um and consideration of the external analysts environment from a consensus perspective, it also specifically needs, I think in terms of what the risk framework is and what the client specific requirements might be. And then we move on to really the implementation and live component and track record of how we would manage the specific structure as we go through time. Um and that really is becomes a operational aspect where critically we're trying to make sure that there are no errors, made errors can be extremely costly. Um And from an operational perspective things need to be very tight. We need to optimize and and minimize the cost component. Make sure that compliance, market risk and video syncretic risks are managed as critically as possible. Um and there's quite an interesting relationship between business risk, the type of risk you would like to run in terms of being a smoker large business, um, and whether the, the component that you're running needs to fund the business or not. Um, so these are all, you know, specific requirements. But then I think most importantly the, we have a rolling map of where we think we should be going and we can run that against the return experience that we actually, that we actually received through time. Um, and this I think is is a relative, is a critical component to make sure that we have some confidence then in our bad test, that there is a relatively strong comparison in what we're doing compared to what we think the ultimate result should be. Um, so here's an example of one of the building blocks that we utilize in our, uh, in our hedge fund space. It is a statistical arbitrage space in the mean reversion component. It's based on the work by Jennings and um, I notice in the pairs trading space, which was published in two 1005 it's specifically suggests that theoretically stocks that are in similar sectors and similar types of stocks whose prices diverge significantly from a statistical perspective should mean revert. It really entails using a dickey fuller test, um, to, to fire station repairs. And then when those pairs are trading at a significant divergence from their normal, you would buy once one stock and sell the other from a pairs perspective. From a South African perspective though, experience with the pairs, we found that, you know, the universe wasn't brought enough isn't significantly broad enough to, to offer large components. And so instead we constructed baskets of shares on a back tested basis which had underlying drivers, fundamental drivers which will mean reverted. So for example the South African, the exposure of various stocks to the South African rand and to the South African interest rate environment, which is a much more process or stationary process themselves than the equity market itself um allows us to construct baskets. You need to the South African space which gives us much more stable excess return expectation as a result. Um This then we can fully back test um and we baptist from june or july um 2000 with the end of december 2000 and three. And we can see that there are times where is relatively flat but on a relatively consistent basis we get a fair um expectation of consistent excess return using this process. Just from a qualitative perspective. Then there's very little to be done from a E S. G. Or proxy voting perspective due to the synthetic construction of the portfolio. The model and process um of putting well followed to be quite religious in terms of following the model. Specifically in this case we can utilize and optimize the building block both the riff and quit space. Um and I think importantly, and the basket so starts to perpetrate are kind of In the much more liquid portfolio and much more liquid top 40 space, which large, which means that we're not significantly um you know, we don't have significant problems in terms of the size of portfolio. We're not capped out in terms of the opportunity value and utility set. I think importantly this portfolio has been running lives since December 2016. The actual portfolio has outperformed the baptist expectation, but that's due to some of the qualitative expectations or optimizations on the leverage that we utilize as well as some of the optimizations on actually trade on trade implementation relative to the back test. But importantly, we can see that the actual live track record performs very much in line with the shape and expectation of the back test. I think the other components that we utilize specifically is credit credit. Obviously it gives access to an illiquidity premium. There's a spread due to an expectation of default. Um but there's also the work that we can do to minimize the risk. And in in doing this, we see this really as being the alpha component that we had to this portfolio as part of the A. M. As absa is part of the broader absolute group. We have significant opportunity to partake in a number of deals that I've done on the prime credit space. Um And so this really is one of the significant benefits we have as an entity when compared with many of our peers who are not um you know, kind of tied to a banking entity uh in this case is very difficult to construct. It's not really feasible, but there are some specific principles that are important in in the construct of these portfolios. Um and that really is that we are looking to generate consistent income with asset backed by low bilateral loan agreements which are always collateralized. And as a result of these always been collateralized. The loss given default is very low due to defined exit strategy and the cover that we have on the assets we never really the lender of last resort on this. And I think what's very exciting for us is there's a really broad range of thematic mandates possible as a result of our integration with the banking entity. Uh We speak a lot to the private client business. We speak a lot to the wealth business. Were integrated with the investment bank. We speak a lot to the CPF guys as well as the Agri team. Uh And recently we've also