The Long and Short Of Hedge Funds: A Complete Guide to Hedge Fund Evaluation and Investing 0471792187, 9780471792185

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The Long and Short of Hedge Funds A Complete Guide to Hedge Fund Evaluation and Investing

DANIEL A. STRACHMAN

John Wiley & Sons, Inc.

C 2009 by Daniel A. Strachman. All rights reserved. Copyright


Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 750-4470, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002. Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic formats. For more information about Wiley products, visit our Web site at www.wiley.com. Library of Congress Cataloging-in-Publication Data: Strachman, Daniel A., 1971The long and short of hedge funds : a complete guide to hedge fund evaluation and investing / Daniel A. Strachman. p. cm. – (Wiley finance series) Includes bibliographical references and index. ISBN 978-0-471-79218-5 (paper/dvd) 1. Hedge funds. I. Title. HG4530.S838 2009 332.64′ 524–dc22 2008028066 Printed in the United States of America 10 9 8 7 6 5 4 3 2 1

OTHER BOOKS BY DANIEL A. STRACHMAN Essential Stock Picking Strategies: What Works on Wall Street (John Wiley & Sons, 2002) Getting Started In Hedge Funds, First Edition (John Wiley & Sons, 2000) Getting Started In Hedge Funds, Second Edition (John Wiley & Sons, 2005) Julian Robertson: A Tiger in the Land of Bulls and Bears (John Wiley & Sons, 2004) The Fundamentals of Hedge Fund Management: How to Successfully Launch and Operate a Hedge Fund (John Wiley & Sons, 2007)

To Felice, Leah, and Jonah

To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks. Benjamin Graham The day is short; the task is great. Ethics of the Fathers Chapter II Verse 20

Contents

Acknowledgments Introduction CHAPTER 1 Hedge Funds Past, Present, and Future The Father of the Hedge Fund Industry Why Invest in Hedge Funds? Understanding the Market What Happened at Bear, and Why Why This Book?

CHAPTER 2 Hedge Funds Today Hedge Funds in the News How Hedge Funds Are Regulated Recent Calls for Regulation Hedge Fund Fees Commission Give-Up Continuing the Jones Legacy

CHAPTER 3 The Men Who Made the Industry What It Is Today A Force to Be Reckoned With Hedge Fund Legends George Soros How Soros Managed Money Michael Steinhardt How Steinhardt Managed Money Julian Robertson How Robertson Managed Money Standing on the Shoulders of Giants

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13 14 16 18 20 22 23

27 28 29 30 31 32 34 36 37 39

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CONTENTS

CHAPTER 4 Running Your Fund Transparently When Good Funds Go Bad What You Can Learn from the Credit Crisis What Went Wrong Perception versus Reality Fraud Information Exchange Giving Your Investors Their Due Explaining Your Strategy Keeping the Lines of Communication Flowing Communicating during a Crisis Jumping on the Hedge Fund Bandwagon The Year of the Hedge Fund Where the Industry Is Heading

CHAPTER 5 How Hedge Funds are Packaged Funds of Funds How a Fund of Funds Works Fund of Funds Economics The Costs of Running a Fund of Funds Fund of Funds Growth Fund of Funds Buyouts Managers of Managers MOM Knows Best The Pros and Cons of Transparency Diversifying Your Portfolio Avoiding Common Problems

CHAPTER 6 How to Raise Money Friends and Family, Referrals, and Perfect Strangers Dialing for Dollars Making Connections Capital Introduction Services Third-Party Marketing Choosing a Third-Party Marketer When to Hire a Third-Party Marketer The Road to Wealth Conducting Reconnaissance A Cautionary Tale

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55 55 57 58 59 61 62 63 64 65 65 66

69 69 69 70 72 73 73 75 77 77 78

Contents

If You Build It, They Won’t Come Finding the Right Investors Taking Your Strategy to the Streets Vetting Your Investors Preparing the Pitch Book A Few Final Thoughts on the Essence of Successful Marketing

CHAPTER 7 The Supporting Staff The Cardinal Rule of Choosing a Service Provider The Lawyers Choosing an Experienced Attorney What to Ask Your Attorney The Accountants Prime Brokers Third-Party Administrators Calculating Net Asset Values Size Matters Finding a Third-Party Administrator Using a Third-Party Administrator for Onshore Funds Using a Third-Party Administrator for Offshore Funds Insurance Companies Headhunters Matching Services Other Services Taking Advantage of Technology Parting Thoughts on Service Providers

CHAPTER 8 Fraud, Collapse, and the Kitchen Sink Why Fraud Exists Is Fraud Really Rampant in the Hedge Fund Industry? Why the Popular Press Has it Wrong Why Hedge Funds Implode In a Word: “Ego” Why Fraud Happens in the Hedge Fund Industry The KL Financial Debacle Manhattan Investment Fund Lake Shore Fund Complex

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87 87 88 88 89 89 90 91 91 93 94 95 96 97 98 99 100 101 102

103 103 104 104 105 106 107 108 108 109

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Hedge Fund Mismanagement The Amaranth Story DB Zwirn & Company Bear Stearns What Went Wrong How to Protect Yourself Regulatory Moves to Stop Fraud and Mismanagement Investor Due Diligence Manager Due Diligence Making a Good First Impression

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CHAPTER 9 A Few Parting Thoughts

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APPENDIX A Due Diligence Questionnaire

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APPENDIX B Resource Guide

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APPENDIX C Historic Performance of Hedge Funds

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Glossary

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Notes

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Index

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Acknowledgments

edge funds here, hedge funds there, hedge funds are everywhere these days. The media are filled with stories of hedge fund managers and their exploits in the markets and beyond. Hedge funds have gone from obscurity to the mainstream in a very short period of time. The ascent of hedge funds in the marketplace may have been rapid, but make no mistake, there is no getting rid of these unique investment vehicles. This project is the result of research and interviews with managers and investors around the world. It was quite a bit of work, but a lot of fun. Hopefully, you will find these pages worthwhile and a resource to turn to again and again to answer questions you have about the hedge fund industry. Two individuals who were particularly helpful were Viki Goldman, the finest librarian I have ever met, and Sam Graff, a man who can make anyone look good in print. Without their effort, support, and guidance, this book would probably not be sitting on any bookshelf. Thanks, also, to Christine Enners for working to gather data, make charts, and deal with a multitude of requests for ridiculous amounts of articles, papers, and information. I also want to thank Kirsten Miller, who helped shape the manuscript into what it is today. I also want to thank Kate Wood and Pamela van Giessen for green-lighting this project. I have never found a place more supportive of my work. As I have said before, I hope this book is everything they intended it to be when they gave me the go-ahead to write it. I truly appreciate all you have done to publish my work. No acknowledgments would be complete without a thank-you to my wife, Felice, and my family, for dealing me with during the difficult days. I appreciate your guidance, support, and understanding.

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Daniel A. Strachman Fanwood, New Jersey September 2008

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Introduction

hen I first started writing about hedge funds in the mid-1990s, the industry was something that people had heard a lot about but didn’t know much about. Since then, it has evolved into a major force on Wall Street, reaching as far as Main Street. Hedge fund companies are now the place where everyone wants to work, the industry that everyone wants to do business with, and the big fish that everyone wants to be involved with their charity. The industry is a tour de force. Whether it’s new funds being launched or existing funds getting more assets to manage, Wall Street’s “engine that could” is humming along at a great clip. Some industry-tracking services forecast that the industry will double in size every five years. It is truly wild, and you and I are in the thick of it. What a great place to be! There are, of course, a couple of things that we need to make clear—rules for the industry and for you that I believe will make things a bit smoother as you read this book. First and foremost, when I refer to a hedge fund, I am talking about an investment vehicle that goes both long and short the market. Second, it’s my opinion that most hedge fund managers don’t really know how to hedge, and merely operate what I consider expensive mutual funds. Make your way through this book and you will understand. For now, just keep these two thoughts in your head, and you’ll be OK. I promise. Why is the hedge fund industry growing so rapidly? It’s simple, really. Investors have come to the conclusion that long-only investment vehicles (i.e., mutual funds), although important to a diversified portfolio, have one fatal flaw. They make money only when markets rise. Unfortunately, that means when the markets fall, unless the manager has gone to 100 percent cash, the fund and its investors will lose money. There’s no way around this simple fact. Proponents of actively managed mutual funds will tell you that their managers can outperform the indices in both good and bad markets. But you and I both know that you cannot eat relative returns. Simply put, it doesn’t matter if the fund you invested in lost only 10 percent while the index lost 20 percent, because you’re still down 10 percent.

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It has taken some time, but investors of all stripes and all levels of investment expertise have concluded that they need to allocate some money to hedge funds, or, more precisely, to funds that go both long and short the market. This will allow their portfolio to generate some alpha without always getting stuck with beta! It makes sense because markets don’t always rise, just as they don’t always fall. The best way to prepare for both possibilities is to invest in vehicles that are able to go both long and short the market. Hedge funds’ dirty little secret is that investors use them to stay wealthy, not to get wealthy. That’s the story that the press has missed, and that investors and the general public don’t really understand. Uneducated people who think that hedge fund managers are all about taking as much risk as possible in order to make outsized returns are simply wrong. Hedge fund managers make sophisticated, calculated, risk-evaluated trades in an effort to make money regardless of which way the market is going. This fact alone has led some of the most sophisticated investors to use hedge funds. It is why all the major Wall Street firms and some of the minors are looking for an entry into the hedge fund industry. They’re the future of Wall Street, and it’s a glorious time to be getting into the business, either as a manager or an investor. As the market continues to evolve over the next 5 to 10 years, I expect the lines between mutual funds and hedge funds will continue to blur. I believe there will always be a place for traditional long-only managers who operate mutual funds. Those same managers will lobby Congress to change the laws that govern mutual funds—in particular the Securities Act of 1940—and the mutual fund industry will evolve into the hedge fund industry. This means that before we know it, there will no longer be “mutual funds” and “hedge funds”—there will only be investment vehicles. There will be products for investors that will go long, products that will go short, and some that go both long and short, all covered under the Securities Act of 1940. It may take 10 years, but it is coming. This, dear reader, is where the investment management business is heading, and you need to make sure that you’re pointed in the right direction. That’s the purpose of this book, to serve as a roadmap to understanding how hedge funds operate, how they raise money, and how they grow from an idea in somebody’s head into a living, breathing entity that manages assets for investors. Along the way, this guide should provide you with ideas on how to take advantage of opportunities in the marketplace, particularly those related to the evolution, creation, and development of a hedge fund organization. Let the journey begin.

CHAPTER

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nowledge is power. If you’ve picked up this book, chances are that you already have some knowledge of the hedge fund industry (and if you don’t, go back and read my book Getting Started in Hedge Funds, John Wiley & Sons, 2005). Maybe you’re an investor, and you want the inside story on how to find the hedge fund that’s the right home for your assets. Maybe you’re a new hedge fund manager, in need of tips on choosing an attorney or a third-party administrator. Or maybe you’re a veteran hedge fund manager, eager to learn from—and avoid—the fiascos that have brought down some of the biggest names in the business in recent months. This book is your ticket to that knowledge, and more. Throughout the following chapters, I’ll explain how hedge fund managers operate their businesses and what potential investors need to know about these unique investment vehicles—in short, how hedge funds work from both the manager’s and investor’s side of the industry. You will learn how the hedge fund industry evolved, how various funds operate, why some funds make money regardless of market conditions—and why others don’t. This book is not a “get rich quick” book, and it’s not the last word on how money is managed. Rather, this book is your roadmap to money management in the hedge fund industry. Your mission, if you choose to accept it, is to stick with me throughout the following pages to gain insight into how money is managed. You will then be equipped to apply your new knowledge to your own firm, the fund you work for, or the investments in your personal account.

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THE FATHER OF THE HEDGE FUND INDUSTRY To understand how the hedge fund industry evolved into what it is today, you need to first understand how and why the product was developed. The

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hedge fund industry was launched by Alfred Winslow Jones, a sociologist, author and financial journalist, who became interested in the markets while writing about stocks for Fortune magazine in the late 1940s. Jones’s early career spanned a number of industries and professions. Early on in his job experimentation, Jones realized that his varied interests would not allow him to live the life he wanted for himself and his family. He knew that his journalist’s salary wasn’t going to cut it, so he looked to the one place he knew would provide him the income he wanted in order to live the way he wanted to live—Wall Street. “My father was a simple man who had lots of ideas and executed most of them,” said Anthony Jones. “If he had an interest in something he would explore it, become comfortable with it, and move onto the next item on his list.” “When he read a book, he would call the author and invite him to dinner,” he continued. “That was the type of person he was. He wanted to learn all the time.” Jones, who died in June 1989 at the age of 88, devised the formula for his investment vehicle while researching a freelance article, Fashion Forecasting, for the March 1949 issue of Fortune magazine. To research the piece, Jones spent many hours speaking with the greatest money managers, traders and brokers of the time, to understand how they operated and made investment decisions. Upon learning—or at least believing—that he had a thorough understanding of how Wall Street operated, he set about creating his own ideas about what would and would not work in the market. And the hedge fund was born. In 1949 in Lower Manhattan, Jones and four friends launched the first hedge fund, with Jones as managing partner. Hedge funds initially began as a means to protect against risk in the markets, to “hedge one’s bets” and to leverage opportunities in the market through a combination of long-stock holding and short-stock selling. Jones based his investment strategy on a very simple theory: that by “going long” (making money for the investor when the price of the security increases) and “going short,” (identifying overvalued shares and buying them when the price decreases), he could create a portfolio that would weather market fluctuations and deliver solid and consistent returns to investors, regardless of which way the market moved. The concept worked: His investors lost money in only 3 of Jones’s 34 years in the business. As his son, Anthony Jones, has noted, “My father was not a great stock picker, he was a great idea man . . . He realized early on that he didn’t know how to pick stocks, and was able to find people who could help him manage the assets, while he managed and grew the business.” Initially, upon launching the partnership, Jones called his investment vehicle a “hedged fund,” a fund that is hedged and is protected against market swings by a portfolio consisting of long and short positions. Over

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the years, the powers that be on Wall Street dropped the “d” and began to call everything that is not a mutual fund, exchange-traded fund, or private equity, a hedge fund. Today, hedge funds are classified based not on their investment portfolios, but rather on their fee structures. If a fund has a management fee and an incentive fee, it is considered a hedge fund. Although the Jones approach became the model for all future hedge funds, today, hedge funds today come in all shapes and sizes. Trade strategies have evolved, and now range from long/short equity and merger arbitrage to fixed income duration speculation and global macro. Estimates put the number of hedge funds operating worldwide at more than 15,000, managing more than two trillion dollars in client assets.1 Hedge funds are not for everybody. These products are only available to well heeled investors. That being said, one thing is certain: More than 50 years after the birth of A.W. Jones and Company, hedge funds are here to stay.

WHY INVEST IN HEDGE FUNDS? Hedge funds are like most things on Wall Street. They sound complicated, but once they’re dissected, they’re quite easy to understand. The underlying concept is very simple: Hedge fund managers use a series of positions to minimize the risk of loss during a market collapse, thereby protecting your portfolio. Again, this is simple in theory, but in practice, it can be quite difficult to achieve. So why would anyone invest in hedge funds? Certainly, there are other ways to grow your money with less risk. The “perfect” hedge doesn’t exist. A perfect hedge would require taking all market risk out of the portfolio; what you’re left with, in that instance, is a portfolio that provides the risk-free rate of return, less the commissions charged by the broker. Of course, this is problematic because anyone can get the risk-free rate of return by buying Treasuries; more important, investors can buy exchangetraded funds with little effort. So why do they need you? Investors need hedge funds—and their managers—because they want to invest in products that deliver greater returns than the average of the markets. Hedge fund investors are more than willing to pay managers who can achieve this on a consistent basis. Your job, as a manager, is to create a portfolio that delivers solid, consistent returns by using all of the arrows in Wall Street’s quiver without taking on significantly more risk than the market as a whole. Hedge fund managers need to know the market well enough to recognize opportunity: in other words, to know when stocks, bonds, options, futures, and synthetics—as well as the other instruments that allow Wall Street to make a profit—are

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undervalued, to buy accordingly, and to wait for the market to realize the instrument’s value so that they can turn a profit. Unfortunately, it doesn’t always work that way. In some cases, a hedge fund manager might believe that a stock or security is undervalued based on his or her research or market intelligence, but the rest of the market may not see it. The result? The position loses money. Hedge fund managers are supposed to create portfolios that zig when the market zags, and zag when the markets zig, avoiding or at least reducing losses through hedging. For the purposes of this book, hedging, in its simplest definition, is the reduction of volatility in a portfolio. Hedge fund managers reduce volatility through shorting stocks, bonds or other financial instruments and through the use of various option strategies and other derivatives. Managers use straight short transactions and spreads, straddles and forward contracts to make sure the portfolio is protected during up and down periods. Wall Street is very good at devising traditional and synthetic short strategies, which are used by managers to manage volatility and risk. To learn more about options and derivatives, read Getting Started in Options (John Wiley & Sons, 2007) by Michael C. Thomsett and Getting Started in Futures (John Wiley & Sons, 2005) by Todd Lofton. Since the first hedge fund was launched, these investment vehicles have been viewed with awe—and some suspicion—by professionals and the public at large. Hedge funds are supposed to do “right” by investors, regardless of market conditions. Because they are not governed by the rules of traditional asset management firms, hedge fund managers literally can use any legal means at their disposal to extract money from the markets, going short or long as market conditions warrant. Managers can employ a combination of longs and shorts, throw in some futures for good measure, or focus on options and leverage in order to make money. Hedge fund managers do not have to stick to one strategy, style or tool. The general public—and even, perhaps, some fairly savvy mutual or hedge fund investors—often initially assume that hedge funds and mutual funds operate in the same way. Although both are pooled investment vehicles—funds in which a number of investors entrust their money to a manager, who then buys and sells securities with those assets to, ideally, make a profit—that’s where the similarity ends. One of the key differences between hedge funds and mutual funds is that hedge fund managers are empowered to pursue absolute return strategies, whereas mutual funds typically only offer relative return strategies. This means, in essence, that hedge funds are measured on their specific performance and not on how their performance compares to a predetermined benchmark, such as the S&P 500 or Lipper Small Cap Index. Mutual funds, by contrast, are for the most part equity based, fixedincome based, or a combination of both. That means that, with few

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exceptions, mutual funds can only go long, and therefore can only make money when the markets rise. If a mutual fund is long, and the stock market is doing well, the portfolio should increase in value. However, if the market is not doing well, the portfolio will suffer losses. Here’s how mutual fund managers construct their portfolios: They use their stock-picking skills to build a portfolio that they expect to perform well over time, and that will provide an edge over the indices used to benchmark their fund’s performance (again, for example, the S&P 500 or the Lipper Small Cap Index). If they can outperform the index—even by just a few basis points—their investors are generally happy, and the manager’s reputation remains intact. Of course, there are other differences between mutual funds and hedge funds, beyond simply their performance measurements. Mutual funds are open-ended investment companies; they sell their shares to the general public through multiple marketing channels. Hedge funds are limited in the number of investors they can have, either 100 or 500, depending on their structure, and are open to only accredited investors or qualified purchasers. Most hedge funds in the United States are either limited partnerships or limited liability companies and as such, are exempt from the Securities Act of 1933. Ultimately, as you compare mutual funds and hedge funds, you need to remember that a rising tide raises all boats, but when the tide rolls out, the boats will sink. Mutual funds are likely to suffer losses—sometimes severe—in bad economic times. But hedge funds don’t need a rising market to make money. In a down market, hedge fund managers can go short, or use other hedging strategies, to make money and/or protect profits. Mutual funds don’t have the same flexibility. Very few managers are able to completely minimize risk to the point that it does not cost some piece of the performance. However, there are hundreds of managers who use shorts and short-like positions to provide a cushion to the portfolio that allows for protection when things head south. This isn’t an easy task, and few get it right consistently over the long term. Later chapters will provide more detail about how you can be one of these lucky few.

UNDERSTANDING THE MARKET Before you learn what you need to know about money management in the hedge fund industry, you first need to learn about the current state of the hedge fund industry itself. In Chapter 2, we’ll examine this in more detail. But you also need to give some thought to the state of the market today. And, as even the most casual market observer can tell you, in recent years, it has become extremely volatile. In the financial industry, 2007 and 2008

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will be remembered as the years of the subprime mortgage meltdown and the ensuing collapse of Bear Stearns Companies. As of this writing, in May 2008, the jury is still out on what exactly happened to the credit markets. The finger pointing has begun, but it’s not yet clear if any action will be taken by the federal government to determine how and why the markets collapsed. Although Washington’s blame machine immediately called on Attorney General Michael B. Mukasey to begin an inquiry, he and his lieutenants seem unable to find anybody to go after. In any event, it is clear that the Treasury, the Federal Reserve, and possibly Congress, will all—either together or independently—issue reports on what went wrong. By the time they’re issued, these reports will likely be worth little more then the paper they were printed on. However, the situation with Bear Stearns is much more fluid, interesting to follow, and easy to get one’s head around. On March 16, 2008, in the wake of the near-collapse/near-bankruptcy of the venerable Wall Street firm, its board of directors voted to sell the company for a fire sale price of $2.00 per share, or $236 million, to JPMorgan Chase & Company. Just a few days earlier, Bear Stearns had seen its stock valued at $3.5 billion, trading at nearly $33 per share. A year prior, Bear’s stock was selling for $170 per share. Now, the firm had to choose between one of two options, both unpleasant: Sell on the cheap or go bankrupt. In an extremely rare move, the Federal Reserve brokered a deal between a near-death Bear and a financially strong JPMorgan, providing nearly $30 billion in financing to cover Bear Stearns’s assets, which included massive pools of mortgage-backed securities with little or no liquidity.2 According to the Wall Street Journal, the Federal Reserve’s move was the single largest advance to a single company by the central bank. The speed of Bear Stearns’ collapse prompted the Federal Reserve to move quickly to stave off a prolonged recession based on continued defaults and dislocation in the credit markets. Many people, including Wall Streeters, Wall Street historians, and, most of all, Bear Stearns employees, are still trying to figure out what caused the bank to fall so quickly and to wind up in such an untenable situation. At this point, however, there isn’t anything that anyone can do it about it. On May 29, 2008, in a mere 10-minute shareholder meeting, JPMorgan Chase’s purchase of Bear Stearns was approved, heralding a speedy and ignominious end to the 85-year-old firm.3

WHAT HAPPENED AT BEAR, AND WHY This book is not going to help dispel any myths that might be circulating, or uncover new information about what happened—I’ll leave that to others.

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But nonetheless, it is important that you understand some of what occurred and why. The credit market meltdown began in the summer of 2007, in the wake of the subprime lending crises. It became harder to borrow money, and both individuals and institutions began to worry that without liquidity, a recession would take grip of the economy. As summer turned to fall and fall to winter, the economy didn’t seem to be getting stronger. Oil, gold, and a number of other commodities reached record levels, while the equity markets continued to operate with extreme volatility. All the while, the market for mortgage-backed securities and the pools of assets that make up these securities were becoming less and less liquid. “The spread for these securities was so wide you could drive a truck through it,” said Richard Bookbinder, managing partner of a New Yorkbased fund of funds. “There were some funds that traded in this space that were unable to deliver a performance number because they couldn’t price their portfolios. It was a very difficult time.” One hedge fund firm of my acquaintance had to suspend calculating the fund’s net asset value at that point, because it could not nail down prices for many of its positions. It was in a tight spot, because it had to deal with shareholders who wanted to redeem their investments, and the fund and its administrator had no way to calculate the true value of the portfolio. It was the first time I saw something like this happen, which should tell you something about how the market was trending in the summer of 2007. As a major player in the mortgage-backed market, Bear Stearns suffered significantly. The firm was trapped—it was running out of cash, and the assets it carried on its books no longer could be priced at a level that would allow them to be sold. Bear borrowed as much as it could from the Federal Reserve through the structured deal with JPMorgan Chase, but eventually was left with no other alternative but to sell itself to the bank in order to avoid bankruptcy. As noted above, the initial sale price was $2 per share; however, JPMorgan revised that number to $10 per share a week later. There are many layers of this onion to peel away, and I am sure someone will write a book about the actions that led to the company’s demise. For our purposes, think of it this way: The company was squeezed into nonexistence because it no longer had the cash to cover its operations. In the macrocosm, the firm was trapped in a situation not unlike that of many other Americans who, in the microcosm, are on the verge of losing their homes because they can’t pay the mortgage. Bear owed massive amounts of money and no longer had the wherewithal to cover its bills. The bailout by the Federal Reserve is not unprecedented; in fact, the government has a way of sticking its nose into the business of the people, whether for good or ill. The actions taken by the Federal Reserve to

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coordinate the Bear Stearns sale were somewhat reminiscent of the bailout it orchestrated of Long-Term Capital Management in 1998, 10 years prior. That particular hedge fund was teetering on the brink of collapse, unable to meet its margin calls and on the verge of being liquidated. In that situation, the Federal Reserve worked with 14 investment houses and banks, persuading those firms to lend the company more than $3.625 billion in return for control of the firm and its assets. The bailout worked out quite well for those who participated; the fund was wound down and the positions in the fund were liquidated at a profit. The difference in the Bear Stearns deal is that, in this case, the Federal Reserve (read, “you and me: the U.S. taxpayer”) has money at risk. If the deal, or more important, the positions, fail, the Federal Reserve is going to have to make good on those losses. In the short term, I suspect that many people believe this to be a smart move on the Fed’s part. Over the long term, though, the questions will keep coming: questions like, “Why did the Feds have to get involved and put money at risk?” Here’s my question: Why was Bear not allowed to fail, go bankrupt, and go through the bankruptcy process? Isn’t that what makes markets efficient? And isn’t that what Wall Street needs to do in order to preserve that market efficiency? It’s still too early to predict what may happen, but as of this writing, investors expect their Bear Stearns deals to close somewhere north of $10 per share. Most of us expect JPMorgan Chase to lay off a considerable number of the 14,000-odd people who work for Bear Stearns. But JPMorgan will likely also be able to take advantage of a number of opportunities, bought literally on the cheap, to solidify their own position both on Wall Street and Main Street in terms of service provision to both retail and institutional investors. In the end, the final chapter written on Bear Stearns will very likely begin the book on the success of JPMorgan Chase. The ripple effects of the mortgage mess and the Bear Stearns bailout will likely be felt for some time. As of the spring of 2008, there’s talk of recession everywhere, with some economists believing we’re already in one. The U.S. economy lost a staggering 240,000 jobs in the first three months of 2008.4 What should you take away from all of this? If nothing else, this information should convince you that managing money is very difficult. It takes a lot of work and an enormous amount of research. You’ll need patience, discipline, and humility. Sure, the advent of technology and the ubiquity of the Internet mean that data and information flow freely with the click of a mouse, but data and information are not equal to years of experience and training. Furthermore, having information does not mean that you know how to use it. Managing money is a skill. It is a skill that is taught, learned, and executed by professionals.

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The news isn’t all bad. Financial managers—whether of hedge funds, mutual funds, or other investment vehicles—can ride out the bad times by making sound and reasoned decisions. Historically, hedge funds have actually gained popularity during market crashes. Although the hedge fund industry has grown steadily over the past 60 or so years, it plateaued for most of the 1980s—until the market crash led traders, brokers, and bankers to reconsider their traditional income streams. It’s important to remember that there are many people who call themselves money managers, or even hedge fund managers, but the number of people that actually manage money well over a consistent period of time are few and far between. This is something that you need to understand if you want to play the game. It is difficult to be successful: Many are called, but only a few will make it. If you’re ready to take the plunge, read on.

WHY THIS BOOK? Today, the Jones model provides the basic foundation for all hedge funds. Again, the concept is quite simple: to create a vehicle that goes long and short the market in an effort to make money, regardless of market conditions. When Jones was managing money, he went long and short equities. Today, however, hedge funds around the world use investment styles and strategies of all shapes and sizes to make investments, and trade any and all types of securities so that their investors will profit. We’ll talk about some of these strategies in the following chapters. The hedge fund industry today is quite different from its birth, or even from five or six years ago. Five or 10 years from now, it will likely look different than it does today. The industry today is made up of both massive investment complexes that manage tens of billions of dollars in hedge funds to small-time operators that only manage perhaps a million or two dollars. And there are funds of every size and shape in between. In The Fundamentals of Hedge Fund Management (John Wiley & Sons, 2007), I spent the better part of the book explaining how a hedge fund comes to life and operates as a business. I discussed the infrastructure, the technology, the people, the documents, the legal aspects, the tax aspects and everything else that goes into the day-to-day operations of hedge funds. I did not cover how money is managed. In this book, we’ll review some of those basics. But for the most part, this book is about how money is managed: how hedge fund managers take a dollar, put it to work in the marketplace, and make a return on it. I’ll provide you with a view of various strategies, across multiple disciplines, which all come down to one thing: making money for investors. We’ll talk

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about how some specific hedge fund managers—the best of the best—have leveraged these strategies to make money for their investors—and, in the process, for themselves. This book is the story of how hedge funds manage money and how investors allocate assets to hedge funds.

CHAPTER

2

Hedge Funds Today

ifteen years ago, if you had asked a representative sample of MBA students from around the country where they wanted to work after graduation, the response would have been Microsoft, Intel, IBM, General Motors, or CocaCola—well-respected Fortune 500 companies that offered the potential of a long, stable, and rewarding career. Other newly minted MBAs would have leaned toward Wall Street powerhouses like Goldman Sachs, Morgan Stanley, and J.P. Morgan. Still others might have cast their lot with firms like Soros Capital Management and Tiger Management. All in all, the choice was simple: Find a position at the finest institution around, and put your education to work. Fast forward to 2008. Today, students all seem to say the same thing: They want to work for firms like SAC Capital, Citadel, Maverick, and The Clinton Group. Of course, if George Soros or Julian Robertson wanted to hire them, they wouldn’t say no. But the world is now consumed with hedge funds. Although new MBAs have some interest in private equity firms, the fallout of the credit markets in 2007 has given them a compelling reason to look elsewhere. Results from my completely unscientific poll of graduate and undergraduate students in Boston and Philadelphia bear this out: Both groups said that they’d work at any hedge fund that would have them upon graduation. It’s not that the financial industry is inherently stable, or that there’s a guarantee that these students will make it big on Wall Street—we all know that it can be a risky business, and there are no guarantees of success. As I noted in Chapter 1, 2007 and the first half of 2008 have been among the most volatile that the market has seen, and that’s not likely to ease up anytime soon. As we enter the waning days of 2008, the United States is unofficially in a recession. Jobs are drying up, costs of staples like milk, bread, and eggs are on the rise, the price of oil is out of control, and frankly, things look quite bleak around Wall Street and the rest of the job market. However, hedge funds still seem to hold opportunities,

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THE LONG AND SHORT OF HEDGE FUNDS

and MBA students are frothing at the mouth to land a job at one of these shops. So why do these students want to work in the hedge fund industry? As Willie Sutton purportedly said when asked why he robbed banks, “It’s where the money is.” And despite the market dislocation of the summer of 2007 and the continuing economic woes of 2008, the hedge fund industry is booming. Hedge funds truly are where the money is, for these students and for other budding Wall Street professionals.

HEDGE FUNDS IN THE NEWS Throughout 2007, among the hottest things on the market were “hedge fund clones.” These products are operated and sold by some of Wall Street’s biggest players: firms such as Merrill Lynch & Company, Goldman Sachs Group Inc. and JPMorgan Chase & Company. The firms analyze hedge fund returns for a set period of time and try to determine how the return was generated. Once they figure out the return streams, they use stocks, bonds, and other securities in an attempt to mimic the return over a set period of time. These companies then develop sophisticated mathematic modeling to come up with algorithms in order to create the return streams on a monthly basis, ensuring that the product can deliver consistent, hedge fund-like returns.1 The appeal of these investment vehicles is that they allegedly provide hedge-fund-like performance to investors with less risk, greater liquidity, and substantially lower fees. The problem with these products, and with other products that attempt to mimic hedge fund returns, is that eventually the models fail, the algorithms stop working, and the investors lose. The reason is simple—predicting and defining hedge fund performance is notoriously difficult—and, more important, no one can truly predict how the market is going to move. Why can’t we neatly define hedge fund performance? It’s easy enough for other investment vehicles, like mutual funds, or stocks and bonds. Mutual funds, for example, strike a net asset value on a daily basis, as required by the NASD. That’s the price you see in the newspaper every day. But unlike these traditional investment vehicles, hedge funds are not marked to market each day. There are no rules or guidelines that require a daily mark or an establishment of a price/net asset value of hedge fund portfolio. Some hedge funds, then, don’t strike a net asset value until the manager decides to, or unless and until the partnership documents call for it. In fact, hedge funds typically strike their net asset values on a monthly or quarterly basis, depending on the fund’s offering documents.

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It’s questionable, then, whether it’s possible to build a product that mimics hedge fund performance, since the data used to create this imitation product is sporadically posted. As of the spring of 2008, there is no standardized reporting requirement for hedge funds, and there is no one place that an investor (or a Wall Street mad scientist), can go to get real-time data on hedge fund performance. Until that happens, products that mimic hedge fund performance are at best well-educated guesses. There are, however, a number of hedge fund databases and services that track the industry. These databases range from fee Web sites that track hedge fund styles and strategies to sophisticated and expensive services that provide not only performance and asset information, but also in-depth research about the manager, the firm, its history, infrastructure, and operation. Although some of their data may be good, a lot of it may be tainted, making it unreliable. Part of the issue is that reporting to these databases is voluntary, and when managers have a bad month or series of months, they have every incentive to simply stop reporting to the databases. In order to truly acquire accurate data points on hedge funds, you need to go to each and every fund, get a copy of their audited track record, and crunch the numbers accordingly. This would be a monumental undertaking, and it is just not being done. Without that kind of data, it is safe to say that “hedge fund clones” are nothing more than the latest Wall Street gimmick to sell something to the public. In fact, a number of the firms offering these products have expressed doubt that the clones could deliver the returns characteristic of the best hedge fund managers.2 It’s a mistake to think that a machine, or mathematical algorithm, can come up with something that approximates the mind of a masterful money manager. You can’t clone a George Soros, Julian Robertson, Michael Steinhardt, Steve Cohen, George Hall, Lee Ainslie, or Ken Griffin. These individuals are some of the brightest investment managers of all time, possessing unique skill sets that have made them extremely successful at managing money and exploiting market opportunities. Each has a distinct way of considering how investments are valued, made, and executed. In essence, they are capable of seeing the markets in ways that most of us simply cannot imagine, and it is this rare vision that allows them to determine whether opportunities have value, thereby creating infinite windows to make money. That is what makes them great hedge fund managers. Consequently, it is ludicrous to think that mathematicians can come up with a way to operate and deliver similar returns. It’s unrealistic to think that a recent MBA graduate at JPMorgan Chase & Company or Goldman Sachs Group Inc., with some product development knowledge, can come up with a mechanism that clones the successful actions of the top hedge fund managers. My experience has been that this type of product might initially

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work—maybe for six months or so—but will then fade into oblivion. There are only so many ways to skin the market, and trying to replicate a person’s investment skills is not one of them. In the long run, a hedge fund’s success depends on the personality and prowess of the person behind the trading decisions. His or her skills and conviction are what allows the hedge fund manager to win, lose, or draw, and that cannot be replicated with a machine or a series of trades. So why would someone invest in a hedge fund clone? The appeal of these clones, according to a number of industry insiders, is that they can be offered to investors at a cheaper price, with less of a lock-up. Lock-ups are, by definition, the term in which an investor is required to keep his or her assets invested in the fund. Most funds have a one-year lock-up; some have a two-year lock-up, and still others require three- to five-year lock-ups. Investors who try to get their money out before the lock-up period ends will pay a hefty withdrawal fee.

HOW HEDGE FUNDS ARE REGULATED Hedge funds have grown from a small, obscure pocket of the Street to an industry of more than 15,000 funds, managing more than $2 trillion.3 To put this into perspective, there are more than 2,781 publicly traded companies on the New York Stock Exchange, which represents more than $18 trillion in market capitalization.4 There are also nearly 11,400 mutual funds, representing nearly $11.4 trillion in assets under management.5 Given these numbers, hedge funds might seem lacking in comparison to stocks, bonds, and mutual funds. But stocks, bonds, and mutual funds are available to the masses, whereas hedge funds are available only to accredited and super accredited investors. Rule 501, or Regulation D, of the Securities Act of 1933 defines an accredited investor as any of the following:














A bank, insurance company, registered investment company, business development company, or small business investment company An employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decision, or if the plan has total assets in excess of $5 million A charitable organization, corporation, or partnership with assets exceeding $5 million A director, executive officer, or general partner of the company selling the securities A business in which all the equity owners are accredited investors

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A natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of purchase A natural person with income exceeding $200,00 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year A trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes6

In plain English, many hedge fund investors are extremely wealthy. Yet, despite their rarified clientele and relatively small holdings, everyone in the financial industry has these investment vehicles on the brain. Firms around the globe continue to work toward ways to bring hedge funds to the masses. Hedge funds’ time has clearly come, and with it come opportunities for smart, ambitious people to manage—and make—money. So how are hedge funds regulated? In two words, “very loosely.” When Jones launched the first hedge fund in 1949, it was his intent to create an investment vehicle that was not subject to the Securities Act of 1933 and the Investment Company Act of 1940. These two acts govern the mutual fund industry and investment managers, and, as a result, regulate the way that most money is managed in the United States. Mutual funds are highly regulated investment vehicles. Governed by the 1940 Act, they are commonly referred to as “40 Act” funds. The 1940 Act limits the amount of leverage a fund can use and therefore limits (or “places a governor”) on how short a fund can be at any given time in its operation. This was troublesome to Jones, obviously, because shorting was the cornerstone to the success of his product. To get around the constraints of the legislation and run the fund as he saw fit, Jones needed to create a product that was exempt from the 1940 Act. The method for this was a limited partnership, which was open to 100 investors. Why a limited partnership? Under this structure, the limited partners acted as the investors, and the general partner operated the fund and acted as money manager. The structure worked from both tax and liability purposes and, most important, avoided falling under the purview of the 1940 Act. Little has changed in the structure of hedge funds over the last almost 60 years. The standard structure for hedge funds today is a limited liability company, or LLC. In this structure, the members are the investors and the managing member operating the fund is its investment manager. The tax issues are the same for an LLC as in a limited partnership, since the profits and losses flow through the entity to the investor or member directly. From a liability standpoint, the LLC structure provides an additional

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level of protection to the manager, and, as such, is now the structure of choice for new funds. However—and you knew this was coming—there may be some changes on the horizon in how hedge funds are regulated, in part because of the recent market volatility.

RECENT CALLS FOR REGULATION For as long as I’ve been following—and participating in—the hedge fund industry, Congress and the federal government have attempted to regulate hedge funds and their managers. Now, I know it sounds crazy, but it’s true: The government wants to reign in the wicked hedge fund managers and put restrictions on all those who invest in these products. There’s a widespread view that hedge funds and their managers are unregulated; that they don’t, in fact, operate under the same guidelines or purview of other, more traditional investment funds. In this case, as I’ve already noted, the conventional wisdom is true. Hedge funds aren’t subject to the legislation that governs mutual funds. In part because of this lack of regulation, many people believe that whenever there’s a hiccup in the markets, whether it’s volatility in the equity market, volatility in the credit markets, or, more recently, the meltdown in the subprime mortgage market, that hedge funds are to blame. If you’ve read any of my other books, you know my view on press coverage of hedge funds. The press has never met a hedge fund that it has liked. Furthermore, most journalists and their editors don’t really understand how hedge funds operate. Given this superficial (at best) understanding of what hedge funds are and how they operate, its unsurprising that media coverage may lead readers to believe that hedge funds and their managers are gunslingers, buccaneers and swashbucklers bent on pillaging the global markets. And here’s the larger problem: The media’s perception, in my view, has become Congress’ reality. And, I believe, as a result of the negative media coverage, the powers that be in Washington, D.C., have come to believe that the only solution to the hedge fund problem is to regulate. In 2006, the Securities and Exchange Commission passed the most aggressive hedge fund regulation ruling yet, requiring all hedge fund managers with 15 investors, or $40 million in assets under management, to become registered investment advisors. Phillip Goldstein, manager of the hedge fund Opportunity Partners L.P., challenged that ruling in court. The U.S. Court of Appeals for the District of Columbia reversed the ruling, leaving many in the SEC scratching their heads wondering what to do next. Since then, everybody and their brother, in both houses of Congress and at the federal

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level, have been trying to figure out what to do with hedge funds and their managers. There have been hearings, inquiries, and lots of meetings. To date, there have been very few recommendations, with the notable exception of guidelines recently released by the Treasury Department. The guidelines, developed by two private-sector committees (one composed of asset managers and the other of investor groups), call for hedge fund managers to improve disclosures of hard-to-value assets, including mortgage-backed securities. However, adopting these guidelines is voluntary on the part of hedge fund managers, and critics claim that little is likely to change as a result.7 Certainly, as a country, we have a lot of other things on our minds. As long as the war rages on in Iraq and Afghanistan and the economy is in the tank, the minds of many are off hedge funds. As is customary, the problems of the day are being blamed on the White House (in this case, the Bush administration), which, in turn, blames them on Congress (but only the Democrats). It’s politics as usual. And Wall Street is throwing a lot of money into the presidential and congressional candidates’ campaigns. As a result, it may be that the heat is off—for now. The upcoming change in administration (regardless of which way it trends) or a power shift in Congress could turn the heat on full blast; in fact, this is likely to occur in the not-so-distant future, in my opinion. For now, however, everything is status quo. Remember the phrase, “Don’t bite the hand that feeds you!” It is very relevant here. Hedge funds are contributing significant sums to both Presidential campaigns as well as the Congressional and Senate races. Therefore, Congress is not likely to make any changes to the laws that regulate hedge funds. Granted, this is a fairly cynical viewpoint. But I also believe that the reason more has not been done to regulate hedge funds is because the powers that be just don’t have any idea what to do with these products. Congress and the Commission do not know how to handle these massive pools of capital, which truly provide liquidity to the marketplace and offer investors a good place to go for solid returns. Most thinking people understand that hedge funds do provide very important services to the capital markets and, as such, regulation will likely neither help nor hinder the service that these investment vehicles provide to the markets around the globe. The other issue is, frankly, that regulation is something that could be a boon for the hedge fund industry. The more regulation, the more legitimate these investment vehicles become, and therefore the greater influence they will have in the markets. Clearly, there will always be people who demand further regulation of hedge funds. My question is always the same. What is it going to achieve, and are hedge fund regulators going to go far enough? Hedge funds are regulated by the SEC, FINRA, the IRS, the Department of Labor, and the

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CFTC. That’s enough. If Congress were to put additional curbs either on hedge funds’ ability to trade or take assets, which it already has done to some extent, what would that do? Does anyone really believe that hedge funds are capable of taking down the markets, either collectively or individually? If so, then that would assume that the markets are inefficient and incapable of self-correction. But we know that the converse is true—the markets are inherently efficient over the long term, and more important, the markets are capable of adapting to situations to ensure not only stability over the short term, but also stability over the long term. Hedge funds are one piece of this puzzle, and they help ensure the overall market stability. If the goal of Congress is to make all stocks go up, then they have to do more than simply regulate hedge funds. But, if the goal of Congress is to ensure orderly and efficient markets, which is what the United States has had since trading began around the Buttonwood Tree (where the first traders met on Wall Street), then regulations will do nothing more than create paperwork to cause lawyers to make more money. That’s all there is to it. There is no threat, in my opinion that hedge funds offer to the markets that investors need to be afraid of—the only real threat is the threat of fraud. Fraud, however, cannot be controlled by Congress or the Feds. It can only be controlled by due diligence. We’ll discuss due diligence more in later chapters.

HEDGE FUND FEES Hedge funds typically charge a 1 percent management fee and a 20 percent incentive fee. Incentive fees are the split of the profits between the manager and the investors. These fees are what make hedge funds so lucrative. For example, let’s say we’re looking at a fund with $100 million in assets under management. Let’s further assume that the fund is up 10 percent within a year and now has assets under management of $110 million. If this particular fund charges a 20 percent incentive fee, the fund manager is entitled to $2 million of the $10 million earned, as incentive for making that money for the fund. Many people believe that these fees are high—in some cases, egregious—as evidenced by a recent Google search that found more than 1.85 million sites with the phrase “high hedge fund fees.” However, in my experience, the only people complaining about hedge fund fees are the people who can’t charge them—often mutual fund managers. If these same firms had products that charged traditional hedge fund fees, you would not be hearing these cries of outrage. Instead, you would be hearing that the skill that goes into the fund management warrants the fees charged.

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Let me reiterate: I have never, in my more than 12 years of working in the hedge fund community, come across an investor who complained about the fees charged by a manager. In fact, when discussions about fees come up, I usually hear that investors believe the fee structure aligns the manager with the investor: “When I win, he wins and when I lose, he loses.” Managers and investors sink and swim together. The one constant in both the limited partnership and the LLC hedge fund structures is the incentive fee. Jones believed that he should share in the wealth that he created for his investors and, more important, that he should only be paid when and if he and his team were successful. As such, he charged a 20 percent incentive fee to investors on new profits. This meant for every dollar that the investor made, Jones’ firm took 20 cents. Although views differ on whether the fee is too large, too small, or just right, most agree that it aligns the interests of the investor and manager. If the investor makes money, the manager makes money. If the investor loses money, the manager doesn’t get paid. The two are in it together. To keep the interests of the two parties aligned, some funds also impose a high-water mark. A high-water mark is the highest point in value that an investment fund reached during the preceding period. A high-water market ensures that the investor earns back any losses taken by the portfolio before the manager receives an incentive fee. Unless the manager recovers the fund’s losses, he or she is not entitled to take any incentive fees. The high-water mark can be problematic for funds that incur substantial losses. These funds need to earn back such significant sums before they can charge a fee, and, in turn, compensate their employees, that it often does not make sense to continue operating. Although it is easy to see why fund managers do not like high-water marks, these devices do play an important role with investors. Investors like the idea that with a high-water mark, a fund manager’s success is truly aligned with their investors’ success. The fund manager does not earn a cent of incentive until the fund brings investors back to par. From an investor’s standpoint, what’s not to like about that? Jones only charged his investors an incentive fee. According to Robert Birch, Jones’s son-in-law and the current co-operator of AW Jones and Co., Jones never believed in management fees. “Jones believed that management fees would only cause him to go out and raise more assets, which, in turn, would take away from the constant pursuit of performance,” he said. “The simple fact is that some people can make more money building assets than they can through performing. Jones focused on performance and did not want to be distracted by asset gathering.” Jones’s model worked well in both up and down markets. During the first 20 years of its operation, the system worked so well that the Jones Fund never had a losing year. It was not until the bear market of late 1969 and

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1970 that the fund posted losses. After that period, the company continued to grow and was successful until the mid-1980s, when it switched from being a single strategy manager to a fund of funds, as it remains today.

COMMISSION GIVE-UP In addition to being the father of the hedge fund industry, Jones is credited with perfecting the art of paying brokers to give up ideas. Although his firm executed most of its trades through Neuberger Berman, Jones was adamant about paying brokers for ideas. The word quickly got out that if you had an idea, you should call the firm and talk to a trader. It was simple: If a broker called on one of the Jones managers with an idea, he knew that he would be paid, regardless of where the order was executed. “We’d give up half the commission to the guy who came up with the idea, whether he worked for us or not,” said Roy Neuberger. “That was how Alfred wanted it to happen. He wanted there to be a constant flow of ideas. At the time I didn’t think the exchange would let us do it. But they did; no ifs, ands or buts; it was perfectly all right with them.” While Jones clearly perfected the sharing of commissions, which continues to this day, he also made sharing in the profits a mainstay of the hedge fund industry. Sharing in profits is what truly defines a hedge fund in today’s investment world. Most mutual funds don’t have this sort of fee structure; in fact, it is extremely difficult for most funds to offer their managers a share of the success. The mutual fund industry is focused on growing assets under management. As the fund’s assets grow, the manager earns more income. The formula is simple, but it’s also what causes most mutual fund managers to manage assets for mediocrity. The managers do not want to take on the additional risk necessary to try to outperform their benchmarks because if they fail, the fund will lose assets and, in turn, its revenue stream. Therefore, mutual fund managers manage toward the norm—or middle of the road—not only in order to preserve the fund’s assets, but also to protect their own income streams. By now it’s clear that the fee structure that allows a manager to share in the success of the portfolio is what defines the hedge fund industry. As the industry has evolved over the last 60 years, hedge funds have taken on all sorts of investment styles and strategies. No market is safe from a hedge fund manager and their will and skill to make money. Hedge fund fees are a funny thing. Chances are, if you ask outsiders about hedge fund fees, they will say that they’re too high. Ask insiders, and they’ll respond that the fees are too low. The real question comes down

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to what investors will pay. For the most part, investors don’t seem to be complaining about fees. The current fee structures offered by managers to their investors consist of a management fee of 1 or 1.5 percent of assets, and an incentive fee of 20 percent of the profits. Some fund managers charge variations on these fees, such as 2 percent management fees or 40 to 50 percent incentive fees. The amounts of the fees can fluctuate based on a number of factors, including the manager’s track record, assets under management, strategy, pedigree, and marketing skill. Successful managers, such as Steve Cohen at SAC Capital, have been known to charge higher fees because there is great demand by investors to invest in his funds. Conversely, some start-up managers have been known to charge lower fees simply because they want the assets and want to get the fund up and running. Again, fees are not an issue for most hedge fund investors. In my experience, as long as a manager continues to deliver solid, consistent returns, investors typically don’t care what they are charged. Investors become concerned and/or angry only when the fund stops delivering on its expectations. I have never met an investor who said that the fees were too high, or who chose not to invest in a specific fund because of the fees. The investment community knows that you get what you pay for—plain and simple.

CONTINUING THE JONES LEGACY As we’ve discussed, when Jones initially launched his investment company, it was with a fairly simple, straightforward idea: to create a portfolio that went long and short the market, providing for substantial profits in good times and limited losses in bad times. He was able to achieve this by limiting his net long exposure, or the amount of long exposure minus the amount of short exposure. An example of net exposure is provided in Figure 2.1. Unfortunately, creating a portfolio that is net long or net short does not mean that you are going to outperform the markets. In fact, just the opposite is true: If the market is flying and your portfolio is 80 percent net long, then 20 percent of your portfolio is lying fallow. The same is true in the converse. So what, if any, value are you offering to your investors? Your value comes in knowing when to go net long and when to go net short, and your ability to work a portfolio that exploits inefficiencies in the market to earn profits for your investors—regardless of market conditions. As I noted in Chapter 1, Jones posted losses in only 3 of his 34 years in the business. This may have been simply the result of being long and short at the right times, or his ability to time market events, or maybe even

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Fund X with Assets Under Management: $100,000,000.00

Net Long Example: Long Positions: $100,000,000.00 Short Positions: $60,000,000.00 Net Long Exposure: 40% Net Short Example: Long Positions: $100,000,000.00 Short Positions: $110,000,000.00 Net Short Exposure: 10%

FIGURE 2.1 Examples of Net Long and Net Short Exposures

his employees’ skill at picking stocks. Most likely, it was a combination of all of the above. To be successful, you need to take a page from Jones’s playbook—you need to understand how to go long, how to go short, and how to use both strategies to make money. To run a hedge fund, you have do more than charge a management and incentive fee to your investors. Simply put, you need to add value to their portfolio. Hedging isn’t really that complicated, although, again, few people do it well. To really hedge the risk of the portfolio, you first need to review the portfolio to determine where the risks are. Your next step is to work to create hedges that will dampen that volatility, should the market move in a direction other than the one you think it will move in. For example, if you have a long a series of equities in one sector of the market, you may consider going short a series of equities in another sector. To short your series of equities, you’ll choose a sector that moves in the reverse of the sector you are long. Hedging—really hedging—comes down to using any and all financial instruments to extract profits from the market. This is what truly sets hedge fund managers apart from mutual fund managers. Mutual fund managers are simply not able to use any (legal) strategy available to make money; instead they simply can only go long. Although there are now literally thousands of players in the hedge fund market, only one stands out as the heir apparent to Jones: Julian Robertson. Robertson, whom I wrote about in Julian Robertson: A Tiger in the Land of Bulls and Bears (Wiley, 2004), and who we’ll look at it in more detail in Chapter 3, is considered by many Wall Streeters to be the person who took over Jones’s role as true leader of the hedge fund industry.

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Tiger Management ceased to exist as a manager of other people’s money in 2000, but Robertson has since gone on to seed and work with a significant number of managers who are truly shaping the future of the hedge fund industry. It is clear that without his involvement with and investment in these managers, many would not have gotten off the ground or been able to expand and grow their businesses. The list of the “Tiger Cubs,” as they are called by the popular press, is quite extensive and includes not only people who worked for Robertson at Tiger Management during the firm’s 20-year tenure, but also those who helped him wind down the business and those he has since found in his current capacity as elder statesman of the hedge fund industry. When I was researching the book on Robertson, I spent a lot of time interviewing people about how the company worked, how he ran the business, and what his effect was and is on the investment community. One person’s comment summed up Robertson’s role in the global money management industry as follows: “No one has had as much effect on how money is managed around the world than Julian Robertson,” Hunt Taylor said. “He has worked with, seeded, and provided guidance to so many managers that his reach is unlike any others in the investment community.”8 To truly understand how the industry has grown into what it is today and to understand where it is going to grow in the future, we should look at three very wise men. These individuals took the torch from Jones and, in their own ways, shaped the hedge fund industry. No conversation of hedge funds is complete without a discussion of George Soros, Julian Robertson, and Michael Steinhardt. It is their collective investment prowess that is to be blamed for the growth, expansion, popularity, and importance that hedge funds play in today’s capital markets. In Chapter 3, we’ll explore their contributions in detail.

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3

The Men Who Made the Industry What It Is Today

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ver the last 50 years, as hedge funds have evolved from a cottage industry to a high-stakes, high-visibility game, a few individuals have clearly influenced their growth. Since the late 1970s, three individuals have shaped the current landscape: George Soros, Julian Robertson, and Michael Steinhardt. These men not only fundamentally altered the way money is managed, but also showed the world how important it is to employ a professional money manager. To fully grasp the importance of these three individuals, it is important to understand where each came from and how their fund complexes evolved.1 At first glance, Soros, Robertson, and Steinhardt seem to have very little in common beyond their profession as hedge fund managers. Yet, these men have demonstrated an extraordinary ability to extract value from market. Extracting money from the market may sound easy, but think of it this way: If it’s so simple, why can’t everyone do it? Although all three have retired from managing money for the public, they are more active today than ever before. Articles detailing what they’re doing in the market have given way to stories about their charitable work and political involvement. But make no mistake: While Soros funds political machine MoveOn.org, Steinhardt pursues Birthright Israel, and Robertson helps reshape New York City public schools, the three are also actively managing money. “Julian is truly a money machine,” said David Saunders, managing partner of K2 Advisors, a fund of funds, and former employee of Robertson’s Tiger Management Inc. “He and his colleagues are still active in the markets, in making investments and making money.” The tie that binds these three is clearly their impact on the way money is managed. Although Benjamin Graham and David Dodd may have provided the blueprint for success in the markets with their work on value investing,

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Soros, Steinhardt, and Robertson clearly have been the architects of hedge fund—and market—success. “There are very few people who you can point to and say they have had as much effect on the way money is managed as these three individuals,” said Hunt Taylor when I interviewed him for my book on Robertson. “Not only did they build fabulously successful businesses for themselves, but in doing so, helped shape the industry into something that will probably last forever.”

A FORCE TO BE RECKONED WITH In 1968 the Securities and Exchange Commission estimated that there were approximately 140 investment partnerships, or hedge funds.2 Back then, many hedge funds were real hedge funds, because the managers used shorting to control downside risk. As the industry grew, some of the people who had entered the arena were unable to go short and created portfolios whose success was directly correlated to the overall success of the stock market. As the markets reeled in the late 1960s and early 1970s, these managers suffered significant losses; according to Eichengreen and Mathieson Asset Management, the 28 largest hedge funds’ assets had declined by 70 percent by 1970. As a result, many were liquidated. At the time, the hedge fund industry managed just $300 million in assets, less than $1.5 billion in today’s dollars. Throughout the rest of the 1970s and 1980s, the industry continued to grow, but at a very slow pace. Still, managers like Soros, Steinhardt, and Robertson managed to build their businesses, raised significant assets and put up great returns. By the mid-1980s, others began to make their mark, and the industry began to really take shape. It wasn’t, however, until 1992 that the industry, and the power it wields, came into focus. For this, we can thank George Soros. Soros, with his colleague Stanley Druckenmiller, put together the trade of a lifetime when they broke the Bank of England in 1992. The pair invested a billion dollars in the belief that Great Britain would have to devalue the pound and pull out of the exchange rate mechanism, the system Europe used to stabilize its currencies before the euro was created. The exchange rate mechanism was a system introduced by the European community in March 1979 as part of the European Monetary System to reduce exchange rate variability and achieve monetary stability among the nations of Europe and their currencies. It was done in order to prepare for the Economic and Monetary Union—which combined European nations’ currencies into a single currency called the euro on January 1, 1999.

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The story behind Soros and Druckenmiller’s trade starts in 1990, when the United Kingdom decided to join the new Western European monetary system, agreeing to maintain its exchange rate at 2.95 German marks to the pound. Soros believed this posed a threat to the country’s currency, as its economy was not as strong as that of the newly united Germany. As the British economy began to suffer problems, the pound was squeezed, but the government, led by Prime Minister John Major, would not move. He assured the world that the economy would improve and that the pound was solid. Soros and Druckenmiller believed that Britain’s economy was a lot worse off than Major insisted, and that the Conservative government would have no choice but to devalue the pound. The opportunity began to really take shape in the summer of 1992, when Italy, also a member of the mechanism, devalued the lira. Then, on September 15, Major announced that Britain was pulling out of the European rate mechanism. When the news broke, the pound dropped, causing havoc among currency traders around the globe, who were forced to cover positions to stem losses. Soros and Druckenmiller were perfectly positioned, though. Over the summer, they had sold short $10 billion worth of sterling. When they covered the short, their profit was nearly $1 billion. In the wake of this fabulously successfully trade, people around the world began to look seriously at the power, influence and potential that hedge funds offered. Soros and Druckenmiller became known, in many circles, as “the world’s greatest investors.” From this point on, the world never looked at hedge funds the same way again. Thanks to Soros and Druckenmiller, hedge funds became a force to be reckoned with. The markets needed to look out.

HEDGE FUND LEGENDS Before we talk about each of these men individually and their contributions to the hedge fund industry, let me make one thing clear: Although it’s true that men built the hedge fund industry and that Wall Street is a maledominated world, there are a number of very successful women who work throughout the financial services industry in all aspects of money management and the capital markets, including several who are extremely successful in the hedge fund industry. Two that immediately come to mind are Nancy Havens of Havens Partners, a New York City–based hedge fund that focuses on merger arbitrage and distressed securities, and Virginia Parker of Stamford, Connecticut–based Parker Global Strategies, a manager of managers. Both Havens and Parker have built extremely successful fund companies that

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offer investors great products. Each has worked in various areas of the Street and is well respected for their ability to manage money and run profitable organizations. Women are clearly in the minority in terms of hedge fund ownership and management; however, I believe that money management is an even playing field because the business is transparent. The numbers don’t lie, and investors don’t care who is managing the money—as long as they stick to the strategy and style, and put up numbers that are respectable. Everyone in the industry—men and women alike—can learn a thing or two from the men who truly made the hedge fund industry what it is today.

