Friday, June 18, 2010

Hedge Fund Ucits Boom?

Reuters reports, Hedge funds leave Monaco conference in bleak mood:

As the Mediterranean resort was hit by stormy weather this week, managers attending the GAIM hedge fund conference focused on the problems that could hit their businesses rather than the past year's client inflows and bumper 20 percent returns.

"There are reservations, and concerns have not yet been rectified... The industry's recovering but has not yet recovered," Ken Heinz, president of Hedge Fund Research (HFR), told Reuters.

"The mood is better than a year ago but it's not as good as several years ago."

Hedge funds lost 2.73 percent in May, according to Credit Suisse/Tremont, wiping out much of this year's gains and raising fears of an extended period of turbulence.

The losses were the biggest since November 2008, near the nadir of the credit crisis, according to Hedge Fund Research, which provides another industry index.

Convincing clients to part with their money continues to be tough, delegates said. The $30 billion or more of net inflows since last summer has not gone far in plugging the gap left by $330 billion of outflows in the year to June 2009.

"(The mood) is mixed, to say the least," Aarnout Snouck, director at AXA Investment Managers, told Reuters.

"May changed the perspective for a lot of managers. Everyone believes we're in for quite some months of substantial volatility... Raising money is very tough in this environment."

Man Group CEO Peter Clarke warned delegates of "a world of volatility and uncertainty," while Mike Powell, head of alternative assets at 30 billion pound ($43.99 billion) pension fund USS, told Reuters he was moving into short-term computer-driven funds due to concerns about the market.

REGULATION

Executives are also worried by the prospect of tougher regulation, particularly the European Union's plans to regulate managers and the possibility of a widening of Germany's ban on naked short selling.

"The hedge fund industry is going to be the subject of some really rash and nasty and intense regulation," said Rick Sopher, chairman of fund of funds LCH Investments. "There are going to be some really difficult moments for our managers."

Europe's proposed Alternative Investment Fund Managers directive (AIFM) is still being debated and could affect the ability of hedge fund managers outside Europe to sell into the bloc.

Olwyn Alexander, head of Irish alternatives practice at PricewaterhouseCoopers, told Reuters that many U.S. hedge fund firms were postponing business decisions until European regulation was resolved.

If regulation turns out to be tough, it could provoke a backlash from the United States and could even divide the European and U.S. industries, Alexander said.

"Regulation and tax are the two biggest challenges the industry faces. Uncertainty is a huge issue for the industry currently," she said.

"You may see a bifurcation of the industry. It's increasingly expensive to manage money in Europe, and it may make sense to have a European product and a fund for the rest of the world."

Meanwhile, accountants are fretting over U.S. tax proposals

which may require much more detailed information on fund investors and which could penalize non-compliant funds.

But not everyone was gloomy.

One Swedish-based statistical arbitrage manager, for example, told Reuters he had found investors more open to his fund than he had expected.

And FRM Capital Advisors' Patric de Gentile-Williams said his funds had raised a net $70 million so far this year and investors such as pension funds and sovereign wealth funds were once again looking at seeding small hedge funds.

If I were running a hedge fund portfolio again, I would be focusing almost exclusively on smaller hedge funds run by smart, experienced but hungry managers who know how to deliver alpha. I'd set up managed accounts and focus on liquid strategies which gives me full control over the portfolio. This way, if anything goes wrong, I can pull the plug fast (remember, the flip side of transparency is liquidity; the former is useless without the latter).

One thing investors are underestimating is liquidity risk. I had a chance to speak with a senior VP at one of Canada's largest pension funds on Thursday. He shared some insights with me:

  • He just returned from Europe where he sees signs of inflation picking up, but nothing to worry him
  • He thinks Spain will show some strain (nothing too damaging) but he mentioned that Germany’s exports are surging because of the lower euro
  • He sees a deceleration of growth in the second half of the year, but does not see a double-dip recession on the horizon (neither do I).
  • In his words: “We will see growth rates dropping to normal levels – 2% to 3% - but not a dramatic slowdown”
  • He thinks the stock market will correct over the summer by 10% (I see a low volume melt-up)
  • He told me that anything in structured finance is dead and illiquid investments like private equity will remain weak.
  • He said: “Investors are not willing to tie up their capital for long. The focus remains on managing liquidity risk.”
  • He mentioned there are glimmers of hope for 2011 in the leading indicators they look at, but for now they're fully hedged and always focused on liquidity risk.
On hedge funds, we both agreed that most deliver leveraged beta and liquid strategies will remain in favor as anything too illiquid and too complicated will get shunned. He finds it "crazy" that investors are rushing back into hedge funds with lock-ups and gates. "These people have short memories and are vulnerable if there is another liquidity crunch".

I agree, too much dumb money chasing alternative investments without fully understanding all the risks, especially liquidity risk, is a recipe for disaster. Reuters reports, Executives sound warning on hedge fund Ucits boom:
Investors clamouring for Europe-based "hedge fund lite" portfolios in the wake of the credit crisis could still be cut off from their cash in a crisis, hedge fund executives have warned.

Some commentators fear these portfolios, designed to meet the EU's Ucits rules allowing funds to be widely sold, are not suited to all hedge fund types, and may hit problems if markets dry up and many investors want to pull out at the same time.

"It's nonsense to create these liquid vehicles. It's much better to realise that hedge funds are an illiquid asset class," said Gerlof De Vrij, managing director of absolute return strategies at APG, which manages 240 billion euros (200 billion pounds) in assets.

"We're not interested in Ucits funds. The focus on liquidity is something I don't understand."

Research last month showed investors have poured almost $200 billion (136 billion pounds) into alternative and absolute return Ucits funds -- often dubbed 'Newcits' by the industry -- which tend to give clients quicker access to money as well as greater transparency.

And a full day of the GAIM International hedge fund conference here was devoted to Ucits, with sessions packed with attendees.

In 2008 many investors were barred from pulling their cash out of hedge funds because the market for many of the funds' underlying investments had dried up.

However, critics of Ucits funds say that these funds can still bar investor exits and may not be the right vehicle for all investors scarred by the credit crisis.

In March, the president of the European mainstream fund association Efama, Jean-Baptiste de Franssu, told Reuters he feared Europe was heading for a mis-selling scandal as the Newcits boom took hold.

"About 90 percent of strategies are fine (for Ucits), but there's always going to be the 10 percent who push the boundaries," Olwyn Alexander, head of Irish alternatives practice at PricewaterhouseCoopers, told Reuters.

"There are some strategies where there's the question of how they're going to cope if there's a crisis. Because of the brand Ucits has, is there going to be a blow-up?"

High-profile hedge fund firms such as Man Group and GLG Partners and Brevan Howard have launched Ucits versions of their portfolios. Man chief executive Peter Clarke agrees Ucits is not a cure-all.

"Ucits is an interesting place for certain hedge fund strategies, but by no means all of them," he said.

Strategic Investments Group said this week that it had raised $250 million for a Ucits III fund, managed by Permal Group, that will invest with a range of hedge fund managers.

And hedge fund firm IKOS is launching a currency Ucits fund this month on Deutsche Bank's platform, the firm's chief executive Elena Ambrosiadou told Reuters on the sidelines of the conference.

"It's very difficult, if everyone seeks daily liquidity, to invest in hedge funds properly," said Steve Friedman, managing partner of EOS Partners.

Sounds like Ucits will be the next big hedge fund flop. If you're reading this, do me a favor, before you get all hot and horny on the next hedge fund hype, think carefully about the risks attached to these investments. If you think there are none, you're likely going to get your head handed to you.

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