Switzerland’s alternative investment industry adapts to new climate
By Hans-Jörg Baumann – For many decades alternative investments have been gaining increasing attention in the financial world, with politicians, with the public, the press and, not least, regulators. They have been recognised as an important element of diversified portfolio management through the benefits of combining listed market activities with private markets activities.
Amid the broader debate on the merits of active versus passive management techniques, alternative investment managers, whether involving hedge funds and the use of long/short investment strategies, or in private debt and private equity transactions, where managers carry out unlisted financing activities on the long side, all require talent, processes and systems to serve client interests best.
Other alternative investment specialists such as commodity managers make use of listed and unlisted instruments in dedicated markets, as do real estate managers that invest directly or indirectly in hard assets. All managers claim to be talented and dedicated in active management styles in their respective markets and strategies, and to deliver superior performance to clients than passive investments techniques.
Switzerland has a long and significant history in the alternative investment industry; locally-focused and international Swiss asset managers account for between 14 and 16 per cent of total alternative assets worldwide. Whether global players or asset management boutiques, they are renowned for building expertise and fostering innovation. The Swiss industry stands for implementation quality and business skills in a world where rapid adaptation has become essential to long-term success.
Best operational practice is now a must in the institutional world amid a fight for capacity, a scarcity of talent, and a reduction in managers’ freedom of action as a result of heightened corporate governance standards and tighter regulation. These developments are currently affecting not only the alternative investment sector but asset management in general and ultimately the entire financial services industry.
The breakdown of trust can only be corrected by evidence that the industry has changed. The unmet expectations engendered by the alternative investment industry are a result of disorderly market conditions in listed and private markets over the past few years, notably the 2008 financial markets crisis. It’s no surprise that market shocks should result in changes in client demand, industry framework, business models, and relationships between market participants and supervisors.
Critical assessment of the achievements of the industry, its strategies and techniques, as well as of individual providers and their rules of engagement, is a logical consequence of this stressed market situation. However, changes throughout the business value chain and in client offerings need to be well thought out. The industry has embraced enhanced investment quality and performance promises in terms of economic return on capital as well as ultimate return of capital, fundamental value propositions that endure in a world of constant change.
In today’s environment, everyone claims to recognise the pitfalls of the past and remedies for the future. But one should also remember the lessons of the good times, the success factors and limitations, before undertaking a drastic change of direction.
Alternative investments have empirically delivered risk-adjusted returns over the longer-term investment cycle, but suffer from the tendency toward correlation in extreme market stress situations. Asset classes such equities, fixed income, foreign exchange, commodities and real estate are the drivers for return; in stress situations pricing and liquidity are often significantly distorted. This creates challenges for market participants in managing expectations and ultimately leads to the readjustment of market exposure and management.
The credit-induced crisis of 2008 has led to changes in the availability and price of borrowing and an overall reduction of leverage. Quality and security have become paramount for institutional and private investors, a situation that will prevail for a long time. A risk-free return rate of zero for more than four years has become a major challenge for the financial industry.
This change in client demand and readjustment of risk premiums in all asset classes has forced the alternative investment industry to re-examine the overall value chain of its services and driven changes in asset classes, structures for packaging assets, and processes. Today institutional investors know precisely to which asset classes they want exposure and what kind of impact they seek in their portfolios.
One of the biggest changes for the industry has been the divergence in the structures used by institutional and private investors. The larger the investor, the more independence and role in governance they require. Tailor-made solutions have become a key demand among institutions, while Ucits have enjoyed success with retail and private banking clients.
Offerings now must be structured distinctly for separate types of client, favouring tailored solutions in the institutional world and more homogenous solutions for private clients. Today, most alternative providers in Switzerland have adapted their business models to establish distinct client segmentation.
Switzerland is well positioned geographically to access global assets, with USD22.9trn in European assets located within three hours’ flying time, and its appeal as a centre for asset management operations also includes its multilingual and internationally experienced human resources. But nothing happens by itself. Vision, hard work, innovation and quality needs to be applied and upheld constantly.
Almost 20 per cent of hedge fund multi-managers with more than USD1bn in assets are based in or have significant operations in Switzerland, including eight of the top 20, and it is also a leading centre for private equity.
Client segmentation approaches vary. Some groups follow a universal approach involving various distribution channels and internal client assets, including Credit Suisse, UBS, Pictet, Rothschild, Union de Banque Privée and Banque Syz, while specialist global players include Man Group, GAM, Gottex and Harcourt. Others focus entirely on institutional business, such as EIM, Unigestion, Swiss Re Private Equity and Swiss Capital Alternative Investments.
Some providers like Man, Lombard Odier and GAM combine single manager and multi-manager activities. Others, such as Partners Group, LGT, Unigestion, Swiss Re and Swiss Capital Group, seek to capture liquidity premium-oriented strategies including infrastructure, private equity, private real estate and private debt. No single model fits all providers, but what the leaders have in common is their willingness to allocate dedicated resources in search of expertise, professionalism, performance, consistency and investment quality.
Changes to the boundaries of regulation can have an extensive impact on business practice. With a more standardised and more stringent European Union regulatory framework for alternative investments looming, Switzerland is also in the process of tightening its Collective Investment Scheme Act. Overall, business is set to become more costly, more oriented toward reporting and audit, and entry barriers for new start-ups will become more challenging. One can also expect more consolidation among existing providers.
Institutional business is currently growing at a faster pace than private banking, which is also undergoing structural changes in Switzerland. The challenge is not to over-regulate the investment framework for institutions that in general are knowledgeable and experienced in integrating alternative investments into their portfolios.
Switzerland boasts many top-class alternative investment providers active not just in the local market but internationally. The ability to compete in the global marketplace therefore requires a liberal framework that focuses on facilitating cross-border activity.
Hans-Jörg Baumann is chairman of the Swiss alternative investment Council and chairman and chief executive of Swiss Capital Alternative Investments
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