Introduction to Alternative Investments

Speakers: Sabby Mionis CEO & CIO, C.M. Advisors Ltd. Yannis Procopis Deputy CIO, C.M. Advisors Ltd. April 7, 2008

Contents
Alternative Investments Hedge Funds
What are Hedge Funds? Hedge Funds History Myth and Reality Hedge Funds vs. Traditional Mutual Funds Hedge Funds Styles & Strategies Strategy Analysed: Merger Arbitrage Risk return Profile of Hedge Fund Styles Hedge Fund Performance Efficient Frontier Argument Investor Base

Funds of Hedge Funds

What is required to select the best Hedge Fund?

Listed Funds of Hedge Funds Conclusions

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Alternative Investments

Investment Universe Investment Universe

Alternative Investments Alternative Investments

Traditional Investments Traditional Investments

Stocks Bonds Cash equivalents

Classic Alternatives Classic Alternatives

Real Estate Natural Resources Private Equity

Modern Alternatives Modern Alternatives

Hedge Funds Hedge Funds

What are Hedge Funds?

A multitude of skill-based investment strategies with a broad range of risk and return objectives.

A common element is the use of investment and risk management skills to seek absolute positive returns regardless of market direction through hedging, use of derivatives, use of leverage and frequent trading.

A hedge fund is a private investment portfolio, usually structured as a limited partnership or an open-end investment vehicle, open to accredited investors, charging an incentive based fee, and managed by a general partner with every financial tool imaginable at his disposal.

Hedge Funds History

History: 1949 - Alfred Jones First Hedge Fund 1968 - 200 Hedge-Funds 2007 - 8000 Hedge Funds 2007 - $1.442 Trillion in Hedge Fund Assets Representing an estimated 3% of all global assets Investing in Hedge Funds: US and European Institutions currently placing 8%-15% in Hedge Funds Majority use Funds of Funds or External Advisors for Hedge Funds Only 10% Manage Hedge Funds internally Swiss Private Banks have 15%-25% allocation in Fund of Funds and Hedge Funds for individual clients
Source: Goldman Sachs and Frank Russell

Myth & Reality

MYTH Hedge funds are very risky and highly volatile. Hedge funds lack transparency over their portfolios and organization. Hedge funds use significant leverage. Hedge funds are always unregulated investment vehicles.

REALITY The primary objective of hedge funds is to preserve capital by reducing volatility, which has historically been much higher on equity markets. Nowadays, most hedge funds provide detailed monthly reports due to the pressure from institutional investors. Less than 30% of hedge fund managers employ a leverage effect greater than 2x. Although true for many offshore hedge funds, numerous investment managers are regulated by local authorities such as the SEC in the US and the FSA in the UK. Hedge funds offer a valid alternative to traditional asset classes by allowing investors to optimize the risk/ return profile of their portfolios. LTCM failure was related to a combination of human error, greed (leverage up to 28x!) and inappropriate risk management techniques. Also, large investment banks sometimes provided unlimited leverage to LTCM, incorrectly assessing the risks embedded in its strategy. There is no evidence that hedge funds are linked to stock market crises. Hedge funds only represent a very small amount of total investments worldwide. This idea belongs to the past. Today, even retail clients can invest in funds of hedge funds.

Hedge funds offer no economic added value. The failure of LTCM was a failure of the market.

Hedge funds are a main cause of market downturns and volatility. Hedge funds are only for wealthy private investors.

Hedge Funds vs. Traditional Mutual Funds

TRADITIONAL INVESTMENTS Limited access to sophisticated instruments and hedging techniques such as short-selling or derivatives trading owing to the restrictive regulatory environment. Performance is largely dictated by the direction of stock markets. Managers aim to outperform a benchmark (seek relative returns), hence providing little protection in times of market downturns. In most cases the portfolio is fully invested. Fees based on the amount of the assets under management (AUM).

HEDGE FUNDS A wide range of financial instruments and investment techniques to choose from, allowing to reduce risks and take advantage of pricing inefficiencies. Performance is driven by investment style and the managers skills Managers aim to achieve risk-adjusted absolute returns regardless of market environment. The manager is free to choose the investments and weightings at its entire discretion. Fees based both on AUM and the funds absolute performance. Generally, fees are higher than the rest of the industry. Usually monthly subscriptions and quarterly redemptions. Some funds impose lock-up periods as well as gates. Managers invest part or all of their own capital and hence bear the same risks as their clients. Hedge funds are incorporated in offshore jurisdictions which sometimes lack specific regulations.

Investments are usually very liquid. Regulations normally prohibit managers from investing in the same securities as their clients. Investment vehicles are often domiciled in regulated jurisdictions.

