Mizuho Eurekahedge Indices Analysis

Eurekahedge November 2011 Introduction Eurekahedge recently launched a suite of new indices, under the name Mizuho-Eurekahedge Index, which are asset weighted and follow a new and unique methodology. In this report we highlight the key features of this set of indices, analyse the risk-return profile.

Key attributes of the methodology Asset weighted to provide a more representative market portfolio All hedge funds underlying local currencies converted to USD on a monthly basis along with 3 additional currency hedged indices. Minimum AUM levels eliminate smaller funds that will not have a significant impact on the asset flows of the industry The new indices account for backfill bias by only taking into consideration the data of funds after they have listed on the Eurekahedge database including all historical returns. The new indices account for survivorship bias by including historical performance of all the funds meeting the index criteria at each point in time even if the fund do not exist any more.

Performance Summary Figure 1 displays the Mizuho-Eurekahedge Index and the Dow Jones World Index and Table 1 shows the corresponding risk return metrics. Figure 1: Mizuho-Eurekahedge Index vs DJ World Index

When compared to the underlying equity markets the Mizuho-Eurekahedge Index has witnessed better performance over the last six and a half years, with less than half the volatility and a low beta (correlation to the markets). Total return for the index stands at 50.27% as opposed to a 17.12% gain in the DJ World Index since December 2004. Funds within the Mizuho-Eurekahedge Index has also provided significant downturn protection in 2011 the index is down only 2.03% (September YTD) compared to an average 13.74% decline in global markets. Since December 2004, the maximum

Represented here by the Dow Jones World Index

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drawdown of the Mizuho-Eurekahedge Index is 17.38%, while that of the DJ World Index stands at 54.38%.

Table 1: Risk-return statistics of Mizuho-Eurekahedge Index and DJ World Index

Mizuho-Eurekahedge Index 2011 Return Annualised Return Annualised Standard Deviation Beta Alpha -2.03% 6.23% 7.22% 0.32 0.42 DJ World Index -13.74% 2.37% 18.85%

Turnover rates Turnover rate implies the number of funds that are replaced in the index or a portfolio over the course of time. For this discussion we consider the Mizuho-Eurekahedge Top100 Index, which displays an average annually turnover rate 32%. This is calculated by taking the difference between the index constituents at the start of a year and the index constituents at the start of the following year. For example in any given year if you invest in 100 funds on Dec 31 you could expect to maintain holdings in 68 of those funds at the end of the year with 32 new funds in your portfolio. Since the index comprises of only the largest 100 funds that report to the Eurekahedge databases, the primary reasons for fund turnover is: (a) funds increasing in assets to break into the top 100 (by AUM) and overtaking the AUM of existing funds within the index (b) new fund launches (c) closures of funds in the index previously This suggests that the Top100 Index broadly follows a momentum (or populist) strategy, where the larger and more successful hedge funds would be added to the index whilst the funds which lose capital (either through performance or asset flows) would be taken out of the index. Table 3: Turnover rate of index constituents of the Mizuho-Eurekahedge Top100 Index
Turnover rate 2005 2006 2007 2008 2009 2010 Top 100 35.0% 23.0% 30.0% 41.0% 25.0% 37.0% Top 300 35.3% 26.7% 30.3% 39.3% 34.3% 30.7% Mizuho-Eurekahedge Index 17.3% 13.4% 18.4% 27.1% 17.5% 13.5%

The turnover rate was at its maximum during the 2008 financial crisis with 41% of the funds in the index at the start of the year being replaced by the year-end. This was primarily because of the heavy redemption pressure and large losses witnessed by many hedge funds during the year. Long/short equity, multi-strategy and distressed debt funds formed the majority of the funds that dropped out of the index as they posted the largest losses in 2008, while a significant number of CTA and macro hedge funds were added to the index as they protected their capital and also posted performance based gains, hence increasing their asset base. In contrast the turnover rate in 2009 was much lower at 25%, as most of the funds that had done well in 2008 attracted assets while also posting performance based gains. In this section we compare the overall Mizuho-Eurekahedge Top 100 index against a portfolio of the top 25 constituents of the index. We use the top 25 for comparison as 20-30 funds is the portfolio size

