By Simon Gray - Switzerland is better known as a source of capital for the hedge funds, with its world-class private banking and wealth management industry, than as a hotbed of alternative fund managers. However, this largely low-profile sector has found itself more in the spotlight over the past couple of years as the Alpine nation emerges as a possible domicile for fund management firms and their principals seeking an alternative to London.
Members of the Swiss fund industry hasten to point out that the influx of firms is far from a flood, and there are plenty of practical reasons relating to resources and infrastructure why it is unlikely to become one in the future. In addition, they are extremely keen to make clear that a move to Switzerland does not offer managers opportunities for regulatory arbitrage. However, there is no escaping the fact that the country’s pragmatic and flexible approach to personal taxation stands in stark contrast to the sharp rise in rates imposed on high earners in the UK.
It may be an exaggeration to suggest, as asset management consultants Kinetic Partners did last year, that up to a quarter of London’s hedge fund industry is considering a move to Switzerland. But the move to Geneva of Brevan Howard founder Alan Howard and some of his staff, along with the opening of an office in the same city by BlueCrest Capital Management, two of Europe’s largest hedge fund managers, certainly made people sit up and take notice, as did the switch of Moore Capital senior partner Jean-Philippe Blochet to a new office in Zürich.
In addition to its two main financial centres, Switzerland has also seen growth of hedge fund manager communities in other municipalities that have rolled out the red carpet to the industry, such as Pfäffikon, a district a few kilometres east of Zürich that has been home to RMF Investment Group, part of London-based Manager Man Group, for nearly two decades, as well as Zug, half an hour’s drive to the south.
“The biggest attraction for these firms is the tax agreements they can negotiate in Switzerland, especially in Geneva,” says Laurent Reiss, managing director and global head of hedge fund advisory at Union Bancaire Privée. “The Swiss authorities are particularly flexible in coming up with tax solutions. For example, Geneva and other cantons offer the forfait fiscal, a lump-sum tax regime for individuals that are not employed in Switzerland, calculated as a multiple of the individual’s rent. You can also negotiate with the authorities if you start a business that will create employment.”
Michael Appenzeller, managing director of asset management outsourcing specialist Etops, says that while there is definitely an upsurge of interest among managers in establishing a base in Switzerland, one should not expect hundreds of firms to quit London. “Switzerland is probably the most attractive place in Europe to position some if not all of a hedge fund manager’s value chain,” he says.
“Everyone knows about the favourable tax environment, but there are other factors in play. There is an institutional asset management culture, especially in the Zürich area where there are a lot of pension funds as well as managers. There is also a fund of hedge funds management cluster, especially in places such as Zug and Pfäffikon, that has helped to create awareness and knowledge of the industry among the investor base. People such as private bankers, independent financial advisers and investment consultants to pension funds are familiar with hedge fund products and what they can do for their portfolios.”
The existence of Switzerland’s large private client market is an important factor in making the environment attractive for managers, Appenzeller says. “It may be hard work to tap into, but at least it’s in front of your door, and there are literally thousands of contact points to go after,” he says. “You are not in the middle of nowhere but in a cluster with plenty of qualified people, service providers and a huge potential investor base. For example, family offices are acting more and more as seed investors.”
Hans-Jörg Baumann (pictured), chief executive and senior partner at Swiss Capital Alternative Investments as well as head of the Swiss Fund Association’s Alternative Investment Council, sounds a note of caution about the ease – or otherwise – of moving operations and people from a global metropolis and financial hub such as London or New York to even a cosmopolitan Swiss city like Geneva.
“To change from one location to another involves considering many different factors,” he says. “The most important is to make sure you don’t endanger your business. You have to make sure you are adequately equipped with resources, including human resources and systems, to run your business, and Switzerland does not have an advantage over London in this respect. Secondly, you must ensure the decision is understood by your investors, and that they do not perceive any risk to your performance as a result.