George Soros In the fall of 2007, Forbes magazine estimated that George Soros was worth nearly $8.8 billion, making him the thirty-third richest person in the United States. While his wealth has been created from his ability to make money in the markets, today more people seem to equate him with his philanthropy and political endeavors. Soros had been a legend on Wall Street for more than 20 years before he became known around the world with his trade against the pound in 1992. In 1997, he gained additional notoriety when he was personally blamed by the prime minister of Malaysia for the Asian flu that caused havoc in the global currency markets. In the late summer of 1997, Malaysian Prime Minister Mahathir Mohamad blamed Soros for an “assault” on the Malaysian ringgit, which saw its value drop by more then 15 percent from July to September. Mahathir said at the time that Soros was trying to punish his country for its support of Myanmar. Although there has never been any direct proof of Mahathir’s allegations, the notion alone created quite a stir, and added to the money manager’s mystique. Soros also gained additional fame during the 2000 and 2004 presidential elections for his anti-Bush work and efforts to derail Republican control of the House and Senate. George Soros was born in Budapest, Hungary, in August 1930. When he was 13, faced with Nazi occupation, his family fled Hungary and made their way to London. Soros eventually entered the London School of Economics, where he began to study under Karl Popper, under whose direction, Soros has said, he learned investment strategies and came to understand the markets. Soros left London for the United States in 1956 to begin a career on Wall Street. In 1970, he launched Quantum fund with Jim Rogers, which became one of the most successful hedge funds. In 1980, Rogers retired and Soros continued with a series of partners, including Druckenmiller and Nick Roditi.

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But it hasn’t been all gravy for Soros. During the Asian currency crisis and the technology bubble, his firm lost significant amounts. The currency crisis was particularly cruel. In late August 1998, after weeks of speculation and rumor, Druckenmiller went on CNBC and told the world that the firm had lost nearly $2 billion in the wake of Russia’s bond default and the devaluation of the ruble. The crisis came from Russian officials’ attempts to renegotiate foreign debt payments inherited from the former Soviet Union in an effort to instill investor confidence. By mid-1997, it looked as if things were going well, but by the end of the year workers weren’t being paid, taxes weren’t being collected, there was governmental uncertainty, and the hard currency was beginning to soften. In early 1998, things looked worse. President Boris Yeltsin fired his entire government, appointed a relative newcomer as prime minister, and made enough missteps to cause investors to question the stability of both the government and the economy. Then, by early summer, things were at their worst. Liquidity had dried up as banks refused to lend to the government, based on their belief that it would not be able to repay them. On August 13, the Russian stock, bond, and currency markets collapsed as investors realized that the government had no choice but to devalue the ruble, and a default on the debt was imminent. On August 17, the government floated the exchange rate, devalued the ruble, defaulted on its domestic debt, and declared a 90-day moratorium on payments by commercial banks to foreign creditors. For Soros and Druckenmiller, this spelled disaster, leaving them holding nothing but worthless slips of paper. It was a tough summer for the pair, resulting in the closure of one of their funds, which lost more than 30 percent as a result of the default. Soros, however, was not alone in his losses. Just a few weeks later, Long-Term Capital Management, a well-known and oncerespected hedge fund complex, was pushed to the brink of collapse, saved only by a bailout orchestrated by the Federal Reserve. Despite these missteps, Soros and his team are experts at taking advantage of political and economic trends and leveraging them into successful fixed-income and currency plays. Soros is a speculator who makes significant trades based on his schooling by Popper, who taught him that financial markets are chaotic and unpredictable, largely dominated by a herd mentality. He has said that he believes that investments are priced by people who act on emotion rather than logic. How Soros Managed Money Soros is a prolific writer, defining his ideas and beliefs on how the markets work, how he views the markets, and how he puts these ideas to work. All are based on what he learned under Popper, especially his theory of falsification.

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Born in 1902 in Austria, Sir Karl Raimund Popper is considered to be one of the most influential philosophers of the twentieth century. Falsification is defined as the logical possibility that an assertion can be shown to be false by an observation or a physical experiment. Something that is considered falsifiable does not mean that it is false, but, rather, that it is capable of being disproved. According to Popper, “all men are mortal” is unfalsifiable, since it is impossible ever to demonstrate that is a falsehood. However, all it takes is one dead man to demonstrate that the statement “all men are immortal” is falsifiable. It is this philosophy that became the backbone of Soros’s trading and investment theories. Soros also uses something called market fundamentalism when making investment decisions. He bases this work on the common misconception that the free market is always beneficial to society and that market forces serve the common good. He has said he believes that markets are, for the most part, unstable, and that he does not agree with most students of the market who believe that markets are in a state of continuous equilibrium. He believes that markets are in a constant state of disequilibrium and provide for excesses, either up or down. Markets, according to Soros, are unpredictable, and therefore must rely on government involvement to ensure that the public’s interest is upheld. He believes that without government involvement, markets will go to extremes, leading to financial ruin. Soros’s philosophy, beliefs, and investment strategies defy conventional wisdom. Furthermore, a number of money managers and even some economists believe that financial markets are often at near-perfect equilibrium and dismiss Soros’s ideas altogether. Dismiss they may, but his work in these areas has led him to make and lose significant—in some cases obscene—amounts of money over the years. People may criticize or discount his methods, but no one discounts his success.

Michael Steinhardt No conversation about the finest hedge fund managers would be complete without a discussion of Michael Steinhardt. According to many reports, including his own biography, Steinhardt was born to a compulsive, high-risk gambling father and reared by a loving and selfless mother who taught him right from wrong. He is a kid of the streets who worked his way through the ranks of Wall Street, creating one of the most successful investment partnerships of all time, as well as a vast fortune for himself and his partners. Steinhardt was educated in brokers’ offices around Wall Street, learning how the market worked, how to read charts, and how to develop investment

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strategy. He took this love for the markets and combined it with his education at the University of Pennsylvania’s Wharton School to Wall Street, first at the mutual fund company Calvin Bullock as a research analyst and then to the brokerage firm Loeb Rhodes. In 1967, he co-founded a hedge fund that would eventually evolve into Steinhardt Partners. His strength throughout his career was his pursuit of making money regardless of market conditions. According to TheStreet.com’s Jim Cramer, Steinhardt pioneered the notion that down days in the market were no excuse for losing money. Steinhardt’s firm experienced incredible growth in its first few years of operation, seeing its managed assets grow nearly 140 percent. By the 1970s, the firm was managing more than $150 million and was the largest hedge fund in the world, according to a Securities and Exchange Commission report. Wyndham Robertson (a reporter at Fortune and sister of Julian) wrote extensively about the report and Steinhardt in a story titled “Hedge Fund Miseries,” which ran in May 1971. The meteoric rise in assets at the firm was attributed directly to its performance, not to an influx of new investors or capital. To put up these numbers, Steinhardt and his colleagues remained extremely focused on micro and macro trends, both in the market and in the economy. Micro trends are small activities that can be identified by money managers and used as tools to forecast the direction of a specific sector of the market or region of the country. For example, a micro trend might be the observation, and subsequent proof through research, that real estate prices are increasing in a specific area of New Jersey based on new home sales and resale sales data. Macro trends are the big picture. For example, a macro trend could be that home sales are decreasing around the country, based on new home sales or resale sales data. Steinhardt used a research process that combined gathering information about a particular security or area of the market, and his instincts and beliefs about what was going on in the economy both here and abroad in order to determine how it would move in the weeks and months ahead. As part of this process, he talked to as many people as possible, met with management or government leaders, and gathered intelligence from various other Wall Street firms. This allowed him to predict which way the markets would move and to trade accordingly. He said in an interview that he operated on the assumption that while he had a lot of information and was capable of putting it to work, he always knew that he didn’t have the complete picture. “You can never have all of the information,” he said. “What you can have is as much information as you can gather and act accordingly. What matters is what you do with the information you have.”

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Throughout his career, Steinhardt put up stellar numbers. According to one press account, a dollar invested with him in 1967 would have been worth over $587.81 in 1995, when he retired from actively managing other people’s money. That same dollar would have been worth just $12.77 had it been invested in a Standard and Poor’s 500 index fund During this tenure, he only had one losing year and used equities, bonds, currencies, and other financial instruments to put up the track record. How Steinhardt Managed Money Steinhardt is a pure fundamentalist with the tendencies of a trader. He operated both a short- term and long-term strategy based on macroeconomic views. This allowed him to pick stocks that he believed made sense, based on how he thought the world was moving. According to some accounts, he constantly reviewed the positions in the portfolio in search of finding opportunities to extract more money from the market. During investment idea meetings, he would know almost instantly if a trade made sense and would act quickly. Steinhardt did this both with winners and losers. Every position in his portfolio was reevaluated if and when his macro view changed. He’s an expert at mixing long-term positions with short-term positions. It didn’t matter if the position was working or not; if he changed his view, the position was up for review. All day long, day in and day out, Steinhardt worked with his team to review, refine, and better his decisions. While Soros perfected the use of philosophy to generate trading strategies, Steinhardt believed in something else—commissions. It is estimated that at the height of his operation in the late 1980s, his firm was regularly paying between $20 million and $35 million a year in commissions to brokerage firms around Wall Street to make sure it got the first call and access to what Steinhardt calls “the best merchandise.” Steinhardt expected to access this information quicker and faster than everyone else because the brokers were loyal to him and his commissions. If news about one of his positions broke, he expected to get the first call from a broker in order to take advantage of it. He didn’t expect inside information, but, rather, the first information. His brokers were his eyes and ears on the Street. He paid them well, and he expected them to deliver. Throughout his career, Steinhardt was an active trader. He executed thousands of orders to make money for his investors. He still believes that trading is a catalyst, and by executing numerous orders he was able to “open up opportunities.” Going after different opportunities simultaneously allowed him to open even more doors for access to potential profits. Steinhardt says the ability to “smell a lot of things” gave him insight to what was going on in the market because he was trading all across it. Even with all of this action and executions, Steinhardt said that most of his long-term

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performance came from his ability to stick with a position and hold it for a year or longer. He picked a direction and followed it for a year or so until it paid off. This was his core position. It allowed him to establish a position in the portfolio that he felt was going to pay off in the long run, and trade both long and short to find other potent opportunities to add to his core. One inviolable rule was that Steinhardt never hedged one stock position with another from the same sector. For example, he would not have gone long Pepsi and shorted Coca-Cola. To him, that meant that he was creating a second problem. It meant that the sector was potentially in trouble, and if the sector was in trouble he didn’t want to be on both sides of the trade. Instead, Steinhardt would go long Pepsi and short another stock in an area of the market that would react negatively to Pepsi’s success. He also did not believe in charts, even though he learned how to read them in his salad days on the Street, and never felt that he made decisions to buy on strengths or weaknesses. He based his trading on the idea of a balance between the conviction to follow his ideas and the flexibility to recognize when he made a mistake. “This balance of confidence and humility is best learned through extensive experience and mistakes,” he said. Steinhardt says that throughout his career, he based a lot of his moves on being intellectually honest and respecting the people on the other side of the trade. It is important, he says, for traders to realize that once they’ve made a decision, they’re going to compete with people who have made the opposite decision, and that often these people will beat them because they have devoted more time, energy, and resources to the trade. He also said that he never saw patterns develop. He said that sometimes specific stocks or sectors would break out and be the ones he would follow over time, but that these break-outs would diminish and something else would evolve. That is why he took a macro view of the world and set out to trade around his ideas. During his tenure, Steinhardt ran his fund, on average, 40 percent net long. The range was 15 to 20 percent net short to more than 100 percent net long. He managed this through the use of leverage. For example, let’s say that he had 100 dollars to put to work. If he shorted 20 percent of the portfolio, he would gain, in theory, an additional $20 to put to work in the market—the proceeds from the short sale. He could take that additional cash and combine it with his portfolio and put it to work. This would allow him to go both long and short. He believes that maintaining this flexibility in market exposure provided him with an important tool that allowed him to be successful. “I was not constrained” he said. “I could do what I wanted to search out profits.”

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Today, Steinhardt concentrates his efforts on two areas: philanthropy and exchange-traded funds. Since 1995, his philanthropic efforts have focused on making schools around the country better and on bringing Jews around the world closer to their religion. In 2004, he financially backed and became a spokesperson for a company called WisdomTree Investments, a firm that created ETFs based on earnings and dividends rather on indexes.

Julian Robertson Julian Robertson could be classified as more than a legend. Prior to 1980, Robertson was not in the hedge fund business; rather, he held various positions at Kidder Peabody & Co. Regardless of where he worked and what he was doing, he is clearly one of the most successful money managers of all time, and someone who revolutionized the hedge fund industry during his tenure at Tiger Management. Robertson has alternately been described as brash, aggressive, and charming. People who meet him at a cocktail party or social event see him as a Southern gentleman straight out of his hometown of Salisbury, North Carolina, while those who worked for him call him crass, mean, and downright nasty. Never in my life have I experienced situations like those while interviewing former employees and colleagues for my biography of Robertson. People would spend hours on the phone or in interviews telling me great stories about the way he operated and the reason behind Tiger’s success and then call me back an hour later or request another meeting to tell me how hard it was to work for him and how badly they were mistreated. “Julian is truly a singular influence,” said his former trader and current fund of funds manager David Saunders. “He has touched so many different managers that it is impossible to think what the hedge fund industry would be like if he had not started Tiger.” Tiger was launched in 1980 with approximately $8 million under management. The firm had grown to just over $21 billion by the late 1990s, but was shuttered as a single-manager organization in 2000 as the technology bubble burst. Robertson’s father was an investor and successful businessman in the textile industry in Salisbury, while his mother was heavily involved in community work. His initial schooling in investing came from his father, who taught young Julian how to read the stock tables in the local newspaper. Senior taught his son the value of owning well-priced stocks and the importance of understanding a balance sheet. Together the two would often read about companies, comparing their operations, organizations, and prospects for success.

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In 1955, upon graduation from the University of North Carolina with a degree in business administration, Robertson entered the Navy. He was stationed as a weapons officer aboard a munitions ship. It was there, Robertson says, he learned the value of being a good leader and the importance of gaining the respect of those who reported to him. Toward the end of the 1950s, Robertson entered the training program at Kidder Peabody & Co., and by 1974 was running the firm’s in-house money management company, Webster Management Corp. It was during his time at Webster that he went from being a broker to being a money manager. He gained a reputation among colleagues and friends as someone who really understood how to make money in the markets. As the 1970s wore on, Robertson began to get restless at Webster. He had spent a fair amount of time with Bob Burch (Alfred Winslow Jones’s son-in-law) and had learned quite a bit about hedge funds, so he decided to give them a try. He partnered with his friend and Kidder colleague, Thorpe McKenzie, to launch the Tiger Management hedge fund in 1980. The firm put up extremely good numbers for most of its life, until it caught the Asian flu and was clobbered by the downturn in technology.

How Robertson Managed Money Robertson’s trading and investment style is based squarely on the work of Graham and Dodd. The writers, who also influenced Warren Buffet’s investment philosophy, shaped the way Robertson makes investment decisions. Robertson is all about the research. Throughout his tenure as an investment professional, he has said that he knows of no substitute for careful and comprehensive analysis of investment situations, other than to get into the trenches and evaluate an opportunity from every angle. This is a guy who does more than simply look at research reports and newspaper clippings; he is someone who sits with senior management, gains access to customers and talks to competitors. Then he looks at the numbers and makes sure everything adds up. He likes to buy things that are cheap and then watch their value rise. If hunting for value investments were an Olympic sport, he’d be a gold medalist. Robertson learned early on at Kidder that information is the key to success. He understands that gathering data and processing the material is what makes people smarter. Over the years, he has worked extremely hard to establish networks he can rely on for information and sources of data to help him make better, more informed decisions. Through his relationship with Burch and his friendship with Jones, Robertson learned the ins and outs of the hedge fund business. He learned how to build a business and also the importance of constructing a portfolio that included both long and short positions. Shorting allowed Robertson to

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accomplish two goals: to hedge the portfolio against a down market, and to take advantage of companies that were destined for failure. Like Soros, Robertson had one trade that the world saw as the defining moment in an already illustrious career. It was his trade in copper. When everyone thought that the price of copper would rise as demand increased, he believed that the data behind the increase were flawed and the market would fall. It was this contrarian idea that caused him to go short the copper market while it was rising. He was going against the grain and he initially lost a bit of money on paper, but by maintaining his conviction he was able to see it through to the end and reap significant rewards. The reality of the situation was that Robertson’s facts, while correct, were short of one thing: a catalyst to make them pay off. Just as Soros needed Major to pull the rug from under the pound, Robertson needed an event to make the trade profitable. The catalyst for Robertson was a rogue trader at Japan’s famed Sumitomo. The trader had amassed a massive amount of copper, so much so that he was rumored to be close to cornering the market. The problem was that his bosses didn’t want the market cornered. When they found out what he had done, the powers-that-be forced him to liquidate his positions. The fire sale flooded the copper markets, caused their collapse and allowed Robertson and his team at Tiger to make nearly $300 million in one day. It was a long, strange, but extremely profitable trip for Robertson and his team at Tiger. It was a trade that solidified Julian’s greatness in the annals of money managers. By contrast, there are some that say the copper trade was the beginning of the end for the firm, as many believe that egos entered a trading desk that had not been burdened with them before. It is clear that it launched the careers of many of the industry’s greatest managers. The roll call at Tiger includes Steve Mandel of Lone Pine, John Griffin of Blue Ridge, Lee Ainslie of Maverick, Andreas Halvorsen of Viking, and Dwight Anderson of Osprey. Robertson’s focus on sticking to a value-orientated philosophy was ultimately the downfall of Tiger Management as a hedge fund that managed money for outside investors. The firm completely missed the technology boom and also got stuck in a number of very large positions that became illiquid. That led to significant losses and investor withdrawals. The Tiger legacy was its return, which on a compounded annual basis was 31.7 percent net of fees during its lifetime. By 2000, when it was apparent that Tiger was over, Robertson returned what was left to investors and turned the company into an investment firm with one client—himself. To transition the company, Robertson worked with a number of Tiger analysts and employees who were rewarded for sticking around when their boss helped them launch their own hedge

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funds. Today, at the firm’s offices in Manhattan, along with the people who work solely for Robertson, there are more than 10 hedge funds that have been seeded through the Tiger platform. Robertson is probably one of the most prolific seeders in the hedge fund industry—he provides capital to managers who fit his specific investment guidelines, working with them to help grow the firms. A number of his successes include Chase Coleman’s Tiger Technology Fund, Tom Faciolla’s TigerShark Fund and Bill Hwang’s Tiger Asia Fund. Although all of the funds have the Tiger name, none are owned outright by Robertson. He is a small, albeit important, part of their existence—but each is an independent entity. It is quite a model that stretches from the building on Manhattan’s Park Avenue to a network of managers and funds in offices around the world. These Tiger cubs are part of the vast network of individuals that exchange information and ideas so all can make money in the markets. Although he is now in retirement, Robertson is still quite active in money management, business ventures and philanthropy. He has developed golf resorts and wineries in New Zealand and has embarked on a number of educational, medical and environmental initiatives as well.

STANDING ON THE SHOULDERS OF GIANTS It is unclear what the hedge fund industry would be like today with Soros, Steinhardt and Robertson. In fact, it’s apparent that some people in the industry have little or no knowledge of their funds or money management skills. I find it funny that sometimes when I give lectures and ask people about these men, few, if any, people know what they have done to further the hedge fund industry. But very few people have truly shaped the way money is managed like these individuals. They all took the concept that Jones created and developed it into something fantastic. They really did build a better mousetrap. Moreover, each, in their own way, became a great teacher and mentor to the hundreds of people who passed through their organizations over the course of their firms’ histories. A number of years ago, when I was writing my book on Robertson, some of his former colleagues said that the Tiger network reached literally around the globe and was estimated to manage nearly 20 percent of all the assets allocated to hedge funds. Even if that number is only half correct, that is a fantastic achievement. If we add in Soros and Steinhardt and even Jones to the mix, the number is undoubtedly much greater. Together Soros, Steinhardt and Robertson have created legacies unlike any others in the investment community. There are very few money managers who have truly shaped the way money is managed. Although many people

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believe that Warren Buffett and Charlie Munger are some of the smartest money managers ever to live and breathe the markets, there is a nagging question that surrounds them: What will happen when they retire from running Berkshire Hathaway? The destiny of the firm, and the legacy of its managers, is unclear. This is a problem. I don’t for one minute doubt their investment prowess or skills; however, I do doubt their ability to pass the torch to a second or even a third generation. The same cannot be said about the three wise men of the hedge fund industry. Together they have spawned literally dozens of successful money managers. Their ability to create and develop organizations that not only put up solid and consistent performance numbers, but also operate as finishing schools of sorts for managers of the future, is unlike any others. The legacies of these men will go on for years to come, as the people who helped build places like Soros Fund Management, Steinhardt Management, and Tiger Management continue to create, launch, and operate hedge funds around the globe. The reach into the markets of these men is wild. It is a truly amazing accomplishment. As a budding or existing manager looking to grow, it is important that you know where the roots of the industry are and how things evolved. There are two keys to your success: Determine a strategy that works, and implement it with conviction. The people in this chapter did this in their businesses, and continue to do so today. It’s why hedge funds are unique, and why they’re so profitable. It’s what breeds success.

CHAPTER

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Running Your Fund Transparently

A

s I’ve discussed in previous chapters, in the summer of 2007, markets around the world were rocked by the sub-prime meltdown in the U.S. mortgage market. The chickens had come home to roost. All the lenders who had been so gung-ho to give everyone with a heartbeat a mortgage realized rather quickly that this was not a good idea. As the borrowers began to default and the lenders began to realize that no one was interested in buying the mortgages, the bond and stock markets began to collapse and many financial institutions—including some very big banks—were left holding the bag. One of the first hedge fund managers to have massive problems was Australia’s Basis Capital Fund Management Ltd., which lost more than 80 percent of its assets. After more than $1 billion in assets in May, it had shrunk to less than $100 million in assets by the end of August, Basis was forced to file for bankruptcy protection. The losses were caused not only by subprime mortgage defaults, but also by its inability to meet margin calls. “The banks squeezed us out of existence,” said Rick Bernie, the manager’s head of marketing. At the time of the bankruptcy filing, the firm’s creditors included JPMorgan Chase Bank NA, Goldman Sachs International, Citigroup Global Markets Ltd., Morgan Stanley, Lehman Brothers International (Europe), and Merrill Lynch International. The creditors forced the bankruptcy after issuing default notices to the fund following a massive devaluation of its portfolio earlier in the summer because the bonds that it had purchased decreased significantly in value. Basis, which was started in 1999 by Steve Howell and Stuart Fowler, had been known around the globe as an expert fixed-income manager. It was named Fund of the Year in 2005 by AsiaHedge and was Macquarie Bank Ltd.’s Skilled Manager of the Year in 2004. The awards didn’t block its losses, though, and by the time the dust settled in early November, the

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firm had decided to file for bankruptcy protection for its other funds as well, citing similar problems and losses.

WHEN GOOD FUNDS GO BAD Still, by far the most interesting failures of 2007 were at Bear Stearns Asset Management, which saw its two flagship funds go basically to zero. Both funds made the same wrong bets on the single-family mortgage market, and the paper they were holding lost nearly all its value. Bear started having problems in the late spring, but saw it all come crashing down in the summer, after it orchestrated a $3 billion bailout of one fund in hopes of staving off further losses. No such luck, however, and both funds filed for bankruptcy protection on July 31. The firm itself weathered the storm for a few more months until it collapsed under a massive weight of debt, and was sold to JPMorgan Chase for $10 per share. The sale was announced on the evening of March 16, 2008. At that time, the 52-week high for the stock was $159.36. In January 2007, the stock had traded for as high as $171.51. And while Basis and Bear saw their funds go down faster than the Titanic, the real marquee player to sink in the whole subprime mess was neither of the two. It was Jeff Larson, a former Harvard Management Co. man, who went from hero to zero in just a few months. His Sowood Capital Management LP saw its funds lose nearly 50 percent, or $1.5 billion. He was forced to liquidate and sell whatever scraps he could find to a hedge fund manager who feeds at the bottom of the money management ocean—Ken Griffin, of Citadel Investment Group. Citadel is known throughout Wall Street as the buyer of distressed assets and by some as the “Federal Reserve of the hedge fund industry” due to its ability to come into a situation and take over assets of those firms that have suffered massive losses. Since 2004, when Larson left the Ivy League where he’d helped manage Harvard’s endowment, he and his team had become the envy of the hedge fund world. Out of the gate, Sowood got nearly $500 million from Harvard and used that as a sales tool to bring aboard more than another $1.5 billion before shutting Sowood’s doors to new investors just a few months after its launch in 2004. The firm traded various securities, including convertible bonds, commodities, fixed income instruments, and equities. But when the illiquidity that swept the markets in the second and third quarters of 2007 hit, Sowood was crushed. Its managers had not been prepared for such volatility. According to a Bloomberg report in July 2007, Larson had written to investors to say that although the firm did not own any subprime loans, his team could not keep up with the volatility and deal

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with the markdowns that the fund’s trading partners were demanding. In plain speak, the portfolio held some mortgage-backed securities that may have not been quite subprime, but that were nonetheless difficult to price when market demands evaporated in the wake of the credit crisis.

WHAT YOU CAN LEARN FROM THE CREDIT CRISIS It was a downright difficult time to be investing in anything, let alone hedge funds. But these cases notwithstanding, hedge funds are exactly the right places to be in such difficult and confusing times. Although liquidity dried up along with credit, there was as lot of money to be made in the summer and fall of 2007. Many who were caught with their pants down complained about all the problems they were having with their brokers and bankers only because they had no one else to blame. Although the credit crisis was a time of desperation, there still was money to be made. Many people were desperate only because they did not have the expertise to manage money during volatile times. They got into the hedge fund game because the barrier to entry was low and they were able to run a business based on mediocre performance that mirrored or performed slightly better then the index. Volatility separated the pros from the Joes. Volatility, coupled with market dislocation and significant Federal Reserve interaction, takes things a bit further than a so-so player can master. Again, remember that a rising tide raises all boats. The stock market since the technology bubble’s burst in 2000, and in the wake of the terrorist attacks of 2001, experienced a nice ride for quite some time, with the S&P going from 855.70 in January 2003 to 1549.38 in October of 2007.1 That is a nice return by any measure. Everyone looks smart when the market rises. It is when markets fall that you realize who is and who is not a true money manager. A true money manager can protect the portfolio during down times, with hedges that cushion the blow of the downward pressure. Hedging doesn’t just mean going short or exercising option strategies. In some cases, managers hedge by getting defensive with their portfolio. For example, the managers go to cash, buy bonds or move out of volatile stocks and into more stable companies.

What Went Wrong So, what happened? It was very simple. The days of easy money-making came to a screeching halt because the days of easy credit were over. Prior to March 2007, anybody with a pulse could buy a house and fulfill the

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American dream of owning a home and living on a street paved with American gold. Unfortunately, that all came to an abrupt and painful end when it became more and more apparent that borrowers with little or no economic means and those who had been given loans with a loan-to-value ratio of 120 percent were probably going to have a hard time making their payments. A loan-to-value (LTV) ratio is the percentage of loan in relation to the value of the house, so, for example, a loan with an LTV of 80 percent means that if the price of the home is $100,000, the value of the loan is $80,000. A loan with an LTV of 120 percent in the same scenario means the value of the loan is $120,000. That might have worked if the housing market kept rising as fast as it had been, but it didn’t. Most people take out mortgages with an LTV of 80 percent or lower, but low-income people and many first-time homeowners take out loans with higher LTVs because they don’t have enough cash for a larger down payment or they want to get more cash in their pockets. If it sounds like a recipe for disaster, that’s because it is. In my estimation, the mortgage company executives must have forgotten to read Economics 101 (rules of supply and demand) before they decided to make these loans. When people started defaulting on their mortgages, these execs couldn’t understand why their books of business went down the drain. The ripple effect of the subprime meltdown reached into all aspects of the economy. Equities and fixed-income instruments around the world were also pummeled, as investors became more and more worried about economic health. For a time over the summer of 2007, it felt as if the market was dying a slow and painful death. It was a nightmare for market participants, regardless of the type, number, and size of their investments. As one hedge fund manager told me, his fund had performed so poorly during the year that it would have been better financially and mentally if he just stayed home all year and collected his management fee. “It kills me to know that I would have made more money sitting on my couch watching television instead of coming to work,” he said. As summer turned to fall and the holidays approached, a number of very prominent Wall Streeters were shown the door because of their inability to manage their companies before, during, and after the credit crises. The two main losers in the meltdown were Merrill Lynch’s chief executive, E. Stanley O’Neal, and Citigroup’s chairman and chief executive, Charles O. Prince III. “Loser” is a relative term, though, as both got tens of millions of dollars in severance and retirement packages. The bottom line is, as President Truman said, the buck stops here! Since the summer of 2007, many heads in the executive offices on Wall Street have rolled. Shareholders and boards of directors have demanded and

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subsequently ensured that those who had gotten many of the large firms into the credit market crisis would lose their jobs. It was an extremely wild time on Wall Street—probably the first time in history that so many senior people, at so many different firms, were fired at the same time. As the postmortem continues to be written, it is clear that many of the problems that came to light weren’t necessarily a direct result of these people’s lack of leadership or oversight, but rather the market’s need for scapegoats. As of this writing, Citibank and Merrill had just recently announced additional multibillion-dollar losses and additional layoffs. The bloodletting on the Street is far from over.

Perception versus Reality It all comes back to cheap money. Cheap money is what caused bankers and borrowers to act crazy, allowing credit to flow as freely as Opus One at The Annual Robin Hood Foundation Gala. If credit had been a bit tighter, things would have been much different over the last few years. Hedge funds would probably not have done as well and, more importantly, would not have fallen so far, so quickly. When massive hedge funds like Bear, Basis, and Sowood get whacked, it isn’t an anomaly, it’s the tip of the iceberg. The reason market observers have been so fascinated by the losses is because of the perception that the depth of talent at the big houses was so strong that they were incapable of losing it all. The reality in 2007 was quite different. Things in the hedge fund industry were bad because many managers simply did not know how to manage money. As I noted in Chapter 1, according to a number of different media outlets, there are more than 15,000 hedge funds managing $2 trillion. I don’t know how they count funds or where they get their data, but there is one thing that I know for sure: There are not 15,000 fund managers in the United States, or the world for that matter, who know how to hedge successfully. I know plenty of people who call themselves hedge fund managers who add little if any value to the portfolio, other than going long a stock or two. The reality of the situation, my friends, is that hedge funds have to hedge. Most people who invest in them don’t fully understand that, and, for the most part, the fund managers don’t know how to do it. Hedging, again, is using financial instruments to protect a portfolio from both expected and unexpected market movements. Managers do this by putting on shorts of specific stocks or bonds, or in some cases elaborate options/derivative strategies. The idea is to put a cushion, if you will, between the portfolio and the floor so that when the market falls, there is something in the manager’s portfolio to soften the blow.

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As I have said in previous chapters, the hedge fund industry includes a lot of managers who run around the world preaching the hedge fund gospel, when all they are really doing is operating expensive mutual funds. This means that the fund is basically 100 percent long and has zero hedging; its performance will mirror or look similar to that of the S&P 500 index. You read it here first. That is what a good chunk of the industry comes down to. Again, you need to know how to hedge. Calling yourself a hedge fund manager does not mean that you hedge, or even know how to: It just means that you’ve created an investment partnership that is exempt from the Securities Acts of 1940 and 1933. That’s where we stand.

FRAUD Fraud is a five-letter word that wreaks havoc in the marketplace. Fraud is a big problem in the hedge fund industry because the barrier to entry for the would-be hedge fund manager is so low that anyone with $50,000 can hire a lawyer and—Bam!—he’s a hedge fund manager. The hedge fund business attracts bad guys; heck, Wall Street attracts bad guys; heck, most places where lots of dollars flow attract bad guys. Fraud is so rampant in the hedge fund community because many investors are anxious to believe what they hear; particularly when they hear that they’re going to make a lot of money. When people do not remember to do due diligence, they lose their ability to make good decisions. People can be na¨ıve when it comes to making investment decisions, saying, for example, “Oh, the fund was up 50 percent when the rest of the market was down 50 percent. This guy must be a genius!” No. This guy must be cooking the books. Do some homework; find out where the returns are coming from. See how the money was made and then make a decision. Don’t take it on face value; the face value could be crap. Investors need to ask questions, review portfolio documents, and look at other similar strategies to determine if the manager is telling them the truth about where the returns are coming from. It is hard work, and fraud is rampant, so people need to tread carefully. The key thing to remember is that if you are the investor, it is your money, and you have the right to ask and get answers to questions. Furthermore if the answers are not satisfactory or given at all—my advice is to steer clear of the manager. As a manager, you need to remember this at all times in order to build good relationships with existing and potential investors. We’ll talk more about fraud later in the book. Investors need to do more than just check to see if the manager really went to the college he said he did; or to make sure that the managers are actually using the accounting firm, the prime broker, the lawyer, and the

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administrator that they say they are. This is real work, and it’s important. It’s your money. As a hedge fund manager, your job is to provide good, solid succinct data so people don’t have to ask a lot of follow-up questions. Answers need to be made readily available so that investors can learn what they need to know to make an educated decision. Consistency is key to the due diligence process. Arrogance is an error. Over the years, I have had the pleasure of working with a large hedge fund complex that at one time was the envy of managers around the globe. The fund was managed by a smart person, surrounded by other smart people, who helped build an enviable organization. Unfortunately, the firm was hit by some negative publicity that caused a loss of assets. There were news reports that the firm was not pricing its portfolios correctly and that a number of the regulators were looking into its operation. Over the next couple of years, as assets shrank even more and the staff turned over, the market decided things weren’t right with the firm and many potential investors turned away. Management tried hard to right the ship, and while it didn’t sink, it clearly took on some water. Somehow it has been able to stay in business, albeit much smaller and less powerful than it once was before. The market sees the firm as arrogant, standoffish, and not committed to the business. Why? Because it continues to introduce new funds that are not perceived to be their core competence and it has continuous staff turnover. Unfortunately, that seems to be the case. Their people don’t seem invested, aren’t willing to listen, and behave as though investors should give them money to manage just because of who they are. It is a weird place that is destined for failure unless management changes its tune and becomes more user friendly. Right now it operates with a woe-is-me attitude and sees little or no new money. Its arrogance is killing it—something to keep in mind as an investor seeking out a hedge fund.

INFORMATION EXCHANGE The popular press loves to write that hedge funds operate under a veil of secrecy. It’s true: Many managers don’t want people to know what they are trading and where they are making money. It is fine for a manager not to want to discuss portfolio positions in detail. It is not fine for the manager to refuse to answer questions about broad strategy and style. Fraud occurs when questions are not asked or answered accurately and when investors do not do thorough due diligence (see Chapter 8). Hedge fund managers and investors need to establish a level of trust that allows

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information to be exchanged without noses getting bent out of shape. Communication only enhances the relationship between the manager and investors. Many managers operate under the assumption that they are the greatest money managers on earth. As an investor, my comment is that it’s my money. If the manager doesn’t want to talk, then I am taking my money out for a walk. It’s just that simple. I understand the importance of keeping your cards close to the vest, but partners are partners. The relationship between the manager and the investor is a partnership, and in a partnership people communicate. Let me put it another way: As a manager, you need to think of the relationship between you and your investors as symbiotic, similar to that of gasoline and cars. If there is no gas, the car isn’t going anywhere. If the management doesn’t have cash, it cannot run its business. The cash powers the fund’s engine and allows it to make even more money, for both managers and investors.

Giving Your Investors Their Due One thing that burns me up is when a manager calls me, as an investor, stupid. Every once in a while, you get managers who think that they have truly reinvented the wheel in such a complicated way that a dumb schmuck like me can’t understand what they have done. When they tell me this, I say, “Thanks for your time,” and walk away. I have no tolerance for this type of manager, and neither should any self-respecting investor. The most famous manager of this sort was John Meriwether of LongTerm Capital Management fame. He and his band of PhDs, including a Nobel prizewinner, refused to disclose how their fund worked. They told existing and potential investors to trust them and not to worry about the strategy, as it was too complicated for mere mortals to understand. More importantly, they told investors and potential investors that if word got out about what they were doing, the fund would lose its edge. Transparency is measured by how much information managers provide to investors and potential investors about their portfolios. Many believe that transparency is good, as it allows people to see what is going on. Others—like LTCM—think it is bad because it lets the public know about the fund’s actions. The reality is that most people don’t know what to do with the data, and the disclosure has little if any effect on anything. As for LTCM, the result was that the “genius” failed and the fund, firm, and people behind it crashed and burned. Two things went wrong: LTCM believed that its trading models, which were built for the fixed income markets, could be used in any market (this proved to be wrong); and LTCM did not have enough cash to meet the fund’s margin calls.

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There’s an amusing postscript to all the secrecy behind LTCM. A few months after the bailout of the fund was complete, Meriwether got together with some people and formed a new hedge fund company called JWM Partners LLC. The new firm got off to a bit of a rocky start, as initially many investors were still licking their LTCM wounds. Still, over time, the fund saw money come in and has blossomed into a billion-dollar-plus hedge fund organization. Ironically, one of Meriwether’s first public appearances after the bailout of LTCM was at a Managed Funds Association conference in February 2001, where he gave the keynote address on the virtues of transparency and the importance of communicating with investors. Anything for a buck, they say!

Explaining Your Strategy When it comes to due diligence, things are quite simple. As a manager, when you discuss your strategy with potential investors, you need to go into great detail as to how the strategy works, why it works, and why you have conviction that it will continue to work. To do this, you need to provide examples of specific trades—trades that were successful, trades that weren’t successful, and trades that are in the pipeline. Oftentimes, managers get bogged down during investor conferences with bios or with other items that don’t really matter. What investors want to know is how their money is going to be managed, so you need to tell them. Do not be afraid of revealing positions that are currently in the portfolio, or positions you expect to put in the portfolio. The investor is not going to steal your idea. Furthermore, if they do steal it, they’ll most likely become investors in your fund. So don’t be shy or afraid. Rather, be open and frank. That’s what investors are looking for from the people who manage their money. Don’t tell people that the strategy is too hard to understand, because if you do, they are going to take their money and run. Investors are going to ask questions and demand answers. If you don’t give them answers to the questions that they ask, then they have no reason to keep their money with you. That’s the bottom line. As Mister Senor Love Daddy said in the fine film Do the Right Thing, “That’s the truth, Ruth!” Stay focused and stay on top of it—be prepared. Because if you don’t, then you’re going to lose out on investors, and the only person you’ll have to blame is yourself. Peter Lynch, the famed former manager of the Fidelity Magellan Fund, wrote that investors spend more time picking the color of their refrigerator than they do on their investments. That’s the problem. Investors, spend time with your investments and your investment professional. Money managers,

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encourage your investors to spend time with you and learn about what you are doing with their money.

Keeping the Lines of Communication Flowing Let me put it another way, managers. Is there any greater marketer for you than your investors? You know the answer. Do investors have specialties that may help you with your investment decisions? You know that answer as well. You need to create and maintain good relationships with investors at all times. If you don’t get these last two points, read the following. If you do, skip ahead a page. Take, for example the long/short money manager who is focused on retail. If you know that one of your investors happens to have a retail organization, say, one that sells bras and panties through a very successful, 20-store retail chain in central New England, you must believe that he or she will be able to give you insight on retail trends, what is selling, what isn’t selling. Sure, it’s not going to tell you what is going on at the big-box retailers like Costco, Wal-Mart or Sears, but it’s going to give you an idea about microtrends. Investors can provide you with insight and information on aspects of the markets that may be out of your reach. They can tell you things that are happening in areas you know nothing about, but where you are nonetheless looking for returns. Doctors, for example, in some cases can provide great information about trends in medicine, medical devices, and pharmaceuticals. For example, cardiologists would know which heart stents are working, which medical device makers are developing new technology, and which ones no one is using. They know which stents are most efficient from a cost standpoint, as well as a medical standpoint and a lifesaving standpoint. It is insight that you will not be able to get from a company or an investor relations professional. It is what sometimes gives managers an edge!

Communicating during a Crisis Dialogue with investors is never more important than during a crisis at the fund or a market meltdown. Managers need to open the lines of communication to ensure the messages you are sending are received. In the summer of 2008, hedge funds of all shapes, sizes, and strategies were hammered. Some were off 6, 7, 8, or 9 percent a month, a quarter, and for the year. There were some funds that saw double-digit losses. Times were not good for many hedge funds during this time of inordinate volatility and economic uncertainty.

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However, what allowed some of them to recover was that they kept their investors abreast of everything that was going on at all times with their portfolios and answered questions, in some cases before they were asked. Communication, coupled with the strength of the fund’s organization, is going to allow many funds that performed poorly to survive to fight another day. The managers acted appropriately and sent their investors the message, “This is what went wrong, this is why we lost money, and here is where we erred in our ways. This is what happened, and more important, this is what we are going to do to fix the problem going forward.” The messages were delivered loud and clear. These managers realized two things that allowed them to maintain their business: 1. They need to be in constant communication with investors during bad times as well as good. When the proverbial usual stuff hits the fan, investors know that they’re not only going to hear what’s going on, but that they’re going to get the straight scoop from the people with whom they’ve entrusted with their assets. 2. They can never give anybody too much information, nor too little information. The key is to come up with the right amount of information to give investors a clear and simple understanding of what’s going on in the portfolio at all times. Remember that when people start hiding things, whether it’s during good times or bad, there’s a problem. Investors can smell rats, especially today in the wake of fraud and market malfeasance that has wiped out many market participants. If you’re a smart money manager, you’ll listen to what the market’s telling you, convert that information, and give it back to your investors so that they have a clear understanding of what’s going on in your portfolio.

JUMPING ON THE HEDGE FUND BANDWAGON Now, there has been a lot of talk about the evolution of the hedge fund industry over the last 25 or 30 years. It started with Jones, moved on to Soros and Steinhardt, and into the Robertson era. Since those days, the industry has continued to evolve, as SAC, Lone Pine, Maverick, Blue Ridge, Clinton Group, and others paved the way for more and more asset growth. All these individuals and organizations have created wealth for their people, their investors, and their service providers. If you attend a hedge fund conference in Boca, Los Angeles, Geneva, London, or New York, you

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always see and hear the same thing. Hundreds of people at these conferences are trying to sell hedge fund managers something at the same time that hedge fund managers are looking for investors with significant assets to be managed. It’s all about the sale. Whether it is administration, accounting services, legal services, financial services, market data, or trade order management systems, the halls are littered with all sorts of things to buy to make a hedge fund more efficient. Over the last few years, a new phenomenon came on the hedge fund scene: lifestyle service providers. There are people trying to sell high-end medical services, fractional ownership of jet airplanes, security, art consultations, and access to exclusive resorts and vacation clubs. It is fascinating. The hedge fund bandwagon is picking up speed by the minute. A lot of people have their heads in the hedge fund trough and, frankly, I believe that a lot of people have their heads up the trough. My attitude has been, and remains, that when everyone starts jumping onto a bandwagon, you need to get away from it as fast as you can. That bad boy’s going to flip, and you don’t want to get crushed. Don’t read this incorrectly and think that I believe the hedge fund industry is in trouble or that it’s going to go away. Quite the contrary, I think the industry is ripe for continued growth for years to come. All I am saying is that there is an inordinate amount of noise right now, and smart people are using noise-canceling headphones. In other words, if you are looking to start a hedge fund or continue building your existing business, you need to make sure you work with firms that have been around awhile. Be careful and wary of new entrants to the marketplace.

The Year of the Hedge Fund To put it a different way, I think we are about to enter the Age of the Hedge Fund. I think 2009 and 2010 are going to be strong for the industry for five reasons, which I list in no particular order: 1. It is relatively easy and inexpensive to start a hedge fund—the barriers for entry are low. 2. Wall Street is going through a difficult time and laying off people—when people lose their jobs, many tend to go out on their own and there is almost no more lucrative career than hedge fund management. 3. The service providers have commoditized hedge fund services. For all intents and purposes, you can get a hedge fund in a box, if you want it. 4. Technology has made everyone an “expert” investor. Data are available 24/7, 365 days a year, so people believe the playing field is level, for good, bad, or indifferent reasons.

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5. People like telling their neighbors at cocktail parties and on the sidelines at their kids’ soccer games that they manage a hedge fund. It is a way to feel glamorous or important, regardless of how much money you have under management. For example, I know a guy who works in Rockefeller Center who started a hedge fund with about $10 million in assets to invest in distressed securities. Sounds good, right? But this gentleman thinks that it’s all about the jeans. Blue jeans, that is. Now that he is a hedge fund manager, he thinks—and will tell anyone who will listen—that he needs to wear designer jeans to work. The outfit, you see, goes with the fund—or maybe the fund just demands the outfit. He speaks openly about this to friends and colleagues and thinks he is the cat’s meow. I just think it is funny and a bit sad. This gentleman and his partners were able to get the fund up and running because the costs associated with launch were relatively inexpensive and an easy hurdle to surmount. They have no experience in the fund business and no experience managing money, except through their own personal investment accounts. They really have no idea what it takes. If the fund makes it through two years, I will be impressed.

Where the Industry Is Heading My conclusions from all of this are that that the hedge fund industry is primed for growth. I believe that many, if not all, of the sophisticated investors at pension plans, endowments, foundations and family offices around the globe have realized that they need diversified portfolios created by managers who are going both long and short the market. These people have come to the conclusion that investments that go one way, say, traditional long-only investments, need to be dialed down, while those that go both ways need to be dialed up. The real question is going to be posed to managers: Can you actually deliver on the hedge fund promise? Hedge funds are designed to deliver alpha. Simply put, alpha is a return in excess of the market. For example, if the market is up 10 percent and your fund returns 14 percent, the alpha you generated is the additional 4 percent. Alpha is the difference between your fund’s return and the overall market’s return. Can you create and manage portfolios that deliver alpha? Nobody has this answer; time is the only thing that will tell if the promise of hedge performance can be delivered. If the performance is uninspiring, investors will walk away. By contrast, as profits continue to flow into the industry, it is easy to see that big hedge funds will only continue to get bigger. This means that

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a fund complex that has $10 billion or $12 billion under management will see the numbers grow to $20 billion or $25 billion, while the massive singlemanager organizations and funds of funds with assets today north of $25 billion or more will easily grow to $50 billion and then $100 billion. The growth will come not only from new clients but also from performance. If a fund has $250 million to $300 million right now with solid performance, I would expect that organization to grow to a billion over the next few years. I believe that hedge funds with between a $100 million and $200 million under management, which would grow over the next few years at the same percentage rate. The simple explanation is that smaller funds will grow as the big funds shut out “smaller” investors. It used to be that a million dollars was enough to get into a hedge fund, but as the funds get bigger and the slots fill up, some of the big firms are going to have to raise their minimums to $5 or $10 million. An endowment with $250 million or pension plan with $150 million or even $500 million cannot afford to take its entire hedge allocation to one fund. Overall, the allocations by pension plans, endowments, and other sorts of institutional investors will grow over the next few years as investors continue to search for the alpha that traditional investments do not provide. Over the years, the hedge fund industry has had its share of both successes and failures, too many to write about (though we’ve gotten into some of the successes, and will discuss some of the failures in more detail later). There are funds that have been massively successful and funds that have been massively unsuccessful, but here’s what you need to know: At the end of the day, most funds are neither huge winners nor huge losers. They are simply good businesses.

CHAPTER

5

How Hedge Funds are Packaged

O

ne of Wall Street’s greatest skills is its ability to create and sell products to investors of all stripes. Whether it’s stocks, bonds, mutual funds, mortgages, investment banking services, or anything else, every Wall Street firm is focused on selling. Selling to individuals, selling to institutions; it’s all about selling. That’s where the bread-and-butter profits are made and it’s the cash cow that allows firms to do other things, like trade for their own accounts or invest in real estate. That’s why most successful Wall Streeters are excellent packagers. Creating investment products such as hedge funds, mutual funds, exchange-traded funds, and funds of funds allows brokers and salespeople to develop revenue streams from different areas of the marketplace. This translates into more cash—and more cash means more money in the pockets of the employees. This is not a bad thing; quite the contrary. Despite its reputation as moneygrubbing (a reputation that’s unfortunately been burnished by the antics of a few bad apples), Wall Street, for the most part, is a beneficial entity. Think of how difficult it would be to save for retirement, for example, without a 401(k), 403(b), or IRA. I suspect most of us would stay into the work force well into our seventies without the returns that Wall Street can offer. The key to success on Wall Street, whether you’re an investor, a broker, a hedge fund manager—regardless of your role, really—is to understand how Wall Street makes its money. Wall Street is constantly evolving, and you need to roll with it. Although this book is intended to provide you with insight into the industry, you need to stay current through other sources as well, such as industry Web sites and periodicals.

FUNDS OF FUNDS When it comes to packaged products, funds of funds are one of Wall Street’s greatest inventions. In the simplest definition, a fund of funds is exactly

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what its name implies: an investment vehicle that invests in other investment vehicles. It makes money by charging a fee to the investors. The evolution of the fund of funds business dates back to 1955 in Paris, when a social worker turned door-to-door salesman named Bernie Cornfield took over a company called Investors Overseas Services. Known as I.O.S., over the next two decades the firm took fund of funds investing to Main Street. At the firm’s height, Cornfield and his team of nearly 15,000 salespeople went door to door to investors, primarily expatriates and servicemen abroad, to sell them the company’s mutual funds, which, according to Cornfield, invested in other mutual funds. I.O.S. became a huge organization, not only defining a new way for small investors to access the markets, but also setting the stage for what today is part of the $1.2 trillion hedge fund industry. Initially, the investment community operated only single manager funds, funds that either traded the whole stock market or a sector. However, over time, managers realized that they could build a product that invested in other funds, rather than just securities. And the fund of funds industry was born. From 1967 to 1974, the firm was the envy of every money manager on Wall Street, because it had billions of dollars under management. At its height, the firm was estimated to have more than $2.5 billion in assets under management. To put that into perspective, $1 billion, in 1970, is equal to approximately $1.8 billion in today’s money.1,2 Unfortunately for investors, I.O.S. turned out to be a massive fraud. Cornfield and company operated a very large pyramid scheme, with I.O.S. taking in money from one investor and using it to pay the “guaranteed” dividends of its existing investors. This, coupled with the bear market that swept through the equity market in 1970, caused the firm to collapse. Cornfield and subsequent owners and operators either went to jail or fled abroad. To learn more about Cornfield and his antics, read a book titled Do You Sincerely Want to Be Rich?: The Full Story of Bernard Cornfield and I.O.S. (Library of Larceny, 2005), by Charles Raw, Bruce Page, and Godfrey Hodgson. Despite Cornfield’s more-than-questionable ethics, the funds of funds concept works. It’s simple, elegant, and easy to understand. Funds of funds allow investors to pool assets in order to gain access to more than one manager by investing in a series of managers, creating a diversified portfolio. Although Cornfield perfected the flair and excitement of the fund of funds business, the history of hedge funds of funds is a little less flashy. Cornfield and his salesman gave investors hope and tricked them into believing that by investing in their products they would get rich. The concept was selling something that was too good to be true and ripping them off with each and every sale. They were not only get rich quick artists but they played on individuals’ patriotism, lust of money, greed, and desires.

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The roots of hedge funds of funds date back to the 1970s; however, the industry really began to grow in the wake of the October 1987 crash of the stock market. The stock market turmoil of the late 1980s prompted investors to demand greater access to hedge funds, and, in turn, access to hedge fund managers. Within the past decade, a large number of organizations have gotten out in front of the fund of funds industry and have built fantastically successful businesses. The premise for each and every one of these firms is that investors, particularly institutional investors, shun the responsibility that comes with allocating assets directly to hedge funds because there is potentially too much risk in allocating to a single manager. Funds of hedge funds provide cover for their institutional rear-ends. Assessing risk is hard work. Performing due diligence isn’t much easier. Naturally, most people want to avoid taking the blame for an investment gone bad. Funds of hedge funds solve both problems—the investor gets someone both to do the due diligence and to take the rap if things don’t go well. Again, it’s simple, elegant—and very attractive to many investors.

HOW A FUND OF FUNDS WORKS Here’s how it works: Clients invest their money in one fund. Its manager takes those assets, combines them with other investors’ assets, and spreads them among a number of hedge funds. This solves two other problems for the investor, as well: how to diversify assets through a single entry point, and how to gain access to multiple managers, regardless of how little money you are able to put to work. The fund of funds industry has grown significantly over the last few years. Today, there are fund of funds complexes that range in asset size from less than $30 million to well into the tens of billions. Organizations offer funds of funds in almost every corner of Wall Street, because they make sense for a lot of investors. In light of the volatility and growth of the market since 1987, institutional investors (e.g., pension plans) have realized that they need not only to make good investment decisions but also to provide cover for their well-tailored behinds. Funds of funds do both, and ensure the most important thing of all: job security. If investors weren’t concerned about their jobs, a lot fewer assets would go into funds of funds. “Cover your ass!” should really be the rallying cry of the fund of funds industry. The industry is booming. Firms like K2, Mariner, Mann, Goldman Sachs, and others are expanding their operations in the fund of funds business. Where are they getting the assets? From the likes of the pension plans

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of the State Teachers of Arkansas, the State Teachers of Massachusetts, and the Transit Workers Union. Hundreds, if not thousands, of pension plan managers around the country want the opportunity to invest in hedge funds. That’s where hundreds of millions of dollars are coming from for fund of funds managers to invest.

FUND OF FUNDS ECONOMICS Size matters. On the one hand, a fund of funds with less than $50 million can be very difficult to run. Why? Because a fund of this size cannot afford to hire staff to operate a business or conduct thorough due diligence on more than a handful of managers because the fees associated with the business are low. A fund of funds with $500 million, $1 billion, or more, on the other hand, becomes a true cash cow, because the management fees it generates can be quite substantial. For example, if a fund has $500 million or $1 billion in assets under management and assesses a one percent management fee, the fund is generating $5 or $10 million a year, respectively, in fees independent of any performance income. Let’s say that the costs of running the organization is kept relatively low, maybe $2 million a year. For the hedge fund with $500 million in assets under management, the owner of the firm can clear nearly $3 million in management fees alone. However, the firm can become even more lucrative, because hedge funds incorporate a performance fee. More important, as the fund grows, the firm will need to hire more employees, but it will not need to double the size of its operation in order to manage double the amount of assets. It’s an economies-of-scale issue. Most funds charge a 1 percent management fee on invested assets, plus a 10 percent manager incentive fee on the return to investors. So, for example, in a fund of funds with $100 million in assets under management, the manager would earn a 1 percent management fee, or $1 million a year, paid quarterly, as well as an incentive fee on the net new profits of the fund. If the fund was up 10 percent, or $10 million, the manager would earn an additional $1 million, for a total of $2 million. In some cases, funds of hedge funds include hurdle rates attached to their incentive fees. The hurdle is the performance bar that managers have to leap before they can charge an incentive fee. Hurdle rates are structured in various ways. Some allow the manager to be paid on all of the fund’s returns once they exceed the hurdle, whereas others allow the manager to earn the incentive fee on only the return above the hurdle. These terms will be outlined in the fund’s documents. Read them. I’ve outlined here how some fees are earned.

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Let’s say that a specific fund of funds has a hurdle rate of 9 percent. If the fund earns a 10 percent return, the manager would receive 10 percent of the 1 percent, the amount earned in excess of the hurdle. If the fund earns 17 percent, the manager would receive 10 percent of the 7 percent, not 10 percent of the entire 17 percent. Not all firms have hurdle rates; it depends, in large part, on the manager. The manager will impose a hurdle rate based on his or her beliefs about what the clients want. Some managers believe that a hurdle rate adds to the marketability of a fund because the fees are lower if the fund does not perform; others think that because it limits the upside, it has a negative effect on the organization. I believe that the key to attracting investors and their assets is to create products that they want—and if your investors want hurdle rates, then you need to have them in place. As an investor, you need to be aware of the ways in which hedge fund fees are structured. As a manager, you need to communicate your fees properly so there is no confusion. Unfortunately, confusion can abound. For example, some firms impose a higher incentive fee based on use of leverage or based on just a straight investment strategy. For the most part, the way incentive fees are charged really depends on the manager and how the fund is structured. For example, if the fund employs no leverage, the fee might amount to a 1 percent management fee and a 10 percent incentive fee. However, if the fund is leveraged, it may charge a 1.5 percent management fee and a 10 percent incentive fee. For the most part, though, investors pay a 1 percent management fee and a 10 percent incentive fee when they invest in funds of funds. As a fund of funds investor, the most important thing for you to know is how much money the fund has under management. When you have that figure, you can do a back-of-the-envelope calculation to determine how strong the organization is and how likely it is that it will be around year after year. A fund of funds with assets of more than $100 million has the potential to earn at least $2 million a year in revenue. A fund of funds with assets of less than $100 million is likely to not generate significant revenue and might not be all that strong.

THE COSTS OF RUNNING A FUND OF FUNDS As a budding fund of funds manager, you need to think about how much it costs to run a business. Frugality is important, but even the most frugal organization needs to spend at least a few hundred thousand dollars a year. Whether it’s on employees, rent, lights, water, insurance, travel, or other office expenses, the numbers add up. A fund of funds with $100 million in

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assets, earning $2 million a year, won’t necessarily be very profitable because its nut—the money it needs to keep its doors open—is so large. Here’s why. Let’s say that a fund of funds is operating on a 1 percent management fee and a 10 percent incentive, regardless of the hurdle, and that it has $50 million in assets under management. On a $50 million trade, or for a $50 million organization, 1 percent is $500,000. If it earns 10 percent on the $50 million, that’s $5 million. Ten percent of the $5 million is another $500,000. So the net income for that fund is approximately $1 million a year. On $1 million a year, you have to assume that the cost of running the business is somewhere between 50 and 150 basis points (a basis point is one-tenth of 1 percent). So this particular fund is earning only 100 basis points, which means that it is going to run the business at a net loss for most of the year. In real terms, then, it is probably not going to be able to hire good analysts, not going to be able to build that infrastructure, and not going to be able to compete against other organizations. And let’s not forget marketing costs—without marketing, you have nothing. Let’s drill deeper. A hedge fund needs investment analysts. Let’s say a good analyst costs $200,000 a year in salary and a crappy analyst costs $100,000 a year in salary. For our hypothetical fund, let’s assume that the manager settles on a mediocre analyst with a salary, bonus, and extras, all totaling $200,000 or so. This analyst will check up on managers in the portfolio, source managers for the portfolio, and be in constant contact with the Street in order to make sure all is well. This guy or gal is costing the firm at minimum 20 percent of its income—and that’s for just one person. Most fund of funds that have less than $100 million under management are really just mom-and-pop shops. These organizations are run very lean and rely heavily on the founder for manager due diligence, portfolio creation, and marketing. That’s a lot of hats to wear, and it’s very difficult to do successfully. I believe that many organizations of this size will have a difficult time growing, as the hedge fund industry becomes more and more institutionalized. Investors have gone from being just a group of high-net-worth individuals and family offices to being pension plans, endowments, foundations, and insurance companies. The bulk of the assets in most hedge funds now come from institutional investors, as opposed to individual investors. And institutional investors are far less apt to work with small funds because of the size of the assets under management. However, it’s not unheard of for a fund of funds with less than $100 million to get into a serious asset-growing groove and become an organization managing $1 billion. As the firm grows, it will naturally expand its infrastructure and all other aspects of its operation.

