Leadership in Finance

Alternative Investments Conference – London School of Economics

Alternative Investment Conference London School of Economics Hedge Fund Day - FLI 4

Alternative Investment Conference London School of Economics Hedge Fund Day – FLI 4

Alternative Investment Conference London School of Economics Hedge Fund Day - FLI 3

Alternative Investment Conference London School of Economics Hedge Fund Day – FLI 3

Alternative Investment Conference London School of Economics Hedge Fund Day - FLI 2

Alternative Investment Conference London School of Economics Hedge Fund Day – FLI 2

Alternative Investment Conference London School of Economics - FLI 1

Alternative Investment Conference London School of Economics – FLI 1

Topic: “Hedge Fund Day”

Organizing Committee: The Alternative Investments Conference is jointly organised by the LSE Private Equity Society and LSE Financial Markets Group, and will enter into its fourth year in 2010.

Media Partner: The Wall Street Journal Europe Future Leadership Institute*
(*Between 2007 and 2011 the Institute carried temporarily the name ‘The Wall Street Journal Future Leadership Institute”)

How to Attend ?
All seats via The WSJE Future Leadership Institute* are currently reserved.
25 January 2010 | Joint Seminar | London, UK

Introduction
Since its foundation in 2007, the AIC has grown to become the world’s largest student organised conference on private equity and hedge funds. Attracting industry leaders and students from as far afield as China and California, the Conference is a unique forum for interaction and learning. Competition for a seat at the conference is fierce and we are unable to accommodate everyone due to logistical constraints: in 2009 we received 1600 applications for only 350 seats.

Planning begins many months before the event itself, and we are most grateful to all of our speakers and sponsors, new and returning, without whom the event would not be possible. We would also like to thank Team AIC for their continued enthusiasm and support for the Conference.

We hope that you will emerge from the Conference with both a holistic view of the hedge fund and private equity industries and also with a network of like-minded students from around the world.

Jaymal Nathwani
Patrick Johnston
Co-Presidents Akhil Chainwala
Dominik Nagly
Co-Chairmen
REPORT

HISTORY
In 2007, a group of undergraduate students set up the London School of Economics Alternative Investments Conference (AIC) with the intention of bringing together the leading industry practitioners and most talented students from around the world. The AIC serves to educate students on the traditionally secretive industries, and provide firms with the brightest students from across the globe.
The 4th Annual AIC was held on January 25th and 26th 2010 at the Marriott Grosvenor Square in London. This year again attracted a noteworthy group of hedge fund managers, private equity general partners, and leading alternative investments academics.
Delegates from 70 countries and 70 universities attended, making the 2010 conference the most successful to date.
A year after the most significant economic and financial crisis in the post-war period, speakers and delegates were most interested in discussing how the alternative investment industry is responding to the crisis and continuing to evolve.
Some of the hedge fund managers represented at the conference included Brevan Howard, GLG Partners, Kynikos Associates, International Asset Management, Lansdowne Partners and Goldman Sachs Investment Partners. Many topics were explored, ranging from the current state of hedge funds to the price of gold, China’s economy, stimulus packages and the overall macroeconomic environment in the years to come.
This summary captures the key themes brought out at the event which were recorded by the undergraduate students on the conference organising committee. We hope you find this report insightful and informative and wish you the best for a successful 2010.

KEYNOTE by Jim Chanos
Jim Chanos is a noted hedge fund manager who focuses exclusively on identifying overvalued securities to short sell. He previously predicted and successfully bet on the bankruptcy of Enron, the US Savings and Loan crisis and the recent credit bubble. Mr. Chanos opened the Alternative Investments Conference 2010 on Monday morning with a presentation entitled “The China Syndrome”, highlighting his contrarian view on the Chinese economy.
Mr. Chanos has identified developments in China as building up to what he believes will become one of the most significant shorting opportunities resulting from overheating and overindulgence and discussed a number of these underlying themes during his talk.
The speech was designed to illustrate the thoroughness of his due diligence and evidence that supports his view, whilst he depicted the key issues as “the Scylla of overcapacity and Charybdis of inflation”.
One of the main problems identified is the veracity of economic statistics. There is a clear disparity between the regional and the national Gross Domestic Product figures that makes it impossible to judge the true level of real economic activity. Much like his analysis of Enron, Mr. Chanos thinks the numbers out of China simply do not add up. He also pointed out the fact that foreign firms find it difficult to conduct business in China due to a regulatory environment which is not favourable for foreign-owned businesses.
Mr. Chanos compared China to Asia’s “paper tigers” of the 1990s arguing that if the growth miracle is based on the expanding quantity of inputs rather than increasing productivity, the economy will be subject to the law of diminishing returns. There will be no medium to long term sustainability of the rapid growth that has been experienced. He supported the argument stating China has experienced a 12 year-long investment boom which is one of the main reasons for overcapacity.
Another reason for the overcapacity present in China is that state-owed enterprises control more than 50% of industrial assets which leads to an inefficient allocation of resources, as firms are not driven by profit maximization.
Another important issue covered was the credit driven property bubble. A wasteful allocation of resources, excessive growth of credit in the last years and diversion of stimulus funds to real estate are likely to be followed by a credit-fueled boom and a bust. In a country where social safety nets do not exist, housing is seen as the store of wealth and housing speculation has recently reached unprecedented levels.