Hedge Funds are Here to Stay

Hedge Fund AUM ($ US Bn) and Number of Hedge Funds (88-08E, Van Hedge) 12000 10000 $1,800 $1,600 $1,400 8000 $1,200 $1,000 6000 $800 $600 $400 2000 0 88 90 92 94 96 98 00 02 04 06 08 $200 $0

4000

Source: Strategas

Hedge Funds Styles & Strategies

ARBITRAGE STRATEGIES Fixed Income Convertible Merger Distressed Securities Special Situations Credit Volatility Carry Mortgage

TRADING STRATEGIES Global Macro Systematic

LONG/SHORT EQUITY STRATEGIES General Sector Focus Region Focus Market Neutral Short Bias

Hedge Fund Strategies: Arbitrage

Arbitrage: Arbitrage is the process of taking advantage of market mis-pricing between two related or highly correlated instruments. This management approach is highly technical and usually exploits a narrow market segment to which it brings liquidity and efficiency. Arbitrage returns are generally characterized by low volatility, and are neutral to market movements. Arbitrage Strategies: Convertible Arbitrage Merger Arbitrage Fixed Income Arbitrage Distressed Securities Special Situations Credit Arbitrage Capital Structure Volatility Arbitrage Carry Trades Mortgage Securities Arbitrage

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Hedge Fund Strategies: Long/Short Equity

Long/Short Equity: This strategy focuses on equity managers who may trade both long and short in the US and international equity markets. These managers carry diversified portfolios and focus on long and short equity securities, in addition to matched pairs and the use of other financial instruments, including stock indices, options, bonds and cash equivalents, to increase flexibility and reduce the risk of capital loss. These managers usually favour a bottom-up approach and their portfolios, in general, will have a directional bias. These managers trade in large, medium and small cap stocks. Long/short Equity Strategies: Market exposure: net long, net short, market neutral Market capitalization focus Geographical focus Sector focus

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Hedge Fund Strategies: Trading

Macro: The macro manager typically invests worldwide, without any limitations either in country allocations or in the types of assets or instruments traded (stocks, bonds, commodities, derivatives, currencies, etc.). The term macro comes from the fact that managers with this style typically seek to profit from anticipated changes in major macro-economic variables, and especially shifts in interest rates. This type of manager is also sometimes called macro discretionary to reflect that the approach is opportunistic, and based on the managers own identification and evaluation of potential trades in any area of interest to them, rather than on a technical or system-based approach to identifying potential trades in a limited set of specific markets. Systematic Trading: The strategy involves the taking of positions in global financial markets based on a systematic approach where trade signals are generated from computer-based models. Managers attempt to add value through the use of various techniques such as identification of trends, or price patterns in order to take advantage of directional moves in markets including fixed income, equities, currencies and commodities. Most managers are mainly active in the derivatives markets, and therefore often referred to as CTAs (Commodity Trading Adviser) reflects the fact that futures and options markets were originally developed as a means of hedging positions in agricultural and other physical commodities.

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Strategy Analysed: Merger Arbitrage

Introduction The strategy involves the purchase and sale of securities of M&A participants and generally involves purchasing shares of a target company and selling short shares in the acquiring company (if not a cash deal).

Where is the Arbitrage? After a company announces an intent to acquire another, the price of the target company's stock predictably goes up, although usually not to the full offering price. This spread exists because of the risk of the deal not closing on time or at all. Before a transaction can be completed, shareholders of both companies must vote to approve the deal and industry regulators and competition authorities must signal their acceptance.

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Strategy Analysed: Merger Arbitrage (cont.)

Why does the spread exist? Time Value of Money Risk of a Deal Break Deal Flow Capital Employed Liquidity Macroeconomic & Market Risk

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Strategy Analysed: Merger Arbitrage (cont.)

Types of Transactions Cash deals. Long the target company. As deal break concern increases there is market risk which can be hedged with options. Stock for Stock

Expected Returns Generally merger arbitrage seeks annual returns of 10%-15% with low volatility. This will depend on leverage. Returns on the upside are capped by the spread, whereas they are not limited on the downside. Payoff resembles the short put option profile.

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Strategy Analysed: Merger Arbitrage (cont.)

Investment Process Announcement of Transaction Assessment/ Evaluation Bottom up analysis. Review deal terms, strategic forces, fundamental attractiveness of deal to participants Effects of new events and information Legal/ anti-trust/ regulatory review Investment Decision / Evaluate Likelihood of deal completing Portfolio building

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Strategy Analysed: Merger Arbitrage (cont.)

Example: AOL/Time Warner A Stock for Stock Deal In January 2000, Time Warner Inc. (TWX), the largest media company in the world stunned the market when it announced that it had agreed to be acquired by AOL. At the time TWXs revenues were 6 times greater than AOLs.

AOL / TIME Transaction Summary Transaction: Deal Announced: Terms: Expected Completion: Actual Completion: Regulatory Risk: Premium: Deal Type: AOL buys Time Warner January 10, 2000 1.5 AOL shares / TWX share 3Q 2000 January 12, 2001 High 73.9% Friendly stock swap

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Strategy Analysed: Merger Arbitrage (cont.)

Example: AOL/Time Warner A Stock for Stock Deal

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Strategy Analysed: Merger Arbitrage (cont.)

