Funds Hub

Absolutely Fabulous?

Among the side-effects of the financial crisis, the importance for European wealth managers and other intermediaries of both managing investors’ expectations and understanding fully what those expectations are, has been underlined.

This is not entirely new. The rise of absolute return products largely reflects intermediaries’ efforts to deal directly with client expectations that, for many, have taken a severe blow. It is worth looking back at the level of inflows to funds seeking absolute returns before and after 2008 (the nadir for the industry in terms of sales activity) to see how this has evolved.

To view the chart, click here.

The data not only show the relative level of in- and out-flows for absolute return funds in Europe since 2005, but serves as a means to illustrate how activity has shifted in Europe.

Up to the middle of 2007, investors in Italy, Switzerland and France were strong supporters of absolute return. However the failure of many of these funds through 2007-2008 sent investors running for the door. The best example of this is enhanced money market funds, primarily bought in France, where 31.6 billion euros of sales in 2005-2006 were followed by redemptions of 39 billion in 2007-2008 and essentially no activity since.

As the fund sales trends suggest, many investors were less than impressed with their funds’ performance as the effects of the credit crisis rippled through the financial markets. By early 2008 the banking ombudsman in Lausanne had already received complaints about absolute return products.

The previous year had seen the arrival of the Eligible Assets Directive (EAD), providing legally-binding guidance on which financial instruments could be included in cross-border Ucits funds, following the expansion of their investment capabilities with the implementation of Ucits III in 2003.

Do do do…

A new song has emerged in the European funds industry, born in the midst of the financial crisis. It is called “let’s all do a Carmignac”. It may not be quite as catchy as the Conga, and maybe not quite as much fun, but it has certainly gained a number of followers.

The fund performance and distribution strategy at Paris-based Carmignac warrant more column inches than are available here. But more broadly, it is well worth looking at some of the numbers that have led others to dance to its historically-unfashionable tune of mixed asset, balanced investing, as well as examining wider industry activity to see what insights can be gleaned.

The largest mutual fund in Europe – Carmignac Patrimoine – has generated net sales of around 10 billion euros ($14.05 billion) in each of the past two years. In both of these years this one fund attracted more than 50 percent of all sales activity across Europe (including those funds suffering redemptions) in its Mixed Assets sector. And even if only those funds generating inflows are compared, the fund drew in around 30 percent of sales in the sector.

Not only has this fund hoovered up huge quantities of investors’ money, but it has happened at a time when other, apparently similar, funds have been largely out of favour. Patrimoine’s ability to generate positive returns in recent dramatic market downturns is clearly crucial in attracting this level of loyalty, particularly as it is not from the new breed of unconstrained ‘absolute return’ funds. It has put its relative success down to well-timed overweight allocations to emerging markets.

But this high concentration of client flows is not just a one fund story, and there are lines of dancers hanging on to the coat-tails of successful party-going peers across asset classes.

I have crunched some numbers looking at the concentration of sales for equity funds across Europe each year since 2002, a universe that has increased from around 10,000 to 12,500 funds. The ten most successful equity funds (in terms of net sales) in 2010 attracted a quarter of all sales activity for the asset class, the highest proportion since 2002, excluding 2007-8 when the asset class was in net outflow.

When this is filtered to look solely at those funds with inflows, the figure is 8.4 percent. The latter proportion has varied from 6.8 to 10.6 percent over this period.

Morning Line-Up: Tories, TPG, GAM

News and views on the fund industry from Reuters and elsewhere:

Hedge fund boss gave Tories £500,000 during election – Guardian

GAM H1 profit rises as hedge funds recover – Reuters

Indian father, son face lawsuit in U.S. over hedge funds – Economic Times

TPG launches second yuan fund in China’s Chongqing – Reuters

Moody Aldrich and Wilshire launch hedge fund seeding platform – HedgeWeek

Threadneedle readies “Triple A” launch

Hedge fund firms are finding themselves back in demand with mainstream asset managers despite a mixed record during the downturn. Threadneedle recently reiterated its interest in acquiring a hedge fund firm whilst adding to its absolute return range with a US equity long/short fund. The rise in interest has also been apparent in F&C’s purchase of Thames River at the end of April and Aberdeen’s recent buy of RBS’s non-core assets which gave the fund manager access to alternative products.

Threadneedle has been on the prowl for something in the absolute return space since last summer, but Campbell Fleming, head of distribution, said the hedge funds business remains “a work in progress”. “We continue to look at a lot of opportunities but not many suitable businesses have presented themselves,” he told Reuters.

In the interim Threadneedle is launching the American Absolute Alpha fund on June 1st, which will be managed by Stephen Moore and his team. Fleming said the product is targeted at investors outside the US who “have seen that it has cost them money ignoring the resurgence of the US.” He added that another half dozen products were planned for the next six months.

You can read the full interview with Campbell Fleming here.

Opportunities in the listed sector

Despite this year’s rally, opportunities remain in the listed hedge funds sector, according to analysts at Numis Securities.

A year ago the future of the sector looked in doubt, the broker writes in a note out today, as discounts to net asset value reached 40 percent and investors scrambled for liquidity in the wake of the collapse of Lehman Brothers.

But after the sector’s subsequent shake-out, as a number of funds wound up or returned capital, share prices have risen and discounts have closed — they are now at 15 percent.

Nevertheless, stockpickers can still find interesting ideas, the broker claims.