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There are a few ways fund of funds managers can increase their success as the industry continues to grow. The first is to pay attention to trends in investing. If you’re a fund of funds manager, you need to stay focused and understand who is investing in fund of funds and what sort of allocations are being made to the industry. Second, you need to understand what the right market for your product is, and who is and is not likely to invest in it. Know your market and build your product accordingly. I can’t emphasize this enough. Finally, you need to focus on getting assets in the door and creating a pipeline of new investors. Too often, fund of funds managers get so focused on the portfolio and spend so little time on marketing that they end up with little or no money. At the end of the day, it’s like saying that you’re going to build a great engine. You’ve got all of the tools and materials that you need to build a great engine, but if you don’t have access to gasoline, the engine will not be able to run. That’s a real problem, and many fund of funds operators don’t take the costs associated with the business into consideration prior to launch. Now I know of a number of small funds of funds, and three in particular are run by a dear friend of mine. He has significantly less than $100 million in assets under management, and it’s a nice little business. His biggest fund has $30 million; the other two have $20 million and $5 million each. They all do fairly well and have compounded at 10 percent for a number of years. He runs an extremely lean shop and is considered a player in the industry. Even so, my friend cannot get arrested naked in front of new investors. I’ve known him for about five years, and within that period his firm has shown little or no growth beyond portfolio returns. He’s failed at marketing. He understands the value of marketing. He’s willing to dip into his own money, or the fund’s, to pay a marketer. But he can’t find a marketer to work for him. Hiring a marketing person is tough, because you need to put capital at risk and nothing protects you from losing it all. A big firm can absorb a mediocre marketer because he’s one of many. At a small firm, the buck stops with you, and if you’ve hired a dud, then you’re finished! This is what has held my friend back. It’s why he cannot raise assets, and it’s why the firm is not growing.

FUND OF FUNDS GROWTH To hire a good marketing person to go out and raise assets for the firm could cost at a minimum $100,000 for salary, plus benefits, and then that person is going to want at least 25 basis points of any income earned from

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new assets that come into the fund as a result of his or her work. It gets to be expensive. It also can be quite nerve wracking. There are a lot of issues associated with running a small business, and keeping costs under control is among the most important, particularly as you’re attempting to grow and expand. But success isn’t unheard of. Several funds of funds have grown quite nicely over the years, and some that have become fantastically successful. One is located some miles outside of New York City in Summit, New Jersey. When I first started talking to the people there, it was small, say, just south of $150 million under management. Still, over the last few years, as the industry has grown and investors have been in search of funds that they can sink their teeth into, the firm has experienced significant growth. How has the firm done it? Its success stems from its ability to find a successful distribution partner—an organization that you can work with to help you raise assets. One of the principals of the firm in question found a high-net-worth retail broker who wanted to develop a relationship with a fund of funds. The broker got the fund cleared through his compliance office; since then, he’s been sending investors to the firm to the tune of $5 million or so each month. Do the math: New assets to the fund at $5 million a month, for 12 months, means $60 million in net new money. This has been going on for about two years, with little or no end in sight. The manager is happy, the broker is happy, and most important, the clients seem happy. It is truly a win-win-win situation for all parties involved. This story is not an unusual one. Hedge fund managers will often struggle for a while and then see the business grow at a fantastic clip. It comes down to distribution or the ability to raise assets and performance—the two most important pieces of any asset management business. At the time of this writing, some of the largest funds of funds had assets in the tens of billions. Some of the biggest ones are run by UBS, with $45 billion in assets under management; Man Investments, with $35.6 billion; and Union Bancaire Privee, with $20.8 billion in assets. These are massive organizations inside massive companies that are a making a fortune both for themselves and their investors, all by picking successful fund managers.

FUND OF FUNDS BUYOUTS Lately, several funds of funds have been bought out by, or have sold stakes to, larger, more sophisticated organizations. The jury’s still out on these transactions, but so far, they seem to be win-wins for all parties involved. K2 Advisors LLC, for example, which at the end of the first quarter of 2007

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had over $5.5 billion under management, entered into a transaction with a private equity firm started in 1994 by David Saunders and Doug Douglas. In March 2007, it sold a minority stake to TA Associates Inc., a large and well-respected private equity firm. The success of K2 is based on a number of factors, including the founding partners’ pedigree, its infrastructure, and its ability to create diversified portfolios with little or no correlation to the market. Another example, albeit a little more dramatic, is the sale of Cadogan Management Inc. to Fortis Investment Management Inc. in late fall of 2006. Fortis purchased 70 percent of the equity in the firm from its founding partners and combined the assets of its fledging money management business with Cadogan’s. When the transaction was completed, the firm had nearly $3.7 billion under management and was able to take advantage of the infrastructure of one of the world’s largest banks to continue to roll out new funds and add to the distribution network. These are just two of the many deals made in 2006. The hedge fund and the fund of funds industries are poised for significant growth because larger, more sophisticated firms—such as investment banks, brokerage firms, commercial banks, private equity firms, and insurance companies—are always searching for talent. By taking out or taking over funds of funds, they are able to gain access to talent that, when married to their distribution, will create one hell of a business.

MANAGERS OF MANAGERS Over the last few years, as the hedge-fund industry has proliferated around the world and developed into a must-have asset class, along with the topic du jour at cocktail parties, a new group of money management organizations has evolved, called managers of managers. These managers of managers, or MOMs, are investment advisors who can provide separate account products for hedge-fund investors. Here’s how it works. An institutional investor comes to a MOM and says, “Look, I want to invest in a diversified portfolio of hedge funds but I don’t want to use the fund of funds and I don’t want to go into individual funds. What I want is separate accounts at the managers I like.” Investors choose this strategy, because they (1) are looking for more transparency, (2) want to negotiate terms, (3) don’t think any of the funds of funds are worth their salt, or (4) don’t like the fee structures of the fund of funds. So what happens? The manager of managers says, “Great; I’ll create a diversified portfolio of investments for you, based on a separate account strategy.” To do this, the MOM goes through a series of questionnaires and

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meetings with the investor to discuss various strategies, as well as various ideas on how the investor wants to earn money over the next few years through these investments, and provides a look at potential strategies for both static and volatile times in the market. With all of these data points in hand, the MOM goes out and identifies hedge fund or other alternative investment managers, and offers them an opportunity to manage a slice of this diversified portfolio. Once the managers are found, the MOM opens a separate account at each of the firms on behalf of the investor, and the assets are wired in for management. In some cases, the MOM will maintain custody of the assets and the manager will simply trade the account, instead of housing the account at the underlying firm. It varies, depending on the needs of the investor and on both of the firms involved.

MOM KNOWS BEST Here’s what it looks like in practice: Say the investor wants to allocate $20 million to five managers. The MOM will find five firms that meet both its and the investor’s criteria and will open accounts at each of them. Usually once a month, but sometimes once a quarter, the manager of managers reports back to the investor with a report that details the performance of the entire portfolio and the individual managers. What is interesting about this structure is that the MOM has complete control over the assets at all times and can dial up or dial down an allocation based on performance, market movement, or economic trends. To make this work, the MOM needs complete transparency over all of the accounts, and uses its own risk system to determine if the managers are delivering on their promises. In some cases, MOMs require real-time data on how the investments are being made and where the assets are being put to work in order to gauge what’s working best at any given time. This is very valuable to investors because their advisors (in this case, their MOM) who get these data on a regular basis can then use them to make better investments for their other portfolios. For example, it means that an investor can see, from the MOM’s report, that the Forex manager may not be doing so well, and can immediately shut down that account and move the assets to another manager who they believe will do better. Or, better yet, if it’s an extremely volatile market or various markets are doing better than others, the MOM can dial up or dial down the exposure to these various managers and, in a sense, always be in control of the diversification aspect.

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THE PROS AND CONS OF TRANSPARENCY Using funds of funds and managers of managers is a great way to allocate assets and a great way for investors of all shapes and sizes to access professional money managers. It’s important to realize, however, that in some cases, the manager of managers may be asking for too much information. Even though the MOM may be getting data on what is going on in the portfolios, it doesn’t necessarily need this information on a regular basis. There is such a phenomenon as information overload, and when you have too much data in front of you, it can be hard to push through the jungle to find the right tree. Furthermore, oftentimes investors misunderstand the value of transparency. Don’t get me wrong: Transparency is important and good, but most people have little or no idea what to do with the data that they receive once they receive it. That means that having access to a trading blotter—the daily list of trades that are executed by the fund manager—is of little or no value because the person receiving the information doesn’t know what do with it. If, by some chance, some of your investors do request the data and do know what to do with it, then that’s great—for both you and them—because it allows you to provide them with good information about what you are doing, and it gives them the peace of mind that comes with knowing that their money is being well managed. It’s not going to affect the way you, as the underlying manager, manage their assets.

DIVERSIFYING YOUR PORTFOLIO As an investor, I am a firm believer in funds of funds. I’m a firm believer in managers of managers, and I’m also a firm believer in direct investment. There are several reasons that all three of these investment vehicles make sense. Number one, you need to have a stake in how your money is managed. Number two, you need to evaluate your skill set to determine if you have the skills to manage money effectively. If you feel that you do, then you should be able to pick money managers. But if you don’t know how to manage money or you don’t understand how money is managed, it’s important for you to find professionals who can help you—smart people who are educated, understand the way of the market, and have a thorough background in the way things work. You need that environment. Regardless of market volatility and regardless of what’s going on today, the key to successful investing is understanding, as much as possible, what’s going to happen

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tomorrow. Nobody knows for sure what’s going to happen tomorrow, but the more tools you have in your shed that you know how to use, the more success you’re likely to have. To diversify, you need to create a portfolio that is going to take advantage of the multiple opportunities in the market. Find investments that are not simply concentrated in one area or one position of the market. For example, a diversified fund of funds will include equity-based funds, fixedincome funds, commodity funds, and potential hard asset funds. The idea is to make sure you are capturing profits from multiple areas of the marketplace without being exposed to a single area of the market, should that area go bad. There are some funds of funds that concentrate in just equity-based managers; to diversify, they choose various managers who trade different areas of the equity markets. In effect, they try to create a portfolio of managers that own different stocks. Again, the key is to avoid concentrated positions because that can lead to losses. If all of the managers in your portfolio own the same positions and those positions go down, your portfolio is going to take a significant hit. Funds of funds managers need to conduct good due diligence to understand what the underlying managers own in their portfolios.

AVOIDING COMMON PROBLEMS Although MOMs and funds of funds are unique business, they’re still businesses—and if they don’t follow a sound business model, they’re not likely to stick around for the long haul. A lot of the problems with managers of managers and funds of funds stem from the fact that many of the organizations can’t continue to provide a valuable service to investors, because they don’t have the skill and don’t generate enough income to afford the infrastructure. The reason for this, simply put, is they just don’t have the financial capability to do it. Many managers of managers are not running good business models. Many of them are simply creating portfolios without an eye toward diversification, and in some cases, are working in a way that provides little or no value to the underlying managers. The key for you, either as an investor or a manager, is to find people who are sophisticated, who you believe understand what they’re doing, who communicate well, and who have a good understanding of what your needs and expectations are, and, most important, what you want from them. In other words, if you’re an investor, you need to conduct due diligence on the investor as much as they do on you. Ask questions about their investment strategy, style, assets under management, allocation theories, expectations, and prospects. If you don’t feel like you’re getting that from these people, it

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doesn’t matter what kind of operation they’re running or how impeccable their reputation—whether they’re a $1 billion fund of funds or a $5 billion fund of funds, or a $30 million fund of funds, a $50 million manager of managers—get the hell out of there and stop using them. Stop giving them money to manage. Find people you can communicate with. If you’re a money manager, your job is to communicate directly to the funds of funds or managers of managers, so that they know what is going on with your fund at all times. There are thousands of people out there who do both these jobs. There are registered investment advisors who act as managers of managers, and there are hundreds of funds of funds that are putting assets to work. As a hedge fund manager, your job is to go out and talk to these people, get in front of them, show them what you’re doing, explain to them your strategy, develop a product for them, and create a marketing pitch for them. That way, when they give you $100, they’ll understand exactly what’s happening with that $100. Many people discount funds of funds because they think that it’s fast money, or money that’s going to move quickly in and out of the funds. Not the case. Most funds of funds are sophisticated and well established, and aren’t moving money around with great frequency. In fact, just the opposite is true of most. They’re finding managers they like and sticking with them. It’s worth it to search them out. That’s where a lot of the money is.

CHAPTER

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How to Raise Money

I

t’s the money, stupid! If you’re just getting started—either as an investor or a hedge fund manager—that needs to be your rallying cry. Let’s be blunt: In many instances, new (and some veteran) hedge fund managers have little to no idea how to raise, acquire, and access capital to manage. These people believe that hanging out a shingle and telling a few people that they are in the hedge fund business means that money will literally flow into their trading accounts. The hedge fund industry doesn’t work that way; instead, assets are commonly raised from three different groups of investors during the life of a hedge fund.

FRIENDS AND FAMILY, REFERRALS, AND PERFECT STRANGERS The first and most common way to raise money is through friends and family. It’s simple. You set up a fund. You talk to the people you know. You tell them what you’re doing. You ask them for money. If they like you, they trust you, they know you’re smart and capable, and they have a little cash to spare, boom, a wire comes in and you’re off to the races. The second way to raise money is through acknowledgment from other people in the industry. This money comes from people you know on the periphery—other hedge fund managers, various institutional investors, and perhaps former colleagues, people you know but who aren’t among those that you consider friends or family. These two groups are the low-hanging fruit: investors who are easily identified, defined, and accessible to new managers, resulting in the assets needed for the launch of the fund.

Dialing for Dollars The last group is made up of perfect strangers. Now, it’s time for salesmanship 101: dialing for dollars. Dialing for dollars is difficult. It’s scary.

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Nobody really wants to call someone solely to ask for money; further, many people believe that the practice runs afoul of hedge fund marketing rules. In the previous chapters, we learned that there are significant rules about who you can contact (accredited and super-accredited investors, or qualified buyers, for example). However, there are also a number of rules about how you can prospect and the right and wrong ways to solicit new investors. First, you need to know that you cannot call someone blindly or completely cold, so proceed with extreme caution. To ensure that you act appropriately, consult with your attorney first. Rules change, and your attorney can advise you of the most up-to-date information on what you can and cannot do. Read those last three sentences again. Do not rush headlong into this: Proceed carefully and cautiously, or you’ll put everything you’ve worked so hard to achieve at risk. Some of the rules are simple. For example, you cannot openly advertise, so don’t buy a Super Bowl ad for your fund or put up a billboard in Times Square. You’re not supposed to talk openly about your fund unless you are asked, and you have confirmed that the person asking is an accredited investor. Another rule is that you cannot solicit blindly. This means that you can’t just go up to someone on the street and say, “Hi, I’m a hedge fund manager. Would you like to invest in my fund?” You need to have met the person before you solicit, or the investor needs to solicit you—to call or e-mail you asking for information. Again, talk to your lawyer. He or she will give a list of the dos and don’ts and you will be on your way.

Making Connections That said, in today’s competitive environment, everyone calls everyone. I want you to stay on the straight and narrow here, but let’s not be na¨ıve. The best analogy I can use is that everyone knows the speed limit and everyone speeds! Speeders know that they are breaking the law but they do it anyway. Marketers know that they are not supposed to cold call, but some people do it anyway, because they need to raise assets. Let’s say you hear that the Verizon pension plan is investing in hedge funds. You’re going to find out who runs investment allocations at the company and get that person on the phone. If you’re at a cocktail party and someone asks what you do, before you know it, you may be holding court with a group of people, discussing money and markets. Good luck. The reality is this: As a hedge fund manager, your most important job is to gather assets and manage the hell out of them. Most managers think only of the latter and nothing of the former, because they do believe that “if you build it, they will come.” I’m sorry to tell you that it’s not true. That sort of thing happens only in the movies. You need to get in front of as many

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people as you can. Talk to them about your strategy, your abilities, and most important, how you are going to make money for them. Get out there. Market your product. Be a salesman. You need several different versions of an “elevator speech”: a pitch that’s condensed, that’s souped up, and that can be delivered in 30 seconds—the time it takes to ride an elevator to your floor. You need to know your audience and know which version to use. Your elevator speech should include the following information: size of the fund, investment strategy and length in operation and outlook for the future. Performance is secondary and should be discussed at a formal meeting. Performance is not something to be discussed right out of the box. In my experience, when I lead with style and strategy I get a much better response and interest than when I lead with numbers. Remember, past performance is no indication of future performance. It is important to know what investors are looking for before you bombard them with information about your fund. Again, I suggest you call a formal meeting in which you ask about their allocation process, their current portfolio, their thoughts on the future, the performance expectations, their appetite for new investments, and other pertinent items about how they make investment decisions. The key to this meeting is to listen. Listen and take notes. But really listen. That way, you will be able to present them with an idea that will work for them, or, conversely, tell them that you don’t have anything for them but will keep them in mind. Any time you meet with an investor, listening is what is important. Speaking is secondary. One of the greatest people I ever knew in the hedge fund industry, a fund of funds manager, told me that he decided whether or not to invest in a fund based on marketing meetings with the salespeople and the money manager. If they told a story that made sense and had legs, it was a fund to get involved in. If the story was unclear or incomplete, well, it was a fund to pass on. Here are some red flags. Let’s say a manager’s fund is making money in the technology sector when everyone else is losing money in that sector. It can happen. But if the manager can’t explain how and why his fund is making money in a sector that’s tanking, the investor will—or should—be concerned. Other red flags include incomplete information about employment or educational background. What are they hiding? In my opinion, if someone lies about where they went to school or where they worked, most likely they are going to lie about the fund and its operation. You need to get the information, kick the tires, and feel comfortable. After all, it is your money! If you believe your product is truly the greatest thing since sliced bread, then you’ve got to shout that from the roof tops. Do it legally, but do it.

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Again, talk to your attorney before you begin marketing or asset gathering. Realize, though, that your attorney is the “head of sales prevention.” Your attorney’s job has nothing to do with running a business or gathering assets. All he or she is really trying to do is tell you how not to get in trouble with the law. Since attorneys are so good at sales prevention, and their jobs are so specialized, you’ll need to find other competent people to help you grow your business. Some funds look to capital introduction services for this help and guidance.

CAPITAL INTRODUCTION SERVICES The capital introduction team is usually the group of people from your prime broker that is charged with raising money for you. Their job is to develop a marketing strategy and get you in front of potential investors. They’ll help you figure out who you need to talk to, to get your hedge fund funded. The capital introduction team will host capital introduction breakfasts, lunches and dinners, in which you’ll make a 15-minute presentation where you describe your fund, outline your strategy and, ideally, get people interested in investing in your fund. The idea is to meet potential investors—think of it as speed dating for hedge fund managers and investors. Most of the big prime brokers, and even some smaller prime brokers, now offer capital introduction services. Some are good; some are bad. But don’t put all of your eggs in the capital introduction basket: Capital introduction teams’ compensation isn’t linked directly to their success. Whether they’re successful or not, they still get paid. In other words, these people do not have any skin in the game. From the business side, capital introduction is really just an add-on product. Most, if not all, brokerage firms feel that they need to offer value-added services, including technology resources and office space, to stay competitive in the prime brokerage business. But there’s a problem with this theory. The rules regarding how money is raised for hedge funds are so strict and stringent that it’s impossible for a brokerage firm to earn commission fees from the assets that are raised for a hedge fund through capital introduction efforts. If a hedge fund manager lands a client or two through the broker’s capital introduction efforts, there’s no way for the manager to compensate the broker. From the brokerage firm’s business standpoint, capital introduction is a cost center—essentially, an overhead expense rather than a profit center. And profit is the point: On Wall Street, no one wants to work on the cost side of the business. This is not to say that the capital introduction services are useless, quite the contrary—they can add real value. Just don’t expect them to show up at your door with buckets full of money. Use the services

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they offer and then go out and meet with the investors they introduce you to. The capital introduction team can help get you in front of people, but it’s up to you and your team to bring in the assets.

THIRD-PARTY MARKETING Third-party marketing is the evil stepchild of the hedge fund new business. It’s viewed as a bit sleazy, but frankly, it’s more than a little misunderstood. People who are not third-party marketers look at these folks as the used car salespeople of the hedge fund industry. I don’t subscribe to this theory. Third-party marketers are either independent groups or individuals who raise money for hedge funds. Many third-party marketers really do a good job, are quite plugged in, and are capable of raising substantial sums of money for new and existing funds. There’s a widespread perception in the hedge fund industry that third-party marketing attracts unsavory characters—people who can’t make it in other areas of the industry. To this I say, “phooey.” You need money to run your business. Hedge funds run on money—it’s their gasoline. If you don’t have any gasoline, guess what? Your car ain’t going anywhere—your fund will stall before you can turn the key in the ignition. Third-party marketing is a very interesting business. For the most part, third-party marketers are very good at finding assets from funds of funds and other, more traditional, hedge fund investors. These people are experienced asset raisers who have extensive contacts with investors. They have strong relationships and often know how to get in front of the right people at large institutions because of their past experience in bringing managers to these companies. Third-party marketers know how to get to small, medium, and large endowments, foundations, and even insurance companies.

Choosing a Third-Party Marketer There are two things that you need to be aware of when using a third-party marketer. First, the marketer will need a strong incentive to raise assets for you. Second, you really need to understand from whom and how the marketer is going to raise assets. Who will be targeted, both from an investor profile and a geographical profile? Ask a lot of questions. Find out how deep the network of potential investors is, where the assets come from, where the marketer was successful and where he or she failed—basic, simple, thoughtprovoking questions about their business. Many third-party marketers’ modus operandi comes down to getting a fund manager and the marketing material in front of as many people as

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they know in hopes of getting some assets to come in over the transom. The concept is simple: Throw as much spaghetti on the wall as possible and see what sticks. There are advantages and disadvantages to this approach. The shotgun approach can work, but it is also very important to develop a thoughtful, intentional plan of attack and target market. The plan should include details of who the marketer is going to contact; what material they are going to use to communicate the fund’s story to potential investors; a follow-up plan for staying in front of the investor; and an action plan for bringing in the assets. A combination of the shotgun approach and an intentional plan usually works best. In most cases, the marketing company is only paid when the money comes in, so it’s in their best interest to do two things: Pick investors that they believe they can successfully pitch, and build extremely strong relationships with these investors so that they can spend time showing product rather than going after new investors. In their business, time truly is money. When it comes to picking a third-party marketing agent, be sure that they truly understand your product, your style, your strategy, your firm, and, most important, you and your organization. You should provide them information on how the firm works, who makes decisions, which people are partners, which are employees, and how each is compensated. Marketers need to know the firm has the staying power needed to maintain its business during good and bad periods and that the partners are committed to its success. Most marketing people, regardless of whether they are inside (working for you in your office) or outside (are contracted by you, as third-party marketers), will say that they know every potential investor for your fund. It’s hard, then, to judge how good these marketers’ relationships truly are until you see them in action. When one of my friends meets a potential marketing person for his fund, he asks them to provide a list of potential investors. To his surprise, often these marketers don’t respond to this and fall off the map. Sometimes, a marketer will send him a directory of endowments and foundations. These directories aren’t hard to get your hands on, and are worth about as much as the paper they are printed on. It is very hard to determine who knows who, and the strength of their relationship with potential investors. If you compensate your marketer solely on the basis of asset flows, however, you can bet that person is fairly confident that he or she can raise money for your fund. Let them eat what they kill and you will find success. My experience with third-party marketers to date has been short, somewhat sweet, and a bit sour. Some groups are nothing short of awesome (I really mean that). Some are absolute dirtballs (and I mean that, too). Thirdparty marketers are an interesting breed. I had the pleasure of meeting a

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three-person team that worked only with new managers: funds that were just starting out, with $100 million in assets. In my opinion, if a fund has $100 million in assets, it doesn’t need this sort of third-party marketer. They need a third-party marketer that is able to get them to $500 million in assets, who can help them reach the next level and also help them develop and implement an internal marketing system that works in conjunction with their efforts. Another third-party marketer of my acquaintance only works with funds with assets of more than a billion dollars. This group works with funds with internal marketing teams to help them exploit opportunities with large investors. The team has extremely close ties to many large institutional investors, and works with these larger funds to get them in front of the investors. The group is able to get the big funds in front of the “right” people, but has had little success in reeling in the catch. In the five years that they have been in business, they have raised insignificant, if any, sums of money for their managers. I work closely with this group and give them advice from time to time on what to do and what not do with their business. And they work hard going after people and putting their managers in front of potential investors. A firm like this can stay in business because they earn fees from the monies that they have placed (in most cases, in perpetuity). Further, it does not cost the fund managers any money to bring them in, as they are only paid on success. It’s a tough business, and it really comes down to relationships. Thirdparty marketers need to be great networkers. They need to be able to pick up the phone and call anyone, without worrying about the reaction. In short, they need to “always be closing.” It’s not easy. Do your homework—understand their process and abilities to the extent possible, through interviews and reference checks. In the end, though, you need to go with your gut. If you believe that this person or this team will be successful, try them out for a period of time and see what happens.

When to Hire a Third-Party Marketer If you plan to use a third-party marketer to raise money, consider hiring three groups: one for the East Coast, one for the West Coast, and one for Europe. You may also consider hiring a marketing group for Asia; however, in that part of the world, it can take an extremely long time for assets to materialize. If time is of the essence, then you might think about forgoing this region—at least until your fund is up and running and has a firm asset base. You need to know where you stand with a third-party marketer before you engage the company to raise assets for you. How many clients does it

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have? If you are one of 20 groups that it raises money for, be sure that you know why the marketer want to work with you and that you thoroughly understand its plan of attack for your fund specifically. If yours is the only group it is working with, you also need to understand why this is the case and, again, how they plan to raise money. Either case or something in the middle will work—you just need to ask a lot of questions. As I already mentioned, you need to know how they run their business, where their relationships are, and what success and failures they have had. Make sure you get and understand the answers. Over the last few years, as hedge funds have really gone mainstream, many third-party marketers have decided not to work with start-up funds. These marketers believe that institutional investors, or funds of funds, don’t want to risk their assets on new, untested organizations. There is some truth to this theory, though not across the board. There are, in fact, many institutional investors who like working with new managers and put plenty of money into these types of funds. However, most third-party marketers charge a percentage of the management and incentive fee (usually 20 percent of each) earned on the assets they bring to the fund. From their perspective, it’s better to work with a fund with assets of $50 or $100 million, bringing their minimum ticket to somewhere between $5 and $10 million. Investors are, by and large, cautious with their hard-earned cash, and no investor wants to make up more than 10 percent of the assets in any given fund. If a fund has less than $50 million in assets under management, the maximum amount an investor will want to put in is less than $5 million. For a third-party marketer, that translates into very modest fees for what most likely is quite a bit of work. Remember: In most cases, the marketer will need to do the same amount of work to get someone to invest $25 to $50 million as to get someone to invest $1 or $5 million. Get a third-party marketing firm to work for you when your fund’s assets range between $25 and $50 million. As I noted already, when your assets are lower—closer to $25 million than $50 million—it may be challenging to find someone to work with you. It’s still worth it to try to search someone out. Talk to your lawyer, administrator and accountant—ask for referrals. Heck, you can e-mail me at [email protected] and I will give you a few names. And after you cross the $100 or $200 million mark, hire a fulltime in-house marketing/investor relations person who will be in constant contact with existing investors and will search out new sources of money. As your fund grows, you will find that some allocators, or hedge fund investors (the terms are synonymous), will search you out through the various hedge fund databases and other means. To some degree, new assets will find you. Don’t think for a minute that you have to stop marketing, though, regardless of how big your fund gets. You’ll always be in a search for new

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assets. However, as your fund grows, you will pop up on radar screens and people will search you out, and, hopefully, invest with you. The primary difficulty, again, in hiring a third-party marketing agent or firm is that it is very hard to determine who is good and who is not good, and there’s no real methodology for it. Most third-party marketers will tell you that they’ve raised considerable amounts of money over short periods of time. Don’t take these claims at face value. Get their references and talk to their other clients to truly validate their ability and their skill set. You need to know how deep their Rolodex is and where their relationships are, both geographically and in terms of the size of their investments. You need to ask questions and get answers about their success—or lack thereof. Find out how much money they have raised and how quickly it has come into the funds. Again, unfortunately the hedge fund industry itself does not think highly of third-party marketers. But there’s nothing wrong with using third-party marketers. They provide a very valuable service and can be integral to the whole process of raising assets. If you find a good thirdparty marketer who can help you raise money, give it a try. A good third-party marketer can help you build your business.

THE ROAD TO WEALTH You’ve learned about how to raise assets. Now you actually need to go out and do it. You likely already have your “friends and family” list, a list of 100 to 200 people that you, a budding hedge fund manager, believe can and will invest in your fund. Your list likely includes old friends, new friends, aunts, uncles, grand parents, existing colleagues, former colleagues, and everyone in between—anyone you know who has a few nickels to rub together. These people are the warm call—people who will pick up the phone, take the meeting, and exchange pleasantries. Unfortunately, they rarely come up with assets. Most new hedge fund managers will have a hard time getting their seed money. Some will rely on their own assets to launch the fund; others will seek out partners. It really varies. The most important thing to do is to get started! Just get started. Talk to as many people as you can. You never really know where the money will come from, or who will be willing to take a chance on you and your fund.

Conducting Reconnaissance Before you communicate with potential investors, you need to prepare a pitch book. The pitch book should be no more then 15 pages, including the

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cover, the contact page, and the disclaimer page (a page full of legal mumbo jumbo that your lawyer will require, and which will ideally keep you out of trouble with the securities regulators.) Including these pages means you have about 12 pages to tell your story. And if you can’t do it in 10, including biographies of key members of your team, then you shouldn’t be in business. There is no hedge fund strategy that can’t be explained in 10 slides or fewer. Bigger doesn’t always mean better: A thick pitch book is no more likely to reel in investors than a thin one.

A Cautionary Tale When I launched Answers and Company in 2001, I struggled for the first few months to get new clients. I was lucky to get a big firm out of the box. Over the first six or seven months, I slowly got more; with that money coming in, I was able to go on. But I really got lucky in the late fall of 2003, when I ran into an old friend at a conference at the Waldorf Astoria. I hadn’t seen him for about six years, so we spent some time catching up and talking about old times. And then he said that he had a fund to introduce me to that could use my help. The fund was still a fledgling—it hadn’t yet launched. As often happens when a new fund launches, the schedule had been pushed back, and instead of launching in January of 2004, they now planned to launch on March 1, 2004. I met the two principals in December 2003. We met in a conference room in the old Bear Stearns building on Park Avenue, which had been converted to a shared office environment. The only positive thing that came out of the two and half hours that we spent together was that the company who rented the room had a great selection of sparkling water. The two principals of the budding fund were without question co-heads of sales prevention. The only goal of the meeting, as far as Naoshi (my partner at the time) and I could tell, was for us to think that they were smart. It was just awful. The principals went on and on about their strategy and how it worked, why it worked, and what they were doing to make it work, with very few concrete plans for moving forward. Within 20 minutes, my head was spinning, and without that sparkling water I probably would have passed out from boredom. A little over two hours into the meeting, I looked at Naoshi and said, “These guys are fixed income guys who are predicting interest rates, right?” That, distilled to a single sentence, is what I deduced from the presentation. He said yes. I asked him if they couldn’t have just said that at the outset, and he said no, the meeting would have been too short. We spent the next 15 minutes discussing how our two companies could work together, and planned a follow-up meeting with their senior partner. Once we were engaged (after our third meeting), we went right to work on developing a new

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pitch book and marketing presentation for them. Over the years, our two firms have worked extremely well together. But in the beginning, it was like pulling teeth. Presentation meetings should be short, to the point, and explicit. Potential investors want to understand the process, learn about the manager, and develop a degree of comfort with the people that they will potentially do business with. Don’t overwhelm your investors with too many details. Keep it simple, and you will win. The point of the story is not to encourage you to call me for help on your pitch book or marketing presentation, but to illustrate that more is not always better. The key to successful marketing is to create clear and concise messages and then to sit back and let your audience ask questions. Blinding people with science and statistics does not translate into assets. The converse is true: Investors like to think that they’re smart, and if they can’t understand what you’re saying, or more important, what you are doing with their assets, they’re not going to invest with you. Period. Keep it simple: It will pay off in the end. By the way, by taking our advice and working together, this firm went from $2 million in assets under management when launched in 2004 to more than $500 million at year-end 2007. Some of it had to do with returns, some of it had to do with being in the right place at the right time, and some of it had to do with the advice that my firm provided about their pitch book and marketing material. The combination of all three led to their success.

IF YOU BUILD IT, THEY WON’T COME If you take only one thing away from reading this book, it should be the following: Every single place you think money is going to come from, is exactly where it’s not going to come from. If you think that Aunt Joanie, who’s got $25 million in T-bills doing nothing, is going to give you a million or two to get your hedge fund off the ground, odds are that she ain’t giving you anything but her well wishes. The same can be said for other family members, former colleagues, associates, and friends. Some of this low-hanging fruit will likely fall into your fund, but you can’t count on it. This kind of exchange of assets isn’t really healthy. A smart guy who works at Morgan Stanley and manages a bunch of high-net-worth brokers and private bankers told me once that when he interviews people, he tells them that no matter how much money is at stake, he doesn’t want them to go after their friends or family for assets. These types of clients can lead to only one thing—lonely holiday dinners. In other words, don’t work with the people you’re close with. Your

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relationships may not survive it. You run the risk of losing your relationship with your favorite aunt and potentially alienating other relatives or friends. Keep close to your friends and acquaintances, but not too close. Let’s face it; you don’t know how much money anybody really has. Forbes magazine can tell you who the 400 richest people in America are, but when it comes down to the inner circle, it’s impossible to know unless you see the documents or they tell you directly. There are a lot of very wealthy people who are cash poor. They may have lots of assets but their cash is tied up, and they simply do not have discretionary cash on hand to give out. Further, when you’re dealing with wealthy people who you are close to, remember that there is always someone with their hand in their pockets. Don’t be that person. At the end of the day, people don’t want to be asked for stuff from their friends—they just want to be friends. They want to be treated with respect. Keep that in mind at all times and your business will grow. I guarantee it.

Finding the Right Investors So, Aunt Joanie is no longer a prospect. Then who is the right type of investor for your product? Who do you need to get the fund into the market, and how are you going to access these potential investors? One problem is that the markets are ever-changing, and as a result, investors’ needs are also ever-changing. This is both good and bad for people who have new ideas. As the markets evolve, everyone thinks that they have a better way to skin the cat. This is just not true. There are only so many ways to make money, and this number is countless and finite at the same time. How can something be countless and finite at the same time? There are only so many stocks, bonds, options, and futures contracts out there; there is only so much real estate, factoring, and manufacturing out there; and there are only so many good ideas out there. But you can come up with a new or better way to beat the market. The question, however, is not whether you have a new strategy for making money, but whether it makes sense and is worth pursuing, since not all good ideas will bear fruit. You need to make sure that there is an appetite for your product in the marketplace. Making money in the markets, regardless of which strategy you employ, is about exploiting opportunities and making good, solid bets on a position. The key is to buy something cheap and watch it appreciate, sell it when it becomes expensive, and then do it all over again. That is how people make money year after year.

Taking Your Strategy to the Streets Explaining this strategy to potential investors is simple, it can be elegant, and, most important, it can be easily understood by the masses. However,

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the markets have evolved over the last 20-odd years. Investors know that stocks don’t always go up and bonds don’t always provide good yield, and have come to the conclusion that they need to create diversified portfolios. So, as with everything else in life, sometimes the market or investors really like certain strategies and sometimes they don’t. You need to understand what investors are looking for. Target investors who want your strategy today, as well as those who may want it in the future. One bright side to all of this is that as investors, particularly institutional investors, create diversified portfolios, strategies that once were out of favor have a place to go. This works well for established, well-heeled (read, “big”) hedge funds, but for the new kid on the block, it’s harder. The hedge fund industry is really an old-boy (with some women) network. Although the number of funds has grown to more than 10,000, with more than $2 trillion in assets, the big funds are getting bigger and the small funds do not seem to be growing. When you do your market research, put some calls into institutional investors and take their temperature about the market, their use of hedge funds, and how they allocate their assets. It will help you define your market and provide you with a path to look for assets. If you talk to some of the most impressive institutional investors—the people at large public and private institutions—you’ll find that for the most part, the people who make allocations to investment managers are concerned about one thing and one thing only: covering their own posteriors. Of course, they also have secondary motives: They want to perpetuate their organizations. If they work for a pension plan, they’re thinking about ensuring that there’s enough money in their account so that when their retirees or pensioners need access to capital, they have it. But they aren’t willing to put their heads on the chopping block in the process. Many of these groups or organizations will hire consultants to help them slog through the investment landscape and to provide them with insight and guidance into two areas of the investment universe. These investment professionals help organizations create a diversified portfolio and pick managers. Often, people who are charged with managing a significant portion of the public pension money are sophisticated individuals with little or no investment experience or expertise. They need to look to professional consultants to provide guidance and support, and advice on how to allocate assets and find hedge fund managers. Because these people are often unwilling to go out on a limb, it can be very difficult for them to really be at the cutting edge of the investment world. They are usually trend followers rather then trend creators, as they don’t want to risk losing their jobs. It is my experience that most of them operate in the “bleeding edge” of the

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investment world—by the time they make an allocation to a specific strategy it may be too late—rather then the leading edge. Most of these investors operate with a check-the-box mentality. This means that as long as they can check off on their list, this or that about the manager, they are going to make an allocation. These investors look for things like a three-year track record, a consistent return over a long period of time, not being down more than three consecutive months, and having no down quarters. The investors also look for lawyers, accountants, administrators, and prime brokers that they recognize, people or firms that are used by other hedge funds and are recognized as players or experts in the hedge fund community. Once these boxes are checked, the due diligence process for the most part ends and the assets start flowing. This is just a silly way to make investment decisions, and yet it is what is used by countless institutional investors around the globe. Checking the box means that things are fine and the manager is worthy of the investors’ money. If you believe that, I have a bridge in Brooklyn to sell you. Making a decision based on who the lawyer, accountant, or prime broker is, is just silly. Obviously, investors need to use respected, well-known firms—that’s the cornerstone of good due diligence. Good due diligence means getting underneath the manager’s skin and learning about how he or she manages money. As a manager, you need to be ready for the checkthe-box investor types and those who do serious due diligence. Both can provide you with assets, and you’ll want to take whatever you can get—but remember who your audience is and provide each with what they need in order for them to make their decision (in your favor). It is easy to deal with substantive objections, such as lack of track record or small amounts of assets under management. Be upfront and honest, and provide the prospective investor with as much information about you, your background and experience, and your firm and strategy. Tell them what you have done in the past, what markets you have traded, where you have lost money, where you have made money, and how you expect to make money going forward. Tell them how much you have in your fund and what you are going to do with your income. Explain to them why you are setting up or running a fund, and why they should invest with you along with or instead of other hedge fund managers. Tell them how you do your research and how you execute your ideas. Give them examples of trades that worked, trades that didn’t, and why you chose or chose not to make an investment. Tell them about yourself. When I am meeting a manager, regardless of whether they’re new to the business or experienced, I ask a lot of personal questions. I ask about their family, their kids, and their wife or husband. I ask about the movies and

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music they like and what they do in their spare time. Sleuth a little before you make the decision to invest into their fund. Here’s why: You can learn a lot about someone in a casual conversation. Let’s say you’re thinking of investing in a low-risk fixed-income fund, and you discover that the manager races cars or goes skydiving on the weekends. This kind of conversation will give you some insight into their personality and what to expect in terms of management style. I would be wary of a fixed-income low-volatility manager who races cars and skydives. That risktaking personality might extend to the portfolio one day, and it could result in a style or strategy shift that equals losses. People understand that you are new, and most people want to give you a break. They are willing to listen, so tell them a good story. Know upfront, though, that it is very difficult to deal successfully with objections that lack substance, such as why you chose this lawyer, that accountant, or the prime broker that nobody else uses. The way to deal with this is work with well-known hedge fund service providers.

Vetting Your Investors This is a fairly simple point, but I’d be remiss not to mention it: Just as your investors need to vet you, you need to ensure that you’re adhering to applicable regulations regarding the number and type of investor you invite into your fund. There are two things that you need to attend to, to ensure that you don’t run afoul of the law: The investment in question must meet or exceed the minimums required, and the investor or its representative must clear any anti–money-laundering rules and regulations. The first issue is more important than the second. The name of the game is assets under management; the process you’ll need to follow is to get in front of as many potential investors as possible to gather those assets. But be sure you’re paying attention to some basic tenets. For example, 3c1 funds are open to only 100 investors, so you need to be careful not to accept too many small accounts. By contrast, 3c7 funds are open only to super-accredited or qualified purchasers, so while the number of investors is not limited to 100, there are greater hurdles to jump in order for investors to qualify. Most newly launched funds are 3c1 funds. Pay attention to the details, and you’ll be fine.

PREPARING THE PITCH BOOK I outlined what the substance of the pitch book should include. I believe that less is truly more in this instance, and as such, I caution all hedge fund

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managers who are hell-bent on creating a 20- or 30-page document about how they manage money. The truth is that very few people actually read the pitch books. Most people just thumb through them with a manager during a presentation and jot notes about things that they do not understand. Your job, then, is to create a document of substance and style that explains the following things about who you are and what you do. It should include seven features: 1. Strategy: Define your investment strategy and explain why you have an edge. 2. Examples: Provide an example of a trade that worked and one that did not work, and explain both in detail. 3. Team: List in detail the people who work with you, what their functions and responsibilities are, and provide organizational detail. 4. Track record: Come up with a slide show that provides information on how you have done and use relevant benchmarks. 5. Service providers: List who you are working with and provide contact details. 6. Contact details: This is self-explanatory. 7. Disclaimers: You will want the lawyers to draw this up—make sure you have it. In total, the book should be no more than 15 pages, including the cover and contact details. It is not about being short; it is about keeping things simple and easy to understand. If you can’t get it done in 15 pages, you probably are not very sure of yourself. That is just my experience, based on what works and what does not work. Keep it short, keep it to the point, and keep it factual. Remember to listen to what your clients and investors need, pay attention to the questions they’re asking, and answer those questions appropriately. Do that, and you’ll do fine. Keeping things simple is a recipe for success.

A FEW FINAL THOUGHTS ON THE ESSENCE OF SUCCESSFUL MARKETING Successful marketing comes from listening and asking questions. It also comes from being aggressive and not taking no for an answer. You need to get in front of as many people as possible. Get your story out there. You never really know where assets might come from. Therefore, the more rocks you turn over, the more likely you’ll be to find investors and assets hiding under them.

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However, this is not to say that you should go out and talk to everyone that moves or that can fog a mirror; but rather, you should come up with a plan of attack that targets specific groups of investors. Marketing is not easy, and it is not something that everyone can do. By developing a plan that keeps you focused and on target, as recommended in this chapter, you will find success.

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s hedge fund managers continue to proliferate around the world, there’s been a corresponding rise in the number of firms that provide services to the hedge fund industry. These service providers—nonplayers, as they’re known in the industry—include investment banks, brokerage firms, insurance companies, accounting firms, law firms, administration companies, real estate firms, and head hunters, all claiming to offer something “unique” to both budding and existing hedge fund managers. These individuals and organizations provide a number of services to hedge funds, which, in turn, allows the managers (at least in theory) to stay focused on the day-to-day management of the portfolio rather than the mundane tasks that are part and parcel of running a business.

THE CARDINAL RULE OF CHOOSING A SERVICE PROVIDER One of the most important things to do when choosing a service provider is to hire a firm that is well recognized in the industry. Though it’s important to conduct your own due diligence, when you hire a recognizable name you will spend less time determining whether the firm can do the job—and less time defending your choice to potential investors. Get out there, ask lots of questions, and get lots of answers about how the firm works. Find out everything you can about the organization, its employees, and its clients. It is important to work with people who have a good reputation both in the industry and with investors. Recommendations will come from all walks of life. If you’re not sure who to hire—or at least which firms you should be researching and vetting—by all means, ask. If you need help, feel free to e-mail me at [email protected]. Working with firms that nobody’s heard of makes potential investors nervous. It might have made sense to go this way 20 years ago. Today, it is

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foolishness. Why? Well, 20 years ago, when the hedge fund industry was still relatively new and operated in relative obscurity, many providers had yet to carve out their hedge fund niche—therefore, the investment community did not necessarily have a group of service providers that were accepted or recognized. And now? When you hire an unknown firm, you’ll immediately run into objections from potential investors, and with investors, the thing you want to avoid at almost any cost is objections. As I have said before, investors do not want to work with funds that don’t use well-recognized service providers. Although this is not always the case, investors believe that new funds that work with well-known service providers have passed some level of due diligence.

THE LAWYERS A discussion of nonplayers in the hedge fund industry begins with the lawyers. We’ve discussed lawyers in the previous chapters, so I won’t spend too much time on them here. Lawyers are the people who will craft your documents, set up your entities and, in a sense, put you in business. A number of boutique firms specialize in hedge funds, and you can expect to find hedge fund experts at all major or large law firms as well. Choosing a lawyer from either of these two groups is the safest—and probably the smartest—way to go.

Choosing an Experienced Attorney There are two reasons to work with an experienced hedge fund lawyer: first, you’re less likely to encounter investor objections or questions. Second, you’ll save money in the long run. A local lawyer may seem less expensive in the short term, but he or she will need time to conduct research and get up to speed—and time is money. Further, an inexperienced lawyer will make mistakes, and when your documents need to be fixed, that will cost you as well. Trust me this much. Choose someone with experience: You’ll thank me later. I like most of the lawyers who operate in the hedge fund community, and I believe, for the most part, that they are professional, efficient, and effective. Your choice of lawyer will come down to price and to personality. Pay attention to both of these factors: Find a lawyer you like at a price you can live with. You need good documents, good counsel, good advice, and good answers to your questions—and you need them fast. As you launch your hedge fund, your lawyer will be the person you’ll be spending the most

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time with. You’re going to need to call them from time to time, and you need to have a good working relationship with them. You need to respect them. They need to respect you. You need to be able to call on them and get good answers to your questions.

What to Ask Your Attorney When you meet with a potential hedge fund lawyer, you’ll first meet with a partner—the attorney who runs the practice. Because your relationship with your attorney is so important, though, be sure to meet the attorney you will actually work with, whether it’s a second year associate or a junior partner. Understand the dynamic at the firm, understand the role that the firm plays for you, and understand your role as a client at the firm. You need to ask the lawyers about structure. Ask them if the fund should be a limited partnership or limited liability company. Ask them if you need an offshore fund and an onshore fund (or both), and what it is going to take to get the firm up and running. You need to explain to them your style and strategy and how you expect to run your business. Your lawyer should talk to you about how to communicate with your potential investors, if you have any, as well as all of the rules about taking in both onshore and offshore assets. Your attorney should also be able to give you guidance on hiring additional service providers as the fund commences operation. You and your lawyer will do a lot of work together, from the beginning of the process to the fund’s ultimate creation. It’s important that you do this work right the first time, because it can be very difficult to make changes once all of the structures are in place. Your lawyer will begin this process by giving you a questionnaire, which will include questions about name, style, strategy, fees, redemptions, leverage, soft dollars, ownership, your experience, your expectations, and the other service providers you’re using. Give a lot of thought to every answer. If you have questions about the questions, ask the lawyer. Remember that your lawyer works for you, so he or she should work for you. It is not an error to ask about something you don’t understand; in fact, the converse is true.

THE ACCOUNTANTS Auditing and accounting are pretty straightforward. The auditors are your number crunchers—the ones who give you a full-on account of how your hedge fund is performing. They’ll tell you the real value of the portfolio and the value of each investor’s individual account; by crunching all of the

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trading data to determine what profits and losses occurred during the period, this will in turn allow you to determine the amounts that you will earn from both your management fee and incentive fee. This is important because it’s your livelihood, so pay attention. Most mid-sized to large accounting firms offer hedge fund audit and tax services. Each of these firms has many dedicated people focused on providing accounting services to funds of all sizes and strategies. For a list of respected auditing firms that specialize in hedge funds, turn to Appendix B. On the accounting side, you’re not likely to work with the junior people on a day-to-day basis. You’re going to work with the person who runs the practice, or the audit partner who signs off on it, and the people who actually crunch the numbers for the audit to be completed and the tax forms to be filed. Again, it’s important to know the team. I think you’ll find that in most accounting firms, the answers you need come from the audit partner and that he or she will always be available to talk when needed. The first thing you need to do is meet with the accounting firm and learn about the organization. Interview them: Find out how long they’ve been in the business of providing audit and tax service to hedge funds; how big the group that works in this area of the business is; and how many clients the firm has. Question them about the strategies they excel in and whether there are strategies that they try to avoid. Try to get a feel for how important your firm will be to them, and get answers about who is going to do the work on your account and why they want your business. Remember, neither lawyers nor accountants will help you build your business. Both will help you construct and maintain the business, but they will not help increase assets under management.

PRIME BROKERS With apologies to my many friends in the prime brokerage industry, I have to say that for the most part, all prime brokerage services are essentially the same. The service levels are largely based on technology platforms that provide money managers with icons on their desktops, not only to have live access to the markets, but to have the ability to slice and dice data to help with investment decisions, literally with the click of the mouse. The prime broker’s function is simple: to provide a trading platform for the manager to execute orders, either via the computer or the telephone. The prime broker is able to provide the manager with reports and statements that detail the portfolio positions. This service, in theory, allows the manager to execute orders without having to worry about any of the back-office functions that need to take place once the trade is made.

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As liquidity in the marketplace has increased, most brokers have seen their services become commoditized, meaning that, for the most part, all prime brokers offer the same products and services. There has been massive price compression over the last few years when it comes to brokerage fees. Prime brokers vary in size, from Goldman Sachs and Morgan Stanley to Vanthedgepoint and Grace Financial. Some firms only work with large, wellestablished funds, while others specialize in working with start-up funds. You need to meet with a series of prime brokers and learn about how their systems work, the services they can provide, and why you should do business with that particular firm.

THIRD-PARTY ADMINISTRATORS In the onshore environment, the role of the third-party administrator is to create and manage the back-office functions of the hedge fund. The thirdparty administrator gathers all of the data from the prime broker and from the banks, and all of the financial information on every position in the portfolio, and processes it to come up with the net asset value, a profit and loss statement, a monthly net asset value, a quarterly performance report, and a yearly performance report. The third-party administrator will crunch your fund’s numbers on a daily, weekly, monthly, quarterly, and annual basis, keeping close track of what is going on inside the portfolio. Most domestic hedge funds don’t strike daily net asset values, or NAVs, for their portfolios, and simply rely on a profit and loss report. Usually, onshore funds create a monthly performance report and put out a quarterly performance report. To calculate a net asset value in its most basic definition, the administrator takes all the money that’s invested in the fund and divides that by the number of units sold. It’s very simple, very basic, and very straightforward.

Calculating Net Asset Values There are two ways to calculate net asset values—Full NAV and NAV light. A full NAV is calculated when the third-party administrator confirms all of the prices and fees that the fund paid from third-party sources to come up with a value of the portfolio. In these situations, the administrator does not simply take the data provided by the manager and come up with information; rather, the administrator prices and verifies the portfolio independent of the manager’s books and records. The task can be mundane. Let’s say that fund Y bought 200,000 shares of IBM on January 13, for $14.75 and paid $100.00 in commission. The net

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effect of the trade was X. The administrator will check various market data sources to acknowledge that, yes, the trade was completed at that price, and yes, the fund paid $100.00 in commission. The administrator will then price the portfolio and determine the value (profit or loss) of the position and how the portfolio performed for the period. The administrator who conducts a full NAV will use pricing services, including the New York Stock Exchange and the NASDAQ market, as well as others—including Bloomberg and Reuters—in order to get pricing and market data. This service is done for the entire portfolio. There is no set schedule for your administrator to calculate the NAV; you as the manager can set the frequency, based on your needs and your investors’ expectations. Talk to your administrator and accountant about it. Check with your lawyer, also, because your fund documents may specify the frequency. In most cases, the actual NAV is calculated on a quarterly basis and performance data are calculated on a monthly basis. In the previous example, on January 13, the fund paid $14.75 for IBM, and on the mark date—January 31—the stock closed at $17.00 a share. With 200,000 shares, that equals a paper profit of $550,000 (less commissions). The hedge fund administrator conducts what seems, for all intents and purposes, to be an audit of the funds in the portfolio, The only distinction is that the administrator doesn’t actually sign off on it. The actual audit is conducted by an accounting firm, which does a full-on, IRS-sanctioned audit of the fund’s portfolio. There are some funds that have semiannual audits, and even one or two that I know of that do it quarterly, but for the most part audits are completed once a year. Along with making sure the portfolio is priced correctly, a full NAV provider also provides a level of comfort regarding fraud avoidance. Of course there is no way to rule out fraud in its entirety; however, it is much harder to pull off if someone is watching over the portfolio. In a full NAV fund, there is very little opportunity for mispricing and fraud, because there are quite a few checks and balances. Obviously, human error can occur. When an administrator conducts a full NAV, that firm is taking responsibility for all the prices in the portfolio and, as a result, is creating an auditable track record. When a full NAV service is conducted for a fund, the audit moves that much more quickly; most of the work regarding pricing the portfolio has already been completed and the information just needs to be reviewed. There are some strategies that do not require substantial oversight, and, as such, a light service is enough. For example, a traditional long/short equity fund can likely use a light provider, since the positions are priced daily and the portfolio is easy to mark to market. Some fixed-income strategies that trade very liquid securities can also use the light services.

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It comes down to three things: What you think you need, what you can afford, and what you think your investors will require. The latter is the most important. If an investor demands a full NAV, then you will have to hire a firm that will do it. There is no direct method to this madness. Some investors like the idea of an independent third party pricing the portfolio; it gives them confidence that the numbers the manager is quoting are on the up-and-up.

Size Matters With administrators, size matters: The size of the fund and of the administration company. All administration companies are not created equal—some are large financial conglomerates that operate literally around the world, whereas others are three- or four-person operations run out of a single location. Size does not always mean a better service or product, however. Some of the big firms are completely overworked and are really unable to process all of the funds that they are working with. Because the industry has experienced massive growth over the last few years, the resources at some firms are strained, and it can sometimes be hard for them to get things done. Nonetheless, from a marketing standpoint, going with a well-known, large administration firm is the right thing to do. As the hedge fund industry has experienced more and more fraud and blowups, many investors are demanding that their funds use a third-party administrator. The reason for this is twofold. The first is to offset the work so that the fund management company—the manager and his or her traders—can stay focused on the job at hand, executing orders and finding investment ideas. The second reason to use an administrator is to create a firewall: a second or third, independent pair of eyes that reviews the portfolio and comes up with a performance reporting number. We’ve talked about fraud and mismanagement blowups in previous chapters. These situations have increased the call for administration in the U.S. market by investors. Most funds with assets of more than $100 million are using third-party administrators for their onshore funds. Today, the technology allows for most funds to see real-time profit and loss statements through their prime brokerage trading systems. Since most funds can create a daily NAV by using the systems provided to them by their prime brokerage service, administration services might seem a little redundant. However, these services provide a second or third pair of eyes—which are, importantly, independent eyes—and that allows many investors to sleep easier. In the offshore environment, it’s a completely different type of situation. All offshore funds operate as their own living, breathing entities, and although the manager who puts the fund together controls the business in

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one sense, he or she isn’t really in control. There’s an independent board of directors that acts on behalf of the fund and its investors. This board approves all contracts between the fund and its service providers. It works with the auditors to make sure the fund is getting the best execution and best prices for its trades and its commission from its brokers. Most important, it works with the administrator to make sure the fund’s manager is running a consistent investment strategy. As a manager it is important to remember that the board is there to help you and that the board is independent and adds legitimacy to your organization. Most managers work well with their boards because their interests are aligned. The way that offshore funds are structured requires that the fund is administered, since the fund needs somebody on its behalf to talk to investors and to move money in and out of the fund as money comes in, is invested, or is redeemed. Because of these requirements, offshore environment funds have been using administration companies since they were developed.

Finding a Third-Party Administrator Hedge fund administration companies, like the funds they serve, come in a range of sizes, shapes and services. (For a complete list, see the back of this book.) Some of the big ones include Fortis, JPMorgan Chase, PFPC, and CITCO; the boutique firms include Bank of Butterfield and Equity Trust. If you check out any of the major hedge fund Web sites, such as www.hedgeworld.com or www.albournevillage.com, you will probably find 25 or 30 real players in the hedge fund administration business. That number changes on a daily basis because there has been a lot of consolidation over the last couple of years, particularly with the smaller administrators. Many administrators have been joining forces with larger firms in order to achieve scale. One of the biggest consolidations in the last few years was the acquisition of Bisys by Citigroup. For the most part, the administrators are independent and, therefore, the look that they provide into the fund is quite good. This means that at the end of the day, the data points are salient. More importantly, it means that, more often than not, they can be trusted 100 percent. It is my personal experience that most administrators work very hard to get the portfolio priced right the first time. Remember, however, that nobody is perfect—and as the liquidity in the market continues to increase and more and more transactions take place, the number of errors or potential errors will probably increase. Make sure you deal with them immediately and right the wrongs so that the portfolio stays on track. When a security is hard to price or difficult to trade because of an illiquid market (e.g., the subprime crisis and mortgage-backed securities),

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the administrator will act in the best interests of the fund, which are not necessarily the same as the manager’s. For example, let’s say that there’s been some market dislocation, and the manager believes that a security should be priced at X, but, because of volatility and other market factors, the administrator believes it should be priced at Y. This will sometimes put them at odds with their clients and often results in friction, because the mark to market or pricing of the portfolio by the administrator isn’t the same as the fund manager’s. It happens, and it’s not fun. This occurs when liquidity dries up and positions become impossible to price. This was a significant problem for funds that traded mortgage-backed securities during the recent credit crisis. The liquidity, or market, for these securities evaporated, and as such the positions were impossible to price. Obviously, the managers and the administrators knew the positions had a value. However, the market was claiming that there was no value, and the administrator prices the portfolio based on the market. To deal with this, some funds suspended the NAV calculation until the market stabilized. Others took the haircuts and saw the value of the portfolios slashed to nearly nothing.

Using a Third-Party Administrator for Onshore Funds Using an administrator allows you to run your business more efficiently. An administrator takes a lot of the day-to-day work out of your hands and puts it into the hands of a team of sophisticated and experienced people. If you have an administration company doing the work, then all you really need to do is have someone on your staff review the work once it is completed. You don’t need full-time accounting people; you don’t need a big back-office operation; and you don’t need a big finance group that’s going to run the numbers and crunch the data—you simply need a competent person who can review the data once it is crunched. That’s the onshore world. Onshore administration has really gained steam in the last three years in light of the frauds we’ve discussed and the CYA mentality we touched on earlier. As a result, a lot of the big investors have said, we want a third party in there to give us advice, guidance, and support about what’s going on at the fund at all times. And most fund managers realize that if a big investor demands something, it’s worth it to have. It’s really a win-win situation in the onshore side, because, frankly, a fund manager can save a considerable amount of money by handing off the day-to-day number crunching that goes into the fund analysis by using an administrator. Further, they can forgo some of the staff costs usually

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associated with this work and save money by using outsourcers rather than building the organizational infrastructure needed for these tasks.

