Liquid Alternatives the Opportunities and Challenges of Convergence

Liquid Alternatives The opportunities and challenges of convergence

September 2016

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The opportunities The mainstream EDITORIAL/SUBSCRIPTIONS and challenges of route for alternative 04 convergence 05 investing This report was researched and written by Philip Moore, special reports writer for Hedge Fund Intelligence.

Editor Nick Evans The growth of The fastest-growing [email protected] 06 retail demand 07 section of the Managing director David Antin [email protected] for alternatives hedge fund industry Commercial director Robert Dunn [email protected] Advertising and sponsorship/Europe Ian Sanderson Growth in the US The pros and cons [email protected] liquid alts space of convergence Advertising and sponsorship/US James Barfield 07 08 [email protected] Data and research Siobhán Hallissey [email protected] Production Michael Hunt An expanding Rising institutional 10 investor base 11 demand in the US Subscription sales UK (and for reprints) UK Ruta Balasaityte [email protected] Asia/Europe Joel Dudden Third-party Exploiting [email protected] 12 platforms: 14 geographical US Augusta McKie spoilt for choice? distribution niches [email protected]

Hedge Fund Intelligence is the most comprehensive provider of hedge fund news Bright, new shiny Defining the liquid and data in the world. With five titles – AsiaHedge, EuroHedge, InvestHedge, objects? alternatives Absolute Return and Absolute UCITS – we have the largest and the most 17 19 universe knowledgeable editorial and research teams of any hedge fund information provider. We collect and supply information on more than 17,000 hedge funds and funds of hedge funds, and provide comprehensive analysis from across the globe. We also produce a number of highly regarded events throughout the year, including The conundrum The growing US over performance retirement market conferences which attract top-level industry speakers and delegates, and awards 20 fees 20 SOCIETE GENERALE PRIME SERVICES dinners which honour the best-performing risk-adjusted funds of the year.

PROVIDING CROSS ASSET SOLUTIONS IN EXECUTION, CLEARING AND Published by Hedge Fund Intelligence, 8 Bouverie Street, London, Asset-raising A broader range of challenges in alternative UCITS FINANCING ACROSS EQUITIES, FIXED INCOME, FOREIGN EXCHANGE EC4Y 8AX, United Kingdom 22 the US 23 strategies AND COMMODITIES VIA PHYSICAL OR SYNTHETIC INSTRUMENTS. Email [email protected] Telephone +44 (0)20 7779 7330 CIB.SOCIETEGENERALE.COM/PRIMESERVICES Fax +44 (0)20 7779 7331 Website www.hedgefundintelligence.com The rise and rise The importance of 24 of risk premia 26 quality control Disclaimer: This publication is for information purposes only. It is not investment advice and any mention of a fund is in no way an offer to sell or a solicitation to buy the fund. Any information in this publication should not be the basis for an investment decision. Hedge Fund Intelligence does not guarantee and takes no responsibility for the accuracy of the information or the statistics contained in this document. Subscribers should not circulate this publication to members of the public, as sales of UCITS regulation: enough is enough? the products mentioned may not be eligible or suitable for general sale in some countries. Copyright in 27 this document is owned by Hedge Fund Intelligence Limited and any unauthorised copying, distribution, THIS COMMUNICATION IS FOR PROFESSIONAL CLIENTS ONLY AND IS NOT DIRECTED AT RETAIL CLIENTS. selling or lending of this document is prohibited. All rights reserved.

SOGE_CIB_1502_EUROHEDGE_205x272_GLOBE_GB.indd 1 15/02/2016 12:14 LIQUID ALTERNATIVES/2016 The opportunities and challenges of convergence

he growth in liquid alternative investment products – through alternative UCITS in Europe, and also through the ’40 Act alternative mutual fund THE RANGE OF INVESTMENT market in the US – has been one of the most STRATEGIES AVAILABLE THROUGH significant developments in the asset management LIQUID REGULATED FUNDS IS industryT on both sides of the Atlantic in recent years. CONTINUING TO EXPAND, WITH Liquid alts have helped to break down long-standing bound- NEW TYPES OF MANAGERS AND INVESTORS ARRIVING TO SWELL aries between traditional and hedge fund products – enabling THE UNIVERSE OF PARTICIPANTS new types of investors to access alternative investment strategies, providing alternative investment managers with new and fast-growing distribution channels in both the retail and institutional investor arenas, and creating new business opportunities for third-party asset management platforms and service providers in other key areas. Especially in the alternative UCITS space, the opportunities for further expansion remain high – with the range of investment strategies available through liquid regulated funds continuing to expand, and with new types of managers and investors arriving to swell the overall universe of participants. But the global convergence trend that liquid alts have helped to accelerate also brings challenges as well as opportunities – in terms of product control, in terms of regulatory oversight, in terms of potential liquidity risks and in terms of investor protection. In this special report, Philip Moore looks at the growth of liquid alternatives and at the key opportunities and challenges that are arising from a dynamic that is changing the face of the mainstream and alternative investment landscape.

