MAPERS One Day Seminar · Defensive: All strategies sensitive to draw downs following the financial...

ABS Investment Management

For institutional investors only. Confidential information herein. Please see the end of this presentation for important disclosure information. This presentation is intended for the sole use of the above named recipient and should not be relied upon by any other person.

MAPERS One Day SeminarHedge Funds

March 6, 2020Presenters: Sean White, CFA

Partner and Head of Risk Management

ABS Investment Management LLC | January 2020 2

Table of Contents

Hedge Fund Industry Background 3

Hedge Fund Characteristics 11

Risks and Misconceptions 15

Expectations and Goals 19

Outlook 22


Hedge Fund Industry Background


Hedge Fund Evolution: The Early Years (1990-1999)


0%

100%

200%

300%

400%

500%

600%

700%

800%

Dec-89 Dec-91 Dec-93 Dec-95 Dec-97 Dec-99

HFRI Equity Hedge Index

MSCI AC World Index

S&P 500 IndexHFRI Fund Weighted Index

Hedge Fund Evolution: The Early Years (1990-1999)Cumulative Performance: 1990-1999 Hedge Fund Assets in Billions: 1990-1999

$39 $58 $96 $168 $167 $186 $257$368 $375 $456

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Concentrated: 76% of funds classified as equity long/short and macro

Small: Average fund size less than $150M

Narrow Ownership: Primarily owned by high net worth individuals, endowments, and foundationsData as of 12/31/2019. Source: Bloomberg, HFRI Q4 2019 Global Industry Report, Please see the end of this presentation for important disclosure information.


Hedge Fund Evolution: Adoption by Institutions (2000-2009)


Hedge Fund Evolution: Adoption by Institutions (2000-2009)Cumulative Performance: 2000-2009 Hedge Fund Assets in Billions: 2000-2009

Risk Focus: Growth in diversified, risk managed strategies (multi-strategy, event driven)

New Entrants: Number of funds nearly triples, 2% and 20% becomes the standard for all

Institutional Adoption: Broader investor base including pensions, AUM rises by over 3X

$491 $539$626

$820$973

$1,105

$1,465

$1,868

$1,407$1,600

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009-60%

-40%

-20%

0%

20%

40%

60%

80%

100%



MSCI AC World Index

S&P 500 Index

HFRI Fund Weighted Index

Data as of 12/31/2019. Source: Bloomberg, HFRI Q4 2019 Global Industry Report, Please see the end of this presentation for important disclosure information.


Hedge Fund Evolution: Underperform the S&P 500 (2010-2019)


Hedge Fund Evolution: Underperform the S&P 500 (2010-2019)Cumulative Performance: 2010-2019 Hedge Fund Assets in Billions: 2010-2019

Defensive: All strategies sensitive to drawdowns following the financial crisis

Composition Change: Big get bigger, quant takes market share, fees begin to fall

Institutionalization: Style box approach designed to fit larger asset allocation policy

$1,917$2,008

$2,252

$2,628

$2,845$2,897$3,018

$3,211$3,110$3,320

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019-20%

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%

220%

240%

260%



MSCI AC World Index

S&P 500 Index


Data as of 12/31/2019. Source: Bloomberg, HFRI Q4 2019 Global Industry Report, Please see the end of this presentation for important disclosure information.


Long-Term PerformanceCumulative Performance: 1990-2019

0%

500%

1000%

1500%

2000%

2500%

Dec-89 Dec-91 Dec-93 Dec-95 Dec-97 Dec-99 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09 Dec-11 Dec-13 Dec-15 Dec-17 Dec-19


MSCI AC World Index

S&P 500 Index


Data as of 12/31/2019. Source: Bloomberg, Please see the end of this presentation for important disclosure information.


Hedge Fund Characteristics


Characteristics of a Hedge Fund

Please see the end of this presentation for important disclosure information.

Flexible

Ability to utilize variety of assets (equity, credit, currency, commodity, etc.)

Active use of short selling to hedge and protect downside risk

Use of leverage to enhance performance

Focused on alpha relative to beta

Selection of underlying assets drives majority of risk and return

Less exposure to traditional market risks

Incentive-based

Partnership structure where manager invests alongside investors

Incentive fees typically charged for positive/excess returns

Highly diverse and competitive

Individual funds have significant differences in risk and return levels

Intense focus on performance

High fees attract new entrants but lead to high attrition rates (many funds shut down each year)


Strategy Classifications

Source: HFRI Q4 2019 Global Industry Report, Please see the end of this presentation for important disclosure information.

