Asset managers and hedge funds square up

Date: Tuesday, April 28, 2009
Author: Phil Craig, Wealth-Bulletin.com

Mainstream asset managers and hedge funds are preparing to battle for retail investors’ money in a conflict that is likely to change both arms of the industry.

The weapons involved are absolute return funds – which aim to generate a positive return no matter what the market conditions. Until recently, retail absolute return funds largely came from mainstream asset managers. Now hedge fund managers are launching strategies under the undertakings for collective investment in transferable securities regulatory framework.

Financial News reported last week that Brevan Howard, the largest hedge fund manager in Europe, hopes to raise $10bn (€7.5bn) in its Ucits funds, and rival Marshall Wace is also preparing a range of such vehicles.

Gartmore has just launched a European absolute return fund under its star hedge fund managers Roger Guy and Guillaume Rambourg, and a UK fund under Ben Wallace. BlackRock has added a European strategy to sit alongside its UK fund managed by Mark Lyttleton. SVM Asset Management, an Edinburgh funds boutique, has created a Ucits fund that mirrors a hedge fund managed by its founder Colin McLean.

Other hedge fund managers, including Caxton Associates, Highbridge, Renaissance Technologies and Cazenove have either planned or launched Ucits funds.

Brevan Howard’s Ucits funds have a minimum investment of $1m and they may not be marketed directly to retail investors. But the public will be able to invest directly in the other hedge fund managers’ Ucits products.

The hedge fund industry’s foray into the retail investor market will change it, according to Jeff Meyer, chief executive of Gartmore.

He said: “It will put pressure on the hedge fund industry because they are selling to retail at a slight discount, with daily dealing and a better regulatory structure. Over time, retail demand for absolute return funds and regulatory demands will accelerate the improvement in the industry. We will see the bigger players in the hedge fund industry changing very significantly, they will be much more transparent.”

UK investors have already poured £3bn (€3.3bn) into the 31 funds that fit the definition of an absolute return fund, as announced a year ago by the Investment Management Association, a trade body for the UK asset management industry. The number of funds in the class has almost doubled in the past 12 months, from 17.

Globally, analysts and providers expect the regulated absolute return sector to grow substantially, as hedge fund clients flee to regulated structures and investors look for funds that offer positive returns despite volatile markets.

Amin Rajan, chief executive of the Centre for Research in Employment and Technology in Europe, a UK analysis firm, said the demand for absolute return funds had grown and inflows into the sector would boom when markets stabilise and investors shift money out of cash.

He said the interest shown so far by investors was a fraction of what they could invest: “The vast majority of investors have lost a lot of money in every strategy and every market. Rebalancing in favour of absolute return is happening, but only on a small scale at the moment.”

Eric Personne, head of the fund solutions group at Merrill Lynch for Europe, the Middle East and Africa, who is overseeing the launch of a BlueCrest absolute return strategy as a Ucits fund, said: “The rise of absolute returns techniques will not stop. The fundamental reason why they emerged is still valid: long-only firms have disappointed, and the techniques can help to improve returns.”

However, some asset managers question whether the growth in interest will last. Chris Cheetham, chief executive of Halbis, the active management subsidiary of HSBC Global Asset Management, said: “Given the tremendous setback in risk assets, we were bound to see interest rise in absolute return as a concept – we saw a similar trend after the tech bubble burst.

“I expect that interest will persist, but in the long term the norm will remain long-only investment in risk assets. Right now investors are risk-averse, and they are concerned about the extreme volatility of the equities markets, but it will pass.”

Another difficulty is that regulated absolute return funds have yet to establish substantial records. Even financial advisers, through whom most UK retail investors place their money, like to see a three-year record before placing money in a fund.

It does not help that performance among absolute return funds so far varies substantially. The UK absolute return funds on offer have posted 12-month returns ranging from -24% to a positive 38%, according to data provider Morningstar. The IMA said the sector includes funds with widely differing strategies, united only by their aim to provide positive returns.

Mark Dampier, head of fund research at Hargreaves Lansdown, a UK fund services provider, said retail investors would find it hard to accept performance fees, a staple in the hedge fund industry, but largely unheard of within the retail funds industry.

He said: “These funds could be useful if they work. I think the danger is that they won’t achieve an absolute return, and end up misleading investors. A manager needs experience in hedging portfolios, but you won’t know who is best until another five years down the line.”

Investors might assume that hedge fund managers with long records would have a head start but, for many, the Ucits structure will require them to give up elements of their strategies such as leverage that they cannot cover.

Philippe Lespinard, head of absolute return strategies at Brevan Howard, said: “It’s definitely a more constrained environment, so you may not be able to use some of the investment strategies you follow in an unconstrained environment, such as a hedge fund. You would have to trim positions and drop some of them completely because they would not qualify.

“As flexible as Ucits is, if you just trim off the strategies that you can’t run in a hedge fund to make a compliant fund, we found you would lose about half of the performance and keep most of the volatility risk.”