Hedge fund reinvention is on the cards

Date: Monday, October 6, 2008
Author: Steve Johnson, Financial Times

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From his office overlooking Geneva’s Jardin Anglais, Guy de Picciotto has a unique insight into the state of the hedge fund industry.

Earlier this year Union Bancaire Privée, the Swiss private bank of which he is chief executive, surpassed troubled compatriot UBS to become the largest allocator to the global hedge fund industry, according to a survey by InvestHedge, with $56.9bn (£32.2bn, €41.2bn) of assets under management. “In the first semester of this year there was still growth for hedge funds. Probably the next survey will be very different,” says Mr de Picciotto, the scion of UBP’s founder and chairman Edgar de Picciotto, hinting at waning desire among UBP’s own clients.

The younger Mr de Picciotto is a deep believer in the absolute return philosophy embedded at the heart of the hedge fund concept. Yet even he foresees a need for rapid re-invention across the $2,000bn industry, which is on course for its worst year on record.

The typical fund has lost 9.6 per cent so far this year, according to the HFRX index of Chicago-based Hedge Fund Research, with the industry almost certain to underperform cash for the first calendar year since 2002.

“We have already changed 40 per cent of our list. In order to deliver performance you need another set of managers,” says Mr Picciotto, citing distressed assets, global macro and arbitrage as strategies that UBP believes can deliver in the next stage of the economic cycle.

While he is unwilling to name the strategies he perceives to be out of favour, equity long/short, the most common strategy, is a glaring omission.

Christophe Bernard, the managing director of UBP responsible for asset management, who has predicted that the number of hedge funds will fall by a third from its current 10,000 as leverage disappears, also predicts a change in leadership of the industry.

“We believe that the hedge funds that will earn money for our clients in the next period will not be the same ones that earned money in the past,” he says.

In particular, Mr Bernard is keen to avoid funds that have an asset/liability mismatch in that their redemption schedule is more generous than the liquidity of their underlying assets, meaning new investment might simply be used to provide liquidity to those looking to exit.

“We want to see symmetry between the underlying investments of the hedge funds and the liability provision on the other side and we want the hedge fund manager to understand the potential that he will get more redemptions than he thinks. I believe there are some hedge fund managers who are complacent as to what may come out in the next few quarters.

“We want funds that will have dry ammunition because the opportunities are just incredible. When [the market] turns there will be three or four years of good returns with low volatility,” he asserts.

“The environment is very conducive to global macro but there are not that many good managers available now. [The] distressed [strategy] is not an easy one to deploy. The fund needs to have a clean sheet of paper,” Mr Bernard adds, fearing that many distressed funds may have invested too soon and will be sitting on losses in beaten-up mortgage assets and financial stocks. For the time being, UBP is not investing new subscriptions and has instead built up a cash buffer of 15 per cent in its fund of hedge funds operation.

“We are in a financial industry that is contracting and some clients might need money back for their own liquidity,” says Mr Bernard.

Other clients of course may be dissatisfied with the returns the hedge fund industry appears to be capable of producing in the current environment. Mr de Picciotto points out that the industry’s performance has not been anywhere near as bad as the slide in equity markets, but adds ominously: “It is never acceptable to lose money”.

UBP is itself tightening its belt a little, cutting back on recruitment and allowing employee numbers to drift down. “Maybe we will have to reduce staff in some areas. We have replaced one out of two [people who have left] and we have decided not to hire any more,” says Mr de Picciotto.

The bank did open an office in Moscow last month. Although this was hardly fantastic timing considering the turmoil in the Russian stock market, Mr de Picciotto remains confident about the long-term picture.

“The wealth in Russia is still there. Looking five years ahead it’s a market we cannot ignore. It’s a very rich country with commodities and with manufacturing capability,” he asserts.

Despite global doom and gloom the former UBS, Morgan Stanley, Bear Stearns and Sanyo banker, who has led UBP since 1998, remains confident in the future of the hedge fund industry, which accounted for 45 per cent of the bank’s asset under management as of June.

“The hedge fund industry is the most talented people who have come together to manage money. When they don’t achieve they disappear. There is a Darwinian process that we don’t really see in the long-only world,” he says.

“There is a re-engineering process that is feasible in hedge funds. That is appealing. If you think [the hedge fund industry] will not survive that is like saying that talented people will never come back, which is odd.”