INC
What Does 2005 Hold?
The 5th Annual Alternative Investments
for Institutional Investors Conference
Mark S. Rzepczynski, Ph.D
President and Chief Investment Officer
You Cannot Look in the Rearview
Mirror to Find the Answers
INC
• Performance reordering – the best strategies change
• Style changes – focused strategies more risk sensitive
• Dynamic industry changes – growth is an issue
“Human History is a Race Between
Education and Catastrophe” — H.G. Wells
INC
• What we know:
¾ Performance persistence does not exist
¾ Volatility persistence does exist
¾ Style alpha high and traditional benchmark tracking error high
• What we don’t know:
¾ Whether recent past is a view of the future
¾ Attribution with dynamic strategies
¾ Style risks
Are We “Gambling with Fair Dice”?
INC
• Faced with uncertainty as well as risk
¾ Risk ~ countable (measurable with a sample)
¾ Uncertainty ~ no sample of events
• We do not like losses
¾ Desire satisfaction, but suffer from regret – negative
skew problem
• Yet, overconfident of what we know
¾ Law of small numbers
Optimization Provides Insights
INC
An Optimizer Focuses on Some Familiar Strategies
and Changes Others Significantly
100%
90%
80%
70%
60%
50%
The Expected and Actual Sharpe Ratio Can be Very
Different for a Hedge Fund Portfolio
CISDM CTA Return
(Equally Weighted)
3.25
HFRI Distressed
Securities Index
2.75
HFRI Equity Hedge
Index
2.25
HFRI Fixed Income
(Total)
1.75
HFRI Relative Value
Arbitrage Index
40%
30%
HFRI Merger
Arbitrage Index
20%
HFRI Equity Market
Neutral Index
10%
HFRI Convertible
Arbitrage Index
0%
1999
2000
2001
2002
Sources: CISDM, Hedge Fund Research, Inc.
2003
1.25
0.75
0.25
-0.25
1999
2000
2001
Optimized from past 3 years
2002
2003
Realized from current year
Coherence is a Big Risk
INC
• What if hedge funds move together?
¾ We can measure overall correlation through coherence
‰ Coherence measures the amount of order with a set of assets
or managers
‰ Between zero and one; (zero, no order; one, perfect order)
¾ Styles driven by limited common factors
¾ Fads, herding or contagion across managers and
investors
Coherence Between Traditional Assets
and Hedge Funds Has Changed
INC
Correlative Coherence
A Measure of the Order Across Assets Has Increased
0.55
0.5
0.4
0.35
0.3
0.25
Traditional assets and hedge funds Correlative coherence
Traditional assets Correlative coherence
-9
4
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De
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Ju
n96
De
c96
Ju
n97
De
c97
Ju
n98
De
c98
Ju
n99
De
c99
Ju
n00
De
c00
Ju
n01
De
c01
Ju
n02
De
c02
Ju
n03
De
c03
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n04
0.2
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Coherence
0.45
Sources: CISDM, Hedge Fund Research, Inc. & Standard & Poor’s
You May Want to be Incoherent!
INC
• “True” diversification vs. pseudo-diversification
¾ Diversification by the style not the numbers
• Convergence versus Divergence
¾ View of the world makes a difference
‰ Convergent (mean-reverting view)
‰ Divergent (mean-fleeing view)
• What should be the price of skew?
Threshold Risk also Important
INC
• What is your target return?
• Downside risk is what we are afraid of
¾ Originally discussed by Markowitz
¾ Selling volatility funds actually creates more potential
for downside risk
• Upside potential also a problem
¾ Higher Sharpe ratios may lead to a return shortfall
Cases or Situations as Stress Analysis
INC
• Stress behavior has to be tied to events
¾ Case based reasoning can be applied
‰ What are the events you expect and fear?
‰ Are they protected with the hedge funds you have?
• What can we expect for 2005
¾ The unknown will happen
¾ What is hot today will not be tomorrow
¾ Analysis is important but the beginning point
Notes
INC
Although offering potential benefits, an investment with JWH is speculative, involves a high degree of risk, and is designed only for sophisticated investors who
are able to bear the loss of more than their entire investment. Some, but not all, of the risk factors that should be considered prior to making an investment
decision include: forward contract trading, which is not afforded the regulatory protection of exchanges or the Commodity Exchange Act and may subject an
investor to greater risks than trading on US exchanges; trading on non-US futures exchanges, which are not regulated by any US government agency and may
involve certain risks not applicable to trading on US exchanges; currency risks associated with foreign-denominated margin deposits; possible failure of
brokerage firms or futures exchanges; illiquid markets, which may make it more difficult to establish or liquidate a position at a given price. For more details on
these and other risk factors, please refer to JWH’s current disclosure document.
OTHER
This presentation does not constitute an offer to sell or a solicitation for any managed account and cannot disclose all risks and significant elements of the JWH investment
programs. Solicitations can only be made with a JWH disclosure document, which is available at the offices of JWH upon request. Further details of past performance and
definitions of terms used to state past performance are presented in the disclosure document.
An investment with JWH is speculative, involves a high degree of risk, and is designed only for sophisticated investors who are able to bear the loss of more than their entire
investment. Read and examine the disclosure document before seeking JWH's services.
PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS.
INC