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European economic recovery drives optimism in 2014

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The Hedgeweek Global Awards 2014 event, sponsored by Lyxor Asset Management and held at the end of February, featured winners from across the hedge funds spectrum who gathered in London’s Mayfair to celebrate a year of illustrious achievement.

In her opening address at the Hedgeweek Global Awards 2014 event, Florence Barjou, Head of Multi Asset Investments and portfolio manager for the ARMA funds, Lyxor Asset Management, said that buy and hold would not be a key strategy in 2014.

“If you look at fundamentals we are clearly in a situation where cyclical risks are receding and market conditions are steadily improving. I think this year will probably be similar to 2013 where both equities and interest rates will increase. The big difference to 2013, however, is that equity valuations are no longer as cheap. 

“When you’re close to fair price with equity valuations becoming a bit more stretched, which we saw at the start of the year, you’re much more sensitive to bad news. I therefore think 2014 will see more volatility in the markets. Equities will rise but there will be less upside compared to last year. A pure buy and hold strategy will leave you more exposed to volatility and less exposed to the upside. This is where tactical asset allocation can make the difference,” says Barjou.

Investors continue to buy corporate credit in the search for yield, even though spreads are tightening. Goldman Sachs’ economics research team forecast investment grade 5-year spreads to contract further from 122 basis points today to 111 basis points by year-end. Continued inflows have the potential to create a bubble but as Barjou notes, “currently, it’s better to participate in the bubble than not to be invested. We are looking at high yield corporate bonds as opposed to investment grade credit.”

Philippe Ferreira, head of MAP Research & External Relations at Lyxor – winner of this year’s Best Managed Accounts Platform – observes that long/short equity and credit managers are currently betting on the recovery of financials in 2014 given that dividend distribution has normalised in financial stocks.

“When we looked at the equities sell-off in January we noticed that financials were quite resilient compared to other stocks. Hedge funds are playing the economic recovery in Europe and the improving financial sector story at the moment; they are two dominant themes,” says Ferreira. 

Ferreira adds that investors remain bullish on long/short equities and event-driven strategies, helped in part by the pick-up in M&A activity in recent months. 

“Just recently we had the Commcast/Time Warner deal and a large number of event-driven funds on our platform are playing these deals. We believe the M&A story is quite strong in terms of the asset volumes we see. 

“In credit the story is slightly different. Investors are slightly more cautious on the asset class, especially in the US in light of the termination of the quantitative easing programme. However, in Europe the outlook remains positive, especially with respect to the periphery. A lot of credit long/short hedge funds have quite significant exposure to peripheral countries such as Ireland, Greece, Spain and Italy, favouring high beta sectors like financials. However, investors are slightly more cautious on credit.”

José Luis Pérez manages the Europa Event Driven Fund at Cygnus Asset Management, winner of this year’s Best Event Driven Multi-Strategy Manager. Since last summer more risk has been added to the fund with Pérez confirming that exposure to equities and credit has increased, as has the hedging book. 

“Year-to-date we are very happy with performance in the fund. We have a lot of ideas in the pipeline. We are seeing corporate activity picking up so that’s encouraging. We have been focused on the periphery of Europe for the last 18 months [purchasing corporate preferred bonds in Spain, for example] as that is where we’ve seen the most interesting events, but we are now looking at core Europe as things appear to be settling down. Corporates have a lot of cash sitting on their balance sheets and hopefully they will start to take advantage of the low interest rate environment.”

Last year, Japan was an important macro play for Jabre Capital Partners, winner of this year’s Best Relative Value Convertible Bond Manager. This was achieved through the JABCAP Convertible Bond Fund’s ability to get leveraged exposure to Japan through asset swaps on convertible bond positions; these are swaps that hedge out the credit risk in the convertible bond and isolate the equity option. Another focus was on high delta bonds, highlighting the fund’s bullish stance on equity markets. 

“Japan will continue to be a theme in 2014,” confirms Mark Cecil, one of the firm’s founding partners alongside Philippe Jabre and Philippe Riachi. “We see good opportunities in all three major markets – US, Europe and Japan. Currently, we have negligible exposure to emerging markets. We think that might be an interesting theme for the second half of 2014 once the cycle of capitulation that we’ve seen recently finishes. This will likely create some value discrepancies, which will create investment opportunities.”