Nick Evans, editor, Hedge Fund Intelligence

4 hedgefundintelligence.com 2016/LIQUID ALTERNATIVES The mainstream route for alternative investing

“The creatures outside looked from pig to man, and from man to pig, and from pig to man again; but already it was impossible to say which was which.” George Orwell, Animal Farm, 1945

en or 15 years ago, the strategic, funds post 2008 was the change in the govern- regulatory and cultural demarca- ance and culture of the alternative investment tion lines between hedge funds and management industry that accompanied it. traditional products were still clearly Deep-pocketed pension funds, in particular, Tvisible and well-understood. signalled that while they were committed to The progressive erosion of those boundaries increasing their allocations to alternatives, in recent years is probably irreversible. In a they were no longer prepared to stomach the report published in 2013, SEI commented that illiquidity, opacity and lack of accountability “it is no overstatement to say that the move to- that characterised swathes of the hedge fund ward alternative investing has been among the universe. And an increasing number indicated farthest-reaching developments in institutional just as emphatically that they were no longer investing over the last quarter century.” prepared to accept all of the above for a 2+20 As an exhaustive 2012 survey conducted by fee structure they regarded as being unwar- KPMG and AIMA pointed out, the institutional ranted and anachronistic. drift towards alternative investment strategies Some would eventually attest to their dis- had begun well in advance of the 2008 crisis. enchantment by withdrawing entirely from the By then, assets under management (AUM) in hedge fund market, frustrated by high fees and the global hedge fund industry had already impatient with modest performance. CalPERS reached $2 trillion. in the US and the Dutch pension scheme for True, high net worth individuals were still healthcare workers, PFZW, are among the the leading investors in hedge funds. But as best-documented examples of institutions that the KPMG/AIMA survey observed, the period have pulled back from hedge funds. of growth leading up to the upheavals of 2008 Others, however, wanted to have their cake were marked by increased participation by and eat it, putting the hedge fund industry institutional investors, with pension funds and on notice that they still expected reasonable, university endowments attracted by hedge uncorrelated risk-adjusted returns in a liquid funds’ uncorrelated returns and low volatility. and transparent format. For good measure, 2008 was therefore a watershed year for they also wanted this at reduced fees. hedge funds not because it marked a sudden Some hedge fund managers dug their heels epiphany among institutional players about the in, seeing no reason why they should abandon investment properties of hedge funds. Indeed, ONE OF THE long-standing practices that had served them in its 2012 survey, KPMG/AIMA reported that PRINCIPAL so well in raising capital throughout the 1990s new inflows into hedge funds from the Euro- SHORTCOMINGS and early 2000s. pean Union had held steady, while those from OF THE FUNDS SOLD An increasingly large cross-section of funds, Switzerland had declined, with the bulk of fresh UNDER THE FIRST however, recognised that if they wanted to money coming from North America, Asia-Pacif- UCITS DIRECTIVE attract new inflows of capital, and the fees that ic and the Middle East. WAS THAT THEY went with them, they would need to overhaul Equally or perhaps more significant than WERE TOO HEAVILY time-honoured business practices and culture. the increase in institutional demand for hedge REGULATED The consequence, as KPMG/AIMA noted in

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2012, was that the term ‘institutionalisation’ equities could be depended upon to provide no longer referred exclusively to the influx of conveniently uncorrelated returns was exposed new institutional capital into hedge funds. It as a dangerous myth. also referred to “the continued evolution and It was not until 2003 that the masonry of advancement of hedge funds’ infrastructure the long-only edifice entrapping retail investors and operational processes with respect to started to crumble, with the passage of the transparency, compliance and due diligence.” UCITS 3 Directive (there was, mysteriously, Specifically, this meant either repackag- no UCITS 2). This was a combination of a ing existing unregulated offshore funds into management directive, introducing tighter risk regulated onshore vehicles that met these new management and capitalisation requirements, standards, or launching entirely new products and a product directive, which expanded the that conformed to investors’ evolving demands range of investments eligible for UCITS to hold. and preferences for liquidity and enhanced This stopped short of giving the green light to governance practices. short selling. But because it allowed for the use of derivatives such as contracts for difference THE GROWTH OF RETAIL (CFDs), it enabled funds to achieve the same DEMAND FOR ALTERNATIVES economic effect as short positioning. In a parallel development, the winds of change Critically, it also enshrined the principle of were also sweeping across the retail-targeted liquidity, requiring that the underlying assets or traditional investment management indus- of UCITS are able to support redemptions on at try. Again, it is sometimes mistakenly assumed least a fortnightly basis. In practice, however, the that it was the crisis of 2008 that opened retail vast majority of UCITS funds offer daily liquidity. investors’ eyes to the benefits of strategies that Nevertheless, a concern in the early years freed them from the long-only constraints that of the UCITS market was that the limitations denied them access to protection in falling or on the use of derivatives, concentration limits volatile markets. and liquidity requirements would inevitably In Europe, the process of weaning retail lead to a high level of tracking error between investors away from a diet of long-only prod- alternative UCITS and the unregulated flagship ucts had started to gather momentum several strategies they aimed to replicate. years before the 2008 meltdown, with the Managers insist that away from highly amendment in 2003 of the ponderously-named illiquid strategies, tracking error has been Directive on Undertakings for Collective progressively minimised and in some cases Investment in Transferable Securities (UCITS). eliminated altogether, which has clearly Originally adopted in 1985, UCITS 1 allowed encouraged a rising number of investors to for the sale of mutual funds to any investor in migrate onshore. So too has the administrative the European Union (EU) under a harmonised simplicity of UCITS. regulatory regime. “For high net worth individuals, it is so much One of the principal shortcomings of the easier to transact in the UCITS market,” says funds sold under the first UCITS directive, how- Donald Pepper, managing director of alter- ever, was that they were too heavily regulated. natives and institutional at Old Mutual Global When equity markets plunged, first after the Investors. “Rather than having to fill in forms puncturing of the dotcom bubble and again af- and wait until the end of the month to put in a ter 9/11, this regulation was exposed as well-in- redemption notice, you just send instructions to tentioned but ridiculously counterproductive, your wealth manager or private banker. Ease of leaving retail investors trapped within a world dealing has been a very important factor in the populated exclusively by long-only products. growth of the market.” Those wanting to express a negative view on Galvanising demand for these alternative equities had nowhere to go other than cash or products on either side of the North Atlantic bonds. This may have worked in the past, but has been the recognition of the limitation in the 2008 crisis the notion that bonds and of the traditional 60/40 model, constructed

