Copyright © 2018 T Leitch & J Liew
Agenda
- Review group assignments
- Long/Short
- “13-F for you”
- Gross vs Net
- “Uncovering HF Skill from the Portfolios Holdings They Hide” Agarwal et al. (2013)
- Paulson & Co Example
- Merger Arb
- Cash Only
- Stock for Stock
- Merger Arb Index
- Merger Arb Products
Long/Short
- Long/Short generally refers to an investment strategy employed by hedge fund managers who typically trade stocks. Stocks that are expected to increase/decrease in value are purchased/sold short.
- Typically, managers will make investments based on fundamental analysis.This category may contains sector-specific managers as well as those that trade across global markets.
- Useful Terms: Gross and Net exposure
- Number of positions: ~20-60
- Long/Short returns are characterized as having “market” exposure but typically have less volatility than a long-only managers.
- Mutual funds have began to offer 130/30 products in direct competition to hedge fund long/short products.
“Gross” vs “Net” Exposure
In order to better understand the risks associated with long/short hedge funds, investors will ask about their “gross” and “net” exposures.
What is this?
Gross Exposure = Total $ Long + abs(Total $ Short)
Net Exposure = Total $ Long – Total $ Short
\[ Total \$ Long = \Sigma^{k}_{i=1}(SharesLong_{i}*Price_{i}) \]
\[ Total \$ Short = \Sigma^{m}_{j=1}(SharesShort_{j}*Price_{j}) \]
Pop Quiz on Gross/Net
Suppose manager A has $100m long, $50 m short. What is her gross and net exposures?
Answer
Gross = $100m + abs(-$50m) = $150m Net = $100m - $50m = $50m
Assuming she had $100m of assets, some refer to Gross as 150% ($150m/$100m) and Net of 50% ($50m/$100m)
How can you learn from the best Long/Short (value) managers?
Let’s make some assumptions… and learn!
- Let’s try to examine what they are holding? How?
- What are the benefits?
- Limitations?
- Will this be a useful exercise?
“13-F for you”
Background: Institutional investment managers with more than $100m, must report their holdings in Form 13F with SEC. Positions are publically disclosed within 45 days after the end of each quarter.
Some say that: “13F information is released with such a long lag, this can’t be useful…”
http://www.sec.gov/answers/form13f.htm
Paulson’s 13-F top positions over the past 3 quarters
Let’s examine the historical performance of the 5 largest positions from 9/30/2012: What portion of his portfolio does the 5 largest position represent? Did he beat the “market”?
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Let’s look at Paulson’s recent holdings…
“Uncovering Hedge Fund Skill from the Portfolios They Hide”
Background Info
- The 13F rule give the SEC discretion to delay disclosure if the information is deemed “necessary or appropriate in the public interest or for the protection of investors”
- Thus, filers may request confidential treatment for certain holdings on their 13F pending approval by the SEC
- If the request is denied, filers must reveal those holdings by filing an amendment to their original 13F/A
- HFs account for 56% of all confidential fillings, however only make up 30% of all institutions (eg. HFs, Investment Company/Advisor, Bank and Insurance)
Contributions
- Paper examines performance and informational content of institutional investor’s holdings by incorporating confidential holdings and comparing results to original holdings
- Sheds light on stock-picking abilities of hedge funds
- Documents affect of portfolio disclosure on money managers, especially hedge funds
- Examines mandatory ownership and holdings disclosures rules
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45.7% = (106/232), 30.2% = (942/3,134)
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“The triggering event for the 1998 rule tightening was the confusion over the 13F reporting of investor Warren Buffett, which caused a significant decline in the share price of Wells Fargo & Co. in August 1997. The 13F form did not show Berkshire Hathaway’s well-known 8% stake in the bank because it was reported in a confidential filing. But the misunderstanding in the market caused Wells Fargo’s stock price to drop 5.8% in 1 hour after Buffett’s 13F Filing.”
Hedge Funds — Confidential vs Original Holdings
Statistically Significant Differences:
Stocks are smaller, more value, less analysts’ coverage, higher probability of default, more volatile both absolute and relative, and higher number of announced merger targets in prior year
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How can we combine, 13-F info and publically announced merger info?
First, learn how to implement
Merger Arb:
- Cash and
- Stock for Stock
Merger Arb
- Cash Deal
Ex. Cash deal, Intel acquires McAfee for $48 per share
Deal terms below:
The announcement date is 8/19/2010, what do you think happens to the price of McAfee around the announcement date?
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Announcement date 8/19/2010, price spikes upward toward $48, why not all the way?
Stock for Stock Deal
Ex. Stock for stock deal, FirstEnergy to acquire Allegheny for 0.667 (Aq sh/Tg sh)
Upon completion (0.667 * FE) will equal AYE,
So, trade is to (1) buy the target AYE and (2) sell 0.667 of acquirer FE
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Stock for stock deal: AYE vs 0.667 * FE
Upon completion for every 1,000 shares of AYE, holders will receive 667 shares of FE.
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Pulling it all together, 13-Fs and merger announced deals: Merger Arb Index
Easy Construction
Step 1: Start with a sample list of hedge fund managers that employ merger arbitrage
Step 2: Incorporate publicly available information to find positions
Step 3: Count the number of overlapping positions each quarter, if over 3 positions include in portfolio
Step 4: Hedge accordingly: cash, stock only, stock and cash, stock or cash, exclude exotic deals(collars).
Step 5: Weigh each position by count divided by sum of all counts
Step 6: Re-balance each quarter
Hedge Fund Manager List and Rebalance Date
Hedge Fund Manager List
1. Brencourt Advisors LLC
2. EAC (Soros) Management, LP
3. Eton Park Capital Management, L.P.
4. Glazer Capital, LLC
5. Gruss Asset Management LP
6. Halcyon Asset Management LLC
7. Paulson & Co Inc
8. Shorewater Advisors LLC
9. Taconic Capital Advisors LP
10. Westchester Capital Management, Inc.
Ex. Positions Over Time (Quarters)
Example for 9/30/2009
If deal consummates then leave final-value in index until next re-balancing period.
Historical Back-Test*
Merger Arb Benchmark Index
Annual Returns: 17.4%
Annualized Standard Dev.: 6.0%
Sharpe Ratio (2% Rf): 2.57
232 days from Feb 17, 2009 to Jan 15, 2009
HFRX Merger Arb Index
Annual Returns: 7.6%
Annualized Standard Dev.: 3.0%
Sharpe Ratio (2% Rf): 1.86
231 days from Feb 17, 2009 to Jan 14, 2009
Twice as volatile as HFRX Merger Arb but more than twice the historical returns results in higher Sharpe Ratio
- Please note that this back-test is only indicative and without transaction costs. Past performance is no indication of future performance.
Conclusion
Introduce a simple investable Merger Arb Benchmark Index to benchmark hedge fund managers’ performance
Index construction methodology - unique and theoretically sound combining 13F positions and announced merger transactions
Back-test shows historically strong risk-adjusted returns, yielding a Sharpe Ratio of 2.57 gross of transaction and market impact costs over time-period examined
Will this be useful benchmark for the institutional investors?
Current Merger Arb Products
