2009 Year in Review

ASSET MANAGEMENT SOLUTIONS GROUP
2009 YEAR IN REVIEW

PRIME SERVICES HEDGE FUND INTELLIGENCE
Earn Success Every Day
CONTENTS
2009 YEAR IN REVIEW
PICK YOUR MODEL
RAISING THE GAME
PICKING UP THE PIECES
DOWN, BUT NOT OUT
ASSET MANAGEMENT SOLUTIONS GROUP OVERVIEW
2009 YEAR IN REVIEW, WITH A LOOK TOWARDS THE FUTURE

Dear Clients, Many thanks for your partnership during the course of the year. Hopefully, most of you are preparing to enjoy your well-deserved end-of-year break. As you start reecting on past events and prepare to address future challenges, we want to share our perspectives on this dynamic year with a look towards the future. In this 2009 Year in Review compilation, we have compiled our three thought pieces on the Hedge Fund industry Raising the Game, Picking Up the Pieces and Down, But Not Out. Additionally in this preface, we revisit the forecasts and predictions we made, as a means for either validating our ndings or citing where our conclusions varied from the actual outcomes. We have also included a new thought piece (Pick Your Model). In this report, we cover the various models that rms are currently utilizing to operate their businesses in the Equity Long/Short and Multi-Strategy arenas. Based on an analysis performed in Q3 2009, we are now for the rst time publishing these insights. In this piece, we aim to provide intellectual capital to what we deem to be an important new dynamic investors are increasingly pushing Hedge Fund Managers to adopt a stronger logic and a more demarcated specialization in the build-out of their rms. Looking towards the future, three critical themes are emerging First, Product Wrapping, i.e., whether and how a rm intends to make investment processes accessible to non-traditional client segments. In this context, we think there is potential for growing demand and evolution of UCITS III products, Managed Accounts and Mutual Fund replicas. Second, Hedge Fund Regulation, is an area of great debate. It is a topic with great potential for impact, and is often overshadowed with vocal political intentions. In turn, this makes it even harder to plan for. Third, Investment Consultants, a market segment being shaken by new entrants but being charged with broader and new responsibilities as plan sponsors seek to increase their allocations to alternatives. We understand investment consultants are a phenomenon that is more specic to the decision-making processes adopted in Anglo-Saxon markets1. However, given the prominence that those markets and investors have in the Hedge Fund industry, investment consultants are difcult to ignore.
KEY LEARNINGS
If we could condense what 2009 has been for Hedge Funds in one phrase, we would say touch-down-and-take-off. At the beginning of the year (about the time we published Down, But Not Out), the end of Hedge Funds was a scenario with a nonnegligible probability of occurrence. Later on in the year (about the time we published Picking Up the Pieces), we were comforted to hear investors reiterate their belief in Hedge Fund investing, albeit not making any allocations. Towards the end of the year (about the time we conducted and published Raising the Game), we were pleased to observe strong performance, a radical change in the way Hedge Fund Managers are approaching asset raising, and yes the leading sentiment indicator inows. In Down, But Not Out published in February 2009 we expressed our condence that Hedge Funds would survive as a core segment of the Asset Management industry. As you saw from the comparison with other forecasts expressed at that time, we were on the optimistic side. While we were right in our forecasts, we underestimated the speed and the magnitude of the recovery. We had forecasted EOY HF AuM to end between $1.21.5trn and 2009 net ows to total negative $210bn. As we speak, HF AuM are estimated to be in excess of $1.5trn, while net ows YTD are approximately negative $145bn2, both of which are
1 2
Refers to English speaking economies in which levels of regulation and taxes are low, including the UK, US, Canada, New Zealand, Australia and Ireland HFR report, Q3 2009
somewhat upwards of our previous estimates. Looking back, it appears as though the drivers behind redemptions broke down into two elements. The rst was due to a loss of condence in functioning capital markets. The second was due to doubts about the soundness of Hedge Funds investment processes. The latter was never put in doubt by investors but the former is clearly a necessary condition for the latter to exist. In Picking Up the Pieces published in May 2009 we observed a cautious, but positive investor sentiment regarding Hedge Fund investing. We were right in predicting the slow but steady entry of new investors (mostly Pensions), downplaying the adoption rate of managed accounts, as well as anticipating the resilience of the HF 2/20 fee model. However, the strong correlation between Multi-Strategy Hedge Funds and Hedge Funds that have undergone gating and restructuring has had a signicant impact on the Hedge Fund strategies that are most likely to have attracted inows in 2009. To shed further light on this subject, we have added Pick Your Model to this collection, where investor demands for Multi-Strategy funds are discussed in detail with the new emerging models that are attracting investor interest. Moving forward, we intend to look at Multi-Strategy funds almost
as a competing proposition to Fund of Hedge Funds (FoHF), as our investors are starting to. In Raising the Game published in December 2009 we captured in a timely manner the changes Hedge Fund Managers are implementing to their Investor Relations and Marketing functions. While it is too early to say if the trends noted in this study will be solidied, we certainly have an opportunity to test whether or not the changes being implemented have any chance of resonating among investors. We plan to tackle these issues directly in the immediate future as part of our constant dialogue with the investor community. This way, we aim to initiate a continuous feedback loop of insights that we hope will ultimately benet all participants. Also, it will be interesting to see whether branding and key performance indicators two management concepts borrowed from more mature industries will be embraced by Hedge Fund Managers. We hope our reections have provided an insightful perspective. Its been a pleasure working with you this year. In 2010, we will be expanding our team as we strive to generate even more impactful thought pieces. We look forward to working with you in the upcoming year.
For Institutional Investors Only
II
PICK YOUR MODEL

December 2009
CONTENTS
PICK YOUR MODEL
I. EXECUTIVE SUMMARY
01 01 04 07
II. EQUITY LONG/SHORT
III. MULTI-STRATEGY
IV. CONCLUSIONS
PICK YOUR MODEL
As a result of the dislocations in the Hedge Fund (HF) industry that occurred in 2008, we see Investors demanding more specialization from the Hedge Fund (HF) Managers they seek to invest in. Two motivations can be found behind this. First, the rush to invest has signicantly decreased (to say it euphemistically), which prompts Investors to take a closer look at the value proposition offered by HF Managers. Second, Investor experience in HFs has signicantly matured (by denition) over the course of the past years, resulting in more educated buyers and more clearly dened preferences. In this paper, we explore the concept of business model segmentation for Equity Long/Short (L/S) and Multi-Strategy (MS) Managers. Two of the most popular HF strategies, Equity L/S and Multi-Strategy Managers, jointly account for approximately 50% of HF assets globally. As most of you are accustomed to, HF Managers have traditionally been segmented across size, strategy and style dimensions. While useful in principle, such approaches rarely get to the core characteristics of the investment process adopted. Consequently, they may be less effective in grouping HF Managers that deliver similar value propositions or behave in similar ways, from a business and investment perspective. The insights reported for both strategies are the result of an extensive, continuous dialogue with Investors and HF Managers FIGURE 1: EQUITY LONG/SHORT MARKET SIZE AND GROWTH
throughout the past year. Yet, they were developed under different circumstances. The Equity L/S business models were developed with an interest towards testing whether certain models were more readily scalable than others. The Multi-Strategy business models are a reection of Investor demands for greater clarity on the value proposition offered by such rms, which have been challenged by 2008 events.
II. EQUITY LONG/SHORT

