Ferd Alternative Investments - 2010 summarized
Ferd Alternative Investments has approximately NOK 4.0 billion of funds under management, allocated between the five portfolios of Hedge Funds (38%), Special Investments (10%), Special Opportunities (14%), Equity Funds (20%) and Private Equity (18%).
- Attractive investment opportunities continued to be available in 2010, although the pricing of financial assets looks to be well on the way to recovering to more normal levels following the financial crisis
- Sound gains secured for the Special Opportunities portfolio
- Satisfactory return from the Hedge Funds portfolio
- Launch of a Special Investments portfolio to take advantage of Ferd’s competitive advantage in the future
On 1 January 2011, the business area changed its name from Ferd External Managers to Ferd Alternative Investments. The background to the change of name is that the business area has steadily increased the scale of its direct investment in the financial markets over recent years, and this trend is expected to continue. Investments made through funds managed by external partners now represent only part of the business area's activities.
Hedge Funds. 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 hedge fund 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 investment return generated is measured in the same currency.
In view of the major macroeconomic imbalances that were in evidence at the start of 2010, we expected the financial markets to be more volatile than normal and anticipated that this would create favourable market conditions for some types of hedge fund strategy. Looking back on the year, market conditions were indeed volatile but the returns seen in the hedge fund market were, in general, not as high as might have been expected. Many fund managers have demonstrated that the degree of correlation between similar assets was relatively high throughout the year, and this made it difficult for them to use volatility to their advantage.
Ferd’s hedge fund portfolio achieved an investment return of 5.2% in 2010, while the benchmark index we measure ourselves against gained 5%.
Ferd has now invested in hedge funds for five years, and its experience over this period has been very pleasing. NOK 100 invested in the portfolio at the start of 2006 was worth NOK 134 at the end of 2010. This represents an annual return of 6.1%. The equivalent amount invested in accordance with our benchmark for hedge funds would have grown to NOK 109. The total out-performance by the NOK 100 investment is accordingly NOK 25, showing that Ferd's portfolio has outperformed the reference index by 4.4 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 113 and NOK 132 respectively. If the comparison also takes into account that Ferd's portfolio has shown lower volatility than the hedge fund market, and markedly lower volatility than the stock market, the risk-adjusted outperformance is seen to be extremely good.
Special Investments. At the start of 2010, the business area took the initiative to establish a new portfolio with the objective of benefiting 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 new portfolio builds on the ideas behind the Special Opportunities portfolio. The feature the two portfolios have in common is investment in 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 fund units. 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. While conditions in many financial markets appear to have normalised, it seems to us that the secondary market for hedge fund units is still affected by the after-effects of the financial crisis. This is demonstrated by some degree of imbalance between the number of buyers and sellers of hedge fund units in the secondary market, and this situation works in our favour.
At the close of 2010, the portfolio held approximately NOK 400 million of investments in a number of such funds. This gives a well-diversified international exposure to both fixed-income and equity markets. All the 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.
The business area has also evaluated a number of direct investment opportunities with a Norwegian basis, including both equity-based investments and various types of credit market investment. For various reasons, none of these opportunities has yet resulted in an investment being made, but we will continue to investigate this kind of opportunity.
Special Opportunities. This portfolio was first established in April 2009, and investments totalling NOK 600 million were made over just a few months. The portfolio is relatively evenly divided between high yielding Norwegian bonds, subordinated bonds issued by banks and financial institutions and hedge fund units purchased in the secondary market.
When this portfolio was first established, it was far from certain that it would achieve the very positive performance we have subsequently observed. Although the cost prices of these investments looked to be attractive, we still took the view that it could take 2 to 3 years to realise any gains. Moreover, we could not exclude the possibility that market conditions would deteriorate further in the meantime, and we therefore placed great importance on finding investments that incorporated the best possible protection against downside risk if the downward market trend continued. The objective was to make the total value of the portfolio less dependent on movements in the equity and bond markets, and more closely linked to concrete events through each investment choice that was made.
Market conditions have normalised far more quickly than most observers had expected. It appeared that much of the portfolio's potential return had already been achieved by the first half of 2010, and the decision was taken to realise the portfolio in a controlled manner over the remainder of the year. The disposals that have taken place so far have realised approximately NOK 820 million, and the remainder of the portfolio has a market value slightly in excess of NOK 110 million. This represents an overall return of around NOK 330 million, equivalent to an annualised return of just over 50%. The portfolio showed growth in market value in 2010 as in 2009, even though the general recovery in prices in the financial markets was much stronger in 2009 than in 2010. Every investment held by the portfolio has generated a positive return over the period.
Equity Funds. The assets of the Equity Funds portfolio are invested in index funds that offer a broad exposure to global stock markets. This type of fund offers exposure to the markets in a liquid and cost-effective manner. This form of investment has been used since Ferd's units in actively managed equity funds were sold in autumn 2008.
The value of the portfolio at the close of 2010 was approximately NOK 830 million. This represented an increase of NOK 90 million for the year, equivalent to a return of almost 12%.
Private Equity. The portfolio comprises investments in six funds, and was built up over the period from 2005 to 2008. Ferd's total commitment to these funds is NOK 1.2 billion. By the close of 2010, approximately NOK 800 million of the total commitment was invested in funds, and the reported estimated value of these investments was a little over NOK 750 million. The unrealised loss of NOK 50 million was due mainly to falls in the value of the funds, but also reflected currency effects when translating the value of fund investments to NOK.
Ferd Alternative Investments has not made any new investments in Private Equity funds over recent years, and does not currently have any immediate plans for new investments in this asset class.
Ferd Alternative Investments received NOK 200 million from the group in 2010. This additional capital was used to meet investment commitments in respect of private equity funds. The new Special Investments portfolio was financed with capital released by the rundown of the Special Opportunities portfolio.
Market conditions and future prospects
After the strong market rally seen in 2009, market conditions continued to improve in 2010. However, the pace of improvement was significantly slower than in the previous year, with large variations from month to month. The markets were caught up in a tug of war between good corporate earnings at the micro level and increasing concerns over macroeconomic imbalances, particularly worries over public sector debt in Europe.
We believe that we are now facing a relatively wide range of possible outcomes for market performance in the coming year. It is possible that markets will continue to follow a positive trend if companies continue to report earnings in line with expectations, but the macroeconomic outlook represents a major source of uncertainty. It is clear that, in one way or another, the affected countries have to tackle the challenges represented by the size of their public sector debt and trade deficits. The important question is what policy solutions they will choose, and how this will affect economic growth and, in turn, the financial markets.
The investment management carried out by Ferd Alternative Investments is not based on an overall market view to any great extent. 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.
We intend to prioritise our work on hedge fund opportunities in 2011, both with the ordinary Hedge Funds portfolio and through the Special Investments portfolio. We are also prepared to consider direct investments, but only where these are a good fit for our investment criteria and make use of Ferd’s comparative advantage.