The Evolving Art of Hedge Funds

Thank you very much and good morning everybody. Um I've got two CEOs and a CIO. So I think we've got some pretty good insights amongst my group here. So um thank you very much for joining me. uh our subject we're looking at hedge funds how they use risk management not just to control risk but actually how that might feature into uh the generation of alpha opportunities in their portfolios and it's often cited certainly I hear from investors that one of the big appeals of hedge funds to them uh is the sophisticated riskmanagement practices that they adopt and uh and utilize in everything that they do obviously in times of heightened uncertainty and volatility, this becomes uh all the more important.

And it's it seems very clear from recent surveys that investors are actually uh signaling their intention to put more money rather than less money to work in hedge funds at the moment. And I think that's quite interesting to think about why they might be doing that for better risk adjusted streams for um uh reducing the correlation after long runs in the equity markets um and perhaps to get some more diversification in their portfolio. So uh link will just dive straight in and and really try and understand what that term sophisticated risk management looks like particularly amongst uh uh large manager firms like um man Group and and Brevin Howard. So Robin I'm going to turn to you first and you know there's there's a lot that's been going on in recent years as the quantitative and technology developments have just you know just carried on at such a pace. How is that changing risk management in in in your firm and and kind of how are you putting that to work?

Not just for risk control, but actually also for identifying opportunities in the market.

I mean, thank you for having us. Um, well, risk is what we do. It we come into work every day and we manage risk. That is fundamental to who we are. And whether that's within quantitative strategies and the hard coding and the the capabilities that you have within those strategies or whether it's in your discretionary in your fundamental business, it's critical to being smart about what you're doing and how you're doing it.

I think there's something else to it. I think we think about risk as this sort of thing sometimes that sits on the side. It doesn't. It sits as every part of our organization. You use every tool capable to you and whether that's the technology you have to understand real time risk or the capability of understanding correlated or uncorrelated risks diversification whether you are thinking about how you are capturing alpha and how you retain that within your within the structure so that you return that to clients risk is at every part and in every part of the organization

and and thanks Robert but Aaron could you talk about it at B I mean because you've moved on from being um traditionally a macro hedge fund. You've got multi strategies uh right across the organization including digital assets a very significant component which perhaps many people in the audience um out there think the digital assets is a huge amount of risk and how do you manage that talk a bit about how you your approach and and particularly the the quantitative techniques that you're using at looking at that risk and using it to your advantage.

Sure. Reverend Howard's approach is really a synthesis of the portfolio manager and the risk manager working in harmony together. My experience is that for the discretionary portfolios that we run, which covers most of the breadth of activity in Brevin Howard, it's essential to have the portfolio manager who's mostly focused on delivering the returns working in complete harmony with the risk team and the risk management analytics to ensure that the portfolios that are selected and decided are ones which can deliver the returns and at the same time within the constraints of the risk that is tolerated by the individual mandate. And to do that, we look at a wide range of risk factors. Counterparty risk, market risk, liquidity risk, but mostly we're focused on stresses and the type of extreme tale risk that can happen from time to time as we saw earlier this year in April around the liberation day and the marker reaction to the announced tariffs uh that the US presidency promulgated in the Rose Garden that day in April.

So those are the type of risks that we always think about. Every portfolio that we run has an objective but it also has a risk tolerance and that harmony between the focusing on the upside and focusing on the downside is the essence of everything that we've done in Brevin over the last 20 years and Jack as you mentioned I was responsible for risk for a big chunk of that. So I I'm been focused on the risk side for a long time but in the last five six years been very much more focused on the upside as well. So it's that harmony which is the essence of Brevin Howard and perhaps is the essence of my part of Reverend Howard as well.

Thanks Aaron. You talked about liberation day where there was an enormous spike in volatility at that time and we'll come back a little bit later on about how we think about volatility and uh and what happens during those particular times of real spikes. Um but shape going to turn to you. You're an allocator to hedge funds. Um let me ask you this for the start.

Um you know I made that premise at the beginning that people think about hedge funds, they like hedge funds um uh if they're going to invest in them because of sophisticated risk management. Why is that true across the entire hedge fund industry? I do you see differences u between the managers that um uh that you look at in terms of their risk management expertise and their practices and then also secondly what as an allocator what how do you want that risk reported to you what risk reporting do you demand from from your managers and the funds in which you're invested that help you in doing the job that you're doing

good morning everybody pleased to be here uh well the nirvana would be to get full transparency, you know, so that that would be uh the the absolute uh northstar from a risk perspective. So, uh we really know what's entirely happening from a portfolio perspective. Uh but what we emphasize uh when we look at any hedge funds uh over the last 18 years that I've been at ADIC is um ensuring that we invest with firms who have risk at the center of everything that they do and they are positioning the portfolio with a key tenant of diversification. We do believe that diversification is one free lunch and we want our funds to think in those terms and uh where they are building portfolios which are convex and long wall in its orientation. Uh and the reason why we do that is in years like 2022 our portfolio was up uh 8.