One area of growth that fund administrators are capitalising on with their clients is the alternative mutual fund space. Total AuM in this segment of the ’40 Act fund space rose 45 per cent in the 12 months to 31 October 2013 from USD89.5bn to USD129.8bn. And for firms like UMB Fund Services – winner of this year’s Best North American Hedge Fund Administrator – which offers a turnkey solution to bring such products to market, these are exciting times.

“We have several clients who have chosen to use our turnkey solution for registered private investments varying from large insurance companies to your standard equity long/short hedge fund manager. It’s starting to really gain traction,” confirms Lonnie Macdonald, EVP of Alternative Investments, UMB Fund Services. 

“We are well placed because we already service mutual funds as well as hedge funds. Clients can either choose our Investment Manager Series Trust with a daily mutual fund, whereby we help them get all their registration done, all their SEC filings, distribution agreements as well as do all the investor servicing and accounting. Or, they can choose a non-daily registered private investment. These are still registered 40 Act funds but are marketed only to private investors,” adds Macdonald. 

“You can’t ignore them. It’s an area of growth. I think this year will be important in terms of seeing how that plays out – what types of hedge funds make the decision to launch such products will be interesting. We’re definitely keeping an eye on that space,” comments Jorge Hendrickson, Director of Sales and Business Development, Opus Fund Services – winner of this year’s Best Offshore Hedge Fund Administrator. 

Hendrickson says that the peer-to-peer lending space is expanding with funds starting to invest in direct lending platforms like Prosper and Google-backed Lending Club, which connect lenders with business borrowers. “We’re seen growth in the number of funds following this strategy,” confirms Hendrickson.

On the regulatory front, there has probably never been a period like this in the history of fund management. Managers face a barrage of regulation from AIFMD in Europe to Dodd-Frank and FATCA in the US; all of which is playing into the hands of firms like DMS Offshore Investment Services – winner of this year’s Best Offshore Regulatory Advisory Firm. 

As Don Seymour, founder of the firm, explains: “We have established an AIFM in Dublin, which will offer passporting capabilities and allow managers to continue to market their funds effectively throughout Europe. It’s a full solution for managers with full risk management capabilities and is the only platform available right now.”

“FATCA presents tremendous challenges for offshore investment funds that we serve in terms of compliance because the penalties for non-compliance are severe. We have a responsibility as directors to ensure that this is avoided. We have created a FATCA platform which is overseen by a team of seven professionals; we have attorneys, US tax professionals, CPAs and it is their job to act as FATCA Responsible Officers on our funds and ensure that compliance with FATCA is upheld.

“This is the first regulatory initiative that directly impacts on the fund not the manager. The stakes are very high so it’s been important to get this FATCA solution in place.” 

With respect to AIFMD, Stephen Burke, Managing Director at Cordium EMEA, says that US managers are somewhat ahead of the curve given that they are already having to comply with Dodd-Frank and file Form PF and that even though they are battle worn from regulation “they understand the nature of the changes and why they are being made”. 

“At the moment, US managers are just interested in mapping the landscape and understanding what the restrictions are with respect to private placement,” says Burke, confirming that an AIFM software compliance program is scheduled to launch this summer.

“This will be for AIFMs to help them manage their obligations under the directive, be it themselves or in combination with the Cordium team. Increasingly you will see Cordium solutions delivered via a platform as well as through our team of consultants.”

Market regulation such as the move towards OTC clearing under new CFTC rules in the US and EMIR in Europe has meant that cross-margining is now an important requirement for hedge funds. With its strong heritage in derivatives, BNP Paribas – winner of this year’s Best European Prime Broker – is well positioned to provide this support to its prime brokerage clients. 

“As OTC transactions move more towards electronic trading and central clearing, initial margin will have to be posted by everyone and will no doubt be a drain on available capital for managers. Whether it’s Dodd-Frank, EMIR, we are fully preparing ourselves. We think that our core competencies of financing and cross-margining could well play to our strengths going forward,” concludes Matt Pinnock, Head of Prime Services, Europe and Asia.

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