Mon, 15/07/2013 - 10:45
By James Williams – Over the past 12 months, total AuM in alternative UCITS funds has risen from EUR139billion to EUR155billion. In 2008, that figure stood at EUR28billion.
Given that the majority of money coming into these products is mostly retail money, invested through private banks and FoHFs, the size of allocation is not substantial. As Amy Bensted, Head of Hedge Fund Products at Preqin, comments: “There’s still less than EUR200billion invested so the industry is not growing as much as people expected a few years ago. However, we think alternative UCITS funds will remain a good option for investors who are looking for volatility dampening, liquidity and greater transparency.
“The appetite is growing, but the money is not there yet. I think we’re still a couple of years away from the big institutional money coming in to these funds.”
This month Preqin launches its latest special report on UCITS hedge funds (see www.preqin.com). Critical to the success of these funds, and what investors will always look at when selecting which funds to choose, is performance. And as the report shows, things are starting to look up for alternative UCITS compared to their offshore hedge fund brethren.
For Q1, 2013, alternative UCITS returned 2.46 per cent compared to 3.22 per cent for hedge funds. Over the last 12 months, the figures are 3.75 per cent and 6.88 per cent respectively.
This year is particularly encouraging because it demonstrates that given that they operate under tighter rules, alternative UCITS are doing exactly what they are supposed to do: keep pace with hedge funds, but sacrifice a little bit of performance for less volatility.
As the report shows, relative value, long/short equity and global macro are the most popular strategies as they seem to best fit the liquidity constraints of the UCITS framework. Relative value strategies are much less prone to liquidity swings. Results show that three-year volatility is just 2.1 per cent, compared to 6.9 per cent volatility for long/short equities and 4.3 per cent for macro strategies.
Taken as a whole, the three-year rolling volatility for UCITS hedge funds is in the 5 to 8 per cent range, whereas the S&P 500’s volatility range was 15 to 22 per cent.
In terms of overall performance, long/short equities lead the way. Between end-2009 and end-2012, they returned more than 8 per cent, and thanks to the strong equity market rally this year, that figure through March 2013 was in excess of 12 per cent. Relative value and macro strategies, during that three-year period, returned 5.08 per cent and 5.24 per cent respectively. Indeed, 54 per cent of all UCITS hedge fund launches in 2013 have been long/short equities, with macro strategies accounting for 31 per cent of launches.
Another encouraging point to note is that more than 70 per cent of UCITS hedge funds made positive gains over a three-year period, with more than half exceeding 10 per cent returns. In 2012, 40 per cent of funds were able to generate more than 5 per cent. Again, considering the attributes of these funds – better liquidity, regulated, transparent – these are respectable returns.
“There are some good performers in the alternative UCITS space now and some of the funds are starting to get large. That will have a positive impact. Size is important in attracting seed capital, gathering assets, and once more funds build momentum the space will become more interesting to institutional investors who want a lower volatility component to their alternative investments portfolio,” says Bensted.
“We are still in the early stages of evolution. I think in a few years it will look much more different and be a lot larger than it is now.”
Without doubt, the alternative UCITS space has crossed the Rubicon. This is not a transient trend. In many respects, given the profile of investors right now, it closely resembles the hedge fund industry of 15 years ago. Most of the money was HNW, FoHF money until suddenly, post-2008, institutions started to seriously ramp up their interest to the point where they now dominate the hedge fund industry. Alternative UCITS could well follow a similar trajectory over the coming years.
Year-to-date, the UCITS Alternative Index Global is up +0.94 per cent compared to +1.63 per cent for the calendar year 2012. Whilst long/short equity is the best performing strategy YTD, with gains of +3.39 per cent, one of the more surprising developments has been the performance of FoFs. The UAI Fund of Funds Index is up +1.24 per cent, having lost -1.34 per cent through 2012. June 2013 was a tough month, as equity markets pulled back, causing the index to give back 1.85 per cent.