Equity L/S strategies remain the most represented HF strategy in the industry, accounting for an estimated 30% of global HF AuM. However, they have undergone two very distinct transformational phases, as depicted in Figure 1. Up until the year 2000, Equity L/S strategies had larger inows compared to other strategies, annualizing a stunning compound yearly growth rate of 22%. From 2001 until 2008, Equity L/S strategies consolidated their share of the total industrys assets as Equity L/S managers grew in size and expanded into other strategies (rebranding themselves as managers of Multi-Strategy rms along the way). It was towards the end of this phase that increased correlation with equity indices and higher leverage started to creep up on the majority of players in this space. 2008 was a year of reckoning and returns dispersion, which has provided great opportunity for Investors to witness the investment processes of many HF Managers under a stress
Equity Long/Short AuM 1 $bn Equity L/S AuM Phase I Growth 700 600 500 400 300 200 100 0 96 97 98 99 00 01 02 03 04 05 06 07 08 09 YTD $bn Equity L/S AuM % of Total HF AuM 10% 0% 30% 20% CAGR = 22% Phase II Consolidation CAGR = 6% 50% 40% % of Total HF AuM
1. Includes Fundamental Growth, Fundamental Value, Quantitative Directional, Technology / Healthcare and Merger Arbitrage strategies specied in HFR Report, Q3 2009
Asset Management Solutions Group Hedge Fund Intelligence | December 2009
PICK YOUR MODEL
scenario. This year has been characterized by renewed Investor appetite for Equity L/S strategies, partially driven by the appealing liquidity characteristics of the investment instruments and their relative simplicity. Equity L/S strategies have the potential to be scaled up fairly signicantly and rapidly, as Figure 2 indicates. In Figure 2, we observe that Equity L/S is the most represented strategy (after Multi-Strategy) among the top 100 HF Managers in terms of total assets. We segmented Equity L/S rms along two dimensions, the degree of Centralization of the investment decision process and the degree of Subjectivity. Centralization speaks to whether the core investment decisions are made by a limited set of individuals (in most extreme cases one) versus a group of professionals in a structured approach. Subjectivity speaks to the degree of formalization of the investment processes, i.e., highly discretionary versus systematic / coded in risk management and investment rules. The four resulting models are depicted in Figure 2. Their characteristics are discussed next and summarized in Figure 3 along key business dimensions.
The Emperor This model is characterized by a high degree of Subjectivity and Centralization. Usually, HF Managers pursuing this model are associated, branded and known by their founder / Portfolio Manager (PM). It is therefore fairly easy for a prospective Investor to get a glimpse of the investment process by means of a dialogue with the PM. Expectedly, the model bears signicant key man risk and there is limited scalability to the breadth of security coverage that can be achieved, given that all investment decisions must be vetted by one individual, which, for as mighty as she / he may be, still has a limited bandwidth. The ability to exibly and rapidly implement changes in the portfolio is another signicant advantage of this model, which we expect to be of a great asset during periods of regime switching (assuming the PM is able to foresee them). However, talent retention might be an issue, given the limited upside for growth and personal recognition that top performing analysts may be allowed to. On the other hand, there is great potential in the spin-off entities that originate out of those models. The Allocator This model is characterized by a high degree of Subjectivity and low Centralization (or high decentralization). The typical
FIGURE 2: EQUITY LONG/SHORT RELEVANCE AND KEY BUSINESS MODELS
Relevance of Equity Long / Short Business1
Four Main Business Models
26
233
Others High
Alchemist Alchemist Model-based Data intensive
Emperor Emperor One-man show Pyramidal
36
484
Multi-Strategy
Centralization Mercenary Mercenary Low Make-or-break Siloed Allocator Allocator Sector specific Complementary
38
317
Pure Equity L/S
Low # Funds AuM ($bn) Subjectivity
High
1. Alpha magazine Top 100 HFs 2009 Ranking, Barclays Capital AMSG estimates
PICK YOUR MODEL
rm pursuing this model organizes investment professionals in separate teams with clear mandates and coverage responsibilities, most notably by sector or geography. Usually, a CIO (namely the Allocator) sits on top of all teams and decides how to allocate capital to (and away from) the head PMs depending on sector rotation views or talent calls (e.g., scaling down assets with a PM who has had a difcult streak). A key success factor for such a model is to establish an incentive scheme that optimally determines which proportion of a PMs compensation model is due to her / his P&L versus the rms P&L. We have found the PMs own P&L to drive about 6080% of the PMs ultimate compensation. The lower numbers in the range tend to be associated with rms where investment processes rely on sector bets rather than individual security selection, which therefore will be more successful if PMs are incentivized to pursue a higher aggregate P&L. The Mercenary This model is characterized by a low degree of Subjectivity and low Centralization (or high decentralization). The typical rm pursuing this model operates with a high number of separate
PMs / investment teams, which are asked to deliver results / performance independently of each other. Quantitative metrics, such as correlation among investment returns, are rarely used when deciding whether or not to on-board a PM onto the platform. Team turnover is intentionally kept high by means of forced attrition. One key success factor of this model is the talentscout acumen of the dedicated professionals at such rms who are tasked to be on a constant search for talent, as well as the risk management capabilities of those that are managing capital allocation among PMs in the platform. Signicant scale is not only possible but required by such models, as very few strategies would immediately trigger Investor questions on the rationale for their presence in the portfolio. Also as we will document later the decentralized nature of the investment process and the relative freedom provided to investment professionals requires signicant infrastructure to monitor risk and adherence to the stated investment strategy. Such infrastructure, being a xed cost, is best spread over a signicant amount of assets and a large number of PMs.
FIGURE 3: KEY CHARACTERISTICS OF EQUITY LONG / SHORT BUSINESS MODELS
Allocator Role of key decision maker Business Model Degree of centralization Degree of subjectivity Capacity constraints Formal career path Resource / Capital Allocation Investment staff turnover % of investment staff Team division Degree of collaboration Portfolio Construction & Balancing Leverage Risk control dimensions Stocks per analysts None No 010% 62% Sector2
3
Mercenary Talent Manager
Emperor Investment Manager
Alchemist 10% 0 Research Manager
Asset Allocator
No 2030% 37% None
Yes1 2030% 49% Sector, Geo & Style
Yes 010% 87% None
12x Pos. Size / Sec. Exp. ~10 Low
24x VaR / Drawdowns N/A4 Medium High
24x Pos. Size / Sec. Exp. ~5
48x VaR ~50
1. In principle given that analysts can naturally aspire to undertake portfolio management roles but strongly affected by retention culture of the rm 2. Allocators can also have (in few cases) geographic based teams 3. Allocator teams collaborate on macro research 4. Mercenary teams vary in the # of stocks per analyst by strategy Note: Figures are based on an AMSG benchmarking study conducted in Q3 08, for which AMSG conducted one-on-one interviews with eight Equity US HFs on their strategies and business models. AuM of participants ranged from $5bn to $20bn. Given the relative small sample size, results are indicative only and not meant to reect conclusive industry trends.
PICK YOUR MODEL
The Alchemist This model is characterized by a low degree of Subjectivity and high Centralization. These HF Mangers are alternatively labeled as Quants. The typical rm pursuing this model operates with costly research infrastructure and signicantly sized research teams (when measured as a share of total headcount). The key success factor in such models is the optimal balance between the rigor of coded quantitative investment models and the intellectual exibility to adapt, perfect and innovate them, which is the core of any successful research function. Not surprisingly, such teams (not necessarily the rm) are best led by individuals who have a successful track record in researching and managing research teams. The key disadvantage in such models lies in the inherent regime switching risk that such strategies are not as well positioned to capture, compared to a more discretionary investment process (provided the PM is on the right side of it). All business models exhibit economies of scale i.e., unitary costs decreasing with volume but some more than others. This FIGURE 4: EQUITY LONG / SHORT ECONOMIES OF SCALE
relationship is depicted in Figure 4, where AuM was chosen as a proxy for Volume on the X-axis and the Headcount / AuM ratio as a proxy for unitary cost on the Y-axis. As the gure depicts, economies of scale are visible, with a notable exception for Mercenaries1. In such rms, the infrastructure needed to monitor the trading teams adherence to guidelines and the operations required to sustain the mid- and back-ofce functions represent a proportionally higher cost that in other models.
III. MULTI-STRATEGY
Multi-Strategy is the third most represented HF strategy in the industry (after Equity L/S and Event Driven), accounting for an estimated 20% of the entire HF assets2. They are the dominant strategy for the top 100 HF rms by total assets, as depicted in Figure 2. To better understand the changes in Investor sentiments towards this space post 08, we conducted a survey with 25 Investors around their appetite for the strategy and view towards funds that have undertaken restructuring actions3.
Volume (AuM) vs. Total Cost Per Volume Unit (Headcount / AuM) Headcount / AuM ($bn) 60 50 40 30 20 10 0 $0 $2 $4 $6 $8 AuM ($bn) Allocator Mercenary Emperor Alchemist $10 $12 $14 $16 $18 Mercenary funds outside economies of scale of other business models
3.205 Width 2.75 Height
Note: Figures are based on an AMSG benchmarking study conducted in Q3 08, for which AMSG conducted one-on-one interviews with eight Equity US HFs on their rm strategies and business models. AuM of participants ranged from $5bn to $20bn. Given the relative small sample size, results are indicative only and not meant to reect conclusive industry trends
1
Based on an AMSG benchmarking study conducted in Q3 08, for which AMSG conducted one-on-one interviews with eight Equity L/S HFs on their rm strategies and business models. AuM of participants ranged from $5bn to $20bn. Given the relative small sample size, results are indicative only and not meant to reect conclusive industry trends. 2 Obtained by summing asset levels of all Multi-Strategy categories within Equity Hedge, Event Driven, Macro, and Relative Value strategies as specied by HFR report as of Q3 09 3 AMSG surveyed 25 HF Investors on their sentiments towards Multi-Strategy HFs in July 09. Participants include Pensions, Family Ofces, Endowments & Foundations, and FoHFs. Given the relative small sample size, results are indicative only and not meant to reect conclusive industry trends.
PICK YOUR MODEL
Our study shows that Pensions and Family Ofces are likely to be the most enthusiastic Investors of Multi-Strategy funds going forward, as depicted in Figure 5. On the other hand, we expect FoHFs and Endowments & Foundations to retrench. The former offer a somewhat competitive proposition to Multi-Strategy HFs, while the latter look for more specialization in the strategies they invest into. Many Multi-Strategy funds have undergone signicant restructuring activities as a result of last years liquidity events. Surprisingly to us and positively for Multi-Strategy funds Investors do not necessarily view this as an impediment to invest. As depicted in Figure 6, our study shows that while 76% of Investors surveyed view funds that gated / restructured unfavorably, 75% of these respondents are still open to investing in them. Together with the portion of Investors who consider gating / restructuring as favorable actions (24%), roughly 80% of surveyed respondents regard these HF Managers as addressable from an investment perspective. Expectedly, sentiments towards restructuring / gating activities differed by the type of actions FIGURE 5: INVESTOR SENTIMENTS FOR MULTI-STRATEGY HFS
taken, as depicted in the right-hand side of Figure 6. Fee discounts in exchange for longer liquidity were viewed most favorably, while restrictions motivated by the desire to protect the investments marks were viewed least favorably. Investors tend to segment Multi-Strategy funds in two broad categories, Focused and Diversied as shown in the left-hand side of Figure 7. Focused rms build upon one core skill / edge in their investment process for example, Value or Arbitrage and tend to deploy it against various asset classes, risk proles, geographies. For each of those channels, there is usually a subfund that offers such direct exposure and receives an allocation from the Multi-Strategy umbrella sitting on top. Usually, Focused rms tend to offer ve or less sub-strategies and promote extensive collaboration among investment teams in order to best determine the market segments that are richer in opportunities. In few cases, Focused rms tend to consolidate the core skill especially if it is research-oriented in a centralized team. Diversied rms on the other hand aim at developing a broad set of strategies that would allow them to play in most markets
Q: Do you expect to increase / decrease / maintain your allocation to Multi-Strategy HFs? Pensions 67% Family Offices FoHFs E&F1 67%
45%
45%
33% 33%
33%
33% 33%
10%
0% Increase Maintain Decrease Increase Maintain Decrease Increase Maintain Decrease
0% Increase Maintain Decrease
Decreasing Appetite for MS by Investor Type 1. Endowments and Foundations Note: Findings are based on a AMSG study on Multi-Strategy HFs, conducted with 25 HF Investors in July 09
PICK YOUR MODEL
FIGURE 6: INVESTOR SENTIMENTS ON RESTRUCTURED HFS
Q: How do you view restructured HFs and are you open to investing?
Q: Do you approve / disapprove of the following actions?
Favorable
24%
25%
Not Open to Investing
30%
30%
25% 5%
Neutral Disapprove
10% 40% Unfavorable 76% 75% Open to Investing 30% 70% Approve
60%
Raise gates to protect value
Restructure to manage liquidity
Lower fees for longer lockups
Note: Findings are based on a AMSG study on Multi-Strategy HFs, conducted with 25 HF Investors in July 09
FIGURE 7: MULTI-STRATEGY SEGMENTATION
MS Segmentation and Proposed Value-Add High
Q: What do you think is the ideal # of sub-strategies within an MS? # Strategies
Focused
Distinct core competency Complementary strategies Usually 5 sub-strategies 15% 15%
43% No Preference
>10 Diversified 610
Strategy Relatedness
Diversified
Dynamic Allocation Integrated Research Usually >5 sub-strategies
57% Have Preference 70% 5 Focused
Low Low # of Strategies High
PICK YOUR MODEL
and have an offering that suits most Investor allocation goals. Usually, Diversied rms tend to operate with ve or more sub-strategies, and are more likely to look at talent as the primary driver to launch new products rather than a t between the strategy that is being on-boarded and the existing portfolio. Diversied rms tend to have higher personnel turnover and are more inclined to compensate investment professionals based on their individual P&L rather than the rms. The right-hand side of Figure 7 indicates that only about half of the Investors have a pre-determined preference for the Multi-Strategy business model and if they do, the overwhelming majority (70%) expressed preference for the Focused model. The historical advantages predicated by Multi-Strategy funds are also under scrutiny, as indicated by Figure 8. Our survey respondents have indicated that three out of the six advantages that have historically been of value to them were not delivered upon over the course of the last year. Areas where expectations do not seem to have been met provide HF Managers with very actionable suggestions on how to correct for potentially false perceptions or to address Investor concerns. For example around Dynamic Allocation to Strategies HF Managers may provide transparency around the movement of capital in and out of strategies over time and analyze whether this has produced a
better outcome than a mere 1/N allocation. Around Diversication, it would be interesting to see whether HF Managers have increasingly moved their holdings to cash as correlations among strategies drifted to one and, therefore, the benets of asset class diversication were vanishing.
IV. CONCLUSIONS
In this paper, we explored a segmentation approach for Equity L/S and Multi-Strategy HF Managers based on their business models, which we believe can offer actionable perspectives for both Investors and HF Managers. HF Managers can debate around which model best ts their core skills / expertise and either build towards that vision or re-focus towards it. Investors on the other hand may start to determine whether some models have business characteristics that are more appealing to their investment objectives. It remains to be determined whether business models translate into identiable clusters of performance or performance attributes. For example, are Equity L/S rms pursuing the Emperor model more or less prone to volatile return streams? On the other hand, are they better positioned to capture upside performance during positive market periods? These questions present an interesting subject for future research.
FIGURE 8: HISTORICAL ADVANTAGES OF MULTI-STRATEGY HFS AND CURRENT VALIDITY
Q: What are the historical MS advantages and do they still apply today? Historical MS Advantages Current Validity Remarks
Dynamic allocation to strategies
No
Many unable to move out of underperforming strategies quickly
Ability to hire / retain talent
Yes
Closing of bank prop desk and small HFs
Diversified investor base
Yes
More institutional investors chose direct allocations
Diversification
No
Correlations across asset classes rose significantly
Operational stability
Yes
Generally still can obtain cheaper financing
Netting benefit on performance fees
No
Less valuable as many HFs are under their HWM
RAISING THE GAME

December 2009
CONTENTS
RAISING THE GAME
I. METHODOLOGY
01 02 02 03 07 09 10
II. EXECUTIVE SUMMARY
III. ASSET-RAISING LANDSCAPE
IV. ORGANIZATIONAL MODELS
V. CHANNEL UTILIZATION
VI. ASSET-RAISING PROCESS
VII. CONCLUSIONS
RAISING THE GAME
I. METHODOLOGY
As part of our continued commitment to thought leadership, the Asset Management Solutions Group (AMSG) set out to investigate the magnitude and nature of the changes that Hedge Fund (HF) managers1 are implementing to their rms asset-raising capabilities. To that end, AMSG conducted one-on-one interviews with 41 HFs centered around four core themes: Asset-raising landscape Organizational models Channel utilization Asset-raising process Our interviews were conducted with the head of Marketing / Investor Relations (IR) or the key executives at the HF who oversee these functions. HF participants were grouped into four distinct segments2 (<$1bn, $15bn, $510bn, $10bn+) based on the Assets under Management (AuM) level across all of the funds they manage. FIGURE 1: PARTICIPANT DISTRIBUTION
These segments effectively reect a common set of strategic priorities for participants in the AuM brackets. Also, we have found the boundaries between each AuM segment to represent key watersheds during a HFs growth trajectory, across which multiple, quantum-like changes in management approaches and product portfolios are implemented3. Figure 1 depicts the breakdown of the participant distribution, by number of HFs in each segment and AuM. Key points to note: The demographic is skewed towards large rms 41% of HF participants have $10bn+ in AuM, accounting for 82% of the total AuM across all participants 56% of HF participants have $5bn+ in AuM, accounting for 92% of the total AuM across all participants A fair representation of all size segments, however, has been secured At least six rms in each size segment have been interviewed
By Number No. HF Managers 17 AuM ($ bn)
By AUM 317
12 29 6 6
38
2 <$1bn % Total 15% $15bn 29% $510bn 15% $10bn+ 41% <$1bn % Total 1% $15bn 7% $510bn 10% $10bn+ 82%
All gures refer to AMSG survey results only
1 2
Hereinafter, and for the sake of simplicity, HF management rms will loosely be referred to as Hedge Funds (HFs) All size segments are in USD throughout the study 3 The results presented are from a relatively small number of respondents and, therefore, are indicative only and not meant to reect conclusive industry trends. Data and other information presented are derived directly from respondents and we do not pass on the accuracy of such information.
RAISING THE GAME
II. EXECUTIVE SUMMARY

The following key ndings have emerged around the four core topics addressed.1 Asset-raising landscape Despite positive returns, a large gap to peak AuM still exists with HF AuMs 32% below peak AuM on average Mid-sized, yet institutional HFs grew the most, with HFs in the $510bn range achieving positive YTD net ows2 Organizational models Hiring of IR / Marketing staff is taking place across the board, with the largest increase (+38%) among HFs with <$1bn The Rolodex asset is a diminishing consideration for hiring, since it is required by only 33% of the respondents Channel utilization HFs view capital introduction desks at Prime Brokers most valuable in providing market / investor intelligence and events; introductions account for only 6% of leads at $10bn+ HFs FIGURE 2: INFLOWS AND OUTFLOWS
Skepticism toward third-party marketing exists, with 40% of HFs having explored the channel, mostly to tap into investors in exotic regions (62%3) Asset-raising process Longer and more invasive due diligence (DD) is now performed by all investors; HFs estimate that new DD standards have doubled sales cycle length Bifurcation of investors is emerging 50% of ticket sizes are <$10mn (mostly traditional investors4) and 14% are >$40mn, indicating entrance of new investors5
III. ASSET-RAISING LANDSCAPE