Using a Third-Party Administrator for Offshore Funds Now, in the offshore world, it’s a completely different animal. We use administrators in the offshore world because, as I discussed earlier in the chapter, offshore funds are truly living, breathing entities. The funds are companies created by fund managers, but once the manager creates them, he or she gives up their ownership stake and operates as an employee of the entity, which is based in Cayman, Bermuda, Dublin, or in some other tax-haven jurisdiction. An offshore fund is very similar to an onshore 1940 Act domestic mutual fund that most people have in their 401(k) programs. These funds are companies that have unlimited investors, are run by a large management company, and have an independent board of directors who can at any time vote to fire the management company in order to better serve the investors/shareholders. The offshore fund has a board of independent directors that can hire and fire the money manager. They can hire and fire the auditor. The board can hire and fire the administrator. And so they take on a lot of responsibilities and act in the best interest of the fund and its investors. Offshore managers don’t necessarily like this. Let’s say that I’m Fund Manager X and I pay Lawyer Y $20,000 to create a fund for me and and I pay all of the filing fees. By then, I’m out of pocket, $25,000 and I’ve got this fund. Why would I be willing to relinquish the opportunity to own it? The answer is that you have to! The benefits of nonownership far outweigh the benefits of ownership. I’ll talk a bit more about this in the next paragraph, but if you’re really interested in this, you should read my recent book, The Fundamentals of Hedge Fund Management (John Wiley & Sons, 2007), which examines in great detail the tax opportunities that exist by managing offshore hedge funds. Here’s why it’s best to be independent of the offshore fund. Simply put, if you are deemed to be a control person of the offshore fund, the Internal Revenue Service will disallow your ability to defer your income from the fund and force you to bring the money back on shore and, in turn, pay a tax on it immediately. However, by being independent (read, “not in control of the fund”), the Internal Revenue Service allows you to defer the income you earn offshore for a set period of years, and not have to pay taxes on it immediately. The IRS lets you keep the money offshore or defer the income and therefore it grows tax free, until you bring it back on shore. I’m not

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giving you tax advice or guidance here, so to learn more about how this applies to your personal situation, you need to talk to an accountant. To the best of my knowledge, a board of directors has never fired a manager who created the fund. It may happen, but I haven’t seen it. Certainly, there have been situations in which managers have resigned from funds because the fund has imploded or has the potential to implode. As a result, the fund manager and the board of directors see that it’s in the best interest of the investors to push the manager out and put in a group who can liquidate the fund’s assets. Why don’t boards of directors fire managers? It’s very simple. Being an independent board member is a very lucrative business. Many companies and individuals (primarily outside of the United States) offer independent board-of-director services at a very hefty fee, and they want to have as many clients as possible. If these people start making noises about firing managers (the managers, who, in a sense actually hired them in the beginning), they won’t be able to grow their businesses. The minute you start firing managers is the minute you start losing business. It is that simple. The second reason is that even though the manager is not technically in charge, he or she did create the fund, gather the assets, and is running the vehicle. Therefore, pushing that person out may be more trouble than it’s worth. However, because the board is independent, it has the right to do so if it believes the manager is not acting in the best interests of the investors. Logistically, firing a manager is, from the board’s perspective, pretty easy. The board simply votes not to renew the manager’s contract and he or she is out. Again, though, the odds of this happening are extremely slim. Along with striking the net asset value of the fund and completing performance reporting, the administrator also performs a number of housekeeping duties for the fund. The administrator works directly with all investors, handles all investor paperwork, sees that all wires come in and go out, and keeps track of all of the pertinent fund data that investors need. They are the contact point between the fund and its investors from the business side of getting things done. The manager and the marketing team work with investors to educate them about the portfolio and strategy. Administrators don’t perform any marketing functions, but all communications to and from the fund go through the administrator. The administrator is really running the day-to-day operation.

INSURANCE COMPANIES Over the last few years, a lot of insurance companies have started to specialize in providing services to both hedge fund managers and hedge funds.

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These firms have decided to go where the money is, so whether it is a hedge fund that needs a directors and officers policy, or a manager who needs a fine arts policy, these firms are going to sell them insurance. Today, many insurance brokers and companies focus on hedge fund managers. These people are looking to be a one- stop shop for all of hedge fund managers’ personal and business insurance needs, and as such have built whole teams to support these potential clients. For example, many firms need a benefits policy for employees, as well as property and causality insurance for the office. Most hedge funds that operate as partnerships have key-man life insurance policies, as well as traditional life insurance. The insurance brokers make it easy: They come to the office and sell you insurance to cover both your personal and private insurance needs. In my experience, most of the large insurance brokerage firms have wrapped their arms around the industry quite well and provide good solutions to insurance needs. The key with these folks is no different than with other service providers—find people who have experience, who can understand your needs, and who won’t waste your time. You need to ask what services they provide and whether they have experience in working with hedge funds. Get references and talk to their clients about how they work and deliver.

HEADHUNTERS Unless you’re capable of working 24 hours a day, seven days a week, when your fund is up and running and the assets are pouring in, you’re going to need help. So where will you find these people? In earlier pages, I briefly touched on my thoughts regarding headhunters. For the most part, I do not think highly of these people. In my experience, headhunters are reactive versus proactive, and I believe you need people around you who are proactive. Therefore, it is fair to say that I don’t see headhunters adding any value to your operation. I have never found headhunters to be truly thinking people, most are simply mechanical. Not a good choice, plain and simple. Headhunters don’t really get the business—or any business, for that matter. In my experience, they don’t see the big picture, and are often focused on putting square pegs into round holes. They don’t know how to ask the right questions. They don’t know how to get the right answers, and they all seem to be operating with herd mentality versus actually getting people placed in the right places at the right time. If anyone has a suggestion of a good headhunter, I’d be happy to talk to them or learn more about them, but I just frankly haven’t run into any of them. I find most of them to

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be rude and obnoxious, and as a result, I’d be hard-pressed to be convinced to work with them. However, you may want to find one that can be helpful. Not too long ago, I got a call from a headhunter about a position at a hedge fund. The position sounded interesting, so I agreed to a meeting to learn more about it. The person said that he knew all about me, had talked to people about my experience, and that I had been referred to the firm by a number of people. When I went to the meeting, the person knew nothing about me and couldn’t fathom how I could both work on Wall Street and write books. Furthermore, the job the company had called me about was one that someone had seen on a Web site and the headhunters were trying to fill it without being asked by the company. It was a colossal waste of time. I also get tons of e-mail from headhunters asking me to recommend people. I used to call them up ask them how they got my name and what I could do for them. The answer: nothing. These people don’t even know who they are sending their spam to. Avoid headhunters. You’ll just be wasting your time. The best way is to go out and find people to work for your organization through Web sites like www.albournevillage.com or www. efinancialcareers.com. There are other sites and services that may be good as well; the only reason I recommend these two is that I have used them to great success. Both have a deep reach in the financial services community and are able to draw good candidates.

MATCHING SERVICES In addition to the service providers we’ve already discussed, a fourth group of people has arrived on the hedge fund scene—the matching services. These people have a new spin on third-party marketing—they operate like a dating service and match investors and managers, raising assets and delivering them into the hands of new and existing managers. As with most things, some of these services are good and some are bad. The way to distinguish the good from the bad is by talking to clients and learning how much, if any, assets have come in, and what sort of investor database they use to set up meetings. Some of these firms charge a fee to the investors, while others charge fees to the managers. Others just operate in the ether. If you are a new manager and you’re trying to gain assets, after you exhaust the 50 or 100 people you know just out of the box, then anything you can do to attract assets is a good thing. It’s very important to get in front of as many people as possible. If these sourcing organizations are worth anything, they’ll be able to get you in front of a large number of potential investors. The problem is this area of the service provider industry is still quite new and it seems that it is hard to

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find many managers that have had much success with these organizations. The jury is still out on whether these services will make it. But if you can get in front of a group that can offer you a hedge fund “speed dating program,” you should try to do it. There are a lot of people who are trying to use innovative ways to match investors with managers, and vice versa. Turn over as many rocks as you can. When it comes to marketing and asset raising, you never know where the money’s going to come from, so don’t automatically discount an organization with a short track record, or one that seems not to have a great business model. You never really know what value they can offer until you see it first hand and experience how they work, who they know and what kind of opportunities they are able to create for you. This is clearly a growing trend in the hedge fund industry. It can be difficult for managers to get in front of investors, and people are trying to solve that problem. The question is whether the markets will allow for these types of matching services to be successful. I think the answer is yes. The rules about how people are compensated are quite clear. In order to charge a success (i.e., a piece of the fees earned by the fund on the assets that are brought in as a result of the matching service efforts), the firm has to be affiliated with or directly be a broker dealer. You need to check with your lawyer on this to make sure you do not get into trouble. As long as people play by the rules appropriately, it should work. Managers and investors need to meet: It’s that simple. As the industry continues to grow, it gets harder and harder to find the needle in the haystack. These matching services create a platform that allows managers to meet with investors who are looking for their particular strategy, fund size and pedigree. Again, think of it as a dating service. That’s just what it is.

OTHER SERVICES From a real estate perspective, I found that it’s important to find space that you like, that is functional, is reasonably priced, and can be built out or expanded as you grow your business. The best way to do that is to find a building or two and try to work with an agent in that building or work with a broker or agent who can help you find the spot you’re looking for within a set location or area. Pick a neighborhood and stick with it. As for technology, there are literally tons of firms out there that are looking to create networks and the like for every hedge fund manager on the planet. Your prime broker should be a good source for referrals for these people. I suggest that you start small and let the technology grow on an as-needed basis. I have never met a technology person who did not want to sell me more then I needed—it is just the way they operate. Stand strong and tough and you should be okay. There are many people who specialize in hedge

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fund trading systems and accounting systems. There’s a big referral network going around these days, and I would suggest you use it to get you where you need to be from a technological standpoint.

TAKING ADVANTAGE OF TECHNOLOGY As the industry grows, news and information about the industry continues to grow. The proliferation of Web sites that provide either real-time news on the hedge fund industry or information for people to gather data on the hedge fund industry is growing on a daily basis. Just a few short years ago, the only game in town was a Web site called www.hedgeworld.com, and the only newsletter was Hedge Fund Alert, which is published by Harrison Scott Publications. Today, there are thousands of sites and hundreds of publications. All the sites that I have seen are pretty good at gathering and processing data. Using these tools is a great way to get your finger on the pulse of what is going on in the industry, both in the United States and abroad. There is a lot of information flying back and forth, and the more data points you have, the more successful you’ll be at getting things done. These sites traffic in the obvious, focusing on current trends in the industry, such as where assets are coming from, who is investing in various strategies, and what’s happening with new fund launches, market information, and performance data. Other more obscure information includes executive moves, new business starts by service providers, and conference and workshop dates and information. Many sites just traffic in hedge fund industry news and information. Paying attention to these Web sites will allow you to be better informed about what is going in the industry, and will probably make you a better businessperson. My favorite Web site—the one that I look forward to reading every day—is www.albournevillage.com. This is a site run out of the United Kingdom that collects and publishes news and information about the industry in a clear and concise manner. It does a great job in aggregating news and information about the hedge fund industry as well as the private equity industry, and really provide a community to exchange ideas and gather data. Another good aggregator is www.opalesque.com. This service does a great job at gathering data from literally thousands of news services and publications and filtering out the noise in a clear and concise morning brief. All these companies offer e-mail alerts. One of the few things you cannot use the Internet for is a complete duediligence package. Due diligence still requires that you hire someone—for example, a private detective agency, a background checker, or a security company—to get information, process it, and package it into a form that

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is worthy of making an investment decision. This material is the final data point an investor needs in the manager due diligence process. Googling someone is not the same as due diligence. The Web is a great equalizer in that it allows people to access a lot of information, literally with the click of a mouse. The Web has really done wonders for hedge fund due diligence and hedge fund manager selection in that there are now multiple places to search out managers, search out performance data and search out strategy information. However, this sort of research is just the beginning. Whether you’re an investor or a manager, don’t fall into the trap of thinking that the Web is a silver bullet. Why can’t you rely heavily on the Web? Although it will offer you a lot of pertinent and valuable information, you won’t get the full picture. For example, let’s Google “Dan Strachman.” You’ll find information about my books, old articles that I have written, some news articles that I have been quoted in over the years, and conferences that I speak at, run, and attend. What you won’t find is any information about my barbeque sauce company and anything more than a small bit of information on job history and education. The Web is a starting point, but that’s all it is. You need to turn over more rocks: Dig for information about the managers, their education, their job history, how they learned their investment strategy, how they implement the strategy, how many assets they have under management, where the assets come from, how their business is growing or slowing, and how they’re addressing either of those situations. Remember that the tools in front of you are only as good as the person who’s using them. For investors, however, the Web has become a great equalizer. It’s fairly simple for investors to use the Web to gather performance data about managers. Such data are available on the Web, but again it’s the first cut of the first draft of the first go-round. It’s a good place to start, but there needs to be is a lot more behind it.

PARTING THOUGHTS ON SERVICE PROVIDERS Service providers play a significant role in establishing and maintaining a fund business. Deciding on one company versus another, while not mission critical, is quite important and should not be taken lightly. Work with people you like, work with people you respect, and work with people you can trust. Most importantly, work with people who are competent. Taking this advice should allow you to create, build, and operate a successful fund. The one ingredient that is missing is managing the money. That’s your job—don’t screw it up.

CHAPTER

8

Fraud, Collapse, and the Kitchen Sink

raud is rampant in the hedge fund industry. Fraud is not rampant in the hedge fund industry. Which sentence do you believe? Which sentence do you think sophisticated investors believe? Which sentence do you think that individual investors believe? Ask a group of people, and you will get a handful of answers. The truth is, there’s fraud in all aspects of Wall Street: market timing with mutual funds, churning of retail stock brokerages accounts, pumping and dumping, front running, other types of stock fraud—and, of course, in the hedge fund industry. There is fraud everywhere; as educated people, we know it, we accept that it exists, and we do our best to avoid it. It’s the nature of the beast. It began with tulip mania in the first part of the seventeenth century and is still going strong today, most recently with some hedge funds that invest in both equities and fixed income securities. (Tulip mania is a metaphor for any economic bubble: an example of when demand outstrips supply and the markets go crazy. Ultimately, the supply will shift—think of the U.S. housing market of the past several years—and the bubble will burst.)

F

WHY FRAUD EXISTS Fraud exists, and people are so susceptible to it, because of one thing and one thing alone: greed. People like to make money, and many are willing to do whatever takes to make it. This applies to the criminals (those who perpetuate the fraud) and the investors (who are taken in by the fraudsters, in part because of greed—remember, if something sounds too good to be true, it very likely is).

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Fraudsters understand this aspect of human nature. Often, they can successfully take advantage of other people’s character flaws. On Wall Street and Main Street, people still subscribe to the words of Gordon Gekko in Wall Street: “Greed is good.” Granted, greed isn’t always bad. Greed drives many areas of Wall Street. Greed fuels ambition, and in some cases, it fuels success. Unfortunately, in other instances, it fuels collapse.

IS FRAUD REALLY RAMPANT IN THE HEDGE FUND INDUSTRY? If, in the last five years, you have read an article in the popular press about hedge funds, you’ll most likely have heard two things about hedge funds: that they’re expensive, and that they screw their investors by taking unnecessary risks. Furthermore, read any daily newspaper and you will see stories about how hedge funds are causing the markets around the world to collapse. The headlines blame hedge funds for every ill that affects Wall Street and the economy. The stories are about rampant fraud, outsized fees, and little if any value added to investors. Some are true. Some are false. Some are just nonsense. Smart, well-educated, and thinking investors need to look through the ink to see what is truly out there. Investors who are thoughtful and who spend time thinking these things through will be able to separate the good from the bad. Obviously, not all hedge fund managers are fraudsters—but they’re not all quite saints, either. Regardless of your role in the industry, the question you need to ask yourself is, what drives managers and investors? What should drive both is a desire and ability to make money in the markets and deliver a good investment vehicle to investors.

Why the Popular Press Has It Wrong Hedge funds are about providing solid investment vehicles that offer a good service to their clients. The idea is for the clients to be able to protect their wealth and make more of it. Bill Michaelcheck, the founder of Mariner Investor Group, an $11 billion hedge fund complex, told me years ago that building his business was about collecting “nickels and dimes” and that he would let someone else pick up the quarters. The idea is that by going after many small, profitable trades, one is more likely to find long-term success than simply by going after the big trades, which have more risk and less potential for success. It is about being able to sleep at night. It is about being able to realize that their investors at his company is providing them with a service that not only made money

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but protected their wealth. From my perspective, this is exactly why people should invest in hedge funds. Of course, there are exceptions to every rule, and though most hedge fund managers build their assets over time, there are many examples of hedge fund managers making a huge amount of money by betting it all on one trade. When George Soros bet against the British pound sterling, he made nearly a billion dollars and clinched his reputation as one of the greatest investors who ever walked the face of the earth. To the unpracticed eye, Soros and other hedge fund operators seem to be taking incalculable risks. In reality, though, the risks that most hedge fund managers take when building their businesses and on behalf of investors are quite calculated. The problem saying it this way is not what sells newspapers or earns ratings. Instead, there needs to be hype and excitement—in other words stuff that sells. I am not saying that all managers act like Soros or for that matter like Michaelcheck but rather some are like the former while others are like the latter. It is your job to understand how your manager operates and what you can expect before you make an investment decision. Both offer good services and there is room for both types of managers in a diversified portfolio—the key for investors is to understand what they are investing in and act accordingly. So don’t be fooled by what you read in the papers. Sophisticated managers make sophisticated investors, and they understand the risks and rewards involved with the trades in their portfolios. They understand that the greater the risk, the greater the potential reward. It’s what they’re paid to do. And consider this: Hedge fund investments come from some of the most impressive, sophisticated investors in the world. They come from people who run pension funds, endowments, trust companies, family offices, and foundations. Ivy-league schools like Yale, Harvard, and others have been investing in hedge funds for years. Private and public pension plans serving teachers, municipal works, firefighters, and police officers invest in hedge funds. Foundations put billions of dollars to work in these unique investment vehicles. Investors of all shapes and sizes look to hedge funds for returns. Most of these investors put their money into hedge funds because they want to protect it and see it grow. Read that last sentence again. It’s contrary to everything the popular press writes about hedge funds, isn’t it?

WHY HEDGE FUNDS IMPLODE If everybody believed hedge funds’ press, nobody would invest in them. There’s a misconception in the marketplace regarding the level of fraud in the hedge fund industry. Of course there’s fraud in hedge funds. There’s

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fraud in hedge funds because there is an ability in the hedge fund industry, unlike other areas of Wall Street, to take advantage of the little guy. The little guy wants to taste the forbidden fruit. The forbidden fruit on Wall Street is nothing other than hedge funds, for the simple reason that the masses cannot invest in them and everyone wants what they cannot have! So let’s talk about hedge fund fraud. Over the last 10 years, there have been a number of instances of hedge fund fraud that were truly remarkable. There’s the Bayou case, there’s the KL Financial case, and then there is the recent case of Lake Shore. These three firms have the dubious distinction of being caught in the act of overt frauds, which did nothing but line the pockets of their managers with the assets of their investors. I’ll discuss these frauds in detail later in this chapter, but first, I want you to understand that there’s an important distinction between this type of fraud and poor investment management. Other hedge funds have blown up, not because of criminal activity, but simply as a result of poor management. Think Amaranth Advisors LLC, Solwood Capital, and, of course, Bear Stearns Asset Management. And chances are, you’ve heard of the collapse and bailout of Long Term Capital Management. That particular fund complex, led by John Meriwether, lost more then $4.6 billion in the wake of the credit crisis of 1998 and was bailed out by a consortium put together by the Federal Reserve.1 Let’s also not forget Victor Neiderhoffer, whose fund collapsed after his ill-advised bet that, in the wake of the Asian financial crisis, the Thai market would be propped up by its government. When the Thai government failed to act and the U.S. equity markets posted a loss of more than 7 percent in October, his fund collapsed.2 Both are unique in their own rights, and both offer fascinating stories of ego, greed, and mismanagement. But we’ll leave that discussion for another book.

In a Word: “Ego” Why do hedge funds implode? Usually, it’s because managers get cocky and let their egos get in the way of making good investment decisions. Assuming an absence of fraud, there’s usually one primary reason that hedge funds experience massive losses through mismanagement: ego. Ego can lead managers and traders to believe that they know more than everyone else, are smarter than everyone else, and can beat everyone else at the money-making game. It may work sometimes, but, friends, it does not work all of the time. What happens when it doesn’t work? You’ll be wiped out. Your assets will be marked to zero. Ego is what gets people in trouble time and again. It’s ego that causes the manager to let a trade continue even when it’s going bad, rather than taking the profits or losses and walking away. Ego

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causes managers to think that if their particular strategy worked well in one area of the market, it’ll work well in another. For example, at Long Term Capital Management, the men behind the money management models believed that because their trading strategies worked well in fixed income, the strategies would work well in equities. Unfortunately, this was not the case, and was one of the factors that led to the firm’s collapse. As a new manager, pay attention to ego. Know that there’s a fine line between selfconfidence and arrogance. Don’t let your ego or arrogance get the best of you. Remember what separates a good manager from a bad manager: A good manager knows that he needs to have money available to trade the market tomorrow. Live to fight another day!

WHY FRAUD HAPPENS IN THE HEDGE FUND INDUSTRY So that’s where mismanagement can lead you. But why does fraud occur in the hedge fund industry? For three, very simple, reasons: (1) Investors are gullible; (2) fraudsters understand that investors are gullible; and (3) fraudsters are able to create a hedge fund vehicle with very little effort. Further, many investors are not only gullible, but uneducated about their investments—and unwilling to admit to their lack of knowledge. Fraud is perpetrated by criminals. The people who do this—for example, the people who created, implemented, and ran firms like Bayou—should go to jail for a long time. Now, I don’t entirely understand the thought process that drives these people, but let’s indulge in some conjecture. Let’s say that the principals of Bayou woke up one morning and said, “I want to steal from investors.” They may have considered other venues—for example, real estate, straight retail brokerage, or maybe even a mutual fund fraud. While I never spoke with any of the principals of Bayou, I can only believe that the reason they chose to use a hedge fund for their scheme was because hedge funds are glamorous, have cache, are easy to get up and running, and deal in big numbers. These individuals made a conscious decision to steal money from both sophisticated and unsophisticated investors. Their scheme included creating their own accounting firm and their own administration, all the while effecting a massive Ponzi scheme that allowed them to live high on the hog by stealing their investors’ money. A Ponzi scheme, named for Charles Ponzi, is a fraud that pays significantly high returns from money paid in by new investors, instead of from the actual business. This is no different than someone going out and robbing a bank. It’s just a

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bit more sophisticated and extensive than walking into a bank branch and brandishing a gun. Other frauds have unfolded the same way. The perpetrators went to great lengths to let investors know that things were okay with their funds, when, in fact, things were not. Don’t join their ranks.

The KL Financial Debacle Jung Bae Kim (also known as John B. Kim), his brother Yung Bae Kim, and a third person named Won Sok Lee were the architects of a massive hedge fund fraud operating under the moniker of KL Financial Group, LLC. The KL “fund,” operated from 2000 to 2005. It used fictitious trade blotters, which, in turn, were used to create phony marketing material that the fund used to scam investors out of their money. The fake trade blotter and statements documented wildly successful trades in many well-known stocks, all of which never occurred. One sheet, in particular, showed a $22 million profit on a trade of Research in Motion Ltd., the maker of the Blackberry phone. This trade only existed in the minds of its creators and those who saw his handiwork. The phony documents and material conned investors out of more than $194 million.3 The fraud was perpetrated on many of Palm Beach County’s wealthy and elite. Those who were defrauded included a number of professional golfers and a prominent trust and estates lawyer, who had also referred many of his clients into the fund. In mid-April, Kim pleaded guilty to the fraud. At the time of this writing, he was awaiting sentencing. This fraud was not unique in that it used phony material that looked official. It’s not clear whether investors might have smelled a rat prior to investing, because the documents were quite good. That in itself is one of the problems with technology today. It’s relatively easy to create official-looking documents and materials, and many take this information at face value. The lesson to be learned here is that data need to be checked and verified for accuracy by a third party. If a manager does not want to refer you to people who can verify statements or materials, then stay clear of that fund.

Manhattan Investment Fund Michael Berger and his Manhattan Investment Fund are at the center of one of the greatest hedge fund fraud stories in the industry’s history. According to a CNN/Money story,4 at the time the fraud came to light, it was among the first widely reported hedge fund misdeeds. The fraud captured headlines—and the public’s attention—when Berger skipped town, went on the lam, and ended up on the FBI’s most wanted list.

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Berger’s fall from grace began with simple mismanagement, but quickly escalated to full-blown fraud. The Manhattan Investment Fund launched in 1995; at its height, it had assets of more than $575 million under management. Unfortunately, for his investors, Berger did not understand the concept of Wall Street bubbles, and shorted the technology market a few years too early. Like any good criminal, he decided he was better off hiding the losses than owning up to them. One thing led to another, and before his investors knew what hit them, Berger had lost more than $400 million of investors’ money and was charged with securities fraud.5 Berger pleaded guilty to the charge in 2000, but instead of facing his day in court, went on the run. He finally was tracked down in July 2007 in Austria, and was brought back to the United States to face the music. So how did Berger’s criminal enterprises come to light? According to one former investor, the beginning of the end came during a routine dinner party conversation. It seems that at dinner parties, hedge fund managers and investors like to brag about their funds and investments. During this dinner party, Investor A was bragging about this great fund that he invested in, which was doing really well shorting the technology sector while the technology sector was rallying. Unfortunately for Berger, the person Investor A was talking to worked at the fund’s prime broker and knew that the fund wasn’t doing nearly as well as this investor seemed to believe. The problem was that the fund’s performance did not jive with the market. It turns out that Berger had created fake statements and sent them out on the prime broker’s letterhead. He was telling his investors, through these statements, that he was making money in technology, when in fact he was losing it like the rest of the market. When the investor found this out as a result of the conversation at the dinner party, the jig, as they say, was up.

Lake Shore Fund Complex One of the latest members of this elite club of hedge fund fraudsters is the Lake Shore fund complex. Lake Shore, which was based in London and Toronto, specialized in managed futures and worked hard to develop trading systems that allowed it to make significant profits for investors, regardless of market conditions. Everything seemed aboveboard: The firm appeared to be well established and sophisticated. Its London offices were on “hedge fund row” in Mayfair. Its salesforce was scattered across the globe, raising assets for a series of funds that, according to the firm’s marketing literature, were doing quite well. There was just one small problem. According to the Commodity Futures Trading Commission (CFTC), the whole operation was a sham.6 Court

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documents allege that the principal of the firm manufactured performance and asset levels for its marketing materials, all the while siphoning off assets for his personal use. As recently as February 2008, the CFTC filed an additional, or amended, complaint against Lake Shore and its principal, alleging that hundreds of investors were defrauded out of at least $273 million.7 The jury is still out on Lake Shore; the principal refuses to acknowledge CFTC’s jurisdiction, since Lake Shore was not based in the United States and did not operate within its borders. The saga came to light in June 2007, and looks as if it will continue for some time. These stories illustrate true fraud—crimes against investors and in the hedge fund industry. But other funds have gone under through simple mismanagement. Fraud is easy to avoid, but mismanagement can happen to you, if you’re not careful. Read on for a few cautionary tales.

HEDGE FUND MISMANAGEMENT What happened at funds like Amaranth, DB Zwirn, and Bear Stearns was not fraud, at least in the sense of the criminal aspect. The managers of these funds misread the markets, misinterpreted their own intelligence, and caused their investors to suffer because of their inability to run their organizations.

The Amaranth Story At its height, Amaranth was a $9 billion, multistrategy fund complex. The firm lost nearly $6 billion after it bet the wrong way in the natural gas markets—according to some sources, the largest collapse in hedge fund history. It is clearly the biggest ego bust up in the hedge fund industry. The firm’s energy trader, a Canadian named Brian Hunter, believed that he knew more than the rest of the energy traders and put a trade on that bet that the energy markets would spike in light of a massive hurricane season like the one the year before. He, in essence, thought the rest the world was wrong and he was right. The year before his massive loss, 2005, Hunter had bet that the markets would rally, and sure enough, when Hurricane Katrina hit, the markets went through the roof. He was truly a master of the universe. But lightning—and hurricanes—don’t hit twice, and in 2006 the markets fell instead of rallying. It was an error in judgment, it was a function of greed, and it was ego and his belief that he was right and everyone else was wrong that led to the losses. As of February 2008, there was still some investor litigation pending, so Mr. Hunter and his colleagues’ fates have not yet been revealed. In the wake of Amaranth’s collapse, both Hunter and the firm’s founder,

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Nicholas Maounis, got back on the horse and are working on developing new funds. This time, however, they seem to be doing it separately!

DB Zwirn & Company Another hedge fund that fell prey to mismanagement is DB Zwirn & Company, which, in late February 2008, announced that it was shutting its main funds in the wake of internal control problems, which resulted in the fund’s investors withdrawing more than $2 billion in assets.8 This particular saga began in March 2007, when the company (which at the time had nearly $5 billion assets under management) announced that it had found some “accounting irregularities” (never a good sign, in the financial world) and that it had hired an independent auditor to review the organization’s allocation of operating expenses. The findings of accounting problems were minimal, in the scope of things, and the company did pay investors back the expenses, plus interest. Despite the company’s efforts and willingness to make things right, the trust had been broken and one thing led to another—“another” being massive redemptions. The firm’s fortunes took another turn for the worse when it announced that the company would be able to distribute approximately 60 percent of the assets due to its inability to sell some holdings.9 Some of the holdings, it turns out, are illiquid. In order to avoid a fire sale, the firm will wind down the positions in an orderly process, which could take years.

Bear Stearns In June 2007, when the first wave of the mortgage crisis hit, Bear Stearns announced that two of its mortgage funds experienced massive losses and would be forced to liquidate in light of investor redemptions and collapsing market prices. In short, the fund’s manager had taken a page from Brian Hunter’s playbook and had bet that lightning would strike twice. The manager got burned, and the fund and its investors suffered for it. In order to shore things up with the fund and Wall Street, the firm committed to a $3.2 billion loan to bail out one of the funds and worked with other investment banks to bail out a second, larger, fund that was hit by the mortgage crisis.10 This led to the eventual collapse of the entire firm. In March of 2007, Bear was sold through a Federal Reserve brokered deal to JPMorgan Chase for $10 a share. The firm for all intents and purposes is now just a memory. However the story of the collapsed funds is far from over. Besides a number of investor lawsuits against the management of the funds, and its managers, in June of 2008 the fund’s managers Matthew Tannin and Ralph Cioffi were arrested and charged with conspiracy, securities fraud, and wire fraud for

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allegedly misleading investors. It will take years for this litigation to play out. It seems however that one thing is for sure: the fund investors got hit because the managers were too focused on themselves instead of the good of the investors.

What Went Wrong I firmly believe that it was arrogance—and not fraud—that caused most hedge funds to suffer losses that cost investors billions. When the dust settles, the suits are completed, and the post-mortem is written, each of these companies will likely be faulted for not having proper risk controls and oversight in place. That seems to be what gets most of these funds in trouble. Had there been proper checks and balances in place, I believe that all three of these situations could have been avoided. Furthermore, if investors had completed thorough background checks and due diligence, the folks at Manhattan, Bayou and Lake Shore would not have been so successful. Remember, greed is a very powerful emotion. It makes people do crazy things and causes them to overlook the obvious. These frauds and blow-ups grabbed a lot of news headlines over the last few years. How can investors avoid this type of situation? The answer is simple, elegant, and, to some degree, bogus: due diligence. Why bogus? Because only those with 20/20 hindsight say they could have avoided any of these funds. I don’t believe that it’s possible to avoid any possibility of fraud. Sometimes the fraudsters are just too good, and will catch anyone in their net. However, thorough due diligence is a good place to start. But understand that thorough due diligence by even the best investors would not have caught all of them. One or two of the funds may have raised red flags, but if I was a betting man, I would not bet on all of them failing due diligence tests. Investors are lazy, and they don’t see what it is in front of them because they are blinded by reputation and experience and their own belief in their investment expertise. But if investors had not been lazy and had thoroughly checked out the funds, it is possible that they still would have been burned because sometimes things are just too hard to see. Nevertheless, if you do the work and still get snookered, at least you can say you did the work.

HOW TO PROTECT YOURSELF There’s only one thing that you can do to separate good investments from bad: due diligence. Due diligence comes down to two parts research and one part instinct. Research can be faked, but instinct cannot. If your gut

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tells you that something is wrong, double-check the research, but still pass. The biggest mistake you can make by not investing in a fund is missed opportunity, and in the grand scheme of things, missing an opportunity is a better option than losing the farm. Continue to watch the fund; if it checks out, you can always choose to invest a year or two later. But if it blows up or turns out to be a fraud, your options are few and far between. Remember, there are plenty of good managers out there, and it takes time and effort to find them. Work hard, and you probably will be able to find at least a few funds worthy of your assets. There are more than a few. In fact, there are likely thousands that trade the markets well and earn money for their investors. But it is like finding the proverbial needle in the haystack. So don’t be lazy: Work hard, do some thorough due diligence, and you’ll come out ahead.

Regulatory Moves to Stop Fraud and Mismanagement In the wake of the recent blow-ups and frauds, there has been a lot of talk regarding hedge fund regulation by Congress, the Securities Exchange Commission, and many mutual fund management companies (refer back to Chapter 2 for more details on this). But here’s a question for you: Would it have made a difference in terms of any of the fraud and mismanagement we’ve discussed in this chapter? In my opinion, more stringent regulation would not have helped avoid any of these situations—or any other instance of fraud, for that matter. Remember that the two largest frauds ever perpetrated against investors was the mutual fund timing scandal and the research scandal that literally affected hundreds of thousands of investors. Both mutual funds and Wall Street research were and are highly regulated; regulation does not necessarily mean things are safer; it just means that there is more paperwork. The market will dictate the future of hedge funds and hedge fund regulation. Investors will continue to demand more from their managers, and, as such, the industry will change and adapt to these demands. Remember, money managers are engines, and engines cannot run without gasoline. Gasoline comes in the form of one thing—assets—and assets come from investors. It is pretty simple.

Investor Due Diligence I’m happy to report that I have a great solution for avoiding fraud: Do the right thing. Do the right thing by your investors, do the right thing by

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yourself, and do the right thing by employees and you won’t have a problem with fraud. It’s pretty simple. If you are an investor and you want to understand how to avoid fraud, you really need to do due diligence. You really need to do more than just look at investment performance and a private placement memorandum. You need to do more than just simply interview the manager or interview his or her people. You need to talk to other investors. You need to talk to consultants. You need to talk to service advisors. You need to do general background checks. You need to do criminal background checks. You need to make sure that what everyone is telling you is truthful and is relevant to what you’re doing. Despite what they may tell you, most hedge fund investors don’t do high levels of due diligence. There are two reasons for this. First, investors are afraid to ask questions. They forget that it’s their money and that they have the right to ask questions and get answers. Often, they’re intimidated, and take the view that the manager is doing them a favor by generating returns on their investments. That’s bull. At the end of the day, it’s your money. If you don’t like what the manager or his people are telling you, then get the hell out of the fund. The way to perform due diligence is to really kick the tires, look under the hood and get a level of information about the fund, its people and its organization sufficient enough to tell you what kind of investment you’re truly making. That’s the only way to do it, and you can’t do it yourself. You need to hire people to help you. You need to hire someone who can do a full background check. Get as much information about the person as possible. You need to hire people who can analyze the returns to see if they’re accurate. You need to hire people who can potentially review the audits. Yes, it’s expensive. Yes, it’s time consuming. But it’s your money, and there’s nothing more important than making sure that you’re putting it in the right place. The second reason investors make bad decisions is the fear of missing an opportunity. But that old saw—that “opportunity only knocks once”—is rarely true in the world of investing. Another opportunity—maybe from the same fund, maybe not—will come along. I’d much rather have you kick yourself for missing an opportunity than for squandering your funds and your future on a fund that’s not above board.

Manager Due Diligence There are a number of theories on due diligence. Most people perform what I would call a rather simple but elegant level of due diligence on potential managers. These investors start with a premise that they have

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115

already decided to give the fund money and are looking for a reason to change that decision. As a manager, these are types of investors you want. If you don’t understand why, then leave the business right now. You want investors to give you money to manage, and you want them to come to you with their checkbooks open. For the budding manager, I recommend a few things to get over the initial shock of the first due diligence. First, never lie. Never. Never lie in an interview, on paper, in person—just don’t do it. Obviously, lying is just plain wrong, and I hope that’s a sufficient deterrent to keep you from doing it. But you also need to recognize that you will be found out—sooner or later—and you will never recover. Just don’t do it! Second, if you don’t know the answer to a potential investor’s question, say that you don’t have an answer—and then go find it. He or she will respect you more for saying that than if you make something up on the fly that does not pan out. Third, make sure that you have all your ducks in a row and that you have a due diligence questionnaire (DDQ) ready. A DDQ is a document that covers a lot of material about the fund manager, the strategy, the style, the people, the service providers and other pertinent (and some not-so-pertinent) information. (See Appendix A for a sample DDQ.)

MAKING A GOOD FIRST IMPRESSION You need to be ready to answer questions, you need to be ready for an intense interrogation and you need to be able to explain in simple, yet detailed information how you manage money and how you are going to manage money going forward. It’s a job interview, and you need to be bothered! If all else fails, ask the potential investor for a sample list of questions and build a response around the questions. It is going to be the little things that get you, so pay attention to detail and make sure things are 100 percent before you go to market. Remember, you only get one first impression. Make it a good one. The way to do this is to be prepared. As I said before, the first rule of this jungle is that if you don’t know an answer to a question, admit it: Say that you don’t know and that you’ll get back to the investor. Don’t make it up. If you do, you’ll lose the client. The second (and related) rule is to always be truthful. It never hurts to tell the truth. Money comes and money goes. Integrity is all you have. Be sure to keep it. As for the meeting, conduct a practice meeting a few times with colleagues and friends to play the part of various investors. This will allow you to be prepared. Ask your friends to give you honest, helpful feedback.

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Listen to the whole question before you respond. Don’t be rude. Pay attention. Make sure that the person in front of you knows that they matter to you. If you can do all of this and put up good numbers, you can build a good business—one that’s successful for both you and your investors. Hard work and sweat are important. Keep that in mind, and you should find success.

CHAPTER

9

A Few Parting Thoughts

ongratulations, you are almost through. Before you know it, you will have finished reading this book and your journey through the world of hedge fund money management will be complete. By now, you should have a basic, yet thorough, understanding of how hedge funds manage money, how hedge funds are created, how hedge funds gather assets, and how investors seek out and find hedge fund investments. You should also have a good understanding of hedge fund service providers and the critical role each plays in the success or failure of a hedge fund management company. Ideally, you’ve gained a bit of knowledge and insight into hedge fund fraud and blow-ups, and have an idea of how to avoid traveling down that same path. You know where hedge funds came from; how the industry has evolved; and why Soros, Steinhardt, and Robertson were so important to the growth of the industry. I hope you’ve also learned one more vital thing—that hedge funds are not evil weapons run by maniacal people trying to control the capital markets and wreak havoc on millions of people around the globe through trading and investing while lining their own pockets with gold. Despite what the press says, hedge funds aren’t bad. Remember that one—it is important. I wrote this book to provide you with insight into (a) how money was raised, (b) how hedge funds are structured, (c) how hedge funds raise money, (d) how an investor should look at hedge funds, (e) how to correctly develop a marketing strategy, and (f) general information and knowledge about the hedge fund industry. I hope you have gathered that knowledge from this book. Please let me know your thoughts via e-mail at [email protected]. As other people who have e-mailed me will tell you, I read all of your e-mails and I respond to them all. I want to hear from you. Also check out my blog at www.hedgeanswers.blogspot.com. Fortunately for all of us, as time goes on, the hedge fund industry has not stopped growing. It is a force that is in a constant state of motion that expands and contracts as the markets move. In the wake of the market

C

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dislocation of 2007 and 2008, many managers were forced out of business and many others decided it was the right time to either launch new funds or expand their businesses. Mark my words: Hedge funds, in one shape or another, are here to stay. Managers will come and managers will go, but the business will remain. Think about it for one minute. Name another business where the barrier to entry is so low, the reward so high, and where the customer and the owner’s interests are so closely aligned. Can you come up with any? Me, neither. That alone is enough to keep the industry going, but that’s not the only reason hedge funds will continue to grow and prosper. The reason is simple: Investors aren’t dumb, and they understand the simple concept that markets do not always rise. Therefore, they want to invest in products that can take advantage of both good and bad markets. Hedge funds offer that opportunity. That being said, the hedge fund industry is still evolving, and will continue to do so for many years to come. Unlike the mutual fund industry, which for the most part offers only one-way investment products (and, let’s face it, can be just the smallest bit boring), the hedge fund industry is full of life and extremely vibrant. Hedge funds are one of the purest forms of capital left in today’s click-ofthe-mouse world. However, not all is good with the hedge fund industry, and things are probably going to get worse before they get better. Throughout the market volatility of 2007 and the early part of 2008, many hedge fund managers found that they could not successfully manage assets, and as such, put up very poor performance. As a result, many funds saw significant redemptions as investors realized that these managers were offering nothing more than expensive mutual funds. These vehicles were unable to hedge the risk of the markets (or hedge at all, frankly), which caused their portfolios to lose value. I believe that as 2009 gears up, many more hedge funds will return capital to their investors, liquidate their portfolios, and go out of business, because their managers cannot keep up with the pressure to deliver performance. However, on the flip side of this gloom-and-doom outlook, institutional investors are clamoring for more and more product. It seems that everybody in the institutional space is looking for more and more hedge fund or hedgefund-like products as homes for their assets. Whether these products have a new moniker (alternative investments) or continue to be called hedge funds, investors are looking for products that are going to perform regardless of market condition. In my opinion, this trend will continue for the next 5 to 10 years. It will continue to grow stronger, in part, because, as the markets continue to be volatile, it’s important that investors are invested in products

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that are managed by people who can use all the arrows in their investment quiver to make money. That’s what hedge funds offer. Hedge funds offer investors a promise of performance, regardless of market conditions, plain and simple. That is the global promise of these unique investment vehicles. The problem is that not all managers can deliver on that promise. Many hedge funds are unable to deliver because their managers do not know how to hedge. Investors demand returns. And hedge fund managers face a considerable amount of pressure to deliver. If a manager cannot hedge, then he or she is going to be redeemed. Investors are not putting their money into these products for mediocre returns without alpha. They want alpha, and they want it consistently. If you look at many of the successful firms, you will find their success is based on their ability to deliver alpha time and time again. As a hedge fund manager, this is what you should strive for, and as an investor, these are the types of funds you want to find for your assets. The inability to deliver is what causes managers to go out of business, with no one to blame but themselves. From any angle, it’s a pressure cooker. There is pressure from within, from the investors, and from the service providers. People are looking at you to deliver, and you don’t want to let them down. It is a tough job, but somebody has to do it. Don’t forget that when you do it right, you are rewarded quite handsomely.

APPENDIX

A

Due Diligence Questionnaire

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Appendix A: Due Diligence Questionnaire

b) Please detail the investment process from trade assessment, execution and risk management.

123

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Appendix A: Due Diligence Questionnaire

125

126

THE LONG AND SHORT OF HEDGE FUNDS

c) How do you calculate your hedges and what instruments do you use?

Appendix A: Due Diligence Questionnaire

127

128

THE LONG AND SHORT OF HEDGE FUNDS

Appendix A: Due Diligence Questionnaire

G. Liquidity & Fees

129

130 H. Compliance

THE LONG AND SHORT OF HEDGE FUNDS

Appendix A: Due Diligence Questionnaire

131

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APPENDIX

B

Resource Guide

Following is a list of service providers that can help you with most aspects of your business. The list has been gathered from a number of industry Web sites, publications, and personal contacts I have made over the years. Under no circumstances should you believe that since a firm is listed here I am endorsing it or its ability to provide you with the services you need. This list should be used solely as a guide to service providers who may prove useful to you in building your business.

PRIME BROKERS Barclays Capital Prime Services 200 Park Avenue New York, NY 10166 (212) 412-2180 www.barclays.com John Stracquadanio Citigroup Global Prime Brokerage 390 Greenwich Street, 5th Floor New York, NY 10013 (212) 723-4813 www.primebroker.citigroup.com Credit Suisse 11 Madison Avenue New York, NY 10010 www.creditsuisse.com (212) 325-6527 Todd Walters

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Cuttone & Company 111 Broadway, 10th Floor New York, NY 10006 (212) 374-9797 www.cuttone.com Paul Mandile Fidelity Prime Services World Trade Center 200 Seaport Boulevard Boston, MA 02210 (800) 988-4794 www.fidelityprime.com James Coughlin Goldman Sachs One New York Plaza, 44th Floor New York, NY 10004 (212) 902-2938 www.gs.com Ron Artzi Grace Financial Group 436 Willis Ave. 2nd FL. Williston Park, NY 11596 (516) 240-8195 Charlie Fisher Jefferies & Co. 520 Madison Avenue, 12th Floor New York, NY 10022 (212) 284-2429 www.jefferies.com David Conover UBS HedgeFund Services 1285 Avenue of the Americas New York, NY 10019 (800) 838-6096 www.ibb.ubs.com Christopher Hagstrom

Appendix B: Resource Guide

VanthedgePoint Group, Inc. 61 Broadway Suite 1915 New York, NY 10006 (212) 514-8639 Geoff Tudisco

LAWYERS Akin, Gump, Strauss, Hauer & Feld 590 Madison Avenue, 20th Floor New York, NY 10022 (212) 872-1030 www.akingump.com Steven Vine Arnold & Porter LLP 399 Park Avenue New York, NY 10022-4690 (212) 715-1000 www.arnoldporter.com Michael Griffin Baker & Hostetler LLP 666 Fifth Avenue New York, NY 10103 (212) 589-4200 www.bakerlaw.com Steven H. Goldberg Davis Graham & Stubbs LLP 1550 Seventeenth Street, Suite 500 Denver, CO 80202 (303) 892-9400 www.dgslaw.com Ronald R. Levine Dechert LLP 30 Rockefeller Plaza, 23rd Floor New York, NY 10112-2200 (212) 698-3500 www.dechert.com George J. Mazin

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Goodwin Procter LLP Exchange Place 53 State Street Boston, MA 02109 (617) 570-1559 www.goodwinprocter.com Elizabeth Shea Herrick, Feinstein LLP 2 Park Avenue New York, NY 10016 (212) 592-1558 www.herrick.com Irwin Latner Holland & Knight 200 South Orange Avenue, Suite 2600 Orlando, FL 32801 (407) 244-5239 www.hklaw.com Scott MacLeod Katten Muchin Rosenman LLP 575 Madison Avenue New York, NY 10022-2585 (212) 940-8930 www.kattenlaw.com William Natbony Kirkpatrick & Lockhart State Street Financial Center One Lincoln Street Boston, MA 02111-2950 (617) 261-3208 Thomas Hickey Lowenstein Sandler PC 65 Livingston Avenue Roseland, NJ 07068-1791 (973) 597-2424 www.lowenstein.com Robert G. Minion

Appendix B: Resource Guide

Mayer, Brown, Rowe & Maw Hearst Tower 214 North Tryon Street, Suite 3800 Charlotte, NC 28202 (704) 444-3500 www.mayerbrown.com Kris Manzano Sadis & Goldberg 551 Fifth Avenue, 21st Floor New York, NY 10176 (212) 573-6660 www.sglawyers.com Ron Geffner Schulte Roth & Zabel 919 Third Avenue New York, NY 10022 (212) 756-2567 www.srz.com Steve Fredman Seward & Kissel One Battery Park Plaza New York, NY 10004 (212) 574-1231 www.sewkis.com Steve Nadel Strook & Strook & Lavan 180 Maiden Lane New York, NY 10038-4982 (212) 806-5400 Sarah Davidoff Tannenbaum Helpern 900 Third Avenue New York, NY 10022 (212) 508-6700 www.thshlaw.com Michael Tannebaum

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Wachtell, Lipton, Rosen & Katz 51 West 52nd Street New York, NY 10019 www.wlrk.com Ian L. Levin Walkers Walkers House P.O. Box 265GT Mary Street George Town, Grand Cayman KY1-9001 Cayman Islands (345) 914-4223 www.walkers.com.ky Mark Lewis

ADMINISTRATORS Bank of Butterfield/Butterfield Fund Services P.O. Box HM 195 Hamilton, Bermuda HMAX (441) 299-3954 www.butterfieldbank.com BNY Alternative Investment Services One Wall Street, 42nd Floor New York, NY 10286 (212) 495-1784 www.bankofny.com Peter Mastriano Columbus Avenue Consulting LLC 152 West 57th Street New York, NY 10019 (212) 500-6200 www.columbusavenue.com Joe Holman

Appendix B: Resource Guide

Conifer Securities, LLC One Ferry Building, Suite 255 San Francisco, CA 94111 (415) 677-1570 www.conifersecurities.com Philip Stapleton Equity Trust 747 Third Avenue 22nd Floor New York, NY 10017 (646) 290-6475 Robert Schaeffer Fortis Prime Fund Solutions 153 East 53rd Street, 27th Floor New York, NY 10022 (212) 340-5545 www.fortisclearingus.com Jacques Bofferding HSBCs Alternative Fund Services 330 Madison Avenue New York, NY 10017 (212) 715-6491 www.us.hsbc.com Michael Regan MadisonGrey Consulting 10 Glenlake Parkway, Suite 900 Atlanta, GA 30328 (866) 473-2955 www.madisongrey.com Christine Kain PFPC Trust Company 301 Bellevue Parkway Wilmington, DE 19809 (302) 791-2000 www.pfpc.com Gerald Barbara

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Price Meadows 11747 NE First Street Bellevue, WA 98005 (425) 454-3770 www.pricemeadows.com Frank Duffy Spectrum Global Fund Services 200 North LaSalle Street Chicago, IL 60601 (312) 697-9900 www. sgfallc.com Chris Farr

ACCOUNTANTS Anchin, Block, Anchin LLP 1375 Broadway, 18th Floor New York, NY 10018 (212) 840-3456 www.anchin.com Gerry Ranzal BDO Seidman LLP 330 Madison Avenue, 4th Floor New York, NY 10017 (212) 885-8505 www.bdo.com Robert V. Castro Coleman, Epstein, Berlin & Company LLP 515 North State Street, Suite 2300 Chicago, IL 60610 (312) 245-0077 www.cebcpa.com Patrick O’Malley Deloitte & Touche Paramount Building 1633 Broadway New York, NY 10019 (212) 436-2165 www.deloitte.com James H. Quigley

Appendix B: Resource Guide

Eisner LLP 750 Third Avenue New York, NY 10017-2703 (212) 891-4062 www.eisnerllp.com Christian Bekmessian Ernst & Young 5 Times Square New York, NY 10036 (212) 773-2252 www.ey.com Arthur Tully Grant Thornton LLP 60 Broad Street 24th Floor New York, NY 10004 (212) 422-1000 www.grantthornton.com Cynthia Keveney Halpern & Associates, LLC 143 Weston Road Weston, CT 06883 (203) 227-0313 www.halpernassoc.com Barbara Halpern KPMG LLP 345 Park Avenue New York, NY 10154-0102 (212) 758-9700 www.kpmg.com Kendi Ullman PricewaterhouseCoopers 300 Madison Avenue 24th Floor New York, NY 10017 (646) 471-7830 www.pwc.com Tony Artabane

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McGladrey & Pullen, LLP 1185 Avenue of the Americas, Suite 500 New York, NY 10036-2602 (212) 372-1535 www.mcgladreypullen.com Peter W. Testaverde Rothstein Kass 1350 Avenue of the Americas 15th Floor New York, NY 10019 (212) 997-0500 www.rkco.com Howard Altman

INSURANCE Baronsmead Insurance Brokers Limited 5th Floor 21 Bruton Street London NA W1J6QD London, United Kingdom +44 (20) 7529 2300 Robert Kelly Frank Crystal & Co., Inc 1 Financial Sq Fl 17 New York, NY, 10005 (212) 504-1871 Ari Kleinman Hub International 1065 Avenue of the Americas New York, NY 10018 Phone: (212) 338-2252 Felice Luxenberg Theodore Liftman Insurance, Inc. 101 Federal Street Boston, MA 02110 (617) 439-9595 Andrew Fotopulos

Appendix B: Resource Guide

The Ross Companies Rockefeller Center, 20th Floor 1270 Avenue of the Americas New York, NY 10020 (212) 582-2524 Norman Ross USI Insurance Services 301 Merritt 7 Norwalk, CT 06851 (203)-354-4900 Marilyn Maffucci

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APPENDIX

C

Historic Performance of Hedge Funds

The following series of charts provides historical performance data for a number of hedge fund strategies and indexes. The trends tracked in these charts indicate that over time hedge funds provide investors with strong investment returns and outperform traditional indices during good and bad markets. This data is here for illustration purposes only. Remember that past performance is no guarantee of future returns and furthermore remember that what happened yesterday is not going to happen tomorrow and therefore you need to create a portfolio for the future which is for the most part completely uncertain. That being said, using historical data can provide you with insight into how strategies perform against each other and the benchmarks which in turn can be used as one building block of a portfolio.

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TABLE C.1 Greenwich Monthly US Hedge Fund Index3 Primary Strategy1

Feb-08

Greenwich US Hedge Fund Index3

1.42% −2.33%

0.63% −1.49%

0.66% −1.69%

Greenwich US Market Neutral Group Index Greenwich US Equity Market Neutral Index Greenwich US Event-Driven Index Greenwich US Distressed Securities Index Greenwich US Merger Arbitrage Index Greenwich US Special Situations Index Greenwich US Arbitrage Index Greenwich US Convertible Arbitrage Index Greenwich US Fixed Income Arbitrage Index Greenwich US Statistical Arbitrage Index Greenwich US Long/Short Equity Group Index Greenwich US Growth Index Greenwich US Opportunistic Index Greenwich US Short Selling Index Greenwich US Value Index Greenwich US Directional Trading Group Index Greenwich US Futures Index Greenwich US Macro Index Greenwich US Market Timing Index Greenwich US Specialty Strategies Group Index Greenwich US Emerging Markets Index Greenwich US Fixed Income Index Greenwich US Multi-Strategy Index2

Aug-07

Jul-07

3.00%

2.57% −1.28%

0.13%

0.24% −0.99%

2.09%

1.54% −0.98%

0.27%

0.82% −1.82%

1.07%

0.15%

2.26%

1.75% −1.79%

0.01%

0.72% −2.64%

0.26% −2.00%

2.58%

1.38% −0.84%

0.21%

0.12% −2.35%

0.04% −2.05%

1.86%

0.53% −1.10% −0.38%

0.39% −2.23% −0.52% −2.17%

1.54%

2.07%

1.01% −2.87% 0.49% −1.94% 0.55% −0.82% −0.18% −0.51%

3.14% 1.57%

1.74% −1.06% 1.61% −0.81%

−2.55% −0.91% −1.89% −2.46%

1.54%

1.32% −2.47% −0.41%

1.31%

1.01%

1.50% −0.22%

1.16% −2.03%

0.45% −0.74%

2.35%

1.63%

0.87% −4.04% 0.48% −6.40% 1.95% −4.83%

0.79% −2.22% 0.65% −2.82% 1.85% −2.64%

3.16% 4.21% 4.20%

2.77% −0.74% −0.19% 3.24% −0.17% −0.04% 3.94% −0.74% 1.71%

3.21% 4.50% 0.64% −3.40%

0.71% 6.84% 0.56% −2.34%

0.55% −1.37% 1.40% 3.39% 2.65% 2.46% −1.03% −1.08%

5.13% 2.20% 7.71% 4.43% 2.56% −0.11%

1.32% −0.18% 1.59% 0.21% 1.04% −0.44%

3.87% 3.83% 3.95%

4.61% −3.60% −0.23% 5.05% −5.62% −2.09% 3.99% −1.21% 2.54%

0.95% −3.17%

0.83% −3.36%

3.68%

4.65% −1.14%

0.51%

1.48% −2.47%

0.43% −1.50%

3.89%

2.58% −1.16%

1.44%

1.71% −5.97%

1.43% −3.23%

7.22%

5.01% −1.76%

3.92%

1.81% −0.15% −0.28%

0.65%

0.65% −1.11% −1.08%

3.67%

1.78% −0.77%

0.56%

0.23%

Jan-08

0.53%

2.15% −2.67%

Dec-07

0.18%

Nov-07 Oct-07

0.02% −0.99%

Sep-07

0.45% −1.20% 1.08% 0.43%

1.45%

1.15% −0.08%

0.39%

©2008 Greenwich Alternative Investments, LLC and/or its licensors. 1 Please see Explanatory Notes. 2 Until Jan. 2004, the “Multi-Strategy” category was named “Several Strategies.” 3 Beginning with the final August 2004 Index, funds of funds are no longer included in the Greenwich US Hedge Fund Index. Historical returns for the Index have been restated to exclude funds of funds. 4 Index returns from January 1988 to December 2002 are based on quarterly compounded index results, while returns from January 2003 to present are based on monthly compounded index results.