Last July was certainly a tipping point, however. Between July 2012 and May 2013, the FoF Index – which is calculated by Geneva-based Alix Capital – generated positive returns every month, except for October (-0.54 per cent).
“Fund of funds are doing better than the wider market,” comments Louis Zanolin (pictured), CEO of Alix Capital. “For the first time since we began running the index, FoFs have been able to add value over and above the wider market, so that’s encouraging. The ones that have done well over the past 12 months are those that tend to have a large allocation to long/short equity – 50 per cent or more. Some of the single manager funds that have done well include Egerton Capital’s Schroder GAIA Egerton Equity Fund and the Odey UK Absolute Return Fund.”
Even though overall performance in the alternative UCITS space is good, Zanolin says that, “Since June 2012 inflows have been largely because of investors’ need for regulated products as opposed to performance per se. So it is very helpful to the industry to have a good period of performance.”
Lyxor Asset Management added three managers to its UCITS offering in early 2013, and even though they only have short-term track records, performance for each has been strong thus far. The three funds in question are: Canyon Credit Strategy Fund, Tiedemann Arbitrage Strategy Fund, and the Lyxor/Winton UCITS Fund.
“Our new UCITS single manager hedge funds include a systematic trend-following CTA, a liquid event-driven global credit fund and a pure merger arbitrage fund. All three managers are performing strongly. Through May 2013, the Tiedemann Arbitrage Strategy Fund is up +5.4 per cent, even though it didn’t launch until March. Winton is up +5.60 per cent, and the Canyon Credit Strategy Fund is up +5.29 per cent,” confirms Jason Funk, a member of the alternative investments business development team at Lyxor Asset Management.
“To stress, it is not always possible to offer pari passu versions of corresponding offshore hedge funds due to UCITS investment restrictions such as physical commodities or shorts. Accordingly, our UCITS hedge funds have been designed thanks to Lyxor’s proven experience in replicating alternative strategies coupled with the managers’ overall expertise in the given strategy.”
The fact that the nature of the alternative UCITS market is gradually changing might explain why performance is improving. Currently, only 12 per cent of funds are long/short equity, by AuM. That figure is much higher in the offshore market. Also, onshore equity-focused funds tend to be less directional and more market neutral in nature, but as Zanolin explains: “This is changing slowly, particularly with the rise of platforms bringing on US managers who tend to take more risk and be more directional. I expect that to further evolve in the future as more US managers enter this space. For the time being, the number of single managers who have performed really well in equity long/short remains quite small.”
One of the best performing equity long/short funds is the Skyline UCITS fund, managed by London-based Skyline Capital. Last September, the fund completed its first year of trading and recorded an impressive 20.5 per cent return, placing it firmly in the top one per cent of all alternative UCITS funds.
The UCITS fund is based on the firm’s emerging market-focused long/short equity strategy. Assets have grown an impressive 65 per cent YTD to USD123million.
“We’re pleased but we think there’s a lot more to come. We’ll be doing our utmost to replicate the level of outperformance last year; both this year and in future years,” asserts Skyline’s CEO, Vernon West.
The strategy predominantly targets large- and mid-cap emerging markets-focussed companies, and as such fits quite neatly into a daily priced UCITS fund. It is not, however, run pari passu to the offshore hedge fund.
“We use the same diligent, bottom up, fundamental approach and look for the same attributes in companies we invest with, but we are subject to UCITS risk limits, and that means the fund has a slightly more defensive, lower volatility profile,” says West.
Emerging markets have not had a good run this year. The MSCI Emerging Markets Index has slumped -13.55 per cent, falling -2.1 per cent alone on 3 July 2013 amid concerns of a slowdown in Chinese services industries. However, the Skyline UCITS fund has remained resilient – testament to the stock-picking talent of the team – and through 1H13 is up +1.4 per cent.
West confirms that in 2012 the hit rate for ideas in the fund was “rather high”, helping to lock in broad-based performance and strong alpha generation in both the long and short book.