After the run-on-liquidity that characterized the HF allocation landscape in Q4 2008, several of our HF participants started the year with a worrisome picture as far as successfully retaining investors, let alone attracting new investors. Figure 2 depicts the inows and outows by size segments as a percentage of the HFs NAV as of January 2009.
Average YTD Inflows1 Size ($bn)
Average YTD Outflows1
Average YTD Net Flows 1
10+
8%
(13%)
(13%
(5%)
510
18%
(13%)
(13%
5%
15
18%
(30%)
(12%)
<1
8%
(22%)
(14%)
Best Performers
1. As of August 2009, expressed as percentage of NAV as of January 2009 Note: All gures refer to AMSG survey results only
1 2
All gures refer to the end of Q3 2009 when measured at a specic date, or the period January through September 2009 when measured over a given period All inows, outows and net ows are reported as a percentage of NAV as of January 2009 3 Among HFs who have used them at least once in the past 4 Fund of hedge funds and family ofces 5 Most notably, pension funds, insurance companies, endowments and foundations, corporations
RAISING THE GAME
Key points to note: HFs with <$1bn were the worst hit, experiencing -14% net ows and the least amount of inows across all size segments HFs with $15bn experienced the largest gross ow uctuation, having had large redemptions (-30%) and large inows (18%) HFs with $510bn were the only net asset gatherers during the period, having experienced a 5% positive net ow HFs with $10bn+ have been fairly stable, with low inows roughly equaling outows; therefore, closing the period with fairly stable asset levels on a net basis If the conclusions derived above represent the entire industry, one may conclude that HFs in the $510bn range represent the new optimum to attract investor inows, i.e., large enough to be considered an institutional business but lean enough to be pursuing investment opportunities without excessive return deterioration. Figure 3 depicts the investor composition by type and region across the several size segments. Interestingly, Proprietary capital i.e., the fund capital that is invested by the HF founder and employees plays a signicant role when AuM crosses the $5bn mark
Not only conrming the effectiveness of HFs as wealth generation vehicles, but also indicating the increased / broader participation of employees into the funds Institutional investors start playing a signicant role when HFs cross the $1bn mark (from 8% to 34%) Indicating that the critical minimum size to capture the attention of institutional investors is around $1bn True geographical diversication across regions meaningfully occurs when HFs cross the $10bn mark Reecting the additional investment into resources and establishment of geographical outposts that rms of that size are able to make
IV. ORGANIZATIONAL MODELS

AMSG has recorded a signicant uptick in hiring activity for IR / Marketing professionals, an indication of the HFs desire to invest signicant resources to win the asset-raising competition. Disparate organizational models, however, are being adopted to organize the work. Figure 4 depicts the size distribution of IR / Marketing teams by HF size segments. Each one of the four boxes contains data pertaining to a given size segment. Specically, two box plots are displayed in each box. The one on the left depicts the current distribution
FIGURE 3: INVESTOR COMPOSITION
Composition by Type
Composition by Region
1% 29% 22%
10x
11% 15% 15%
9% 9%
Proprietary 43% 43%
6% 6% 4% 4% 33% 33% 37% 37%

(1/3x)
6% 9% 9%
Middle East Asia
25% Private 25% Clients1 24% FoHF 24%
39% 39%
43% 63% 62%
40%
Europe
4.5x 8% <$1bn
34%
34%
43% Institutional 2 42%
57% 57%
52% 52%
67% 67% 46% 46% North America
$15bn
$510bn
$10bn+
<$1bn
$15bn
$510bn
$10bn+
1. High net worth individuals, family ofces and private banks 2. Pension funds, insurance companies, endowments and foundations, corporations Note: All gures refer to AMSG survey results
RAISING THE GAME
and reects the team sizes as of September 2009. The box plot on the right depicts the target distribution, i.e., the size distribution as it will appear in six months after all the target hires will have come on board. In each box plot, the upper and lower dots indicate the maximum and minimum staff size recorded. The white horizontal bar indicates the average across the population surveyed within each size segment. The box surrounding the average value crosses the rst and third quartile in the distribution. In each size segment, we note signicant hiring plans. HFs with AuM <$1bn are set to hire the most, with a planned 38% increase in staff size. This marks a signicant change in practice, since HFs in this size segment historically refrained from hiring a dedicated IR / Marketing team. Additionally, the distribution of staff sizes widens with increasing AuM (or average staff size), a well-known statistical phenomenon called heteroskedasticity. Among other things, this reveals that for every size segment there are HFs whose IR / Marketing functions are fairly thin-resourced, and so they will remain. Another interesting point relates to the average increase in staff size when moving towards higher AuM size segments. For HFs >$1bn in AuM, the average staff size almost doubles for every transition to higher size segments. HFs looking to grow their FIGURE 4: MARKETING / IR TEAM SIZE
organizations can use these gures to estimate the necessary investments in IR / Marketing personnel. Figure 5 depicts the four key functions that exist in a typical IR / Marketing team and the way HFs bundle these functions into different organizational models. In the Integrated model, either one or a few individuals tend to cover most functions simultaneously. Expectedly, this model is most popular for HFs <$1bn as small teams demand role exibility. Indeed, such a model is adopted by 75% of HFs <$1bn. Beyond its importance in early growth stages, this model also tends to persist at higher AuM levels. It is adopted by approximately onethird of HFs in both the $15bn and $510bn segments. Given the versatility that is required of members of an Integrated team, the model offers great advantages when circumstances demand a rapid shift in focus. Adopters of this model were pleased by the exibility with which they redirected the teams attention to investor retention from investor acquisition during the turbulent 2008. In the Skill-based model, the investor-facing responsibilities i.e., both investor acquisition and investor relations are condensed into one separate team of individuals. Routine investor communication, reporting and due diligence monitoring are assigned to a dedicated client service team. Adopters of this model seek to maintain the continuity of traditional investor services
Current and Target Size of IR / Marketing Teams <$1bn $15bn $510bn $10bn+ 52 46 3x2 2x2 2x 2
19 15 10 3 1 0
1 +38%
18 +8%1 9 4
15
+14%1
17
5 2 1
5 1
+34%1
7 2
8 4
2 Average
Current Min / Max, 25 / 75 Percentile
Expected Min / Max, 25 / 75 Percentile
1. Percent increases were measured between the two averages 2. Current average staff from one size segment versus the segment preceding it Note: All gures refer to AMSG survey results only
RAISING THE GAME
e.g., reporting and communication while freeing up time for dedicated individuals to be constantly on the road with investors. By splitting such responsibilities into two separate teams, individuals with investor-facing responsibilities can spend most of their time on the road assured that the investor communication engine back in the ofce maintains its full functionality. This model is also more condusive to maintaining continuity in investor relationships since one person handles the relationship regardless of whether the investor is a prospect or an existing investor in the rm. This model also allows one to exibly and rapidly shift focus from investor acquisition to investor retention during times of crisis. Despite its many advantages, this model is not widely used. Of the HFs interviewed, none of the HFs <$1bn use this model, and only one in every seven HFs in all other size segments adopts it. In the Function-based model, a group of individuals cover prospects, while another distinct team covers existing investors. While this construct ensures that a certain prospecting effort is active at all times (since prospecting is the single objective of a dedicated team), it takes great effort to provide continuity in investor relations. In this model, investors are theoretically handed over to the IR team once an allocation is made. Practically, however, both Marketing and IR coverage individuals will co-cover the account, putting the burden on the HF team to ensure continuity FIGURE 5: ORGANIZATIONAL MODELS
of service. This may duplicate efforts and costs. Despite its shortcomings, this model remains widely used (by one in four HFs with <$1bn and one in three HFs with >$1bn in AuM). We believe the pre-existence of a signicant IR team and the subsequent establishment of a Marketing team in parallel (in order to add capabilities while minimizing organizational disruptions) are the main reasons for the high adoption rates of this model. In the Specialized model, all four functions are covered by distinct, dedicated teams. The Product Specialists usually spend a signicant portion of their time with the investment teams, since they are asked to speak about the investment strategies and portfolios with investors as uently as the investment professionals themselves. As such, Product Specialists are often part of the investment professionals team payroll. This model is inspired by the sales organization structures of large, established long-only asset management rms. As such, it is only affordable by the larger HFs. In fact, 35% of the HFs with $10bn+ in AuM adopt this model. The model is still a work-in-progress for most, since the signicant ramp-up in staff size ought to be nanced, to some extent, by inows. One particularly innovative aspect of the Specialized model lies in the caliber of talent of the client service function / teams. We observed a signicant upgrade in skill set, pay levels and responsibilities for the individuals in this model versus their
Four Key Functions
Bundled in Four Different Models Integrated Skill-Based Function-Based Specialized
Product Specialist
Technical expertise available to investors
Sales Professional
Investor prospecting and acquisition
Investor Rel Liaison
Coverage of existing investors
Client Service Rep
Documentation / reporting preparation
Note: All gures refer to AMSG survey results only
RAISING THE GAME
colleagues performing the same functions in organizations adopting other models. While in the Skill-based model, for example, Client Service Representatives are mostly occupied with investor reverse inquiries and broad investor reporting, their colleagues within Specialized models tend to play the role of a dedicated investment advisor for investors. It is not uncommon for such individuals to be closely aligned with investor pools, so as to become trusted advisors on investment allocation matters. In essence they become the conduit for the HFs intellectual capital to be deployed to the advantage of investors. This role and its advantages are best understood when comparing it to the advisory practices at investment banks. M&A investment bankers may service large corporations and their boards for free on strategic matters for months and even years in order to know their corporations inside out and ultimately becoming the most likely candidate for an M&A mandate. Similarly, Client Service Representatives may invest signicant time and resources with investors to become the most likely chosen manager for an upcoming mandate. Figure 6 depicts the time allocation aggregated across all individuals in IR / Marketing functions for each of the following four activity clusters: Client Prospecting, Third-Party Coordination (mostly with cap intro desks and third-party marketing rms), Investor Relations and Internal Work (mostly refers to the
preparation of marketing materials, investor letters and other internal projects related to IR / Marketing). Of note, regardless of the model adopted, Client Prospecting and Investor Relations (the pre- and post-allocation) occupy approximately equal shares of the aggregate time invested. ThirdParty Coordination shrinks in importance to the advantage of Internal Work when crossing the $10bn mark in AuM, a tangible consequence of HFs investing in in-house resources to deliver capabilities once outsourced to cap introduction desks. Figure 7 lists the skill sets required of the new hires in IR / Marketing in decreasing order of importance. Product Knowledge has become highly valued as HFs now want their marketing staff to competently speak Some hires are seasoned about portfolios. Talent with M&A bankers. demonstrated capital markets credentials and an investment banking background is highly preferred for such roles, more so than a traditional sales-oriented background (e.g., institutional coverage). Sales Instinct speaks to the desire of HFs to enhance their IR / Marketing teams with deal-closing capabilities, a skill set that has not historically been a core capability (nor should it be) of an IR team.
FIGURE 6: IR / MARKETING TEAMS RESOURCE ALLOCATION
Time Split by Activity Cluster
34%
37%
34%
34% 5%
Client Prospecting Third-Party Coordination 1
17%
10%
20% 40% Investor Relations
37%
34% 33% 19% $15bn 21% $10bn+ Internal Work 2
12% <$1bn
13% $510bn
1. Refers to cap intro desks and third-party marketers 2. Developing / updating marketing presentation and investor letters, plus ad-hoc assignments for investors Note: All gures refer to AMSG survey results only
RAISING THE GAME
Process Orientation is a credential desired to best cope with the radical changes in the asset-raising landscape of the last few years, which transformed itself from a We look for a military referral-driven process among a approach to marketing. few allocators and managers to a large scale competitive arena where many large (and known) institutional investors participate, dictating long complex sales cycles, low conversion ratios and invasive due diligence. Multiple leads must be opened and followed through rigorously in order to secure assets, thereby requiring the coverage person to have a strong process mentality and execution-oriented mindset. I dont know what a rolodex Expectedly, ex-military ofcers adds... wed rather hire and management consultants someone who can gure are now more sought after given it out. their structured and disciplined approach. Team Player and Relationships can be described in the same context. We have heard HFs say that while an existing book of relationships (the so-called Rolodex) is certainly useful, it is not a must for a candidate. There now exists a fairly pervasive skepticism on the portability of a given set of relationships. Additionally, incentive schemes that would reward IR / Marketing professionals based on a tight, formulaic link to assets raised (akin to a commission-
based model that many ex-investment banking sales teams used) are also less commonly adopted. All HFs interviewed are very keen to replace their investor base with more stable allocators after the massive redemptions in 2008. The result: HFs disincentivize the IR / Marketing teams from seeking allocations from hot-money investors, as these allocations are inevitably as quick on the way out as they are on the way in. The Team Player skill set almost becomes a corollary due to the former arguments, since the rejection of a commission-based scheme immediately places the emphasis on teamwork, especially collaboration with investment professionals.
V. CHANNEL UTILIZATION
Figure 8 depicts the split of investor leads by channel, dened as Internal (if the lead has been generated by the internal marketing efforts), Capital Introduction and Third-Party Marketing. Expectedly, the role of Capital Introduction diminishes as AuM Market intelligence is where increase. While accounting for Cap Intro does its best. 33% of all investor leads of HFs with <$1bn, Capital Introduction only accounts for 6% of the investor leads for HFs with $10bn+. Post-2008, in an environment where most Prime Services divisions are competing to win a share of the largest, most established providers, cap intro desks
FIGURE 7: SKILL SETS REQUIRED FOR MARKETING / IR JOBS
Q: What skill sets do you require in an IR / Marketing person? % of Respondents
76%
67% 67%
62% 62% 43% 43% 33% 33%
Product Knowledge
Sales Instinct
Process Orientation
Team Player
Relationships
Note: Percent gures in each chart indicates the % of respondents who mentioned the specic skill as being critical to the role Note: All gures refer to AMSG survey results only
RAISING THE GAME
are taking a hard look at their historical business models. While the introduction service is fading in importance, this is not to say that the role of cap intro desks is less valued. On the contrary, they are becoming increasingly sought after to provide investor and market intelligence, as well as to become architects of high prole investor / manager events, an offering HFs consider a great return on time invested. The advisory component of a cap intro offering is likely to be perceived as a key differentiator. Figure 9 illustrates the usage of third-party marketing rms. 40% of all HFs have used a third-party marketing rm at least once in their history, mostly (in 62% of the cases) to gain access to investors in exotic geographies, such as Latin America, Asia and South Africa. In spite of what we deem signicant usage, HFs indicate that they will use less of these services moving forward. Lack of control over the outcome, along with the diminishing value of introductions, have been mentioned as critical factors behind such intent. HFs with Private Equity (PE) products continue to see the value in retaining third-party marketing rms for the PE area of their rms. When investigating fees demanded (and paid) for these services, a broad variation of price points emerged, as well as a wide bid-ask spread. Most third-party marketers demand fairly standard terms, either in the order of 2% of assets raised or 20% of management
and performance fees charged on the assets raised for a given period (usually three to ve years with a sunset provision). Yet the spectrum of fees ultimately charged ranges from less than 50 bps (11% of cases) to fees in excess of 250 bps (32% of cases). All HFs have accelerated or reinforced their coverage plans with investment consultants. Figure 10 shows the investment consulting rms that HFs mostly focus on at present. Two interesting observations emerge. First, most rms tend to consistently work with the six global players highlighted in Figure 10. Of these, the counts around the three HF Specialists clearly provide recognition for the signicant market share strides made by these rms in recent years. The other three Traditional Players in the top six have been identied as those wellestablished rms that have made the most signicant progress in establishing a dedicated HF expertise. Second, if an HF was willing to extend the breadth of coverage beyond the top six, a signicant investment in time and resource would be needed. This is a result of the fact that the investment consultants beyond the top six have been given equal priority and tend to have regional coverage niches requiring frequent travel. The same proportion of HFs (44%) work with the big six players versus twelve or more investment consulting rms. A small minority of HFs (12%) have put tremendous emphasis on
FIGURE 8: CHANNEL UTILIZATION
What percent of your leads come from interal sources, vs. cap intro desks and third-party marketers? % Investor Leads 6% 31% 33% 12% 6%
88% 61% 69%
94%
<$1bn Internal Leads