been looking at doing a lot of social impact type funding and understanding how we can integrate ourselves into the sme space um to look at very specific portfolios that meet a social impact requirement and mandate from in this case, the quantitative qualitative factors are critical. It's a highly fundamental process with rigorous assessment of annual financial statements and credit rating process, there are about six different credit rating processes that we utilize to look at the probability of payment. Um Specifically the, from a credit rating perspective, we utilize the movies methodology. We look very much at the distance to default calculations and we have our own internal models that that look at optimizing the defaults and distance to default else. Um as well as a number of other metrics that we utilize. And in this case there is a very significant integration with the management team of the company that we that we would lend to. Um And historically we have had situations where there is board representation specifically on the actual underlying entity. From an operational perspective is, you know, the legal um Adherence to loan covenants is critical and the monthly assessment of ongoing management account is also critical and then all aspects around the loan repayments. Also critically important Um itself has a has a four track record in managing these types of portfolios. We started this specific portfolio in 2015 2016. The portfolio, we specifically put some of the names and opportunities there was running at an aggregate job plus 500, you know, kind of 5% above after costs and fees. Um And we really were generating Mezzanine type returns at senior risk portfolio at senior risk levels, which is really the alpha component that we're seeing added to the to the credit component space. Unfortunately lost this portfolio as a result of some movements in the AM. Teen in mid early 2019. But sorry, 2020. But we have recently rekindled this and have a new mandate to get this up and going and again speaking to multiple pension fund clients in terms of understanding how we integrate this into the social um in that space. So I think that, you know, some of the key considerations to think about is, you know, where do you get maximum utility and maximum usage for your excess return that you expose yourself to when you allocate to alternative assets. Um The the exceptional work that neville has done and kind of looking at un correlated um Alpha generate, generate this when comparing the portfolios to active managers is really kind of quite unique. Um And I think is a piece of research looking at some of the constraints and difficulties faced by active managers in the South african component. We really need to have all the components that generate um steady and consistent access return profiles. And I think that from a Absa entity, you know, working with specifically with the multi manager, the experience that we have in the better X. The better execution. Um you know, we have well over 15 years execution in the in the actual underlying derivative space. Um And the ability to manage sustainable replicable help innovative alpha is really key to the success of this. Um So this is this really research that we're really excited about. It's been fantastic to share it with you. I would really appreciate any questions from your side just in terms of understanding what your specific thoughts and views are. And so, um if you're unable to ask questions or you have any criticisms or concerns or thoughts on it, you know, please please don't hesitate to reach out and be in touch with us. Thanks very much. Well, thanks Engine. Let me now introduce our last speaker for today. Michael Rhodes. Michael is a senior portfolio manager within the quantitative investment strategies team developing multi asset alternative risks, premiere solutions in europe, the Middle East and Africa. His work focuses on helping investors combined systematic alternative strategies with traditional and alternative portfolios to produce improved risk and return outcomes. He joined Goldman Sachs asset management in 2000 and seven, working with quantitative strategy and alternative solutions in client portfolios. Marco earned his B. A. Honours from the University of Chicago in 1998 and an M. B. A. From the University of Maryland College Park In 2005. Welcome Michael. Hello everyone. Welcome. It's a pleasure to speak to you today. Um We're going to be discussing diversifying with portfolio with portable alpha and the properties of the hedge fund industry. We feel that this is a very important topic in today's marketplace as the economy is, has various areas of uncertainty given the recovery from lockdowns from the virus continuing from last year and various other macroeconomic risks and changes to the marketplace that increase the need for diversification for investors. Maybe we'll start with an overview on page two if you're following along and you can see what we're going to discuss today. We're going to talk about hedge funds as a portable alpha diversity fire on these three areas that we'd like to talk through. So first of all, um hedge funds are an incredibly diverse group of investments. And so we need to develop a model of what the hedge fund industry looks like. Um and importantly for this to be a valuable discussion, there needs to be some aspect of invest ability that comes along with that model. Um And so there's a few points that we'll be discussing that are important for building a robust model, um that includes multiple data sources, organizing and classifying funds and building an aggregate performance composite. Um Well then discuss some of the properties of hedge funds, um and see how they compare primarily to equities. We wish to spend some time talking about Alpha and um, some of the benefits that hedge funds can bring to a portfolio. And then also a discussion about the value of diversification within this asset class. And then finally, we'll talk about, um, you know, investing in the