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Hope for the best, prepare for the worst

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By Stefan Keller, Head of Managed Account Platform Research & External Relations, Lyxor Asset Management – Recent market turmoil has understandably made people nervous. I believe we’re going through a once-in-a-generation period of uncertainty. The ongoing sovereign debt crisis in Europe has spilled over to the banks, pushing up credit and market risks and disrupting bank funding markets.

Counterparty risk, then, is back on the table.

Our Lyxor Managed Account Platform uses open architecture. This enables us to manage risk by working with 10 different prime brokers, 15 OTC counterparties and three administrators. This year we’ve been very active, launching more than 20 new funds on our platform. There are virtually no mono-counterparty fund launches anymore.

With transparency such a key issue, I’d like to share some thoughts on how Lyxor, hedge fund managers and investors are responding to these challenging markets.

Risks to financial stability have increased for the first time since ’08. Knowing your risks and understanding the positioning of hedge fund managers is vital. To address this and enhance professional investors’ access to transparency, Lyxor launched a new website in September to help optimise portfolio construction. The website allows investors to track their investments within our universe of 100+ managed accounts, giving them access to literally hundreds of risk indicators. The ability to view aggregated risk figures weekly, by rating, by region, by sector, is an important tool for investors when making asset allocation decisions.

In a nutshell, hedge fund managers’ response to this year’s crisis has been to hope for the best, prepare for the worst. Convertible arbitrage strategies were hit hard in ’08 because they were highly leveraged. Early this year we saw these managers reducing their exposures well in advance of summer volatility, although some have started increasing exposures in recent weeks to capitalise on favourable valuations in the credit markets.

Looking at country exposure, the entire platform has a couple of basis points to Greece, whilst collective exposure to Italy, Portugal, Spain, Ireland totals just a dozen basis points. Clearly, managers have recognised the political risks and avoided placing significant bets.

At the sector level, data shows that equity l/s managers have an overall defensive position. Between mid-June and mid-September, net exposure to basic materials fell from nine per cent to under six per cent, industrials from seven per cent to four per cent and energy plummeted from 9 per cent to just over one per cent. Aggregate exposure to cyclicals suggests that mManagers are bearish on global GDP growth over the next 12 months. It also suggests they moved early into defensive positions before this summer’s turmoil took hold.

Figures on equity beta directionality confirm this; we’ve seen a large reduction. The platform hosts a diversified range of funds across all strategies. We measured equity beta exposure for each portfolio, produced a fund ranking and then picked the median exposure. What we found was that median Median equity directionality peaked at 37 per cent in May. As of 11 October, that number had fallen to 1.26 per cent. By June it was already at single digit levels. Strategies like CTAs and global macro did a good job of managing net exposure and this has helped provide protection and drive performance.

Investors have also reduced equity directionality. Looking at weekly flows we see that March was the last month they added more beta to their portfolios. Clearly, since spring there’s been a rotation, strategy-wise, from directional strategies into more arbitrage strategies. We’re not seeing any significant asset outflows. If there’s an out-of-favour strategy, investors can simply switch into those they prefer. We’ve launched 20 new funds in 2011 and now offer access to multi-strategy managers, which is a major innovation and helping attract new assets. Gross inflows are more than USD3billion this year.

Stefan Keller is Head of Managed Account Platform Research & External Relations, Lyxor Asset Management

Please click here to download a copy of the Hedgeweek Special Report: Hedge Fund Managed Accounts November 2011

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