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James Williams, Hedgeweek

Winners focus on good governance and consistent returns

By James Williams – The winners of hedgeweek’s Global Awards 2013 gathered at an awards presentation lunch sponsored by Lyxor Asset Management in London’s Mayfair earlier this month.

All agreed that last year was far from a watershed for the hedge fund industry. Some managers pointed to the fact that average returns of 6.2 per cent (according to the HFRI index) did nothing more than paper over the cracks of 2011, when the average hedge fund lost some 5 per cent, but were an institutional investor to take such a simplistic view, they would have missed out on countless compelling opportunities at the strategy level.

“On Lyxor’s Managed Account Platform for instance 11 out of 14 investable strategy indices were in positive territory. A handful posting double digits returns,” comments Philippe de Beaupuy, Head of MAP (Managed Account Platform) UK, Lyxor Asset Management, who delivered the introductory address at the Awards.

As it happens, institutions continued to allocate to such an extent that industry-wide assets topped USD2.25trillion and total net inflows for 2012 were USD34.4billion.

Sunil Gopalan, hedgeweek’s Publisher says, “What this tells us, in no uncertain terms, is that the face of the industry has undergone a facelift. No longer dominated by HNW individuals, this is a far more grown-up market where sophisticated institutions allocate for the long-term. Managers should take reassurance from this. The only downside, potentially, is that we will continue to see bifurcation, whereby large managers net the majority of new assets.”

“In a lower return environment, the distribution of wealth between investors and managers is increasingly challenged. Big is beautiful, very often leaving a number of talented managers in the street struggling to attract initial capital to launch their strategy,” adds Philippe de Beaupuy.

Last year, according to Hedge Fund Research, fixed income-based relative value arbitrage became the largest strategy area, by assets: total capital inflows for 2012 were USD41.4billion, taking total assets in the strategy to USD609billion. This is hardly surprising given that the HFRI Relative Value Index ended the year up +10.5 per cent.

What is more surprising is that the strategy overtook equity-based strategies for the first time in more than 20 years. Investors withdrew USD10.4billion in equity hedge funds last year, leaving total strategy assets at USD598billion.

For the first time in at least 18 months, there are signs that the risk on/risk off environment – which has plagued stock pickers – has diminished. Equity markets have recovered strongly in recent times, and YTD the S&P 500 Index is already up 9.34 per cent. Suddenly, equities have regained a degree of lustre.

As Duncan Crawford, co-global head, Newedge Alternative Investment Solutions – winner of this year’s Best European Prime Broker – comments: “The markets are like a coiled-up spring; they are ready to trend, they need trend, and I think they will trend.”

European institutions are favouring US equities, and for firms like Mendon Capital Advisors – winners of this year’s Best Equity Long/Short Manager – the outlook for 2013 looks promising.

Mendon focuses its strategy on the US financial services sector. Its approach is both bottom-up stock picking and scanning the universe of 7,000 US banks for event-driven positional plays, which founder Anton Schutz looks to build way in advance of deals being completed (or not). “We meet with management teams literally hundreds of times a year so we don’t just know the numbers, we know the people. We’ve got off to a great start this year and we expect to see a lot more M&A deal flow in 2013.

“For me, a perfect M&A deal is one where everybody’s stock goes up not just the target stock, and we’re starting to see that in some transactions. I think in the next five years we’re going to see the number of US banks fall from 7,000 to around 4- to 5,000 banks; that’s a lot of banks that might disappear. So there will be plenty of opportunities for our fund.”

Fixed income was, as mentioned, the top strategy for 2012. But with US 30-year treasuries at historic lows, and pressure for investors to find attractive yields in a low-rate environment, strategies that can deliver either through arbitrage opportunities, or through superlative bond picking in the corporate high yield space, are worth their weight in gold.

Some believe we will see the Great Rotation this year from fixed income into equities. Others believe investors will take an intermediate step, from investment grade into high yield; in particular short duration high yield.

Dexia Asset Management’s Long/Short Credit Fund (Best Long/Short Credit Manager) is designed precisely to capitalise on market fluctuations by trading on inefficiencies between IG and high yield bonds. It does so by leveraging two strategies: relative value and directional, the former being best suited to dispersion in the market, the latter when directionality builds in the market.

“Directional strategies work well by going long and short and taking profits where possible. This certainly helped the fund’s performance last year. Right now, we are holding short-duration IG bonds. Around 12 per cent of the book is holding selected names with less than one-year maturity.

“The idea is for the gross exposure of our relative value bucket to grow versus the gross exposure of our directional bucket. Currently, around 50 per cent of gross exposure is in the relative value bucket and the idea is to build that exposure as there’s less directionality in the market than last year,” explains Portfolio Manager, Patrick Zeenni.

Investor preferences have moved to embrace high quality strategies offering transparency, liquidity, tactical flexibility, strategic innovation and consistent performance gains according to Kenneth Heinz, President of Hedge Fund Research, winner of hedgeweek’s award for Best Index Provider. This promoted HFR to launch a new suite of HFRU indices at the start of 2013, to track the daily performance of UCITS-compliant hedge funds.