Numis says it favours Dexion Absolute, Absolute Return, BH Global and BH Macro among more liquid funds.

Among less liquid names it likes Signet (one of its corporate broking clients) and FRM Credit, which are both on discounts of more than 20 pct.

And it also sees some short-term opportunities — for instance, MW TOPS is on a 12 pct discount but is expected to offer an exit to shareholders at a 2 percent discount in April next year.

Wace wades into HFT debate

High frequency trading strategies have been in the news for all sorts of reasons recently, attracting controversy over their effect on markets, whether some other investors may be disadvantaged, or for the level of fees piled up as the trades tick through in their thousands.

However, Ian Wace, co-founder of Marshall Wace — one of Europe’s biggest hedge fund firms with assets estimated by EuroHedge at $6.5 billion at the end of last year — has leaped to the industry’s defence, citing performance from the firm’s own Eureka fund.

“We manage an active trading fund and I do accept there are frictional charges,” he said at yesterday’s Hermes Fund Managers and City of London responsible asset management conference. “If we have turnover of 15 to 20 times per annum and it costs 30 basis points to turn the assets that implies a 6 per cent charge per annum.

“People could say “how can you justify that?”. I reply that if you provide 14.59 per cent of absolute return after fees and the 6 per cent charge, then it could be justified.

“I go to huge lengths to find where the alpha is, and I don’t pay a penny more than I want to pay for transactions.”

And while hedge funds will always have their critics, Wace drew a contrast with broad stock market returns.

“When I look at returns, over the last 12 years equities are unchanged while we have provided 400 per cent compound returns because of the turnover in our funds. So who’s wrong?”

Morning line-up

Hedge fund stories from the past 24 hours from Reuters and elsewhere:

Hedge funds slash costs to win back investors – Daily Mail

Ex-GLG fund head to set up in Paris – FT

John Paulson tops list of most admired hedge fund managers – Absolute Return

FRM Capital invests in Asia hedge fund – WSJ

Hedge funds threatened by redemption requests – Hedge Funds Review

GLG pulls in punters

GLG Partners has confirmed positive client money flows are back on the agenda, reporting net sales of $2.2 billion in the second quarter in a trading statement which sparked a rise in the share price. The company also reckons strong performance among its funds has set the scene for more to come.

Barclays Capital last month predicted net inflows could reach as much as $50 billion in 2009, and GLG shows the numbers are starting to come through to support that theory. Of about 300 investors, BarCap found that some 80 percent were expecting to move back out of cash and into hedge funds this year.

The argument goes that investors burned by 2008 will get greedy again, and aggressively seek out the quickest route they can see to recoup the losses. If that theory proves true then perhaps investors were not as spooked as some have thought by the imposition of gates to redemptions when the crisis was at its height.

Longer term, it will be interesting to see if flows can recover enough to send total assets back to pre-crisis levels, because the revived love affair with hedgies is hugely vulnerable to fresh market wobbles, and is not universal. Trustees of the $40 billion Massachusetts’ state pension fund on Wednesday voted to scrap its portable alpha strategy and slash absolute return fund allocations by a quarter.

Staying long

The mammoth rally we had in Q2 may be starting to falter — the FTSE 100 is now below 4,200, having hit 4,500 last month — but Octopus’s David Crawford is sticking with a 60 percent net long position.

Crawford made part of his Absolute Return Ucits III fund’s 71.1 percent return (since launch last March) by shorting stocks in 2008 and by going net long four months ago.

And while the recent downturn is painful, Crawford says he “wouldn’t want to sell” at these levels.

He believes equities in general are good value and price in most of the disappointing economic news to come, while short ideas are hard to find.

His recent call has been to switch his equity exposure — from cyclicals, which has surged in the Q2 rally, to defensives such as pharmaceuticals.

(See also Jabre upbeat (but not quite bullish) on stocks and Watch BlackRock’s Mark Lyttleton give his market view)

Return to sender

The rush by traditional asset managers to embrace absolute return products has failed to impress investors, who are now switching to cheaper, passive investing. But what will fill the revenue hole left by these high margin products is far from clear.

Aymeric Poizot, a senior director at Fitch Ratings, points out that many of the alternative offerings developed by traditional managers in the boom years have been quietly wound up, or had their resources reduced. For example, Fortis Investments has closed some of its internal hedge funds, whilst heavy redemptions have hit alternative offerings at Credit Agricole. SSgA also wound up its own hedge fund unit at the end of 2007.

Other mainstream managers have reappraised their 130/30 offerings – long/short equity products which Poizot says have at best just delivered benchmark performance. Investors have been voting with their feet, switching to money market funds last year, and passive investing this year.

This is hitting fees at traditional asset management houses, as 100 billion euros of money market funds are needed to generate the same revenues as 10 billion euros of high margin products. “When the market is up, no one cares about paying 80 basis points for beta,” said Poizot at a briefing on Tuesday. “But when the market is down, investors question whether the fees are justified.”

Some managers like Natixis Global Asset Management have opted to purchase hedge fund specialists to overcome any cultural or operational issues which may have bedevilled running absolute return products in-house.

Poizot said that he was not sure having an absolute return process within a traditional organisation would be viable going forwards, and that in any case, absolute return would have to change. He pointed out that many absolute return products were sold as “Libor plus”, when they should have been more about capturing two-thirds of any upside and preserving some capital in a down market.

“Absolute return was more a marketing concept than a reality,” he said.