“The third factor is that some people have a personal preference to work in a city such as London or Paris. You have to make sure your key people do not feel their private lives are adversely affected, because you are moving families. Clearly Switzerland is attractive and offers various advantages such as taxation, but that should not be the sole trigger to move.”
It is not just managers who are looking at opportunities in Switzerland. Apex Fund Services became the newest member of the fund administration sector when it opened an office in Zürich in February. “A third of the world’s assets are managed from Switzerland, which makes it a huge market,” says managing director Peter Hughes. “We are committed to doing work locally, and we don’t believe you can market successfully into jurisdictions from afar. You need to meet people regularly, and it’s very hard to do that when you are coming and going.”
Apex’s philosophy is based on being close to fund managers and other clients in order to understand their needs better. That’s particularly important at a time when Swiss hedge fund professionals identify important structural changes underway in the industry that are set to increase the importance of transparency, reporting to investors and servicing of individualised structures and portfolios.
Baumann, who co-founded Swiss Capital Alternative Investments in 1988, says the industry is having to come to terms with a shift not so much in market preferences but in business model in the wake of the crisis of 2008 and 2009, as institutional investors in particular increasingly demand tailor-made investment solutions and have a strong preference for individual rather than commingled structures.
“The requirements have changed for roughly 70 per cent of our clients, and Swiss investment managers have undertaken a great deal of effort to cope with this,” he says. “Large investors not only prefer single investor funds but have moved away from the multi-strategy, multi-manager concept.
“As a provider you need the efficiency to provide scalable structures and tailor-made solutions tailored to the clients’ clearly defined objectives. On the private client side, recovery is gradual because investors are more reticent. Their confidence has not fully returned after the industry failed to live up to their expectations in terms of returns and underlying liquidity in 2008.”
According to Baumann, both these trends have slowed the recovery of the traditional fund of funds sector, he says, which – with some exceptions – is struggling to rebuild assets under management. “As large institutional investors create their own single-investor fund structures, many of the original commingled funds of funds have seen their asset volumes shrink,” he says. “However, assets under management in specific provider platforms have grown due to a noticeable increase in institutional investor demand.”
Matthäus Den Otter, chief executive of the Swiss Funds Association, says some Swiss funds of funds are still dealing with the legacy of the downturn, including side-pocket structures with illiquid assets. “We don’t see much of a rebound yet, especially among funds sold to the public,” he says. “One or two new funds of funds have been launched recently, but it’s still too early to talk about recovery; it might take another six or 12 months.”
Philippe Bens, managing director of fund administrator Caceis Fastnet (Suisse), says that private investors were particularly affected not only by the performance losses of 2008, which averaged around 20 per cent across the hedge fund industry, but by the Bernard Madoff fraud, which caught up a number of Swiss asset managers.
“Some of these people, at least those who were not affected by Madoff or other Ponzi schemes, are starting to come back to funds of funds, but very slowly,” he says. “One big obstacle is that today Finma, which was one of the few regulators in Europe or worldwide to authorise public distribution of funds of hedge funds, has changed its stance. It’s now almost impossible to get this kind of product authorised for public distribution in Switzerland.”
Lorcan Murphy, managing partner of Swiss distribution specialist Acolin Fund Services, says that part of the problem in the run-up to the crisis was a lack of co-ordination within investment management businesses. “There were often completely different desks and specialists handling long-only and hedge fund investment,” he says. “No-one had the full picture, no-one had overall control.
“That’s why the Madoff scandal was so painful, because people would never admit they didn’t know how much their bank had invested with Madoff – it wasn’t in the system. Because of that big scare, everyone was very keen to crack down. A lot of banks that had invested their clients’ money in 50 hedge funds or more decided they wanted to get that down to a more manageable number, like 10, in order to rebase the more extensive due diligence required post-crisis.”