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around a 60% allocation to equities and the to Morningstar’s numbers, they channelled balance to bonds. The problem with this model, €70 billion of new assets into alternative as a report from PIMCO explains, is that risk is UCITS, a 30% increase over 2014’s total, lead- driven almost entirely by the equity component ing Lyxor to describe them in a recent update because of its higher volatility. “While this can as “much the fastest-growing section of the lead to strong performance during equity bull hedge fund industry”. markets, as has been the case in the US since While some say this demand continues to 2009, it can also leave portfolios exposed to outpace supply of alternative assets, managers severe drawdowns,” PIMCO cautions. are clearly rising to the challenge of providing Specifically, according to the PIMCO analysis, Andrew Dollery, new product. “UCITS is a continuing theme in the 1980s and 1990s a traditional 60/40 as- director, Societe that at Societe Generale we see as core to the set allocation generated an average annualised Generale Prime strategy of any alternative asset manager of return of 13.7% over rolling five-year periods. scale,” says Andrew Dollery, director at SG Services After 2000, that average shrank to 5.9%. Prime Services. “In Europe, at least half of the None of this need mean that the bell is new funds in our pipeline today are alternative tolling for unregulated offshore strategies. “It’s UCITS as opposed to offshore products.” clear that in the equity long/short space the “I see two main reasons why the alternatives best way to engage investors in Europe is now UCITS market will continue to grow over the through the UCITS market because they are next few years,” says Daniele Spada, Par- liquid and should have limited tracking error,” is-based head of the Lyxor managed account says Serge Houles, head of client portfolio platform. “The first is that the regulatory management at the Stockholm-based system- environment is leading more and more inves- atic manager, IPM. tors to look at UCITS, since the AIFM regula- “But I think there will still be demand for tion designed for hedge funds has not been Cayman vehicles. Offshore products will remain very successful.” Published in 2011, the AIFM relevant for US investors, while equity strat- Directive is a comprehensive regulatory and su- egies that are too concentrated or leveraged pervisory framework for non-UCITS alternative won’t fit into the UCITS format.” investment funds marketed in the EU. Others agree that even in the equity space, “Second,” says Spada, “with political and there are several reasons why there is still economic uncertainty likely to remain high, plenty of room in the market for unregulated we don’t think anyone can expect to generate strategies that are not constrained by daily or high single digit or double digit performance weekly liquidity rules. Pepper points to M&A from long-only equity strategies. We believe arbitrage as one example of an equity-based investors will increasingly turn their attention strategy where quarterly liquidity remains to strategies which allow them to maintain a more appropriate structure for managers WITH POLITICAL an exposure to the market but with less entering into longer payoff trades. AND ECONOMIC directionality and a stronger attention to risk UNCERTAINTY LIKELY management. This is what is delivered by most THE FASTEST-GROWING SECTION TO REMAIN HIGH, strategies in the alternatives UCITS space.” OF THE HEDGE FUND INDUSTRY WE DON’T THINK Nevertheless, it is the confluence of all these ANYONE CAN EXPECT GROWTH IN THE US powerful trends that has given rise to the TO GENERATE HIGH LIQUID ALTS SPACE rapid growth in the market for alternative SINGLE DIGIT OR In the US, the more expressively-named liquid investment funds on either side of the Atlantic. DOUBLE DIGIT alternatives are structured under the confines Although these are sometimes clustered to- PERFORMANCE of the 1940 Investment Act, making them the gether under the umbrella of “liquid alterna- FROM LONG-ONLY only practical option for retail investors looking tives”, in Europe they generally still go under EQUITY STRATEGIES for access to hedge fund-style strategies. the acronym of alternative UCITS. DANIELE SPADA, As a recent note published by Allen & Overy The name may be ponderous, but demand LYXOR ASSET explains, “US retail investors generally do not from investors is anything but. In 2015, according MANAGEMENT qualify to invest in traditional hedge funds or

