Starving the Black Swan

Presented by George EvansGlobal Head of Business Development

GlobeOp Financial Services

Why Invest in Hedge Funds (after all that has happened).

Today’s Hedge Fund Landscape. Confidence is Back.

• Despite continued economic uncertainty, hedge funds are still on the upswing, delivering solid performance for global investors.

• The hedge fund industry worldwide now controls total assets worth $2.02 trillion as of April, 2011, greater than what the industry held prior to the credit crisis (Hedge Fund Research, 2011)

• Year-over-year assets in hedge funds in 2011 are up by $102 billion over the first quarter of 2010.

• In the post-Madoff era, regulatory scrutiny has intensified and will likely expand.

• Institutions – such as corporate pension plans, family offices, endowments and foundations – have become major participants, expanding the core investor base beyond wealthy individuals.

Paradigm Shift: Institutions allocatemore capital to hedge funds.

2008 to 2010 Projected next 12 to 18 months

Institutional types.Trends and allocations.

What kind of investment strategiesdo you want?

• Pension funds are facing the prospect of an exponential increase in withdrawals from retiring subscribers -- despite the shrinking value of their asset base.

• In this scenario, hedge funds provide a powerful tool foreffective liability hedging.

• The specter of inflation has increased the appetite for capital preservation among endowments and foundations – and these investors have targeted rates of return that can’t be achieved with today’s low-yielding bonds.

• Global alternatives like real-estate, infrastructure bonds and natural resources offer all types of hedge investors the potential for diverse anticipated returns and high earnings quality.

Type of Security 2004 2005 2006 2007 2008 2009

US Equities 0.4363 0.4322 0.4172 0.3957 0.3378 0.3299

Non-US Equities 0.1497 0.1534 0.1743 0.1848 0.1802 0.188

US Fixed Income 0.2769 0.2757 0.2648 0.2629 0.2528 0.2486

Non-US Fixed Income 0.0116 0.0114 0.0087 0.0085 0.0143 0.009

US Real Estate 0.0396 0.0434 0.052 0.0553 0.0647 0.0524

Private Equity 0.0429 0.0432 0.0454 0.0499 0.0715 0.0659

Hedge Funds 0.0002 0.0013 0.0089 0.0082 0.0115 0.0238

Funding Ratio 0.825 0.8454 0.8618 0.9336 0.7831 0.5832

Pension Funds: Unfunded liabilities / hedge fund strategies

"Portfolio Allocation for Public Pension Funds" by George Pennacchi and Mahdi Rastad in Journal of Pension Economics and Finance, April 2011,

http://bit.ly/iVkaCk

How has the governance ofhedge funds improved?

• Hedge funds are responding to the changed environment: Nearly half (46%) of funds have enacted a risk management system consistent with the expectations of boards of trustees or legislative mandates. (Preqin 2011)

• Administrators have become central in helping investors to meet the need for transparency and integrity in hedge fund governance.

• Investor demands and transparency/reporting requirements continue to increase rapidly

Why it’s a good ideato invest in Hedge Funds today

• Hedge fund managers typically invest their own money in the fund they manage, which helps align their interests with investors.

• Hedge funds typically have the resources and research to find and evaluate the best options across multiple categories and strategies.

• Industry has been secured against operational risk.

• Investment strategies of hedge funds have been customized for institutional investors.

…but beware the black swan

the black swan

• Operational risks predominate, with an average of 15 hedge funds collapsing each year on average

(Edhec’s Risk and Asset Management Center, 2005)

• 2002 CAPCO study found 41% of hedge fund failures are due to misrepresentation, 30% involved misappropriation of monies

• 14% due to trading outside accepted boundaries and 6% due to inadequate or faulty technology.

How to Starve the Black SwanNine Best Practices

1 Know the marks of a credible administratorCheck their standards – at least SAS 70 Type II. Preferably ISAE 3402, SSAE 16 certifications

4 Nip fraud in the bud

Reconcile data from all sources--prime-brokers, counter-parties and exchanges

7 Pay-for-performance

Measure and evaluate performance of managers in both the short and long term and ensure commensurate fees

2 Identify risk “landmines” Value-at-Risk, Extreme risks, consistency with memorandum

5 Transparency Communicate in real-time with reporting via a Web interface

8 Monitor counterparty risk

Include prime brokers, valuation agents, auditors and other partners

3 Pay attention to key metricsSnapshots of NAV are available every day to support evaluation and decision making

6 Eliminate conflicts of interest

Independently verify price data for unlisted assets and disclose sources

9 Guarantee IT data integrity and backupPlan for business continuity and disaster recovery for all IT systems

Questions? Comments?