“The reason why the HFRU Index is important to us is because by virtue of having these indices it enables the user to draw relevant comparisons between the HFRI Index and the HFRU Index, which are based on a common language. There are important elements of risk that need to be taken into consideration when evaluating performance, and I think the indices that we now offer can empower investors to make those important characterisations,” says Heinz.

There’s no doubt that the maturation of the hedge fund industry is pushing managers to rely on their service providers more than ever, particularly their administrators. They need help filing their Form PF returns, building compliance controls, and delivering accurate investor reports as clients become more forensic. They want to know exactly where the alpha that their annual fees are paying for is coming from.

There’s no hiding for today’s manager. And with the threat of the SEC or FCA paying firms a visit, getting one’s house in order is vital. No wonder compliance firms like Kinetic Partners – voted Best European Regulatory Advisory Firm – enjoyed a 25 per cent increase in revenues in 2012. One of the firm’s big advantages is the ability to support UK and US managers on the big regulatory issues: CFTC and SEC regulations and the European AIFM Directive.

“Our US office has had to train our UK office on US regulation; we’ve put a lot of investment into that. You need people here in the UK to understand US regulation, more so for day-to-day queries given the time-zone issue,” says Andrew Shrimpton, who heads up the Regulatory Compliance practice at Kinetic Partners, overseeing the US, the UK and Hong Kong.

The firm has 25 people giving FSA advice to clients in the UK, and approximately 15 people in its New York office advising US managers on the best way forward under the Directive, which comes into effect this July. There are four menu options to the Directive depending on whether or not the fund is in Europe, or whether or not the manager is based in Europe.

“The light touch version of the Directive is where both your fund and your manager are outside Europe. A US manager looking at this menu of four options will say ‘I’ll choose the lightest touch option. I’ve got a Cayman fund so I’ll choose my US manager, rather than my UK manager, to be the AIFM’. All they have to do is some reporting, and register the fund that they market in Europe, which will be the biggest hassle.”

Corporate governance has become a much bigger focus in the last 12 months and will continue to shape the way hedge fund managers think about running their firms. Institutional investors want demonstrable reassurances that independent boards of directors are put in place to protect their interests rather than those of their paymasters.

Bermuda-based Meridian Fund Services – winner of Best Offshore Hedge Fund Administrator – prides itself on having been at the forefront of the governance issue. At a time when differentiation is key, having a strong governance offering is a huge advantage.

“The funds’ shareholders are our ultimate clients. We are the stewards of information that relates to their funds and it’s extremely important that they can rely on the information they receive and that the fund groups that we are associated with are organised in such way that the integrity of that information is of the highest quality. We see ourselves in that role,” explains CEO Tom Davis, who makes a further interesting observation on how the offshore and onshore worlds are converging with respect to governance.

“We’re seeing hedge funds taking on independent directors not just in the offshore world but also onshore in the US as well.

“What we’re recommending to our clients is that they should appoint an advisory board for their onshore funds that has similar responsibilities to a board of directors of offshore funds. To achieve this, we have developed a prototype of powers and indemnities that can be formally transferred and/or bestowed by the general partner or managing member to the advisory board. We’ve been working with clients to help achieve this independent oversight role that institutional investors are increasingly looking for, and regulators may start to demand,” adds Davis.

One trend likely to continue in 2013 is the willingness for institutions to consider seeding emerging managers. There is a growing awareness that more diverse sources of alpha are needed and that institutions have to become more adventurous, backing smaller managers as well as writing huge tickets for billion dollar fund managers like Ray Dalio’s Bridgewater Associates.

Amsterdam-based IMQubator is one of Europe’s leading seeding platforms – and winner of Best Hedge Fund Seeding Platform this year. Its CEO, Jeroen Tielman, says that there seems to be less reluctance among continental European institutions towards seeding, although he admits that it remains more widely accepted in the US, Asia and Scandinavia.

“I’m quite optimistic about the funding climate this year. There is increasing awareness that seeding is not something exotic bur rather an interesting area to pursue for one’s portfolio. A vehicle like ours provides investors with the opportunity to tap into young emerging managers.

We have also seen an increasing number of applications from funds with one to three years’ track instead of from pure start ups. We’ve seen a number of managers with good track records but who are finding it hard to break through the EUR100million barrier. In earlier days we turned down these managers but now we want to start including them; that’s been a shift in strategy. We will continue to seed managers, but in addition provide acceleration capital,” confirms Tielman.

Everyone involved within the industry needs to continue to raise their game and take the industry to the next level as the tectonic plates, pushed by regulation and greater governance and transparency, realign themselves.

Lyxor Asset Management, which won this year’s hedgeweek award for ‘Best Managed Account Platform’, will be doing this with three initiatives in 2013. Firstly, through the introduction of a super-institutional share class (“S” class) to give institutions access to strategies through a managed account format for the same Total Expense Ratio as the main hedge fund in exchange for slightly lower liquidity and a higher minimum allocation (USD5million).

“We are also launching a new transparency project. The aim is to provide aggregated positions reports, with a lag, to our clients invested in a portfolio of managed accounts. This “look through” capability will help them monitor capital costs under Solvency II.

“Finally, another key project is the establishment of an early stage manager platform. This will enable investors to allocate to emerging managers in the same risk management and transparency framework that prevails for more established ones,” says de Beaupuy.

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