The key statistics reinforcing these arguments were:
• 20% of office space is vacant in Beijing while 16% is vacant in Shanghai.
• Office rents fell in 2009 by 22% in Beijing and 26% in Shanghai.
• 2.6 billion square metres of non-residential real estate is currently under construction.
• Unfunded liabilities and government guarantees may mute the support offered by foreign currency reserves.

Mr. Chanos believes that generational savings may be destroyed if the bubble bursts, exacerbating the ticking demographic time bomb. To implement his thesis he would target commodity and materials orientated companies that are major suppliers to China, allowing him to express his bearish view while limiting his counterparty risk.


KEYNOTE by Randall Dillard

Randall Dillard spoke about the state of the economy and his perspective, as the CIO of Liongate Capital Management, one of the largest fund of hedge funds in London.
Mr. Dillard sees a bright future for the hedge fund industry. Funds of hedge funds outperformed long only managers in 2008, and recovered most of the losses in 2009. Additionally, he pointed out that hedge funds tend to do well in times of high volatility and declining markets, making the current environment very attractive for them.
Mr. Dillard’s address highlighted some of the concerns that he faces as a fund of funds manager. Surprisingly, he told the delegates that business risk is often higher than market risk. Managing the co-investor, financing and valuation risks were the aspects of investing in funds that concerned him more than a manager’s market exposure. Understanding liquidity risks and how they differ across strategies
is a key challenge. He also noted that knowing when to leave managers that are no longer performing is essential along with paying attention to active portfolio reallocation.
The second half of the presentation concerned the health of the global economy. The key points made were:
• The recent market rally has occurred on declining volumes, signaling that it may not last much beyond the first half of 2010.
• Economic contributions of the US stimulus package are declining.
• The housing market faces further floating mortgage rates resets in the coming year.
• US total debt has reached all time highs and the marginal return per dollar of debt has been steadily declining since the 1960s.
• Foreign buying has propped up the treasury bubble, while the duration of holdings is getting shorter

In concluding, Mr. Dillard predicted that sovereign risk is under-appreciated, that treasuries were entering the end of an era of declining yields, and that gold will be in a bull market for the foreseeable future because of inflationary expectations.

HEDGE FUND PANEL DISCUSSION
The Hedge Fund Day closed with a lively panel discussion that focused on how managers create alpha, manage risk and develop their investment strategies. The participants included Stuart Roden (Lansdowne Partners), Victor Haghani (Private investor), Morten Spenner (International Asset Management), and Randall Dillard (Liongate Capital). The panel was chaired by Neil Wilson (Hedge Fund Intelligence).
Creating Alpha – One of the panelists led the discussion by saying that he feels alpha can be produced by managers working harder than competitors, effective counterparty risk management and the building of operational capacity to support investments.
Another member of the panel echoed this sentiment by signaling out hard work and risk management as the keys to consistent alpha generation.
Victor Haghani steered the discussion in a different direction. He thought that the equity markets should be viewed as a “zero-sum game” and added that when transaction costs, venture capital backed startups and private equity investors are factored in, they are likely to constitute a “negative sum game”. Therefore he views alpha in some hedge fund strategies as very difficult or even impossible to achieve.
Morten Spenner encouraged investors in hedge funds to think about the quality and consistency of the returns as well as what the return drivers are.
Investment Process – One of the managers represented said his fund used a combination of a top down and bottom up investment approach. In addition to fundamental analysis he concentrated on uncovering hidden correlations and systemic risk.
Another panel member added some useful insights into their top down themed analysis. He claimed it is impossible to be a consistently better forecaster than the rest of the market participants, so a critical part of the investment process consists of finding convex bets on multiple scenarios that offer asymmetric returns. He made it clear that more than half of his firm’s investment approach, and thus its competitive advantage, entails finding the most effective way to express a view and manage the downside risk.
Mr. Spenner and Mr. Dillard added the fund of hedge funds perspective. Mr. Spenner noted that the key to avoiding disappointment during 2008 in the hedge fund industry was managing investor’s expectations, careful due-diligence and looking at the most liquid managers to minimize the likelihood of encountering gates on redemptions. Mr. Dillard believes that 2010 will be a year of reallocating into hedge funds and fund of funds despite the fact that many of them did not capture the full extent of the 2009 rebound. He also noted that fund of hedge funds managers were right not to focus on the rally in illiquid asset classes.
Risk Management – All panel members were in agreement that risk management in hedge funds is critical.
Victor Haghani opined that volatility measured by standard deviation was not of much help in managing risk due to its inability to capture tail risk. He also said that this is true of beta except in times of crisis.
“The greatest risks are the ones that cannot be modeled or measured,” claimed another panelist.

SEMINARS
Delegates broke into smaller and more interactive seminars during the day to explore topics more thoroughly with leading industry experts. Some of these thoughts are presented below.