5% net you know you know the 7030 uh was down around 18%. uh and it's a liquid portfolio. So it's not like we are taking liquidity risk and get benefits of marks. Uh and then now if you look at our track record in other periods like this year for instance touchwood so far we are up about 13%. Last year we're up about 14% on a five and seven year basis we are up uh north of 10% uh or even 11 11 and a half%.

So the reason uh is we our beta is around 02 to.3 as our overall portfolio and with regards to your question on u reporting we ensure if we don't get full transparency we try to ensure that uh we get uh independent uh exposure reports uh directly from the administrator into uh report aggregating reporting risk reporting agencies like riskmetrics. So that is something that is critically important for us. Uh so we have a risk team. What is unique about within ARIC?

We have the firmwide risk group that looks at risk across uh ADIC. And in addition to it, we are the one unit at ARIC uh which is the public markets team that has a risk unit sitting side by side with us. You can think of it like front office risk uh both from a market risk perspective as well as an operational due diligence perspective. And I can't tell you and this was something that I'd emphasized when I joined uh long back and and that has been incredibly helpful because the risk team and and the investment team sits side by side and calls and any conversations they get to hear what what is happening. So uh and I think it's incredibly helpful because hedge funds at the end of the day is a liquid asset class and it is an asset class where things evolve and change.

So you have the flexibility to take action if you catch it early or if you see changes in um you know concentration risk or liquidity risk which does happen in funds for a variety of reasons from time to time and uh so it's almost like close to real time uh you know risk management I as so we expect reports to come in timely we we want full transparency and if we don't get full transparency we we get uh transparency directly through an administrator from risk metrics which we aggregate and we have all the various risk tools like stress analysis and all of that we stress the portfolio for a variety of different market conditions

and what by full transparency just to be clear you want line by line portfolio

yes that would be ideal I mean if you can get full line by in in certain cases we absolutely do get that and we enforce that I think we have and partly because I think we have the benefit of having a close partnership uh and we have a significant partnership. We run a concentrated book. Uh we tend to get that where we can if and if we don't get it, we go for plan B which is what I said through risk metrics

and I'm sure you give it to them.

Absolutely. And I think what's what's really good about these conversations is that more and more if if I could say one of the things that's changed over time is that engagement with clients who want to speak to your chief risk officer. They want to see that reporting and they want to see that stress reporting undertaken. So that you're they're helping being part of a partnership to position a portfolio and position the contents of that portfolio so it performs through different market cycles. I think if the last couple of years has demonstrated anything, it's that the engagement with clients to understand risk, understand the positioning of the portfolio, understand how that portfolio is supposed to perform in these different cycles.

When we lived through 2022, we saw the correlation between equities and bonds. Classic example, right? Where you think, hang on a second, these were supposed to be something that that provided a hedge position. Not so much. So, what are the conditions that give rise to that?

What is the tail risk? What is the draw down risk? How are you focused? What does the portfolio do in these circumstances? It's inherently part of now what we deliver and how we talk with allocators across the world.

It's table stakes in what we do.

Right.

Sorry. I I just wanted to add that the overwhelming reason why uh the majority of our LPs trust us with their assets is the diversification benefit of many of our strategies which can um when they're placed in a broader portfolio and that diversification benefit is something that naturally arises from the n from the strategies themselves. But it's also something that sophisticated investors like ship um are increasingly attuned to and increasingly uh desirous of checking and monitoring and observing because it's obvious that the alternative industry more broadly contains a range of strategies. Some are diversifying which can be very helpful in a portfolio allocation context and other strategies which are less diversifying and maybe more correlated and identifying the differences is of course super important. We know for all of our LPs.

There are a broad range of approaches and some of the most sophisticated investors uh do require the more detailed type of reporting which sh mentioned and others are I have to say content with a lesser degree of transparency and we try to cater to everybody uh in the best possible way but that essence of the purpose of our existence as alternative managers and the provision of diversifying strategies ies strategies which as Robin was saying don't necessarily just correlate with equities or bonds is really important. We know that that's a driver for the LP decision and that's something which justifiably should be checked from time to time.

Great. Great. And so I want to touch just very briefly on that volatility as a concept um just before as really as a segue to the final part where I'm I'm going to eek out a view where you think the best risk adjusted returns might be as we look forward um to the next year or so. But it's often said that volatility is the friend of hedge funds that it presents opportunity uh for hedge funds and certainly we've had very volatile periods this year not just in the equity markets but also uh in the government bond markets as well but there's also been times in history when the markets have been very volatile and hedge funds haven't performed very well. So ask the question is there such a thing as as as the right kind of volatility?

Difficult question that one. But Robin, you'll get a difficult question. I'm gonna ask you.

I love I'm getting these questions. Okay, let's let's give it a shot then. Um, hedge funds alternatives tend to talk about volatility providing opportunity and I think they do. Um, they provide opportunity not least in markets like this because there's also dispersion and when there's volatility and dispersion that gives us opportunity to find alpha and outperformance. Um, so so Yes, we like a bit of volatility.

