Ferd Alternative Investments - 2011 summarised
Ferd Alternative Investments has approximately NOK 3.9 billion of funds under management, allocated between the four portfolios of Hedge Funds (39%), Special Investments (36%), Private Equity (22%) and Fixed Income (3%).
- Investing in the secondary market for hedge funds has produced a sound return for the Special Investments portfolioTwo new appointments to the Alternative Investments team, which now has four employees.
- Our hedge fund portfolio outperformed hedge funds in general, but the performance of the hedge fund market has been somewhat disappointing
- Positive results from increased exposure to reinsurance, despite a year which saw many serious natural disasters
Ferd’s objective for the management of its hedge fund investments is to achieve a satisfactory risk-adjusted return over the longer term, both relative to the market and in absolute terms. In addition, the hedge fund investments are intended to represent a risk-reducing factor in the group's overall portfolio.
The portfolio comprises investments in funds that are judged to have good investment managers and that represent a range of strategies. A key factor in the analysis carried out to select investment managers is differentiating between return created by general market movements and return created by the manager's performance.
In order to achieve good risk diversification, it is important that the composition of the portfolio features a range of funds which generate returns that are not dependent on the same factors. In addition, the hedge fund portfolio will normally have a relatively small weighting in funds that are heavily exposed to the stock market, since a large proportion of the group's other investments are exposed to stock market factors.
The portfolio is invested in USD denominated investments, and the currency exposure is hedged against the Norwegian krone.
Macroeconomic imbalances were again a main theme in 2011, and the debt crisis in Europe was the main source of market uncertainty. The markets saw rapid changes in risk appetite, leading to high volatility for most asset classes. These market conditions should in theory have been favourable for hedge fund managers, who are more interested in volatility than in the overall market direction. Despite this, the major hedge fund indices showed losses of 3-6% over the course of 2011. A recurring explanation from hedge fund managers is that markets have principally been driven by political developments in connection with the EU debt crisis rather than by fundamental factors at the micro level.
Measured in US dollar terms, the value of Ferd’s hedge fund portfolio fell by 2.6% in 2011, while the benchmark index we compare ourselves against fell by 3.6%. The return in Norwegian krone terms for the year was a loss of NOK 9 million.
Reinsurance is an area of investment that we have followed with great interest over a number of years. Reinsurance can offer an attractive risk-adjusted return, and it is also attractive because it is an area that is little affected by the overall performance of the financial markets in which Ferd invests. In 2011 we identified two investment managers that specialise in this area, and transferred a little over 10% of the total hedge fund portfolio to the funds they manage.
Ferd has now invested in hedge funds for six years, and its experience over this period has been very pleasing. To illustrate, NOK 100 invested in the portfolio at the start of 2006 has grown to NOK 130 at the end of 2011. This represents an annual return of 4.6%. The equivalent amount invested in accordance with our benchmark for hedge funds would have grown to NOK 105. The total out-performance for the NOK 100 investment is accordingly NOK 25, showing that Ferd's portfolio has outperformed the reference index by 3.8 percentage points annually. By way of comparison, investments of NOK 100 in the global equities index and in the Oslo stock exchange would have grown to NOK 107 and NOK 116 respectively. If the comparison also takes into account that Ferd's portfolio has shown lower volatility than the hedge fund market, and only around 25% of the volatility seen in the stock market, the risk-adjusted outperformance is seen to be very good.
This portfolio was established in May 2010. The portfolio's objective is to benefit from investment opportunities which Ferd is well placed to evaluate and hold, but which fall outside the group's other investment mandates.
The core investment philosophy for this portfolio builds on the ideas behind the Special Opportunities portfolio. The feature the two portfolios have in common is financial investments where there is a favourable balance between the potential return and the risk of loss. We attach particular importance to being able to identify one or more ways in which every investment in this area incorporates protection against downside risk.
So far, we have largely concentrated our efforts on the secondary market for hedge funds. This is a niche market, where we make use of the insight we have developed through our regular hedge fund portfolio and combine this with other aspects of Ferd’s particular competitive advantage. We saw a good flow of attractive investment opportunities over the course of 2011.