$15bn Capital Introduction
$510bn Third-Party Marketing
$10bn+
RAISING THE GAME
investment consultants. As a result, they have decided to replicate within their IR / Marketing teams the organizational structure of investment consulting rms. Often the process gets stuck In other words, they have both dedicated dedicated coverage removes established research as well coverage teams. the hurdle. The responsibility of the former consists of working with the research teams at investment consulting rms to troubleshoot and ultimately expedite the due diligence process for admission on the approved list. The responsibility of the coverage teams, on the other hand, involves developing relationships with the eld consultants at investment consulting rms, in order to gain access to institutional clients.
to double in duration. This is mostly driven by the adjustments / upgrades to the DD processes in the post-Madoff era. While operational DD was performed by few institutional investors previously, it seems to have become an integral part of every investors process now. The evolution toward such new standards is certainly a welcome development, although it comes at a cost for HFs. In the Targeting area, HFs signicantly increased the number of one-on-one meetings with investors, dramatically raising their travel budgets to establish new relationships. Figure 11 depicts the usage statistics of various investor communication vehicles. Clear consensus has emerged around the appropriate frequency of NAV estimates and risk reports. The former are now being issued at a weekly frequency (90% of the cases), the latter at a monthly frequency (79% of the cases). As far as the depth of information provided, commentaries / letters, websites and risk reports are areas that have undergone the most signicant changes in the last 12 months. Investor communication has evolved to provide greater transparency. We have analyzed the risk reports provided by one-third of the HFs included in this survey. Figure 12 provides an indication of how often certain information elements are provided. Finally, we asked HFs to comment on their brand. We dened this
VI. ASSET-RAISING PROCESS

We asked HFs to elaborate on the differences in the assetraising process now versus a year ago. Specically, HFs were asked to provide feedback on three areas: Sourcing (i.e., investor identication), Targeting (i.e., investor outreach), and Closing (i.e., operational DD). From most to least changed, HFs unanimously ranked Closing, Targeting and Sourcing. Everyone is now doing Operational DD. In the Closing / operational DD phase, HFs expect the sales cycle FIGURE 9: THIRD-PARTY MARKETING USAGE AND FEES
Usage % Respondents % Respondents
Fees1 (Consolidated, in bps)
25% 60% 60% Have Not Have not Used Used 38% 38% Outsourcing 16% 11% 40% 40% Used Used 62% 62% Regional Regional 11% 5% 16% 16%
<50
50100
100150
150200
200250 250300
300+ bps
1. Consolidated fees are calculated based on the NPV of fees collected in current and future years assuming 15% discount rate, 15% yearly performance, and 2/20 HF fees Note: All gures refer to AMSG survey results only
RAISING THE GAME
as what they thought their rms stood for. In an environment where supply exceeds demand, we believe that a strong, simple and consistent brand may help in the differentiation battle. Figure 13 highlights the results, revealing that only a minority of HFs (about 25%) have a distinct awareness of their brand, which is largely related to functional attributes (either the value generated to investors or the product attributes). A few of those focused on brand cite Persona as the main thrust behind the brand (10% of cases). Despite its appeal (it remains a privilege to most investors to invest alongside legendary portfolio managers), HFs are well aware of the risk of raising key-man concerns and thereby moving toward establishing a rm brand based on functional attributes.
necessarily imply evidence of a lack, it is surprising that many HFs did not seem to have a detailed monitoring system in place, e.g., around number of meetings held per week, number of consecutive meetings, statistics around sale cycle duration and conversion ratios. We fully empathize with the several arguments against the case for building one, such as the need to attentively deploy tight resources, and the outlier nature of the asset-raising environment of the past two years. That said, we do believe there is value in quantifying the past and using such metrics as a tool to improve. (2) Emphasizing team approach No single organizational model of any IR / Marketing function is superior to any other. That said, the Function-based model has appeared to offer more shortcomings than advantages. While appreciating the fact that adding a parallel Marketing team to the pre-existing IR team might have seemed like the least disruptive move from an organizational continuity perspective, we would invite HFs to re-think or at least address the shortcomings discussed earlier. (3) Elevating Client Services to Client Advisory As discussed earlier, some HFs have radically changed their Client Services function and transformed it into a team of Client
VII. CONCLUSIONS
This survey reveals a great dynamic shift in the way HFs are modifying their IR / Marketing functions. Historically, IR /Marketing was a cost function built to minimally serve investor demands, but it is now a key investment area to secure growth and stability. In the spirit of providing a few actionable ideas, we invite HFs to consider the following. (1) Instituting a metric system around IR / Marketing Most HFs did not have the key metrics of their IR / Marketing performance ready at hand. While lack of evidence does not
FIGURE 10: INVESTMENT CONSULTANTS PREFERRED BY HFS
Which investment consulting firms do you mostly work with? Big Six Global Players HF Specialists Traditional Players
Top Regional Players 89% 89% 68% 54% 54% 50% 46% 29% 29% 21% 21% Wilshire
14% Callan
14% Ennis Knupp
14% 14%
11%
11% Rogers Casey
Albourne Cambridge Aksia
Watson Wyatt
Cliffwater Mercer
NEPC
Summit Rocaton
10
RAISING THE GAME
Advisors who align their interests with allocators and position themselves to be the rst-in-line for future allocations. While acknowledging that this may be pursued by only a few HFs who have the resources to invest in such build-out, we would encourage others to experiment with this concept on a smaller scale. If intellectual power drives return generation, it may seem obvious for investors to be willing to access it via a more personable channel than mere prot participation in the fund.
(4) Investing in brand equity For an industry that has been dominated by the belief that returns sell themselves, the concept of brand may seem futile and not applicable. And yet, a case can be made that brand can be a very tangible asset. A survey participant commented you need performance to develop a brand, but a brand may save you when performance isnt there. We encourage HFs to keep the debate alive and to experiment further in this area. It will be interesting to measure its developments.
FIGURE 11: INVESTOR COMMUNICATION STANDARDS
Frequency of Commonly Adopted Investor Communication Channels Estimates Commentary / Letter Website
90% 71% 54% 36% 29% 10% 10%
None
None
Yes
No
Conference Call
Investor Event
Risk Report
82% 59%
79%
18% 21% 3% W M Q S A None W 6% M Q S
12%
9%
12%
None
None
Current industry benchmark W = Weekly M = Monthly Q = Quarterly
Areas experiencing most changes S = Semi-Annually A = Annually
11
RAISING THE GAME
FIGURE 12 : RISK REPORTS TABLE OF CONTENT
Information Item Organizational Update Firm
Adoption
Information Item Stress Test / VaR Risk Attribution by Risk Type Counterparty Exposure & Cash Mgmt Overview Attribution by Strategy Performance Attribution by Longs & Shorts Attribution by Sector Performance Drivers Best / Worst Trade PnLs
Adoption
Asset Level Market Overview Top Portfolio Positions Exposure by Sector
Portfolio
Exposure by Region Exposure by Asset Class Exposure by Currency Exposure by Instrument
~1/4 adoption rate
~1/2 adoption rate
~3/4 adoption rate
Areas with most changes
FIGURE 13 : BRAND AWARENESS

What is your firms distinct brand? / What is it based on? % Respondents Are you actively building your brand and if so, how? % Respondents
No Distinct Awareness
60% 75%
Value Not Actively Building 85%
50%
Both
33% 30% Distinct Awareness 25% 10% Persona Product Actively Building 15% 17%
Research Press / Media
12

May 2009
CONTENTS
01 01 03 03 14
II. METHODOLOGY
III. INVESTOR LANDSCAPE
IV. INVESTOR SENTIMENT
V. CONCLUSIONS
The turbulence of 2008 and early 2009 in the hedge fund industry is likely to generate dramatic changes in investment practices among allocators, as well as signicantly different business practices among hedge funds. If 2008 was a challenging year for hedge funds, it was an even more challenging year for their investors. Hedge fund assets fell alongside global investable assets, which declined by ~20%. Allocators of all types discovered that years of experience investing in hedge funds does not necessarily translate into an ability to pull capital out of hedge funds. Withdrawal freezes and restructurings have created liquidity challenges and spurred the creation of a more active, discounted secondary market. Even where withdrawal freezes were not at issue, due diligence capabilities have come under re, especially at Fund of Hedge Funds (FoHFs), where numerous brand-name players missed early-warning signs of fraud at Bernard L. Madoff Investment Securities and elsewhere. Finally, even for those allocators that avoided the pitfalls of withdrawal freezes or outright fraud, weak performance across the hedge fund space has led to a host of problems, including funding shortfalls at Pensions, Endowments & Foundations, and a crisis of condence in the FoHFs model that have led to signicant redemptions. Our survey results indicate the following major themes are most likely to shape future activities among hedge fund industry participants this year: Redemptions Overall, both hedge fund managers and investors expect stabilization of net ows during 09 Cash Balances Hedge fund managers and investors are holding signicant levels of cash in preparation for rebalancing activities and to better manage liquidity Manager Turnover Hedge fund manager turnover within investors portfolios is likely to remain elevated above historical levels for the duration of 09 Strategies of Interest Investors current strategy appetite clusters around Credit, Macro/CTA, L/S Equity and Distressed opportunities
1
Liquidity Investors are pushing for greater alignment among the several components of hedge fund terms, particularly initial lockups and performance fees Fees While the two and twenty price structure remains for now, the introduction of hurdle rates on performance fees and downward pressure on fees will continue Managed Accounts Investors show signicant interest in managed accounts, more for fear of commingled assets due to co-investor risk than transparency needs Prime Broker (PB) Counterparty Risks HF managers remain more sophisticated/better equipped to evaluate and select their PB counterparties than are investors 09 Allocations In order of most to least likely active investors: Family Ofces, Pensions, FoHFs, Endowments & Foundations and Insurance Companies1
II. METHODOLOGY
The Asset Management Solutions Group (AMSG) set out to answer two critical questions for the hedge fund industry: what are global investable assets and what is investor sentiment? To that end, AMSG conducted an extensive market sizing research effort across all major investor types globally. The research is complemented by interviews with approximately 300 hedge fund investors and approximately 100 hedge fund managers. Interviews focused on major trends in the industry, including redemptions, cash holdings, strategies of interest, liquidity demands, fees, managed accounts and PB counterparty risks. Market Sizing Model Over the course of the last four months, AMSG developed a comprehensive market sizing model aimed at assessing global investable assets, global hedge fund assets and allocation to hedge funds by investor segments on a global basis. In our model, a segment is dened by a specic investor type and geography, e.g., American Pensions. Six investor types were considered: Pensions, Insurance Companies, Private Banks2, Sovereign Wealth Funds (SWFs), Endowments & Foundations (E&F) and Family Ofces (FO)
Sovereign Wealth Funds and Private Banks were excluded for two reasons: (1) Sovereign Wealth Funds did not experience substantial changes in their investment attitudes and do not represent a substantial portion of the hedge fund investor community, and (2) Private Banks were structurally impaired from the previous year and future hedge fund allocations are largely dependent on the institutions of which they are a part; as a result, we do not predict Private Banks to be a major hedge fund allocator in the coming year Private Banks include wealth management service providers
Asset Management Solutions Group Hedge Fund Intelligence | May 2009
Five geographies have been analyzed: Americas, Europe and Central Asia, Middle East, Asia Pacic and Other We adopted the following three-step process to estimate global investable assets, allocation to hedge funds and hedge fund assets: Global investable assets were assessed by comparing and triangulating estimates from a mixture of 50+ publicly available and proprietary sources, including (most notably) OECD, the US State Department, Federal Reserve, World Insurance Directory, Capgemini World Report and Boston Consulting Group Asset Management Report Hedge fund allocation gures were estimated on a segmentby-segment basis by comparing four independent sources: Investor data resulting from our interviews and insights captured as a result of our continuous dialogue with the investor community Preqin database allowing us to calculate average allocation gures across multiple investors in each segment Public research providing us the ability to leverage previously conducted, segment-specic investor research Industry experts enabling us to compile up-to-date information from investor specialists within Barclays Capital FIGURE 1: AMSG INVESTOR SURVEY PARTICIPANTS
Hedge fund assets were calculated as the product of global investable assets and hedge fund allocation gures Investor and Manager Interviews In conjunction with the market sizing model, AMSG conducted approximately 300 interviews with hedge fund investors and maintained extensive, ongoing dialogue with approximately 100 hedge fund managers. Our dialogue took place during the period of December 08 through March 09. We chose to capture investor sentiment by means of in-depth dialogue with market participants as opposed to a broad, template-based Internet survey in order to achieve two objectives: To deepen our understanding of the core issues faced by investors and hedge fund managers, specically focusing on the reasons and the constraints behind specic choices To be constantly in the ow of information during a period of high volatility, both in the market and with regard to investor sentiment Figure 1 depicts the distribution by type of investors interviewed, both by the number of participants and by their hedge fund Assets under Management (AuM). Our respondents comprise a wide variety of investor types, ranging from FoHFs to Family Ofces and Pensions, in North America and Europe.
Participant Distribution by Investor Type # Participants
Participant Distribution by HF AuM Investor Hedge Fund AuM ($bn)
144 509 100 67 23 HF Mgrs FO E&F 38 20 Pensions FoHFs Other1 80 HF Mgrs 23 FO 27 Pensions FoHFs 93 Other1
16 E&F
% Total
23%
8%
7%
49%
13%
% Total
4%
2%
4%
76%
14%
1. Includes Insurance Companies, Private Banks, Consultants, and Seeders Note: All gures cited refer to AMSG survey results only
III. INVESTOR LANDSCAPE