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of many funds of hedge funds and in addition is a sensible number of investments for the average institutional investor. Interestingly from a risk-return perspective the top 25 funds have delivered significantly better performance, with an annualised return of 8.53%, a low volatility of 5.5% and a Sharpe ratio of 1.19 while the maximum drawdown stands at -10.6% in 2008. These numbers also compare favourably with funds of hedge funds as shown in Figure 3. The numbers imply that a passive portfolio of the 25 largest constituents of the Mizuho-Eurekahedge Top 100 index, rebalanced quarterly, should outperform the larger index as well as the average fund of hedge fund in fact the 5 this portfolio outperforms 92% of the funds in the Eurekahedge Fund of Funds database over the Jan-2005 to September 2011 period. Figure 2: Performance of the top 100 and top 25 funds

Table 4: Risk-return statistics of Mizuho-Eurekahedge Top 100 Index, top 25 funds and Eurekahedge Fund of Funds Index from Dec-2004 to Sep-2011
ME Top 100 Index Annualised Return 2011 Return 2010 Return Annualised Volatility Sharpe Ratio 7.12% 1.29% 10.19% 6.30% 0.81 ME Top 25 8.53% 4.99% 10.06% 5.50% 1.19 EH Fund of Funds Index 6 3.0% -5.07% 4.58% 5.91% 0.18

Geographic mandates Global hedge funds account for 52% of the assets in the Mizuho-Eurekahedge index, which is hardly surprising as the largest funds invest with a global mandate. It should be noted that globally investing hedge funds allocate a significant amount of their assets to emerging markets, including Asia. Hedge funds investing solely in Asia account for nearly 10% of the index (Asia ex-Japan + Asia inc Japan + Japan), which is a unique and distinguishing aspect of the Mizuho-Eurekahedge Index.

Brown, Stephen J., Gregoriou, Greg N. and Pascalau, Razvan C., Diversification in Funds of Hedge Funds: Is it Possible to Overdiversify? (July 7, 2011) Including different share classes and dead funds, using annualised returns

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Figure 3: Geographic mandates of Mizuho-Eurekahedge Index constituents by AUM

This is an important advantage for observers as this geographical split of the index has greater coverage of the all regions, as opposed to most other hedge fund indices that only cover a fraction of Asian and European hedge funds. The comparative capitalisations of equity markets in America, Asia 7 and Europe are 38%, 34% and 28% respectively, and as such any representative benchmark should have reasonable coverage of assets allocated to all these regions.

Strategic mandates The distribution of the Mizuho-Eurekahedge Index according to strategic mandates is broadly in line with the distribution of global hedge fund assets by strategies. Long/short equity and multi-strategy funds together account for 49% of total assets. Additionally, CTA/managed futures and fixed income funds account for 15% and 10% of the assets respectively, displaying an equitable distribution across the different asset classes as well as strategies. Figure 4: Strategic mandates of Mizuho-Eurekahedge Index constituents by AUM

World Federation of Exchanges July 2011 data Copyright Eurekahedge Pte Ltd 2011. All rights reserved.

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Fund size breakdown Figures 5a shows the number of funds in the index that fall in the different AUM ranges, while figure 5b shows the distribution of index assets amongst these different AUM ranges. Although the largest funds with more than US$1 billion form only 6% of the population, their assets account of 49% of the total assets in the index. Figures 5a-5b: Breakdown of Mizuho-Eurekahedge Index constituents by fund size (US$ million)

Performance Review Figure 6 plots the number of index constituents against the performance of the Mizuho-Eurekahedge Index. The sharp decline in the index from May 2008 onwards was followed by a drop in the number of constituents in 2H 2008 as the a number of funds closed down while other fell below the US$5 million exclusion criteria of the index and exited. Figure 6: Performance of the Mizuho-Eurekahedge Index vs number of constituents

The assets covered by the index grew significantly between 2005 and 2008. The index gained 30.5% in performance between January 2005 and January 2008 whilst the assets covered by the index increased by 92.4%. However through the financial crisis, as the index declined by 15.4% between January 2008 and March 2009, the assets covered by the index declined by 47.2%. Since March 2009, the index has gained 27.8% (as at July 2011) while assets are up by 79.2%.
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The current size of the Mizuho-Eurekahedge Index is 1441 funds and US$480bn AUM. Figure 7: Performance of the Mizuho-Eurekahedge Index vs total assets under management (US$ million)

Conclusion While the Eurekahedge indices give a great overall indication of the performance of hedge fund managers in the industry the Mizuho-Eurekahedge Indices offer a different picture of the hedge fund industry to the established norms by looking at the universe from an asset flow and investible perspective.

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