Appendix C: Historic Performance of Hedge Funds

Jun-07 May-07 Apr-07 Mar-07 Feb-07 Jan-07 Dec-06 Nov-06 Oct-06 Sep-06 Aug-06

147

Jul-06 Jun-06

0.90% 1.95% 1.77% 0.71% 0.69% 1.20% 1.16% 1.95% 1.69% 0.09% 1.01% −0.28% −0.40%

0.57% 1.33% 1.07% 0.90% 1.18% 1.38% 1.23% 1.18% 1.29% 0.41% 0.69% 0.37% 0.20% 0.42% 1.08% 1.14% 1.02% 0.36% 1.21% 1.04% 0.80% 1.12% 0.32% −0.20% 0.53% 0.45% 0.07% 1.97% 1.56% 1.05% 1.65% 1.84% 1.47% 1.73% 1.85% 0.20% 0.89% −0.17% −0.15% 0.44% 1.67% 1.60% 0.94% 1.79% 1.68% 1.56% 1.92% 1.65% 0.23% 1.04% 0.09% −0.21% −0.67% 2.47% 1.68% 0.83% 0.77% 2.38% 1.21% 1.07% 1.85% 0.59% 0.53% 0.44% 0.79% −0.05% 2.08% 1.51% 1.21% 1.74% 1.87% 1.40% 1.68% 2.00% 0.03% 0.83% −0.55% −0.31% 1.03% 0.88% 0.56% 0.69% 1.17% 1.02% 1.11% 0.86% 0.87% 0.66% 0.92% 0.88% 0.44% 0.16% 0.87% −0.15% 0.62% 1.41% 1.40% 1.24% 0.72% 0.42% 0.99% 0.94% 0.95% 0.17% 2.05% 0.39% 0.46% 0.60% 1.48% 0.75% 0.92% 0.80% 0.76% 0.44% 1.09% 0.09% 0.09% 0.74% 1.21% 1.37% 1.59% 0.24% 0.75% 1.35% 1.08% 1.21% 0.48% 0.64% 0.90% 2.39% 0.66% 2.33% 2.02% 1.12% 0.70% 1.20% 1.29% 2.21% 2.19% 0.11% 1.32% −0.31% −0.19% 0.48% 3.16% 2.11% 1.19% 0.45% 1.30% 1.35% 2.67% 2.26% 0.03% 1.52% −0.37% 0.15% 1.02% 1.97% 2.00% 1.18% 0.61% 1.45% 1.28% 2.54% 2.16% −0.60% 0.69% −0.60% −1.04% 3.40% −2.48% −2.71% 0.06% 1.42% −1.26% 0.83% −2.96% −2.41% −2.00% −1.88% 3.81% 1.32% 0.46% 2.39% 2.20% 1.13% 0.78% 1.19% 1.29% 2.17% 2.37% 0.47% 1.62% −0.41% −0.15% 1.90% 2.10% 2.64% −1.38% −0.70% 0.70% 0.07% 2.95% 0.95% −1.35% 0.86% −2.01% −2.59% 2.65% 2.52% 3.89% −2.88% −1.80% 0.79% −0.44% 3.81% 0.82% −1.68% 1.23% −3.21% −4.18% 0.71% 1.51% 0.95% 0.51% 0.87% 0.66% 0.67% 1.92% 0.96% −1.14% 0.29% −0.19% 0.03% 0.55% 1.63% 2.00% −0.09% −0.19% 0.23% 0.76% 1.83% 1.49% −0.48% 0.83% −0.04% −0.06% 1.24% 2.40% 2.01% 1.19% 0.99% 1.26% 1.78% 2.06% 1.89% 0.83% 0.94% −0.06% −0.39% 2.63% 3.60% 3.13% 1.37% 0.54% 0.33% 2.75% 3.60% 2.62% 0.25% 0.94% 0.14% −1.34% 0.58% 1.07% 0.99% 0.21% 1.13% 1.01% 0.95% 1.09% 0.88% 0.81% 1.09% 0.75% 0.22% 0.18% 2.18% 1.83% 1.82% 1.25% 2.16% 1.60% 1.49% 2.00% 1.24% 0.84% −0.80% −0.18% (continues)

148

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.1 (Continued) Primary Strategy1

May-06

Apr-06

Mar-06

Feb-06

Jan-06 Dec-05 Nov-05 Oct-05

Greenwich US Hedge Fund Index3

−1.05%

1.97%

1.88%

0.00%

3.36%

1.3%

1.7% −1.2%

0.23%

1.24%

1.54%

0.59%

2.21%

1.0%

0.5% −0.5%

−0.68%

1.53%

0.97%

0.12%

1.49%

1.0%

0.4% −0.4%

−0.02%

1.46%

2.08%

0.37%

2.77%

1.2%

1.1% −1.1%

0.80%

1.91%

2.00%

0.33%

2.54%

1.3%

1.0% −0.3%

0.19%

0.89%

1.78%

0.72%

3.00%

1.2%

0.9% −0.9%

−0.68% 0.87%

1.29% 0.89%

2.26% 1.15%

0.32% 1.00%

2.98% 1.85%

1.1% 0.7%

1.1% −1.7% 0.1% 0.1%

1.78%

0.41%

1.02%

1.39%

2.56%

0.5%

−0.2%

0.0%

0.60%

1.06%

0.91%

0.54%

0.82%

0.7%

0.3%

0.5%

−1.63%

1.44%

2.26%

1.30%

1.13% −0.6%

1.2% −0.2%

−1.99% −3.06% −2.54%

1.46% 0.69% 1.73%

2.18% 0.08% 2.50% 0.12% 2.58% −0.31%

4.50% 5.37% 5.07%

1.8% 1.5% 2.0%

1.9% −1.8% 2.2% −2.3% 2.1% −2.5%

0.35% −3.30% −0.5% 0.16% 4.32% 1.9%

−3.8% 2.9% 2.0% −1.7%

Greenwich US Market Neutral Group Index Greenwich US Equity Market Neutral Index Greenwich US Event-Driven Index Greenwich US Distressed Securities Index Greenwich US Merger Arbitrage Index Greenwich US Special Situations Index Greenwich US Arbitrage Index Greenwich US Convertible Arbitrage Index Greenwich US Fixed Income Arbitrage Index Greenwich US Statistical Arbitrage Index Greenwich US Long/Short Equity Group Index Greenwich US Growth Index Greenwich US Opportunistic Index Greenwich US Short Selling Index Greenwich US Value Index Greenwich US Directional Trading Group Index Greenwich US Futures Index Greenwich US Macro Index Greenwich US Market Timing Index Greenwich US Specialty Strategies Group Index Greenwich US Emerging Markets Index Greenwich US Fixed Income Index Greenwich US Multi-Strategy Index2

4.08% −0.04% −2.32% −1.84% 1.75% 2.20% −1.23% −1.52% −0.47%

5.45% 7.28% 2.37%

2.21% −2.38% 3.55% −3.13% 0.17% −1.25%

2.48% −0.1% 1.87% −1.1% 3.62% 1.9%

3.9% −1.2% 5.7% −1.2% 1.4% −1.0%

−1.63%

2.47%

0.38% −0.64%

2.86%

0.1%

0.9% −1.9%

−1.24%

2.18%

1.37%

0.61%

3.48%

2.2%

2.0% −1.2%

−3.46%

3.82%

1.59%

0.98%

6.16%

4.0%

3.7% −2.9%

0.87%

0.51%

0.81%

0.77%

0.84%

0.9%

0.4%

−0.77%

1.91%

1.51%

0.16%

2.90%

1.6%

1.7% −0.8%

0.2%

149

Appendix C: Historic Performance of Hedge Funds

Sep-05 Aug-05

Jul-05 Jun-05 May-05 Apr-05 Mar-05 Feb-05 Jan-05 Dec-04 Nov-04 Oct-04 Sep-04

1.4%

0.6%

2.2%

1.6%

1.2% −1.9% −0.9%

1.7% −0.7%

1.6%

3.3%

0.7%

1.9%

0.9%

0.7%

1.6%

1.1%

0.2% −1.4% −0.2%

0.9% −0.1%

1.6%

2.2%

0.6%

0.9%

0.8%

0.5%

1.0%

1.0%

0.2% −0.4%

0.9%

0.2%

1.2%

2.3% −0.4%

1.7%

0.8%

0.9%

2.1%

1.4%

0.5% −1.5% −0.2%

1.9% −0.3%

2.6%

3.8%

1.4%

1.6%

1.3%

1.5%

1.9%

1.4%

−0.4% −0.8%

0.6%

1.2%

0.3%

2.9%

3.3%

1.6%

1.0%

−0.2%

0.6%

1.6%

0.9%

0.6% −0.7%

0.8%

0.6%

0.2%

1.1%

1.2%

0.5%

0.2%

0.7% 1.1%

0.6% 0.5%

2.5% 1.2%

1.4% 0.7%

1.1% −2.0% −0.7% −0.2% −1.7% −0.3%

2.4% −0.6% 0.1% −0.1%

2.5% 0.8%

4.0% 0.8%

1.3% 0.3%

2.0% 0.1%

1.5%

0.6%

1.8%

1.4%

−1.2% −4.3% −1.7% −0.7% −0.8%

0.6%

1.0% −0.2%

0.0%

0.9%

0.4%

0.8%

0.2%

−0.3%

0.6%

0.9% −0.5%

0.6% −0.3%

3.3% 4.1% 4.8%

2.2% −2.6% −1.3% 3.1% −3.2% −2.5% 2.8% −3.3% −1.8%

1.9% 0.6% 1.6% −0.1% 2.7% 0.7%

2.2% 2.6% 2.8%

0.3%

0.2%

0.3%

0.3%

0.6%

0.3%

0.3% −0.2%

0.6%

0.4%

0.6% −1.5%

0.6%

0.5%

0.3%

1.3% −1.4%

2.1% −1.3% 2.0% −3.5% 2.1% −1.0%

1.8% 2.1% 1.9%

4.2% 0.6% 6.3% 1.2% 4.4% −0.7%

2.7% 4.5% 2.4%

1.4% 1.8%

2.6% −2.3% −0.6% 0.7% 2.8% 2.0%

−3.7% 4.0% 2.5% −0.1% 2.9% −5.2% −6.5% −0.2% −2.6% 2.0% −2.6% −1.0% 2.3% −1.0% 2.2% 4.2% 0.8% 2.5%

0.8% 0.0% 2.8%

0.7% 1.0% 0.4%

0.5% 0.0% 1.5%

2.0% 2.5% 0.9%

2.4% −2.8% −0.7% 3.5% −4.2% −0.4% 0.9% −0.5% −1.1%

0.5% −2.0% −0.2% 0.0% −2.8% −0.8% 1.4% −0.9% 0.4%

4.9% 6.4% 2.8%

4.1% 6.1% 0.7%

2.3% 3.3% 0.6%

0.4%

0.0%

0.7%

1.2%

1.0% −1.2% −1.1%

0.7% −0.8%

0.6%

1.9%

0.9%

1.4%

1.7%

0.4%

2.0%

1.3%

0.8% −0.7% −1.5%

2.2%

0.2%

1.6%

2.7%

1.3%

1.8%

3.5%

0.5%

2.8%

1.8%

1.7% −1.5% −3.5%

3.9%

1.2%

2.9%

5.1%

2.0%

4.5%

0.6%

0.4%

1.0%

0.8%

0.6%

1.1%

1.0%

0.9%

1.4%

1.1%

1.2%

1.2%

0.4%

2.0%

1.3%

0.3% −0.8% −0.9%

1.6% −0.8%

1.0%

1.7%

0.8%

0.5%

0.3% −0.1%

(continues)

150

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.1 (Continued) Primary Strategy1 Greenwich US Hedge Fund Index3 Greenwich US Market Neutral Group Index Greenwich US Equity Market Neutral Index Greenwich US Event-Driven Index Greenwich US Distressed Securities Index Greenwich US Merger Arbitrage Index Greenwich US Special Situations Index Greenwich US Arbitrage Index Greenwich US Convertible Arbitrage Index Greenwich US Fixed Income Arbitrage Index Greenwich US Statistical Arbitrage Index Greenwich US Long/Short Equity Group Index Greenwich US Growth Index Greenwich US Opportunistic Index Greenwich US Short Selling Index Greenwich US Value Index Greenwich US Directional Trading Group Index Greenwich US Futures Index Greenwich US Macro Index Greenwich US Market Timing Index Greenwich US Specialty Strategies Group Index Greenwich US Emerging Markets Index Greenwich US Fixed Income Index Greenwich US Multi-Strategy Index2

Aug-04

Jul-04

Jun-04

May-04

Apr-04

Mar-04

Feb-04

Jan-04

0.0%

−1.3%

0.8%

−0.2%

−1.6%

0.0%

0.9%

2.1%

0.2%

−0.1%

0.6%

−0.1%

−0.5%

0.2%

0.7%

1.9%

−0.2%

0.3%

0.9%

0.4%

−2.3%

0.2%

0.8%

1.5%

0.0%

−1.0%

1.5%

0.0%

−0.5%

−0.2%

1.1%

3.2%

0.4%

0.1%

2.5%

0.3%

1.4%

0.0%

1.3%

3.6%

−0.1%

−0.7%

0.0%

0.1%

−0.2%

0.1%

0.3%

0.8%

−0.1% 0.4%

−1.6% 0.4%

1.0% −0.3%

−0.1% −0.3%

−1.2% 0.2%

−0.2% 0.4%

1.0% 0.5%

3.0% 1.2%

0.7%

0.4%

−1.0%

−1.7%

0.1%

0.6%

0.0%

1.2%

0.5%

0.5%

0.4%

0.7%

0.1%

0.3%

1.1%

1.0%

0.0%

−0.2%

−0.6%

1.3%

0.8%

−0.1%

0.1%

0.5%

−0.2% −1.2% 0.2%

−2.4% −4.7% −2.7%

1.1% 1.2% 0.6%

−0.1% −0.5% −0.1%

−2.3% −3.6% −1.9%

−0.2% −0.6% −0.3%

0.9% −0.2% 1.3%

2.4% 3.3% 2.4%

1.2% 0.0%

6.2% −1.8%

−1.6% 1.4%

−0.1% 0.1%

3.1% −2.3%

−1.6% 0.2%

−0.1% 1.4%

−1.3% 2.3%

−1.0% −1.4% −0.7%

−0.6% −0.4% −0.7%

−1.5% −2.5% −0.6%

−0.7% −0.6% −1.4%

−5.1% −6.8% −2.5%

0.7% 1.1% 0.3%

3.9% 6.4% 1.2%

1.0% 0.8% 1.5%

−0.2%

−0.8%

0.5%

0.1%

−2.1%

−0.1%

0.4%

1.2%

0.8%

0.7%

0.6%

−0.7%

−2.0%

0.2%

1.3%

1.8%

1.3%

0.8%

0.1%

−2.3%

−3.4%

1.5%

3.3%

2.1%

1.2%

1.3%

1.1%

0.3%

−0.8%

0.6%

0.9%

0.7%

0.3%

0.3%

0.6%

−0.1%

−1.8%

−1.2%

0.5%

2.3%

151

Appendix C: Historic Performance of Hedge Funds

Dec-03 Nov-03 Oct-03 Sep-03 Aug-03

Jul-03 Jun-03 May-03 Apr-03 Mar-03 Feb-03 Jan-03 Dec-02

1.9%

1.3%

2.8%

0.7%

1.7%

1.1%

1.2%

4.1%

2.8%

0.4% −0.3%

0.5% −0.4%

1.2%

1.0%

1.6%

1.0%

0.6%

0.2%

0.8%

1.8%

1.6%

0.5%

0.4%

1.4%

1.3%

0.0%

0.6%

1.4%

0.4%

0.7%

0.1%

0.8%

1.2%

0.5% −0.1% −0.1%

0.5%

1.6%

2.1%

1.7%

2.7%

1.4%

1.5%

1.2%

2.0%

3.2%

2.8%

0.9%

0.0%

1.1%

0.7%

2.3%

1.9%

2.7%

2.2%

1.2%

1.5%

2.3%

2.4%

2.6%

1.1%

1.0%

2.4%

1.6%

2.1% 0.8%

1.5% 0.7%

2.7% 1.0%

1.1% 1.7% 1.1% 1.9% 1.0% −0.1% −0.3% −0.1%

3.6% 1.1%

2.9% 1.2%

0.9% −0.6% 0.4% 0.9%

0.4% 1.8%

0.1% 1.6%

2.0% 0.8% 2.8%

1.7% 1.2% 1.7%

3.6% 0.3% 4.9% −0.1% 3.8% 0.4%

5.7% 8.1% 5.2%

3.7% 4.4% 4.5%

0.4% −0.9% −0.1% −1.9% 0.3% −1.6% −0.2% −5.0% 0.6% −0.7% −0.2% −0.9%

−1.7% −1.3% −5.4% 2.6% 2.1% 3.4%

2.2% 2.8% 3.1%

2.0% 2.4% 2.5%

1.6% 2.3% 1.8%

0.7% −3.1% −3.2% −1.6% 0.5% 2.0% 2.0% 1.5%

−5.8% −5.5% −0.6% 1.8% 5.2% 3.7% 0.5% −0.7%

0.7% 5.2% 0.0% −1.1%

3.7% 0.1% 4.1% −0.2% 3.9% 0.6%

2.0% 0.5% 1.7% −0.3% 2.5% 2.8%

1.3% −1.0% −1.7% 1.2% −1.7% −3.5% 1.5% −0.8% −0.6%

4.5% 5.6% 4.5%

1.1% −3.7% 0.5% −7.4% 1.9% −0.2%

3.9% 7.5% 0.8%

2.0%

0.4%

2.2%

0.3%

1.4%

0.2%

0.9%

2.6%

1.3%

0.0% −0.5% −1.9%

3.4%

0.7%

2.6%

1.4%

2.3%

0.0%

1.2%

3.9%

3.7% −0.1%

0.5%

6.4%

0.4%

4.6%

2.0%

4.9%

1.8%

3.5%

4.7%

4.7% −0.5%

1.0% −0.3% −0.1%

2.2%

0.8%

1.0%

1.6%

0.4% −1.4%

0.0%

2.5%

1.7%

1.1%

1.5%

0.9%

1.9%

0.6%

2.3%

0.5%

5.4%

5.2% −0.3% −0.9%

0.7%

0.0%

0.4%

3.1% 6.0% 1.2%

0.8%

0.6%

3.5% 6.5% 4.3%

0.2%

2.3%

2.1% −1.9% (continues)

152

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.1 (Continued) Primary Strategy1 Greenwich US Hedge Fund Index3 Greenwich US Market Neutral Group Index Greenwich US Equity Market Neutral Index Greenwich US Event-Driven Index Greenwich US Distressed Securities Index Greenwich US Merger Arbitrage Index Greenwich US Special Situations Index Greenwich US Arbitrage Index Greenwich US Convertible Arbitrage Index Greenwich US Fixed Income Arbitrage Index Greenwich US Statistical Arbitrage Index Greenwich US Long/Short Equity Group Index Greenwich US Growth Index Greenwich US Opportunistic Index Greenwich US Short Selling Index Greenwich US Value Index Greenwich US Directional Trading Group Index Greenwich US Futures Index Greenwich US Macro Index Greenwich US Market Timing Index Greenwich US Specialty Strategies Group Index Greenwich US Emerging Markets Index Greenwich US Fixed Income Index Greenwich US Multi-Strategy Index2

Nov-02

Oct-02

Sep-02

Aug-02

Jul-02

Jun-02

May-02

Apr-02

2.8%

1.0%

−1.4%

0.5%

−3.1%

−2.0%

0.1%

0.2%

1.6%

0.3%

−0.1%

0.7%

−1.8%

−0.7%

0.6%

0.8%

0.1%

0.9%

0.2%

1.9%

−1.3%

0.5%

1.4%

1.9%

3.1%

−0.3%

−1.5%

0.1%

−3.2%

−2.8%

0.4%

0.4%

1.9%

−0.3%

−1.5%

−0.3%

−1.8%

−1.6%

1.0%

1.2%

3.8% 1.2%

−0.3% 0.4%

−1.5% 0.7%

0.4% 0.5%

−3.9% −1.2%

−3.6% 0.0%

−0.2% 0.3%

−0.1% 0.6%

3.7% 5.4% 3.1%

1.5% 2.1% 0.2%

−2.3% −2.2% −1.7%

0.3% 0.4% 0.1%

−4.3% −4.2% −2.9%

−3.2% −4.9% −2.4%

−0.2% −2.1% 0.4%

−0.3% −2.7% 0.4%

−5.9% 3.9%

−3.8% 2.2%

5.8% −3.6%

−0.4% 0.5%

7.4% −6.3%

4.9% −3.6%

3.9% 0.2%

5.4% 0.5%

−0.5% −2.7% 1.8%

−2.3% −4.5% −1.2%

2.1% 4.4% −1.6%

2.0% 3.6% 0.5%

0.8% 3.3% −3.6%

3.2% 7.6% 0.2%

1.5% 2.7% 2.5%

−0.3% −0.9% 3.4%

1.7%

0.5%

0.6%

0.3%

−1.1%

−1.9%

−0.4%

−1.3%

3.4%

2.4%

−2.7%

0.6%

−2.6%

−1.5%

0.3%

0.6%

3.3%

2.8%

−1.4%

0.0%

−3.0%

−2.0%

0.4%

1.8%

1.1%

−1.5%

−0.1%

1.6%

0.1%

0.6%

0.7%

1.1%

8.6%

8.6%

−6.8%

−0.4%

−6.3%

−4.6%

−0.4%

−1.3%

153

Appendix C: Historic Performance of Hedge Funds

Mar-02 Feb-02 Jan-02 Dec-01 Nov-01 Oct-01 Sep-01 Aug-01

Jul-01 Jun-01 May-01 Apr-01 Mar-01

2.3% −1.1%

0.5%

1.7%

2.7%

2.3% −3.0% −0.7% −0.6%

0.9% −0.3%

0.9%

0.5%

1.5%

1.1% −0.1%

0.0%

1.0%

0.6%

1.4% −0.1%

1.6% −0.6%

0.1%

0.9%

1.5%

0.6% −0.2%

1.5%

0.5%

2.1% −0.9% −0.5% 0.9% −0.2% 1.4%

3.3% −1.8% 0.3% 3.9% −3.7% −0.8% 3.0% −0.7% 0.3%

−0.1%

−3.1% 3.3% 3.8% −1.7%

1.5%

2.7% −1.7%

0.8%

0.1% −0.2%

1.5%

1.1%

0.6%

0.7%

0.3%

0.1%

2.0%

0.8%

1.7%

0.5% −0.5%

0.7% −0.1% −0.8%

2.0%

0.9% −0.5%

1.0%

0.4% −1.1%

1.2%

2.4%

5.1%

1.3%

1.1% 0.4%

1.8% 1.5%

0.6% −0.3% 1.9% −0.3%

0.5% −0.6% −1.8% 1.0% 0.3% 0.3%

1.2% 0.8%

0.9% −1.0% 1.2% 1.0%

2.3% 2.9% 1.9%

3.4% 4.1% 2.2%

3.0% −5.1% −1.8% −1.2% 0.5% 2.6% −5.4% −3.8% −2.7% −0.8% 1.3% −2.9% −0.8% −0.6% 0.4%

1.5% 0.9% 0.9%

3.5% −3.0% 4.0% −4.6% 2.3% −3.2%

0.8%

1.7%

5.2% −2.3% −5.0% −3.4% 5.8% 7.7% 5.0% 0.4% 2.8% 4.9% 5.1% −7.2% −2.0% −1.4%

0.3% −1.0% −1.0% −0.7% −1.8% −1.7% −0.1% −1.1% 0.6% 2.1%

0.3%

0.1% −0.7%

1.8% 1.3%

0.8%

0.6% −9.5% 7.0% 2.4% 5.1% −2.7%

1.5% −2.5% 1.1% −7.1% 2.6% 1.0%

4.1% 1.2% −0.7% −1.9% 0.0% 4.7% 4.4% 1.7% −2.2% −0.9% 5.2% −6.7% −6.6% −3.5% 0.0%

1.2% −1.1% 0.7% −5.2% 1.9% 3.6%

1.4%

2.4%

3.1%

1.5%

1.7%

2.8% −3.2%

1.1% −1.9% −0.7%

2.9% 7.4% 0.6%

2.8% −0.2%

1.0%

2.2%

2.5%

1.8% −1.9%

1.2%

0.4%

0.1%

2.0%

2.5% −1.1%

4.7% −0.2%

4.5%

4.6%

2.9%

4.5% −5.6%

2.2% −3.3%

0.0%

4.0%

2.8% −1.8%

1.4%

1.8%

0.4%

0.2%

1.1%

1.7% −0.3%

0.9% −1.8% −1.3%

2.6%

0.2%

1.9%

3.4% −1.6%

−0.1%

0.0%

0.6% −0.4% −0.1%

3.8% −0.4% −1.6%

2.7%

3.8%

0.6%

(continues)

154

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.1 (Continued) Primary Strategy1

Feb-01

Jan-01

Dec-00

Nov-00

Oct-00

Sep-00

Aug-00

Jul-00

Greenwich US Hedge Fund Index3

−2.5%

3.2%

2.0%

−3.0%

−1.5%

−0.7%

4.9%

−0.4%

0.5%

1.6%

1.9%

−0.2%

−0.4%

0.7%

2.9%

0.6%

1.7%

1.3%

4.0%

1.8%

1.2%

1.2%

3.8%

−0.1%

−0.4%

2.2%

1.5%

−2.1%

−1.3%

0.9%

3.6%

0.8%

−0.3%

9.3%

−1.0%

−1.8%

−1.5%

−0.6%

1.5%

0.3%

−0.4% 0.9%

0.8% 1.3%

2.6% 1.0%

−2.2% 0.1%

−1.3% −0.6%

1.4% 0.2%

4.4% 1.7%

1.0% 0.7%

−4.4% −7.7% −5.3%

4.0% −0.3% 4.2%

2.1% 1.4% 1.9%

−4.8% −7.7% −3.4%

−1.8% −4.1% −1.9%

−0.8% −2.1% −1.1%

5.9% 8.8% 5.4%

−0.9% −4.4% −0.1%

9.3% −2.7%

0.1% 7.7%

1.1% 2.9%

15.4% −5.5%

9.8% −1.2%

11.7% −1.0%

−14.3% 6.1%

6.5% −0.1%

−1.5% 0.8% −2.7%

0.1% −0.5% 1.8%

5.7% 10.0% −1.9%

1.8% 6.3% 0.0%

−0.6% 1.2% −5.9%

−3.7% −3.3% −4.6%

4.6% 4.1% 4.5%

−1.9% −1.6% −4.0%

−4.2%

0.5%

3.5%

−3.7%

−1.0%

−4.0%

5.2%

−1.9%

−0.7%

5.7%

2.8%

−2.8%

−3.1%

−1.2%

5.0%

0.3%

−2.8%

15.1%

1.1%

−4.6%

−3.0%

−4.5%

4.5%

2.3%

0.9%

3.1%

4.3%

1.2%

−3.7%

1.6%

3.1%

−0.3%

−1.5%

−0.8%

3.0%

−4.9%

−2.9%

−1.4%

5.9%

−0.6%

Greenwich US Market Neutral Group Index Greenwich US Equity Market Neutral Index Greenwich US Event-Driven Index Greenwich US Distressed Securities Index Greenwich US Merger Arbitrage Index Greenwich US Special Situations Index Greenwich US Arbitrage Index Greenwich US Convertible Arbitrage Index Greenwich US Fixed Income Arbitrage Index Greenwich US Statistical Arbitrage Index Greenwich US Long/Short Equity Group Index Greenwich US Growth Index Greenwich US Opportunistic Index Greenwich US Short Selling Index Greenwich US Value Index Greenwich US Directional Trading Group Index Greenwich US Futures Index Greenwich US Macro Index Greenwich US Market Timing Index Greenwich US Specialty Strategies Group Index Greenwich US Emerging Markets Index Greenwich US Fixed Income Index Greenwich US Multi-Strategy Index2

155

Appendix C: Historic Performance of Hedge Funds

Jun-00 May-00 Apr-00 Mar-00

Feb-00 Jan-00 Dec-99 Nov-99 Oct-99 Sep-99 Aug-99 Jul-99 Jun-99

4.7% −2.0%

−2.3%

1.4%

10.1%

1.0%

9.5%

5.8%

1.9%

0.8%

0.5%

0.8%

3.5%

3.9% −0.3%

−1.0% −0.4%

7.2%

1.3%

5.6%

3.4%

0.5%

0.5% −0.1%

1.1%

2.8%

2.1%

0.5%

−0.8% −2.5%

8.1%

1.5%

7.6%

2.3%

1.4%

1.9%

1.1%

1.8%

3.2%

6.6% −1.0%

−2.2% −0.3%

10.7%

0.8%

5.4%

4.6%

0.5% −0.8% −1.2%

1.2%

2.8%

2.1%

0.1%

−2.6% −0.9%

7.8%

2.3%

1.2%

1.0%

0.3% −1.0%

0.2% −0.3%

1.3%

8.3% −1.4% 1.7% −0.1%

−2.1% −0.1% 0.3% 1.1%

11.7% 2.5%

0.3% 1.7%

7.6% 4.1%

6.2% 0.7% −0.7% −1.8% 3.1% −0.2% 1.1% 0.5%

5.1% −3.1% 8.2% −6.0% 5.2% −4.1%

−2.6% 2.4% −6.9% −1.3% −5.5% 1.1%

13.2% 1.1% 20.1% −0.2% 21.2% 0.6%

11.9% 18.7% 15.7%

−11.2% 10.4% 5.4% −2.4% 2.2% −0.7% −1.6% 1.0% 8.4% −7.5% 4.9%

19.2% −2.2%

1.0% −21.3% 4.7% 9.9%

−2.7% −0.3% −0.7% −1.6% −9.9% 2.5%

7.3% 10.7% 8.5%

1.6% 0.5%

3.5% 2.5%

1.0% 0.6% 1.3%

3.4% 6.8% 2.6%

2.7% 4.2% 4.6%

1.1% 1.7% 1.6%

1.2% 1.4% 0.4%

2.9% −13.3% −10.6% −4.3% 1.9% 9.6% 7.6% 1.9%

5.3% 0.0%

3.5% −2.2% −4.9% 1.3% 1.4% 4.1%

4.5% 0.7% −0.3% 1.9% 1.7% −4.8%

6.8% 1.0% 15.0%

3.9% −1.5% 2.3% −6.5% 3.4% 0.6%

0.7% −0.4% −0.5% 4.8% 0.4% −0.7% −0.5% 2.1% 3.3% −2.7% −1.7% 10.1%

1.4%

−1.6%

0.1%

12.7%

1.8%

11.1%

6.6%

4.5% −0.8%

4.3% −2.3%

−4.4%

2.4%

3.2%

0.5%

7.9%

5.7%

1.8%

6.1% −7.2% −12.0%

4.2%

6.1%

0.0%

16.2%

10.9%

−0.4% −0.4%

1.0%

1.0%

1.8%

1.2%

0.2% −0.1% −0.3%

0.9% −0.1%

2.8%

4.5%

0.4%

8.8%

6.7%

3.3%

0.2%

2.8%

0.7%

3.9% −1.2%

−1.6%

0.9% −0.2%

0.2% −0.4%

5.8%

0.2%

3.0%

1.9% −2.2% −1.1% −0.5%

5.1%

2.4%

0.3%

2.8%

(continues)

156

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.1 (Continued) Primary Strategy1 Greenwich US Hedge Fund Index3 Greenwich US Market Neutral Group Index Greenwich US Equity Market Neutral Index Greenwich US Event-Driven Index Greenwich US Distressed Securities Index Greenwich US Merger Arbitrage Index Greenwich US Special Situations Index Greenwich US Arbitrage Index Greenwich US Convertible Arbitrage Index Greenwich US Fixed Income Arbitrage Index Greenwich US Statistical Arbitrage Index Greenwich US Long/Short Equity Group Index Greenwich US Growth Index Greenwich US Opportunistic Index Greenwich US Short Selling Index Greenwich US Value Index Greenwich US Directional Trading Group Index Greenwich US Futures Index Greenwich US Macro Index Greenwich US Market Timing Index Greenwich US Specialty Strategies Group Index Greenwich US Emerging Markets Index Greenwich US Fixed Income Index Greenwich US Multi-Strategy Index2

May-99

Apr-99

Mar-99

Feb-99

Jan-99

Dec-98

1.4%

4.8%

2.6%

−2.0%

3.2%

4.0%

1.3%

3.8%

1.7%

−0.5%

1.3%

2.5%

0.6%

1.4%

1.9%

−0.1%

0.9%

3.5%

2.1%

5.3%

1.3%

−1.0%

1.7%

1.6%

1.2%

6.1%

2.0%

−0.4%

1.4%

−0.5%

2.5% 0.8%

4.9% 3.8%

1.1% 1.8%

−1.3% 0.0%

1.9% 1.2%

2.7% 2.6%

1.8% 0.5% 4.6%

5.7% 5.2% 6.3%

2.9% 5.7% 3.2%

−3.4% −5.1% −3.1%

4.4% 6.4% 3.2%

5.3% 12.2% 4.3%

1.8% 1.2%

−2.1% 6.5%

0.7% 2.2%

5.0% −3.8%

−6.6% 5.4%

−12.9% 4.7%

−1.8% −2.7% 1.7%

4.8% 4.0% 12.0%

0.2% −3.1% 3.3%

−0.3% 3.7% −2.1%

1.0% −2.5% 5.1%

3.5% 2.4% 2.0%

−3.6%

1.7%

3.8%

−5.6%

4.2%

5.5%

0.9%

4.0%

3.5%

0.1%

2.8%

1.8%

1.5%

6.6%

5.2%

1.2%

1.4%

2.0%

−0.3%

1.8%

0.9%

−0.5%

1.4%

0.7%

2.1%

4.5%

3.6%

−1.9%

5.7%

3.2%

157

Appendix C: Historic Performance of Hedge Funds

Nov-98

Oct-98

Sep-98

Aug-98

Jul-98

Jun-98

May-98

Apr-98

Mar-98

Feb-98

Jan-98

4.0%

1.6%

1.3%

−6.1%

−0.9%

0.8%

−1.5%

1.1%

3.6%

3.4%

−0.3%

1.9%

0.7%

−1.2%

−3.5%

−0.2%

0.7%

0.2%

1.6%

2.8%

2.2%

0.5%

0.3%

1.4%

−1.3%

−1.4%

0.3%

0.1%

0.5%

1.5%

2.7%

1.2%

0.0%

2.2%

0.1%

−1.5%

−6.9%

−0.9%

1.2%

−0.4%

1.6%

2.9%

3.4%

−0.2%

1.5%

−0.7%

−3.0%

−3.5%

0.8%

2.3%

0.4%

2.6%

2.2%

1.6%

0.7%

2.6% 3.1%

0.6% 0.9%

−0.8% −0.7%

−8.0% −1.0%

−1.3% 0.2%

1.0% 0.7%

−0.7% 0.7%

1.3% 1.9%

3.1% 2.6%

4.0% 1.5%

−0.4% 2.0%

5.5% 9.2% 5.4%

2.4% 3.2% 2.7%

4.0% 7.2% 2.4%

−7.7% −11.4% −7.9%

−1.6% −2.2% −0.6%

1.3% 4.7% 2.0%

−1.8% −3.0% −1.2%

1.2% 1.1% 1.0%

4.1% 4.2% 4.2%

3.9% 5.8% 3.8%

−0.2% 1.7% −1.2%

−8.2% 5.2%

−18.7% 3.5%

−7.5% 5.1%

29.1% −9.1%

1.7% −2.2%

0.6% −0.8%

10.5% −2.3%

−4.2% 1.6%

−0.4% 4.5%

−7.3% 4.3%

−0.9% −0.6%

2.3% −0.2% −2.9%

−0.6% −1.4% −8.7%

1.6% 4.4% −3.2%

6.4% 11.9% 2.0%

−0.7% 0.1% −2.4%

0.7% 0.3% −0.4%

0.6% 2.8% −0.9%

−2.8% −3.8% −8.3%

2.2% 0.4% 4.7%

2.1% 0.5% 0.8%

0.3% 1.3% −0.2%

7.9%

5.8%

0.8%

0.3%

−0.9%

3.1%

−1.9%

1.0%

3.5%

5.2%

−1.0%

3.8%

2.0%

−1.7%

−12.5%

0.9%

−2.2%

−5.4%

0.4%

3.4%

4.1%

−3.2%

5.3%

3.4%

−10.0%

−18.9%

1.4%

−4.6%

−11.1%

−0.5%

2.5%

5.0%

−8.0%

2.6%

0.2%

0.3%

−7.0%

0.6%

−2.0%

0.1%

1.2%

2.5%

4.1%

0.6%

3.6%

2.1%

3.4%

−9.6%

0.2%

0.3%

−1.1%

0.5%

5.1%

3.1%

−2.5%

158

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.2 Greenwich Investable Hedge Fund Index (GI2 ) Primary Strategy1

Apr-08 Apr-08 Mar-08 Mar-08 Feb-08 Feb-08 Jan-08 Jan-08 (20th (7th (20th (7th (20th (7th (20th (7th Bus Day) Bus Day) Bus Day) Bus Day) Bus Day) Bus Day) Bus Day) Bus Day)

Greenwich Investable Hedge Fund Index (GI2 ) 98.67 Greenwich Market Neutral Group Investable Index 100.35 Greenwich Long/Short Equity Group Investable Index 97.70 Greenwich Directional Trading Group Investable Index 98.80 Greenwich Specialty Strategies Group Investable Index 98.82

97.48

97.26

98.47

97.88

97.48

97.37

99.98

99.18

98.94

99.88

98.92

98.19

98.17

99.98

95.18

94.56

97.03

96.83

96.65

95.45

99.98

99.58

99.44

99.68

98.16

97.55

96.92

99.98

98.53

98.83

98.94

99.04

98.78

100.27

99.98

TABLE C.2 (Continued) Primary Strategy1 Greenwich Investable Hedge Fund Index (GI2 ) Greenwich Market Neutral Group Investable Index Greenwich Long/Short Equity Group Investable Index Greenwich Directional Trading Group Investable Index Greenwich Specialty Strategies Group Investable Index

Dec-06 Nov-06 Oct-06 Sep-06 Aug-06

Jul-06 Jun-06 May-06 Apr-06

96.90

95.20

93.65

92.33

91.96

91.16

90.95

91.57

92.90

94.85

94.02

92.88

91.50

91.09

90.59

90.44

90.32

90.02

92.37

90.16

88.47

87.17

86.57

85.63

85.57

86.00

88.50

106.73

104.50

102.78 101.57 101.95

103.27

104.56

103.27

101.41

96.61

97.04

Jan-05 Dec-04 Nov-04 Oct-04 Sep-04 Aug-04

Jul-04

102.96 102.72 99.36

97.98

97.96

96.94

96.09

TABLE C.2 (Continued) Primary Strategy1 Greenwich Investable Hedge Fund Index (GI2 ) Greenwich Market Neutral Group Investable Index Greenwich Long/Short Equity Group Investable Index Greenwich Directional Trading Group Investable Index Greenwich Specialty Strategies Group Investable Index

Mar-05 Feb-05 83.13

84.07

82.98

83.37

82.19

80.35

79.64

78.98

79.34

82.62

83.01

82.41

82.33

81.58

80.60

80.28

80.26

80.19

75.48

76.85

75.62

76.59

74.61

72.05

71.35

69.93

70.59

100.53 100.89

100.84

102.60

100.48

99.46

87.11

85.98

84.06

82.90

100.47 87.70

88.89

86.92

103.14 109.90 81.47

80.63

© 2008 Greenwich Alternative Investments, LLC and/or its licensors. 1 Please see Explanatory Notes. As of Jan 2008, the Investable Index values are now calculated twice monthly, on the 7th and 20th business day, to provide investors more frequent performance data. The prior month’s returns of the Index constituents are the basis of the calculation on t.

159

Appendix C: Historic Performance of Hedge Funds

Dec-07

Nov-07

Oct-07

Sep-07

Aug-07

Jul-07

Jun-07

May-07

Apr-07

Mar-07

Feb-07

Jan-07

100.00

100.10

102.77

100.94

98.98

101.83

102.85

102.67

100.82

99.34

98.59

98.15

100.00

99.55

100.92

98.16

96.78

99.21

99.87

99.79

98.39

97.73

97.36

96.18

100.00

100.38

103.17

100.82

98.63

100.91

100.98

100.67

98.39

96.46

94.67

94.22

100.00

99.29

102.44

103.21

100.71

106.49

110.83

110.44

108.21

106.25

107.18

107.67

100.00

100.31

105.37

105.01

102.71

106.01

107.23

107.39

105.54

103.67

103.15

103.48

Mar-06

Feb-06

Jan-06

Dec-05

Nov-05

Oct-05

Sep-05

Aug-05

Jul-05

Jun-05

May-05

Apr-05

91.82

90.55

89.59

87.52

86.67

85.76

86.75

85.49

85.08

83.44

82.32

81.77

89.23

88.00

87.46

86.02

85.28

84.63

85.06

84.15

83.41

82.03

81.42

81.62

87.26

85.50

84.09

80.90

79.56

78.62

80.76

79.47

78.81

76.15

74.46

73.16

103.77

103.75

103.21

101.97

103.18

101.47

100.86

98.41

100.57

99.86

101.44

99.90

95.76

95.27

94.36

93.30

91.91

90.89

90.71

89.52

89.12

89.35

87.93

87.59

Jun-04

May-04

Apr-04

Mar-04

Feb-04

Jan-04

Dec-03

Nov-03

Oct-03

Sep-03

Aug-03

Jul-03

80.24

79.85

80.19

81.07

80.44

79.18

77.77

76.15

75.00

72.93

72.29

71.24

80.28

80.35

80.89

81.06

80.90

80.45

78.84

78.21

77.50

76.55

76.23

76.04

73.12

72.10

72.09

73.30

72.55

70.94

69.46

67.66

66.03

63.22

62.42

60.91

108.61

110.39

112.98

115.57

115.75

115.44

115.67

114.17

114.02

113.96

113.03

113.06

80.05

79.64

79.86

80.01

78.78

77.27

76.17

73.50

73.47

71.92

71.50

70.39 (continues)

160

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.2 (Continued) Primary Strategy1

Jun-03 May-03 Apr-03 Mar-03 Feb-03 Jan-03

Greenwich Investable Hedge Fund Index (GI2 ) 69.97 Greenwich Market Neutral Group Investable Index 76.02 Greenwich Long/Short Equity Group Investable Index 58.77 Greenwich Directional Trading Group Investable Index 112.58 Greenwich Specialty Strategies Group Investable Index 70.15

Dec-02

69.00

66.71

65.14

64.84

64.83 6458.1%

75.64

74.91

74.03

73.74

73.11

72.42

57.52

54.43

52.47

52.02

52.46

52.38

112.62

110.34

110.07 109.59 109.13

109.04

68.87

66.87

65.11

65.52

65.06

65.12

161

Appendix C: Historic Performance of Hedge Funds

TABLE C.3 Greenwich Investable Hedge Fund Index (GI2 ) Primary Strategy1

YTD-08

Mar-08

Feb-08

Jan-08

Dec-07

Greenwich Investable Hedge Fund Index (GI2 ) −2.52% −1.01% 1.01% −2.52% −0.10% Greenwich Market Neutral Group Investable Index −0.82% −0.71% 1.73% −1.81% 0.45% Greenwich Long/Short Equity Group Investable Index −4.82% −1.91% 0.39% −3.35% −0.38% Greenwich Directional Trading Group Investable Index −0.42% −0.09% 2.18% −2.45% 0.72% Greenwich Specialty Strategies Group Investable Index −1.47% −0.41% 0.16% −1.22% −0.31% Comparative Benchmarks Lehman Brothers Aggregate Bond 2.17% 0.34% 0.14% 1.68% 0.28% S&P 500 −9.45% −0.43% −3.25% −6.00% −0.69% MSCI EAFE −8.91% −1.05% 1.43% −9.24% −2.25% MSCI EMF −11.10% −5.40% 7.38% −12.48% 0.36% Nikkei 225 −18.18% −7.92% 0.08% −11.21% −2.38%

Nov-07

Oct-07

Sep-07

−2.60%

1.81%

1.98%

−1.36%

2.82%

1.42%

−2.70%

2.33%

2.22%

−3.08% −0.75%

2.49%

0.34%

2.24%

−4.80%

1.80% 0.90% 0.76% −4.18% 1.59% 3.74% −3.26% 3.94% 5.37% −7.08% 11.16% 11.05% −6.31% −0.29% 1.31%

TABLE C.3 (Continued) Primary Strategy1 Greenwich Investable Hedge Fund Index (GI2 ) Greenwich Market Neutral Group Investable Index Greenwich Long/Short Equity Group Investable Index Greenwich Directional Trading Group Investable Index Greenwich Specialty Strategies Group Investable Index Comparative Benchmarks Lehman Brothers Aggregate Bond S&P 500 MSCI EAFE MSCI EMF Nikkei 225

Aug-07

Jul-07

Jun-07

May-07

Apr-07

Mar-07

Feb-07

Jan-07

−2.80%

−0.99%

0.17%

1.84%

1.49%

0.76%

0.45%

1.29%

−2.45%

−0.66%

0.08%

1.42%

0.68%

0.38%

1.23%

1.40%

−2.26%

−0.07%

0.31%

2.31%

2.00%

1.90%

0.47%

2.00%

−5.43%

−3.91%

0.35%

2.06%

1.85%

−0.87%

−0.46%

0.88%

−3.11%

−1.14%

−0.15%

1.75%

1.81%

0.50%

−0.32%

0.21%

1.23% 1.50% −1.54% −2.09% −3.94%

0.83% −3.10% −1.46% 5.33% −4.90%

−0.30% −1.66% 0.15% 4.73% 1.47%

−0.76% 3.49% 1.89% 4.98% 2.73%

0.54% 4.43% 4.53% 4.64% 0.65%

0.00% 1.12% 2.60% 4.02% −1.80%

1.54% −1.96% 0.82% −0.58% 1.27%

−0.04% 1.51% 0.68% −1.04% 0.91%

© 2008 Greenwich Alternative Investments, LLC and/or its licensors. 1 Please see Explanatory Notes. As of Jan 2008, the Investable Index values are now calculated twice monthly, on the 7th and 20th business day, to provide investors more frequent performance data. The prior month’s returns of the Index constituents are the basis of the calculation on t.

162

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.3 (Continued) Primary Strategy1 Greenwich Investable Hedge Fund Index (GI2 ) Greenwich Market Neutral Group Investable Index Greenwich Market Neutral Group Investable Index Greenwich Long/Short Equity Group Investable Index Greenwich Directional Trading Group Investable Index Comparative Benchmarks Lehman Brothers Aggregate Bond S&P 500 MSCI EAFE MSCI EMF Nikkei 225

Dec-06

Nov-06

Oct-06

Sep-06

Aug-06

Jul-06

Jun-06

May-06

1.78%

1.66%

1.43%

0.40%

0.88%

0.23%

−0.68%

−1.43%

0.88%

1.23%

1.51%

0.45%

0.55%

0.16%

0.14%

0.33%

2.46%

1.91%

1.49%

0.69%

1.10%

0.07%

−0.50%

−2.83%

2.14%

1.49%

0.24%

−0.06%

1.19%

−0.37%

−1.28%

−1.23%

1.83%

2.06%

1.41%

0.02%

1.05%

0.89%

−0.54%

−0.44%

−0.58% 1.40% 3.15% 4.51% 5.85%

1.16% 1.90% 3.02% 7.45% −0.76%

0.66% 3.26% 3.90% 4.75% 1.69%

0.88% 2.58% 0.17% 0.84% −0.08%

1.53% 2.38% 2.78% 2.60% 4.42%

1.35% 0.62% 1.00% 1.50% −0.31%

0.21% 0.14% 0.04% −0.21% 0.24%

−0.11% −2.88% −3.76% −10.45% −8.51%

Apr-05

Mar-05

Feb-05

TABLE C.3 (Continued) Primary Strategy1 Greenwich Investable Hedge Fund Index (GI2 ) Greenwich Market Neutral Group Investable Index Greenwich Market Neutral Group Investable Index Greenwich Long/Short Equity Group Investable Index Greenwich Directional Trading Group Investable Index Comparative Benchmarks Lehman Brothers Aggregate Bond S&P 500 MSCI EAFE MSCI EMF Nikkei 225

Jan-05

Dec-04

Nov-04

Oct-04

Sep-04

−1.64% −1.11%

1.31% −0.47%

1.44%

2.29%

0.89%

0.84%

−1.21% −0.47%

0.73%

0.09%

0.92%

1.22%

0.40%

0.02%

−3.07% −1.78%

1.62% −1.26%

2.65%

3.55%

0.99%

2.03%

0.05% −1.72%

2.11%

1.03% −3.57%

2.29%

1.40%

−0.57% −0.06% −0.35% −0.13% −1.34%

1.35% −1.90% −2.24% −2.67% −5.66%

2.27% −0.22%

−0.51% −0.59% 0.63% −1.77% 2.10% −2.44% −2.47% 4.34% −1.83% −6.59% 8.78% 0.32% −0.61% 3.10% −0.88%

1.31%

1.75%

0.92% −0.80% 0.84% 0.27% 3.40% 4.05% 1.53% 1.08% 4.39% 6.86% 3.42% 2.63% 4.81% 9.26% 2.40% 5.78% 5.41% 1.19% −0.48% −2.33%

163

Appendix C: Historic Performance of Hedge Funds

Apr-06 Mar-06

Feb-06

Jan-06

Dec-05 Nov-05

1.18%

1.40%

1.07%

2.36%

0.99%

0.88%

1.40%

0.62%

1.68%

1.43%

2.06%

1.67%

3.94%

0.76%

0.02%

0.52%

1.33%

0.52%

0.96%

Sep-05 Aug-05

Jul-05

Jun-05 May-05

1.06% −1.14%

1.47%

0.48%

1.96%

1.37%

0.86%

0.77% −0.50%

1.08%

0.88%

1.68%

0.75% −0.24%

1.69%

1.19% −2.65%

1.63%

0.84%

3.49%

2.27%

1.77%

1.22% −1.18%

1.69%

0.60%

2.49% −2.14%

0.71% −1.56%

1.54%

1.14%

1.51%

1.12%

0.20%

1.33%

−0.18% −0.98% 0.33% 0.01% 1.34% 1.24% 0.27% 2.65% 4.85% 3.34% −0.20% 6.15% 7.14% 0.90% −0.10% 11.23% −0.90% 5.27% −2.67% 3.34%

0.95% 0.03% 4.66% 5.92% 8.33%

0.44% 3.78% 2.47% 8.28% 9.30%

Aug-04

Jul-04

Jun-04 May-04

Oct-05

0.67%

0.45% −0.26%

1.62%

0.39%

−0.79% −1.03% 1.28% −0.91% −1.67% 0.81% −0.91% 3.72% −2.91% 4.47% 2.56% 3.07% −6.53% 9.32% 0.90% 7.08% 0.24% 9.35% 4.32% 2.72%

0.55% 0.14% 1.37% 3.45% 2.73%

1.08% 3.18% 0.15% 3.52% 2.43%

Jan-04 Dec-03 Nov-03

Oct-03

Sep-03

Apr-04 Mar-04 Feb-04

0.49% −0.43% −1.08%

0.78% 1.59%

1.82% 2.12%

1.54%

2.83%

0.89%

0.09% −0.11% −0.09% −0.66% −0.21%

0.19% 0.56%

2.05% 0.80%

0.92%

1.23%

0.42%

1.41%

1.03% 2.27%

2.13% 2.67%

2.46%

4.44%

1.29%

1.18% −1.61% −2.29% −2.24% −0.16% 0.27% −0.20% 1.32%

0.13%

0.05%

0.82%

1.05%

0.72%

0.04%

2.15%

0.59%

1.91% 0.40% 0.46% 4.19% −2.15%

0.99% −3.31% −3.23% −1.77% −4.50%

−0.46% −1.12%

−0.94% −3.46% −6.15%

0.02% −1.65%

0.51% −0.27% −0.19%

1.56% 1.95%

0.57% −0.40% −2.60% 0.75% 1.08% 1.94% 1.37% −1.57% −1.51% 1.39% 2.23% 0.43% −2.18% 0.60% 2.33% 0.46% −1.97% −8.18% 1.28% 4.61% 5.54% −4.47% 0.40% 6.10% 2.40%

1.45% 3.64%

0.80% 1.84% 1.42% 3.55% 1.00%

1.02% 0.24% −0.93% 2.65% 5.24% 0.88% 5.66% −1.06% 7.82% 2.24% 6.24% 3.10% 7.25% 1.23% 8.51% 0.73% 5.70% −4.35% 3.33% −1.20% (continues)

164

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.3 (Continued) Primary Strategy1 Greenwich Investable Hedge Fund Index (GI2 ) Greenwich Market Neutral Group Investable Index Greenwich Long/Short Equity Group Investable Index Greenwich Directional Trading Group Investable Index Greenwich Specialty Strategies Group Investable Index Comparative Benchmarks Lehman Brothers Aggregate Bond S&P 500 MSCI EAFE MSCI EMF Nikkei 225

Aug-03

Jul-03

Jun-03 May-03

Apr-03

Mar-03

Feb-03

Jan-03

1.47%

1.82%

1.40%

3.43%

2.41%

0.47%

0.02%

0.38%

0.25%

0.03%

0.50%

0.98%

1.19%

0.39%

0.86%

0.96%

2.48%

3.63%

2.18%

5.67%

3.75%

0.86%

−0.84%

0.16%

−0.02%

0.42%

−0.03%

2.06%

0.25%

0.44%

0.42%

0.08%

1.57%

0.34%

1.87%

2.99%

2.70%

−0.62%

0.70%

−0.10%

0.66% 1.95% 2.43% 6.71% 8.16%

−3.36% 1.76% 2.44% 6.26% 5.29%

−0.20% 1.28% 2.47% 5.70% 7.82%

1.86% 5.27% 6.15% 7.18% 7.57%

0.83% 8.24% 9.92% 8.91% −1.77%

−0.08% 0.97% −1.89% −2.84% −4.67%

1.38% −1.50% −2.29% −2.70% 0.28%

0.09% −2.62% −4.17% −0.44% −2.79%

165

Appendix C: Historic Performance of Hedge Funds

TABLE C.4 Greenwich Monthly Global Hedge Fund Index3 Primary Strategy1

YTD-08 Feb-08

Greenwich Global Hedge Fund Index3

−1.00%

Jan-08 Dec-07 Nov-07 Oct-07 Sep-07 Aug-07

1.84% −2.79%

0.59% −1.66%

2.96%

2.60% −1.64%

Greenwich Global Market Neutral Group Index −0.62% 0.81% −1.42% 0.19% −1.13% 1.94% 1.39% −1.14% Greenwich Global Equity Market Neutral Index −1.04% 0.71% −1.74% 0.63% −0.51% 1.79% 1.67% −1.24% Greenwich Global Event-Driven Index −1.80% 0.76% −2.54% 0.18% −1.94% 2.37% 1.18% −1.11% Greenwich Global Distressed Securities Index −2.06% 0.19% −2.25% −0.09% −1.69% 1.72% 0.37% −1.32% Greenwich Global Merger Arbitrage Index −2.09% 0.12% −2.21% −0.41% −1.97% 1.76% 1.50% 0.17% Greenwich Global Special Situations Index −1.63% 1.16% −2.76% 0.43% −2.07% 2.87% 1.60% −1.35% Greenwich Global Arbitrage Index 0.41% 0.90% −0.49% 0.01% −0.76% 1.69% 1.43% −1.13% Greenwich Global Convertible Arbitrage Index −1.08% −0.92% −0.16% −1.24% −1.92% 1.84% 1.45% −1.89% Greenwich Global Fixed Income Arbitrage Index 0.17% 0.02% 0.15% 0.22% 0.17% 1.17% 0.99% −0.79% Greenwich Global Other Arbitrage Index 1.08% 1.83% −0.74% 0.36% −0.77% 1.93% 1.74% −0.68% Greenwich Global Statistical Arbitrage Index 0.56% 1.97% −1.38% 0.34% −0.87% 1.93% 1.51% −1.84% Greenwich Global Long/Short Equity Group Index −3.15% 1.37% −4.46% 0.67% −2.40% 3.10% 2.80% −1.42% Greenwich Global Growth Index −4.94% 1.58% −6.42% 0.37% −2.81% 3.80% 3.53% −0.98% Greenwich Global Opportunistic Index −2.95% 1.73% −4.60% 1.49% −2.03% 3.87% 3.71% −1.56% Greenwich Global Short Selling Index 5.42% 2.37% 2.98% 1.06% 5.41% 0.77% −0.90% 1.39% Greenwich Global Value Index −2.94% 1.13% −4.02% 0.50% −2.71% 2.71% 2.43% −1.64% Greenwich Global Directional Trading Group Index 5.28% 4.70% 0.55% 1.03% −0.12% 3.31% 3.90% −2.60% Greenwich Global Futures Index 8.84% 6.64% 2.06% 1.15% 0.12% 3.60% 4.19% −3.40% Greenwich Global Macro Index 1.56% 2.62% −1.03% 1.03% −0.42% 2.98% 3.59% −1.58% Greenwich Global Market Timing Index 0.16% 1.95% −1.76% 0.29% −0.47% 2.71% 3.02% −1.47% Greenwich Global Specialty Strategies Group Index −1.66% 2.34% −3.91% 0.72% −2.01% 3.98% 3.17% −2.05% Greenwich Global Emerging Markets Index −3.22% 3.15% −6.18% 1.29% −2.81% 5.13% 4.54% −2.47% Greenwich Global Fixed Income Index 0.21% 0.05% 0.16% −0.25% −0.80% 0.98% 1.01% −1.70% Greenwich Global Multi-Strategy Index2 0.03% 1.98% −1.91% 0.19% −1.14% 3.68% 2.09% −1.58% Comparative Benchmarks Lehman Brothers Aggregate Bond 1.82% 0.14% 1.68% 0.28% 1.80% 0.90% 0.76% 1.23% S&P 500 −9.06% −3.25% −6.00% −0.69% −4.18% 1.59% 3.74% 1.50% MSCI EAFE −7.94% 1.43% −9.24% −2.25% −3.26% 3.94% 5.37% −1.54% MSCI EMF −6.02% 7.38% −12.48% 0.36% −7.08% 11.16% 11.05% −2.09% Nikkei 225 −11.14% 0.08% −11.21% −2.38% −6.31% −0.29% 1.31% −3.94%

© 2008 Greenwich Alternative Investments, LLC and/or its licensors. 1 Please see Explanatory Notes. 2 Until Jan. 2004, the “Multi-Strategy” category was named “Several Strategies.” 3 Beginning with the final August 2004 Index, funds of funds are no longer included in the Greenwich Global Hedge Fund Index. Historical returns for the Index have been restated to exclude funds of funds. 4 Index returns from January 1988 to December 2002 are based on quarterly index results, while returns from January 2003 to present are based on monthly index results. (continues)

166

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.4 (Continued) Primary Strategy1

Jul-07

Jun-07 May-07 Apr-07 Mar-07

Feb-07

Jan-07 Dec-06

Greenwich Global Hedge Fund Index3

0.40%

0.93%

2.04%

1.80%

0.87%

0.63%

1.19%

1.54%

0.27%

0.40%

1.26%

1.09%

0.99%

1.10%

1.38%

1.27%

0.43% 0.32%

0.85% 0.20%

0.99% 1.81%

1.10% 1.52%

0.98% 1.18%

0.41% 1.53%

1.11% 1.85%

1.13% 1.57%

−0.40%

0.47%

1.67%

1.61%

1.08%

1.55%

1.63%

1.63%

−0.88% −0.71%

2.13%

1.68%

0.76%

0.61%

2.15%

1.34%

Greenwich Global Market Neutral Group Index Greenwich Global Equity Market Neutral Index Greenwich Global Event-Driven Index Greenwich Global Distressed Securities Index Greenwich Global Merger Arbitrage Index Greenwich Global Special Situations Index Greenwich Global Arbitrage Index Greenwich Global Convertible Arbitrage Index Greenwich Global Fixed Income Arbitrage Index Greenwich Global Other Arbitrage Index Greenwich Global Statistical Arbitrage Index Greenwich Global Long/Short Equity Group Index Greenwich Global Growth Index Greenwich Global Opportunistic Index Greenwich Global Short Selling Index Greenwich Global Value Index Greenwich Global Directional Trading Group Index Greenwich Global Futures Index Greenwich Global Macro Index Greenwich Global Market Timing Index Greenwich Global Specialty Strategies Group Index Greenwich Global Emerging Markets Index Greenwich Global Fixed Income Index Greenwich Global Multi-Strategy Index2 Comparative Benchmarks Lehman Brothers Aggregate Bond S&P 500 MSCI EAFE MSCI EMF Nikkei 225

1.37% 0.15%

0.21% 0.35%

1.82% 0.96%

1.44% 0.73%

1.40% 0.84%

1.80% 1.10%

1.95% 1.13%

1.52% 1.10%

−0.34%

0.05%

0.84%

0.18%

0.72%

1.33%

1.51%

1.39%

0.35%

0.33%

0.67%

0.55%

0.86%

1.33%

0.92%

0.86%

0.29%

0.67%

1.35%

1.02%

0.89%

0.99%

1.22%

1.29%

−0.16%

0.15%

1.04%

1.75%

0.87%

0.07%

0.86%

0.84%

0.16% 0.25% 1.32% 3.60% −0.37%

0.73% 2.33% 1.93% 1.26% 0.73% 3.11% 2.01% 1.37% 1.02% 2.09% 1.90% 1.27% 2.47% −2.48% −2.97% −0.15% 0.59% 2.32% 2.06% 1.27%

0.66% 1.22% 0.35% 1.28% 0.71% 1.36% 1.55% −1.50% 0.71% 1.23%

1.57% 1.54% 1.69% 0.56% 1.57%

−0.56% −2.09% 1.43%

1.50% 1.98% 0.94%

2.26% 2.62% 1.73%

2.45% −0.91% −0.86% 3.40% −1.91% −1.76% 1.08% 0.41% 0.36%

0.84% 1.09% 0.53%

1.01% 1.13% 0.95%

1.06% −0.01%

1.90%

1.80%

0.66%

0.46%

0.27%

0.35%

2.07%

1.79%

2.65%

2.25%

1.41%

1.11%

1.08%

2.41%

3.41% 2.40% −1.69% −0.56%

3.42% 0.91%

2.79% 1.04%

1.76% 0.34%

1.25% 0.94%

0.74% 1.00%

3.25% 0.94%

1.99%

1.96%

1.33%

0.97%

1.63%

1.65%

1.14%

1.64%

0.83% −0.30% −0.76% −3.10% −1.66% 3.49% −1.46% 0.15% 1.89% 5.33% 4.73% 4.98% −4.90% 1.47% 2.73%