While the total size of global investable assets shrank in 08, to ~$60 trillion, down 20% from $75 trillion at the end of year 07, the overall composition of global investable assets was only marginally impacted. Figure 2 depicts the map of global investable assets by investor segment as of EOY 08. Interestingly, the top three segments are in the Americas region Pensions, Insurance, and Private Banks as they were at EOY 07. Most investor segments saw their investable assets decline throughout the year, within a range of -19% to -27%. One notable exception was SWFs, particularly the Middle East SWFs whose assets swelled by 8%, now totaling $1.6 trillion. This is credited to the fact that the inows resulting from oil revenues obtained at high oil prices in 08 were quickly diversied into other asset classes before oil stumbled during 2H 08. As a result of extensive analysis and as quoted in our previous quarterly piece, Hedge Fund Intelligence Down, But Not Out, hedge fund assets fell by 25% (from $1.8 trillion to $1.4 trillion) in 08 compared to a ~20% decrease in global investable assets. As a result, hedge fund assets as a percentage of total investable assets have contracted slightly to 2.4% by EOY 08 versus 2.6% one year ago. Figure 3 indicates that American Endowments & FIGURE 2: GLOBAL INVESTABLE ASSETS
Foundations and Family Ofces were the most active hedge fund allocators in terms of percentage of allocation, with 10% or more of their portfolios invested in hedge funds. Figure 4 depicts the product between Figures 2 and 3, and illustrates that the top four investor segments, in terms of hedge fund assets in 08, were American Pensions ($306 billion), American Private Banks ($216 billion), European Private Banks ($177 billion) and American Endowments & Foundations ($140 billion), together accounting for 50% of the industrys AuM.
IV. INVESTOR SENTIMENT

