Mark Chapman, Managing Partner at Deloitte & Touche in the British Virgin Islands, explores the breadth of investment strategies employed by the offshore jurisdiction's burgeoning hedge fund industry…
It is well known that the British Virgin Islands' funds sector has enjoyed rapid growth in recent years. Indeed, a recent survey by Advent Software ranked the BVI as second among hedge fund domiciles with 9% of the global market, overtaking Bermuda (7%). Funds with an estimated asset value of over EUR100bn now operate in or from within the jurisdiction, drawing upon the support of some 500 managers and administrators licensed to provide fund support services in the Territory.
Perhaps less well known however, is that diversity has accompanied maturity. Deloitte & Touche has recently conducted research into the investment strategies utilized by British Virgin Islands Hedge Funds, collecting data from a sample of more than 10% of the 2,437 reported funds domiciled in the BVI. The research uncovered a truly diverse sector with a number of central and recurring themes.
Whist there are a multitude of strategies that Hedge Funds employ, the data was distilled down to seven major strategies as follows:
Long/short equity funds invest in a portfolio of long and short securities, sometimes in equal amounts, sometimes not, often in different markets and different countries. The funds generally utilize active portfolio management to identify securities, which are significantly mispriced relative to their intrinsic value.
Fund of Funds
A fund of funds invests in other hedge funds that utilize a variety of investing styles and market segments. This provides an opportunity for the fund of funds to participate a diversified portfolio at a substantially lower minimum investment than normal.
Hedge funds employing an event driven strategy take positions based on their expectations about an event that has or is expected to occur. Events range from an earnings announcement by a company to political or world events. Included in this category is merger arbitrage, where the fund invests in event-driven situations, such as leveraged buy-outs, mergers, and takeovers and the fund will often take positions in companies which are distressed, being taken over, are badly managed or are under threat.
These funds invest in derivatives such as futures, forwards, swaps and options with the aim of leveraging high returns. The most common of these are managed futures funds but this category also includes commodity funds.
These funds typically engage in fixed income or convertible arbitrage, the later being especially popular. Typical of convertible arbitrage is where convertible securities are held long and the underlying equities sold short. With fixed income arbitrage, the fund exploits pricing inefficiencies between related fixed income securities and attempts to neutralize exposure to interest rate risk.
Emerging market funds will often hold securities long but will always invest in companies domiciled or headquartered in emerging market or developing countries.
A market neutral fund uses strategies to neutralize market risk. The fund, typically an equity fund, mainly invests through the use of market neutral asset allocation techniques and generally utilizes quantitative analysis of technical factors to exploit pricing inefficiencies between related equity securities, neutralizing exposure to market risk by combining long and short positions.
Included in other funds are funds with strategies including dedicated short bias, global debt, global equity, global macro, growth, long only, market timing, multi-strategy, opportunistic and sector funds.
Chart 1 below shows the analysis of strategies from the sample of all BVI Hedge Funds. This shows a relatively versatile spread of funds using a variety of trading strategies as described above.
Not surprisingly long/short equity funds come out on top accounting for 32% of all BVI funds, closely followed by fund of funds with 28%. These two strategies are certainly the easiest to comprehend and could be considered the least esoteric of all offshore fund strategies.
Chart 2 below shows the analysis of strategies from the sample of BVI Hedge Funds with assets in excess of USD 1 billion (USD 1,000,000,000). In this category long/short equity funds and fund of funds take a far less dominant position than for all BVI funds and derivative, emerging market and market neutral funds all take an equal and greater percentage of the market at 12% each.
Multi-strategy funds, where specific parts of the portfolio are utilized for separate strategies and global macro funds, which are based on shifts in global economies, account for most of the 21% of other funds. Dedicated arbitrage funds were noticeably absent.
Chart 3 below shows the analysis of strategies from the sample of BVI Hedge Funds with assets between USD 100 million and USD 1 billion. In this size range long/short equity funds and fund of funds predominate, accounting for more than 50% of market share. Event driven funds take a larger proportion in this classification than any other size range while derivative, emerging market and market neutral funds are more in line with the analysis of all funds.
Chart 4 below shows the analysis of strategies from the sample of BVI Hedge Funds with assets less than USD 100 million. In this size range, fund of funds dominate with 35%, reflecting the fact that these funds may be the easiest to manage in start up situations. There are significantly less of the more complex strategy funds in this category, although arbitrage funds feature more often than in the larger sized funds.
Finally a study was made of all funds audited by Deloitte & Touche in the British Virgin Islands as presented in Chart 5 below. This proved a remarkably consistent picture of the cross section of BVI domiciled funds, with long/short equity funds and fund of funds accounting for more than 60% of the total and a reasonable cross section of other types of fund strategy.
In the past year Deloitte & Touche has seen an ever-growing number of fund of funds coming to the market and our study has shown that this is reflected in the market as a whole. Fund of funds is a fascinating concept as it clearly engenders an additional layer of fees to the shareholder or limited partner but this is compensated for by effectively acquiring the very best brains in the hedge fund market to put together what could be described as the most diversified portfolio available.
The research has highlighted a number of other interesting trends for the BVI fund sector. Overall, long/short equity is the strategy of choice for BVI hedge funds, whilst event driven funds are popular amongst funds between USD 100 million and USD 1 billion. What's more there appears to be no room for long-only funds in the offshore market.
Perhaps most interesting of all however is the fact that these market trends should be understood in the context of a truly diverse market of investment strategies. There are many routes to investment success in the British Virgin Islands.