Equity Long/Short ($972B) Bottom-up strategies seeking to generate alpha

long and short relative to equities Low leverage, liquid securities, highly diverse

universe, comprises over 40% of total # of funds

Relative Value ($877B) Risk-managed strategies seeking steady

returns Heavy use of fixed income and derivatives

to exploit pricing anomalies

Event Driven ($874B) Risk-controlled approach to access alpha from

corporate events (mergers, turnarounds, etc.) Active use of leverage and company engagement

Macro ($600B) Trades all asset classes, wide range

of risk levels Systematic (quant) strategies

Benefits Risks

Liquid Less Predictable

Downside Protection Monitoring

Benefits Risks

Steady Returns Tail Risk - Leverage

Low Market Risk Complexity

Benefits Risks

Diversity of Styles Market/Factor Risk

Transparency Flexibility

Benefits Risks

Diversified Upside Event Risk

Asymmetric Risk/Return Complexity


Roles in Institutional Portfolios

Source: 2020 Prequin Global Hedge Fund Report, Please see the end of this presentation for important disclosure information.

Diversification Differentiated risk relative to long-only with returns generated from security-specific factors

Risk buffer Focus on risk management typically leads to lower volatility than long-only Incentives designed to promote risk reductions in prolonged market drawdowns

Return enhancement Certain hedge fund strategies are more aggressive in nature and seek to deliver high upside Concentration, leverage, and activism are some of the tools used to enhance returns

Opportunistic allocations Special situation funds seek to take advantage of market dislocations

Prequin Survey: Reasons Investors Allocate to Hedge Funds63%

37% 37%28% 26%

2% 1%0%

10%

20%

30%

40%

50%

60%

70%

Diversification Low Correlation Absolute Returns Risk-Adjusted Returns Reduce Risk Inflation Hedge Income Stream


Risks and Misconceptions


Risk Profile vs. AlternativesEquity Risk

Liquidity Risk

Credit Risk

Duration Risk

TraditionalEquity

TraditionalBonds

Venture Capital

PrivateEquity

Cash

EquityLong/Short

RelativeValue

Macro

EventDriven

Long-Only

Hedge Funds


Risk Factors to Consider


Alpha

Alpha is not a straight line – nearly all hedge funds go through periods of negative alpha

Flexibility

Risk Control – risk reductions during a drawdown can be negative if markets recover

Buy the Dip – works in a positive market, but painful in down periods

Liquidity

Fund level – most funds offer quarterly redemption windows but can range from daily to annual

Strategy level – flexibility to invest in less liquid securities can result in negative outcomes

Leverage

Escalator up/elevator down – high leverage can be a tail risk in times of stress

Complexity

Certain strategies carry risks that are difficult to quantify

Comparisons to traditional asset classes can be challenging


Misconceptions of Hedge Funds


Risk

Risk factors are generally different relative to traditional strategies

The majority of hedge funds carry lower risk than long-only equity and commodity strategies

Definition and Measurement

Hedge fund indexes are based on averages of a wide variety of hedge fund types

The return of an individual hedge fund is rarely similar to its headline index

Transparency

In comparison to the early years, hedge fund transparency has improved dramatically over the last 10 years

Full portfolio snapshots along with detailed attribution and risk reporting are common

Fees

2% and 20% is dying

Growth in alternative fee structures (i.e., alpha/beta separation, founders terms, etc.)

Client Base

Wealthy individuals makes up only a small fraction of the total assets managed by hedge funds

Majority pensions, endowments, foundations, sovereign wealth funds dominate AUM


Expectations and Goals


Expectations Investor expectations of hedge funds can vary considerably

Diverse universe of funds that cannot be easily categorized

Risk considerations must be properly considered

Achieving a return of 9% will require a different level risk relative to a 4% return

Risk tolerance has a significant impact on return expectations

Prequin Survey: Mean Hedge Fund Return Expectations by Investor Type


6.1%

8.9%

6.0% 6.2% 6.1%5.7%

3.9%

8.9%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

Endowment Plan Family Office Foundation InsuranceCompany

Private SectorPension Fund

Public PensionFund

Sovereign WealthFund

Wealth Manager


Keys to a Successful Hedge Fund Portfolio


Diversification

Individual funds can carry significantly different risk profiles

Define clear objectives and communicate directly to investment managers

Alignment of the program’s objectives and managers creates mutual understanding

Establish ground rules surrounding risks that you are willing and not willing to take

It’s a big universe, this can narrow the scope significantly

Set reasonable expectations

Alpha generation and downside protection generally comes at a cost

Fees are relative

High alpha strategies may earn higher fees - focus on the net outcome

Assess the downside potential relative to the fees paid for upside

Take a long term view

Diversification strategies may underperform when stocks and bonds are performing well


Outlook


11.4%

-0.1%

9.2%

19.4%

7.8%5.9%

17.5% 18.2%

-0.9%

13.6%

-5%

0%

5%

10%

15%

20%

25%

1920-1929 1930-1939 1940-1949 1950-1959 1960-1969 1970-1979 1980-1989 1990-1999 2000-2009 2010-2019

Market Performance by DecadeS&P 500 Annualized Returns by Decade

Data as of 12/31/2019. Source: Bloomberg, Robert Shiller U.S. Stock Markets 1871-Present http://www.econ.yale.edu/~shiller/data.htm. Please see the end of this presentation for important disclosure information.