Yes, we like a bit of dispersion. It gets us in the crosshairs of what we should do well for allocators. That is what we're here to do. Is there bad volatility? Well, there's bad volatility when um certain strategies require a little bit more predictability in in in the world.

And so whipsaw volatility that sort of um for example announcement on a tariff one day and then a withdrawal of that the next that is much harder but that's harder for all markets and but it certainly is harder if you've got certain strategies that are looking for some different type of signals over a number of weeks rather than a number of hours. But volatility broadly dispersion gives us opportunity to find out performance.

I think that's a key point. Dispersion has to go hand in hand.

Dispersion has to go hand in hand. And you're seeing that in markets now. If you look at some of the opportunities with fiscal stimulus across Europe and outside of the US, these are times when at the beginning of this year in January, we had a little bit softer view perhaps on Europe. I think right now in December with what's gone on through this year, we're seeing quite interesting opportunities that appear across Europe and across other parts of the world um outside of the US core capital markets. So dispersion really really important in this discussion.

Brilliant. Well, listen, Mission Impossible. I see we've got five minutes left and what I really want to try and do here is is is get out of you and I'm going to start with you first, but with everything we know now, we we're in markets. I think most people would agree there's a lot of uncertainty out there. Volatility is fluctuating around the place.

We're at the end of the year. Everyone starts thinking what the next year will bring. So from your point of view when you're thinking about trying to identify the best risk adjusted adjusted returns amongst the various different hedge fund strategies that are at your disposal, how are you thinking about 2026 at this stage as to where you're going to achieve that?

Sure. uh 2026 I mean we have a midterm elections in the US and so that's certainly likely to create a lot of volatility we are potentially we are already in a path of a fed easing cycle so the fixed income markets are clearly in play will the Fed won't the Fed how much would the Fed and likewise a few other markets uh there is elections in Brazil depending on the candidate you saw on Friday the Brazilian markets was down six and a half% uh but with pain comes opportunities down the line and uh so there are lots of opportunities. So the one asset class we really like uh you you alluded to markets have done well. So one has to always have one foot on the ground when you're when you're aiming for the sky in this type of market to make sure if there is volatility and things do turn the other way we are able to partake. So we like macro strategies very much uh and uh they are tend to be long volatility in their orientation.

They capture dispersion across markets and political cycles incredibly well. Um and those strategies did really well for us in 2022 along CTAs did well. So we like that. Uh within equities we continue to like the AI opportunity. I think in this uh very uh event last year I recalled saying I like AI and biotech and they have been big winners.

I continue to like them uh because I think uh innovation is something that's a high alpha strategy but what has changed as far as AI is concerned is it seems to me like we are in the middle third to use a baseball analogy of a nine inning cycle and uh and so it is as Robin was highlighting a more dispersion trade. you're going to have winners and losers and uh and so that but but then you you I I continue to think that that's a structural opportunity and there will be winners and and you're going to get paid for that as long as you have protection on the other side. Biotech we we've always liked it. We continue to like it as well. And um and I feel like US markets there's a strong incentive.

I mean people talk about valuations on the top but we could be surprised uh you know on the upside uh you know given that there's a strong incentive for the current administration uh to make sure that the markets are well bid. So

yeah going to cut in there because I saw Aaron actually he he had a rise smile actually when you said you like macro and fixed income uh for 2026. So, um, do you want to build on that? Um, from what you do, Aaron, if you can hear me. All right. Macro and fixed income, which Shiv has just said, um, uh, he likes for next year.

Well, it's it's undeniable [clears throat] that was saying the dispersion in the in global markets and the tension between the geopolitical blocks is high highly likely to continue. I can't imagine any scenario where the US administration turns around and becomes suddenly China's best friend. Uh so all of those tensions in the markets are are bound to persist and as you said the US midterms coming up. Uh in addition we've got big dispersions in equity markets which all of you I'm sure are very familiar with and also big divergences between the different interest rate markets with markets in the US uh forecasting lower rates and in other countries forecasting rate hikes at the moment. So it's very interesting set of divergences geopolitically which uh should lead to uh volatile markets.

uh interesting opportunities and um good opportunity set for for macros. So I I really concur. And of course then as Sh was partially alluded to, there's the opportunity set set in crypto which of course is the most volatile asset class. There's a packed auditorium um just across the other side uh for crypto stuff, but there's incredible opportunities there. Of course, it's volatile, but that's uh I know we don't have much time left.

So, I just in a couple of words about crypto, I wanted to pass on my usual comment about crypto, which is the biggest risk in crypto is to have no exposure at all. It's a a sector where there'll be some incredible winners and one has to be involved as an investor.

Brilliant. Final word from Robin as you look ahead to next year. A final word from me in 10 seconds is I think a diversified portfolio is your friend. I think that ultimately we're not in a world anymore where passive and private equity alone is going to protect you where you should think about dynamic and defensive alpha as much as you should think about diversification in the upside. And so I think diversification is your key and hopefully you know we can have more conversations about that when we've got more time.

Brilliant. Well, listen, we're out of time. Thank you very very much indeed. Please give a warm hand to my panel. Um and thank you very much for joining us this morning.

Thank you.