Institutional Investor's Alpha Magazine - October 2008 - (Page 28)

André Perold when others know your positions and might try to effect a squeeze. On the positive side, those risks will be mitigated for funds less sensitive to disclosure, such as strategies that involve holding numerous but small short positions. Those managers may now ﬁnd they have less competition. What has been the impact on the industry of the volatility of the past few months? lation between developed and emerging equity markets has been very high, meaning that there have been only limited diversiﬁcation beneﬁts to investing in emerging markets. We also assess how the present may be different from the past, particularly when factoring in the opportunities our managers are currently pursuing. Quantifying risk is a difﬁcult and error-prone process, but it is an essential aspect of any investment. How do you plan to adjust the HighVista portfolio in light of recent market events? It is punishing because it is the combination of extremely volatile prices, great uncertainty about fundamentals and unparalleled opaqueness in the system, including a lack of assurance that counterparties and others will be able to deliver on their contractual obligations. How can funds with short-term ﬁnancing and an uncertain investor base survive periods where the equity market ﬂuctuates up or down by more than 5 percent many times during the same day — where a short squeeze within hours gives Volkswagen a higher market capitalization than Toyota? Hedge fund capital, in theory, can and should play a crucial role in helping to stabilize the ﬁnancial system. The problem is that the risks today may be too great for even the best investors to want to step up to the plate. “André is one of the few people I know who has very strong academic credentials but is also very plugged in to the real world.” — WILLIAM SPITZ, FORMER CIO, VANDERBILT UNIVERSITY What does the hedge fund allocation usually look like at HighVista? Our investment process is designed to be cognizant of changing risks. Broad asset-class risks and correlations generally do not oscillate back and forth in rapid fashion, but rather tend to be persistent, meaning that we usually experience lengthy periods of high or low volatility and correlation. Because we manage to a stable risk budget, we reduce our exposures when broad asset-class risks are high. For example, global equity market volatility increased signiﬁcantly in mid-2007, and it has remained high ever since. We reacted by commensurately reducing our equity market exposure, a posture we have continued to maintain. Obviously, these actions greatly aided our investment performance. At the same time, we are faced today with attractively priced opportunities in many areas of the capital markets, particularly in the credit markets. Distressed valuations seem to be occurring on an unprecedented breadth and scale, but so are the risks. The challenge is how to avail ourselves of these opportunities and yet remain within our overall risk parameters. What’s the summary lesson, then? We are presently 50 to 60 percent invested in alternatives, of which about two thirds is in hedge funds. The remainder of the portfolio is invested in various indexes representing broad market asset classes such as global equities, sovereign bonds and inﬂation bonds, commodities, real estate and various categories of credit exposure. We invest in alternatives managers purely for their alpha, and we do so opportunistically. Therefore we don’t have set allocations to long-short, distressed, event-driven and multistrategy. How do you usually approach risk? We think there are basically two kinds of risk: broad asset-class risk — beta — and the risks managers take in pursuit of alpha. An important part of our process is to quantify both types of risk, based on an analysis of recent historical relationships. For example, the correlation between equities and Treasury bonds in the past few years has been signiﬁcantly negative, making Treasury bonds an excellent hedge for equities. By contrast, the corre28 • INSTITUTIONAL INVESTOR’S ALPHA • OCTOBER 2008 The risks of all asset classes are very high today, be they equities, bonds, inﬂation-protected bonds, currencies, commodities or emerging-markets securities. The correlations among these asset classes have increased signiﬁcantly — such as the correlation between equities and commodities — or have become much more negative, such as the correlation between equities and Treasury bonds or between equities and currencies like the yen. At the same time, alternatives managers not only need to navigate the current environment from an investment point of view, they also need to confront challenges to their basic business model. We continue to hold modest equity exposures, but through alternatives managers primarily. We are cautiously investing capital in situations where the pricing is extremely attractive. Some segments of the municipal debt, bank debt and mortgage markets seem priced assuming Armageddon scenarios. In part that’s because a vast amount of paper that was considered high quality when issued has now become risky. The owners no longer have the know-how or wherewithal to hold that paper. Instead, more knowledgeable, sophisticated buyers need to step in, but they have limited capital relative to the total supply. The real edge today resides with those who do not have to sell, those who have dry powder to invest. If you are lucky enough to be one of those, you may not have to be a genius over the next ﬁve years.

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - October 2008

Institutional Investor's Alpha Magazine - October 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Process of Evolution The Good Guys: Israel's Champion Interview: Fast Lessons for Hard Times Cover Story: Industry Under Siege The New Hedge Fund Economics Good-Bye, Easy Money Caging the Shorts Strategies: Bottom Fishing Profile: Cult of Personalities Research Center: Alpha Awards: Eye of the Storm Alpha Bytes: Funneling the Chatter Unhedged: Commentary: Attention, Hedge Fund Shoppers

Institutional Investor's Alpha Magazine - October 2008

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