0.54% 0.00% 1.54% −0.04% −0.58% 4.43% 1.12% −1.96% 1.51% 1.40% 4.53% 0.82% 0.82% 0.68% 3.15% 4.64% 4.02% −0.58% −1.04% 4.51% 0.65% −1.80% 1.27% 0.91% 5.85%

167

Appendix C: Historic Performance of Hedge Funds

Nov-06

Oct-06

Sep-06 Aug-06

Jun-06

May-06

Apr-06 Mar-06

Feb-06

Jan-06 Dec-05

1.93%

1.67%

0.01%

0.87% −0.21% −0.38%

−1.30%

1.92%

1.88%

0.29%

3.37%

1.7%

1.14%

1.30%

0.34%

0.69%

0.18%

0.22%

1.23%

1.49%

0.69%

2.19%

1.0%

0.87% 1.65%

1.23% 1.81%

0.19% 0.20%

0.12% 0.29% 0.10% 0.83% −0.08% −0.04%

−0.64% 0.19%

1.33% 1.53%

1.40% 1.94%

0.43% 0.51%

1.47% 2.78%

1.0% 1.2%

1.81%

1.90%

0.31%

0.97% −0.03% −0.18%

1.03%

2.04%

1.93%

0.37%

2.61%

1.1%

1.01%

1.70%

0.46%

0.51%

0.66%

0.16%

0.73%

1.54%

0.73%

2.76%

1.3%

1.61% 0.87%

1.78% −0.03% 0.94% 0.52%

0.75% −0.33% −0.17% 0.84% 0.73% 0.41%

−0.48% 0.63%

1.44% 0.91%

2.13% 1.11%

0.52% 0.96%

3.05% 1.90%

1.3% 0.9%

0.87%

0.48%

0.88%

1.05%

0.80%

0.21%

1.29%

0.49%

1.05%

1.29%

2.58%

0.8%

0.63%

0.86%

0.41%

0.75%

0.65%

0.27%

0.48%

1.16%

0.90%

0.58%

0.87%

0.6%

1.25%

1.34%

0.43%

0.90%

0.73%

0.35%

0.61%

1.11%

1.16%

0.89%

2.21%

1.4%

0.82%

1.21%

0.40%

0.27%

0.84%

1.96%

−0.96%

0.85%

1.76%

1.19%

0.83%

0.1%

−0.10% 1.29% −0.19% −0.35% 1.57% −0.38% −0.23% 0.79% −0.27% −2.20% −1.85% 4.32% 0.12% 1.50% −0.30%

−0.46% −0.31% −0.78% 1.38% −0.49%

2.11% 2.11% 2.22% 2.43% 2.53% 2.12% −3.34% −2.64% 2.12% 2.16%

Jul-06

0.33%

0.42%

−2.39% 1.53% 2.28% −3.58% 0.63% 2.52% −2.47% 1.95% 2.63% 4.26% −0.33% −2.54% −2.29% 1.78% 2.31%

0.22% 4.32% 2.2% 0.10% 5.17% 2.1% 0.16% 4.80% 2.6% 0.26% −3.14% −0.4% 0.27% 4.16% 2.3%

2.17% 2.68% 1.54%

0.96% −0.87% 0.20% −1.75% −1.24% 1.09% −0.96% 0.58% −2.72% −2.19% 0.71% −0.83% −0.42% −0.46% 0.13%

−1.10% −1.49% −0.41%

3.62% 4.69% 2.01%

1.97% −1.26% 3.04% −1.95% 0.39% −0.11%

2.44% 0.6% 2.29% −0.2% 2.60% 1.8%

1.46%

1.38% −0.32%

0.91%

0.08%

0.50%

−0.90%

2.11%

0.74% −0.79%

2.90%

0.6%

2.74%

2.04%

0.46%

0.89%

0.14% −0.50%

−2.16%

2.87%

1.61%

1.06%

4.37%

2.6%

3.92% 1.07%

2.58% 0.91%

0.37% 0.72%

1.11% 1.13%

0.27% −0.82% 0.99% 0.09%

−3.66% 0.66%

3.93% 0.47%

1.62% 0.83%

1.66% 0.64%

6.13% 0.90%

3.5% 1.0%

1.52%

1.60%

0.50%

0.50% −0.48% −0.28%

−0.78%

2.17%

1.95%

0.23%

3.09%

2.0%

1.53% 1.35% 0.21% −0.11% −0.18% −0.98% 0.33% 0.01% 2.38% 0.62% 0.14% −2.88% 1.34% 1.24% 0.27% 2.65% 2.78% 1.00% 0.04% −3.76% 4.85% 3.34% −0.20% 6.15% 2.60% 1.50% −0.21% −10.45% 7.14% 0.90% −0.10% 11.23% 4.42% −0.31% 0.24% −8.51% −0.90% 5.27% −2.67% 3.34%

1.0% 0.0% 4.7% 5.9% 8.3%

1.16% 1.90% 3.02% 7.45% −0.76%

0.66% 0.88% 3.26% 2.58% 3.90% 0.17% 4.75% 0.84% 1.69% −0.08%

(continues)

168

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.4 (Continued) Primary Strategy1 Greenwich Global Hedge Fund Index3 Greenwich Global Market Neutral Group Index Greenwich Global Equity Market Neutral Index Greenwich Global Event-Driven Index Greenwich Global Distressed Securities Index Greenwich Global Merger Arbitrage Index Greenwich Global Special Situations Index Greenwich Global Arbitrage Index Greenwich Global Convertible Arbitrage Index Greenwich Global Fixed Income Arbitrage Index Greenwich Global Other Arbitrage Index Greenwich Global Statistical Arbitrage Index Greenwich Global Long/Short Equity Group Index Greenwich Global Growth Index Greenwich Global Opportunistic Index Greenwich Global Short Selling Index Greenwich Global Value Index Greenwich Global Directional Trading Group Index Greenwich Global Futures Index Greenwich Global Macro Index Greenwich Global Market Timing Index Greenwich Global Specialty Strategies Group Index Greenwich Global Emerging Markets Index Greenwich Global Fixed Income Index Greenwich Global Multi-Strategy Index2 Comparative Benchmarks Lehman Brothers Aggregate Bond S&P 500 MSCI EAFE MSCI EMF Nikkei 225

Nov-05 Oct-05 Sep-05 Aug-05

Jul-05 Jun-05 May-05 Apr-05

1.8% −1.3%

1.8%

0.8%

2.0%

1.5%

0.8% −1.5%

0.6% −0.4%

1.0%

0.7%

1.5%

0.9%

0.1% −1.2%

0.8% −0.5% 1.0% −1.0%

0.8% 0.9%

0.6% 1.0%

1.2% 2.0%

1.1% 1.3%

0.3% −0.4% 0.5% −1.3%

1.1% −0.2%

1.3%

1.5%

1.8%

1.3%

−0.3% −0.7%

0.8% −0.8%

0.0%

0.4%

1.5%

0.8%

0.7% −0.5%

1.0% −1.5% 0.2% 0.0%

0.8% 1.1%

0.8% 0.5%

2.3% 1.3%

1.3% 0.6%

0.9% −1.7% −0.3% −1.4%

0.0% −0.1%

1.5%

0.6%

1.7%

1.3%

−1.3% −3.4%

0.4%

0.5%

1.0%

0.2%

1.0% −0.1%

0.2% −0.2%

1.2%

0.7%

1.3%

0.8%

−0.3% −1.1%

0.8% −0.1% −0.1%

0.8%

0.8% −0.2%

0.7% −0.1%

2.1% 2.6% 2.2% −4.3% 2.2%

0.2%

−1.9% −2.1% −2.2% 3.0% −1.9%

2.2% 2.1% 2.9% 1.7% 2.1%

0.9% 3.1% 2.1% 0.4% 4.1% 2.3% 1.0% 4.1% 2.6% 2.7% −2.4% −0.8% 0.9% 2.6% 2.1%

3.6% −1.1% 5.0% −1.4% 1.8% −0.5%

1.4% 0.8% 2.8%

0.6% 0.3% 0.7% −0.3% 0.4% 1.3%

1.9% 2.6% 0.7%

1.6% −2.1% 2.1% −3.2% 0.7% −0.4%

0.8% −1.7%

0.3%

0.0%

0.7%

1.0%

0.9% −1.0%

2.1% −1.8%

2.7%

1.0%

2.0%

1.3%

0.3% −0.8%

2.8% −2.8% 0.4% −0.1%

4.1% 0.8%

1.1% 0.6%

2.5% 1.1%

1.5% 0.7%

0.8% −0.7% 0.0% −0.2%

1.8% −1.0%

1.6%

1.0%

1.8%

1.2%

−0.2% −1.1%

1.3% −0.9% −0.9% 3.7% 2.6% 3.1% 0.9% 7.1% 4.3% 2.7%

0.6% 0.1% 1.4% 3.5% 2.7%

0.4% 3.8% 2.5% 8.3% 9.3%

−0.8% −1.0% −1.7% 0.8% −2.9% 4.5% −6.5% 9.3% 0.2% 9.4%

1.7% 2.4% 2.0% −4.0% 1.7%

0.1%

1.1% 3.2% 0.2% 3.5% 2.4%

−2.3% −3.0% −2.6% 4.3% −2.2%

1.4% −1.9% −2.2% −2.7% −5.7%

169

Appendix C: Historic Performance of Hedge Funds

Mar-05

Feb-05

−0.8%

1.7%

−0.1%

1.5%

2.7%

0.6%

1.5%

0.0%

−0.9%

0.6%

−0.5%

−1.2%

−0.2%

0.9%

0.1%

1.3%

1.8%

0.4%

0.6%

0.2% −0.1%

0.3%

−0.2%

−0.2%

0.1% −0.1%

1.0% 1.8%

0.8% −0.2%

1.2% 2.4%

1.8% −0.4% 3.3% 1.2%

1.2% 1.4%

0.0% 0.2%

0.0% −0.7%

0.7% 1.2%

0.1% −0.2%

−1.4% −0.2%

0.4%

1.4%

0.3%

2.8%

3.2%

1.4%

1.0%

0.5%

0.2%

2.0%

0.0%

1.3%

0.7%

0.6%

0.2%

1.1%

1.1%

0.4%

0.2%

0.0% −0.8%

0.0%

0.0%

−0.1%

2.1% −0.5% 0.3% 0.1%

2.2% 0.7%

3.3% 0.8%

1.1% 1.6% 0.1% −0.1%

−0.5% −0.3%

Jan-05 Dec-04 Nov-04 Oct-04

Sep-04 Aug-04

Jul-04

Jun-04 May-04 Apr-04

0.0% 0.3%

−1.2% 0.2%

0.8% −0.4%

−0.2% −0.4%

−0.8% 0.3%

−0.4%

0.4%

0.1%

−1.1%

−1.5%

0.3%

−1.5%

−0.5%

−0.8%

0.6%

0.9% −0.3%

0.4%

1.0%

0.5%

0.4%

0.2%

0.6%

0.2%

0.4%

0.4%

0.7%

0.4%

0.5%

−0.2%

0.6%

0.1%

0.9%

1.0%

0.1%

0.2%

0.1%

0.4% −0.3%

−0.1%

0.3%

0.6%

0.0%

1.4%

0.5%

1.0%

0.0% −0.6%

0.1%

0.5%

−0.7%

0.8%

0.3%

−1.1% −2.1% −1.4% 2.5% −0.8%

2.0% −0.5% 1.5% −2.2% 2.2% −0.4% −0.5% 2.3% 2.3% −0.1%

1.8% 2.0% 1.6% −5.2% 2.4%

−0.3% −2.0% 1.1% −1.1% −4.2% 1.0% 0.0% −2.0% 0.8% 1.3% 5.2% −1.3% −0.2% −1.6% 1.4%

−0.3% −0.6% −0.5% −0.4% −0.1%

−1.7% −3.0% −1.6% 3.2% −1.6%

−0.4% −0.3% −0.5%

1.0% −2.1% 0.9% −3.3% 1.2% −0.4%

0.1% −0.3% 0.6%

4.4% 6.1% 2.4%

2.7% 1.6% 4.0% 2.7% 0.8% −0.2%

−1.0% −0.7% −1.6% −1.4% −0.8% −2.9% −0.7% −0.5% −0.2%

−0.7% −0.6% −1.2%

−4.5% −7.1% −1.1%

−1.1%

0.9%

−0.6%

0.9%

1.5%

0.6%

0.9%

0.0%

−0.9%

0.3%

0.4%

−1.6%

−1.4%

2.8%

0.7%

1.7%

2.8%

1.4%

2.0%

0.8%

0.1%

0.1%

−1.3%

−2.4%

−2.2% −0.2%

3.9% 1.3%

1.5% 0.8%

2.2% 1.1%

3.8% 1.1%

1.8% 1.0%

3.4% 0.9%

1.3% −0.2% −0.1% 1.0% 0.9% 1.0%

−2.3% 0.0%

−3.7% −0.1%

−0.8%

1.9%

−0.4%

1.1%

2.1%

1.1%

0.5%

0.2%

0.1%

−0.5%

−1.2%

−0.5% −0.6% 0.6% −1.8% 2.1% −2.4% −2.5% 4.3% −1.8% −6.6% 8.8% 0.3% −0.6% 3.1% −0.9%

0.9% 3.4% 4.4% 4.8% 5.4%

1.9% 1.0% 0.4% −3.3% 0.5% −3.2% 4.2% −1.8% −2.2% −4.5%

0.6% 1.9% 2.2% 0.5% 5.5%

−0.4% 1.4% 0.4% −2.0% −4.5%

−2.6% −1.6% −2.2% −8.2% 0.4%

3.5% 0.6% 2.3% 5.0% 0.9% 3.3% 3.6% 0.0% 2.1% −6.4% −0.5% −2.4% 3.6% 0.7% 2.3%

−0.8% 0.8% 0.3% 4.1% 1.5% 1.1% 6.9% 3.4% 2.6% 9.3% 2.4% 5.8% 1.2% −0.5% −2.3%

−0.1%

(continues)

170

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.4 (Continued) Primary Strategy1 Greenwich Global Hedge Fund Index3 Greenwich Global Market Neutral Group Index Greenwich Global Equity Market Neutral Index Greenwich Global Event-Driven Index Greenwich Global Distressed Securities Index Greenwich Global Merger Arbitrage Index Greenwich Global Special Situations Index Greenwich Global Arbitrage Index Greenwich Global Convertible Arbitrage Index Greenwich Global Fixed Income Arbitrage Index Greenwich Global Other Arbitrage Index Greenwich Global Statistical Arbitrage Index Greenwich Global Long/Short Equity Group Index Greenwich Global Growth Index Greenwich Global Opportunistic Index Greenwich Global Short Selling Index Greenwich Global Value Index Greenwich Global Directional Trading Group Index Greenwich Global Futures Index Greenwich Global Macro Index Greenwich Global Market Timing Index Greenwich Global Specialty Strategies Group Index Greenwich Global Emerging Markets Index Greenwich Global Fixed Income Index Greenwich Global Multi-Strategy Index2 Comparative Benchmarks Lehman Brothers Aggregate Bond S&P 500 MSCI EAFE MSCI EMF Nikkei 225

Mar-04 Feb-04

Jan-04 Dec-03 Nov-03 Oct-03

Sep-03 Aug-03

0.2%

1.0%

2.0%

1.9%

1.0%

2.5%

0.8%

1.7%

0.3%

0.7%

1.7%

1.0%

0.9%

1.4%

1.0%

0.5%

0.3% −0.1%

0.8% 1.0%

1.6% 2.8%

0.3% 2.0%

0.6% 1.5%

1.4% 2.4%

0.4% 1.5%

1.0% 1.3%

0.3%

1.2%

3.2%

2.2%

1.8%

2.6%

2.3%

1.3%

0.0%

0.3%

0.9%

0.8%

0.3%

0.4%

0.3%

0.2%

−0.3% 0.5%

0.8% 0.5%

2.7% 1.1%

1.8% 0.7%

1.3% 0.7%

2.3% 0.9%

1.1% 1.0%

1.3% −0.1%

0.6%

0.2%

1.2%

0.4%

0.9%

1.6%

1.8%

−0.8%

0.1%

0.9%

1.0%

0.8%

0.6%

0.8%

0.4%

0.7%

0.8%

0.7%

1.4%

0.9%

0.6%

0.5%

0.9%

0.0%

0.5%

0.0%

0.8%

0.1%

0.5% −0.5%

1.2%

−0.2%

1.0% 2.4% 1.8% 0.1% 3.0% 0.9% 1.4% 2.1% 2.1% 0.0% −1.4% −2.0% 1.4% 2.5% 2.4%

1.3% 3.4% 0.2% 1.0% 4.7% −0.3% 1.1% 3.6% 0.5% −1.3% −6.0% 0.7% 1.7% 3.4% 0.3%

2.2% 2.9% 2.6% −3.3% 2.1%

0.2% 0.2% 0.6%

3.4% 6.4% 0.5%

1.2% 1.2% 1.1%

3.4% 4.1% 2.9%

0.1% −0.2% 0.5%

−0.7%

0.3%

1.4%

2.2%

0.8%

1.8%

2.2%

1.4% 0.4%

2.7% 0.4%

−0.2% 0.8% −1.5% 0.6% 1.3% 6.1%

0.0% −0.2% 0.1% −1.7% 0.3%

1.8% 0.9% 2.1% −0.3% 1.3% 2.9%

1.2% 0.7% 1.4%

0.2%

2.1%

0.7%

2.0%

3.8%

0.7%

3.1%

2.1%

3.1%

2.8% 0.8%

5.4% 1.6%

0.8% 0.8%

4.5% 1.0%

3.2% 1.4%

4.8% 0.2%

1.0%

1.7%

1.8%

0.6%

1.6%

0.5%

2.0%

1.1% 1.4% 2.3% 4.6% 2.4%

0.8% 1.8% 1.4% 3.6% 1.0%

1.0% 5.2% 7.8% 7.3% 5.7%

0.2% −0.9% 2.7% 0.9% 5.7% −1.1% 2.2% 6.2% 3.1% 1.2% 8.5% 0.7% −4.4% 3.3% −1.2%

0.7% 2.0% 2.4% 6.7% 8.2%

171

Appendix C: Historic Performance of Hedge Funds

Jul-03

Jun-03 May-03 Apr-03 Mar-03

Feb-03

Jan-03 Dec-02 Nov-02 Oct-02

Sep-02 Aug-02

1.0%

1.3%

3.6%

2.6%

0.3% −0.1%

0.6%

0.0%

2.2%

0.8% −1.4%

0.5%

0.3%

0.8%

1.6%

1.6%

0.4%

0.4%

1.3%

1.1%

1.5%

0.3%

0.0%

0.5%

0.2% 1.2%

0.7% 2.2%

1.2% 3.1%

0.9% 3.0%

−0.2% −0.1% 0.9% 0.2%

0.5% 1.2%

1.2% 0.6%

0.4% 0.4% 0.1% 2.8% −0.3% −1.3%

1.2% 0.0%

1.4%

2.5%

2.7%

3.0%

1.2%

1.2%

2.3%

1.5%

2.0% −0.1%

−1.3%

−0.3%

0.0%

0.1%

0.8%

0.5%

0.2%

0.4%

0.5%

0.5%

0.1%

0.1%

0.7%

1.0% −0.1%

2.0% 0.1%

3.4% 1.0%

3.0% 1.1%

0.7% −0.6% 0.4% 0.8%

0.5% 1.6%

−0.1% 1.3%

3.3% −0.4% −1.4% 1.2% 0.6% 0.7%

0.2% 0.5%

−0.5%

−0.5%

1.3%

1.6%

0.8%

1.4%

2.8%

1.6%

2.6%

1.2%

1.6%

0.6%

−0.3%

0.9%

1.5%

1.2%

0.0%

0.9%

1.2%

1.5%

1.3%

0.5% −1.7%

0.7%

0.1%

0.2%

0.8%

0.8%

0.2%

0.4%

1.3%

1.2%

0.7%

0.0%

0.3%

0.2% −0.6%

0.5%

0.8%

2.0% −0.1%

0.6%

3.1%

1.9% 1.7% 2.3% 2.5% 2.5% 1.5% −3.3% −1.7% 1.9% 1.6%

5.1% 7.7% 4.5% −5.7% 4.9%

3.3% 4.2% 3.5% −6.2% 3.7%

0.3% 0.3% 0.5% −0.8% 0.2%

−0.7% 0.0% −1.4% −0.2% −0.4% 0.2% 1.5% 0.8% −0.6% −0.2%

−1.2% −4.2% 0.3% 4.9% −1.3%

2.9% 1.2% 5.3% 1.8% 2.0% 0.0% −5.9% −3.9% 3.1% 1.9%

−2.0% −2.0% −1.5% 5.9% −3.4%

0.2% 0.2% 0.1% −0.5% 0.4%

−0.8% −1.2% −1.6% −2.8% −0.1% 0.2%

4.5% 6.0% 4.0%

0.8% 0.5% 1.0%

−3.2% −6.4% −0.1%

3.4% 6.4% 0.9%

2.8% 5.7% 0.6%

3.3% 6.7% 1.4%

−0.5% −2.6% −2.6% −4.9% 1.5% −1.0%

2.5% 4.8% −0.4%

1.9% 3.4% 0.3%

−0.1%

0.1%

0.6%

2.2%

1.3%

−0.1%

−0.2%

−0.6%

−1.6%

1.7%

0.2%

0.8%

0.7%

0.8%

2.2%

4.3%

3.8%

0.3%

0.2%

0.7%

0.8%

2.5%

1.7% −4.4%

1.0%

1.9% −1.2%

3.6% 0.3%

5.5% 2.1%

5.1% 1.8%

0.5% 0.2%

0.0% 0.9%

0.0% 0.8%

0.7% 1.8%

2.3% 1.6% −6.0% 1.5% −0.8% 0.1%

1.5% 1.2%

0.5%

0.8%

4.2%

2.8%

−0.2%

−0.1%

2.0%

0.2%

4.2%

−3.4% −0.2% 1.8% 1.3% 2.4% 2.5% 6.3% 5.7% 5.3% 7.8%

1.9% 5.3% 6.2% 7.2% 7.6%

0.8% 8.2% 9.9% 8.9% −1.8%

4.9% −4.4%

−0.3%

−0.1% 1.4% 0.1% 1.0% −1.5% −2.6% −1.9% −2.3% −4.2% −2.8% −2.7% −0.4% −4.7% 0.3% −2.8% (continues)

172

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.4 (Continued) Primary Strategy1 Greenwich Global Hedge Fund Index3 Greenwich Global Market Neutral Group Index Greenwich Global Equity Market Neutral Index Greenwich Global Event-Driven Index Greenwich Global Distressed Securities Index Greenwich Global Merger Arbitrage Index Greenwich Global Special Situations Index Greenwich Global Arbitrage Index Greenwich Global Convertible Arbitrage Index Greenwich Global Fixed Income Arbitrage Index Greenwich Global Other Arbitrage Index Greenwich Global Statistical Arbitrage Index Greenwich Global Long/Short Equity Group Index Greenwich Global Growth Index Greenwich Global Opportunistic Index Greenwich Global Short Selling Index Greenwich Global Value Index Greenwich Global Directional Trading Group Index Greenwich Global Futures Index Greenwich Global Macro Index Greenwich Global Market Timing Index Greenwich Global Specialty Strategies Group Index Greenwich Global Emerging Markets Index Greenwich Global Fixed Income Index Greenwich Global Multi-Strategy Index2 Comparative Benchmarks Lehman Brothers Aggregate Bond S&P 500 MSCI EAFE MSCI EMF Nikkei 225

Jul-02

Jun-02 May-02 Apr-02 Mar-02 Feb-02

Jan-02 Dec-01

−2.7% −1.9%

0.0%

0.2%

1.9% −0.6%

0.8%

1.5%

−1.3% −0.8%

0.3%

0.7%

0.9% −0.3%

1.0%

0.6%

−0.7% 0.1% −3.2% −2.8%

1.0% 0.0%

1.6% 0.4%

0.1% −0.3% 1.6% −0.6%

0.9% 0.6%

0.7% 1.3%

−1.6% −1.6%

0.8%

1.1%

0.5% −0.1%

1.0%

0.3%

−1.2% −0.8%

0.0%

0.1%

0.5% −0.3%

1.0%

0.6%

−4.1% −3.6% −0.7% −0.1%

−0.8% 0.2%

0.0% 0.5%

2.1% −0.9% 0.8% −0.2%

0.4% 1.2%

1.9% 0.3%

−1.3%

0.0%

0.4%

0.8%

0.5%

0.1%

1.4%

0.2%

0.5%

0.7%

1.1%

1.6%

0.5%

1.0%

1.6%

0.8%

3.1%

0.0%

0.3%

0.2%

0.3% −1.1%

0.5%

1.1%

−3.5% −4.0% −2.0% 7.1% −5.5%

−2.6% −4.8% −1.6% 4.6% −3.2%

−0.3% −0.2% −1.9% −2.8% 0.0% 0.3% 3.3% 5.2% 0.2% 0.5%

1.2% 3.4% 4.1% 7.9% −3.0% −1.1%

1.7% −0.3% 2.8% −0.9% 1.9% 2.1%

−0.9% −0.8% −4.9% −2.7%

−0.4%

2.8% 3.8% 2.5% −3.2% 3.2%

−1.3% 0.5% 1.8% −2.8% −0.8% 2.2% −0.7% 0.2% 1.6% 2.9% 4.4% −1.8% −1.1% 0.8% 2.3%

0.8% −1.1% −0.7% 0.1% −2.3% −1.4% 0.9% −0.5% 1.1%

1.0% 1.1% 0.6%

−0.1% −0.6%

2.0%

0.3% −0.7%

1.3%

0.2%

2.0%

1.1%

1.7%

3.4%

−7.2% −4.0% 0.4% 1.0%

−0.9% −0.1% 0.9% 1.0%

2.6% 0.1%

2.2% 0.2%

3.2% 0.6%

5.0% 0.4%

−4.4% −3.2%

−0.4% −0.5%

2.4% −0.7% −0.7%

2.2%

173

Appendix C: Historic Performance of Hedge Funds

Nov-01 Oct-01

Sep-01 Aug-01

Jul-01

Jun-01 May-01 Apr-01 Mar-01

Feb-01

Jan-01 Dec-00

2.3%

2.1%

−2.3%

−0.4%

−0.9%

0.3%

1.4%

2.3%

−1.2%

−2.0%

3.1%

1.8%

1.0%

1.0%

−0.3%

0.9%

0.1%

0.0%

1.3%

1.1%

0.6%

0.9%

1.7%

1.3%

1.2% 1.2%

−0.1% 1.0%

0.4% −0.9%

0.9% 0.2% −0.1% 0.9% −0.3% −0.5%

1.3% 1.8%

0.9% 1.3%

1.6% −0.3%

1.8% 0.0%

1.4% 2.2%

3.4% 1.0%

0.9%

0.7%

−0.7%

1.2%

1.5%

2.3%

4.1%

1.0%

0.7%

0.1%

5.7%

−0.7%

0.2%

0.6%

−1.7%

0.6%

0.6% −0.3%

1.2%

0.6%

−0.4%

0.3%

1.5%

1.2%

1.4% 0.8%

1.2% −1.0% 1.4% −0.2%

0.8% −0.8% −1.5% 1.0% 0.3% 0.3%

1.3% 0.9%

1.4% 1.1%

−0.8% −0.1% 0.8% 1.0%

1.2% 1.5%

1.8% 0.6%

0.8%

1.2%

0.9%

1.5%

0.9%

0.2%

0.5%

1.7%

2.0%

1.8%

3.8%

−0.1%

0.9%

1.5%

0.3%

1.0%

0.6%

0.1%

1.1%

0.9%

0.7%

0.8%

1.4%

0.6%

−0.1%

0.8%

−2.2%

0.1% −0.4%

−1.7%

0.7%

2.1%

1.2%

1.0%

3.9%

3.1%

−1.2% 0.4% −2.5% −0.1% −0.5% 0.3% 4.2% 1.3% −1.8% 0.7%

1.4% 0.8% 0.8% 0.7% 2.2%

3.2% 4.3% 2.4% −9.5% 4.2%

−2.4% −3.9% 3.4% −5.0% −8.1% −0.6% −2.1% −3.6% 3.7% 6.7% 10.3% 0.1% −2.0% −3.0% 6.3%

1.9% 0.7% 2.6% 1.5% 2.6%

0.1% −1.3% −0.3% 1.9% −1.5% −0.7% −1.5% −1.6% −1.1%

1.0% 0.8% 0.8%

−1.0% −4.7% 1.1%

2.5% −1.5% 0.4% 6.8% 0.6% −0.2% −0.5% −0.5% 1.9%

5.3% 8.7% 0.0%

−0.9%

1.2%

1.5%

3.8%

−2.7%

−6.0%

0.6%

3.9%

2.7% 4.1% 1.5% −4.9% 3.6%

2.6% −3.4% 2.5% −4.6% 0.9% −0.8% −3.2% 6.5% 4.6% −5.6%

−1.4% −3.7% −0.2% 7.3% −1.7%

−2.3% −6.5% 1.2%

3.6% 4.1% 2.7%

2.0% 5.2% −2.5%

2.0%

3.4%

0.2%

5.3%

3.1%

−3.9%

0.1% −2.4%

0.9%

2.3%

1.5%

−1.4%

−1.6%

6.4%

2.1%

7.7% 0.1%

4.5% −6.6% 1.2% −0.3%

0.0% −5.0% 1.5% 0.4%

1.1% 0.4%

3.2% 1.0%

1.4% 0.4%

−2.5% −2.3% 0.5% 0.9%

9.6% 2.2%

1.4% 3.3%

3.9%

1.9%

1.4%

0.9%

1.3%

2.7%

−1.4%

2.1%

1.8%

−2.3%

−1.7%

−1.8%

−2.8%

(continues)

174

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.4 (Continued) Primary Strategy1

Nov-00 Oct-00 Sep-00

Greenwich Global Hedge Fund Index3

−2.6% −1.3% −1.5%

Greenwich Global Market Neutral Group Index Greenwich Global Equity Market Neutral Index Greenwich Global Event-Driven Index Greenwich Global Distressed Securities Index Greenwich Global Merger Arbitrage Index Greenwich Global Special Situations Index Greenwich Global Arbitrage Index Greenwich Global Convertible Arbitrage Index Greenwich Global Fixed Income Arbitrage Index Greenwich Global Other Arbitrage Index Greenwich Global Statistical Arbitrage Index Greenwich Global Long/Short Equity Group Index Greenwich Global Growth Index Greenwich Global Opportunistic Index Greenwich Global Short Selling Index Greenwich Global Value Index Greenwich Global Directional Trading Group Index Greenwich Global Futures Index Greenwich Global Macro Index Greenwich Global Market Timing Index Greenwich Global Specialty Strategies Group Index Greenwich Global Emerging Markets Index Greenwich Global Fixed Income Index Greenwich Global Multi-Strategy Index2 Comparative Benchmarks Lehman Brothers Aggregate Bond S&P 500 MSCI EAFE MSCI EMF Nikkei 225

Aug-00

Jul-00 Jun-00 May-00 Apr-00

4.4% −0.5%

4.2%

−2.1% −2.5%

0.0% −0.1%

0.5%

2.3%

0.5%

2.9%

0.0% −0.4%

1.9% 0.9% −1.7% −0.9%

1.3% 0.3%

3.3% 2.8%

0.0% 0.8%

1.8% 5.0%

0.7% −1.6% −0.6% −1.3%

−1.3% −0.5% −0.3%

1.0%

0.3%

1.6%

0.1% −1.5% 1.2%

0.9%

0.6%

1.8%

1.2%

1.4%

1.7%

−1.9% −1.0% 0.2% −0.2%

0.5% 0.3%

3.6% 1.5%

1.1% 0.6%

6.4% 1.6%

−1.3%

0.5%

1.1%

1.8%

0.8%

2.1%

1.2%

1.6%

0.5%

0.5%

0.7%

0.9%

0.7%

0.8%

0.3%

0.9%

1.9%

2.8% −0.5%

1.3%

1.9%

1.4%

2.5%

5.0%

−1.3% 5.5% −0.8% 4.9% −2.8% 9.3% −4.4% 8.4% −1.3% 4.9% −0.8% 4.9% 10.5% −12.4% 6.5% −9.7% −1.8% 5.4% 0.1% 4.9%

−3.0% −6.2% −4.4% 9.4% −2.4%

−2.6% −6.2% −5.3% 18.1% −2.6%

−4.3% −7.5% −2.7% 14.7% −5.7%

−1.8% −4.7% −1.9% 9.6% −1.2%

2.6%

−0.9% −1.3% 0.0% 1.0%

1.4% −0.8% −3.3% 5.4% 1.1% −2.7% −0.7% −4.8% −4.0%

4.5% −1.9% 1.5% 3.4% −1.4% −1.9% 4.9% −2.1% 4.8%

−3.3% −1.4% −3.8%

5.6% −2.4%

4.6%

0.8% −1.2%

−2.9% −2.3% −4.3%

4.0% −0.9%

4.7%

−3.9% −6.7%

−3.9% −2.8% −7.1% 1.8% −1.1% 1.0%

3.6% −1.2% 2.6% −0.3%

5.3% 2.7%

−5.4% −9.1% −0.2% −0.7%

−3.8% −2.1% −1.7%

5.9% −0.4%

4.3%

−1.4% −2.5%

−0.5% −2.8% 1.1% −1.0% −5.8% −9.6%

175

Appendix C: Historic Performance of Hedge Funds

Mar-00

Feb-00

Jan-00

Dec-99

1.9%

8.6%

1.0%

9.0%

5.5%

1.8%

0.7%

0.3%

0.5%

4.3%

1.3%

5.8%

0.1%

5.1%

1.3%

4.5%

3.2%

0.7%

0.6%

−0.1%

1.1%

2.5%

1.5%

3.5%

−1.7% 0.0%

6.2% 7.9%

1.4% 0.7%

6.7% 4.1%

2.9% 4.1%

1.2% 1.6% 0.6% −0.3%

1.0% −0.9%

1.7% 1.0%

2.7% 2.6%

0.8% 2.1%

1.6% 4.9%

−0.5%

5.4%

1.5%

1.1%

1.6%

0.2% −0.8%

0.0%

0.2%

1.4%

1.1%

4.8%

1.4%

1.9%

1.6%

0.9%

1.9%

0.9%

1.6%

0.8%

1.7%

1.8%

1.9%

1.9%

0.2% 1.1%

8.9% 2.2%

0.3% 1.5%

5.6% 3.7%

5.2% 2.7%

0.7% −0.1% 0.4% 0.9%

−1.3% 0.1%

1.3% 0.7%

3.3% 1.9%

2.5% 1.2%

5.0% 2.7%

2.5%

2.7%

2.5%

2.7%

1.6%

0.5%

0.8%

0.6%

0.9%

1.0%

1.6%

3.1%

0.8%

1.2%

0.9%

1.5%

1.1%

1.5%

1.4%

0.2%

0.5%

0.8%

1.0%

1.8%

6.4%

0.6%

6.7%

−1.0%

1.2%

1.0% −0.9%

0.7%

2.7% 11.8% −0.5% 18.4% 1.9% 18.2% −0.1% −24.3% 4.7% 9.7%

Nov-99 Oct-99 Sep-99 Aug-99

1.1% 11.0% 6.9% 2.6% 0.7% 18.3% 10.7% 4.6% 0.3% 14.0% 8.2% 3.7% 2.6% −12.0% −10.1% −3.2% 1.6% 9.2% 7.0% 2.0%

Jul-99 Jun-99 May-99 Apr-99

1.1% 1.4% 1.3% 5.3% 0.0%

1.0% 1.0% 3.8% 1.6% 0.8% 7.2% −0.2% 1.3% 2.7% 3.7% −1.7% −4.4% 1.0% 1.3% 4.5%

1.7% 5.8% 0.6% 6.5% 3.5% 5.1% 2.0% −2.3% 1.3% 6.8%

0.1% 0.0% 1.2%

−0.2% −0.5% −0.6% −0.6% −1.8% −0.6%

5.0% 2.5% 9.1%

−1.6% −2.2% −0.3%

4.8% 3.9% 9.6%

4.9% 1.6% −0.3% 2.3% 6.3% −2.0%

6.2% 1.4% 10.5%

3.8% −1.3% 2.3% −5.1% 2.3% 0.4%

0.3%

11.7%

2.7%

10.8%

6.8%

3.4% −0.9%

1.1% −0.3%

6.1%

−2.1%

2.7%

3.6%

5.4%

0.3%

12.5%

6.2%

1.6% −0.1%

−0.8% −1.8%

7.2%

0.5%

9.4%

4.7% −0.5%

7.2% 1.3%

0.1% 0.1%

20.0% 1.5%

9.8% 1.1%

1.9% −0.8% 0.3% −0.1%

−1.4% −2.8% 0.0% −0.1%

10.5% 0.2%

0.9% −1.2%

12.8% 2.3%

3.4%

5.2%

1.0%

7.7%

5.8%

2.3%

−0.1%

0.4%

2.8%

1.8%

4.3%

−0.7% −1.5% −0.3%

1.7%

(continues)

176

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.4 (Continued) Primary Strategy1 Greenwich Global Hedge Fund Index3 Greenwich Global Market Neutral Group Index Greenwich Global Equity Market Neutral Index Greenwich Global Event-Driven Index Greenwich Global Distressed Securities Index Greenwich Global Merger Arbitrage Index Greenwich Global Special Situations Index Greenwich Global Arbitrage Index Greenwich Global Convertible Arbitrage Index Greenwich Global Fixed Income Arbitrage Index Greenwich Global Other Arbitrage Index Greenwich Global Statistical Arbitrage Index Greenwich Global Long/Short Equity Group Index Greenwich Global Growth Index Greenwich Global Opportunistic Index Greenwich Global Short Selling Index Greenwich Global Value Index Greenwich Global Directional Trading Group Index Greenwich Global Futures Index Greenwich Global Macro Index Greenwich Global Market Timing Index Greenwich Global Specialty Strategies Group Index Greenwich Global Emerging Markets Index Greenwich Global Fixed Income Index Greenwich Global Multi-Strategy Index2 Comparative Benchmarks Lehman Brothers Aggregate Bond S&P 500 MSCI EAFE MSCI EMF Nikkei 225

Mar-99

Feb-99

Jan-99

Dec-98

Nov-98

Oct-98

3.2%

−1.4%

1.9%

2.6%

4.0%

1.2%

1.8%

−0.4%

1.4%

2.0%

2.3%

0.1%

2.3% 1.7%

−0.2% −0.9%

0.6% 1.6%

2.6% 1.6%

1.3% 2.5%

0.7% 0.5%

2.0%

−0.6%

1.6%

0.3%

1.7%

−0.6%

1.5%

1.2%

1.6%

1.6%

2.3%

1.3%

1.5% 1.5%

−1.0% 0.2%

1.7% 1.8%

2.3% 2.1%

2.9% 3.1%

1.0% −1.1%

1.3%

0.8%

2.3%

1.6%

2.4%

−1.0%

1.6%

2.6%

2.8%

2.1%

0.9%

−7.2%

2.5% 4.1% 2.7% 0.5% 2.2%

−2.8% −4.1% −2.2% 5.2% −3.7%

3.7% 6.0% 2.4% −4.6% 4.4%

4.0% 10.1% 2.6% −9.7% 3.8%

4.8% 9.0% 4.2% −7.4% 4.9%

1.7% 3.7% 0.3% −16.1% 3.6%

0.4% −2.2% 2.5%

−0.4% 2.8% −2.8%

0.4% −2.0% 2.5%

3.4% 2.4% 3.8%

2.0% −0.4% 0.6%

−0.4% −1.4% −5.1%

3.1%

−4.0%

2.8%

4.8%

6.8%

4.8%

7.2%

0.4%

−1.9%

−1.5%

5.4%

2.0%

10.0% 1.3%

0.7% 0.1%

−4.6% 1.1%

−2.9% 0.9%

7.3% 2.8%

2.4% 0.2%

3.6%

−0.8%

4.6%

2.4%

3.5%

2.2%

177

Appendix C: Historic Performance of Hedge Funds

Sep-98

Aug-98

Jun-98

May-98

Apr-98

Mar-98

Feb-98

Jan-98

0.8%

−7.9%

−0.5%

−1.6%

0.4%

3.5%

4.7%

−0.9%

−1.5%

−3.7%

0.7%

0.0%

1.5%

2.7%

2.0%

0.6%

−1.1% −1.7%

−1.2% −7.2%

0.7% 0.7%

0.3% −0.3%

1.2% 1.6%

2.6% 2.9%

1.5% 2.7%

−0.2% 0.5%

−2.4%

−4.7%

1.1%

0.3%

2.1%

1.8%

1.7%

0.8%

1.7%

−4.9%

0.9%

0.6%

1.7%

0.7%

1.6%

0.6%

−1.3% −1.6%

−8.2% −1.3%

0.5% 0.7%

−0.6% 0.4%

1.3% 1.7%

3.3% 2.6%

3.1% 1.4%

0.4% 1.2%

−1.3%

−1.5%

0.0%

0.6%

1.4%

1.7%

1.5%

1.5%

−1.0%

−0.6%

0.4%

0.6%

0.8%

1.3%

0.7%

0.4%

3.4% 7.6% 1.6% −6.1% 4.4%

−7.9% −12.2% −7.4% 24.9% −10.1%

1.1% 4.3% 1.2% 0.4% −0.6%

−1.5% −2.9% −1.2% 9.2% −1.9%

1.0% 1.0% 0.5% −2.7% 1.5%

4.1% 4.5% 3.7% −0.2% 4.6%

4.4% 7.3% 4.2% −7.1% 4.7%

−0.3% 1.2% −0.9% −1.8% −0.7%

2.2% 4.7% −1.0%

3.8% 10.8% −1.7%

0.6% 0.3% −0.4%

0.5% 2.7% −1.5%

−2.4% −3.4% −4.0%

3.0% 1.5% 5.3%

2.2% 0.9% 2.7%

0.6% 1.7% −0.8%

0.8%

−4.1%

2.4%

−1.5%

0.4%

3.7%

4.5%

0.2%

−1.6%

−16.2%

−6.3%

−5.4%

−2.2%

2.7%

9.4%

−5.1%

−3.3% −1.3%

−19.9% −7.2%

−8.6% −2.2%

−8.9% −0.3%

−3.2% 0.5%

2.3% 1.9%

12.1% 2.8%

−7.9% 0.8%

2.4%

−8.4%

0.5%

−0.8%

0.6%

4.6%

2.8%

−1.9%

178

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.5 Greenwich Investable US Hedge Fund Index (GI2 ) Primary Strategy1 Greenwich Investable Hedge Fund Index (GI2 ) Greenwich Market Neutral Group Investable Index Greenwich Long/Short Equity Group Investable Index Greenwich Directional Trading Group Investable Index Greenwich Specialty Strategies Group Investable Index

2008

2007

2006

2005

2004

2003

−2.52%

3.20%

10.7%

5.0%

7.2%

20.4%

−0.82%

5.43%

10.3%

4.5%

4.4%

8.9%

−4.82%

8.25%

14.2%

5.6%

10.3%

32.6%

−0.42%

−6.31%

4.7%

1.1%

−12.8%

6.1%

−1.47%

−3.16%

10.7%

7.1%

14.4%

17.0%

© 2008 Greenwich Alternative Investments, LLC and/or its licensors. 1 Please see Explanatory Notes.

TABLE C.6 Greenwich Ytd International Hedge Fund Index3 Primary Strategy1 Greenwich International Hedge Fund Index3

2007 2006 2005 11.3% 12.3% 9.7%

2004

2003

2002 2001

2000

1999

1998

7.2% 17.3%

0.5% 7.2%

4.8% 36.4% −2.0%

Greenwich International Market Neutral Group Index 7.7% 11.4% 5.6% 5.7% 10.8% 4.5% 8.8% 11.1% 19.4% 4.9% Greenwich International Equity Market Neutral Index 8.1% 7.7% 8.2% 5.5% 7.4% 2.5% 4.4% 23.7% 20.7% 8.3% Greenwich International Event-Driven Index 8.5% 14.1% 7.3% 10.8% 21.4% −0.6% 10.6% 4.5% 18.4% 6.0% Greenwich International Distressed Securities Index 6.2% 15.4% 9.5% 17.3% 28.2% 3.2% 14.1% 2.6% 13.7% 0.9% Greenwich International Merger Arbitrage Index 6.5% 11.8% 5.9% 3.4% Greenwich International Special Situations Index 11.1% 13.3% 6.8% 7.7% 17.7% −3.6% 9.0% 5.4% 21.3% 9.4% Greenwich International Arbitrage Index 6.9% 10.8% 3.6% 3.1% 7.9% 7.5% 10.0% 10.8% 18.8% 0.6% Greenwich International Convertible Arbitrage Index 5.0% 12.7%−0.8% 0.3% Greenwich International Fixed Income Arbitrage Index 6.5% 8.3% 5.9% 6.2% Greenwich International Statistical Arbitrage Index 4.5% 8.9% 6.0% 3.5% Greenwich International Long/Short Equity Group Index 11.0% 12.3% 13.4% 8.1% 19.2% −3.1% 4.5% 6.1% 41.0% 9.4% Greenwich International Growth Index 13.1% 9.8% 11.5% 3.7% 26.2%−11.4%−8.7% −4.7% 85.2% 25.7% Greenwich International Opportunistic Index 15.0% 15.0% 15.4% 7.8% 20.4% −2.3% 9.4% 10.7% 35.6% 0.4% Greenwich International Short Selling Index 8.0%−7.0% 1.7%−10.8%−26.7% 25.9% 15.8% 14.4%−13.9%−14.0% Greenwich International Value Index 8.9% 12.6% 13.8% 11.1% 21.0% −5.4% 5.9% 8.6% 35.3% 11.2% Greenwich International Directional Trading Group Index 10.7% 6.0% 6.1% 2.5% 13.9% 11.1% 5.8% 8.3% 17.6% 14.5% Greenwich International Futures Index 10.5% 5.8% 3.5% 3.3% 14.6% 18.9% 8.8% 11.5% 4.1% 17.4% Greenwich International Macro Index 10.3% 5.5% 10.0% 1.9% 15.0% 3.8% 0.6% 6.2% 26.1% 7.5% Greenwich International Market Timing Index 11.4% 11.2% 1.9% 1.5% 10.6% 3.0% 5.3% 2.5% 35.2% 16.3% Greenwich International Specialty Strategies Group Index 17.8% 18.7% 13.3% 10.4% 30.7% −1.9% 11.6% −5.1% 55.4%−21.5% Greenwich International Emerging Markets Index 23.1% 23.2% 16.8% 12.7% 42.2% −3.6% 13.2%−10.1% 76.7%−26.1% Greenwich International Fixed Income Index 0.6% 9.7% 5.7% 7.4% 8.9% 10.1% 10.3% 2.6% 6.6% −5.8% Greenwich International 2 Multi-Strategy Index 13.5% 12.4% 8.5% 6.5%

© 2008 Greenwich Alternative Investments, LLC and/or its licensors. 1 Please see Explanatory Notes. 2 Until Jan. 2004, the “Multi-Strategy” category was named “Several Strategies.” 3 Beginning with the final August 2004 Index, funds of funds are no longer included in the Greenwich International Hedge Fund Index. Historical returns for the Index have been restated to exclude funds of funds. 4 Index returns from January 1988 to December 2002 are based on quarterly index results, while returns from January 2003 to present are based on monthly index results.

180

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.7 Greenwich Quarterly International Hedge Fund Index3 Primary Strategy1 Greenwich International Hedge Fund Index3

4Q07

3Q07

2Q07

1Q07

4Q06

3Q06

2Q06

1Q06

1.69% 1.30% 5.15% 2.77% 5.48% 0.57% 0.72% 5.86%

Greenwich International Market Neutral Group Index 0.76% 0.27% 2.93% 3.54% 3.77% 1.09% 1.60% 4.48% Greenwich International Equity Market Neutral Index 1.01% 1.39% 3.08% 2.44% 3.51% −0.20% 0.37% 3.89% Greenwich International Event-Driven Index 0.36% 0.09% 3.21% 4.64% 5.10% 0.90% 2.11% 5.34% Greenwich International Distressed Securities Index −0.04% −1.67% 3.71% 4.20% 5.61% 0.58% 3.41% 5.03% Greenwich International Merger Arbitrage Index −0.28% 0.40% 2.93% 3.32% 4.04% 1.26% 1.30% 4.76% Greenwich International Special Situations Index 0.74% 1.48% 2.90% 5.64% 4.80% 0.66% 1.37% 5.98% Greenwich International Arbitrage Index 0.94% −0.07% 2.65% 3.25% 2.99% 1.70% 1.78% 3.98% Greenwich International Convertible Arbitrage Index −0.26% −0.18% 1.73% 3.69% 3.10% 2.49% 1.67% 4.94% Greenwich International Fixed Income Arbitrage Index 1.03% −0.62% 2.70% 3.33% 2.30% 1.34% 2.01% 2.42% Greenwich International Statistical Arbitrage Index 1.10% −1.47% 3.41% 1.49% 2.48% 1.21% 1.66% 3.32% Greenwich International Long/Short Equity Group Index 1.05% 1.28% 5.00% 3.27% 6.00% 1.00% −1.94% 6.98% Greenwich International Growth Index 0.80% 2.61% 6.03% 3.11% 6.21% 0.58% −4.49% 7.64% Greenwich International Opportunistic Index 3.25% 2.35% 5.18% 3.46% 6.73% 0.74% −0.89% 7.91% Greenwich International Short Selling Index 6.52% 4.82% −2.65% −0.66% −6.72% 0.40% 5.21% −5.61% Greenwich International Value Index 0.16% 0.42% 4.77% 3.35% 5.99% 1.12% −1.75% 6.91% Greenwich International Directional Trading Group Index 3.85% 0.66% 6.65% −0.69% 4.32% −2.86% 0.86% 3.69% Greenwich International Futures Index 4.53% −0.68% 8.52% −1.90% 5.33% −3.92% 0.33% 4.15% Greenwich International Macro Index 3.06% 2.37% 3.63% 0.87% 3.07% −2.20% 1.63% 3.02% Greenwich International Market Timing Index 2.76% 1.69% 3.24% 3.26% 2.25% 3.40% 1.82% 3.25% Greenwich International Specialty Strategies Group Index 2.58% 3.23% 7.26% 3.69% 7.91% 1.98% −0.03% 7.88% Greenwich International Emerging Markets Index 3.18% 5.11% 9.04% 4.09% 10.21% 2.42% −0.62% 9.82% Greenwich International Fixed Income Index −0.33% −3.24% 2.08% 2.23% 2.92% 3.39% 0.68% 2.36% Greenwich International Multi-Strategy Index2 2.70% 1.72% 5.05% 3.39% 4.70% 0.30% 1.19% 5.81%

© 2008 Greenwich Alternative Investments, LLC and/or its licensors. 1 Please see Explanatory Notes. 2 Until Jan. 2004, the “Multi-Strategy” category was named “Several Strategies.” 3 Beginning with the final August 2004 Index, funds of funds are no longer included in the Greenwich International Hedge Fund Index. Historical returns for the Index have been restated to exclude funds of funds. 4 Index returns from January 1988 to December 2002 are based on quarterly index results, while returns from January 2003 to present are based on monthly index results.

181

Appendix C: Historic Performance of Hedge Funds

2005

4Q05 3Q05

2Q05

1Q05

4Q04

3Q04

2Q04

1Q04

4Q03

3Q03

2Q03

9.7%

2.6%

5.0%

0.5%

1.4%

4.4%

0.4%

−1.2%

3.5%

4.8%

3.6%

7.1%

5.6%

1.4%

3.3% −0.2%

1.0%

2.8%

0.5%

−0.2%

2.5%

2.8%

1.6%

3.9%

8.2% 7.3%

1.5% 1.4%

2.8% 3.8%

1.2% 0.5%

2.4% 1.4%

2.2% 5.9%

0.8% 1.0%

−0.4% 0.5%

2.8% 3.1%

2.3% 5.1%

1.8% 3.7%

3.2% 8.7%

9.5%

1.9%

4.6%

0.5%

2.2%

7.2%

2.2%

2.4%

4.6%

6.3%

5.3%

9.2%

5.9%

1.5%

1.9%

1.0%

1.4%

2.6% −0.5%

0.0%

1.3%

6.8% 3.6%

1.0% 1.5%

4.3% 0.5% 3.0% −1.1%

1.0% 0.2%

5.2% 1.3%

0.4% 0.1%

−0.3% −0.5%

2.3% 2.2%

4.6% 2.0%

2.9% 0.9%

8.6% 2.2%

−0.8%

1.2%

3.7% −3.0% −2.6%

0.7% −0.3%

−2.2%

2.1%

5.9%

1.6%

2.1% −0.2%

2.3%

1.5%

0.7%

1.9%

1.9%

6.0%

0.9%

1.6%

2.8%

1.2%

0.7%

0.0%

1.6%

0.6%

13.4% 3.3% 11.5% 4.2% 15.4% 3.7% 1.7% −2.4% 13.8% 3.0%

6.8% 1.4% 1.4% 5.2% −0.4% 8.1% 0.5% −1.5% 6.0% −2.8% 8.0% 1.7% 1.4% 4.8% 0.3% 2.2% −0.8% 2.7% −12.0% 3.1% 6.2% 1.6% 2.5% 6.1% 0.1%

−0.7% 3.9% 5.7% 4.0% 8.7% −2.5% 3.3% 6.2% 4.7% 14.1% −1.2% 3.8% 5.2% 5.1% 7.8% 1.6% −3.3% −10.2% −6.0% −13.9% −0.1% 4.8% 7.0% 4.0% 10.0%

6.1% 3.5% 10.0%

3.3% 3.2% 3.6%

2.6% 1.6% 4.3%

1.3% −1.1% 1.3% −2.6% 0.9% 0.8%

6.1% −0.9% −6.3% 8.2% −0.2% −10.8% 3.7% −1.7% −1.7%

4.0% 7.2% 1.6%

4.7% 1.5% 6.5% −1.8% 3.3% 4.8%

4.4% 4.5% 4.9%

1.9%

0.3%

0.9%

0.8% −0.1%

2.4% −0.6%

−0.4%

0.1%

4.0%

4.2%

3.2%

13.3%

2.9%

6.5%

0.6%

2.8%

6.2%

2.8%

−4.1%

5.4%

8.2%

7.4%

11.4%

16.8%

3.0%

8.0%

1.5%

3.5%

7.5%

4.2%

−6.1%

7.2%

10.8%

10.6%

15.3%

5.7%

1.0%

2.9% −0.3%

2.0%

3.1%

2.0%

1.2%

0.9%

2.7%

0.2%

4.0%

8.5%

3.0%

5.1% −0.8%

1.1%

5.0%

0.3%

−1.8%

3.0% (continues)

182

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.7 (Continued) Primary Strategy1

1Q03

4Q02

2Q02

1Q02

4Q01

3Q01

2Q01

Greenwich International Hedge Fund Index3

0.9%

2.6% −2.7% −1.0%

1.7%

5.0% −1.2%

3.0%

2.0%

2.9% −0.1% −0.1%

1.8%

2.2%

0.9%

2.1%

−0.1% 2.4%

0.4% 1.0% 0.5% 2.6% −4.0% −1.6%

0.6% 2.6%

1.8% 4.2%

0.5% 0.0%

0.8% 3.8%

4.9%

4.2% −2.4%

0.2%

1.3%

1.7%

2.1%

5.3%

0.7% 2.5%

0.9% −4.8% −2.9% 3.9% 1.3% 0.3%

3.4% 1.8%

5.6% −1.1% 1.7% 1.4%

3.1% 2.0%

Greenwich International Market Neutral Group Index Greenwich International Equity Market Neutral Index Greenwich International Event-Driven Index Greenwich International Distressed Securities Index Greenwich International Merger Arbitrage Index Greenwich International Special Situations Index Greenwich International Arbitrage Index Greenwich International Convertible Arbitrage Index Greenwich International Fixed Income Arbitrage Index Greenwich International Statistical Arbitrage Index Greenwich International Long/Short Equity Group Index Greenwich International Growth Index Greenwich International Opportunistic Index Greenwich International Short Selling Index Greenwich International Value Index Greenwich International Directional Trading Group Index Greenwich International Futures Index Greenwich International Macro Index Greenwich International Market Timing Index Greenwich International Specialty Strategies Group Index Greenwich International Emerging Markets Index Greenwich International Fixed Income Index Greenwich International Multi-Strategy Index2

3Q02

−0.3% 1.1% −3.9% −0.9% 0.6% 4.3% −0.9% 3.3% −0.5% 2.1% −5.7% −6.7% −1.4% 7.4% −5.9% 6.2% 1.1% −0.2% −3.4% 0.0% 1.3% 3.0% 3.4% 2.6% 0.9% −3.0% 12.4% 12.0% 3.1% −6.5% 18.3% −8.2% −1.2% 2.2% −6.5% −1.4% 0.4% 6.3% −4.5% 4.1% 2.6% −0.8% 7.0% 5.1% −0.4% 1.2% 4.9% −1.6% 13.3% 10.2% −3.2% −1.2% 1.2% 0.3% 0.1% 0.5% 2.9% 2.3% −1.2% −0.6%

2.3%

0.5%

0.8%

3.3% −1.0% 6.9% −3.4% 1.5% −2.1%

4.5% −2.4%

6.7%

1.0%

5.6% −7.4% −3.1%

3.5% 12.9% −7.0%

4.9%

0.6%

6.3% −9.7% −4.4%

5.0% 17.0% −9.9%

6.5%

1.7%

2.9% −0.1%

2.2%

0.8%

4.8%

4.0% −0.4%

183

Appendix C: Historic Performance of Hedge Funds

1Q01

4Q00 3Q00 2Q00

1Q00

4Q99 3Q99 2Q99 1Q99

2Q98

1Q98

0.9% 12.2%

3.4%

6.0% −7.8% −5.8%

6.5%

6.2%

2.2%

6.9%

2.9%

3.6% −6.2%

1.2%

6.7%

11.3% 3.4%

8.6% 4.2%

3.6% 1.3%

4.8% 9.1%

2.4% 2.8%

3.7% −1.5% 5.2% −9.0%

0.8% 0.8%

5.2% 9.8%

1.7% −0.6%

2.5%

3.2%

0.3%

7.1%

2.6%

3.1% −9.7%

1.6%

6.7%

1.2% −1.7% 4.6% −0.1%

0.5% 2.3%

4.0% 5.7%

4.9% 6.7%

1.9% 10.2% 2.4% 5.3%

3.0% 3.3%

6.5% −8.5% 1.6% −6.2%

0.3% 2.2%

11.9% 3.3%

−2.1% −3.1% −14.9% −13.9% 0.1% 0.4% 14.0% 20.3% 0.2% −3.9%

1.9% 1.7% 1.6% 4.4% 1.9%

0.3% −1.7%

0.7% −2.0%

8.0%

16.5%

3.3%

0.6%

2.1%

2.2%

5.8%

1.2% 5.6% 2.3% −1.4%

3.2% 0.9%

2.0% 1.6%

4.4% −1.0%

2.2% 6.6% −1.0%

2.6% 2.6%

−2.5% 10.2% 20.3% −7.3% 17.4% 40.7% −6.0% 15.4% 22.0% 13.2% −19.5% −19.0% 0.3% 10.6% 18.3%

2.5% 3.2% 1.1% 8.6% 1.3%

4Q98

3Q98

10.7% 3.3% 8.4% −6.1% −0.1% 7.6% 15.5% 10.4% 18.6% −9.0% 1.7% 14.5% 7.4% 2.4% 2.3% −4.9% −1.6% 4.9% −5.8% 3.9% −20.4% 16.1% 5.8% −12.0% 13.5% −0.5% 14.0% −10.7% −1.4% 10.8%

6.1% −0.3% −1.5% 13.3% −0.4% −2.1% 1.6% −0.9% −1.9%

3.9% 0.9% 7.5%

9.6% −0.8% 7.0% 0.9% −1.3% 4.5% 13.3% −1.0% 10.9%

1.1% 0.0% 1.4%

2.6% 5.7% −0.2% 0.5% 10.8% 0.6% 0.6% −0.9% −0.7%

5.8% 4.8% 8.6%

0.3% −0.1%

5.9%

21.5%

7.7%

2.9%

8.7%

3.3% −1.1%

4.7%

1.3% −3.7% −2.6% −6.3%

8.0%

27.0% −3.0% 20.7%

4.5%

5.7% −14.7% −17.2%

5.2%

0.8% −6.0% −4.7% −8.1%

9.2%

38.8% −4.4% 27.3%

4.6%

6.4% −17.5% −20.3%

5.6%

2.9%

3.3% −7.2% −4.0%

2.4%

−3.2% −3.4%

5.6%

4.8%

4.2% −5.4% −0.7%

0.4%

3.7% −0.9%

0.8%

184

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.8 Greenwich Quarterly Global Hedge Fund Index3 Primary Strategy1 Greenwich Global Hedge Fund Index3 Greenwich Global Market Neutral Group Index Greenwich Global Equity Market Neutral Index Greenwich Global Event-Driven Index Greenwich Global Distressed Securities Index Greenwich Global Merger Arbitrage Index Greenwich Global Special Situations Index Greenwich Global Arbitrage Index Greenwich Global Convertible Arbitrage Index Greenwich Global Fixed Income Arbitrage Index Greenwich Global Other Arbitrage Index Greenwich Global Statistical Arbitrage Index Greenwich Global Long/Short Equity Group Index Greenwich Global Growth Index Greenwich Global Opportunistic Index Greenwich Global Short Selling Index Greenwich Global Value Index Greenwich Global Directional Trading Group Index Greenwich Global Futures Index Greenwich Global Macro Index Greenwich Global Market Timing Index Greenwich Global Specialty Strategies Group Index Greenwich Global Emerging Markets Index Greenwich Global Fixed Income Index Greenwich Global Multi-Strategy Index2

4Q07

3Q07

2Q07

1Q07

4Q06

3Q06

2Q06

1Q06

1.85%

1.32%

4.84%

2.71%

5.23%

0.67%

0.21%

5.62%

0.98%

0.50%

2.77%

3.51%

3.76%

1.37%

1.64%

4.43%

1.91%

0.84%

2.97%

2.52%

3.26%

0.60%

0.78%

3.33%

0.56%

0.38%

3.56%

4.63%

5.11%

0.95%

1.68%

5.31%

−0.09% −1.35%

3.79%

4.32%

5.44%

1.25%

2.91%

4.98%

−0.65%

0.78%

3.11%

3.55%

4.10%

1.40%

1.56%

5.10%

1.17%

1.60%

3.50%

5.24%

4.99%

0.39%

0.78%

5.79%

0.93%

0.43%

2.05%

3.10%

2.94%

2.10%

1.96%

4.02%

−1.35% −0.81%

1.07%

3.60%

2.76%

2.75%

2.00%

4.99%

0.54%

1.56%

3.14%

2.37%

1.82%

1.92%

2.37%

1.51% −1.79%

3.07%

3.13%

3.93%

2.07%

2.08%

4.32%

1.39% −0.43%

2.96%

1.81%

2.90%

1.52%

1.84%

3.83%

1.30%

1.50%

5.07%

3.17%

5.90%

1.00% −1.35%

6.93%

1.26%

2.77%

5.95%

3.03%

6.32%

0.83% −3.27%

7.93%

3.28%

3.44%

5.09%

3.38%

6.47%

0.29% −1.34%

7.73%

7.35% 0.43%

4.09% −3.04% −0.12% −5.36% 0.38% 5.04% 3.24% 5.96%

1.56%

0.14% 5.35% −5.35% 1.32% −1.04% 6.85%

4.25% 0.63% 4.92% −1.46% 3.60% 3.41%

6.34% −0.94% 8.21% −2.59% 3.80% 1.31%

4.19% −2.41% 4.97% −3.10% 3.23% −1.70%

1.21% 0.87% 1.72%

3.14% 3.34% 2.89%

2.52%

2.58%

3.72%

1.40%

3.22%

0.67%

1.70%

2.84%

2.62%

3.15%

6.84%

3.64%

7.36%

1.50%

0.14%

7.17%

3.49%

5.43%

8.86%

3.79% 10.07%

1.76% −0.69%

9.64%

−0.08% −2.39%

1.39%

2.30%

2.95%

2.87%

1.22%

2.39%

5.69%

3.98%

4.85%

0.52%

1.09%

5.34%

2.69%

1.62%

© 2008 Greenwich Alternative Investments, LLC and/or its licensors. 1 Please see Explanatory Notes. 2 Until Jan. 2004, the “Multi-Strategy” category was named “Several Strategies.” 3 Beginning with the final August 2004 Index, funds of funds are no longer included in the Greenwich Global Hedge Fund Index. Historical returns for the Index have been restated to exclude funds of funds. 4 Index returns from January 1988 to December 2002 are based on quarterly index results, while returns from January 2003 to present are based on monthly index results.