hedge fund industry, um, and how someone might implement some of these, uh, some of this exposure using derivatives, the sub strategies and instruments and capital requirements required for investing in this sort of group. So, um, if you're following along, if you have a look at his life for, you will be able to see um, you know, the beginning of how we form a composite or a model of the hedge from the industry. And what you see here is a lot of dots And this represents some work that we've been doing here at Goldman Sachs asset management and the quantitative investment strategies team since 2004. Um We have been building and compiling a database of the returns of as much of the hedge fund industry as we can. And what you're looking at at the moment is every light blue dot represents the three year risk and return Of 3600 individual hedge funds. Yeah, the dark blue dots or all of the fund of funds and the light green dot that you can see there is the composite that will begin to be discussing in just a few moments. The first thing that we want to take away from this image is if we focus on the individual fund risk and return, we see an incredibly diverse set of results. This is very different from many other asset classes. If we're looking at a similar chart for equity managers, we would see a much more common set of results, largely because equity investors are required. You often have benchmarks that they need to match themselves to hedge fund investors have a lot more freedom and as a result, have produced a great deal of variability in results. So the value of understanding the fund of funds, which are the darker blue dots, is that they are more condensed. And we begin to understand the phenomenon, uh, that holds true for other asset classes in the world and that as you combine more and more managers, the idiosyncratic risk that they represent decreases. Uh, this is basically the law of diversification and it applies to hedge funds just as much as it does to any other asset cost. So those dark blue dots are a lot closer together than all the light blue dots. And that's because each of those fund of funds has several managers and then they begin to present some more similar behavior. Um and then finally the green dot, there is the model that we're actually going to use to advocate for diversifying portfolios using hedge funds as an asset class. Um and so well on slide five will begin to discuss how we put uh that together. So, um to construct a model or a representation of the hedge fund industry, As I mentioned, we, you know, we have a database that has roughly 3600 individual hedge funds in it That covers a little bit more than two trillion And assets. And there are three sources of data. Um These are hedge fund databases that come from a hedge fund research, commonly known as HFR Barkley hedge. And liberals has now, hedge funds will be reporting their returns voluntarily into each of these databases. For them, it's it's often a source of advertising, but for us it is quite a fertile ground for research and understanding of the behavior of this very interesting asset class. And so I won't bore you with a lot of the details. But the this inverted pyramid talks about how we take three different databases and combine them to produce one clean aggregates composite of the hedge fund industry. And there's two primary processes involved here. The first is the removal of duplicates as there are lots of duplicates. And so we, you know, we need to remove, you know, funds that have, you know, different currencies or in multiple share classes. But then even more importantly, is we need to categorize all the funds so we know um you know what they are, and that's a bit that takes a bit of work because within these three databases, they use different names to classify themselves. Um and so we go through a little bit of data matching and testing in order to make certain that funds belong are organized correctly and that we can understand which type they are. At the end of the day, we're left with slight more, slightly more than 3600 unique funds. Each fund in that composite is equally weighted. That means that no individual manager, regardless of its size or assets or popularity dominates any more than any other one. We feel this is quite important in building a model of the hedge fund industry because it gives us an understanding of the broad investing properties of the whole group. If we were to use assets as a way to wait the managers inside, Um, there's a smaller group, roughly, about 10% of the funds that are very, very large. And the individual choices of those managers or investment choices of those managers would begin to dominate or affect the performance of the model And that's a less desirable quality. As it's, it's, if you want to understand those managers, then we should just look at those managers. So, um to have a full view of the industry, we use an equal weighting methodology so that no management matters more than any other. So that's all a little bit esoteric. But what does this all mean? Well, on on slice six, we should know you kind of how to compare these. So, um, what we have here, this Green don't is called the hedge fund universe. That is the alternative investment strategies group, the group at GSM that has developed and completed this research, um and we compare it to a few different averages. So we've averaged all of the light blue dots from that massive scatter plot a few slides ago and that's the single hedge funds and averaged all of the dark blue dots fund of funds. And what you can see here is that the volatility of the average fund is quite high. Um it's about 16 And the annualized returns over the past three years or about 4.5%. And then when we look at fund of funds, Um we see an annualized volatility of 9.7% and annualized returns of 3.4%, Excuse me. And then our model, our database model Has an average volatility of 8.6% and returns of 6.1. Um So what are we actually seeing here? Well, um the reason why the green dot is so far