“Notable themes that helped us on the long side were education in Brazil, travel in Latin America, and Turkish autos. On the short side, going short solar companies was a key trade in terms of profit generation, as was being short a Brazilian pulp and paper company,” says West, adding that in 2013 two key investment themes on the long side have been Russian hypermarkets and Chinese casinos.
“Russian hypermarkets are currently underpenetrated – representing around 10 per cent of total food retail footfall – so there’s plenty of scope to roll out the hypermarket format across Russia. Also, since the start of 2013 there’s been a ban on sales of alcohol in small shops, which has led to greater footfall in the hypermarkets.
“In Hong Kong, we’ve had positions in Chinese casinos and there again you’ve got a penetration story; 2 per cent of Chinese have visited the casinos in Macao, versus 40 per cent of Americans who have visited Las Vegas. Coming into 2013, you had completion of some key railway infrastructure cutting the journey time to Guangzhou, which is helping drive incremental footfall.
“On the short side, we’ve had a couple of key winners in, broadly speaking, project businesses in the engineering space; super low margin businesses where we’ve seen evidence of pretty aggressive accounting treatment.”
Chris Nichols is Investment Director, Multi Asset Investments at Standard Life Investments. The firm’s Global Absolute Returns Strategy (GARS) fund is one of the largest funds in the alternative UCITS space – global AuM in GARS was GBP26.7billion through end-Q1, 2013, while the UK pooled fund was GBP16.7billion.
What makes the multi-strategy fund so scalable is that it uses the largest, most liquid, and most plain vanilla instruments to express investment views.
On Europe, one of the fund’s strategies that worked well overall until more recently this year was a financial capital structure strategy. As Nichols explains: “It was designed to hold senior credit of the European financial system long versus main credit index short, in addition to holding a small short position in European bank equities. That was a strategy that paid out 3.5 per cent per annum. However, as senior credit spreads began tightening in Q1 this year and equities performed well we exited the strategy.
“Another interesting theme for us is the story of France being unreformed versus Germany having reformed its labour market,” says Nichols. The fact that France has yet to start implementing austerity measures is not reflected in market pricing in either its bonds or equities says Nichols. “We have had a German 10-year bond versus a French 10-year bond position, which we recently re-struck as a German versus France equity position. On a three-year view, we think French equities are overpriced versus Germany’s.”
Performance-wise, between end-May 2010 and end-May 2013, GARS generated cumulative gross returns of 23.8 per cent (based on the UK unit trust). Over the past 12 months, gross returns were 10.37 per cent, while this year, through May, it is up +5.72 per cent.
“Year-to-date we’re seeing positive performance in the portfolio from things like US equities and global equities. The US dollar has been appreciating against the yen, Canadian dollar, and was very positive against the euro in Q1 although it pulled back a lot in Q2.
“Another good trade has been the Mexican peso against the Australian dollar. The slowdown in China is bad for Australia. The AUD had previously been suspended in the stratosphere by Chinese resource demand.”
Nichols says that some of the key ideas in GARS for delivering strong payout in an uncertain growth scenario are US equities, large cap versus small cap, and US tech sector versus Taiwan. Being long the US dollar is designed to deliver modest payout in a growth scenario but a stronger payout in a market downturn scenario.
“Those are some of the main elements right now. We also have a relative volatility strategy that would position us to make money from higher volatility in Asian markets relative to Western developed markets. We also added global REITs to the portfolio last December.”
West thinks there are a number of reasons to remain bullish on emerging markets but stresses the import of remaining selective and identifying themes that are in a “fundamental sweet spot”.
One of those themes ties in to next year’s FIFA world cup in Brazil.
“We expect a double-digit increase in incoming passengers. We have a position in a beverages company with 70 per cent market share – the dominant duty-free concession operator – and FIFA’s global sports-ware partner. We are well positioned for this event next year.”
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