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Hedge funds

UBS View Prefer Relative value and Event-driven
• We expect hedge funds (HF) to offer positive asymmetric returns characteristics vs. the S&P 500 due to active management and stop-loss strategies. (HF were down 1.9% in May 2012 vs MSCI world at –8.5%)
• Decelerating global growth prospects, the next leg in the ongoing Eurozone crisis, is challenging mostly equity long-short managers, who are net-long the market. While event-driven managers share some of the performance drivers, idiosyncratic bets (event) reduce the exposure to markets. The real reason to own this strategy, however, is the potential for out-sized return in distressed, high yield and other credit investments as the Eurozone crisis plays out. The inherent hedging in relative-value should remain appealing. Credit relative-value managers should perform well in this environment of higher fixed income volatility and increasing pricing anomalies created by central bank interventions (OT2) and limited competition.

Recommendations
Strategic (1 to 2 years)
• Active risk management is instrumental for capital preservation during adverse market conditions. At the moment, we therefore favor relative value and event-driven strategies, since they are less hinged to equity markets and other risky assets than trading is.
• Value proposition: Hedge funds should achieve robust performance over an extended horizon, while displaying limited volatility vis-à-vis equities and other risky assets, in general. Hedge funds minimize downside losses in adverse market conditions (e.g. active risk management) and play a crucial role in wealth appreciation, since there is less ground to regain in the recovery phase and ultimately greater chances for superior long-term returns.

Positive scenario Prefer Equity long-short
• A reduction of uncertainty (e.g. resolution in Europe) lowers equities' correlation and volatility. This helps bottom-up fundamental analysis and equity long/short managers the most. Also, CEOs will likely make more corporate transactions that can be monetized by event-driven managers, and a clearer macroeconomic environment with more persistent trends would be supportive for macro managers

Negative scenario Prefer Trading (Global Macro + CTA)
• A 2011-type scenario in which hedge fund managers get whipsawed through the year with risk-on and risk-off circumstances, driven by a multitude of political interventions, is difficult to anticipate. That would impact long-short managers, event-driven, and to a lesser extent global macro managers.
Note: Scenarios refer to global economic scenarios (see slide 7)

What we're watching Why it matters
Global equity direction / economic cycle The outlook for global equities becomes an important HF performance driver. The economic cycle impacts the strategies differently.
Correlation Correlation among pair-stocks; an important performance/alpha driver for equity long/short, the largest HF strategy by assets under management.
Leverage Gross and net leverage are key to monitoring risk.
Volatility The direction influences certain HF strategies (e.g. convertible arbitrage).
Liquidity Particularly for large HF that are less nimble to enter and exit their strategies
Regulation Volcker's rule, USCITS III/IV

Performance (year-to-date)
Relative value
Event driven
Trading
Equity hedge
Hedge Funds
-1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0%

Source: HFRI, UBS CIO, as of 18 June 2012
Note: Past performance is not an indication of future returns.

UBS

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For further information please contact CIO's asset class specialist Cesare Valeggia, cesare.valeggia@ubs.com
Please see important disclaimer and disclosures at the end of the document.
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