to the left of the blue dot is the power of diversification. Um Whenever you combine several single managers together, just like in any other asset class, you reduce the impact of any of their idiosyncratic choices. Um And um you know, we see less of a reduction in volatility from the fund of funds average, but we do see better performance for both and there may be a few reasons. Um Number one is that, you know, the uh you know, the individual choices of managers may um um you know, cause them to have more volatile performance and you know, if they haven't performed very well in the past couple of years, um you know that they could be dragging the average down. Um There is an extra layer of fees on fund of funds, so all of these are reported meta fees, but fund of funds have two sets of fees, not just one, and that may be why that blue dot is just a little bit lower. Um So this is what we believe to be a clear and usable representation of the hedge fund industry in order to make our develop our understanding of how it might help us in diversifying our portfolio. You know, slide seven. We can talk about what that looks like. Um And so, um if we were to drill down into that compulsive of the entire hedge fund industry, we can see that it is roughly almost 50% 47% equity long short strategies, 24% macro strategies, 22% relative value strategies and seven event driven strategies. Um This is just a view of the entire hedge fund industry and we've, you know, after studying these numbers for more than a decade, they are very stable. One of the things we have found is that these numbers rarely move, they move a little bit over time, Maybe one or 2% per year, most, but they are quite, quite stable. Um, and so that's a comforting thought because that helps us understand the properties of hedge funds as an industry and helps us build some maybe stronger assumptions or convictions and how we might think about combining them with a more traditional portfolio. Um, you know, why are there so many more equity? Long short funds is a common question that that might be raised. Um, you know, the answer may be that of all the types of hedge funds. This is probably the least difficult to set up. Equities are an asset class that are likely understood a lot more by more people trading cash. Equities is uh, maybe a little less complicated than some of the derivative structures required um, for macro and relative value investing. Um, you know, measuring risk is a little bit more straightforward. There's a lot more tools available in the marketplace and event driven, by the way, is actually the smallest, probably for two reasons. First of all, most of these types of hedge funds are involved in specific corporate actions. Um that's debt restructurings or, you know, buyouts or mergers and acquisitions, these sorts of things. Um, there's a finite amount of capital that can flow into those types of corporate actions and any given time. And there's a relatively small number of people who are familiar enough with those types of corporate actions to successfully investment. So that is our composite, that is our model. And now we'll begin in the next section to discuss some of the benefits or or the quality of the diversification that neighboring To a portfolio. And so we begin that discussion on slide nine. Um and so here we've we've decided made a choice to compare hedge funds with equities as they are. The primary role that they often will play in a portfolio is to number one reduced risk significantly relative to equities. And also to uh provide some global diversification in in many cases. Um It's despite the fact that we chose to focus on equities here it's looking at the combinations of fixed income and hedge funds is quite interesting. Correlations between the two tend to be very very low close to zero. Um And they may have some additional interesting properties if rising rates are concerned. But let's let's talk about uh let's talk about equities here. And so we've produced some return statistics just to give you all some perspective. Um so the time period here for this analysis is from March 31 of 2007. Um up through March 31 of 2021. That's just a data availability choice. Um So and what we can see is that the return of the S. C. Top 40 index and the Embassy I. World are over that time period annualized or about the same? Um 6.7%. Hedge funds came in a little bit lower at 5.2%. Um But what is probably quite important to understand is the difference in volatility between them. The annualized volatility for both the JSS Top 40 and the embassy in the world is about 16%. Whereas hedge funds are coming in at just under seven. Um that is almost uh close to 1/3 of the volatility um of the equity market. What that often then translates to is a vastly improved Sharpe ratio. So the Sharpe ratio for the two equity indices are the same 0.35. Um and hedge funds coming in at 0.65. Um And we see here also some interesting properties around drawdowns. This is one of the main things that's driving that improved Sharpe ratio, the maximum drawdowns for for both of these equity indices we've seen can were quite substantial Um for the hedge fund index um down 18%. So a greatly reduced drawdown um and it didn't take as long to recover. Um The other thing that we thought it was worth to highlight is kind of the upside downside capture ratio that we see um between hedge funds and both of these equity disease. We compare these relative to MSC I World. So we actually see some great properties for the jsc top 40 but similarly we see some other asymmetric properties relative to MSC I World for Hedge funds at the same time with an outside capture of 42 And Downside 31. No, the last statistic I want to highlight here is correlation. Um, and we see here the way this table is oriented is just relative to jsc top 40. MSC I World is a correlation of 72% and so your hedge fronts. Um, and so you know that, You know, that is often a question that investors race and are interested in discussing, um, you know, why