US hedge funds react to new regulatory paradigm
This year’s Hedgeweek USA Awards event, held at the ‘Les Trois’ private room at Restaurant Ca Va in the Intercontinental Hotel, brought together an exclusive group of some of the hedge fund industry’s leading practitioners.
Fom leading high yield credit hedge funds such as Jeff Peskind’s Phoenix Investment Adviser LLC, DUNN Capital Management and Paulson & Co, through to Goldman Sachs (Best North American Prime Broker), Rothstein Kass and leading administrators’ SEI and Meridian Fund Services, the atmosphere left one in no doubt that the esprit de corps is fervent within the US hedge fund industry.
In his opening address, Ron Geffner, partner and head of the Financial Services Group at law firm Sadis & Goldberg LLP (winner of Best North American Law Firm), said: “Years ago when I was told that both I and my firm are part of the ‘hedge fund mafia’, I felt that was a negative statement. However, I have come to realise that it is positive as it reflects that we are a community. A community of lawyers, auditors, accountants, prime brokers, administrators and hedge fund managers. We are all privileged to be a part of this community.”
One of the hallmarks of this industry is the rich vein of innovation that runs through it. Not only are managers looking at new ways to improve their strategies, but administrators, prime brokers and technology specialists are likewise pushing the boundaries to support managers in a better, more cost-effective way.
SEI won this year’s award for Best North American Hedge Fund Administrator. According to Jim Cass, Senior VP and Managing Director, SEI Investment Manager Services: “We’re never going to be finished innovating. In today’s marketplace, managers must deal with an environment of escalating challenges, risks and opportunities. Investors are demanding more choice, customisation and transparency while product innovation and convergence are increasing apace. The marketplace will continue to adapt in terms of product innovation and client convergence. One example of this happening is in liquid alternatives; we see that as a huge growth area and we’ve continued to evolve our developed a solution to handle the increased desire for that.
“To accommodate the growing interest, in the last several months we’ve recently launched a third series trust (The Advisors’ Inner Circle Fund® (AIC) III), using our comprehensive turnkey solution focused on hybrid and alternative strategies. We provide everything from a board of trustees and custody through to fund administration and distribution support services.”
Cass said that this trend for alternative mutual funds is one that will build over the coming years, adding: “If you’re a talented manager that generates demonstrable returns, you don’t want to be limited to a certain investor base or distribution channel because of the investment vehicle or structure you’ve been using; liquid alts is a truly viable option for a lot of hedge fund managers who are looking to diversify their revenue stream and package their strategies for a broader market.”
This theme of supporting multiple fund structures is one that has grown significantly in recent times. One saw evidence of this in Europe a few years ago when US managers like Paulson & Co started to launch alternative UCITS funds to cater to European institutional investors. With ’40 Act funds now gaining prominence, not to mention AIFs in Europe under AIFMD and segregated managed accounts, US hedge fund managers suddenly find themselves juggling multiple balls.
Lyxor Asset Management, winner of Best Managed Account Provider, was cognisant of this trend and explains why this year one of its key implementation projects is the migration of the platform from Jersey to Luxembourg.
“We’re moving into a world where you have to have a sound infrastructure and a lot of operational flexibility to handle the different investment vehicles that investors now require. There are few organisations that have the scale to be able to handle this. We’re investing heavily in our infrastructure to support these different products,” says Michael Bernstein, Managing Director and Head of North American Business Development.
This is what is now required of service providers: to scan the market and understand not only how to support managers today, but years down the line. Pushed by regulation, these solutions are often complex and multi-faceted. Relocating an entire MAP is not a simple task but it is a vital one. Lyxor recognises that both investors and managers want reassurances that the managed accounts they run will comply with AIFMD.
“Investors want our managed accounts to grow; they don’t want to be the only investor!” notes Bernstein. “So it’s important that they know that we are making them available to investors across Europe in full compliance with AIFMD. It’s also equally important to managers; they want to know that we can continue to market their funds on a proactive basis across Europe.”
Innovation drives success and last year Florida-based DUNN Capital Management, one of the oldest and most highly regarded CTAs in the business (winner of this year’s Best CTA/Managed Futures Manager) proved that point emphatically. Despite most CTAs having a bad run, 2013 saw the firm’s flagship fund, the USD308mn DUNN World Monetary & Agriculture (‘WMA’) Program return over 30 per cent. This was, in part, due to the implementation of significant new research according to Marty Bergin, President of DUNN Capital Management.
“We began to implement what we call an Adaptive Risk Profile (ARP) during January. We’ve changed the VaR from a 1 per cent risk of losing 20 per cent per month on any given day to a number based on certain proprietary measures. Our average VaR is now closer to 15 per cent,” explains Bergin, noting that the VaR range for the programme will fluctuate between 21 per cent and 8 per cent.
This ability to dial up and dial down risk in response to market dynamics actually led DUNN to roll out an institutional version of the WMA programme – the WMA Institutional Program – in late 2013, using 50 per cent of the VaR of the flagship strategy.
“We’ve found that institutional appetite is for lower risk products, they’re not comfortable with having a large drawdown in any given month,” says Bergin.
Within the equities space, Houston based-Bayou City Capital LP (winner of this year’s Best Equity Market Neutral Manager) has introduced a series of safeguards to mitigate drawdowns during periods of market stress. These safeguards include technical indicators to flag up potential market downturns, as well as a futures strategy based on the VIX (also known as the Fear and Greed Index) that is designed to offset losses during option price spikes.
The strategy is primarily short volatility, using an S&P 500 Option Overwriting Program to trade S&P 500 futures at the Chicago Mercantile Exchange but it also actively manages delta exposure to capitalise on upside tail events (when the price of options rise in response to the underlying stocks).
“We have found that a more active management style has minimised drawdowns over a variety of time periods and market cycles. During upside tail events (which could be described as 2013), the proactive mindset also contributes to market outperformance. Also, we have a very systematic process of covering option positions, both outright and synthetic, that have decayed to a certain value. These tweaks to the strategy have lowered the volatility of returns over the last few years, raising our Sharpe ratio and risk-adjusted performance,” says Robert Hay, founder of Bayou City Capital.
This again perfectly illustrates the level of innovation among hedge fund managers (risk management in Bayou City’s case) that no amount of regulation will dampen.
One of the big trends that leading software provider Advent (winner of Best Fund Accounting & Reporting Systems Firm) has noticed over the last 12 months is a blurring of the lines between hedge funds and private equity, which has also prompted the firm to come up with an innovative solution. Given that clients previously would have used Advent Geneva, the accounting engine, for their hedge funds and another system for their private equity funds, the emergence of ‘hybrid funds’ means that is no longer possible.
“We’ve built out a new capability whereby managers can now run their funds, including these hybrid fund structures, on one system rather than having to assemble a patchwork of multiple systems. There was no system out there that could support managers wanting to run these structures with two different tiers of liquidity (short-term and long-term). Our solution gives managers best-in-class accounting capabilities (Geneva) coupled with support for multiple fund types (Geneva World Investor),” comments Robert Roley, Vice President of Solutions Consulting at Advent.
One of the big initiatives for Advent in 2014 is bringing Geneva into the Advent Direct cloud platform, as well as making further enhancements to make the product more of a cloud-based system.
Wherever you look in the hedge fund community, innovation and the spirit of collaboration appear to be thriving. And long may that continue.
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