This portfolio holds investments in around 50 hedge funds, which gives a well-diversified international exposure to both credit and equity markets. All the fund units were purchased at a significant discount to reported market value. Our research focuses on identifying fund units that are trading at significant discount to the underlying portfolio value where we believe that the fund managers have the right skills and incentives to realise the underlying value in a controlled manner.
At the close of 2011, the value of the portfolio was approximately NOK 1,4 bn. Funds allocated to the portfolio since its launch total NOK 1,250 million, and the year-end value represents a return of NOK 150 million. The performance of the portfolio is measured against an index which reflects the performance of the three markets in which we could have instead invested these funds: hedge funds, global equities and credit. If the portfolio had been invested in these indices in the same period, it would have fallen in value by approximately NOK 10 million. For the 2011 financial year in isolation, the portfolio produced a return of NOK 140 million, but investment in the benchmark index would have represented a loss of almost NOK 30 million.
The portfolio comprises investments in six funds established over the period 2005 to 2008. Ferd's total commitment to these funds is around NOK 1.2 billion. By the close of 2011, approximately NOK 930 million of the total commitment was invested, and the funds have repaid NOK 30 million. The reported estimated value of these investments is a little under NOK 860 million, representing a negative portfolio return of around NOK 40 million since the start. The return for 2011 is estimated to be a decline in value of NOK 27 million.
Over recent years, new investments in private equity funds have not been a priority for Ferd Alternative Investments.
Credit is an asset class in which Ferd invests on an opportunistic basis, and it is accordingly not a permanent portfolio for Ferd Alternative Investments.
Towards the end of 2011, we invested in bonds issued by a Norwegian financial institution. The rationale for this decision was that the credit rating of the institution in question had been sharply downgraded by two of the leading credit rating agencies, and this caused selling pressure which reduced the market value of the bonds very substantially. This investment is expected to generate an attractive return in relation to the risk involved.
At the close of 2011, the value of the Fixed Income portfolio was NOK 120 million, with a return for the year of NOK 7 million.
The remaining positions held by this portfolio were sold in 2011.
NOK 600 million was invested in this portfolio in 2009, and the decision was taken in spring 2010 to realise the gains achieved by running down the portfolio in a controlled manner. The run-off generated NOK 954 million, representing a gain of NOK 354 million. This represents an annualised return (internal rate of return) of almost 50%.
This portfolio was closed in 2011. The portfolio's assets were invested in index funds which provided a broad exposure to global stock markets in a liquid and cost-effective manner.
Ferd Alternative Investments received approximately NOK 100 million net from the group in 2011. NOK 120 million was applied to meet investment commitments in respect of private equity funds, and NOK 20 million was realised from the Hedge Funds portfolio.
MARKET CONDITIONS AND FUTURE PROSPECTS
Global equity markets fell by around 5% in 2011. The overall performance hides some relatively large regional differences. Global credit markets gained around 6% in value, but here too performance varied between different segments and geographical areas.
Frequent and at times pronounced changes in risk appetite among investors dominated the financial markets in 2011. The markets focused their attention principally on Europe and the political response to the debt crisis. Investor sentiment, and hence the overall direction of the market, was largely driven by political pronouncements and actions. The markets saw their largest falls in August in connection with the downgrading of the USA's credit rating.
We think it likely that overall macroeconomic themes will continue to dominate market developments, and we expect to see sizeable volatility and a broad range of possible outcomes for market direction over the course of the year. While the measures taken by central banks and the authorities to provide liquidity have helped to keep the markets in operation and have created a somewhat more positive outlook, there are still very good reasons to believe that more comprehensive political decisions will be needed in order to secure a sustainable long-term solution.
The investment management carried out by Ferd Alternative Investments is not based on an overall market view to any great extent, and we have no intention of trying to forecast the future direction of financial markets. Our activities are focused on finding investment opportunities, both in the form of hedge fund investments and direct investments, where the principal common feature is an attractive potential return balanced by sound protection against downside risk. If our approach is successful, we will achieve a good return over the longer term regardless of short-term changes in market direction.
In 2012, we will continue to prioritise our work on hedge fund opportunities, both with the ordinary Hedge Funds portfolio and through the Special Investments portfolio. We are also prepared to consider new investment opportunities that may arise, but only where these are a good fit for our fundamental investment criteria and for Ferd’s comparative advantage.