is that correlation as high as it is? Uh, if you recall a few slides ago, roughly, 50 of the hedge fund industry or equity strategies, equity strategies tend to have some equity better and that often drives a bit of correlation between them, but that doesn't mean that they are investing in hedge funds is beneficial to a portfolio. Um, let's see if we look at slides 10 together, then we can begin to discuss what value are we getting from investing in hedge Fox. So, um we thought to examine the question, well, what if instead of investing in hedge funds, they have lower volatility um and slightly lower returns than equities. What if we instead just cut down our equity allocation and put the rest of the money in cash? Um Would we be better off in hedge funds, foreign or only most equity? And so in order to do this, we compared to items, so we took our same hedge fund model, the composite, and we compared it um to um it's long, you know, it's long term data to equity market here, were you modeling on the S. And P. But it's pretty similar across the most equity markets? Uh 0.35 And so we've we've multiplied the returns of 0.35 S and P plus 65% in cash, to see what do we get, and the result is actually Alpha. So, um if you just equities in cash running somewhere around 4.89% annualized total return since 2002. Um and here we have Hedge funds delivering almost 200 basis points more in average, annualized total return, a slightly more volatility um from the hedge fund universe, but a better Sharpe ratio, um and lower correlation. That difference is what is traditionally called in the marketplace as Alpha. And it comes from the idiosyncratic and specialist choices that these managers are making in hedge funds specifically. That comes into three primary categories. The first is security selection, so which assets they choose to buy? The second is market timing when they choose to buy them. And the third is usually associated with a liquid assets or the illiquidity premium. And sometimes there's extra return to the to be garnered from that. So let's, let's also look at this relative to the JSC 40 which is we have on slide 11. A bit of a comparison here um, as well as we can quantify the risk there. So if we look at slide 11, we can see 12 month rolling Sharpe ratio. So if we look at, if we see here this chart on the left, we can see the hedge fund index compared with jsC top 40. What you're looking at is a 12 month rolling Sharpe ratio here. So we look at the sharp Ratio of both of these indices every 12 months and compare the two. And here we see some other interesting diversification benefits. The chart on the right is simply the difference between those two lines. So hedge funds minus jay Z 40 and that's maybe a clearer way to see that in many markets and through many, many points in time, um you know, hedge funds have a higher risk adjusted return than um uh the equity market index. And um that means that there's an asset class may be able to help diversify a portfolio. Um The I mentioned before the primary driver of sharper issues are often um you know, drawdowns and we have a view of that on the slide 12, where we've looked at the five largest drawdowns um in the JSC in the time period that we have available. And um what we what we see here is that, you know, hedge funds outperformed the JsC in four out of five Of its worst drawdowns um during this time period including 2008. Uh it was actually made to August of 2015 where the J. c. 40, you know did a little bit better. But um the other thing to point out is that hedge funds only had positive returns in one of these four the predominant um you know kind of common behavior that we see here is that uh you know if equities are down hedge funds will also like to draw down. There are several things we mentioned about the speed of recovery. Um And risk adjusted returns that we feel is a an important aspect of including them in a portfolio. Now there's one other point that we wanted to talk about in you know what's under the hood in this in this hedge fund composite because you know it certainly has some compelling properties and it's that all of those blue dots that I showed you before are constantly changing And that is due to the level of freedom that these managers have. And we begin to show a little bit of that slide 13. But we split up all of these funds into some categories. And look at their performance year on year. And so the top chart that you're looking at is a comparison every year. We split up, you know, each of all the funds into their four major categories. And we just ranked those categories average performance every year. And the takeaway from this, this picture is that um, there is a great deal of variability. We don't see a clear pattern. There is no foregone conclusion that one of these categories is going to outperform another over time. And um the other thing that we wanted to show here is at the manager level. This is even more varied. So the chart at the bottom Is looking at 18 years of performance data from our database compulsive. And what we've done is we compared um in the first year we split all the performance into quintiles and we looked at the top quintile managers and we want to see in the second year, how do they appear? And so the way to read this is that um for any top quintile manager in year one, Um, there's a 22% chance that they will remain in the top quintile the second year. Um, but there's also a 20% chance that they stopped reporting or they go to the bottom quintile, um and almost a roughly equal chance that they end up something somewhere in the middle. Um This means that this year's management, top manager is unlikely to be next year's top manager. Um In our view, this does not isn't a bad thing. Honestly, this doesn't mean that these managers aren't delivering value or Alpha or doing a good job. What this means is that hedge funds have a great deal of freedom and they have a great deal of variability. And so, um you know, selecting them requires some patience and care. And