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private equity funds due to the high net worth more than 500 alternative UCITS and ’40 Act requirements and steep minimum investment funds being launched in Europe and the US,” amounts, and therefore must look to 1940 Act she says. “The liquid alternatives market now Funds, which do not typically require net worth covers a multitude of investment strategies or similar minimums. 1940 Act Funds also do with drastically different investment objectives, not require subscription documents, which risk-return characteristics and performance makes the investing process more streamlined records.” than traditional hedge or private equity funds.” That may be. But the common thread that As with UCITS, liquidity is (by definition) a key draws together demand from heavyweight feature of the liquid alternatives market, with Mark Aldoroty, institutions as well as retail investors is their alternative mutual funds required to ensure head of Pershing pursuit of uncorrelated returns in a liquid, that at least 85% of their exposure is to liquid Prime Services transparent and relatively low-cost format. assets. As with the UCITS market, this has given rise among some investors to concerns that THE PROS AND CONS the performance potential of liquid alternatives OF CONVERGENCE may be compromised. A paper published in With further growth in the market for liquid July 2015 by K2 Advisors – Liquid Alternatives: alternatives on either side of the Atlantic will Dispelling the Myths – rejects this suggestion. come an acceleration in convergence between “Our empirical examination of the actual hedge funds and traditional, regulated invest- performance and composition of liquid alter- ment products. native funds and their traditional hedge fund For some industry participants, this need counterparts illustrates the illiquidity premium not make much of a difference to their day-to- may be overstated, and in fact very little is lost day business. “If you think of it from a prime in terms of investment performance on the broking perspective, a hedge fund is a mutual part of liquid alternatives,” notes the K2 report. fund by another name,” says one market In its sample, which K2 recognises is “some- participant. “The two are legally different, and what limited”, liquid alternatives outperformed are governed by different regulations. But they traditional hedge funds over a one, three and both trade. They both need execution, clearing five year period by margins of 217, 104 and 303 and custody services. And they both use basis points respectively. leverage in some shape or form, although ’40 As PIMCO puts it, the growth of liquid alter- Act Funds have stricter rules about how much natives has acted as a democratising force for leverage they can use.” investors. It is, however, by no means purely a That is true enough. But for the firms and retail market, as a BNY Mellon representative individuals used to managing unregulated and points out. regulated funds on a daily basis, the changes “Funds of funds used to be the access point that are being brought about by the con- of choice for pension funds and other institu- vergence between the two are far-reaching. tional investors expanding into alternatives,” “Traditional long-only investment managers says BNY Mellon. “But growing concerns already possess the infrastructure and distri- about the high costs and relative illiquidity of bution channels,” says Mark Aldoroty, head of funds of funds have fuelled a rise in institu- Pershing Prime Services. “When launching an tional demand for alternative UCITS and other alternative strategy, their challenge is expand- liquid alternative products such as managed ing their portfolio management to include a accounts.” levered and/or short component.” The net result, says TeHsing Niu, who is re- This echoes a point that McKinsey made in a sponsible for liquid alternatives business devel- 2012 report entitled The Mainstreaming of Alter- opment at BNY Mellon, is that aggregate assets native Investments, which identified the seismic under management in the US and Europe now changes that the convergence dynamic would exceed $1 trillion. bring to the global asset management industry. “In the last 12 months alone, we have seen “This is a massive opportunity,” said

8 hedgefundintelligence.com By bringing together people, capital and ideas, Goldman Sachs produces solutions and results for our By bringing together people, capital and ideas, Goldman Sachs produces solutions and results for our clients. Our Fund Solutions team within the securities division helps clients access both unique internal clients. Our Fund Solutions team within the securities division helps clients access both unique internal cross asset content and a select group of external alternative asset managers. cross asset content and a select group of external alternative asset managers.

gsfundsolutions.com gsfundsolutions.com © Copyright 2016 Goldman Sachs. All rights reserved. See www.gs.com/disclaimer/email-salesandtrading.html. This material is a solicitation of derivatives business generally, only for the purposes of, and to the extent it would otherwise be subject to, CFTC Regulations 1.71 and 23.605. Goldman Sachs International (“GSI”) is © Copyright 2016 Goldman Sachs. All rights reserved. See www.gs.com/disclaimer/email-salesandtrading.html. This material is a solicitation of derivatives business authorised by the Prudential Regulation Authothorityrity and regulated by the Financial Conduct Authothorityrity (“FCA”) and Prudential Regulation Authothorityrity (“PRA”) and generally, only for the purposes of, and to the extent it would otherwise be subject to, CFTC Regulations 1.71 and 23.605. Goldman Sachs International (“GSI”) is appears in the FCA register under number 142888. GSI is subject to the FCA and PRA rules and guidance. authorised by the Prudential Regulation Authothorityrity and regulated by the Financial Conduct Authothorityrity (“FCA”) and Prudential Regulation Authothorityrity (“PRA”) and appears in the FCA register under number 142888. GSI is subject to the FCA and PRA rules and guidance.

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McKinsey. “But to capture it, traditional asset audience face other complications. Foremost managers will need to embark on a major shift among these is the prohibition on fees in the in their operating focus, away from the relative market for ’40 Act Funds, which potentially return investment framework and well-defined raises the issue of cannibalisation of the boundaries (such as style boxes, or long-only investor base. After all, it’s hard to see how products), toward managing investments to an managers charging existing investors 2+20 can absolute return target or objective. In addition, justify offering the same product with the same they will need to address shortcomings in risk returns for 100bp. This is why in many cases management and reporting and sales capabil- managers have chosen to act as sub-advisors ities, and resolve the organisational conflicts on multi-manager platforms. that will likely arise from the integration of traditional and alternative work cultures.” AN EXPANDING INVESTOR BASE Firms with a long standing presence in Although there are some important differences the traditional side of the asset management between liquid alternatives and UCITS – or, industry reject any suggestion that their more specifically, alternative UCITS – the two long-only heritage may make them ill-equipped products are similar in that they provide in- to compete against hedge funds. “There is no vestors with a low entry point to the strategies evidence to support this argument,” says Old that were previously the preserve principally of Mutual’s Pepper. “At Old Mutual, we run a UK high net worth individuals and family offices. mid and small-cap equity fund which has never It is institutional demand for UCITS, however, had a negative year in its 13-year history. Its that is seen by most managers in the market as average net exposure over the last five years the key to raising assets, and demand is clearly has been around 3%, so it has effectively been gathering significant traction. “UCITS are now run as a market-neutral strategy, but it was up attracting serious institutional money, and it’s 14% last year. In some years, more of its alpha not uncommon to see tickets of €20-€50 mil- has been generated by the short side of the lion going into UCITS strategies from pension book than by the long side.” funds and insurance companies these days,” The so-called traditional investment man- says Dollery at Societe Generale. agement industry on either side of the Atlantic Insurance companies are also stepping is certainly serious about further penetrating up their participation in alternative UCITS, in the market for hedge fund-style products. Take part because of the regulatory imperatives of the example of a firm like Jupiter, which in July Solvency II. “We see Solvency II as a very good announced the appointment of Magnus Spence, opportunity for us,” says Lyxor’s Spada. “The former chief executive and managing partner liquidity of alternative UCITS makes them an of Dalton Strategic, as its new head of invest- ideal investment for insurance companies, and ments for alternatives. “This is an asset class we have the necessary technology to help them which is highly sought after and important build well-diversified and transparent portfolios for the future development of our investment and optimise their capital requirements in proposition,” said Jupiter at time. conformity with Solvency II.” For hedge funds relaunching unregulated Individual managers confirm that the products in the regulated format required to volumes of new money flowing into UCITS are reach a broader retail and institutional inves- formidable. Take the example of a manager tor base, the opportunities and challenges like the Nordic systematic specialist, Informed are no less extensive. “Hedge funds under- Portfolio Management (IPM), which was found- stand leverage and shorting,” says Aldoroty. ed in 1998 and had AUM of some $5.6 billion in “Their challenges centre around leverage June 2016. IPM launched a UCITS version of its within the ’40 Act construct and developing systematic global macro flagship strategy last distribution channels.” year on Morgan Stanley’s FundLogic platform Hedge funds stepping into the liquid alter- with assets of $50 million. “Since then, its as- natives space to target a different investor sets have risen to $650 million, so by whatever