The major themes and trends that were identied by the Asset Management Solutions Group investor survey can be classied in two categories: Evergreen or Contingent. Evergreen Topics, for example, fees, are those that are always topical and relevant for most participants in the hedge fund industry, regardless of market conditions. Contingent Topics, such as redemptions, are those that demand increased attention as a result of the current market turmoil. The following sections will highlight investor sentiment around the major themes listed below: Evergreen Topics Based on our interviews conducted around such topics, we believe that many hedge fund investors feel that the power has shifted into their hands, allowing them to apply
#1 Americas Pensions $13.7trn
#5 European Pensions $4.9trn
#7 Asian Pensions $3.7trn
Pensions $22.8trn
#4 European Insurance $5.8trn #2 Americas Insurance $7.2trn #6 European Private Banks $4.8trn
Insurance $16.4trn #10 ME SWF $1.6 trn #8 Asian Insurance $2.7trn
#3 Americas Private Banks $6.2trn
#9 Asian Private Banks $1.6trn
Private Banks1 $13.2trn
SWFs $3.9trn
} E&F $1.4trn
FO $.9trn Americas $28.6trn Europe and Central Asia $16.9trn Middle East $2.8trn Asia Pacific Other $9.8trn $.6trn $58.6trn
1. Includes both Private Banks and Wealth Management rms Source: Barclays Capital Asset Management Solutions Group Market Sizing Model
FIGURE 3: ALLOCATION TO HEDGE FUNDS BY SEGMENT
Estimated 08 HF Allocations as a % of Their Portfolio
Projected 09 Allocation Trend
Pensions1
2%
1%
2%
1%
Insurance2
1%
1%
1%
2%
E&F3 FO4 Private Banks5 SWFs6 10%
14%
4% 6%
3% 5%
N/A 5%
4%
4%
5%
4%
5%
<1%
2%
4%
Americas
Europe
Asia
Middle East
Increase
Decrease
Sources: 1. UBS, Mercer Consulting, Russell, Watson Wyatt, Barclays Capital Analysis 2. US Federal Reserve, Patpatia & Associates, UBS, IFSL, Barclays Capital Analysis 3. Watson Wyatt, Commonfund Institute, NACUBO, University of Melbourne, Oxford, Cambridge, Barclays Capital Analysis 4, 5. Merrill Lynch, Capgemini, Wharton, Barclays Capital Analysis 6. McKinsey Global Institute, Henderson Global Advisors, A. Blundell-Wignall, Y. Hu and J. Yermo, New Mexico State Investment Council, Alberta Heritage Fund, Alaska Permanent Fund Corporation, The Economist, Barclays Wealth, and Barclays Capital Analysis
FIGURE 4: HEDGE FUND AUM BY INVESTOR SEGMENT
#1 Americas Pensions $306bn
#9 European Pensions $56bn #10 European Insurance $42bn #3 European Private Banks $177bn #7 ME SWF $65 bn
#6 Asian Pensions $73bn
Pensions $437bn
Insurance $133bn #5 Asian Private Banks $86bn Private Banks $496bn
#8 Americas Insurance $62bn #2 Americas Private Banks $216bn
#4 Americas Endowments & Foundations $140bn
SWFs $106bn
} E&F $156bn
FO $72bn Americas $772bn Europe and Central Asia $313bn Middle East $96bn Asia Pacific $219bn $1,400bn
Source: Barclays Capital Asset Management Solutions Group proprietary market sizing model year-end 2008 gures
considerable pressure on hedge fund fees. Looking forward, we predict that the investor community will increase its inuence to enforce favorable liquidity terms and apply downward pressure on hedge fund fees. Evergreen Topics include Fees, Liquidity and Strategies of Interest. Contingent Topics Increased focus on topics such as redemptions, cash balances and transparency provide evidence that there is still much to be resolved between hedge fund managers and investors. Interestingly, we found that PB Counterparty Risk, an area of focus that we originally thought to be a Contingent Topic, is not resulting in the major structural changes that some had originally predicted. Contingent Topics include Redemptions, Cash Balances, Manager Turnover, Managed Accounts and PB Counterparty Risk. A. Evergreen Topics A.1 Fees While the two and twenty fee structure is likely to remain largely intact, pressure will be put on both management and performance fee price points, with additional investor demand for hurdle rates on performance fees in 09. Recent market conditions have led to signicant pressure on hedge fund fees. Figure 5 indicates that 50% of our surveyed investors FIGURE 5: AMSG SURVEY RESULTS ON FEES
and 65% of managers expect an explicit reduction in hedge fund fees in 09. While the two and twenty model still has a We anticipate both management strong following, as evidenced and performance fees to decline. by the 50% of investors who $800mn FoHF expect fee levels to remain the same, we expect fee reductions to come in one of three forms: Hurdle rates allowing investors to pay for true performance by means of a pragmatic proxy for alpha Multiple share classes that offer a spectrum of reduced fees in return for reduced investor liquidity/longer lockups Variable management fees that track rather than exceed manager cost and are a function of the LP investor size or fund size In terms of pricing structure, we expect the current structure with both management and performance fee components to survive despite pressures on both price points. Of the respondents who predicted a fee decline, 68% expected both management and performance fees to decline. Only 11% predicted the current hedge fund fee structure to evolve into a management fee only model like most traditional asset management products. Additionally, we noted a discrepancy between investors and
Where do you see fees trending in 2009? % Respondents
Which portion of the fees will it affect? % Respondents1 12% 20% Decline in Perf Fees Decline in Mgmt Fees
25% 35% 50%
65% 50% Expectations By HF Mgrs on HF Fees By Investors on HF Fees
75%
68%
Decline in Both Fees
By Investors on FoHF Fees
Sources of Fee Reduction
Decrease
No Change
1. % of respondents who expected a fee reduction Note: All gures refer to AMSG survey results only
managers outlook on fees: 65% of managers versus 50% of investors expect a reduction in fees. In our opinion, the divergence potentially highlights the shift in power from managers to investors, as the former demonstrates a greater willingness to accept a lower fee in order to attract or retain investor assets. Finally, our survey results show that FoHFs face considerably more fee pressure than hedge funds, as 75% of investors predicted a decline in FoHF fees compared to 50% for hedge fund fees. This nding is consistent with the general perception that FoHFs are under more stress from poor performance and have not implemented a due diligence process that protects against fraud. As a result, the second layer of fees has led many investors to reconsider FoHFs role in their portfolios. A.2 Liquidity Demands Investors are pushing for greater alignment and more consistency among other terms of the contract, most notably hurdle rates in the presence of signicant performance fees and performance fee payments at the end of initial lockup periods, especially if they exceed one year. The recent environment has accelerated the industry trend toward greater liquidity terms. 66% of our respondents expect initial hedge fund lockups to become shorter in duration, as depicted in Figure 6. FIGURE 6: AMSG SURVEY RESULTS ON INITIAL LOCKUPS
Investors, however, will consider liquidity terms in conjunction with other aspects of the investments, such as the nature of the strategy, business model of the manager, and other terms such as transparency and fees. In fact, as seen in the right-hand side of Figure 6, more than half (54%) of investors are open to longer initial lockups if they believe there is a sensible justication for their presence. For example, many investors acknowledge that certain strategies, especially in illiquid credit markets, may actually require longer lockups in order to avoid asset-liability mismatches. The current environment brought back signicant attention to the link between liquidity and fees. Numerous managers are We do not mind longer lockups offering investors reduced fees if the strategy requires it. $3bn Pension in return for longer lockups as a short-term solution to entice investors to stay. We predict that the solution of trading reduced fees for longer lockup periods will continue to persist through the increased use of multiple share class structures, as investors grow to expect more exible and benecial fee structures in exchange for less liquidity. A.3 Strategies of Interest In order to reap the benets of the current dislocation in the market, investors interest clusters around general Credit and Distressed
Where do you see hedge fund lockups trending in 2009?
Can you invest in hedge funds with one-year lock?
66% 46% 31%
54%
3% Shorter Lockups No Change Longer Lockups Require <1 Year Lockup Open to >1 Year Lockup
opportunities, as well as strategies with favorable liquidity terms, such as Macro/CTA and L/S Equity. With respect to investment strategies, we forecast a sharp move away from high leverage, high beta strategies that performed poorly during the 08 downturn for example, Relative Value and Convertible Arbitrage. In the new environment, we expect winning strategies to include both: (1) strategies well suited to take advantage of the current Were interested in the same dislocation by buying assets at re strategies as everyone else: sale prices, including Distressed credit, macro/CTA and other credit and other directional Credit liquid strategies such as L/S opportunities and (2) simple and Equity. inherently more liquid strategies, $700mn FoHF such as L/S Equity and Macro/ CTA, as depicted in Figure 7. Additionally, we observe a high level of concentration of interest among the top strategies, with the fourth most preferred strategy (Distressed) gathering four times as many votes as the next favored (Market Neutral). B. Contingent Topics B.1 Redemptions Overall, both hedge fund managers and investors expect
stabilization of net ows, with 09 redemptions expected to represent 10% of the current hedge fund AuM level, versus 25% in 08. Hedge fund managers suffered heavy redemptions in 08. Nearly half (47%) had redemptions between 20%30%, with the average manager suffering redemptions equal to 25% of their HF assets, as depicted in the left-hand-side chart of Figure 8. Managers, however, believe the market is beginning to stabilize with expected redemption levels for 09 at 10% of hedge fund AuM. Investors who tried to redeem in 08 had an average of 25% of their redemption requests restricted or otherwise delayed, as depicted in the middle chart of Figure 8. The degree of impact from withdrawal freezes has been uneven among investors. Nearly half (45%) of all investors had only 10% or less of their assets withheld, while 20% of investors were severely affected, with more than 30% of their assets blocked by their managers. As depicted in the right-hand-side chart of Figure 8, investors share optimistic sentiments and are more hopeful about getting their restricted withdrawals back. Some managers have developed redemption schedules and have shared them with their investors. Additionally, investors expect that approximately 85% of their restricted redemption requests will gradually be honored in 09.
FIGURE 7: AMSG SURVEY RESULTS ON STRATEGIES OF INTEREST
What hedge fund strategies are you most interested in? 1 Count (#) Top 4 strategies 84% of all count
49
44 38 29 ~4X
7 Credit Macro/CTA L/S Equity Distressed Market Neutral
6 Emerging Market
6 Convertible Arbitrage
4 Relative Value
1. Not all surveyed investors responded to question Note: All gures refer to AMSG survey results only
B.2 Cash Balances Hedge fund managers and investors are both holding signicant cash positions in their portfolios, at 20% and 14%, respectively, in preparation for rebalancing activities that will take place in 09 as well as to provide liquidity in the still volatile environment. Investors and managers both hold signicant levels of cash balances, setting the stage for sizeble amounts of cash exchanging hands in 2009 as investors reallocate and managers honor new and previously blocked redemptions. Our surveyed investors have an average of 14% of their portfolios in cash, as depicted in Figure 9, and nearly 80% of them plan to reallocate this cash in 09. Similar to investors, hedge fund managers have amassed a 20% average cash position, for an industry total of approximately $250 billion. As indicated in the top right-hand-side graph of Figure 9, high cash levels (mostly from FoHFs) will result in $50 billion in new allocations from investors to managers in 09. The bottom right-hand-side graph of Figure 9 denotes that the high cash levels from hedge fund managers will result in $200 billion to be returned to investors in the form of met redemptions, including $150 billion in new redemption requests from hedge fund investors and $50 billion to honor previously blocked requests. Looking into 09, we forecast $250 billion of gross cash transfer and $150 billion of net outow from the hedge fund industry FIGURE 8: AMSG SURVEY RESULTS ON REDEMPTIONS
as a result of the $200 billion expected outow and $50 billion expected inow. B.3 Manager Turnover Hedge fund manager turnover within investor portfolios is likely to remain elevated above the historical 10% average level, settling in the 10%15% range, for all of 09. Our survey results revealed that pre-crisis hedge fund manager turnover has averaged around 10%, as depicted in Figure 10. Survey results suggest average turnover in 09 will be in the 10% 15% range, still more elevated than the historical level, but lower than the extremely high rates of 20%30% experienced towards the end of 08. Three broad categories of investors have been identied with respect to turnover activities. The rst group includes We will hold 30% in cash for investors forced to unwind at least the next quarter. $1.5bn FO their investments due to poor performance in some asset classes. For example, investors that entered distressed strategies too early were likely to have run into liquidity issues, and were compelled to exit more liquid positions. Expected 09 turnover for this group is likely to revert to the historical rate of 10%, as many
What redemptions did you have in 08? What do you expect for 09 08 Actual 09 Expected
What % of your Q4 08 redemptions were restricted by HF managers?
By when do you expect them to be honored?
4050%
5%
>50% 4050% 3040%
11% 5% 3% Severely affected
Q1 09
6%
3040%
11%
Q2 09
28% 84% in 09
2030%
47% 08 Avg = 25% 2030% 18% 18% Avg = 25%
Q3 09
28%
1020%
21% 36% 09 Avg = 10% 1020% Q4 09 22%
<10%
16% 64%
<10%
45%
> 09
16%
% Redemptions Note: All gures refer to AMSG survey results only
% Redemptions Frozen
Time
already rebalanced in Q4 08 when hedge fund performance was at its lowest. The second group is interested in seeking strategic openings and trading up for high-quality managers that were previously closed to new investors. Turnover activity for this group is likely to be higher than the historical average (i.e., in the range of 15%25%) given the current dislocation in the market environment. Finally, the third group includes investors who are undecided on their future actions. For these investors, 09 turnover activities will heavily depend on the return of their previously blocked redemptions. These investors are waiting for their restricted requests to be honored before making decisions about how to rebalance. However, hedge fund investors who were severely impacted by withdrawal freezes are unlikely to reallocate immediately. Thus, we expect turnover activity of this group to be relatively low. B.4 Managed Accounts Investors show signicant interest in managed accounts with fear of commingled assets as the primary driver rather than the desire for transparency. Managed accounts are drawing considerable attention from the investor community. Overall, 80% of our surveyed investors FIGURE 9: AMSG SURVEY RESULTS ON CASH HOLDINGS
have expressed interest in the investment structure, as seen in Figure 11. The primary driver is a desire to gain better control over the exercise of their own liquidity rights without being exposed to the risk of gate provision implementation. Such desire is fueled by a fear that commingled vehicles will result in signicant uses (and abuses) of withdrawal restrictions and coinvestment risk. According to our survey, the goal of the transparency requirement relates more to rm control and governance than it does to investments. Nearly 66% of investors demand monthly reporting and 57% require asset class exposure (mainly to ensure no style drift), while 34% require position level transparency and a mere 9% actually require the use of managed accounts. This leads us to believe that most investors require only sufcient transparency to ensure adherence to strategy principles and investment processes. Many institutional investors, in fact, do not possess the capability to exploit the full position-level transparency. Based on the results of our survey, our view is that transparency is not the primary reason for adoption of managed accounts because (1) it can be obtained in more cost efcient alternatives and (2) full transparency does not necessarily fully benet investors, as it generally cannot be efciently utilized. A more compelling motivation for managed account adoption is asset control. This is especially true among institutional investors, who fear being lumped together with fast money investors especially certain FoHFs whose rapid
Significant Cash Balances
2009 Expected Cash Flows from Investor to HF Manager
~$50bn Investor Net Transfer ~$150bn Gross Transfer 14% ~$250bn Investor ~$200bn Manager 2009 Expected Cash Flows from HF Manager to Investor 20% Re-allocation Manager
Investor Cash
HF Manager Cash
Blocked redemptions honored + New redemptions
FIGURE 10: AMSG SURVEY RESULTS ON MANAGER TURNOVER
How much annual manager turnover has your firm incurred historically? % Investors Avg = 10%
33% 25% 16% 10% 5% 05% 510% 1015% % Turnover Note: All gures refer to AMSG survey results only 1520% 2050% 50100% 11%
FIGURE 11: AMSG SURVEY RESULTS ON TRANSPARENCY AND MANAGED ACCOUNTS
Are you interested in managed accounts?
What transparency do you demand from your HF manager?
80%
A vast majority of investors expressed interest in managed accounts
63%
57% 40% 34% 9%
Interested in Managed Accounts
Monthly Reporting
Asset Class Exposure
PB Exposure
Position Level Exposure
Managed Accounts
10
withdrawals can endanger hedge fund managers performance. If, however, the composition of a hedge funds capital base is already predominantly institutional investors, or the fund has a relatively long lockup term, the justication for managed accounts dissipates quickly as the risk of a run on the fund scenario decreases. Alternatively, for those investors wishing to maintain the highest possible level of liquidity, managed accounts provide protection from any gate provision that might be implemented on commingled fund vehicles. B.5 Prime Broker Counterparty Risks HF managers remain more sophisticated and in our view better equipped in the context of the evaluation and selection of their PB counterparties than are underlying investors. PB counterparty risk exposure has become a major headline topic since the Lehman Brothers bankruptcy. Many had expected investors to play a much more signicant role in dictating to hedge fund managers which PB to use. Our survey results, however, show that the increased attention is not resulting in the dramatic structural changes that some originally predicted. In fact, many surveyed investors commented that they continue to trust their managers to make the decisions around their PBs. Furthermore, survey results suggest that our investors largely rely on general market reputation for their PB choices, despite recent failures of previously well-known PBs. Specically, 66% of surveyed investors rated market reputation as a top attribute in PB selection, as shown in Figure 12. On average, our investors believe having two PBs is sufcient in diversifying PB counterparty risks, We keep trusting our whereas hedge fund managers managers in their selection prefer having three PBs. The gap of PBs. could be an indication of a higher $10bn FoHF level of cautiousness among managers. Despite differing opinions, we predict that the preference around the number of PBs for managers (over investors) will likely prevail. C. Market Sentiment by Investor Type Based on our survey, we found that attitudes toward hedge fund allocations for 2009 have never differed so dramatically among investor types and with respect to historical sentiment levels. Figure 13 depicts the ve major hedge fund investor types by two characteristics that are most relevant in determining the current sentiment of the participants in the hedge fund industry: average cash position and average AuM decline.
With an average decline in AuM of -24%, Family Ofces are licking their wounds. However, unlike FoHFs, whose performance was generally in line with hedge funds, Family Ofces have proved to be exible asset allocators and were quicker to move to cash at the rst sign of the nancial crisis, thus allowing them to outperform other investor groups. In contrast, historically high allocations to traditional asset classes and private equity vehicles resulted in major losses for Pensions and Endowments & Foundations. However, Figure 13 reveals that Pensions are the more likely allocators due to average stronger performance and larger cash holdings than Endowments & Foundations. While the placement of Insurance Companies on Figure 13 may suggest that the investor group is well positioned to allocate in the near future, in-depth interviews suggest diminished appetite in hedge funds due to perceived risk, desire for less mark-to-market positions and restrictions on proprietary capital usage. Our interviews have led us to rank the overall attractiveness for capital raising purposes of each investor type, as depicted in Figure 14. The following sections will detail the characteristics of each investor type. C.1 Family Ofces The markets meltdown has not deterred most single-family ofces from moving forward on hedge funds. According to our survey, many even plan to increase their allocation to hedge funds in 09. The vast majority (89%) of Family Ofces have indicated that they continue to have faith in hedge funds and plan to allocate in 09. With the decrease in AuM among surveyed respondents ranging from -40% to -8% (with an average of -24%), Family Ofces have by no means emerged unscathed from 2008. Many Family Ofces, We are sticking with hedge however, have reported a more funds and we are not scared. $700mn FO positive long-term outlook, especially on the alternatives space. They view 2008 as a cleansing period and are not looking to redeem signicant capital. With an average cash position of 15%, as depicted in Figure 13, this investor type will have the means to deploy cash in the near future. C.2 Pensions Many anxious investors may have been rushing to redeem from their hedge fund investments but the most resilient of all are our pension investors. In fact, Pensions are likely to award hedge fund mandates to catch up to their liability, just as they did in response
11
FIGURE 12: AMSG SURVEY RESULTS ON PB COUNTERPARTY RISKS
What are the top three attributes you look for during a PB selection?
What is the ideal number of PBs?1
67% 57% 50% 40% 27% 23% 10% 16% 45% 29%
63%
26%
21%
Market Available Reputation B/S
Jursidiction /Entities
Credit Rating
Asset Raising
Capital Ratio
CDS Spreads
2 According to Investors
More than 3 According to HF Managers
1. Assuming HF >$1bn Note: All gures refer to AMSG survey results only
FIGURE 13: INVESTOR CASH AND AUM DECLINES
Investor Cash and AuM Declines 20% Insurance Companies EOY 08 Cash Position Pensions
Family Offices FoHF
Endowments & Foundations
10% -15% FY 08 AuM Decline (%) -30%
12
to the 02 bear market. Our ndings reveal Pensions have a perhaps surprising level of optimism about alternatives. Despite the turbulence of 08, the vast majority (88%) said they remain opportunistic, hold sizable cash positions (as seen in Figure 13) and will continue to fund existing allocations or even increase targets in 09. One prominent US pension plans to ramp up their hedge fund allocation over the next couple of years even though they already have a relatively large exposure to hedge funds. Indeed, approximately a quarter of our respondents plan to increase their allocations over the next 12 months, citing promising market conditions and a need to catch up to their near- and medium-term liabilities. Like We will ramp up allocations many investors, Pensions have to over 10% next year. become skittish around the more $5bn Pension complex strategies that defy easy explanations. With limited due diligence teams and limited ability to verify the results of esoteric trading schemes, we are seeing pension funds focusing on simpler strategies, including L/S Equity, and Macro/CTA. The perception among pension investors is that they now have more power in the alternatives space to demand increased FIGURE 14: KEY THEMES BY INVESTOR TYPE
transparency, rationalized fee structures, and better liquidity terms. In addition, many investors are trading up to higher quality managers based on the view that blue-chip managers are safer counterparties. Many such managers have been closed for years but have recently re-opened in order to replenish capital lost to redemptions and underperformance. C.3 Funds of Hedge Funds Despite being impaired, FoHFs still expect to be active allocators in the hedge fund industry and the larger players with institutional clients have fared much better than the markets perception. The year 2009 will be a year in which a clear separation between the winners and losers will emerge. Figure 13 indicates that the majority of FoHFs in our survey posted 09 returns of between -15% and -20%, in line with FoHF industry averages of -19%. As compared with average hedge fund performance of -18% to -19%1, these returns suggest that FoHFs with average management fees of 1% in 2008 are providing diversied exposure to hedge funds across all strategies, but are not selecting managers with superior performance. Nonetheless, the overall outperformance of hedge funds suggests that, after the current dislocation, institutional investors will maintain hedge fund investments and in some cases even increase
Decreasing Attractiveness for Capital Raising
Family Offices
Pensions
FoHF
Endowments & Foundations
Insurance Companies
Re-deploying cash balances
Catching up on underfunding
Partnering to stabilize business
Re-evaluating liquidity risk
Bracing for economic slowdown
Waiting for market stabilization
Enforcing new terms
Fighting to prove value
Rebalancing portfolios
Deleveraging to meet rising reg. capital req.
Staying course on present allocations
Allocating confidently
Re-packaging to increase transparency
Re-entering selectively closed funds
Limiting exposure to market volatility
FY08 HFR HF Performance
13
allocations. FoHFs at least those that were unscathed in 08 still offer some value in conducting hedge fund due diligence, as well as offering access and knowledge that is not readily available to mid-sized and small investors, or those large institutional investors who do not have a dedicated hedge fund research resource. Institutional investors channel their hedge fund allocations through FoHFs in order to get three Ds due diligence, diversication and deniability. The rst and most important of these benets (due diligence) has recently come under intense scrutiny. The mix of average performance, bad press, and a questioning of the fundamental value of their business model will lead to a shakeout in the FoHF business. Funds that did not deliver promised due diligence or diversication, as well as funds with inadequate marketing efforts, will close in 2009. For those who survive, 2010 and beyond may see a signicant improvement as institutions continue to make investments and even increase target allocations. C.4 Endowments & Foundations Endowments & Foundations are impaired due to their high allocation to illiquid alternatives and we predict that they will not be a main source of capital in 2009. Regardless, our respondents still value hedge funds and we foresee their return in another six plus months. The last six months have been especially difcult for those Endowments & Foundations that retained a traditional focus on beta-heavy equities and credit allocations. Alternative investments, especially in hedge funds, were a comparatively healthy portion of their overall portfolios in 2008, but have nonetheless been regarded as a source of liquidity to fund capital commitments on the PE side. Figure 13 indicates that surveyed Endowments & Foundations lost an average 28% of their overall AuM in 2008. In a recession, Endowments & Foundations tend to have a cash ow negative business charitable need is Hedge Funds performed, greatest just as donors and but we must trim our 41% alumni trim support. As a group, allocation. they tend to have very high $750mn Endowment allocations to hedge funds and private equity. US endowments, for example, have 19.6% allocated to HFs and 6.9% allocated to private equity. Many have found their real estate and private equity investments are either making capital calls or are greatly
impaired. These combinations of circumstances have pushed Endowments & Foundations to tap their hedge fund investments for liquidity despite performance. Surveyed Endowments & Foundations redeemed approximately 30% of their hedge fund portfolio in the last year. Endowments & Foundations will continue to experience capital calls to fund operations and tap sources of liquidity where they can, making it highly unlikely they will be active allocators to new strategies in 09. However, we expect they will enthusiastically return to the asset class in the long term. C.5 Insurance Companies Appetite for hedge funds may be diminished due to desire for less mark-to-market positions and proprietary capital restrictions. While Figure 13 would suggest that Insurance Companies are well positioned to fund new hedge fund allocations out of their strong cash positions, the in-depth interviews we conducted suggest otherwise. Recent market declines, combined with growing regulatory and rating agency capital restraint, have constrained investment decisions for insurers. Some insurers that have had to broadly redeem hedge fund investments told us the decision came as parent rms withdrew capital due to regulatory constraint, as well as the perceived illiquid nature of hedge fund investments. Many Insurance Companies face the additional challenge of dealing with a hedge fund portfolio in their variable income portfolio, where they must report valuation mark-to-market. Our conversations with Insurance Companies suggest that they are either holding tight or beginning to cull their most illiquid hedge fund positions.
V. CONCLUSIONS
While painful, the current market dislocation offers both hedge fund managers and investors several opportunities to reposition, redeploy resources, and mutually benet from a realignment of interests. The following is a checklist of the items that should be a top priority for every manager and investor. Recommendations for hedge fund managers (1) Reposition marketing efforts to target new allocators Most hedge fund marketing efforts are still centered on segments that traditionally were high allocators to hedge
14
funds. The investor landscape has dramatically changed, however. Former high allocators, such as endowments, once ush with cash, liquidating hedge We have technical constraints are impeding us from increasing our fund assets to ll budget shortfalls In contrast, other allocations to hedge funds. $300bn Insurance investors are increasing hedge fund allocations. Pensions, in a bid to catch up with rising liabilities, are pursuing a more aggressive investment stance. Family Ofces, sitting on high cash balances, plan to deploy aggressively once they sense the market stabilizing. Hedge funds that get an early start marketing to the new allocators will be well positioned once the market stabilizes. (2) Encourage creativity around fee structures Some hedge fund managers are offering sharp fee discounts to the few investors allocating in the present market. This approach builds the risk of souring relationships with current investors (who will seek to renegotiate fees) and suggests particular weakness. Both parties can win in this discussion. Investors feel the two and twenty structure rewards outsized risk taking, while funds now realize they cannot survive poor times on management fees alone. Rather than lower fees outright, we suggest that managers move to new models that offer investors what they truly want: transparency, asset protection, and better alignment of incentives. (3) Work actively towards marketing goals Hedge fund managers should take advantage of the current challenging allocation market as an opportunity to rethink their competitive edge and broaden their investor coverage and targeting approach. Hedge funds that work to cultivate relationships now will have the greatest yield once the markets thaw.
Recommendations for hedge fund investors (1) Model and manage for liquidity risk Some investors faced twin challenges in 09. Institutions and businesses that once generated cash suddenly started demanding money just as investments turned illiquid. A downturn can reduce the number of ush donors to a charity just as charity cases increase. Institutions should implement risk models that assume illiquidity in investments. We recommend that investors subject their business and investments to regular stress tests, maintain a contingency funding plan, and maintain appropriate levels of liquid assets. (2) Push for better alignment of incentives Investors have an unprecedented opportunity to push for a better alignment of incentives. In the old order, the standard two and twenty pricing model seemed nonnegotiable, whether the investor was discussing placement with the largest industry player or with a startup fund. Now everything appears negotiable. Many investors are demanding segregation of their assets, monthly reporting of underlying exposures, and lower fees. Smart investors will ask for fee reductions and drop these demands to get what they really want: increased transparency and better alignment of incentives. (3) Fund re-openings offer opportunity to those who were once locked out Some of the most promising strategies have only limited capacity. As a result, only insightful or lucky investors could participate in the most lucrative funds. While outside investors once found the doors to those funds closed and locked, the current crisis offers a rare opportunity to get into funds with impressive pedigrees. Should you be interested in hearing more, we encourage you to reach out to our team, the Barclays Capital Asset Management Solutions Group. We look forward to providing you with deeper insights tailored to your unique challenges.
15
DOWN, BUT NOT OUT

