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Case for Long Short Equity 2010 August | Stock Market Index | Hedge Fund
Uploaded by Franklin Forward
A Case for Long/Short Equity in a Long-Only Equity Portfolio
THIS PRESENTATION SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF ANY OFFER TO BUY WHICH MAY ONLY BE MADE AT THE TIME A QUALIFIED OFFEREE RECEIVES A CONFIDENTIAL PRIVATE OFFERING MEMORANDUM (“CPOM”) DESCRIBING THE OFFERING AND RELATED SUBSCRIPTION AGREEMENT AND IN THE CASE OF ANY INCONSISTENCY BETWEEN THE DESCRIPTIONS OR TERMS IN THIS PRESENTATION AND THE CPOM, THE CPOM SHALL CONTROL. THESE SECURITIES SHALL NOT BE OFFERED OR SOLD IN ANY JURISDICTION IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL UNTIL THE REQUIREMENTS OF THE LAWS OF SUCH JURISDICTION HAVE BEEN SATISFIED. WHILE ALL THE INFORMATION PREPARED IN THIS PRESENTATION IS BELIEVED TO BE ACCURATE, LASAIR MAKES NO EXPRESS WARRANTY AS TO THE COMPLETENESS OR ACCURACY NOR CAN IT ACCEPT RESPONSIBILITY FOR ERRORS APPEARING IN THE PRESENTATION. ANY PROJECTIONS, MARKET OUTLOOKS OR ESTIMATES IN THIS PRESENTATION ARE FORWARD LOOKING STATEMENTS AND ARE BASED UPON CERTAIN ASSUMPTIONS. OTHER EVENTS WHICH WERE NOT TAKEN INTO ACCOUNT MAY OCCUR AND MAY SIGNIFICANTLY AFFECT THE RETURNS OR PERFORMANCE OF THE FUND. ANY PROJECTIONS, OUTLOOKS OR ASSUMPTIONS SHOULD NOT BE CONSTRUED TO BE INDICATIVE OF THE ACTUAL EVENTS WHICH WILL OCCUR. FURTHER, THE PARAMETERS AND RESTRICTIONS CONTAINED HEREIN MAY BE CHANGED AT ANY TIME IN THE SOLE DISCRETION OF LASAIR WITHOUT NOTICE TO INVESTORS. AN INVESTMENT IN THE FUND IS SPECULATIVE AND INVOLVES A HIGH DEGREE OF RISK. OPPORTUNITIES FOR WITHDRAWAL/REDEMPTION AND TRANSFERABILITY OF INTERESTS ARE RESTRICTED, SO INVESTORS MAY NOT HAVE ACCESS TO CAPITAL WHEN IT IS NEEDED. THERE IS NO SECONDARY MARKET FOR THE INTERESTS AND NONE IS EXPECTED TO DEVELOP. AN INVESTOR SHOULD NOT MAKE AN INVESTMENT UNLESS IT IS PREPARED TO LOSE ALL OR A SUBSTANTIAL PORTION OF ITS INVESTMENT. THE FEES AND EXPENSES CHARGED IN CONNECTION WITH THIS INVESTMENT MAY BE HIGHER THAN THE FEES AND EXPENSES OF OTHER INVESTMENT ALTERNATIVES AND MAY OFFSET PROFITS. THE INFORMATION CONTAINED HEREIN IS CONFIDENTIAL AND INTENDED FOR USE BY THE IMMEDIATE RECIPIENT AND CANNOT BE REPRODUCED, SHARED OR PUBLISHED IN ANY MANNER WITHOUT THE PRIOR WRITTEN CONSENT OF LASAIR CAPITAL LLC. THE INFORMATION IS NOT INTENDED FOR PUBLIC USE OR DISTRIBUTION NOR IS THIS AN OFFER OR SOLICITATION.