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measure you look at it, it has been a great mance of absolute return strategies. “I don’t success,” says IPM’s Stockholm-based CEO, see a short term period in which alternatives Stefan Nydahl. are down by 3% as having the capacity to Demand for the IPM UCITS has come from a throw demand off-kilter,” he adds. reassuringly diverse range of investors. “Prior This argument appears to be supported to 2008, demand for alternative UCITS was by the empirical research into the long term concentrated largely among private banks in risk-adjusted returns of liquid alternative mu- the UK and Switzerland,” says Tara Skinner, tual funds (AMFs) undertaken by Craig Lewis, head of UK and US Sales at IPM. “Over the Madison S. Wigginton Professor of Finance at last five years, we have seen a broadening of Tara Skinner, the Owen Graduate School of Management at demand, and in some strategies UCITS are now head of UK and US Vanderbilt University. becoming the investment of choice for institu- sales, Informed This includes the reassuring finding that tions in Europe.” “the diversifying nature of AMFs expands the Portfolio Management Investor demand for alternative UCITS “efficient frontier” available to investors. This (IPM) has not weakened in spite of the iffy recent enables investors to construct portfolios that performance of much of the absolute return either reduce the level of risk for a given level of sector. Quite the reverse. As Lyxor observed in return, or increase returns at the same level of an update published in July, alternative UCITS is risk, or both. That is, investors could possibly add the only asset class which has seen inflows this 1-2% per year in expected return without taking year, with €3.6 billion in March alone bringing more risk, or allowing them to meaningfully the total for the first quarter to €7.7 billion. reduce risk without reducing expected return.” “This strong appetite for alternative UCITS is Sarah Alfandari, head of sales and partner in stark contrast with the outflows experienced of Longchamp Asset Management, says that by traditional asset classes, as equity mutual investors are lowering their expectations about funds experienced outflows of €20 billion and the performance of alternative UCITS. “Rather fixed income and credit funds saw outflows than look at hedge fund UCITS as separate near €13 billion in the first quarter,” added the asset classes, they are now looking at them as Lyxor review. “Money market and diversified a bond diversifier, which is probably a more funds have been hit as well. This is fully in line realistic approach,” she says. “In other words, with what we have been hearing in our dis- instead of looking for annual risk-adjusted cussions with our clients; investors are clearly returns in the high single digits, they are ex- interested in UCITS hedge funds at present.” pecting returns in the 4% to 6% range.” Much of this demand is coming from inves- This, say others, probably explains why tors that are moving away from unregulated demand may be weakening for traditional products, either because of misgivings long/short equity products in favour of those about transparency and costs or, in some offering more in the way of risk mitigation. “For instances, because of regulatory pressure in RATHER THAN LOOK several years we’ve had an equity bull market their home markets. AT HEDGE FUND which has driven demand for equity long/short “We’ve been seeing very strong demand UCITS AS SEPARATE and long-biased products,” says Societe Gen- from high net worth individuals and the private ASSET CLASSES, erale’s Dollery. “The volatility we’ve seen this banks that advise them, as well as from wealth THEY ARE NOW year has made investors rather more cautious, managers and institutions throughout Europe,” LOOKING AT which is why there has been rising demand for says Pepper at Old Mutual. “Demand has been THEM AS A BOND CTAs and global macro strategies relative to particularly strong from some of the big Euro- DIVERSIFIER, WHICH some of the higher beta equity funds.” pean countries where regulators are increas- IS PROBABLY A ingly ill-disposed towards funds from offshore MORE REALISTIC RISING INSTITUTIONAL jurisdictions such as the Cayman Islands.” APPROACH DEMAND IN THE US This growth in demand, says Pepper, is a SARAH ALFANDARI, A similar trend of rising institutional demand long term phenomenon that is unlikely to be LONGCHAMP ASSET is unfolding in the US, where the speed with derailed by the disappointing recent perfor- MANAGEMENT which the market for liquid alternatives has