February 2009
CONTENTS
DOWN, BUT NOT OUT
01 01 02 04 04 05 05 07
II. PERFORMANCE OVERVIEW
III. NET FLOWS STATISTICS
IV. INDUSTRY GROWTH OUTLOOK
V. STRESSED ACTIONS
VI. RESTRUCTURING OPTIONS
VII. CONCENTRATION AND CONSOLIDATION
VIII. CONCLUSIONS
DOWN, BUT NOT OUT
After a year of performance meltdowns and excruciating press, hedge funds are certainly down, but they are not out. 2008 was a year of poor performance and negative press. Hedge funds are hurting, but we believe that some among them will not only survive but ourish. True, performance declines were the worst in industry history, but not since 2002 have hedge funds outperformed the S&P so dramatically. Net outows in the fourth quarter dominated headlines, but in the end accounted for less than 10 % of industry assets, which now stand close to 2006 levels. As managers, investors and pundits survey the damage, they nd that not every fund, rm and strategy lies in ruins. In fact, there are reasons for optimism in 2009 and beyond. To some, any optimism will seem unfounded. After all, redemptions in 2008, and especially in the fourth quarter, appeared to be an indiscriminate re sale not limited to underperforming or undersized managers, but affecting nearly every fund. Moreover, 14 of the largest 25 hedge fund managers took some form of stressed action last year, such as gating, suspending redemptions, and/or restructuring. These actions, together with multiple scandals, have weakened investors trust serious injuries that will be slow to heal, regardless of proactive measures by regulators and managers. A closer look, however, reveals temporary, frictional reasons for a FIGURE 1: RELATIVE PERFORMANCE1
large portion of the outows, as well as indications that both ows and performance will stabilize by the second half of this year. Among investors, funds of hedge funds (which account for just under half of industry assets) have over-redeemed, creating sizeable cash levels, which they expect to redeploy to hedge funds this year. Moreover, while some beta-heavy strategies will continue to experience signicant outows, many directionally agnostic strategies including global macro, managed futures and equity market neutral will enjoy renewed interest. Finally, the impact of forced deleveraging on asset valuations is largely complete, and many asset classes and funds are likely to see price stabilization, if not a rebound.
II. PERFORMANCE OVERVIEW

Although the hedge fund industry turned in an average performance of -18% in 2008 compared with 10% in the prior year as shown in Figure 1, it still outperformed the S&P 500 Index by approximately 20% during 2008, the highest spread achieved since 2002. Not surprisingly, those strategies that employed greater levels of leverage (e.g., convertible arbitrage) and those that relied heavily upon beta returns (e.g., emerging markets, equity long/short)
Performance
30% 10%
(10%)
(30%)
(50%) 2000 2001 2002 S&P 500 2003 2004 HFR Index 2005 2006 Spread 2007 2008
1. HFR data
Asset Management Solutions Group Hedge Fund Intelligence | February 2009
DOWN, BUT NOT OUT
clearly underperformed, as illustrated in Figures 2 and 3. Those that were less levered and directionally agnostic (managed futures, global macro) fared better. It is worth noting, however, that the worst performing strategy convertible arbitrage still outperformed the S&P 500, despite the increasing costs of leverage and the negative impact of emergency short ban restrictions enacted in Q3 08. Looking to 2009, we expect hedge fund performance to improve. First, overall hedge fund leverage has declined signicantly from pre-crisis levels to approximately 1.0x by year-end 08, suggesting that the de-levering is largely behind us. Secondly, as the industry shakeout continues to unfold, the survivors will be those with better management and longer, stronger track records features that should bolster future returns. Finally, valuations of certain asset classes, such as corporate credit and ABS, have declined drastically over the past few quarters and could provide some upside opportunity for funds that take advantage of these depressed price levels. Further details are available upon request to the Barclays Capital Asset Management Solutions Group.
As shown on the left-hand side of Figure 4, hedge fund performance during the third quarter was correlated with asset ows. This behavior, although indicative of a performancechasing allocation strategy, can also be seen as some indication of rational or at least deliberate asset allocation in the market. Q4 redemptions, on the other hand, as depicted on the righthand side of Figure 4, have been an indiscriminate re sale, not limited to small or underperforming funds. In fact, the redemptions impacted many hedge funds with positive performance as well especially among equity hedge funds, which are often used as liquidity sources for large allocators. Looking forward, we expect continued net outows in 1H 09, as frictional outows persist and the lifting of withdrawal freezes allows for additional redemptions. We expect net ows to moderate, however, and turn net positive by the second half of the year. In December 2008, Barclays Capitals Asset Management Solutions Group (AMSG) surveyed our top hedge fund investors on major hedge fund industry trends, including redemptions, cash holdings, strategies of interest, liquidity demands and fees. Taking the funds of hedge funds (FoHF) population, it appeared that FoHFs over-redeemed in the latter part of 08, asking for far more cash from their underlying funds than their investors requested. This has created sizeable FoHF cash positions, which they expect
III. NET FLOWS STATISTICS

In 2008, hedge funds saw record negative net ows of $155 billion, of which $152 billion came in Q4 alone. FIGURE 2: INDUSTRY PERFORMANCE BY STRATEGY1
08 Performance (%)
20%
15%
18%
0% (6%) (20%) (18%) (30%) DSB EM MN D ED GM Market Neutral LS Distressed MF (17%) (5%)
(20%) (32%)
(20%)
(40%) Total Convertible Arb Event Driven CA
Dedicated Short Bias Global Macro
Emerging Markets Long / Short Equity
Managed Futures
1. Total industry and Market Neutral data from HFR Q4 report, all other data from CS Tremont HF Index as of 12/31/08
DOWN, BUT NOT OUT
FIGURE 3: LEVERAGE AND CORRELATION BY STRATEGY1
08 Correlation with S&P 5002 1.0 D 0.5 MN 0.0 GM Winning traits: Directionally agnostic / short and low leverage (0.5) DSB MF Leverage (1.0) 0.0x 2. 0x 4.0x 6.0x LS EM ED CA
1. CS Tremont HF Index as of 12/31/08, Scott Frush, Hedge Fund Demystied Note: Leverage is at typical pre-crisis levels, Barclays Capital Asset Management Solutions Group analysis 2. 12 months correlation for 2008
FIGURE 4: NET FLOWS
Q3 08 Performance (%)
Q4 08 Performance (%)
(15%)
(10%)
(5%)
0%
5% 0%
(15%)
(10%)
(5%)
0%
5% 0%
Event Driven

Relative Value Equity-hedge
Global Macro
(1%)
(5%)
(2%)
3.205 Width Event Driven 2.75 Height

Relative Value Equity-hedge Global Macro
(10%)
(3%)
(15%)
Q3 08 Net Flow (%)1 1. As a % of beginning of period AuM Source: HFR Q3 and Q4 reports
Q4 08 Net Flow (%)1
DOWN, BUT NOT OUT
to redeploy during 1H 09. Complete survey results and analysis can be obtained through Barclays Capital Asset Management Solutions Group (AMSG).
IV. INDUSTRY GROWTH OUTLOOK

According to Hedge Fund Research (HFR), 2008 hedge fund AuM declined by about $460 billion to a total of $1.4 trillion, down 25% from 2007 levels. Of this decline, approximately $154 billion was attributed to poor performance and $306 billion to net ouows. Taking a closer look at the year, performance accounted for nearly all (99%) of the industry AuM decline through the rst three quarters, but only half (52%) of the AuM decline in the fourth quarter, as depicted in Figure 5. Based on our net ows outlook discussed above, we expect hedge fund AuM levels to be between $1.0 trillion and $1.4 trillion by the end of Q2 09, with the mid-point implying a decline of about $200 billion from current levels, as depicted in Figure 6. We expect this to be a result of negative net ows of about $250 billion, somewhat offset by positive performance of $50 billion. Our negative net ow estimate is based partly on the view that, amid widespread use of withdrawal freezes, actual Q4 08 outows represented about 50% of total redemption requests during the quarter. We expect the other half to materialize over the next two quarters, generating incremental net outows of $150 billion. FIGURE 5: HEDGE FUND AUM
In addition, our survey suggests that new Q1 09 redemptions requests might mirror the record Q4 08 levels of $150 billion. Combined with expected inows of $50 billion from FoHFs re-investments, this provides for a total net ow of negative $250 billion in 1H 09. Our analysis assumes a modest 3% average hedge fund return in 1H 09, or approximately $50 billion performance far worse than that recorded in 99, following the last difcult year for hedge funds. For the second half, we expect AuM to rebound slightly, leading to a projected year-end AuM of $1.2 trillion to $1.5 trillion, based in part on the view that redemption requests will fade and investors will re-deploy cash. It should be noted that our estimates are slightly more optimistic than those of most industry analysts, whose estimate ranges are depicted as the grey-shaded area in Figure 6.
V. STRESSED ACTIONS
In 2008, the majority of hedge funds responded to massive redemption requests coupled with asset illiquidity by undertaking stressed actions, including fund closures, redemption suspensions, gating, fee reduction, and fund restructuring. These stressed actions have been a widespread phenomenon, even among top tier rms. Based on our proprietary research, large rms appear to have a broader set of available options in dealing with
AuM ($ billions) 2,000 2 145 152 1,600 1% 99% 48% 52% 162 (25%)
1,200 1,868 800 1,105 400 1,465
% of AuM decline 1,721
% of AuM decline 1,407
0 05 06 07 Net flow Perf. Q3 08 Net flow Perf. 08
DOWN, BUT NOT OUT
redemptions. A greater percentage of large rms have restructured, raised gates, and renegotiated fees, while the majority of smaller hedge funds either simply suspended redemptions or closed. Historical data suggests that a fund is unlikely to fully recover after blocking withdrawals unless there is a rapid improvement in performance and market conditions; prior to this year, more than half of all hedge funds that froze withdrawals subsequently went out of business. That said, we expect a higher rate of survival for hedge funds which have undertaken stressed actions in the most recent past when compared to similar gures for 07 and earlier, as withdrawal freezes have become a more widespread phenomenon.
lliquid assets typically are frozen and the portfolio is managed through liquidation. Finally, a hybrid approach separates assets across all investors by asset liquidity, followed by an additional partitioning between investors wishing to redeem and investors wishing to stay with the fund.
VII. CONCENTRATION AND CONSOLIDATION

