Citigroup Alternative Investments Reviews Hedge Fund Success Factors
Introduces Inaugural Citigroup Alternative Investments Journal
Jun 27, 2006, New York – Many critics have expressed concern that the rapid influx of assets spells trouble for the long-term return potential of hedge funds. Citigroup Alternative Investments (CAI) analyzes this issue in a recently published report entitled “Hedge Funds: Built to Last?”. This paper begins with a discussion of the critical success factors for a hedge fund and uses this framework to derive four key conclusions about the industry.
1. Innovations by hedge funds will continue, creating opportunities for firms with sustainable advantages to generate attractive returns.
2. Structural advantages (such as economies of scale and scope) will become increasingly important.
3. As entry by new managers continues, average returns will fall, but hedge funds with competitive advantages should continue to deliver returns at historically strong levels.
4. Investors need to become increasingly sophisticated and nuanced in their evaluation process in order to identify the hedge funds positioned to deliver.
“When any industry is growing and transforming dramatically, it is often accompanied by a great deal of uncertainty and anxiety by participants. The hedge fund industry, with its spectacular rise, is no different,” said Rui de Figueiredo, research leader for Citigroup Alternative Investments and one of the authors of this hedge fund report.
“To analyze the capabilities required to outperform, it is necessary to move away from treating a hedge fund as one might a financial security – represented solely by its historical returns – and evaluate a hedge fund as an innovation business,” he added.
“While average returns will fall as more managers enter the industry, hedge funds with competitive advantages should continue to deliver returns at favorable levels,” Mr. de Figueiredo notes. “To appropriately evaluate hedge fund managers will increasingly require specially trained professionals with the expertise, resources and networks to evaluate opportunities more deeply in order to separate businesses with sustainable advantages from “one-trick ponies.”
“While the industry will present challenges for investors in the future, the prospects for good business models to continue to generate attractive returns – to generate alpha – will persist,” he summarized.
The in-depth hedge fund report is the lead article of the Citigroup Alternative Investments Journal, a recently published 66-page, bi-annual periodical that includes seven white papers that offer thoughtful perspective on trends, opportunities and issues in the alternative investment arena. The Journal also contains market overviews on private equity, hedge funds and real estate.
The Citigroup Alternative Investments Journal also includes in-depth reports on other pertinent alternative investment topics, including:
* “Asset Allocation: A New Paradigm” – This paper suggests a multi-dimensional asset allocation approach which improves upon classic asset allocation models. Considering four components of return (beta, alpha, liquidity and downside risk) offers investors a more comprehensive view of the risk and return tradeoffs they face when attempting to integrate alternatives alongside traditional investments.
* “The Premium for Non-Traded Assets” – Based upon an examination of risk and return data from 1992 to 2Q 2005, CAI estimates that significant tradability premiums exist for private real estate, leveraged buyouts and venture capital. Given the existence of a premium for non-tradability, investors should carefully examine their tolerance for illiquidity in addition to their tolerance for risk when constructing portfolios so that they may benefit from this additional return source.
* “Portfolio Management with Illiquid Investments” – Illiquidity and uncertainties associated with investments in private equity and private real estate increase the risk that an investor’s portfolio will diverge too far from its target allocations. CAI examines data on leveraged buyouts over the period 1985 and 2004 and concludes that the risks associated with investing in non-traded asset classes are significantly lower when measured on a combined basis than when they are viewed in isolation.
* “The Impact of the European Union on Real Estate Markets” – The expansion and further development of the EU will continue to change the European property markets for years to come. The fluidity of goods, services, capital and people will create winners and losers in different markets. Through time, the quality and quantity of real estate in Central and Eastern Europe should converge with that of Western Europe, thereby creating more harmonization within the EU.
* “Investing in Commodities” – Dramatic price appreciation in commodities such as gold, silver, copper, sugar and petroleum products has made headline news during the past year, piquing interest in these products and the investment opportunities they offer. This article explores the advantages and disadvantages of seven different approaches to investing in commodities including direct cash investment, futures, investable commodity indices, commodity-based equities, exchange traded funds (ETFs), commodity-linked ETFs and managed futures.
* “Understanding Structured Investment Vehicles” – Structured Investment Vehicles have grown in popularity and are currently approximately a $200 billion market. This paper offers an overview of the SIV market, outlines the basic principles and risks of the products, and concludes with observations on recent market developments and expectations for the future.
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Citigroup Alternative Investments
Citigroup Alternative Investments is an alternative investment platform that manages a wide range of products across five asset classes, including private equity, hedge funds, real estate, structured products and managed futures. CAI manages capital on behalf of Citigroup, as well as third-party institutional and high net worth investors. As of March 31, 2006, CAI had approximately $39.3 billion of un-levered assets under management, ranking CAI among the world’s largest alternative asset managers. CAI’s goal is to enable its 14 investment centers to retain the entrepreneurial qualities required to capitalize on evolving opportunities, while benefiting from the intellectual, operational and financial resources of Citigroup.
Citigroup, the leading global financial services company, has some 200 million customer accounts and does business in more than 100 countries, providing consumers, corporations, governments and institutions with a broad range of financial products and services, including consumer banking and credit, corporate and investment banking, insurance, securities brokerage, and asset management. Major brand names under Citigroup’s trademark red umbrella include Citibank, CitiFinancial, Primerica, Smith Barney, and Banamex. Additional information may be found at www.citigroup.com.
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