Major Regional Indexes: Last 20 Years US stocks significantly outperformed non-US markets last decade due primarily to:

Tech earnings growth

Dynamic monetary policy

Safe haven status and dollar strength

The 2010s were a mirror image of the prior 10 years

Global equity markets have produced single digit gains with 15-20% volatility since 2000

-0.9%

13.6%

6.1%

1.2%

5.5%

3.3%

9.8%

3.7%

6.7%

-2%0%2%4%6%8%

10%12%14%16%

2000-2009 2010-2019 Last 20 YearsS&P 500 Index MSCI EAFE Index MSCI EM Index


Positioning

Where We Are in the Current Equity Market Cycle: Fund Managers vs. Investors

5.0%

67.0%

7.0% 8.0%14.0%

10.0%

69.0%

6.0%2.0%

13.0%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Recovery / Expansion Peak Recession Trough Unsure

Fund Managers Investors


6%

51%

43%

More Aggressively -Asset Accumulationis a Priority

No Change

More Defensively -Asset Protection isa Priority

How are investors positioning their hedge fund portfolios in 2020?


Conclusion

“Ignoring the risk and uncertainty in every decision might make us feel better in the short run, but the cost to the quality of our decision‐making can be immense.”― Annie Duke, Thinking in Bets


This presentation has been provided for informational purposes only and shall not constitute an offer to sell or the solicitation of any offer to buy which may only be made at thetime a qualified investor receives a final confidential private offering memorandum (the “Fund Documents”) describing an opportunity to invest with ABS. This material is notintended to be used as a general guide to investing, or as a source of any specific investment recommendations, and makes no implied or express recommendations concerningthe manner in which any client’s account should or would be handled, as appropriate strategies depend upon the client’s specific circumstances and investment objectives. Incases where estimates or other materials not originated by ABS have been used, they have been obtained from sources believed to be reliable but ABS has presented theseitems “as is” and has undertaken no independent verification and makes no warranties with regard to their accuracy. Past returns are not an indicator of future performance.

Although indices used in this presentation have been gathered using public and private sources and data we believe to be reliable, we make no representations as to theiraccuracy or completeness.

The HFRI Equity Hedge is composed of Investment Managers who maintain positions both long and short in primarily equity and equity derivative securities. A widevariety of investment processes can be employed to arrive at an investment decision, including both quantitative and fundamental techniques; strategies can be broadlydiversified or narrowly focused on specific sectors and can range broadly in terms of levels of net exposure, leverage employed, holding period, concentrations of marketcapitalizations and valuation ranges of typical portfolios. EH managers would typically maintain at least 50% exposure to, and may in some cases be entirely invested in,equities, both long and short.

The HFRI Fund Weighted Composite Index is a global, equal-weighted index of over 1,400 single-manager funds that report to HFR Database. Constituent funds reportmonthly net of all fees performance in US Dollar and have a minimum of $50 Million under management or a twelve (12) month track record of active performance. TheHFRI Fund Weighted Composite Index does not include Funds of Hedge Funds.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks.Investors cannot invest directly in an index and unmanaged index returns do not reflect any fees, expenses or sales charges. The index is not managed and not subjectto management or brokerage commissions. Dividends are subject to reinvestment.

The MSCI All Country World Total Return Index (Local) includes the reinvestment of dividends net of foreign taxes, symbol NDLEACWF.

Source: MSCI. The MSCI information may only be used for your internal use, may not be reproduced or redisseminated in any form and may not be used as a basis for or a component of any financial instruments or products or indices. None of the MSCI information is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied upon as such. Historical data and analysis should not be taken as an indication or guarantee of any future performance limitation, lost profits) or any other damages. (www.msci. analysis, forecast or prediction. The MSCI information is provided on an “as if” basis and the user of this information assumes the entire risk of any use made of this information. MSCI, each of its affiliates and each other person involved in or related to compiling, computing or creating any MSCI information (collectively, the “MSCI Parties”) expressly disclaims all warranties (including, without limitation, any warranties of originality, accuracy, completeness, timeliness, non-infringement, merchantability and fitness for a particular purpose) with respect to this information. Without limiting any of the foregoing, in no event shall any MSCI Party have any liability for any direct, indirect, special, incidental, punitive, consequential (including, withoutcom)

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