185

Appendix C: Historic Performance of Hedge Funds

4Q05 3Q05

2Q05

1Q05

4Q04

3Q04

2Q04

1Q04

4Q03

3Q03

2Q03

1Q03

2.2%

4.7%

0.8%

0.8%

4.9%

0.6%

−1.1%

3.2%

5.5%

3.5%

7.7%

0.8%

1.2%

3.2%

−0.2%

0.8%

3.5%

0.7%

−0.1%

2.7%

3.3%

1.8%

4.1%

2.1%

1.3%

2.6%

1.0%

1.9%

2.6%

1.2%

−0.6%

2.7%

2.3%

1.6%

2.8%

0.2%

1.2%

3.9%

0.5%

1.5%

7.1%

0.9%

0.8%

3.7%

6.0%

4.1%

8.5%

2.3%

2.0%

4.7%

0.3%

2.1%

7.6%

1.7%

3.3%

4.8%

6.7%

5.1%

8.4%

4.8%

1.3%

1.9%

1.0%

1.5%

2.6%

−0.6%

−0.1%

1.2%

1.5%

0.5%

1.4%

1.1%

0.8%

3.9%

0.5%

1.1%

6.7%

0.4%

−0.2%

3.2%

5.5%

3.4%

8.6%

0.6%

1.1%

2.9%

−1.1%

0.1%

1.6%

0.4%

−0.5%

2.1%

2.3%

0.8%

2.2%

2.8%

0.7%

3.8%

−3.4%

−2.8%

1.2%

0.1%

−2.3%

2.0%

2.9%

0.5%

2.4%

5.1%

1.5%

2.2%

0.2%

1.9%

1.2%

1.0%

1.6%

2.0%

2.2%

0.8%

3.6%

2.1%

1.4%

3.2%

−0.6%

0.5%

2.0%

0.7%

−0.1%

2.9%

2.0%

1.0%

1.8%

1.9%

0.8%

1.5%

0.4%

2.0%

1.5%

0.0%

0.4%

1.3%

0.1%

2.2%

1.0%

0.1%

2.4%

6.3%

1.4%

0.4%

6.0%

0.0%

−0.9%

3.4%

6.6%

4.4%

10.4%

−0.4%

2.6%

6.7%

1.6%

−2.8%

8.1%

−2.1%

−2.6%

2.9%

6.7%

5.0%

15.0%

−1.3%

2.6%

8.2%

1.9%

0.4%

5.3%

0.1%

−1.3%

3.6%

6.9%

5.7%

9.8%

0.3%

−1.8% 2.6%

1.9% 5.7%

−0.7% 1.6%

4.3% 1.4%

−11.7% 6.8%

4.0% 0.5%

1.5% −0.3%

−3.1% 4.2%

−9.1% 7.7%

−5.8% 4.4%

−13.1% 10.5%

1.5% −0.6%

3.1% 3.3% 3.1%

2.3% 1.2% 4.6%

1.4% 1.4% 1.0%

−1.5% −2.7% 0.3%

7.3% 10.0% 3.8%

−0.1% 0.5% −1.4%

−6.7% −10.3% −2.5%

4.9% 7.9% 2.2%

5.4% 6.1% 4.8%

1.3% −1.2% 4.2%

4.1% 3.5% 5.3%

2.9% 5.3% 1.4%

−0.3%

1.0%

0.9%

−0.8%

3.0%

0.0%

−0.9%

1.0%

4.6%

2.8%

4.1%

−0.9%

2.9%

5.8%

0.8%

2.1%

6.0%

2.9%

−3.6%

4.9%

7.8%

6.1%

10.6%

1.2%

3.4%

7.9%

1.6%

3.1%

8.0%

4.5%

−6.0%

7.1%

11.0%

10.2%

14.9%

0.5%

1.3%

2.5%

0.5%

1.9%

3.2%

2.8%

0.9%

1.6%

3.4%

0.4%

4.2%

1.9%

2.8%

4.5%

−0.1%

0.7%

4.4%

0.6%

−1.6%

2.5%

4.0%

3.0%

8.0%

1.7% (continues)

186

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.8 (Continued) Primary Strategy1

4Q02

2Q02

1Q02

4Q01

3Q01

2Q01

1Q01

Greenwich Global Hedge Fund Index3

3.2% −3.3% −1.3%

1.6%

5.7% −2.7%

3.9%

−0.5%

1.7%

2.1%

1.0%

2.2%

3.1%

0.7%

2.1%

0.7%

2.1%

2.6%

2.1%

2.8%

0.1%

2.8%

1.5%

1.8%

2.0%

1.6%

6.6%

4.2%

1.1%

1.5% −0.6%

1.4%

1.4%

2.2%

3.2% −0.6%

1.3%

0.4%

1.9%

1.9%

1.5%

1.9%

4.3%

2.0%

2.1%

3.1%

2.3%

7.6%

3.3%

3.5%

1.9%

2.0%

2.8%

−0.3%

1.8% −2.4%

0.9%

6.0%

0.9%

7.2% −5.0%

5.0%

−2.8%

−2.6%

9.1% −9.2%

6.7% −12.0%

2.4%

4.6% −0.4%

2.8%

−2.1%

4.0% −7.7% 17.9% −10.1% 1.6% 10.5% −8.1% 7.4%

14.5% 1.1%

3Q02

Greenwich Global Market Neutral Group Index 3.2% −0.4% 0.4% Greenwich Global Equity Market Neutral Index 0.5% 1.4% 2.4% Greenwich Global Event-Driven Index 3.2% −4.6% −1.6% Greenwich Global Distressed Securities Index 4.0% −3.5% 0.3% Greenwich Global Merger Arbitrage Index 0.5% 0.0% −0.7% Greenwich Global Special Situations Index 2.4% −5.2% −3.1% Greenwich Global Arbitrage Index 4.1% 1.1% 0.7% Greenwich Global Convertible Arbitrage Index 5.6% 0.9% 1.2% Greenwich Global Fixed Income Arbitrage Index 3.7% −0.2% 3.5% Greenwich Global Other Arbitrage Index Greenwich Global Statistical Arbitrage Index 1.4% 7.5% 0.5% Greenwich Global Long/Short Equity Group Index 2.8% −5.0% −2.3% Greenwich Global Growth Index 2.9% −5.4% −7.9% Greenwich Global Opportunistic Index 1.5% −5.1% −0.7% Greenwich Global Short Selling Index −3.3% 14.1% 12.6% Greenwich Global Value Index 4.2% −7.3% −2.4% Greenwich Global Directional Trading Group Index 0.3% 5.1% 4.5% Greenwich Global Futures Index −1.6% 12.5% 10.3% Greenwich Global Macro Index 4.4% −1.8% 1.1% Greenwich Global Market Timing Index −0.4% −2.2% −2.8% Greenwich Global Specialty Strategies Group Index 5.0% −6.7% −2.3% Greenwich Global Emerging Markets Index 6.1% −8.4% −3.8% Greenwich Global Fixed Income Index 2.3% −0.1% 3.5% Greenwich Global Multi-Strategy Index2 4.6% −8.6% −4.8%

−1.2% 1.8% 1.5% −3.5% −1.2% 4.7% 0.8% 4.6% −2.9%

0.2% −3.9% 0.7%

1.3% 7.1% −0.6%

1.0%

4.9% −0.4%

7.7%

−7.3%

3.5%

10.8% −4.4%

4.8%

1.0%

5.8%

16.4% −8.9%

6.4%

0.9%

2.0%

2.2%

2.0%

2.5%

3.7%

0.0%

5.3% −2.1%

3.9%

−1.9%

187

Appendix C: Historic Performance of Hedge Funds

4Q00

2Q00

1Q00

4Q99

2Q99

1Q99

4Q98

3Q98

2Q98

1Q98

2.1% −0.7%

9.4%

19.4%

1.7% 11.2%

3.9%

8.6%

−6.9%

−1.9%

7.2%

1.0%

3.2%

2.2%

6.4%

9.0%

2.0%

8.8%

3.4%

4.3%

−5.3%

1.4%

6.3%

5.3%

4.1%

3.4%

8.9%

10.5%

4.6%

6.5%

2.7%

4.7%

−2.9%

1.4%

5.1%

−1.1%

3.7%

1.4%

5.9%

10.5%

0.3% 11.5%

4.0%

5.2%

−7.7%

0.9%

8.2%

−2.7%

1.6% −0.3%

3.8%

3.3% −0.6%

7.6%

2.8%

1.7%

−8.6%

2.2%

5.1%

3.2%

4.4%

5.5%

4.8%

3.8%

5.7%

4.4%

5.3%

−2.5%

2.9%

2.7%

−0.3%

4.5%

2.2%

6.9%

14.0%

0.9% 13.4%

4.5%

7.0%

−7.3%

0.5%

9.4%

0.5%

2.3%

2.4%

5.6%

6.8%

2.4%

6.1%

3.4%

2.8%

−3.9%

2.5%

4.0%

−0.4%

3.7%

4.9%

8.0%

5.0%

2.2%

5.3%

3.9%

3.9%

−4.7%

2.1%

5.7%

1.5%

2.5%

1.9%

2.9%

4.2%

1.9%

3.6%

7.2%

−4.4%

−2.3%

1.3%

2.5%

8.1%

2.8%

8.7%

14.4%

1.4%

0.7%

6.9% −0.3%

−4.3%

2.8% −1.5%

12.1%

25.4%

2.9% 10.7%

3.7%

12.0%

−5.9%

1.2%

8.0%

−12.3%

1.9% −4.9%

15.1%

39.4%

4.1% 14.8%

8.3%

24.4%

−7.9%

2.7%

12.3%

−1.9%

2.6% −4.5%

17.9%

30.3%

2.6% 10.3%

3.7%

7.1%

−3.6%

0.7%

6.1%

23.0% −3.9%

4.4% 15.9% −20.2% −22.7% 3.4% −0.1% 12.4% 23.0%

8.9% −6.7% 1.4% 11.7%

2.6% −23.9% 18.1% 1.9% 14.4% −10.2%

−2.3%

3Q00

6.5% −0.2% −1.1% 15.7% −0.5% −1.7% −2.0% −0.6% −2.8%

3Q99

4.1%

5.6% −10.2% −0.1% 9.4%

6.1% 0.5% 10.8%

11.3% −0.1% 7.2% 1.6% −1.0% −1.0% 3.7% −1.0% 23.5% −0.1% 15.3% 2.8%

5.3% 0.5% −1.5%

6.8% 12.8% −0.9%

0.4% 0.2% −1.7%

6.3% 3.5% 10.3%

0.8%

11.9%

22.8%

19.3%

3.1%

2.9%

7.8%

−2.3% −1.3% −4.0% −5.2% −4.8% −7.3%

−2.4%

4.4% −4.3%

0.5%

6.7%

5.2%

7.6%

21.9% −1.9% 17.0%

4.7%

6.6% −15.4% −13.9%

5.7%

9.2%

36.7% −4.2% 24.7%

4.7%

7.8% −21.2% −19.4%

4.6%

1.2%

2.7%

3.4%

−4.6%

−2.8%

4.6%

9.2%

7.0%

6.8%

−8.5%

0.1%

10.6%

4.8% −0.6%

0.3%

2.4%

9.3%

3.2%

1.4%

3.8% −0.8% 16.7%

2.2%

TABLE C.9 Greenwich YTD Global Hedge Fund Index3 Primary Strategy1 Greenwich Global Hedge Fund Index3 Greenwich Global Market Neutral Group Index Greenwich Global Equity Market Neutral Index Greenwich Global Event-Driven Index Greenwich Global Distressed Securities Index Greenwich Global Merger Arbitrage Index Greenwich Global Special Situations Index Greenwich Global Arbitrage Index Greenwich Global Convertible Arbitrage Index Greenwich Global Fixed Income Arbitrage Index Greenwich Global Other Arbitrage Index Greenwich Global Statistical Arbitrage Index Greenwich Global Long/Short Equity Group Index Greenwich Global Growth Index Greenwich Global Opportunistic Index Greenwich Global Short Selling Index Greenwich Global Value Index Greenwich Global Directional Trading Group Index Greenwich Global Futures Index Greenwich Global Macro Index Greenwich Global Market Timing Index Greenwich Global Specialty Strategies Group Index Greenwich Global Emerging Markets Index Greenwich Global Fixed Income Index Greenwich Global Multi-Strategy Index2

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

11.1% 12.1%

8.6%

7.7%

18.6%

0.1%

6.3%

8.4%

40.3%

6.3%

8.0% 11.6%

5.1%

7.0%

11.8%

5.0%

8.7% 13.3%

25.1%

6.5%

8.5%

7.0%

6.0%

7.1%

5.1%

7.7% 23.4%

26.4%

8.3%

7.4% 10.1%

28.5%

6.0%

8.2%

9.4% 13.6%

7.3% 12.9%

22.5% −1.1%

6.7% 15.3%

9.3% 18.4%

27.4%

6.9% 12.7%

5.8%

12.0% 12.4% 6.7% 11.5%

3.1%

6.4% 10.4%

4.6%

2.5% 15.1%

2.3%

13.6% −0.2%

0.9%

3.7% 19.1%

19.2%

8.5%

19.2% −3.9%

4.3% 13.8%

36.3%

9.1%

9.9% 11.2%

20.0%

5.3%

10.0% 15.9% 17.0%

17.4%

6.9%

10.6% 10.6%

17.9% −3.0%

3.0%

3.6%

8.4%

2.5% 13.1% −1.8%

1.0%

11.3%

7.0%

8.0%

8.7%

5.9%

6.0%

9.0%

9.3% 13.0%

4.6%

5.6%

6.9%

5.8% 10.4%

4.8%

3.2%

3.4%

11.5% 12.8% 10.8%

8.6%

22.4% −3.7%

8.6%

48.1%

15.2%

13.6% 11.9%

8.1%

6.0%

27.1% −12.7% −7.0% −2.2%

80.4%

32.1%

16.1% 13.5% 13.5%

7.7%

24.4% −2.1%

52.9%

10.3%

8.2% −5.5%

3.7% −9.7% −24.4%

9.3% 13.5% 11.6% 11.5%

9.2%

9.1%

6.3% 38.2% 3.9%

4.8% 13.3%

8.8%

29.2% 12.0% 18.8% −19.4% −14.8%

23.4% −4.2% 10.3% 11.6%

42.0%

12.3%

10.5%

6.1%

5.3%

4.9%

14.3%

8.8%

4.9% 11.5%

21.1%

20.0%

9.0%

6.0%

3.1%

6.9%

14.2%

17.8%

6.5% 13.7%

0.6%

17.6%

12.7%

6.2%

9.2%

2.1%

16.5%

4.5%

4.9%

46.2%

5.8%

10.6%

8.7%

0.8%

3.1%

11.0% −4.4%

4.3% 10.6%

39.8%

36.4%

1.7%

17.2% 17.0% 12.0% 10.3%

28.0% −0.9% 12.1% −0.4%

46.5% −17.9%

23.3% 21.9% 16.9% 13.6%

41.3% −1.1% 13.8% −8.6%

71.0% −28.4%

1.2%

9.8%

6.4%

8.8%

10.3%

7.9% 10.8%

14.7% 12.2%

8.0%

5.9%

17.7% −9.0%

9.1%

7.0%

0.3%

5.1% 10.5%

39.4%

8.2%

© 2008 Greenwich Alternative Investments, LLC and/or its licensors. 1 Please see Explanatory Notes. 2 Until Jan. 2004, the “Multi-Strategy” category was named “Several Strategies.” 3 Beginning with the final August 2004 Index, funds of funds are no longer included in the Greenwich Global Hedge Fund Index. Historical returns for the Index have been restated to exclude funds of funds. 4 Index returns from January 1988 to December 2002 are based on quarterly index results, while returns from January 2003 to present are based on monthly index results.

189

Appendix C: Historic Performance of Hedge Funds

TABLE C.10 Greenwich MonthlyInternational Hedge Fund Index3 Primary Strategy1

Feb-08

Greenwich International Hedge Fund Index3

2.06% −3.05%

Jan-08 Dec-07 Nov-07 Oct-07 Sep-07 Aug-07 0.56% −1.76% 2.94%

2.62% −1.85%

Jul-07 0.57%

Greenwich International Market Neutral Group Index 0.90% −1.25% 0.16% −1.22% 1.84% 1.27% −1.25% 0.27% Greenwich International Equity Market Neutral Index 0.67% −1.70% 0.36% −0.84% 1.50% 1.62% −0.94% 0.72% Greenwich International Event-Driven Index 0.79% −2.45% 0.11% −1.90% 2.19% 1.00% −1.33% 0.43% Greenwich International Distressed Securities Index 0.23% −2.18% −0.18% −1.45% 1.61% 0.24% −1.48% −0.43% Greenwich International Merger Arbitrage Index −0.06% −2.19% −0.32% −1.83% 1.90% 1.09% −0.07% −0.61% Greenwich International Special Situations Index 1.28% −2.66% 0.37% −2.20% 2.63% 1.46% −1.61% 1.66% Greenwich International Arbitrage Index 1.08% −0.30% 0.11% −0.91% 1.76% 1.31% −1.32% −0.04% Greenwich International Convertible Arbitrage Index 0.30% 0.40% −0.80% −1.50% 2.08% 1.56% −1.44% −0.28% Greenwich International Fixed Income Arbitrage Index −0.27% −0.05% 0.23% −0.46% 1.26% 0.71% −1.07% −0.25% Greenwich International Statistical Arbitrage Index 2.36% −1.01% 0.29% −0.95% 1.77% 1.47% −2.84% −0.06% Greenwich International Long/Short Equity Group Index 1.69% −4.75% 0.59% −2.53% 3.06% 2.83% −1.92% 0.42% Greenwich International Growth Index 2.23% −6.43% 0.18% −2.80% 3.52% 3.76% −1.58% 0.48% Greenwich International Opportunistic Index 1.62% −4.47% 1.28% −1.67% 3.68% 3.56% −2.18% 1.03% Greenwich International Short Selling Index 1.75% 1.57% 1.34% 4.08% 0.99% −0.47% 1.39% 3.87% Greenwich International Value Index 1.49% −4.48% 0.46% −2.98% 2.76% 2.42% −2.07% 0.12% Greenwich International Directional Trading Group Index 4.49% −0.26% 0.90% −0.09% 3.02% 3.53% −2.05% −0.74% Greenwich International Futures Index 6.15% 0.86% 0.94% 0.07% 3.48% 3.78% −2.25% −2.09% Greenwich International Macro Index 2.65% −1.50% 1.02% −0.40% 2.43% 3.37% −1.79% 0.84% Greenwich International Market Timing Index 2.30% −1.37% 0.15% 0.17% 2.43% 1.99% −1.71% 1.44% Greenwich International Specialty Strategies Group Index 2.57% −4.37% 0.81% −2.17% 4.01% 3.35% −2.35% 2.29% Greenwich International Emerging Markets Index 3.38% −6.22% 1.27% −2.74% 4.76% 4.45% −2.59% 3.31% Greenwich International Fixed Income Index −0.07% −1.20% −0.33% −1.23% 1.25% 1.24% −2.27% −2.21% Greenwich International Multi-Strategy Index2 1.91% −1.61% 0.26% −1.21% 3.69% 2.21% −1.94% 1.49%

© 2008 Greenwich Alternative Investments, LLC and/or its licensors. 1 Please see Explanatory Notes. 2 Until Jan. 2004, the “Multi-Strategy” category was named “Several Strategies.” 3 Beginning with the final August 2004 Index, funds of funds are no longer included in the Greenwich International Hedge Fund Index. Historical returns for the Index have been restated to exclude funds of funds. 4 Index returns from January 1988 to December 2002 are based on quarterly index results, while returns from January 2003 to present are based on monthly index results. (continues)

190

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.10 (Continued) Primary Strategy1

Jun-07 May-07 Apr-07 Mar-07 Feb-07 Jan-07 Dec-06 Nov-06

Greenwich International Hedge Fund Index3

1.16%

2.10%

1.81%

0.98%

0.59%

1.18%

1.80%

1.92%

Greenwich International Market Neutral Group Index 0.58% 1.21% 1.11% 1.06% 1.05% 1.39% 1.30% 1.11% Greenwich International Equity Market Neutral Index 1.06% 0.93% 1.06% 0.95% 0.45% 1.02% 1.21% 0.93% Greenwich International Event-Driven Index 0.03% 1.66% 1.49% 1.29% 1.42% 1.86% 1.67% 1.57% Greenwich International Distressed Securities Index 0.38% 1.67% 1.62% 1.21% 1.35% 1.58% 1.70% 1.69% Greenwich International Merger Arbitrage Index −0.69% 1.93% 1.68% 0.73% 0.50% 2.06% 1.42% 0.98% Greenwich International Special Situations Index −0.02% 1.53% 1.37% 1.62% 1.87% 2.05% 1.65% 1.53% Greenwich International Arbitrage Index 0.76% 1.02% 0.85% 0.95% 1.05% 1.22% 1.09% 0.89% Greenwich International Convertible Arbitrage Index 0.42% 0.81% 0.49% 0.81% 1.24% 1.60% 1.54% 1.00% Greenwich International Fixed Income Arbitrage Index 1.26% 0.83% 0.59% 1.02% 1.25% 1.02% 0.83% 0.54% Greenwich International Statistical Arbitrage Index 0.49% 0.97% 1.92% 0.57% 0.00% 0.91% 0.58% 0.67% Greenwich International Long/Short Equity Group Index 0.73% 2.34% 1.86% 1.38% 0.63% 1.23% 1.81% 2.03% Greenwich International Growth Index 0.93% 3.07% 1.92% 1.55% 0.27% 1.26% 1.72% 1.75% Greenwich International Opportunistic Index 1.11% 2.18% 1.81% 1.34% 0.78% 1.30% 1.97% 2.53% Greenwich International Short Selling Index 3.38% −2.49% −3.43% −0.50% 1.75% −1.88% 0.12% −3.96% Greenwich International Value Index 0.47% 2.28% 1.96% 1.39% 0.66% 1.26% 1.82% 2.08% Greenwich International Directional Trading Group Index 1.82% 2.35% 2.34% −0.64% −0.96% 0.92% 1.57% 1.72% Greenwich International Futures Index 2.47% 2.67% 3.15% −1.41% −1.74% 1.26% 1.98% 2.04% Greenwich International Macro Index 0.59% 1.85% 1.15% 0.35% 0.06% 0.46% 1.12% 1.34% Greenwich International Market Timing Index −0.53% 2.22% 1.54% 1.63% 1.30% 0.30% −0.11% 1.10% Greenwich International Specialty Strategies Group Index 2.02% 2.73% 2.34% 1.49% 1.15% 1.01% 2.63% 2.99% Greenwich International Emerging Markets Index 2.67% 3.39% 2.72% 1.83% 1.39% 0.82% 3.34% 3.98% Greenwich International Fixed Income Index 0.22% 0.75% 1.10% 0.47% 0.75% 0.99% 0.92% 1.04% Greenwich International Multi-Strategy Index2 1.04% 1.92% 2.01% 1.12% 0.85% 1.38% 1.67% 1.54%

191

Appendix C: Historic Performance of Hedge Funds

Oct-06

Sep-06 Aug-06

Jul-06

Jun-06 May-06

Apr-06 Mar-06

Feb-06

Jan-06 Dec-05 Nov-05

1.66% −0.04%

0.76% −0.16%

0.36% −1.50%

1.89%

1.87%

0.52%

3.38%

2.0%

2.0%

1.31%

0.28%

0.68% −0.16%

0.17%

0.21%

1.22%

1.45%

0.79%

2.18%

1.1%

0.7%

1.33%

0.08%

0.36%

0.29% −0.18% −0.62%

1.18%

1.72%

0.67%

1.45%

1.1%

1.1%

1.78%

0.20%

0.76%

0.02%

0.07%

0.41%

1.62%

1.79%

0.67%

2.80%

1.2%

0.9%

2.12%

0.40%

0.90% −0.20% −0.14%

1.31%

2.22%

1.85%

0.41%

2.70%

0.9%

1.2%

1.59%

0.35%

0.49%

0.14%

0.60%

1.35%

0.75%

2.60%

1.4%

0.8%

0.41%

0.56%

1.55% −0.11% 0.98% 0.42%

0.66% −0.06% 0.79% 0.58%

0.00% −0.24% 0.39% 0.45%

1.61% 0.93%

1.96% 1.07%

0.78% 0.92%

3.14% 1.94%

1.4% 1.1%

0.9% 0.4%

0.53%

0.77%

1.15%

0.64%

0.24%

0.84%

0.58%

1.06%

1.21%

2.60%

1.1%

0.2%

0.91%

0.39%

0.51%

0.44%

0.37%

0.41%

1.22%

0.89%

0.61%

0.90%

0.6%

0.5%

1.21%

0.36%

0.11%

0.82%

1.74% −0.63%

0.55%

1.50%

1.14%

0.65%

0.5%

0.5%

2.04% −0.28% 2.62% −0.79%

1.26% −0.08% −0.72% −2.78% 1.63% −0.38% −0.84% −4.22%

1.60% 0.56%

2.38% 2.55%

0.36% 0.08%

4.12% 4.88%

2.8% 2.9%

2.4% 3.2%

2.09%

0.87% −0.01% −0.56% −2.42%

2.14%

2.66%

0.57%

4.52%

3.2%

2.4%

0.06%

−2.99% −2.54% −1.81% 5.17% 1.48% 4.63% −0.91% −2.90% 1.97% −0.19% 1.38% −0.19% −0.81% −2.72% 1.82% 2.41%

0.12% −2.91% −0.3% −5.1% 0.37% 4.01% 2.7% 2.5%

0.97% −0.61% −0.21% −1.58% −0.40% −1.01% 1.22% −0.60% 0.16% −2.37% −0.83% −1.47% 0.58% −0.67% −0.80% −0.60% 0.18% −0.37%

2.30% 2.68% 1.82%

1.81% −0.55% 2.70% −1.13% 0.50% 0.39%

2.41% 2.57% 2.11%

1.0% 0.4% 1.7%

3.4% 4.5% 2.1%

1.25% −0.10%

1.02%

0.29%

0.27%

1.55%

1.34% −1.05%

2.97%

1.2%

0.6%

2.09%

0.34%

0.88%

0.22% −0.54% −2.57%

3.16%

1.70%

1.25%

4.77%

2.8%

2.2%

2.57%

0.38%

1.14%

0.30% −0.71% −3.71%

3.95%

1.63%

1.82%

6.13%

3.3%

2.6%

0.93%

0.65%

1.18%

1.35% −0.09%

0.35%

0.42%

0.85%

0.53%

0.96%

1.1%

0.4%

1.42%

0.13%

0.33% −0.28% −0.34% −0.79%

2.34%

2.22%

0.28%

3.22%

2.3%

1.8%

0.00%

(continues)

192

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.10 (Continued) Primary Strategy1

Oct-05 Sep-05 Aug-05

Greenwich International Hedge Fund Index3

−1.4%

2.1%

1.0%

1.8%

1.3%

0.5% −1.3% −0.7%

−0.4%

1.0%

0.8%

1.5%

0.8%

0.0% −1.0% −0.2%

−0.7%

0.8%

0.7%

1.3%

1.2%

0.4% −0.4%

−0.7%

0.9%

1.1%

1.8%

1.1%

0.4% −1.0% −0.1%

−0.2%

1.3%

1.5%

1.7%

1.1%

−0.1% −0.5%

0.3%

−0.7%

0.1%

0.3%

1.5%

0.7%

0.7% −0.4%

0.6%

−1.3% 0.0%

1.0% 1.2%

1.1% 0.5%

2.1% 1.3%

1.2% 0.5%

0.7% −1.4% −0.3% −0.3% −1.3% −0.4%

−0.1%

1.5%

0.6%

1.6%

1.1%

−1.3% −2.8% −1.4%

0.5%

1.0%

0.0%

1.1% −0.4%

0.1%

0.1%

0.4%

−0.1%

0.0%

0.9%

0.7% −0.1%

0.7%

0.0%

0.6%

−1.9% −1.9%

2.6% 2.8%

1.3% 1.0%

2.8% 4.1%

2.0% 1.8%

1.3% −1.9% −0.8% 1.6% −2.8% −1.6%

−1.9%

3.1%

1.4%

3.3%

2.3%

1.4% −2.0% −1.1%

3.2% −2.2%

2.1% 2.3%

2.8% −2.6% −1.1% 1.3% 2.5% 2.1%

−4.3% 4.8% 2.5% 1.3% −1.8% −0.6%

−1.1% −1.6% −0.2%

1.9% 1.4% 2.8%

0.5% 0.2% 0.6% −0.4% 0.3% 1.2%

1.9% 2.7% 0.6%

1.0% −1.6% −0.3% 1.2% −2.5% −0.3% 0.6% −0.3% −0.2%

−1.5%

0.0%

0.1%

0.8%

0.8%

0.8% −0.8% −1.1%

−2.1%

3.2%

1.2%

2.0%

1.3%

0.1% −0.8% −1.3%

−2.8%

4.2%

1.2%

2.4%

1.5%

0.6% −0.6% −1.9%

−0.5%

1.1%

0.7%

1.1%

0.6%

−0.4% −0.5% −0.3%

−1.1%

1.9%

1.4%

1.7%

1.2%

−0.6% −1.4% −0.8%

Greenwich International Market Neutral Group Index Greenwich International Equity Market Neutral Index Greenwich International Event-Driven Index Greenwich International Distressed Securities Index Greenwich International Merger Arbitrage Index Greenwich International Special Situations Index Greenwich International Arbitrage Index Greenwich International Convertible Arbitrage Index Greenwich International Fixed Income Arbitrage Index Greenwich International Statistical Arbitrage Index Greenwich International Long/Short Equity Group Index Greenwich International Growth Index Greenwich International Opportunistic Index Greenwich International Short Selling Index Greenwich International Value Index Greenwich International Directional Trading Group Index Greenwich International Futures Index Greenwich International Macro Index Greenwich International Market Timing Index Greenwich International Specialty Strategies Group Index Greenwich International Emerging Markets Index Greenwich International Fixed Income Index Greenwich International Multi-Strategy Index2

Jul-05 Jun-05 May-05 Apr-05 Mar-05

0.0%

193

Appendix C: Historic Performance of Hedge Funds

Feb-05

Jan-05 Dec-04 Nov-04 Oct-04

Sep-04 Aug-04

Jul-04

Jun-04 May-04 Apr-04 Mar-04

1.7%

0.4%

1.5%

2.2%

0.6%

1.1%

0.0% −0.7%

0.4%

−0.7%

−0.9%

0.5%

0.9%

0.3%

1.2%

1.4%

0.2%

0.3%

0.2%

0.0%

0.1%

−0.4%

0.1%

0.4%

1.1%

1.3%

1.2%

1.4% −0.4%

0.8%

0.1% −0.1%

0.4%

−0.1%

−0.7%

0.4%

1.6%

−0.1%

2.2%

2.7%

0.9%

1.1%

0.3% −0.4%

0.9%

−0.4%

0.0%

−0.1%

1.6%

0.3%

2.7%

3.1%

1.2%

1.1%

0.7%

0.4%

1.4%

−0.2%

1.2%

0.6%

0.6%

0.2%

1.2%

1.0%

0.4%

0.2%

0.1% −0.8%

0.0%

0.0%

0.0%

0.0%

1.7% −0.4% 0.4% 0.2%

1.9% 0.6%

2.4% 0.8% 0.8% −0.1%

1.1% −0.2%

0.1% −0.8% 0.6% 0.2% 0.1% −0.4%

−0.4% −0.4%

−0.5% 0.3%

−0.5% 0.6%

−0.6%

0.3%

0.0% −1.2%

−1.3%

0.3%

0.6%

−0.4%

−0.8%

0.5%

0.7% −0.5%

1.2%

0.7%

0.4%

0.6%

0.5%

0.0%

0.3%

0.4%

0.9%

0.2%

0.8%

0.1%

0.5%

1.7%

0.5%

1.2% −0.5%

−0.2%

0.1%

0.8% −0.7%

0.6%

0.1%

0.7%

1.9% 0.9%

0.3% −0.8%

1.9% 1.8%

2.7% 3.5%

0.5% 0.6%

1.7% 1.7%

−0.5% −1.6% −1.0% −3.5%

1.0% 0.6%

−0.6% −0.9%

−1.1% −2.2%

0.3% 0.4%

2.3%

0.2%

1.3%

2.8%

0.6%

1.9%

−0.2%

−1.4%

0.9%

−0.8%

−1.3%

0.4%

−1.2% 2.3%

1.4% 0.8%

−5.3% 2.5%

−6.3% −0.8% −2.3% 2.9% 0.6% 2.0%

1.3% −0.5%

4.2% −0.9% −1.4% 1.4%

−0.8% −0.5%

3.3% −1.0%

−1.8% 0.4%

1.3% −2.1% 1.4% −3.7% 1.1% −0.1%

0.4% 0.1% 0.7%

4.0% 5.8% 2.2%

1.6% 0.9% 2.2% 2.2% 0.8% −0.6%

−1.0% −0.8% −1.7% −1.4% −1.0% −3.3% −0.8% −0.3% −0.1%

−0.7% −0.5% −1.1%

−4.0% −7.3% −0.5%

−0.2% −0.7% 0.6%

1.3%

−0.3%

1.2%

1.0%

0.2%

0.0%

0.4% −1.0%

−0.3%

0.9%

−1.0%

−1.6%

3.1%

1.0%

1.7%

2.9%

1.5%

2.1%

0.8% −0.1%

−0.1%

−1.5%

−2.5%

1.0%

3.9%

1.5%

2.0%

3.6%

1.7%

3.2%

1.4% −0.4%

−0.2%

−2.2%

−3.8%

1.4%

1.6%

0.7%

1.3%

0.9%

0.9%

0.6%

0.8%

0.9%

−0.2%

0.5%

0.1%

2.0%

−0.1%

1.3%

2.4%

1.2%

0.5%

−0.3%

0.1% −0.2%

−0.7%

−0.9%

0.4%

0.6%

(continues)

194

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.10 (Continued) Primary Strategy1 Greenwich International Hedge Fund Index3

Feb-04 Jan-04 Dec-03 Nov-03 Oct-03 Sep-03 Aug-03 1.1%

1.9%

1.8%

Greenwich International Market Neutral Group Index 0.6% 1.5% 0.8% Greenwich International Equity Market Neutral Index 0.8% 1.6% 0.4% Greenwich International Event-Driven Index 0.8% 2.4% 1.7% Greenwich International Distressed Securities Index 1.2% 2.7% 2.0% Greenwich International Merger Arbitrage Index 0.3% 1.0% Greenwich International Special Situations Index 0.6% 2.2% 1.6% Greenwich International Arbitrage Index 0.5% 1.1% 0.6% Greenwich International Convertible Arbitrage Index 0.4% 1.1% Greenwich International Fixed Income Arbitrage Index 0.8% 1.0% Greenwich International Statistical Arbitrage Index 0.0% 0.9% Greenwich International Long/Short Equity Group Index 1.3% 2.3% 1.7% Greenwich International Growth Index 0.5% 2.4% 1.2% Greenwich International Opportunistic Index 1.5% 1.9% 1.4% Greenwich International Short Selling Index 0.1% −1.6% −2.4% Greenwich International Value Index 1.5% 2.8% 2.3% Greenwich International Directional Trading Group Index 3.0% 1.2% 3.1% Greenwich International Futures Index 6.4% 1.5% 4.1% Greenwich International Macro Index 0.1% 0.9% 2.3% Greenwich International Market Timing Index −1.5% 0.0% 1.7% Greenwich International Specialty Strategies Group Index 2.0% 2.3% 4.0% Greenwich International Emerging Markets Index 2.6% 3.0% 5.2% Greenwich International Fixed Income Index 0.0% 0.8% 1.1% Greenwich International Multi-Strategy Index2 1.3% 1.3%

Jul-03

0.7%

2.2%

1.0%

1.7%

0.9%

0.8%

1.2%

0.9%

0.4%

0.3%

0.6%

1.3%

0.4%

1.1%

0.3%

1.2%

2.1%

1.5%

1.1%

1.1%

1.6%

2.6%

2.4%

1.4%

1.4%

1.1% 0.7%

1.8% 0.7%

1.1% 0.9% 1.0% −0.1%

0.9% 0.0%

0.7% 0.5%

3.2% 0.0% 4.4% −0.6%

2.2% 3.0%

1.8% 2.3%

0.4%

3.3%

2.1%

2.4%

0.5%

−1.4% −6.7% 0.7% −3.4% −3.4% 1.2% 3.4% −0.1% 2.4% 1.7% 0.0% −0.2% 0.4%

1.6% 1.2% 2.5% −0.4% 0.6% 3.0%

1.0% −0.7% 0.2% −1.6% 1.4% 0.3%

2.4% −0.2%

1.8%

1.5%

2.8%

0.7%

3.3%

2.4%

3.5%

1.3%

0.9%

4.4%

3.6%

4.8%

1.9%

0.7%

0.9%

1.0%

0.0% −0.8%

195

Appendix C: Historic Performance of Hedge Funds

Jun-03 May-03 Apr-03 Mar-03

Feb-03

Jan-03 Dec-02 Nov-02 Oct-02

Sep-02 Aug-02

Jul-02

1.4%

3.1%

2.4%

0.2%

0.1%

0.6%

0.4%

1.6%

0.6% −1.4%

0.5% −2.3%

0.8%

1.5%

1.6%

0.4%

0.4%

1.2%

0.9%

1.4%

0.3%

0.1%

0.4% −0.9%

0.7%

1.2%

1.3%

−0.3%

−0.2%

0.4%

0.9%

0.8% −0.2%

−0.1%

0.3% −0.1%

2.3%

3.0%

3.2%

0.8%

0.4%

1.2%

0.5%

2.3% −0.3%

−1.2%

−0.2%

−3.2%

2.6%

2.9%

3.4%

1.2%

1.4%

2.2%

1.4%

2.0%

0.1% −1.1%

−0.3%

−1.4%

2.1% 0.2%

3.2% 1.0%

3.1% 1.0%

0.6% −0.4% 0.4% 0.7%

0.5% 1.4%

−0.5% 1.1%

2.6% −0.6% −1.2% 1.3% 0.8% 0.7%

−0.1% −4.3% 0.6% −0.3%

1.7% 3.0%

4.1% 6.8%

2.7% 3.7%

0.1% −0.4% 0.5% −0.8%

0.0% −0.2%

−0.2% −2.1%

1.5% 5.0%

0.1% −2.3% −0.1% −3.5%

1.2%

3.9%

2.5%

0.4% −0.1%

0.8%

1.6%

−1.8% 1.8%

−5.5% 4.3%

−7.2% 3.6%

−1.1% −0.2%

1.2% −0.5%

0.8% −0.5%

−0.8% −2.2% 0.7%

4.6% 6.4% 3.7%

0.6% 0.4% 0.5%

−2.7% −5.5% −0.1%

2.9% 5.4% 1.0%

0.2%

1.7%

1.3%

−0.1%

2.6%

4.5%

3.9%

0.4%

3.7%

5.7%

0.6%

1.3%

0.7% −1.5% 1.1% −1.8% −1.3%

0.2% −1.1%

4.7% −1.5%

−5.9% −4.0% 5.9% 1.8% 1.5% −2.9%

−0.6% 6.7% 0.3% −4.1%

2.5% 5.3% 0.3%

3.0% 6.8% −0.2%

−0.4% −2.9% −2.6% −5.3% 1.4% −0.8%

2.8% 5.1% 0.3%

1.9% 1.5% 3.2% 4.8% 0.1% −2.6%

−0.4%

−0.7%

−1.1%

1.8% −0.5%

1.0%

1.3% −0.3%

0.0%

0.6%

1.1%

2.1%

1.4% −5.2%

1.2% −6.1%

5.2%

0.7% −0.2%

0.1%

0.8%

2.1%

1.4% −7.0%

1.8% −7.8%

2.1%

0.0%

1.2%

1.4%

2.2%

0.6%

0.4%

0.5%

0.8% −0.2%

0.2%

1.2%

(continues)

196

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.10 (Continued) Primary Strategy1

Jun-02 May-02 Apr-02 Mar-02 Feb-02 Jan-02 Dec-01 Nov-01

Greenwich International Hedge Fund Index3

−1.7%

−0.2%

0.3%

1.4%

0.0%

1.1%

1.4%

2.0%

−0.9%

0.0%

0.6%

0.9% −0.4%

1.1%

0.7%

0.6%

−0.5%

0.4%

1.2%

0.3% −0.8%

0.8%

0.8%

1.1%

−2.7%

−0.4%

0.5%

1.5% −0.6%

1.3%

1.9%

0.8%

−1.5%

0.6%

1.0%

0.4%

0.0%

0.5%

0.2%

0.8%

−3.7% −0.2%

−1.8% 0.1%

0.2% 0.5%

2.2% −0.9% 0.8% −0.2%

1.8% 1.2%

2.9% 0.3%

0.8% 0.4%

−1.8% −4.6%

−0.3% 0.0% −1.5% −2.9%

1.7% −0.5% 0.7% 3.5% −1.4% −0.7%

1.0% 0.9%

1.6% 4.0%

−0.7%

−0.6%

1.8% −0.6%

1.2%

0.5%

4.3% −2.6%

2.7% 0.2%

3.5% 8.1% −1.9%

2.1% −0.3% 3.0% −1.0% 1.3% 0.1%

1.3% −1.2% −0.2% 0.6% −2.2% 0.8% −2.8% −1.1% 1.0% −5.8% 1.6% −0.1% 1.4% −0.6% 1.3%

1.3%

0.4%

1.8%

0.8% −0.6%

1.1%

1.0%

−3.3%

−0.7% −0.2%

1.7%

1.5%

2.0%

4.0%

6.4%

−4.4%

−1.1% −0.6%

2.1%

2.4%

3.0%

5.1%

8.7%

0.4%

0.3%

0.7%

1.1%

0.3%

Greenwich International Market Neutral Group Index Greenwich International Equity Market Neutral Index Greenwich International Event-Driven Index Greenwich International Distressed Securities Index Greenwich International Merger Arbitrage Index Greenwich International Special Situations Index Greenwich International Arbitrage Index Greenwich International Convertible Arbitrage Index Greenwich International Fixed Income Arbitrage Index Greenwich International Statistical Arbitrage Index Greenwich International Long/Short Equity Group Index Greenwich International Growth Index Greenwich International Opportunistic Index Greenwich International Short Selling Index Greenwich International Value Index Greenwich International Directional Trading Group Index Greenwich International Futures Index Greenwich International Macro Index Greenwich International Market Timing Index Greenwich International Specialty Strategies Group Index Greenwich International Emerging Markets Index Greenwich International Fixed Income Index Greenwich International Multi-Strategy Index2

1.0%

1.6%

1.2%

0.2%

5.1% −3.3% 2.4% 0.6% 1.6% −0.3%

1.0%

0.1%

3.8% −1.3% −4.9% 1.4% 1.3% 1.7%

197

Appendix C: Historic Performance of Hedge Funds

Oct-01

Sep-01 Aug-01

Jul-01

Jun-01 May-01 Apr-01 Mar-01

Feb-01

Jan-01 Dec-00 Nov-00

1.9% −1.4%

0.0% −1.2%

0.3%

1.3%

1.8%

−0.7%

−1.3%

2.9%

1.4%

−2.0%

0.9% −0.4%

1.1%

0.1%

0.2%

1.0%

1.1%

0.7%

1.3%

1.8%

0.6%

0.3%

0.0%

1.1%

0.2% −0.2%

0.6%

0.9%

1.5%

2.0%

1.5%

2.3%

1.9%

−0.2%

1.8% −1.5%

1.3% −0.8%

0.0%

1.6%

2.0%

−0.1%

0.7%

2.1%

0.1%

−1.1%

1.2% −0.3%

1.4%

2.2%

2.2%

0.6%

0.6%

0.7%

2.1% −0.3%

−0.8%

2.1% −2.2% 1.1% −0.2%

1.2% −1.4% −1.0% 0.9% 0.4% 0.4%

1.4% 1.0%

2.5% 0.9%

−0.4% 0.7%

0.7% 1.1%

2.1% 1.7%

0.4% 0.3%

−1.2% 0.3%

−0.8% −1.2% −3.4% −1.9%

0.3% 1.1%

1.2% 0.7%

2.7% 5.0%

−1.3% −6.3%

−3.0% 2.2% 1.7% −9.5% −1.2% −0.8%

−3.5% −7.2%

0.6% −0.2%

0.2%

0.5%

2.4%

−0.7%

−1.2%

2.7%

3.9%

−1.5%

2.0% −1.0% 2.4% −3.0% 0.3%

1.6%

1.2%

−2.9% 7.3% 3.7% −3.1%

6.8% 3.3% 0.9% −1.3% −2.3% −0.2%

0.8% −9.4% 1.9% 2.7%

6.4% −0.9%

11.5% −3.3%

0.1% 4.0%

1.8% 2.0%

14.1% −5.9%

3.0% 2.6% 3.6% 6.0% 1.6% −0.2%

1.1% −0.8% −0.6% 2.1% −0.7% −0.4% 0.6% −0.8% −1.8%

0.5% −1.0% 0.9% −4.2% −0.3% −0.4%

2.1% 6.2% −1.3%

−1.4% 0.4% 0.3%

1.0% 0.1% 2.1%

5.0% 7.4% 1.4%

1.1% 4.4% −1.4%

4.6% −1.0%

−1.0% −1.1%

0.8%

0.8%

6.4%

−2.0% −11.6%

1.3%

4.3%

−2.4%

3.8% −5.1%

−0.4% −3.8%

1.3%

2.4%

0.9%

−1.6%

−2.1%

6.7%

1.4%

−2.9%

4.5% −6.8%

−0.4% −5.2%

1.4%

3.0%

1.2%

−2.7%

−2.2%

8.4%

1.6%

−3.8%

0.8%

0.8% −1.1%

1.7%

0.7%

1.0%

2.2%

2.9%

0.5% −1.6%

0.9%

0.4%

(continues)

198

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.10 (Continued) Primary Strategy1

Oct-00 Sep-00

Greenwich International Hedge Fund Index3

−1.1% −2.4%

Greenwich International Market Neutral Group Index Greenwich International Equity Market Neutral Index Greenwich International Event-Driven Index Greenwich International Distressed Securities Index Greenwich International Merger Arbitrage Index Greenwich International Special Situations Index Greenwich International Arbitrage Index Greenwich International Convertible Arbitrage Index Greenwich International Fixed Income Arbitrage Index Greenwich International Statistical Arbitrage Index Greenwich International Long/Short Equity Group Index Greenwich International Growth Index Greenwich International Opportunistic Index Greenwich International Short Selling Index Greenwich International Value Index Greenwich International Directional Trading Group Index Greenwich International Futures Index Greenwich International Macro Index Greenwich International Market Timing Index Greenwich International Specialty Strategies Group Index Greenwich International Emerging Markets Index Greenwich International Fixed Income Index Greenwich International Multi-Strategy Index2

Aug-00

Jul-00 Jun-00 May-00 Apr-00 Mar-00

3.8% −0.6%

3.7%

−2.3% −2.8%

2.5%

0.2%

0.3%

1.6%

0.5%

1.6%

0.3%

0.3%

0.7%

0.6%

1.5%

2.3%

0.1%

1.3%

1.1% −2.6%

0.0%

−0.1% −0.6%

1.3%

0.9%

1.8%

0.1%

0.2%

0.5%

0.2%

0.3%

0.4%

0.7%

0.2%

0.2%

0.0%

−0.4% −1.1% 0.1% 0.4%

1.9% 1.4%

1.1% 0.5%

2.3% 1.6%

0.0% 0.1%

0.3% 1.7%

0.7% 1.2%

−1.7% −2.1% −6.4% −4.1%

4.9% −0.7% 10.5% −4.5%

4.6% 8.7%

−2.9% −2.5% −6.5% −5.2%

3.3% 1.9%

−1.9% −1.7%

4.1% −2.3%

4.5%

−4.8% −5.1%

3.0%

0.5%

9.3% 9.2% −10.6% −1.2% −2.9% 4.6%

6.6% −8.2% 0.6% 3.9%

8.4% 16.8% −1.4% −2.5% −3.3% 4.9%

−1.1% −2.8% 1.0% −2.2% −3.6% −3.3%

4.4% −1.9% 0.4% 2.7% −1.3% −2.3% 5.2% −0.7% 1.8%

−0.3% −3.0% −1.1% 1.3% −1.3% −1.4% −3.4% −9.2% −2.6%

−2.7% −3.5%

6.7% −4.1%

3.9%

−0.2% −0.6%

0.6%

−1.8% −5.6%

3.6% −1.3%

4.9%

−4.5% −7.6%

4.2%

−2.8% −7.5%

3.5% −1.7%

5.2%

−5.2% −8.7% −4.9%

2.3% −0.3%

2.6%

−1.6% −1.2% −0.6%

1.9%

0.4%

199

Appendix C: Historic Performance of Hedge Funds

Feb-00

Jan-00

6.3%

1.0%

8.2%

5.0%

1.6%

0.5%

0.1% −0.1%

5.4%

1.0%

6.8%

4.0%

2.0%

1.1%

2.9%

2.9%

0.9%

0.7%

0.0%

1.1%

1.8%

1.7%

3.0%

1.9%

1.9%

1.3%

4.4%

4.4%

0.8%

1.1%

0.8%

1.6%

1.6%

1.1%

2.2%

3.2%

2.4%

0.4%

1.5%

2.9%

0.6%

0.5%

−0.2%

0.6%

2.3%

2.1%

4.2%

2.2%

1.8%

0.3%

0.8%

3.2%

0.1% −0.4%

−0.2%

0.7%

1.4%

1.1%

2.8%

2.0%

2.7% 1.9%

0.5% 1.3%

1.8% 3.2%

2.7% 2.4%

0.8% 1.2%

1.1% 0.7%

−0.2% −0.2%

0.5% 1.1%

2.7% 1.3%

2.6% 1.7%

5.1% 1.2%

2.4% 1.0%

9.1% 15.2%

1.0% 3.1%

8.9% 17.3%

6.1% 10.7%

2.5% 5.7%

1.1% 1.0%

0.8% 1.9%

1.0% 1.3%

4.5% 7.7%

1.4% 1.0%

5.8% 8.5%

1.7% 1.7%

13.3% −0.1%

10.9%

7.8%

1.7%

0.6%

−1.0%

1.4%

3.0%

1.5%

3.3%

1.8%

−9.1% −1.8% 5.3% 2.2%

5.2% 0.2%

2.2% −2.5% 1.4% 7.6%

0.3% 2.1%

−30.4% 9.0%

Dec-99 Nov-99 Oct-99

2.0% −10.4% 0.9% 8.3%

5.5% −0.2% 11.9%

2.5% 2.7% 0.3%

5.3% 1.9% 6.1%

10.1%

3.9%

10.4%

7.0%

6.6%

0.1%

16.8%

7.4%

0.2%

1.9% −1.9%

Sep-99 Aug-99

3.5% −1.4% −0.7% 2.2% −3.4% −0.4% 0.4% 0.2% −0.9%

Jul-99

Jun-99 May-99 Apr-99 Mar-99

3.9% −1.1% −3.6% 0.4% 1.0% 5.4% 0.1% −0.4% −0.5% −0.7% −1.0% 0.5%

5.2% 3.1% 8.2%

−1.3% −1.5% −1.6%

5.0% 3.8% 8.3%

0.4% −1.1% 1.6%

0.8% −0.9%

1.3% −0.6%

6.5%

−0.6%

3.9%

2.1%

6.8%

1.4% −0.3%

−1.0% −2.6%

9.1%

0.4%

11.3%

9.5%

21.2%

9.2%

1.9% −0.4%

−1.4% −3.4%

11.9%

0.8%

13.8%

11.5%

0.9%

0.7%

0.4% −0.2%

0.3% −1.3%

0.4%

−2.1%

2.9%

2.0%

(continues)

200

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.10 (Continued) Primary Strategy1

Feb-99

Jan-99

Dec-98

Nov-98

Oct-98

Sep-98

Greenwich International Hedge Fund Index3

−0.5%

0.0%

0.7%

4.0%

0.4%

−0.1%

−0.2%

1.5%

1.3%

3.2%

−1.1%

−2.0%

−0.4%

0.0%

0.9%

4.0%

−1.1%

−0.5%

−0.6%

1.5%

1.6%

2.9%

1.2%

−2.0%

−1.0%

1.8%

1.3%

2.0%

−0.3%

−1.3%

−0.4% 0.4%

1.3% 2.6%

1.8% 1.3%

3.4% 3.0%

2.1% −3.8%

−2.4% −3.0%

−1.5% −2.2%

2.0% 5.3%

1.4% 6.5%

2.9% 8.0%

0.2% 4.9%

2.1% 8.2%

−0.8%

1.2%

0.4%

2.3%

−3.5%

0.6%

5.5% −3.4%

−1.9% 1.0%

−6.6% 1.3%

−6.7% 4.0%

−13.1% 3.8%

−4.1% 1.6%

−0.6% 1.6% −3.2%

−0.3% −1.4% 0.9%

3.3% 2.5% 4.5%

1.6% −0.6% 2.6%

−0.2% −1.3% −2.6%

2.9% 5.1% 0.8%

−1.7%

0.4%

3.6%

4.9%

3.8%

0.9%

0.6%

−4.2%

−2.8%

6.6%

2.0%

−1.6%

0.6%

−6.1%

−3.9%

7.8%

2.1%

−1.3%

0.8%

0.7%

1.2%

3.0%

0.2%

−4.0%

Greenwich International Market Neutral Group Index Greenwich International Equity Market Neutral Index Greenwich International Event-Driven Index Greenwich International Distressed Securities Index Greenwich International Merger Arbitrage Index Greenwich International Special Situations Index Greenwich International Arbitrage Index Greenwich International Convertible Arbitrage Index Greenwich International Fixed Income Arbitrage Index Greenwich International Statistical Arbitrage Index Greenwich International Long/Short Equity Group Index Greenwich International Growth Index Greenwich International Opportunistic Index Greenwich International Short Selling Index Greenwich International Value Index Greenwich International Directional Trading Group Index Greenwich International Futures Index Greenwich International Macro Index Greenwich International Market Timing Index Greenwich International Specialty Strategies Group Index Greenwich International Emerging Markets Index Greenwich International Fixed Income Index Greenwich International Multi-Strategy Index2