Example: AOL/Time Warner A Stock for Stock Deal

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Strategy Analysed: Merger Arbitrage (cont.)

Example: AOL/Time Warner Payoff (the stocks of both companies fell by nearly 50% in the same period)

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Strategy Analysed: Merger Arbitrage (cont.)

Risks Deal-Break Risk (can hedge with put options on the target company if spread allows) Macroeconomic / market risk. Reduced attractiveness of the deal (can hedge with put options on the market) Liquidity Deal Flow & Capital Employed Duration

Risk Management Diversification & position weighting Independence of factors influencing deals Duration limit Market Cap Stop Losses

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Strategy Analysed: Merger Arbitrage (cont.)

Success Factors Agility. Timing is very important. Experience in information processing. Investment banking background is very useful. Diverse analytical resources needed to perform various analyses from company valuations to legal assessments. Trading skills. As new information becomes available trading around positions may be necessary. Risk Management Low Transaction Costs

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Strategy Analysed: Merger Arbitrage (cont.)

Findings Simple concept but becomes complex in practice. Stable returns not dependent on market moves. Ability of manager to process information and evaluate the probability of a deal-break is paramount.

Different Versions In the 1980s merger arbitrage typically involved going into unannounced deals, companies thought to be transaction candidates. This however is highly speculative and more risky. Doing the Reverse: shorting target companies believing the deal will break.

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Risk/Return Profile of Hedge Fund Styles

Return

Trading

Long/Short Equity

Arbitrage

Risk

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Hedge Fund Performance (1994-Feb 2008)

500 450 400 350

Growth of $100

300 250 200 150 100 50 0 Dec-93 Jun-94 Dec-94 Jun-95 Dec-95 Jun-96 Dec-96 Jun-97 Dec-97 Jun-98 Dec-98 Jun-99 Dec-99 Jun-00 Dec-00 Jun-01 Dec-01 Jun-02 Dec-02 Jun-03 Dec-03 Jun-04 Dec-04 Jun-05 Dec-05 Jun-06 Dec-06 Jun-07 Dec-07

CSFB-Tremont

MSCI World

SSB Corporate

Source: CSFB Tremont, Pertrac

- Low Volatility - Stable Returns - Protection of Capital in Difficult Markets

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Efficient Frontier Argument

Adding hedge funds to portfolio of stocks and bonds increases return and reduces volatility*
Risk and Return of Portfolios of Stocks, Bonds and Hedge funds 12% Portfolio Annualized Return 10% 8%
100% stocks 100% bonds 50% hedge funds 25% stocks 25% bonds 100% hedge funds

6% 4% 2% 0% 0% 2% 4% 6%

50% stocks 50% bonds

70% stocks 30% bonds

8%

10%

12%

14%

16%

Portfolio Annualized Volatility

*Following indices are used: MSCI World Index (stocks), SSB World Government Bond index (bonds) and CSFB Tremont index (hedge funds)

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Investor Base

Funds of Funds Multi Strategy / Single Strategy

70% of total global assets allocated to Hedge Funds are deployed by Funds of Funds which give access to retail investors

Listed Funds of Funds

A growing trend with 30 funds listed in London through which even a tiny investor can participate

Structured Products: Capital Protection, Leverage High Net Worth Individuals Institutions: Private Banks, Insurance Companies, Pension Funds, Endowments, etc.

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Benefits of Funds of Hedge Funds

Superior Returns, Low Volatility Low correlation with traditional market indices Diversification Access to Closed Hedge Funds Better Liquidity Terms Flexibility of Investment Structures Expert Due Diligence and Selection Process

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What is required to select the best hedge funds?

CMA methodically narrows the list of potential investment candidates to a short-list of well-researched investment ideas
Hedge Fund Universe
Capital Introduction 20% News Flow 20% Proprietary Database 10% Industry Network 50%

Screening/ Idea Generation:

Initial review of investment candidates 500-600 hedge funds per year bottom-up and top-down sourced
[First Checks] [37 (11%) Report 1: initial due diligence

80% of opportunities screened Report 2: Full due diligence 20% of Report 1 Stage OFFSITE(5.6%) ONSITE [20 Investment 85
[Full Due Diligence]

Portfolio Management Ongoing Monitoring Risk Management Rebalancing Redemption Maturity

Inception

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Benefits of Listed Funds of Hedge Funds

Only listed Funds of Funds approved by the Greek Capital Markets Commission Public listing provides daily liquidity for investors High level of transparency Access to an alternative asset class not widely open to small investors Multiple currency share classes: USD, GBP, and EUR No Minimum Investment Requirement Attractive Fee Structure Access to permanent capital facilitates investment in hedge funds with longer lock-ups
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Conclusions

Hedge Funds, an alternative asset class Tremendous growth of the Hedge Fund industry over the years and especially recently Wide range of strategies with different risk/return profiles Hedge Funds enhance the risk/return profile of an investment portfolio Funds of Funds are the main source of capital for Hedge Funds Hedge Funds now available to all investors through Funds of Funds and Listed Funds of Funds

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