Lasair Capital LLC
Please refer to the Appendix for important disclosures. Long/Short Equity in a Long-Only Equity Portfolio In this paper. Historical Results Results over more than twelve years suggest that long/short equity strategies have produced higher long-term returns. downside protection qualities and correlation benefits. 2 . All investments involve risk including the complete loss of principal. I. The Equity Index used by Lasair in this example is designed to capture broad equity market returns. The HFRX Equity Hedge Index (the "Index") is an asset weighted hedge fund index which is included throughout this presentation to show the general trend in investing in both the long and short sides of the equity market in the periods indicated and is not intended to imply Lasair or the underlying hedge funds that Lasair invests in will be comparable to the Index either in composition or element of risk. Past performance is no guarantee of future results and no representation is made that in the future Lasair will or is likely to achieve results similar to those shown. we evaluate the impact of allocating to a long/short equity strategy within a traditional long-only equity portfolio. We demonstrate the potential benefits of an increased long/short equity exposure within a traditional long-only portfolio by analyzing the potential risk-adjusted returns. Traditional Long-Only Equity1 January 1998 to June 2010 350 300 250 200 150 100 50 0 Jan‐98 Jul‐98 Jan‐99 Jul‐99 Jan‐00 Jul‐00 Jan‐01 Jul‐01 Jan‐02 Jul‐02 Jan‐03 Jul‐03 Jan‐04 Jul‐04 Jan‐05 Jul‐05 Jan‐06 Jul‐06 Jan‐07 Jul‐07 Jan‐08 Jul‐08 Jan‐09 Jul‐09 Jan‐10 S&P500 Source: Bloomberg HFRX Equity Hedge 1 Source: Bloomberg. Chart 1: HFRX Equity Hedge Index vs. with less volatility and smaller drawdowns than major equity indices. Chart 1 illustrates that long/short equity strategies have been an attractive way to capture risk-controlled equity returns. The S&P Index is well-known stock market index which is included throughout this presentation merely to show the general trend in the equity markets in the periods indicated.
28% 8. The HFRX Equity Hedge index has generated significantly greater returns over this time period than the S&P500 index. 3 . we evaluate the average annualized returns and volatility of the S&P500 index and the HFRX Equity Hedge index using monthly data from January 1998 to June 2010. Table 1: Annualized Returns and Volatility of L/S Equity and Equity Indices January 1998 to June 2010 S&P 500 Annualized Return Annualized Standard Deviation Source: Bloomberg & Lasair Capital HFRX EH 7. As shown below. the HFRX Equity Hedge Index return for the same periods Average Down Month Return from the S&P 500 Index vs.02% Equity index ‐4.19% Source: Bloomberg & Lasair Please refer to the Appendix for important disclosures.74% HFRX ‐1. In Table 1. Chart 2: Average Up and Down Month Comparison January 1998 to June 2010 Average Up Month Return from the S&P 500 Index vs.25% 16. we examine the average up and down months for the equity market versus the long/short equity strategy during the same periods. the HFRX Equity Hedge index exhibits a capture of 52% of long-only equity portfolio gains.67% 2. while limiting participation in downside month moves to 24% of the traditional long-only equity index. the HFRX Equity Hedge Index return for the same periods Equity index 3.38% HFRX 1. The HFRX Equity Hedge index has also had significantly lower volatility than the S&P500 index.54% In Chart 2.
5% 2.0% 3. Risk Adjusted Performance Enhancement Our analysis suggests that increasing allocations to long/short equity in a traditional long-only portfolio improves the risk-adjusted performance.0% 2.50% 15. Chart 3: Annualized Performance and Volatility Performance 3.54%.00% Equity Portfolio Equity Portfolio with L/S 5% Equity Portfolio with L/S 10% Equity Portfolio with L/S 15% 15.5% 2. As we can observe from Chart 3.25% Annualized Performance (%) Annualized Volatility (%) 2.5% Source: Bloomberg & Lasair Capital Downside Protection Qualities We believe that an increased allocation to long/short equity strategies not only enhances returns. but also provides downside protection qualities in a traditional long-only equity portfolio.25% Volatility 17. We analyze the period from January 1998 to June 2010. the average annualized return for a traditional long-only equity portfolio was 2. As an illustration. 90% and 85%) while increasing the allocation to long/short equity by 5% (5%. 4 . with lower volatility and an asymmetric return profile with enhanced downside protection qualities. 10% and 15%). We now examine the potential benefits of an increased long/short equity allocation to a traditional long-only equity portfolio. We progressively reduce long equity exposure by 5% (95%. If the equity manager had allocated 15% to the long/short equity index. Methodology We begin with a portfolio allocated 100% to the S&P 500 index. Long/Short Equity Allocations in a Traditional Long-Only Equity Portfolio The historical results shown in the previous charts and table show that long/short equity strategies have delivered attractive risk-controlled returns.00% 16.75% 16.95%. Please refer to the Appendix for important disclosures. we used the same data shown above and compared the average monthly loss and drawdown statistics of a long-only equity portfolio to an equity portfolio with progressively increased allocations to long/short equity.10% with a drop in annualized volatility to 14.25% with a volatility of 16. II. This analysis supports the thesis that an increased allocation to long/short equity can enhance the downside risk protection qualities of the equity portfolio as measured by VaR and drawdowns. the annualized return of the portfolio would have improved to 3.0% 14.