Taking mutual funds as a point of comparison, we nd that the hedge fund and mutual fund industries are already very similar with respect to the concentration of players (as measured by cumulative percentage of AuM versus cumulative percentage of rms). In both cases, the top 2% of players control around twothirds of industry AuM, as depicted in Figure 8. However, our analysis suggests that there is still room for the largest hedge fund rms to grow assets. Looking to Figure 9 (which measures cumulative of AuM versus number of rms), we note that, despite similar concentration levels, hedge funds have not yet reached the level of consolidation experienced by mutual funds, where the top 20 rms control about two-thirds of all assets. Even though the share of the top 20 hedge fund rms has nearly doubled in the last ve years (from 16% to 30%, as shown in Figure 9), we expect the hedge fund industry to continue to become more consolidated. The charts in
VI. RESTRUCTURING OPTIONS

Massive redemptions forced many hedge funds with illiquid assets to restructure their investment vehicles. Broadly speaking, there are three main restructuring approaches, as depicted in Figure 7. An investor-based split has been the most common, in which a separate vehicle is created for investors wishing to redeem based on their proportion of the total portfolio. Redemptions on liquid assets are usually satised quickly, but the new vehicle may also specify a lockup period or simply be managed through liquidation. An asset-based split is another approach whereby assets are separated across all investors by liquidity. Redemptions on FIGURE 6: HEDGE FUND AUM PROJECTIONS
Actual $ trillions 2.0 1.7 1.5 1.4 1.2 1.0 1.0 0.5 1.4 Q308 Q408 Q109 Q209
Estimate Q309 Q409
1.6
1.5 1.3
1.2
0.0 HFR
Source: Media reports, HFR, Barclays Capital Asset Management Solutions Group analysis Note: Shaded grey area represents envelope of about 20 industry estimates from database providers, sell-side and buy-side rms
DOWN, BUT NOT OUT
FIGURE 7: THREE MAIN RESTRUCTURING APPROACHES IDENTIFIED
Asset Split Asset Liquid Illiquid
Investor Split Asset Liquid Illiquid
Hybrid Split Asset Liquid Illiquid
Stay
Stay
Investor
Investor
Redeem
Investor 65% 26% HFs 2008 Redeem
FIGURE 8: HEDGE FUND CONCENTRATION
% AuM 100%
80% 70% 60%
40%
20%
Redeem
Stay
HFs 2003 MFs 2003 / 20081
0% 0% 1% 2% 3% 4% 5% % Players 1. Mutual funds 2003 and 2008 data are not materially different Source: All about Alpha for hedge fund data; Strategic Insight Sim fund for mutual fund data, Barclays Capital Asset Management Solutions Group analysis
DOWN, BUT NOT OUT
Figures 8 and 9 will come to resemble one another more closely as the number of players in the hedge fund industry shrinks. Today, there are about 3,500 hedge fund rms and 1,000 mutual fund rms; if approximately 2,500 hedge fund rms went out of business, we would see consolidation reach the levels currently experienced in the mutual fund industry. We expect some of this displaced hedge fund talent to join traditional asset management rms, including mutual fund companies.
favorable equity markets, cheap and broadly available credit and loose regulation contributed to a ood of hedge funds capable of securing prots even with sub-scale operations. This model is no longer sustainable. While the light at the end of the tunnel seems to be approaching, we are not there yet. In the meantime, we believe two priorities should be at the top of every hedge fund managers agenda. First, work remains to be done to reassure disgruntled investors who have been injured by withdrawal freezes and restructurings. In some cases, this must be balanced against the need for a controlled pace of divestment. Second, more robust business platforms must be designed and built, with illiquid strategies coming to rely on longer term capital with an eye to resolving asset-liability mismatches. Regrettably, there is no standard one-ts-all solution. Consider the use of gates for example: they have enabled some funds to survive while sending others into a vicious spiral of redemptions and eventual liquidation. Moving forward, good strategic decision making will require a detailed analysis of a given hedge funds investor base, portfolio liquidity, and potential new sources of capital. Should you be interested in hearing more, we encourage you to reach out to our team, Barclays Capitals Asset Management Solutions Group. We look forward to providing you with our thoughts.
VIII. CONCLUSIONS
There is no doubt that the recent market dislocations have created signicant turmoil for many hedge fund businesses and their investors. Also, there is no doubt that recent market dislocation will result in a signicant transformation of the hedge fund industry. That said, several of the core benets of alternative investing remains. Hedge funds, especially those that offer directionally agnostic, alpha-generating products, provide a compelling investment proposition in todays uncertain economic and market environment. In many ways, the recent shake-out will benet the industry, with the survivors eventually enjoying a renewed injection of condence and, more importantly, inows. Historically, low barriers to entry, FIGURE 9: HEDGE FUND CONSOLIDATION
% AuM 100%
80% 70% 60%
40% 30% 20% 16 % 0% 0 10 20 30 40 50 60 70 80 90 100 # Players HFs 2008 HFs 2003 MFs 2003 / 2008
Source: All about Alpha for hedge fund data; Strategic Insight Sim fund for mutual fund data, Barclays Capital Asset Management Solutions Group analysis
ASSET MANAGEMENT SOLUTIONS GROUP OVERVIEW

Asset Management Solutions Group The Barclays Capital Asset Management Solutions Group spans Banking and Prime Services and is designed to offer a unique blend of industry insight and tailored client solutions for Hedge Funds, Asset Management rms, and Institutional Investors. Our integrated offering includes: Asset Management Banking Advise on control and minority stake M&A transactions Raise strategic LP capital / advise on fund restructurings Underwrite and place term debt nancings and equity offerings Global Capital Solutions Capital Introductions: Maintain ongoing investor dialogue providing valuable feedback to fund clients Deliver targeted capital introductions Host events that provide a forum for knowledge transfer and intellectual content to help educate and inform both clients and investors Strategic Consulting: Provide tailored management consulting services that help asset managers achieve a competitive edge Develop actionable and insightful industry thought pieces Advisory and Financing offerings are serviced by the Investment Banking team of the Asset Management Solutions Group.
CONTACTS
Andrea Gentilini Global Head of Strategic Consulting Director +1 212 526 7226 andrea.gentilini@barclayscapital.com
Louis Molinari Global Head of Capital Solutions Managing Director
+1 212 526 0742 louis.molinari@barclayscapital.com
Brian Reilly Global Head of Asset Management Solutions Group Managing Director
+1 212 526 8887 brian.reilly@barclayscapital.com
Shelly Li Associate
+1 212 526 7657 shelly.li@barclayscapital.com
Nitika Gupta Analyst
+1 212 528 6348 nitika.gupta@barclayscapital.com
Disclaimer
This document has been prepared by Barclays Capital, the investment banking division of Barclays Bank PLC (Barclays), for information purposes only. This document is an indicative summary of the terms and conditions of the securities/transaction described herein and may be amended, superseded or replaced by subsequent summaries. The nal terms and conditions of the securities/transaction will be set out in full in the applicable offering document(s) or binding transaction document(s). This document shall not constitute an underwriting commitment, an offer of nancing, an offer to sell, or the solicitation of an offer to buy any securities described herein, which shall be subject to Barclays internal approvals. No transaction or services related thereto is contemplated without Barclays subsequent formal agreement. Barclays is acting solely as principal and not as advisor or duciary. Accordingly you must independently determine, with your own advisors, the appropriateness for you of the securities/transaction before investing or transacting. Barclays accepts no liability whatsoever for any consequential losses arising from the use of this document or reliance on the information contained herein. Barclays does not guarantee the accuracy or completeness of information which is contained in this document and which is stated to have been obtained from or is based upon trade and statistical services or other third party sources. Any data on past performance, modelling or back-testing contained herein is no indication as to future performance. No representation is made as to the reasonableness of the assumptions made within or the accuracy or completeness of any modelling or back-testing. All opinions and estimates are given as of the date hereof and are subject to change. The value of any investment may uctuate as a result of market changes. The information in this document is not intended to predict actual results and no assurances are given with respect thereto. Barclays, its afliates and the individuals associated therewith may (in various capacities) have positions or deal in transactions or securities (or related derivatives) identical or similar to those described herein. IRS Circular 230 Disclosure: Barclays Capital and its afliates do not provide tax advice. Please note that (i) any discussion of US tax matters contained in this communication (including any attachments) cannot be used by you for the purpose of avoiding tax penalties; (ii) this communication was written to support the promotion or marketing of the matters addressed herein; and (iii) you should seek advice based on your particular circumstances from an independent tax advisor. BARCLAYS CAPITAL INC., THE UNITED STATES AFFILIATE OF BARCLAYS CAPITAL, THE INVESTMENT BANKING DIVISION OF BARCLAYS BANK PLC, ACCEPTS RESPONSIBILITY FOR THE DISTRIBUTION OF THIS DOCUMENT IN THE UNITED STATES. ANY TRANSACTIONS BY US PERSONS IN ANY SECURITY DISCUSSED HEREIN MUST ONLY BE CARRIED OUT THROUGH BARCLAYS CAPITAL INC., 200 PARK AVENUE, NEW YORK, NY 10166. NO ACTION HAS BEEN MADE OR WILL BE TAKEN THAT WOULD PERMIT A PUBLIC OFFERING OF THE SECURITIES DESCRIBED HEREIN IN ANY JURISDICTION IN WHICH ACTION FOR THAT PURPOSE IS REQUIRED. NO OFFERS, SALES, RESALES OR DELIVERY OF THE SECURITIES DESCRIBED HEREIN OR DISTRIBUTION OF ANY OFFERING MATERIAL RELATING TO SUCH SECURITIES MAY BE MADE IN OR FROM ANY JURISDICTION EXCEPT IN CIRCUMSTANCES WHICH WILL RESULT IN COMPLIANCE WITH ANY APPLICABLE LAWS AND REGULATIONS AND WHICH WILL NOT IMPOSE ANY OBLIGATION ON BARCLAYS OR ANY OF ITS AFFILIATES. THIS DOCUMENT DOES NOT DISCLOSE ALL THE RISKS AND OTHER SIGNIFICANT ISSUES RELATED TO AN INVESTMENT IN THE SECURITIES/TRANSACTION. PRIOR TO TRANSACTING, POTENTIAL INVESTORS SHOULD ENSURE THAT THEY FULLY UNDERSTAND THE TERMS OF THE SECURITIES/TRANSACTION AND ANY APPLICABLE RISKS. Barclays Bank PLC is registered in England No. 1026167. Registered Ofce: 1 Churchill Place, London E14 5HP. Copyright Barclays Bank PLC, 2009 (all rights reserved). This document is condential, and no part of it may be reproduced, distributed or transmitted without the prior written permission of Barclays. CSNY9008119 12/2009

2009 Year in Review

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ASSET MANAGEMENT SOLUTIONS GROUP

2009 YEAR IN REVIEW

Earn Success Every Day

PICK YOUR MODEL

RAISING THE GAME

PICKING UP THE PIECES

DOWN, BUT NOT OUT

ASSET MANAGEMENT SOLUTIONS GROUP OVERVIEW

2009 YEAR IN REVIEW, WITH A LOOK TOWARDS THE FUTURE

For Institutional Investors Only

ASSET MANAGEMENT SOLUTIONS GROUP

PICK YOUR MODEL

Earn Success Every Day

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II. EQUITY LONG/SHORT

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II. EQUITY LONG/SHORT

Asset Management Solutions Group Hedge Fund Intelligence | December 2009

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FIGURE 2: EQUITY LONG/SHORT RELEVANCE AND KEY BUSINESS MODELS

Relevance of Equity Long / Short Business1

Four Main Business Models

Alchemist Alchemist Model-based Data intensive

Emperor Emperor One-man show Pyramidal

Pure Equity L/S

Low # Funds AuM ($bn) Subjectivity

For Institutional Investors Only

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FIGURE 3: KEY CHARACTERISTICS OF EQUITY LONG / SHORT BUSINESS MODELS

Mercenary Talent Manager

Emperor Investment Manager

Alchemist 10% 0 Research Manager

No 2030% 37% None

Yes1 2030% 49% Sector, Geo & Style

Yes 010% 87% None

12x Pos. Size / Sec. Exp. ~10 Low

24x VaR / Drawdowns N/A4 Medium High

24x Pos. Size / Sec. Exp. ~5

48x VaR ~50

Asset Management Solutions Group Hedge Fund Intelligence | December 2009

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3.205 Width 2.75 Height

3.205 Width 2.75 Height

For Institutional Investors Only

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0% Increase Maintain Decrease Increase Maintain Decrease Increase Maintain Decrease

0% Increase Maintain Decrease

Asset Management Solutions Group Hedge Fund Intelligence | December 2009

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FIGURE 6: INVESTOR SENTIMENTS ON RESTRUCTURED HFS

Q: Do you approve / disapprove of the following actions?

Not Open to Investing

Raise gates to protect value

Restructure to manage liquidity

Lower fees for longer lockups

FIGURE 7: MULTI-STRATEGY SEGMENTATION

MS Segmentation and Proposed Value-Add High

Q: What do you think is the ideal # of sub-strategies within an MS? # Strategies

>10 Diversified 610

57% Have Preference 70% 5 Focused

Low Low # of Strategies High

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