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BSAIS Hedge Fund Day

ReportOréus Business Society

4 December 2013

Philip Lazar

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Agenda• Macro developments

o Asset class correlationso U.S. equity marketo Japanese marketo Macro strategy

• Micro developmentso Earnings surpriseso Energy sectoro Financial services sectoro Micro strategy

• Hedge fund developments• Practical implementation

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Macro Developments: Asset class correlations

• Bond-equity correlation has turned positive

• Decreases diversification opportunities• Alternative: managed futures (also, event-driven

investing)

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Macro Developments: U.S. equity market

• U.S. equity market has been bullish during past year

• So has the Japanese market (+67% YTD)

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Macro Developments: U.S. equity market

• Factors influencing US equity market forecasts:o Housing market: housing prices rising again, as per 5-6

year cycle. Impact being undervalued (opportunities in MBS market)

o Shale gas (fracking), tar sandso QE tapering expected to hold off until at least Q1/Q2

2014 (but, note yesterday’s news!)o Market cycles are shortening (data appears ambiguous)o Regulatory influences via Basel IIIo Stock market bubbles (e.g. tech, financial services)"I am most worried about the boom in the US stock market. Also because our economy is still weak and vulnerable. […] Bubbles look like this. And the world is still very vulnerable to a bubble“

Robert Shiller (1 Dec 2013)

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Macro Developments: Japanese market

• Investors confident in Abenomics (QE, sales tax hike, Yen devaluation)o But, due to compensatory measures, success of Abenomics not guaranteed

• Foreign investors buying Japanese equity via ETFs• Hedge fund market weak ($0.5 billion AuM)

o Enormous opportunities in HF expansiono Many arbitrage opportunities due to still-existing inefficiencies

• Guys to watch:o Dan Loeb, Third Point Capital (“We recognized from past experience that meaningful

quantitative easing in Japan could provide opportunities like our “don’t fight the Fed” investments in 2009‐10 and European sovereign debt trades in 2012.”)

o Kyle Bass, Hayman Capital Management (“Olympics don’t have any material impact on our investment philosophy in Japan. They are at best a net neutral for Japan.”)

o David Einhorn, Greenlight Capital (“Japan may already be past the point of no return.”)

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Macro Strategy

Rating Analysis

Legal Environment

Reference Market (Sector analysis)

Geopolitical Analysis

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• Following earnings surprises/earnings revisions as a trading strategy (higher implies buy, lower implies sell, based on pure-long strategy)"There is clear evidence that stock prices drift in the direction of earnings surprise for several months following an earnings announcement. […] Going long on firms in the highest [earnings surprise] decile and going short on firms in the lowest [earnings surprise] decile generates a greater than 6% excess return in the 60 days following the earnings announcement.”

Chudek, Truong, Veeraraghavan (2001 working paper) 

Micro Developments:Earnings surprises

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Micro Developments:Energy sector

• Energy sector shows promising prospects; sector appears to be under-valuedIn Wisconsin, the source of white sand perfectly suited for hydraulic fracturing, state officials now estimate more than 100 sand mines, loading, and processing facilities have received permits, up from just five sand mines and five processing plants operating in 2010. And the stocks of publicly traded companies that deal in sand have soared. Shares of Houston-based Hi-Crush Partners LP has jumped 59% since it began trading in August 2012. Shares of U.S. Silica Holdings Inc., based in Frederick, Md., have doubled since it went public in 2012, giving it a stock market value of $1.9 billion.

Wall Street Journal (3 Dec 2013)

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Micro Developments:Financial services

sector• Reversedly, financial services sector appears to be

over-valued, especially when considering leverage ratios

• Situation unimproved: Deutsche Bank at 37x leverage ratio (2.27% equity/assets)

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Micro Strategy

Sensitivity analysis and stress testing

Historical economic and financial analysis

Competitive positioning

Market analysis

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Hedge Fund Developments

• On average, hedge funds have been under-performing, especially when considering 2/20 fees

• Increase in S&P correlation; HF space closer to mimicking mutual fund/index fund behavior

• Still opportunities in 6-18 month opportunity-based (i.e. event-driven) hedge funds (less S&P correlation)

• Choose working themes

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Hedge Fund Developments

• Most hedge funds use long/short equity strategy. Some growth in macro, managed futures.

• Vast majority of HFs still concentrated in U.S. (NY), Asia (HK). Potential in EU markets (long-term).

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Practical implementation

• Strategic positioning: event-driven hedge fund ETFs in overall portfolio, need for superior selection with little S&P correlation (otherwise index fund)

• Micro strategies: based on earnings surprises/revisions• Macro strategies: based on MBS outlook, US energy market undervaluation, Japanese inefficiencies (via ETF)• Specific sectors: long energy, real estate; short financial services, technology

• Specific stocks: long FRAK, short DB

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Thank you for your attention