We show the improvement in VaR in Chart 4. we believe that when combined with other risk statistics. on average.00% 11.0% 8. With that caveat in mind.50% 12. The average drawdown of a long-only equity portfolio is 13. over the period January 1998 through June 2010.00% reduced to 11.50% portfolio with increased allocations to long/short equity. Chart 5 shows the Average Drawdown improvement in the average drawdowns of the 13. it can signal potential downside risk in a portfolio. Please refer to Appendix for important disclosures.50% Equity Portfolio Equity Portfolio with L/S 5% Equity Portfolio with Equity Portfolio with L/S 10% L/S 15% The analysis provides strong support that the addition of a long/short equity allocation can provide downside protection qualities for a traditional long-only equity portfolio.00%.36%. which was 13. While we recognize its drawbacks as a true downside risk measure.0% Equity Portfolio Drawdown Improvements Source: Bloomberg & Lasair Equity Portfolio with Equity Portfolio with Equity Portfolio with L/S 5% L/S 10% L/S 15% Drawdown analysis of the portfolio is another useful risk tool. While the long-only equity portfolio Chart 4: Portfolio VaR with has a monthly 95% confidence VaR estimate an Increased Allocation to L/S Equity of 9.74% when we added a 15% allocation to the long/short equity index. 5 .5% 9.37% showing a significant protection from potential downside losses.5% 8. Source: Bloomberg & Lasair 2 The VaR number is the average historical monthly VaR from January 1998 to June 2010 at the 95% confidence level. We analyzed the average drawdown of the long-only equity portfolio and compared it to the average drawdown of the equity portfolio with Chart 5: Portfolio Drawdown Buffered with an Increased progressively increased allocations to the Allocation to L/S equity long/short equity index.0% 8. the equity portfolio with a 15% allocation to long/short equity has a Value at Risk monthly 95% confidence VaR estimate of 10. The average drawdown measures the percentage loss of a portfolio. Value at Risk (VaR) Improvements2 VaR is the snapshot of a portfolio’s theoretical maximum loss at a specified statistical significance for a given time horizon. we calculated the VaR for the long-only equity portfolio and compared it with the VaR of the equity portfolio with an increasing allocation to the long/short equity index. 9. 12.
In addition. Finally. there is an opportunity to enhance the benefits of long/short equity index returns with thoughtful manager selection and portfolio construction. This implies that long/short equity has a potential significant diversification benefit for a typical long-only equity portfolio. Results over more than twelve years demonstrate that long/short equity index strategies have shown higher long-term returns. Portfolio Management We believe a subset of carefully selected long/short equity managers blended with thoughtful portfolio construction can further amplify the benefits that have been illustrated above. We note the relatively low correlation between the long/short equity index and long-only equity index. Based solely upon index returns utilized. less volatility and lower drawdowns as well as moderate correlation to long-only equity market indices. Conclusion There is a compelling case for long/short equity allocation within a long-only equity portfolio. Correlation Benefits The return enhancement and the downside protection qualities that we reported above stem partly from the relatively low correlation between the long/short equity index and long-only equity indices. which was 65% correlation over this period. 6 . A clear manager selection process and risk management philosophy can seek to increase the benefits provided by an index of long/short equity managers. the best portfolio managers continue to be attracted to the investment flexibility and aligned incentive structure available in the hedge fund format and thereby offer opportunities for a non-traditional solution provider. evidence supports the risk-adjusted return enhancement and downside protection qualities of a long/short equity allocation in a traditional long-only equity portfolio. we believe that in the changing investment management industry.
The information contained herein is confidential and intended for use by the immediate recipient and cannot be reproduced. Past performance is no guarantee of future results and no representation is made that in the future Lasair will or is likely to achieve results similar to those shown. All investments involve risk including the complete loss of principal. The HFRX Equity Hedge index (the “HFRX”) is comprised of a basket of long/short equity hedge funds which includes equity hedge strategies that maintain positions both long and short in primarily equity and equity derivative securities. Appendix Lasair may modify its investment approach and any portfolio parameters at any time in any manner which it believes is consistent with its overall investment objective without notice to investors. The HFRX is included merely to show the general trend from long/short equity hedge funds and allow for comparison to that of a recognized hedge fund index and is not intended to imply that the portfolio of the Fund is comparable to the HFRX either in composition or element of risk. Lasair Capital (“Lasair”) has made reasonable efforts to obtain information from reliable sources and all statistical and graphical information contained herein is from sources believed to be accurate. Performance for the index includes the reinvestment of all dividends. 7 . interest. The S&P 500 (“S&P”) is a well-known stock market index that is included merely to show the general trend in the equity markets in the periods indicated and is not intended to imply that the portfolio of the Fund is comparable to the S&P either in composition or element of risk. Lasair makes no representations or warranties as to the accuracy. This information is not intended for public use or distribution nor is this an offer or solicitation. shared or published in any manner without the prior written consent of Lasair. with all constituent funds reporting returns net-of-fees and expenses on a monthly basis. Lasair utilized such information to compile the charts and tables presented herein. reliability or completeness of any information in these materials. and capital gains.
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