Effie Datson is the Product Head for the Managed Investment Platform at Deutsche Bank. Ms. Datson focused her remarks on the increased interest in managed accounts in hedge funds and the benefits and drawbacks of employing segregated portfolios. She believes that the crisis revealed previously under-appreciated risks associated with investing in hedge funds and that managed accounts may be able to address some of those risks. In particular she cited the following benefits:
• Avoidance of fraud by providing transparency and control.
• Security of assets.
• Mitigating the liquidity risks of investing in hedge funds.

A few of the drawbacks she touched on include the fact that managed accounts:
• Often create liquidity mismatches.
• Restrict leverage and thus returns.
• Add an additional layer of fees and reporting costs.
• Result in varying returns.
She concluded by noting that managed accounts do not suit all strategies, nor are they suitable for all investors. However, managed accounts can alleviate some of the problems investors can encounter with investing in hedge funds. According to Ms. Datson: “It’s still an evolving area of the hedge fund industry that is likely to grow in importance.”

Richard Gower is the co-founder of Armajaro, a London based hedge fund focused on commodities. Mr. Gower summarised the advantages of investing in commodities as:
• Lack of correlation with equities and bonds.
• High levels of liquidity.
• Hedge against inflation and the US dollar.
• Diversification from other asset classes.
Mr. Gower also talked about the complex nature of investing in commodities and what investors need to consider. He noted that understanding the impact of weather on the price of soft commodities was crucial and thus having information on expected weather systems can help in an analysis of agricultural prices. Armajaro achieves this by accessing over 3,000 weather systems around the world and employing former UK Met office employees. He also said that having the capacity to take physical delivery of commodities is a key advantage and that selling short commodity options was not advisable due to a poor risk/return profile.

Savvas Savouri is the Chief Economist at Tosca Fund. He discussed an interesting, but little discussed solution to Greece’s financial problem and London’s position as a financial centre.
Mr. Savouri believes a solution to Greece’s financial problem may be an injection of capital from Russia. He believes that Greece is closer with Moscow than many of its fellow EU member states and Russia has always prized some of the assets held by Greek banks in the Balkans. The infusion could come in the form of a partial nationalization of the Greek banking system followed by an equity swap for some of the assets held by the banks. Mr. Savouri conceded that it was a complex solution, but noted that so too is the problem.
On the topic of London as a financial centre, Mr. Savouri took a different stance than many of his counterparts. He thinks London will add 10,000 financial services jobs in the next decade as emerging markets look for a western financial hub because it is the obvious choice and will benefit greatly as these economies grow.
Another workshop speaker opined on the current state of the credit markets, offering a bullish outlook for credit in 2010. Among the factors he cited are:
• Investors are seeking returns in high yielding assets with demand far exceeding supply in 2009.
• The return of financing for Leveraged buyouts which will have higher leverage multiples than in 2008 & 2009.
• Continued refinancing of maturing bonds.
• Capital appreciation and “above coupon” returns expected to continue throughout 2010.
Despite a number of positive technical indicators, this speaker cautioned that the global economic recovery and the actions of central bankers will have a substantial impact on credit markets and could potentially derail the predicted recovery.

Discussions took place regarding how the crisis came to be, what could have been done to mitigate the effects and how the aftermath is affecting hedge funds.
Many speakers see the root of the crisis in credit expansion and misperception of omnipresent risks. They drilled deeper into this and highlighted the following specific points:
• Insurance companies started to take on the “tail risks” that investment banks wanted to hedge. AIG underestimated the risks they had on their books.
• BRIC countries were considered decoupled from developed markets and thus, incorrectly, a safe haven.
• Contagion risk to developing countries and across industries was underestimated by most, if not all market participants.
• The failure to save Lehman Brothers caused severe market dislocations.
In addition to outlining the causes of the crisis, the speakers turned to the regulatory proposals currently being discussed. Their thoughts included:
• Market liquidity would be significantly reduced if investment bank proprietary trading activities are restricted. This is especially true in the swaps market.
• The focus of regulation should be requiring banks to have more capital and less leverage.
• Derivatives and structured products need to be better regulated.
• Basel 3 is mostly headed in the right direction.
Some speakers saw a bubble forming in the gold market as being long gold has recently become a consensus trade among hedge fund managers. However, this was not the consensus view during the day. There was also a divergence of opinion on the likelihood of the hedge fund industry fleeing London in anticipation of the new European regulations.

CONCLUSION
Although the conference covered a variety of viewpoints, almost all of the speakers agreed that the
hedge fund industry is well positioned. Like the rest of the financial services industry it was not without
its casualties, but overall most of the participants felt that the industry delivered superior returns to
long only managers and the overall markets. With the continuing recovery of the global economy,
the Hedge Fund industry will realign itself and recover too. Indeed, almost all speakers present at the
conference felt that the industry’s best years are still to come.

Authored by:
Richard Dewey – London School of Economics Financial Markets Group
Dominik Nagly & Jaymal Nathwani – London School of Economics and Political Science

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