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Hedge Fund Analysis Founded in 1807, John Wiley & Sons is the oldest independent pub- lishing company in the United States. With offices in North America, Europe,Australia,andAsia,Wileyisgloballycommittedtodevelopingand marketing print and electronic products and services for our customers’ professionalandpersonalknowledgeandunderstanding. TheWileyFinanceseriescontainsbookswrittenspecificallyforfinance and investment professionals as well as sophisticated individual investors and their financial advisors. Book topics range from portfolio manage- menttoe-commerce,riskmanagement,financialengineering,valuationand financialinstrumentanalysis,aswellasmuchmore. Foralistofavailabletitles,visitourWebsiteatwww.WileyFinance.com. Hedge Fund Analysis An In-Depth Guide to Evaluating Return Potential and Assessing Risks FRANK J. TRAVERS, CFA John Wiley & Sons, Inc. Copyright(cid:2)c 2012byFrankJ.Travers.Allrightsreserved. PublishedbyJohnWiley&Sons,Inc.,Hoboken,NewJersey. PublishedsimultaneouslyinCanada. Nopartofthispublicationmaybereproduced,storedinaretrievalsystem,ortransmittedin anyformorbyanymeans,electronic,mechanical,photocopying,recording,scanning,or otherwise,exceptaspermittedunderSection107or108ofthe1976UnitedStatesCopyright Act,withouteitherthepriorwrittenpermissionofthePublisher,orauthorizationthrough paymentoftheappropriateper-copyfeetotheCopyrightClearanceCenter,Inc.,222 RosewoodDrive,Danvers,MA01923,(978)750-8400,fax(978)646-8600,orontheWeb atwww.copyright.com.RequeststothePublisherforpermissionshouldbeaddressedtothe PermissionsDepartment,JohnWiley&Sons,Inc.,111RiverStreet,Hoboken,NJ07030, (201)748-6011,fax(201)748-6008,oronlineathttp://http://www.wiley.com/go/ permissions. LimitofLiability/DisclaimerofWarranty:Whilethepublisherandauthorhaveusedtheir besteffortsinpreparingthisbook,theymakenorepresentationsorwarrantieswithrespectto theaccuracyorcompletenessofthecontentsofthisbookandspecificallydisclaimanyimplied warrantiesofmerchantabilityorfitnessforaparticularpurpose.Nowarrantymaybecreated orextendedbysalesrepresentativesorwrittensalesmaterials.Theadviceandstrategies containedhereinmaynotbesuitableforyoursituation.Youshouldconsultwitha professionalwhereappropriate.Neitherthepublishernorauthorshallbeliableforany lossofprofitoranyothercommercialdamages,includingbutnotlimitedtospecial, incidental,consequential,orotherdamages. Forgeneralinformationonourotherproductsandservicesorfortechnicalsupport,please contactourCustomerCareDepartmentwithintheUnitedStatesat(800)762-2974,outside theUnitedStatesat(317)572-3993,orfax(317)572-4002. Wileyalsopublishesitsbooksinavarietyofelectronicformats.Somecontentthatappearsin printmaynotbeavailableinelectronicbooks.FormoreinformationaboutWileyproducts, visitourWebsiteatwww.wiley.com. LibraryofCongressCataloging-in-PublicationData: Travers,FrankJ. Hedgefundanalysis:anin-depthguidetoevaluatingreturnpotentialandassessingrisks/ FrankJ.Travers.–1sted. p.cm.–(Wileyfinance;778) Includesindex. ISBN978-1-118-17546-0;ISBN978-1-118-22710-7(ebk);ISBN978-1-118-23756-4(ebk); ISBN978-1-118-26474-4(ebk) 1.Hedgefunds.2.Riskmanagement.I.Title. HG4530.T6952012 332.64’524–dc23 2012010597 PrintedintheUnitedStatesofAmerica 10987654321 I dedicate this book to my wife Tara and my children, Brendan, Sean, and Lauren. My writing skills are insufficient to properly describe how much I love and am inspired by each of you. Thank you for bringing such joy to my life. Contents Introduction xi PARTONE Background CHAPTER1 HedgeFundHistory 3 SoWhoInventedtheHedgeFund? 4 TheSamurai 4 TheAcademic 5 TheLegend 14 TheInnovator 17 CHAPTER2 HedgeFundAssetClass 29 Definition 29 HedgeFundStructure 31 HedgeFundStrategies 32 AdvantagesofAllocatingtoHedgeFunds 43 HedgeFundSizeandAgeImpactsPerformance 52 PARTTWO HedgeFundDueDiligence CHAPTER3 DueDiligenceProcess 57 KeyAreasofFocuswithinEachComponentofDueDiligence 57 TheDueDiligenceProcessHighlightedinThisBook 60 vii viii CONTENTS PuttingItAllTogether 67 SomeInitialThoughts 70 CHAPTER4 InitialDataCollection 77 DataCollection 78 DueDiligenceQuestionnaire(DDQ) 80 FictionalCapitalManagement 80 OtherMaterials 106 FurtherAnalysis 108 13FAnalysis 116 HedgeFundJournal 119 CHAPTER5 InitialInterview 121 InitialCallorMeeting 121 PhoneInterviews 122 MeetingNotes 139 CHAPTER6 QuantitativeAnalysis 145 PerformanceMeasures 146 AbsoluteReturnMeasures 146 AbsoluteRiskMeasures 154 Regression-BasedStatistics 164 PeerGroupAnalysis 168 CHAPTER7 PortfolioAnalysis 173 AttributionAnalysis 174 FundamentalAnalysis 189 EvaluatingPortfolioData 193 CHAPTER8 OnsiteInterviews 217 OnsiteMeetingStrategies 219 One-on-OneMeetings 219 MeetingwithMoreThanOnePerson 222

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Copyright c 2012 by Frank J. Travers Primer on interviewing skills The hedge fund industry is generally linked historically to Alfred Winslow or 100 percent (equities plus bonds) and a net equity exposure of 80 percent.