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grown in recent years has encouraged a series Within the US retirement system market, of bullish projections about its potential over perhaps the most exciting area in terms the coming five to 10 years. of demand for liquid alternatives is in the Cerulli Associates, for one, has forecast that defined contribution (DC) space. “A growing by 2023 liquid alternatives will account for number of DC sponsors in the US are looking 14% of total mutual fund industry assets. PwC, to increase their use of alternative strategies meanwhile, has calculated that demand for in a liquid and transparent format,” says liquid alternatives will rise from $260 billion at Denehan. Convergence between the hedge the end of 2013 to around $664 billion by 2020. fund and regulated mutual fund sectors is ac- Much of the growth in demand for liquid Stefan Nydahl, celerating this process, although distribution alternatives may come from heavyweight CEO, Informed remains a challenge. institutions that have recently announced plans Portfolio Management As Pershing explains in a recent report on to reallocate some of their assets to alterna- DC plans’ increased demand for liquid alter- (IPM) tives, most notably among investors in the natives, “there are two elements that should $24.2 trillion US retirement system. Several US be considered to make an alternative offering pension systems have already set up managed attractive to a DC plan. First, plan advisors accounts as a cost-effective way of accessing need to examine what reasonably converts liquid alternative strategies. from the hedge fund space to the DC plan “One of the themes we’ve been seeing over space. The strategy needs to feel like a daily the last two years has been an increase in liquid product, and not everything will prove to institutional demand for dedicated managed be transferable. Originally, the first transferred accounts through our HedgeMark subsidiary,” strategies were in the futures and CTA space says Declan Denehan, liquid alternatives where there was already liquidity.” business head at BNY Mellon. HedgeMark, “Second,” adds the Pershing note, “the DC which was founded in 2009 and became a BNY plan itself wants to know how to get greater ac- Mellon subsidiary in 2014, specialises in sup- cess to hedge funds. DC platforms are evolving to porting institutional clients in the development accommodate less frequent liquidity events, so as and operation of their own private hedge fund hedge funds begin to understand what products dedicated managed account (DMA) platforms. work within the space, alignment will increase, One of the main attractions for managers driving more liquid alternatives into DC plans.” using this private structure, says Denehan, is that it allows them to charge performance THIRD-PARTY PLATFORMS: fees which are prohibited under most cir- SPOILT FOR CHOICE? cumstances in the ’40 Act market. Investors, A notable by-product of the breathless ex- meanwhile, are attracted by the visibility and pansion of alternative UCITS over the last five liquidity offered by the platform mechanism, years has been the proliferation of third-par- as well as by the fees which Denehan says are ty platforms and their rapid AUM growth. flexible and transparent. “Third-party platforms are generally umbrella Little wonder, against this backdrop, that fund structures established by investment Denehan believes there will be substantial managers or promoters, including distributors, interest from US institutional investors, led which allow other previously unaffiliated (sub-) by pension funds, for this type of structure. investment managers to essentially “plug and His confidence is supported by a survey of play” by joining the platform with their own institutional investors published in June 2016 in separately managed sub-fund,” explains a note a paper by BNY Mellon and FT Remark entitled published by the law firm, Dechert. Split Decisions: Institutional Investment in The Dechert piece goes into considerable de- Alternative Assets. 43% of respondents to this tail about the principle advantages and draw- survey indicated that they are currently invest- backs of the platforms. Foremost among their ed in hedge funds via managed accounts, while benefits for managers are the cost savings they a further 13% are considering doing so. can offer, twinned with access to platforms’

12 hedgefundintelligence.com 2016/LIQUID ALTERNATIVES

capital bases. Platforms can also accelerate “Rather than focus purely on asset growth, the the launch of new funds, provide know-how on platform aims to attract the best in breed for the launch process and take responsibility for each strategy, which we thought was an impor- time-consuming compliance and governance tant feature of its branding among investors.” requirements. Spada at Lyxor’s managed accounts platform, Perhaps their most important advantage, which has total AUM of $8 billion, of which $2 however, is the established distribution net- billion is accounted for by eight alternative work and potential for capital introduction that UCITS, explains that the platform is much more the leading platforms can offer. than a distribution hub. “We have an investment The platforms come, however, with a handful banking approach,” he explains, “which means of notable strings attached. One of these is we have an open architecture set-up which their costs. As Dechert cautions, “with fees provides much more than basic infrastructure.” calculated on an AUM basis, platforms may “We have built our managed account plat- be prohibitively expensive once a certain form around a series of additional services that size is achieved”. The Dechert note adds that are highly valued by our investors,” he adds. for start-ups the costs incurred during the “For example, as of today, the platform has a on-boarding process can easily equal those of team of 30 analysts, 20 of whom exclusively a new launch. cover hedge fund strategies, while the other Many managers that have recently under- 10 follow the long-only world. This means that taken the platform selection process confirm our research and selection capabilities are such that distribution capabilities were at or near that we can advise investors on how to build a the top of their priority list. “Because the client diversified allocation beyond the funds that we base for our Cayman strategy had always been have on our own platform.” mainly large institutions, we had had very little Spada adds that the length of the Lyxor contact with the UCITS investor base when platform’s track record means that it is well-po- we decided to launch our flagship strategy in sitioned to fulfil another key role, which is to UCITS format last year,” says Houles at IPM support managers that are launching UCITS in Stockholm. “So it was critical that as well versions of unregulated strategies. “Because as providing all the necessary reporting and we’ve been in this market since 1998, we have passport support, the platform could distribute built up very strong expertise in structuring the strategy as broadly as possible.” funds,” he says. “This means we can help Houles, who led IPM’s platform selection hedge fund managers to convert and adapt an project last year, adds that IPM chose Morgan existing strategy into a UCITS fund. Because Stanley’s FundLogic platform for several rea- we are not restricted to any individual sons. While he recognises that all of the leading strategy, we can do this across all funds that platforms have good distribution capabilities, meet the UCITS requirements on leverage and he says that FundLogic’s proactive interaction liquidity, be it equity long/short, event-driven, with the investor base gives it an edge over its credit, CTA or whatever.” competitors. None of the leading platforms have aimed to “One of the things that Morgan Stanley did specialise in any individual strategy. That, man- very well was enter into a dialogue with a num- agers say, would probably be self-defeating, ber of early-bird investors, which we didn’t feel given their objective of providing investors with other platforms did as well,” says Houles. “Get- access to a well-diversified range of strategies. ting UCITS investors to commit to the strategy The result is that the inventory of products early was key for us because we wanted to grow offered by the largest platforms tend to mirror the fund to a decent size as rapidly as possible.” the broader structure of the alternative UCITS “We also liked the Morgan Stanley model Daniele Spada, universe, which means that their strategy because rather than setting out to on-board head of managed range is inevitably weighted towards equi- as many funds as it can, it is highly selective account platform, ty-based funds. about the strategies on its platform,” he adds. Lyxor Asset Management In the case of the Bank of America Merrill

