Speaking at the Fourth Annual European Alternative Investments Conference hosted by Duff & Phelps in London on Thursday 20 September, Emmanuel Roman (pictured), President and COO of Man Group and CEO of GLG Partners, said that capital constraints being put on investment banks presented a great opportunity for hedge funds today.
“I always said, 10 years ago our biggest competitors (in the hedge fund industry) were investment banks,” said Roman, adding that because of Basel III and the increased capital requirements being put on these institutions, there are attractive opportunities for managers to engage in direct lending and buy high yield bonds.
“People that look selectively at assets will find alpha. I envisage credit funds to do well. They are already the best performing strategy year-to-date, having returned 10 per cent.”
The “shadow banking” market – where hedge funds act as alternative lenders to SMEs who cannot get access to funding from traditional bank channels – has become a popular growth area in the hedge fund space. With banks keen to offload risky assets, managers operating in the distressed debt space have been quick to step into the breech. Clearly this is a trend that Roman sees continuing.
“We live and die by performance. What matters is alpha generation. That banks are going through a bad patch is good news for us,” said Roman. With some USD60billion in assets, being a big player like Man Group is helpful in what remains a challenging economic environment, with Roman confirming that the firm was hiring people to build out the business into different areas like credit.
The general outlook given by Roman was, aside from credit opportunities, somewhat cautious. It was, he said, “difficult to be too optimistic”. Take emerging markets for instance: the view is that companies bailed out by the US or China will do well and are priced accordingly. McDonalds is a good example of this: it operates a simple business model, 3 per cent yield, 16x earnings. But as Roman stated: “If you buy a company with decent exposure to emerging markets, are you paying too much?”
At a macro level, against a backdrop of continued government and central bank intervention in the US and Europe – where leverage in the UK continues to be 350 per cent of GDP – hedge funds delivered a “C-plus performance last year, B-minus this year”, said Roman, adding that the biggest problem for hedge fund managers was trying to guess what policy makers would do next, what the implications of the next bailout would be.
There were, he said, two implications to this. Firstly, that interest rates (and ergo growth) would remain “very low for a very long time”. Secondly, and specific to Europe, Germany would need to make a decision to either leave the euro and re-value its currency so much that its exports would fall off a cliff, “or stay and pay for everyone’s sins”.
Roman said Chancellor Merkel was right to ask for a higher retirement age in Spain. The challenge for fund managers was knowing whether Merkel (and other heads of state) would be re-elected to push through these initiatives. It’s hard developing long-term fund strategies in these politically charged markets, for sure.
Whilst there would be further pain, crises, dislocations in the market, the euro “will not implode and things will improve eventually”, said Roman. But how long that takes is anyone’s guess. What is likely is that there will be a significant wealth transfer from the German taxpayer to the rest of Europe.
A quick appraisal of how other hedge fund strategies had performed this year was then given. With respect to global macro and CTA strategies, Roman said that these would start performing when the ECB stops interfering in the markets, noting that a lot of the devaluation in G10 currencies and rates didn’t make sense and that eventually things would revert.
Long/short equity has been a mixed bag. What has surprised Roman is how well the US stock market has done. “There is a strange situation right now where some of the cheapest stocks in terms of valuation and earnings growth are actually the big media companies – Apple, Viacom, Disney,” said Roman. Apple has an estimated P/E ratio of 15.76 according to Bloomberg.
With dispersion in the markets still high – Spain’s stock market rallied 26 per cent between end of July and mid-August – there remains lots of opportunities to go long and short, with Roman confirming that the average long/short equity fund at GLG this year was up 4 to 5 per cent.
Wrapping up his speech by fielding questions, Roman believed that clients had generally revised their expectations of hedge funds, particularly institutionals like pension funds. He said that managers “who tell investors that a 15 per cent annual return with a 2.0 Sharpe Ratio is unrealistic, is a good thing”.
When asked about his fears of inflation, Roman responded: “For me it’s not an issue. I just don’t see inflation becoming a problem.”
Looking back on the performance of hedge funds in 2008 when the credit crisis erupted, Roman said that with the benefit of hindsight they should have done better. “I think the industry became a little complacent with respect to risk.”