201

Appendix C: Historic Performance of Hedge Funds

Aug-98

Jul-98

Jun-98

May-98

Apr-98

Mar-98

Feb-98

Jan-98

−9.9%

0.3%

−2.2%

−1.6%

−0.7%

3.2%

6.4%

−1.7%

−4.1%

−0.3%

0.6%

0.0%

1.1%

2.6%

1.6%

0.6%

−0.9%

−1.5%

2.7%

−0.8%

0.3%

2.1%

2.3%

−0.7%

−7.9%

−0.4%

−0.5%

0.1%

1.4%

2.9%

1.5%

1.5%

−6.6%

0.2%

−0.2%

0.2%

1.5%

1.5%

1.8%

0.9%

−8.3% −1.6%

−0.7% 0.4%

−0.6% 0.8%

0.0% 0.1%

1.3% 1.3%

4.0% 2.5%

1.3% 1.2%

1.8% 0.3%

−8.4% −13.5%

−0.8% −1.7%

0.7% 3.4%

−0.9% −2.8%

0.6% 0.7%

4.0% 5.1%

5.5% 9.7%

−0.7% −0.2%

−6.6%

−0.9%

0.1%

−1.1%

−0.4%

2.9%

4.8%

−0.3%

20.6% −12.9%

3.5% −1.1%

0.2% −0.3%

7.9% −1.0%

−1.2% 1.3%

0.0% 4.9%

−6.9% 5.9%

−2.7% −0.9%

−3.1% 9.4% −3.8%

−0.1% −1.0% 1.7%

0.4% 0.3% −0.4%

0.4% 2.5% −1.9%

−1.8% −2.9% −0.9%

4.0% 2.8% 5.7%

2.4% 1.3% 3.5%

0.9% 2.3% −1.1%

−12.2%

−0.6%

1.7%

−0.7%

−0.7%

4.0%

3.5%

1.0%

−17.3%

2.0%

−7.7%

−5.4%

−3.0%

2.2%

11.3%

−6.2%

−20.1%

2.6%

−9.1%

−7.5%

−3.4%

2.3%

13.2%

−7.9%

−7.3%

0.5%

−2.5%

−0.7%

−0.1%

0.9%

1.4%

1.0%

202

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.11 Greenwich US YTD Hedge Fund Index3 Primary Strategy1

2007 2006 2005 2004

2003

2002 2001 2000

1999

1998

Greenwich US Hedge Fund Index3 11.2% 11.9% 7.1% 8.4% 19.7% −0.4% 5.8% 11.4% 42.4% 12.6% Greenwich US Market Neutral Group Index 8.9% 11.8% 4.8% 8.5% 12.8% 5.5% 8.6% 15.3% 28.9% 7.4% Greenwich US Equity Market Neutral Index 9.0% 6.9% 5.6% 6.5% 6.2% 6.9% 11.8% 23.6% 28.8% 8.2% Greenwich US Event-Driven Index 10.1% 13.6% 6.9% 14.2% 22.6% −1.6% 5.2% 13.6% 33.2% 5.9% Greenwich US Distressed Securities Index 7.2% 14.6% 9.3% 19.9% 26.3% 1.9% 16.1% 2.1% 13.7% −1.0% Greenwich US Merger Arbitrage Index 7.8% 13.8% 5.7% 3.3% Greenwich US Special Situations Index 12.3% 12.8% 5.9% 12.1% 21.0% −3.9% 1.3% 18.2% 42.2% 8.9% Greenwich US Arbitrage Index 7.7% 12.0% 2.2% 4.6% 8.7% 8.5% 10.0% 11.5% 20.9% 9.1% Greenwich US Convertible Arbitrage Index −0.2% 13.3%−3.2% 1.7% Greenwich US Fixed Income Arbitrage Index 11.5% 9.0% 5.6% 5.8% Greenwich US Statistical Arbitrage Index 11.2% 13.4% 1.1% 2.5% Greenwich US Long/Short Equity Group Index 12.1% 13.6% 9.2% 8.6% 24.4% −4.1% 3.4% 10.2% 51.0% 18.2% Greenwich US Growth Index 14.4% 13.9% 5.2% 7.5% 28.0%−13.3%−6.2%−0.1% 76.9% 35.2% Greenwich US Opportunistic Index 17.7% 10.9% 11.6% 7.5% 28.5% −1.8% 1.0% 14.9% 62.8% 18.4% Greenwich US Short Selling Index 10.0%−4.4% 5.0%−8.9%−22.6% 32.1% 8.2% 23.9%−23.7%−15.0% Greenwich US Value Index 9.6% 14.9% 9.4% 11.4% 25.2% −3.9% 12.7% 13.3% 44.3% 13.3% Greenwich US Directional Trading Group Index 11.3% 4.7% 3.9% 7.6% 14.3% 6.8% 3.9% 14.5% 23.7% 25.1% Greenwich US Futures Index 7.8% 3.7% 2.6% 11.3% 13.2% 16.9% 4.3% 15.6% −2.3% 17.4% Greenwich US Macro Index 16.0% 7.3% 7.9% 1.5% 19.5% 6.3% 2.1% 2.6% 70.0% 4.1% Greenwich US Market Timing Index 9.4% 7.8%−0.1% 3.8% 11.3% −9.7% 3.7% 15.8% 43.4% 54.4% Greenwich US Specialty Strategies Group Index 15.7% 14.4% 9.7% 10.5% 22.3% 1.4% 12.2% 8.7% 33.5% −9.1% Greenwich US Emerging Markets Index 26.5% 18.6% 15.9% 19.0% 38.4% 11.2% 15.7%−3.2% 54.2%−38.1% Greenwich US Fixed Income Index 3.7% 10.0% 7.4% 10.3% 11.4% 6.2% 10.8% 15.6% 7.3% 6.8% Greenwich US Multi-Strategy Index2 14.3% 13.0% 6.9% 4.9% 21.6%−13.8% 8.3% 11.6% 43.6% 8.5%

203

Appendix C: Historic Performance of Hedge Funds

TABLE C.12 Greenwich Quarterly US Hedge Fund Index3 Primary Strategy1 Greenwich US Hedge Fund Index3

4Q07

3Q07

2Q07

1Q07

4Q06

3Q06

2Q06

1Q06

2.10%

1.39%

4.69%

2.62%

4.88%

0.84%

0.50%

5.30%

Greenwich US Market Neutral Group Index 1.32% 0.82% 3.00% 3.50% 3.75% 1.55% 1.68% 4.40% Greenwich US Equity Market Neutral Index 3.51% −0.06% 2.66% 2.61% 2.99% −0.08% 1.29% 2.60% Greenwich US Event-Driven Index 0.79% 0.74% 3.63% 4.61% 5.14% 1.34% 1.29% 5.30% Greenwich US Distressed Securities Index −0.19% −0.95% 3.75% 4.47% 5.22% 1.29% 2.51% 4.94% Greenwich US Merger Arbitrage Index −1.18% 1.30% 3.49% 4.02% 4.19% 1.53% 1.88% 5.59% Greenwich US Special Situations Index 1.63% 1.75% 3.57% 4.90% 5.17% 1.25% 0.29% 5.64% Greenwich US Arbitrage Index 0.87% 1.22% 2.49% 2.91% 2.87% 2.38% 2.22% 4.05% Greenwich US Convertible Arbitrage Index −2.83% −1.59% 0.88% 3.47% 2.40% 2.92% 2.37% 5.05% Greenwich US Fixed Income Arbitrage Index 2.52% 2.75% 2.92% 2.85% 2.50% 2.19% 1.76% 2.29% Greenwich US Statistical Arbitrage Index 2.05% 2.72% 3.36% 2.60% 3.68% 2.23% 2.17% 4.76% Greenwich US Long/Short Equity Group Index 1.67% 1.82% 5.09% 3.05% 5.80% 1.28% −0.75% 6.86% Greenwich US Growth Index 1.93% 3.02% 5.84% 2.97% 6.41% 1.25% −2.24% 8.13% Greenwich US Opportunistic Index 3.33% 4.94% 5.07% 3.27% 6.10% −0.87% −1.89% 7.45% Greenwich US Short Selling Index 8.19% 3.40% −1.90% 0.20% −4.51% 0.20% 5.41% −5.21% Greenwich US Value Index 0.81% 0.31% 5.12% 3.13% 5.94% 1.85% −0.27% 6.79% Greenwich US Directional Trading Group Index 5.05% 0.61% 6.79% −1.38% 4.00% −2.93% 1.46% 2.25% Greenwich US Futures Index 5.70% −2.93% 9.33% −3.87% 4.20% −3.81% 1.23% 2.18% Greenwich US Macro Index 4.57% 5.34% 3.20% 2.05% 3.59% −0.86% 1.92% 2.50% Greenwich US Market Timing Index 1.03% 3.98% 4.23% −0.05% 4.13% 0.21% 0.74% 2.59% Greenwich US Specialty Strategies Group Index 2.77% 2.85% 5.75% 3.48% 5.84% 1.93% 0.52% 5.54% Greenwich US Emerging Markets Index 5.24% 7.21% 9.65% 2.25% 9.24% 0.86% −1.12% 8.90% Greenwich US Fixed Income Index 0.22% −1.54% 2.66% 2.37% 2.95% 2.63% 1.61% 2.44% Greenwich US Multi-Strategy Index2 2.66% 1.39% 4.24% 5.32% 5.18% 1.77% 0.94% 4.62%

© 2008 Greenwich Alternative Investments, LLC and/or its licensors. 1 Please see Explanatory Notes. 2 Until Jan. 2004, the “Multi-Strategy” category was named “Several Strategies.” 3 Beginning with the final August 2004 Index, funds of funds are no longer included in the Greenwich US Hedge Fund Index. Historical returns for the Index have been restated to exclude funds of funds. 4 Index returns from January 1988 to December 2002 are based on quarterly index results, while returns from January 2003 to present are based on monthly index results. (continues)

204

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.12 (Continued) Primary Strategy1

4Q05 3Q05

2Q05

1Q05

4Q04

3Q04

2Q04

1Q04

Greenwich US Hedge Fund Index3

1.8%

0.9%

0.1%

5.7%

0.6% −1.0%

3.0%

3.2% −0.1%

0.6%

4.5%

1.0%

0.0%

2.8%

2.3% 3.8%

1.4% 1.4%

3.1% 8.0%

1.8% −1.0% 0.6% 1.0%

2.5% 4.1%

4.8% 0.2% 2.1% 2.0% 0.8% 1.6% 3.8% 0.5% 1.1% 2.8% −1.2% −0.3%

8.0% 1.5% 4.2% 2.8% −0.6% −0.1% 8.0% 0.3% −0.3% 1.9% 0.9% −0.4%

4.9% 1.2% 3.8% 2.1%

3.9% −4.1% −3.2%

1.4%

1.1% −2.6%

1.8%

2.1%

0.7%

1.4%

1.2%

2.4%

2.1% −1.6%

1.5%

0.5%

Greenwich US Market Neutral Group Index 1.0% Greenwich US Equity Market Neutral Index 1.0% Greenwich US Event-Driven Index 1.2% Greenwich US Distressed Securities Index 2.0% Greenwich US Merger Arbitrage Index 1.2% Greenwich US Special Situations Index 0.5% Greenwich US Arbitrage Index 0.9% Greenwich US Convertible Arbitrage Index 0.3% Greenwich US Fixed Income Arbitrage Index 1.5% Greenwich US Statistical Arbitrage Index 0.4% Greenwich US Long/Short Equity Group Index 1.9% Greenwich US Growth Index 1.4% Greenwich US Opportunistic Index 1.5% Greenwich US Short Selling Index −1.5% Greenwich US Value Index 2.2% Greenwich US Directional Trading Group Index 2.6% Greenwich US Futures Index 3.3% Greenwich US Macro Index 2.3% Greenwich US Market Timing Index −0.9% Greenwich US Specialty Strategies Group Index 3.0% Greenwich US Emerging Markets Index 4.7% Greenwich US Fixed Income Index 1.5% 2 Greenwich US Multi-Strategy Index 2.5%

4.3%

0.8% 0.4%

0.7%

1.2%

1.2% −0.2% −0.3%

5.9% 1.7% −0.5% 6.7% 0.0% −1.3% 3.1% 5.7% 2.4% −4.0% 9.8% −1.6% −2.9% 2.5% 8.4% 2.2% −0.7% 5.6% −0.2% −1.4% 3.4% 1.6% −0.4% 5.4% −11.5% 4.7% 1.3% −3.0% 5.4% 1.3% 0.3% 7.3% 0.7% −0.8% 3.9% 2.0% 1.0% 4.8% 1.1%

1.5% 1.6% 1.3% 1.0%

−2.2% −3.2% −0.6% −1.2%

9.0% 0.7% −7.2% 12.0% 1.4% −9.7% 3.9% −0.8% −4.4% 3.4% 0.4% −1.5%

5.7% 8.4% 3.0% 1.5%

4.1%

1.4%

0.9%

5.7%

3.3% −2.1%

3.3%

6.9% 2.0% 3.6%

2.0% 1.5% 1.7% 2.0% 0.8% −0.1%

10.3% 3.4% 3.5%

6.7% −5.5% 3.7% 0.6% 1.1% −1.3%

7.1% 2.2% 1.6%

205

Appendix C: Historic Performance of Hedge Funds

4Q03

3Q03

2Q03

1Q03

4Q02

2Q02

1Q02

4Q01

3Q01

2Q01

1Q01

6.1%

3.5%

8.3%

0.6%

3.7%

−3.8% −1.5%

1.4%

6.3%

−3.9%

4.9%

−1.3%

3.8%

1.8%

4.3%

2.3%

3.5%

−0.7%

0.9%

1.7%

2.1%

1.0%

2.3%

2.9%

2.0% 6.6%

1.2% 4.2%

2.5% 8.2%

0.3% 2.0%

0.6% 3.6%

1.8% 3.7% −5.1% −1.7%

0.7% 1.8%

2.5% 1.7%

1.1% 0.2%

3.8% 2.1%

3.9% 1.1%

7.1%

5.0%

7.5%

4.6%

3.8%

−4.4%

0.5%

2.2%

2.2%

1.2%

7.9%

4.0%

6.4% 2.5%

3.9% 0.6%

8.6% 2.2%

0.7% 3.1%

3.4% 4.3%

−5.5% −3.2% 0.8% 1.1%

1.6% 2.1%

1.4% 2.2%

−0.3% 1.7%

0.2% 1.8%

0.0% 4.0%

7.5% 4.6% 11.4% −0.6% 3.9% 7.0% 5.2% 15.5% −1.5% 3.2% 8.5% 6.1% 11.9% −0.3% 3.0% −8.2% −5.5% −12.4% 1.9% −3.6% 8.3% 4.6% 10.7% −0.2% 5.5%

3Q02

−5.6% −5.3% −6.2% 15.8% −7.8%

−3.3% 1.1% 9.1% −7.7% 6.1% −3.2% −8.4% −3.1% 10.0% −10.7% 6.9% −10.7% −1.4% 3.1% 6.0% −3.7% 3.0% −3.9% 13.0% 4.7% −8.8% 17.4% −12.1% 15.0% −3.1% 2.0% 12.7% −10.3% 9.7% 1.6%

5.9% 0.8% 5.7% −0.8% 7.1% 3.5% 4.7% 1.9%

3.9% 3.2% 1.5% 2.4% 5.5% −1.6% 5.8% 1.8% 11.7% 4.9% −0.5% −0.3%

3.1% 4.0% −1.9% 2.4% 11.8% 10.5% −3.8% −1.2% −4.9% 2.2% −2.1% 8.0% −6.0% −4.7% 1.1% 5.1%

−0.4% 2.5% −9.9% 1.0%

1.3% −4.3% 4.9% 8.3%

0.6% 7.6% 0.0% −9.8%

6.8%

3.7%

9.0%

1.2%

3.5%

−5.0% −0.5%

3.6%

6.7%

−0.1%

4.6%

0.6%

11.7% 4.0% 4.4%

8.9% 0.6% 3.6%

13.5% 4.2% 11.4%

0.2% 2.1% 0.9%

5.1% −2.5% −0.6% 1.6% 0.0% 2.6% 3.9% −12.7% −5.8%

9.2% 1.9% 0.9%

13.8% 0.6% 6.4%

−5.2% 3.6% −0.6%

5.9% 3.7% 4.7%

1.3% 2.5% −2.2% (continues)

206

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.12 (Continued) Primary Strategy1 Greenwich US Hedge Fund Index3

4Q00

3Q00

2Q00

1Q00

4Q99

−2.7%

3.2%

0.4%

10.5%

21.1%

3Q99

2Q99

1Q99

2.2% 10.4%

4.2%

Greenwich US Market Neutral Group Index 1.4% 4.1% 2.3% 6.8% 10.9% 2.0% 9.8% 3.8% Greenwich US Equity Market Neutral Index 5.1% 4.8% 4.2% 7.7% 11.3% 5.0% 7.2% 2.8% Greenwich US Event-Driven Index −0.9% 5.3% 1.4% 7.4% 13.3% −0.2% 12.6% 4.6% Greenwich US Distressed Securities Index −3.9% 1.6% −0.2% 4.8% 3.4% −1.1% 7.8% 3.1% Greenwich US Merger Arbitrage Index Greenwich US Special Situations Index 0.5% 6.5% 2.0% 8.3% 17.5% 0.3% 14.8% 5.1% Greenwich US Arbitrage Index 1.3% 2.2% 2.2% 5.4% 6.9% 2.4% 6.7% 3.5% Greenwich US Convertible Arbitrage Index Greenwich US Fixed Income Arbitrage Index Greenwich US Statistical Arbitrage Index Greenwich US Long/Short Equity Group Index −4.9% 3.5% −0.9% 13.0% 27.5% 3.0% 10.7% 3.9% Greenwich US Growth Index −11.6% 2.0% −3.0% 14.2% 38.8% 4.6% 14.3% 6.6% Greenwich US Opportunistic Index −3.1% 3.2% −3.7% 19.3% 34.5% 3.3% 12.0% 4.6% Greenwich US Short Selling Index 26.5% 4.4% 18.5% −20.8% −25.7% 9.1% −7.4% 1.6% Greenwich US Value Index −3.9% 4.6% −0.3% 13.1% 24.4% 1.4% 11.1% 3.0% Greenwich US Directional Trading Group Index 7.2% −0.2% −0.8% 7.9% 12.4% 0.4% 7.4% 2.1% Greenwich US Futures Index 18.0% −0.7% −1.4% 0.1% −2.8% −0.7% 3.1% −1.8% Greenwich US Macro Index −6.8% −0.2% −4.0% 14.9% 34.8% 0.7% 20.1% 4.3% Greenwich US Market Timing Index −1.8% 0.5% 1.1% 16.1% 23.7% 2.1% 5.8% 7.3% Greenwich US Specialty Strategies Group Index −0.7% 1.7% 0.9% 6.7% 15.8% −0.5% 10.1% 5.2% Greenwich US Emerging Markets Index −3.6% −5.3% −3.0% 9.3% 30.4% −3.5% 16.5% 5.2% Greenwich US Fixed Income Index 4.0% 5.4% 4.2% 1.2% 3.8% −0.6% 1.6% 2.4% 2 Greenwich US Multi-Strategy Index −2.2% 3.3% 1.9% 8.4% 19.7% 2.4% 9.0% 7.5%

207

Appendix C: Historic Performance of Hedge Funds

4Q98

3Q98

2Q98

1Q98

4Q97

3Q97

2Q97

1Q97

4Q96

3Q96

2Q96

1Q96

10.2%

−6.1%

1.0%

7.7% −0.1%

11.7%

7.8%

1.2%

4.5%

2.5%

6.4%

5.3%

4.7%

−4.7%

1.5%

6.0%

3.1%

7.7%

6.0%

3.4%

4.3%

4.8%

6.2%

6.3%

5.2% 5.2%

−3.5% −7.0%

1.5% 0.9%

5.0% 7.3%

3.2% 3.2%

7.5% 8.6%

4.9% 7.2%

2.6% 2.9%

3.6% 4.7%

5.7% 4.3%

7.3% 6.5%

6.6% 7.1%

0.9%

−7.7%

2.7%

3.5%

0.7%

7.3%

3.7%

2.4%

2.9%

3.1%

8.1%

5.3%

7.2% 3.6%

−6.7% −1.9%

0.5% 2.6%

8.3% 4.6%

4.0% 2.7%

9.1% 6.3%

8.3% 5.1%

3.0% 5.4%

5.3% 4.2%

4.8% 4.9%

6.1% 4.7%

7.7% 4.5%

13.7% −5.8% 27.4% −7.2% 10.3% −2.2% −26.4% 19.5% 14.6% −10.0% 7.6% 0.4% −3.7% 27.2%

1.9% 8.3% −1.3% 14.4% 9.0% −0.4% 3.0% 11.0% −4.3% 17.0% 11.9% −7.1% 2.4% 7.2% −1.5% 14.5% 8.2% 2.7% 5.3% −8.2% 15.2% −5.0% −8.2% 14.4% 0.8% 9.0% −1.5% 14.9% 9.9% 0.4%

7.7% 14.4% −0.8% 2.8%

1.0% −0.2% −2.8% 6.6%

8.4% −16.8%

−5.5%

6.9% 2.4% 12.1% 10.8%

3.1% 4.5% 5.4% 0.7%

6.6% 1.9% 3.4% −1.5% 9.4% 2.4% 10.0% 6.8%

4.5% 1.3% 6.3% 5.5% 0.7% 1.3% 7.5% 5.0% 6.3% 3.0% 5.4% 5.5% 4.8% −4.6% −2.6% −3.4% 5.6% 1.4% 6.9% 6.6%

6.2% 9.6% 8.9% 12.4% 9.3% 7.5% 0.7% 6.4%

2.2% 1.8% 0.5% 4.6%

4.1% −0.2% 6.0% −1.3% 4.0% −1.9% 1.0% 2.9%

6.6% −3.9%

8.9%

6.8%

2.7%

4.3%

1.3%

9.6%

3.9%

13.7% −36.7% −13.9% −0.1% −9.3% 3.5% −1.7% −1.8% 6.9% −1.9% 7.9% −9.9% −0.4% 12.1% −0.9%

9.2% 6.6% 9.8%

12.3% 4.8% 4.5%

7.2% 1.3% 0.1%

5.3% 2.6% 4.9%

1.9% 2.3% 0.2%

17.5% 2.7% 6.6%

4.2% 3.0% 4.2% (continues)

208

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.12 (Continued) Primary Strategy1

4Q95

3Q95

2Q95

1Q95

4Q94

2Q94

1Q94

Greenwich US Hedge Fund Index3

3.5%

8.2%

6.5%

3.8%

−1.1%

3.9% −0.3%

−0.6%

5.4%

5.1%

4.7%

−0.7%

2.9%

0.4%

0.8%

6.7% 6.2%

5.0% 6.1%

2.4% 5.1%

0.7% −2.2%

1.7% 1.6% 4.7% −0.7%

0.2% 0.7%

4.4%

5.4%

4.8%

−2.2%

3.5% −1.4%

2.9%

6.8% 2.4%

6.5% 4.8%

5.2% 3.5%

−2.1% 0.2%

5.3% −0.3% 1.5% 0.8%

−0.3% 1.3%

10.3% 8.6% 12.4% 10.2% 9.5% 6.7% −4.8% −10.3% 11.0% 7.7%

5.3% 4.7% 4.3% 0.0% 5.6%

−0.7% 4.4% −0.2% 1.5% 6.4% −4.6% −2.0% 3.7% 1.7% 3.8% −9.2% 15.2% −2.3% 4.7% 0.4%

−0.4% −2.5% 0.3% 4.7% 0.2%

0.2% 6.7% 3.4% 14.3% −5.1% −2.2% 3.0% 2.7%

−1.0% −2.4% 3.3% 1.6% −4.7% 8.9% −5.7% −0.6% −4.9% −0.4% 0.8% 2.1%

−3.1% −2.0% −6.3% 0.6%

7.4% −1.5%

−3.6%

Greenwich US Market Neutral Group Index 3.3% Greenwich US Equity Market Neutral Index 2.9% Greenwich US Event-Driven Index 2.8% Greenwich US Distressed Securities Index 2.7% Greenwich US Merger Arbitrage Index Greenwich US Special Situations Index 2.9% Greenwich US Arbitrage Index 4.4% Greenwich US Convertible Arbitrage Index Greenwich US Fixed Income Arbitrage Index Greenwich US Statistical Arbitrage Index Greenwich US Long/Short Equity Group Index 3.9% Greenwich US Growth Index 4.5% Greenwich US Opportunistic Index 5.3% Greenwich US Short Selling Index 6.4% Greenwich US Value Index 2.5% Greenwich US Directional Trading Group Index 6.9% Greenwich US Futures Index 7.5% Greenwich US Macro Index 13.6% Greenwich US Market Timing Index 0.1% Greenwich US Specialty Strategies Group Index 1.5% Greenwich US Emerging Markets Index −1.8% Greenwich US Fixed Income Index 2.6% 2 Greenwich US Multi-Strategy Index 3.0%

3.3% −2.5% 12.5% 2.1%

0.7%

3Q94

4.8%

9.0%

2.5% 4.9% 5.6%

9.8% −8.4% −11.6% 18.0% −1.5% −10.9% 3.5% 1.3% 0.1% 2.8% −0.2% −3.5% 7.0% 5.7% −1.3% 3.6% −2.0% 0.2%

−3.9%

209

Appendix C: Historic Performance of Hedge Funds

4Q93

3Q93

2Q93

1Q93

4Q92

3Q92

2Q92

1Q92

4Q91

3Q91

2Q91

1Q91

5.3%

6.8%

5.6%

5.7%

7.9%

4.0%

0.4%

5.4%

6.0%

8.1%

2.4%

13.5%

5.3%

5.0%

5.8%

6.4%

4.6%

3.2%

1.5%

7.0%

5.3%

4.7%

3.9%

9.4%

5.0% 6.5%

4.8% 5.8%

6.5% 6.8%

4.8% 8.3%

4.4% 6.4%

5.0% 2.2%

−0.6% 0.9%

6.4% 9.4%

5.7% 5.2%

5.8% 6.0%

0.9% 6.3%

11.0% 10.9%

6.6%

3.8%

7.8%

10.1%

6.2%

2.4%

2.4%

13.9%

5.1%

9.0%

8.0%

11.8%

6.4% 3.9%

6.8% 4.0%

6.4% 3.8%

7.4% 4.8%

6.5% 1.8%

2.1% 3.6%

0.3% 3.8%

7.6% 3.4%

5.3% 5.0%

4.5% 1.8%

5.4% 2.3%

10.5% 6.1%

4.1% 3.4% 6.3% −0.3% 3.9%

7.7% 8.2% 7.8% −3.7% 8.9%

5.1% 5.7% 6.8% −1.8% 4.5%

5.3% 3.2% 7.3% 0.6% 6.7%

10.1% 14.3% 10.2% −8.5% 9.3%

4.1% 4.4% 5.7% 3.0% 3.1%

−0.6% −5.2% 2.1% 14.7% −0.6%

4.5% 4.3% 6.3% −1.9% 4.8%

6.2% 9.0% 8.6% −2.6% 4.2%

9.3% 10.9% 12.9% −0.3% 7.9%

1.7% 1.0% 2.0% 4.0% 1.5%

15.3% 21.1% 14.5% −18.7% 17.7%

30.3% 53.3% 10.1% 2.2%

5.6% 3.3% 11.6% 2.4%

8.8% 8.9% 10.1% 6.1%

6.2% 6.9% 7.9% 2.6%

2.0% 0.4% 2.8% 5.6%

9.8% 10.7% 10.3% 4.5%

5.4% 7.4% 5.1% −0.4%

−5.1% −10.7% −0.9% 3.5%

15.8% 22.5% 11.8% 4.2%

6.9% −2.3% 17.4% 13.1%

0.3% −0.6% −1.8% 5.6%

6.6% −1.4% 8.6% 23.9%

11.9%

7.3%

5.7%

6.0%

6.4%

2.2%

1.5%

8.1%

6.0%

6.5%

3.1%

15.1%

34.1% 4.6% 4.4%

8.0% 3.9% 8.6%

12.0% 4.8% 3.4%

8.3% 6.0% 5.3%

5.3% 0.5% 9.3%

−0.1% 6.7% 1.5%

4.4% 2.8% −0.1%

16.2% 6.1% 6.3%

5.5% 7.8% 5.4%

5.4% 7.9% 6.4%

8.3% 5.0% 0.4%

19.1% 4.9% 17.6% (continues)

210

THE LONG AND SHORT OF HEDGE FUNDS

TABLE C.12 (Continued) Primary Strategy1

4Q90

3Q90

2Q90

1Q90

4Q89

Greenwich US Hedge Fund Index3

3.9%

−4.4%

5.6%

2.3%

1.7%

2.9%

1.0%

4.0%

3.4%

1.6%

3.6% 3.2%

5.0% −2.3%

4.9% 5.1%

7.1% 3.6%

1.2% 0.0%

−0.3%

−1.6%

2.4%

6.1%

1.4%

4.9% 2.0%

−2.7% 4.6%

6.2% 1.6%

2.7% 1.2%

−0.4% 3.9%

4.2% 6.2% 3.4% −3.9% 4.6%

−7.7% −13.0% −6.3% 30.7% −10.6%

6.2% 8.5% 5.2% 1.7% 5.8%

1.4% 2.6% 1.3% 7.6% −0.3%

1.5% 0.4% 0.0% 16.3% 0.4%

1.7% −0.9% 2.6% 7.0%

17.6% 35.9% 0.7% −2.5%

4.3% 2.7% 4.8% 7.3%

12.4% 21.9% 3.8% 6.8%

4.4% 5.8% 2.2% 4.5%

4.4%

−3.0%

6.9%

3.1%

2.7%

10.9% 2.1% 2.7%

−10.8% 1.1% −1.5%

14.1% 4.6% 5.3%

13.0% 2.1% −0.4%

5.7% 2.0% 1.7%

Greenwich US Market Neutral Group Index Greenwich US Equity Market Neutral Index Greenwich US Event-Driven Index Greenwich US Distressed Securities Index Greenwich US Merger Arbitrage Index Greenwich US Special Situations Index Greenwich US Arbitrage Index Greenwich US Convertible Arbitrage Index Greenwich US Fixed Income Arbitrage Index Greenwich US Statistical Arbitrage Index Greenwich US Long/Short Equity Group Index Greenwich US Growth Index Greenwich US Opportunistic Index Greenwich US Short Selling Index Greenwich US Value Index Greenwich US Directional Trading Group Index Greenwich US Futures Index Greenwich US Macro Index Greenwich US Market Timing Index Greenwich US Specialty Strategies Group Index Greenwich US Emerging Markets Index Greenwich US Fixed Income Index Greenwich US Multi-Strategy Index2

211

Appendix C: Historic Performance of Hedge Funds

3Q89

2Q89

1Q89

4Q88

3Q88

2Q88

1Q88

6.4%

7.1%

7.3%

3.7%

1.9%

7.8%

10.5%

4.0%

4.6%

5.9%

3.8%

3.0%

11.1%

13.5%

4.6% 4.5%

3.8% 5.0%

6.9% 8.3%

4.8% 4.1%

3.3% 5.3%

5.6% 6.4%

5.9% 19.8%

5.4%

4.7%

9.9%

2.8%

7.6%

12.8%

29.7%

4.3% 2.9%

5.1% 4.5%

8.1% 2.3%

4.3% 2.7%

5.0% 0.1%

5.6% 19.9%

18.5% 9.7%

7.1% 10.5% 6.9% 0.1% 6.1%

8.5% 10.5% 9.6% 8.8% 6.6%

7.7% 8.4% 11.4% −0.4% 7.0%

3.8% 3.0% 2.8% 7.9% 4.0%

1.2% 0.5% 1.2% 5.2% 0.8%

6.3% 5.4% 8.6% 2.4% 6.5%

9.0% 10.3% 9.2% −0.5% 9.7%

−2.1% −12.4% 9.2% 4.3%

10.8% 14.0% 8.1% 9.0%

9.6% 9.1% 11.4% 6.9%

4.1% 5.0% 2.7% 4.4%

0.1% −5.1% 6.5% 2.6%

14.6% 20.6% 8.7% 8.1%

−0.8% −10.8% 11.1% 4.3%

10.7%

6.7%

8.6%

3.3%

1.1%

6.0%

11.2%

27.5% 2.5% 6.9%

13.4% 4.4% 4.5%

15.4% 2.5% 9.1%

7.1% 2.4% 1.7%

−3.6% 2.7% 3.0%

10.0% 2.4% 6.4%

15.9% 3.2% 14.7%

Glossary

Absolute-return fund A fund that tries to perform positively for investors regardless of market conditions. The fund is not benchmarked against traditional long-only indices because it is able to go long and short to provide returns to investors. Accredited investor Under the Securities Act of 1933, a company that offers or sells its securities must register the securities with the SEC or find an exemption from the registration requirements. The Act provides companies with a number of exemptions. For some of the exemptions, such as rules 505 and 506 of Regulation D, a company may sell its securities to what are known as accredited investors. The federal securities laws define the term accredited investor in Rule 501 of Regulation D as:

1. a bank, insurance company, registered investment company, business development company, or small business investment company; 2. an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million; 3. a charitable organization, corporation, or partnership with assets exceeding $5 million; 4. a director, executive officer, or general partner of the company selling the securities; 5. a business in which all the equity owners are accredited investors; 6. a natural person who has individual net worth, or joint net worth with the person’s spouse, that exceeds $1 million at the time of the purchase; 7. a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or 8. a trust with assets in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.1

213

214

GLOSSARY

Administrator A service provider hired by the hedge fund to calculate the overall performance and net asset value for the fund, as well as to perform other recordkeeping functions. Alpha The return as measured by the fund’s performance over the risk-free rate and/or other performance measurement tools, including, but not limited to, traditional and nontraditional indices. Alternative assets Any investment vehicle that is not considered a traditional or long-only fund. Alternative assets include hedge funds, private equity funds, and commodities pools that are not regulated under the Securities Act of 1940. Annual rate of return The compounded gain or loss in a fund’s net asset value during a calendar year. Arbitrage An investment strategy that attempts to take advantage of the mispricing of securities from one market to another. Assets under management Includes all investments, leveraged and unleveraged, including cash, that are overseen by a fund manager. Average annual return (annualized rate of return) Cumulative gains and losses divided by the number of years of a fund’s existence, that takes into account compounding. Average monthly return Cumulative gains and losses divided by the number of months of the investment’s life, with compounding taken into account. Average rate of return The mean average of a fund’s returns over a given number of periods. It is calculated by dividing the sum of the rates of return over those periods by the number of periods. Back-test Attempts to determine the effectiveness of an investment model by applying the system to past periods and comparing those results with the actual performance of other strategies. Bear market Prolonged period of falling prices.* Bull market Prolonged period of rising prices.* Clearing The process of reconciling transactions between the manager and the broker once a trade is entered and executed. Commodity trading advisor (CTA) A person or entity providing advice to others on investments in commodity futures, options, and foreign-exchange contracts. Custodian A bank, trust company or other financial institution that holds and protects a fund’s assets and provides other services, including collecting money from investors, distributing redemption proceeds and maintaining margin accounts. Derivative A financial instrument whose performance is linked to a specific security, index or financial instrument. Typically, derivatives are used to transfer risk or negotiate the future sale or delivery of an investment. Diversification The variety of investments in a fund’s portfolio. Risk-averse fund managers seek to combine investments that are unlikely to all move in the same direction at the same time. Drawdown The percentage loss that a fund incurs from its peak net asset value to its lowest value. The maximum drawdown over a significant period is sometimes employed as a means of measuring the risk of a vehicle. Usually expressed as a percentage decline in net asset value.

Glossary

215

Due diligence Questions by investors to the manager regarding investment style and strategy as well as the manger’s background and track record.* Exposure The extent to which an investment has the potential to change based on changes in market conditions. In the hedge fund world, exposure is measured on a net basis. Net exposure takes into account the difference between the long positions versus the short positions. For example, if a fund is 150 percent long and 65 percent short, its net exposure would be 85 percent. Fair value The price at which a single unit of a security would trade between parties that don’t have interests in the issue. Forward contract A private, over-the-counter derivative instrument that requires one party to sell and another party to buy a specific security or commodity at a preset price on an agreed-upon date in the future. Fund of funds A hedge fund that invests in other funds and does not directly make investments in securities on behalf of its investors with its assets. Futures contract An exchange-traded agreement to buy or sell a particular type and quantity of commodity or security for delivery at an agreed-on place and date in the future. General partner The individual or firm that organizes and manages a limited partnership, such as a hedge fund. The general partner assumes unlimited legal responsibility for the liabilities of a partnership. Haircut The amount by which a lender discounts the actual market value of collateral pledged by a borrower. High-water mark A provision serving to ensure that a fund manager only collects incentive fees on the highest net asset value previously attained at the end of any prior fiscal year—or gains representing actual profits for each investor. Hurdle rate The minimum return necessary for a fund manager to start collecting incentive fees. The hurdle is usually tied to a benchmark rate such as Libor or the one-year Treasury bill rate plus a spread. If, for example, the manager sets a hurdle rate equal to 5 percent, and the fund returns 15 percent, incentive fees would only apply to the 10 percent above the hurdle rate. Incentive fee (performance fee) The fee, usually 20 percent, that a fund manager is paid on the profits made in the portfolio. Inception date The day on which a fund starts trading. Limited liability company A legal structure that is the hedge fund investment vehicle.* Limited partnership A legal structure that is used as a hedge fund vehicle.* Liquidity The ease with which an investment can be sold, without impacting its price in the market. Lock-up The period of time—often one year—during which hedge-fund investors are initially prohibited from redeeming their shares. Long position A transaction to purchase shares of stock resulting in a net positive position.* Management fee The charge that a fund manager assesses to investors, often used to cover operating expenses. The fee generally ranges from an annual 0.5 percent

216

GLOSSARY

to 2 percent of an investor’s entire holdings in the fund, and it is usually collected on a quarterly basis. Margin call Demand that an investor deposits enough money or securities to bring a margin account up to the minimum maintenance requirements.* Margin of safety Common stock issues are considered either underpriced or overpriced in the market relative to the intrinsic value of their companies. This brings error to truth for correction. To identify mispriced stocks, the value of a company is compared to its stock market price. Minimum investment The smallest amount that an investor is permitted contribute to a hedge fund as an initial investment. Minimum investment requirements can range from $50,000 to $5 million, but most funds insist on $500,000 to $1 million. Net asset value (NAV) The market value of a fund’s total assets, minus its liabilities and intangible assets, divided by the number of its shares outstanding. Net-fee requirement An SEC rule stating that hedge fund managers and other types of investment advisors must deduct advisory fees they charge from any performance figures they present to prospective investors. Netting The process of adjusting a gross amount, usually by subtracting. The term usually applies to the deduction of fees and taxes from an investment’s return. Offshore fund An investment vehicle that is domiciled outside the United States and has no limit on the number of non-U.S. taxable investors it can take on.* Onshore fund An investment vehicle that is set up in the United States that is available to U.S. citizens.* Operational risk Measures the probability that investment losses will result from factors other than credit risk, market risk, or liquidity risk, such as employee fraud or misconduct, errors in cash-flow models, incorrect or incomplete documentation of trades, or manmade disasters. Option A contract that gives parties the right to buy, or sell, a specific asset or security at a specified strike price by a preset date. It falls under the derivatives category and comes in the form of calls (options to buy) and puts (options to sell). The cost of an option is generally a fraction of the cost of its underlying security. Performance trigger The point at which a hedge fund’s losses cause specific contractual provisions designed to insulate investors from further losses. Performance fee Fee paid to a manager based on how well the investment strategy performs.* Pooled investment vehicle Any limited partnership, trust, or company that operates as an investment fund and is exempt from SEC registration under the Investment Company Act of 1940. Portfolio manager A company or individual that runs capital on behalf of an investment fund. Portfolio turnover rate The rate of trading activity in a hedge fund or mutual fund, expressed as a percentage of the portfolio’s size, that is bought or sold each year. Calculated by dividing the lesser of purchases or sales by average assets during that year.

Glossary

217

Poison pill Any number of legal defensive tactics written into a corporate charter to fend off the advances of an unwanted suitor.* Prime broker A bank or securities firm that provides various execution, administrative, back-office, and financing services to hedge funds and other professional investors. Private-equity fund Entities that buy illiquid stakes in privately held companies, sometimes by participating in leveraged buyouts. Private placement Issues that are exempt from public-registration provisions in section 4-2 of the Securities Act of 1933. Hedge fund shares are generally offered as private placements, which are typically offered to only a few investors, rather than the general public. Quantitative analysis Security analysis that uses objective statistical information to determine when to buy and sell securities.* Rate of return The annual appreciation in the value of a fund or any other type of investment, stated as a percentage of the total amount invested. Sometimes referred to as simply the return. Redemption fee A charge, intended to discourage withdrawals, that a hedge-fund manager levies against investors when they cash in their shares in the fund before a specified date. Redemption notice period The amount of advance notice that an investor must give a hedge fund manager before cashing in shares of the fund. Notification is usually required in writing. Redemption Liquidation of shares or interests in an investment fund. Regional investment strategy An approach in which the fund manager invests in instruments that are issued by companies or governments in a specific geographical region. Regulation D A provision in the Securities Act of 1933 that allows privately placed transactions to take place without SEC registration and prohibits hedge funds from advertising themselves to the general public. It also outlines which parties qualify as company insiders.2 Regulation T A Federal Reserve Board rule that dictates requirements for margin loans and differentiates “listed” and “unlisted” securities. Listed, or registered, securities are subject to more-stringent borrowing limits. Governs extension of credit by securities brokers and dealers, including all members of national securities exchanges.3 Risk-free rate The theoretical return on a risk-free investment, usually a U.S. security. Section 3(c)(1) A provision in the Investment Company Act of 1940 that allows certain hedge funds to be established without registering as investment advisors, provided their shares are owned by 100 investors.4 Section 3(c)(7) A provision in the Investment Company Act of 1940 that allows hedge funds to have more then 100 investors, provided all investors are considered to be qualified purchasers.5 Settlement Synonymous with a transaction’s closing, when, after clearing has taken place, securities are delivered and payment is received.

218

GLOSSARY

Sharpe ratio The ratio of return above the minimum acceptable return dividend by the standard deviation. It provides information of the return per unit of dispersion risk.* Short position A transaction to sell shares of stock that the investor does not own.* Short sales The process of borrowing securities from a broker and “selling them into the market” with the belief that the security can be bought back at a later date at a lower price. Soft dollars Credits that can be used to pay for research and other services that brokerage firms provide to hedge funds and other investor clients in return for their business. Those credits are accumulated through soft-dollar brokers, which channel trades to multiple securities brokers. Spread The difference in price or yield between two securities. Most often used to describe the difference between the yield on a Treasury security and the yield on another type of bond. It also refers to the return from a given investment product, such as a hedge fund, versus the return of a benchmark such as the S&P 500 index. Standard deviation A measure of the dispersion of a group of a numerical values from the mean. It is calculated by taking the difference between each number in the group and the arithmetic average, squaring them to give the variance, summing them, and taking the square root.* Traditional investments Products whose performances closely track the broader stock and bond markets. Volatility The likelihood that an instrument’s value will change over a given period of time, usually measured as beta.

∗ Strachman,

2005.

Daniel A. Getting Started in Hedge Funds. Hoboken, N.J.: John Wiley & Sons,

Notes

Chapter 1 Hedge Funds Past, Present, and Future 1. There is no clear definition of the size of the industry because, unlike the mutual fund industry, there is no central reporting agency. The number is what is quoted in many news reports throughout the last eight months. Its accuracy, however, cannot be verified. 2. Robin Sidel, Dennis K. Berman, and Kate Kelly, “J.P. Morgan Buys Bear in Fire Sale As Fed Widens Credit to Avert Crisis.” Wall Street Journal, March 17, 2008, p. A1, http://online.wsj.com/article/SB120569598608739825. html?mod=hps us whats news. 3. Elizabeth Hester, “Bear Stearns Shareholders Approve Sale” Bloomberg News, May 30, 2008, from Washingtonpost.com: http://www.washingtonpost. com/wp-dyn/content/article/2008/05/29/AR2008052903247.html. 4. United States Department of Labor Bureau of Labor Statistics, “Employment Situation Summary,” May 2, 2008, http://www.bls.gov/news.release/ empsit.nr0.htm; Chris Isidore, “80,000 Jobs Lost, Unemployment Spikes: Employers Slash Jobs for Third Straight Month While Unemployment Jumps to 5.1%, a Nearly Three-Year High,” CNN (online: http://money.cnn.com/2008/ 04/04/news/economy/jobs march/), April 4, 2008.

Chapter 2 Hedge Funds Today 1. Eleanor Laise, “The Hedge Fund Clones,” Wall Street Journal, July 21, 2007, p. B1. 2. Ibid. 3. This number is estimated, because unlike in the mutual fund industry, there is no central data source for hedge fund information. 4. New York Stock Exchange Fact Book, www.nysedata.com/factbook. 5. Investment Company Institute, “Trends In Mutual Fund Investing—June 2007,” July 30, 2007. http://www.ici.org/stats/mf/index.html#Trends%20in% 20Mutual%20Fund%20Investing 6. FINRA, http://www.finra.org/RulesRegulation/PublicationsGuidance.

219

220

NOTES

7. Reuters, “U.S. Hedge Fund Oversight Needs Teeth, Say Critics,” April 15, 2008. 8. This quote is from an interview with Hunt Taylor during research for my book on Julian Robertson. Hunt died in 2006. He was a dear friend, and the reason that I know what I know about hedge funds and money management.

Chapter 3 The Men Who Made the Industry What It Is Today 1. Fund complexes are money management firms composed of more than one hedge fund, mutual fund or investment vehicle. 2. Alan Rappeport, “A Short History of Hedge Funds.” CFO Magazine, March 27, 2007. Barry Eichengreen and Donald Mathieson, “Hedge Funds: What Do We Really Know?” The International Monetary Fund, September 1999, http://www.imf.org/external/pubs/ft/issues/issues19/index.htm. Matthew Miller (ed.), “The 400 Richest Americans,” Forbes, September 7, 2007, http://www. forbes.com/lists/2007/54/richlist07 The-400-Richest-Americans NameProper 14.html. Stanford Encyclopedia of Philosophy, http://plato.stanford.edu/ entries/popper. The Wharton School, “125 Influential People and Ideas,” “Turned Risk into Wealth—Michael Steinhardt,” Wharton Alumni Magazine, October 27, 2007. Wyndham Robertson, “Hedge Fund Miseries,” Fortune, May 1971, 269. Stephanie Strom, “Top Manager to Close Shop on Hedge Funds,” New York Times, October 12, 1995, p. D1.

Chapter 4 Running Your Fund Transparently 1. S&P 500 Index, http://moneycentral.msn.com/investor/charts/chartdl.aspx? Symbol=%24INX&CP=0&PT=10.

Chapter 5 How Hedge Funds are Packaged 1. The Inflation Calculator, http://www.westegg.com/inflation/infl.cgi. 2. “UBS Tops Alpha Magazine’s Fund of Hedge Fund 50 Ranking for the Third Time,” November 21, 2005. http://old.institutionalinvestor.com/pdf/ pressRoom/pressrelease/alpha funds NOV.pdf

Chapter 8 Fraud, Collapse, and the Kitchen Sink 1. Edwards Evans, “Bear Stearns Joins Wall Street, Wrecks Drexel, LTCM” (Update 1), Bloomberg, March 17, 2008. 2. Deepak Gopinath, “Niederhoffer, Humbled by ’97 Blowup, Posts 56 Percent Return,” Bloomberg, May 31, 2006. 3. Randy Diamond, “KL Principal Pleads to Fraud” Palm Beach Post, April 18, 2008. 4. Amanda Cantrell, “Hedge Fund Has-Beens,” CNN/Money, June 11, 2005.

Notes

221

5. Ibid. 6. Matthew Leising, “Lake Shore Asset Management Accounts Frozen by U.S.,” (Update 4), Bloomberg, June 28, 2007. 7. Commodity Futures Trading Commission, “Case Status Report: Lake Shore Asset Management,” Case Number 07 C 3598, April 28, 2008. 8. Jenny Strasburg, “Zwirn Shuts Hedge Funds after Clients Pull $2 Billion,” Bloomberg, February 22, 2008. 9. Henry Sender, “Zwirn Winds Down Principal Funds,” The Financial Times, February 22, 2008. 10. Jeff St. Onge and Bill Rochelle, “Bear Stearns Caymans Filing May Hurt Funds’ Creditors,” Bloomberg, August 7, 2007.

Glossary 1. Securities Lawyer’s Deskbook. The University of Cincinnati College of Law: www.law.uc.edu/CCL/33ActRls/rule501.html. 2. U.S. Securities and Exchange Commission. www.sec.gov/answers/regd/htm. 3. The Free Dictionary. http://financial-dictionary.thefreedictionary.com/ Regulation+T+(Reg+T). 4. Securities Lawyer’s Deskbook. The University of Cincinnati College of Law. www.law.uc.edu/CCL/InvCoAct/sec3.html. 5. Ibid.

Index

A Accountants, 89–90 resource guide for, 133–35 Accredited investor, defined, 16–17 Administrators, resource guide for, 133–35. See also Third-party administrators Age of the Hedge Fund, 52 Alpha, 53 Alternative investments, 118 Amaranth, hedge fund mismanagement and, 110–11 Auditing, of hedge funds, 89–90 AW Jones and Company, 5, 21 B Bear Stearns Companies, 8–11, 106 hedge fund mismanagement and, 111–12 Berger, Michael, 108, 109 Bookbinder, Richard, 9 Buffett, Warren, 37, 40 Burch, Robert, 37 Buyouts, fund of funds, 62–63 C Capital introduction services, 72–73 Cioffi, Ralph, 111 Commission, sharing, 22–23 Commodity Futures Trading Commission (CFTC), 109–10 Communication during crisis, 50–51 open, 50 Cornfield, Bernie, 56 Costs, of running fund of funds, 55–57 Credit crisis, learning from, 43–46 fraud, 46–47 information exchange, 47–51 perception versus reality, 45–46 Criminal background checks, 114 D DB Zwirn & Company, 111 Dialing for dollars, 69–70

Diversifying, portfolio, 65–66 Dodd, David, 27 Douglas, Doug, 63 Druckenmiller, Stanley, 28 Due diligence investor, 113–14 manager, 114–15 questionnaire, 115, 121–32 E Economics, funds of funds, 58–59 Employee Retirement Income Security Act, 16 Equity-based funds, 66 European Monetary System, 28 Exposures net long, 24 net short, 24 F Falsification, 32 Family, raising money from, 69–72 Federal Reserve, 8, 9, 10 Fees for hedge funds, 20–22 management, 58 Fidelity Magellan Fund, 49 Fortune 500 companies, 13 Fraud, 46–47 existence of, 103–4 in hedge fund industry, 104–5 KL Financial and, 108 Lake Shore fund complex and, 109–10 Manhattan Investment Fund and, 108–9 media and, 104–5 reason for, in hedge fund industry, 107–10 regulatory move to stop, 113 Friends, raising money from, 69–72 Front-line investment analysis, 124–25 Full NAV, 91 Fund of funds, 55–57 buyouts, 62–63 common problems, avoiding, 66–67

223

224 Fund of funds (Continued) costs of running, 58–61 economics of, 58–59 functioning of, 57–58 growth, 61–62 growth in industry, 57 Funds equity-based, 66 hedge (See Hedge funds) mutual, 6–7 offshore, 96–97 onshore, 95–96 G Gekko, Gordon, 104 Goldman Sachs Group Inc., 14, 15, 41, 91 Graham, Benjamin, 27 Greenwich Investable Hedge Fund Index, 158–64 Greenwich Investable US Hedge Fund Index, 178 Greenwich Monthly Global Hedge Fund Index, 165–77 Greenwich Monthly International Hedge Fund Index, 189–201 Greenwich Monthly US Hedge Fund Index, 146–57 Greenwich Quarterly Global Hedge Fund Index, 184–87 Greenwich Quarterly International Hedge Fund Index, 180–83 Greenwich Quarterly US Hedge Fund Index, 203–11 Greenwich US YTD Hedge Fund Index, 202 Greenwich YTD Global Hedge Fund Index, 188 Greenwich Ytd International Hedge Fund Index, 179 H Havens, Nancy, 28 Headhunters, 98–99 Hedge Fund Alert, 101 Hedge fund clones, 14 Hedge fund industry evolution of, 118 fraud, reason for, 107–10 fraud in, 104–5 future of, 53–54 growth of, 1 legends in, 28–40 shaping of, 27–40

INDEX Hedge fund manager, job description for, 70–71 Hedge funds auditing, 89–90 go bad, 42–43 databases and services, 15 development of, 3–5 fees, 20–22 historic performance of, 145–211 history of, 3–5 implosion of, 105–7 Jones legacy, continuing, 23–25 jumping on bandwagon, 51–54 mismanagement of, 110–12 mutual funds versus, 7 in the news, 14–16 packaging of, 55–67 Presidential campaign and, 18 reasons for investing in, 5–7 regulation of, 16–18 running transparently, 41–54 size of, 93–94 today, 13–25 year of, 52–53 High-water mark, 21 Hiring, third-party marketer, 75–77 Historic performance, of hedge funds, 145–211 Greenwich Investable Hedge Fund Index, 158–64 Greenwich Investable US Hedge Fund Index, 178 Greenwich Monthly Global Hedge Fund Index, 165–77 Greenwich Monthly International Hedge Fund Index, 189–201 Greenwich Monthly US Hedge Fund Index, 146–57 Greenwich Quarterly Global Hedge Fund Index, 184–87 Greenwich Quarterly International Hedge Fund Index, 180–83 Greenwich Quarterly US Hedge Fund Index, 203–11 Greenwich US YTD Hedge Fund Index, 202 Greenwich YTD Global Hedge Fund Index, 188 Greenwich Ytd International Hedge Fund Index, 179 Hurdle rates, 58

225

Index I Information exchange, 47–51 communicating during, 50–51 investors, giving due to, 48–49 open communication in, 50 strategy, explaining, 49–50 Insurance companies, 97–98 resource guide for, 133–35 Internal Revenue Service, offshore funds and, 96 Investments alternative, 118 in hedge funds, reason for, 5–7 Investor due diligence, 113–14 Investors accredited, 16–17 finding right, 80 giving due to, 48–49 strategy, explaining to, 80–83 vetting, 83 J Jones, Alfred Winslow, 4, 17 Jones legacy, continuing, 23–25 J.P. Morgan Chase & Company, 8, 9, 10, 14, 15, 41, 42, 91, 94, 111 K KL Financial Group, LLC, fraud and, 108 L Lake Shore fund complex, 109–10 Lawyers, 88–89 experienced, choosing, 88–89 questions for, 89 resource guide for, 133–35 Legends, in hedge funds, 28–40 Robertson, Julian, 36–39 Soros, George, 30–32 Steinhardt, Michael, 32–36 Light NAV, 91 Lipper Small Cap Index, 6, 7 Loan-to-value (LTV) ratio, 44 Lock-ups, 16 Long-Term Capital Management (LTCM), 10, 48–49 M Management fee, 58 Manager due diligence, 114–15 Manager of managers (MOMs), 63–64 common problems with, avoiding, 66–67

Manhattan Investment Fund, 108–9 Mariner Investor Group, 104 Market. See Stock market Market fundamentalism, 32 Marketing successful, 84–85 third-party, 73–77 Matching services, 99–100 Merrill Lynch & Company, 14, 41, 44 Michaelcheck, Bill, 104 Mismanagement Amaranth and, 110–11 Bear Stearns and, 111–12 DB Zwirn & Company and, 111 in hedge fund industry, 107 of hedge funds, 110–12 regulatory move to stop, 113 Money, raising, 69–85 capital introduction services, 72–73 connections, making, 70–72 dialing for dollars, 69–70 road to wealth and, 77–79 sources of, 69–72 third-party marketing, 73–77 Money management by Robertson, 37–39 by Soros, 31–32 by Steinhardt, 34–36 Mortgage loan-to-value (LTV) ratio and, 44 market, sub-prime meltdown in, 41 Mukasey, Michael B., 8 Munger, Charlie, 40 Mutual funds, 6–7 hedge funds versus, 7 regulation of, 17 N NASDAQ market, 92 Neiderhoffer, Victor, 106 Net asset values, calculating, 91–93 full NAV, 91 NAV light, 91 Net long exposures, 24 Net short exposures, 24 Neuberger Berman, 22 New York Stock Exchange, 92 O Offshore funds Internal Revenue Service and, 96 third-party administrator for, 96–97

226 Onshore funds, third-party administrator for, 95–96 Opportunity Partners L.P., 18 P Packaging, of hedge funds, 55–67 funds of funds, 55–57 Parker, Virginia, 28 Pitch book, preparing, 83–84 items included in, 84 Ponzi, Charles, 107 Popular press, fraud and, 104–5 Portfolio, diversifying, 65–66 Presidential campaign, hedge funds and, 18 Prime brokers, 90–91 resource guide for, 133–35 Q Questionnaire, due diligence, 115, 121–32 R Referrals, raising money through, 69–72 Regulation of hedge funds, 16–18 of mutual funds, 17 Regulatory move to stop fraud, 113 to stop mismanagement, 113 Resource guide, 133–43 accountants, 140–42 administrators, 138–40 insurance companies, 142–43 lawyers, 135–38 prime brokers, 133–35 Risk management, 122–27 Road to wealth, 77–79 cautionary tale about, 78–79 reconnaissance, conducting, 77–78 Robertson, Julian, 15, 24, 25, 27, 28, 36–39 money management by, 37–39 S SAC Capital, 23 Saunders, David, 27, 36, 63 Securities Act of 1933, 7 Securities Act of 1940, 2, 17 calls for, 18–20 Securities and Exchange Commission (SEC), 18, 28, 33, 113 Service providers. See also Supporting staff accountants, 89–90 choosing, 87–88

INDEX headhunters, 98–99 insurance companies, 97–98 lawyers, 88–89 matching services, 99–100 prime brokers, 90–91 third-party administrators, 91–97 Soros, George, 27, 28, 30–32, 105 money management by, 31–32 S&P 500 Index, 6, 7, 46 Steinhardt, Michael, 27, 28, 32–36 money management by, 34–36 Stock market understanding, 7–8 volatility of, 7–8 Strangers, raising money from, 69–72 Sub-prime meltdown in mortgage market, 41 Successful marketing, essence of, 84–85 Supporting staff, 87–102. See also Service providers accountants, 89–90 headhunters, 98–99 insurance companies, 97–98 lawyers, 88–89 matching services, 99–100 prime brokers, 90–91 third-party administrators, 91–97 T Tannin, Matthew, 111 Technology, taking advantage of, 101–2 Third-party administrators, 91–97 finding, 94–95 funds, size of, 93–94 net asset values, calculating, 91–93 for offshore funds, 96–97 onshore funds, using for, 95–96 Third-party marketer choosing, 73–75 hiring, 75–77 Third-party marketing, 73–77 Tiger Management, 25 downfall of, 38 Transparency measurement of, 48 pros and cons of, 65 V Vetting, investors, 83 W Warm call, 77 Wealth, road to, 77–79