hedgefundintelligence.com 13 LIQUID ALTERNATIVES/2016

Lynch platform, which is the largest in the Jain, executive director at Goldman Sachs in alternatives UCITS space, seven of its funds are London. “We view the platform as a partner- equity long/short strategies, while two each ship with our hedge fund clients and hence are long-only, event driven and multi-strategy. give the manager control over the brand and The other strategies represented on the plat- growth of the fund, while generating direct, form are commodity arbitrage, dynamic asset strong relationships between the manager and allocation, enhanced volatility premium, global underlying investors.” macro and CTA. The four third-party alternative UCITS on The spread of strategies on the BAML platform the Goldman Sachs platform are LBN China is also well-diversified geographically, with 12 Federico Foglietta, Opportunity, Maverick Fundamental Quant, named as global strategies, with three focused executive director, MSK Equity and Select Equity Long/Short. The on Europe, two on the US and two on Asia. Morgan Stanley fifth alternative UCITS strategy on the platform The second largest platform is the Schroders is an internal, rules-based, algorithmic equity GAIA offering which had AUM at the end of risk premia fund. June of $4.8bn. By August, Schroders had nine Jain agrees that two of the requisites for funds on its two GAIA platforms, eight of which success for a third-party UCITS platform are are managed by external hedge fund managers diversification of their strategies twinned with and one internally. robust and far-reaching distribution capabili- Among investment bank platforms, one of ties, both of which will be fundamental to the the fastest growing is Morgan Stanley’s Fund- continued growth of the Goldman Sachs plat- Logic Multi-Asset Alternatives Platform, which form. “There is a well-acknowledged shortage was set up in 2010 and saw over $1 billion of supply across all alternative UCITS, especial- added to the programme in the last two years, ly in strategies other than long/short equity,” according to Federico Foglietta, executive she says. “We’re in an exciting growth phase in director at Morgan Stanley. He says that at the our business, and the industry as a whole, and end of July 2016 platform AUM stood at $2.6 we are looking to expand our offering and add billion. “Our investor base has expanded in high calibre managers and diverse strategies.” breadth and we now have a more diversified As to the platform’s distribution strategy, reach than we did a year ago,” says Foglietta. Jain says that Goldman Sachs has opted for a Foglietta adds that demand from this wid- very bespoke and targeted approach which she ening investor base is for diversification away believes differentiates it from its competitors. from higher beta strategies. “Whilst there still “Engaging sales people across the firm who sell aren’t that many products to meet investor ap- other alternative products and have strong ex- petite for discretionary macro, we do see a lot isting client relationships maximises access and of demand in that space,” he says. “In terms of impact,” she says. “It also eliminates the need flows for FundLogic, we see significant interest to fill our shelves with products, allowing us to from investors in CTA, market neutral and cred- be very selective about the number and type of it long/short strategies. More generally, any managers that we choose to partner with.” low beta strategy which can provide diversification and yield generates interest.” EXPLOITING GEOGRAPHICAL Another of the fastest growing of the plat- DISTRIBUTION NICHES forms is the Goldman Sachs offering, which has While the platforms do not specialise from a been active in the alternative UCITS space since strategy perspective, some of the more recent 2011. The platform now hosts five alternative entrants have aimed to build their franchise UCITS funds with AUM of about $1 billion, with around highly concentrated geographical the emphasis firmly on quality and geographi- distribution. One example is Longchamp Asset cal diversification rather than quantity. Management (Longchamp AM), which was “Investors buy funds primarily because they founded in 2013 by David Armstrong, previ- like the manager and/or strategy, and they are ously managing director at Morgan Stanley, often agnostic about the platform,” says Neha where he was global head of the funds and

14 hedgefundintelligence.com FundLogic Alternatives Platform Liquidity. Access. Oversight.

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FundLogic Alternatives Platform refers to FundLogic Alternatives plc, an open-ended investment company with variable capital and segregated liability between sub-funds established as an umbrella fund authorised by the Central Bank of Ireland. This document is issued and approved by Morgan Stanley & Co. International plc (25 Cabot Square, Canary Wharf, London E14 4QA), authorised in the United Kingdom by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. This document is intended exclusively for use by and is directed to Eligible Counterparties and Professional Clients. This document has been prepared solely for informational purposes and is not an offer to buy or sell any financial instrument or participate in any trading strategy. This material was not prepared by the Morgan Stanley research department. Morgan Stanley is not acting as your advisor (municipal, financial, or otherwise) and is not acting in a fiduciary capacity.