While Reiss acknowledges that across the industry assets are now flowing primarily to single-manager funds, he believes that funds of funds could see a change of fortunes soon. “The statistics indicate that funds of funds are still facing redemptions, whereas 75 per cent of single managers are seeing money coming in;” he says. “The fund of funds industry is still trying to recover from the massive correction of 2008 and 2009. We do see money moving from non-performing hedge funds to better performing ones, and maybe some new money at the margin, but not in massive quantities.
“There are two main factors. Some funds of funds still have illiquid investments and haven’t paid back all the redemptions requested in 2008. Until they receive all their money back, private banking clients will not put more money into the sector, although that will probably happen over the next six to 12 months. The second driver will be performance – if it is strong relative to the market, the industry will attract new inflows. All in all we are very bullish, because eventually investors will realise that hedge funds ultimately do better than the market over a long period of time.”
Gottex Fund Management, one of Switzerland’s best-known managers of funds of hedge funds, has responded to the challenging environment for the sector with a two-pronged strategy, according to head of marketing for Europe Dominique Kuettel. “At a fund of funds level we are using Ucits structures to sell into the broader European market,” he says. “Meanwhile we have a managed account platform, LUMA Solutions Services which is a joint venture between OFI Asset Management and Gottex Solutions Services, that enables us to unbundle services for the big pension funds that want the increased control and governance that commingled funds of funds do not offer.”
Kuettel says an important change in the marketplace is that the large Swiss institutions are turning away from the open architecture philosophy. “Big wealth managers in Switzerland are focusing more and more on internal products,” he says. “They may have some niche external funds on their platform but for the most part they are using products from their in-house asset management businesses.”
The smaller private banks are out of the market altogether for now, he says. “Either they do not fully understand the risks related to staying in hedge funds, or their clients are less interested in hedge fund investments. Family offices are different in that their main interest is single manager niche types of fund. Their approach has always been different in that they went straight into single-manager funds.”
Kuettel expects to see more private banking money coming back into the hedge fund market by the middle or end of next year, but he draws a distinction between banks’ discretionary and advisory mandates. “Banks do have a decent amount allocated to hedge funds through discretionary mandates, but where clients have the final decision they are likely to remain on the sidelines for a while. By contrast, institutions such as pension funds do need to allocate to hedge funds because they have future liabilities to meet, and bonds and cash deposits will not get them there. They are grappling with interest rates and inflation, so they are under much more pressure.”
Jean-Pascal Porcherot, head of hedge fund sales at Lombard Odier Investment Managers, part of the private bank and wealth manager Lombard Odier Darier Hentsch, says the firm launched its internal hedge fund business, which now has some USD2.9bn in assets in 10 hedge funds across equities, fixed income and macro strategies, in November 2007. Its motivation stemmed from factors that would come to the forefront as the crisis came to a head over the coming months: to have full transparency over the portfolios, and to be able to put in place its own risk management framework.
Says Porcherot: “Many hedge fund investors had a number of misconceptions. They thought they were buying uncorrelated sources of returns, whereas there were actually buying hidden beta, for which they were paying 2 and 20. They did not understand that they were taking liquidity risk, and they did not understand how to build hedge fund portfolios. They thought that putting together three good managers equalled a good hedge fund portfolio.
“We believe that the asset allocation model based on static weights across asset classes does not take into account the short-term volatility that one sometimes sees in the market. What was crucial, we decided, was to understand true sources of return between alpha, exposure to idiosyncratic risk, beta, exposure to liquid market premiums, and the liquidity premium.
“Any kind of client solution should be based on that risk matrix, and therefore you need to understand where the returns are coming from. Our organisation is based on the principle that beta and alpha should be separated. Alpha managers require specific skills – they need to operate in an unconstrained environment, to go long or short, to be able to invest in equities or debt. It’s very different from the beta world.”
Events have borne out Lombard Odier’s convictions, and other banks are looking at its internal hedge fund management model, although Porcherot cautions that it is not something that can be replicated overnight. “Some competitors are thinking about it, but we have an edge having started more than three years ago,” he says. “What we have done is in line with what clients want. The crisis is not that far in the past.”