it also means that we may need to um include even more diversity in our hedge fund selections than we would in in other asset classes. Um And so what I wanted to do next was talk about how we might invest In this hedge fund composite, uh that we've we've introduced you because it includes uh it doesn't have really any risk from any specific manager and may give us access to this asset class without that selection problem. So we look at that a little bit on slide 15. Um And so what we what we've broken down here is a deconstruction of the performance of that aggregate of hedge funds. Um, As I mentioned, we've been analyzing these returns over more than a decade and we found that we can essentially capture or reproduce the returns that hedge fund universe Or split it up into three main groups traditional market exposure, alternative, or premium and alpha. So let's talk about a little bit what these, what these mean? So traditional market exposures are essentially mono directional, long short trades and these are behaviors that are likely well known for hedge funds. Should we be long or short oil this month, um, is today the right time to go long or short the euro. Do we want to buy amazon today or should be short amazon today? Those are traditional market exposures that have one direction to them. Alternative risk premium, um, are long short ideas, effectively. They are strategies that, um, essentially capture the difference between securities and are repeatable and essentially represent very similar investing, are very consistent investment behaviors. Over time, the vast majority of the returns of hedge funds can be explained using these two tools. There is a 3rd component. It is alpha, Alpha is uh, as I mentioned before, comes from security selection specific security selection, market timing and illiquidity premium. The quantity of alpha and the difference between a combination of movie risk premier and market exposures, um, uh, is, you know, various over time. Um, sometimes it is less than 100 basis points. Um, sometimes it can be large. Um, it kind of depends on the market opportunities. So for example, last year, when we had a significant market dislocation due to the virus, um, and then a lot of government supported markets, there was a lot of Alpha to be had from taking concentrated positions in specific or distressed assets. And so, you know, that's, that's the sort of trading behavior that's not really capture Herbal using alternative risk premium and traditional market exposures. But through most normal markets, uh the these two kind of more accessible aspects of the investment universe will do a pretty good job of capturing most of the returns of hedge funds as an asset class. And so how on earth do we invest in them? We talk about that a little bit on slide 16, uh when we discuss implementation. So, uh, first of all, we wanted to describe the approach that we have undertaken in our years of research, Um, we have developed in house 40 for liquid, alternative strategies that combine traditional market exposures and alternative this premium. And these are systematic daily liquid and consistent investment strategies that have shown that they have a strong ability to reproduce the returns of this asset class. Um, You know, day in and day out now, it's important to understand that the, some of those exposures have lasted for decades, um, and others have appeared and disappeared. So there's a little bit of a research effort that needs to be completed in order to continually match the returns of the hedge fund industry as a composite. Um, the instruments that can be used in order to accomplish this are largely derivative based. Um, they are found from almost all asset classes. So equities fixing credit FX commodities and, you know, all over the globe. And from an instrument perspective, we're generally talking about futures, cash equities, fX, forwards, swaps, e G S options. Um, It's largely derivative based portfolio. So this creates some portfolio flexibility and coming back to our discussion of portable alpha. Um, You know, this allows us to think about ways that we could include these sorts of exposures of the portfolio alongside more traditional asset classes of equities and fixed income. Um, so in investing in them, we can, you know, what we're suggesting is that by using liquid exposures to access the returns of hedge funds, um, through a separate account structure, um, you know, we have a very liquid, very transparent way to access this valuable asset class and give investors and comfort that they can understand exactly what's in their portfolio through full transparency. The other interesting advantage that derivative portfolios may have, um, depending on how an investor wanted to structure of their exposure is that they don't generally need to be fully funded. It's very easy to require some leverage through the use of derivatives. Um, so we have seen some investors do this and only put up enough cash to cover the margin requirements for the derivatives and others. Um, you know, fully fund them. What do you do with the rest of money? Well, it could be invested in usually in riskless or, or low risk, um, securities that, you know, I don't really have much volatility or may be required as apartment of the and liability offsets for foreign investors. So in summary, we just wanted to recap briefly, we've outlined, um, that we feel that hedge funds as an asset class would be a very valuable in addition to traditional portfolios and from a portable alpha perspective could fit in very nicely alongside both equities and fixed income. And, um, you know, there are a lot of choices to be made about how to implement them, but certainly there's a wealth of information available around the performance and properties of this asset class. That could help many investors to make decisions about how they'd like to include it or not. And with that, we thank you all very much for your time and attention today and enjoyed speaking with you very much. Thank you.