fund-linked business which developed the strategies by offering access to alternative risk FundLogic UCITS platform. Aside from offering premia across equities, fixed income, interest asset management and advisory services, rates and FX. Longchamp AM operates in the distribution “My objective is to on-board good manag- of absolute return UCITS to investors in the ers with strategies that can be co-branded by French-speaking markets of Europe. Aquila and distributed across our core region,” “Of the 18 funds on the FundLogic platform, says Schraepler. Although he includes Italy many are managed by US-based asset manage- and Central Europe among the regions that ment firms,” says Alfandari at Longchamp AM. make up Aquila’s target market (it has recently “An increasing number of these managers feel Neha Jain, opened an office in Prague), Schraepler is less comfortable with having marketing teams executive director, especially enthusiastic about the potential dedicated or partially dedicated to developing Goldman Sachs for the investor base in the German-speaking relationships in Europe.” countries. In the case of France, says Alfandari, “I was very impressed with the inflows that insurance companies make up a large portion we saw in the alternative UCITS space between of the investor market for alternative UCITS. 2013 and 2015,” says Schraepler, who was Those insurers, she adds, have in the past often previously at Deutsche Bank, IKOS and, most guaranteed policyholders annual returns of recently, Bank of America Merrill Lynch’s Fund 3% or 4%, which used to look modest, but in Solutions Group. “There was massive interest this era of low or negative rates are becoming from wealth management clients and other increasingly elusive in fixed income markets. institutions throughout Europe, but especially “Insurance companies in France are chasing from Germany, where investors were starting returns, which is one reason why they are to allocate big tickets to alternative UCITS. The becoming so active in the alternatives space,” largest I was concerned with was a €150 million says Alfandari. ticket from a German pension fund to an alter- Hence Longchamp’s other business line of native UCITS strategy.” providing distribution as well as outsourced The increasing popularity of liquid and investor relations for some FundLogic funds transparent absolute return strategies among which represent a well-diversified cross-section institutional investors in Germany gives Schrae- of UCITS strategies. “Some of these managers pler confidence that the Aquila platform can still travel to Europe a few times a year to meet grow its share of an already crowded market. investors, but feel that it makes sense to be “We have identified 600 to 800 active investors represented by an outsourced IR team with in this space across Europe, including pension a permanent local presence,” says Alfandari, funds, insurance companies and family offices, who was in charge of marketing and commu- which are increasing their allocations to alter- nications for FundLogic before co-founding native UCITS,” he says. Longchamp AM. The challenge, Schraepler adds, is to attract Another example of a platform that has top quality managers to the platform. “We trailed its sights on distribution of alternative know we’re playing catch-up,” he says. “But we UCITS to a specific European investor base is believe that the combination of our selection the Hamburg-based alternative investment expertise and investor demand will allow us to company, Aquila Capital. identify one or two managers per year. Some In March, it appointed the much-travelled of the larger funds are running into capacity Manfred Schraepler to head up its liquid private constraints and we believe this is creating room markets business. In July, Aquila named Alpha for newcomers.” Centauri as the first manager to be added to Schraepler insists that in the search for new its Associated Manager Group Platform. The managers, the emphasis needs to be on quality Alpha Centauri alternative beta strategy, which rather than quantity. Others echo this view. Spa- will be offered in a UCITS format, feeds into the da says that it typically takes between three and strength of investor demand for market neutral six months of due diligence before a strategy

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can be admitted to the Lyxor managed account UCITS space was still in its nascent stages platform, and that plenty of poorly performing five or six years ago, the bank platforms were funds have been axed from the platform over generally able to charge relatively high fees,” the years. “The business model does not consist says Dollery. “The sheer choice available these of saying yes to everybody,” he says. days probably means we are reaching the It is not just the platforms themselves that point where there has been a normalisation have much of their time taken up by the due dil- of hosting fees, which are now within a much igence process. “Intuitively, you would assume tighter range.” that there is less work associated with buying a regulated UCITS fund via a platform than there Dirk Wieringa, BRIGHT, NEW SHINY OBJECTS? is when you buy an offshore hedge fund,” says alternative Fundamental to the proposition offered by Dirk Wieringa, alternative investments advisor investments advisor, alternative UCITS in Europe and liquid alterna- at Credit Suisse in Zurich. “But we find there tives in the US is their ability to use derivatives Credit Suisse is actually more work involved, because there for investment purposes. This means that is one more party involved in the sense that although UCITS products may not be able to you need to do extensive due diligence on the replicate Cayman-based strategies precisely, manager, the fund and the platform.” they can come very close, thanks to the alche- “Where the leverage factor starts to work for my of synthetic prime broking, which many the investor is that when you feel comfortable bankers say is the fastest growing area of the with the platform you don’t have to do the work prime brokerage business today. again,” he adds. “Approving funds for due dili- “In the case of an equity long/short, gence purposes then becomes easier and faster.” market-neutral or convertible bond arbitrage Beyond helping existing strategies to launch strategy, for example, we would set up a products in UCITS format, third-party platforms synthetic prime brokerage relationship with an can play a key role in supporting new fund ISDA agreement where we hold the underlying launches. Dollery says that Societe Generale’s equities or convertible bond in swap format prime broking unit supports new launches allowing the manager to access the leverage in a number of ways. “Through our capital or long/short exposure he needs,” says Societe introduction team we are helping managers Generale’s Dollery. connect with investors across a number of “In the case of CTAs or macro funds, most jurisdictions,” he says. “And because Societe of what they do is naturally eligible for UCITS Generale hosts UCITS funds we can either help because it involves trading futures, options and managers launch their own products via our FX,” he adds. “The tricky part is commodities, platform or offer them consultancy to find which UCITS are prohibited from holding in external platforms.” physical form. In that case, the UCITS would SGSS’s Irish UCITS platform, Gateway, was typically hold a certificate issued by a bank launched in the summer of 2015, providing ac- referencing an underlying managed account in cess to an investment fund structure, Gateway which the commodities are traded.” UCITS Funds Plc. As SGSS explained at the time While the use of derivatives to structure of the launch, “with significantly lower start-up hedge fund-style products for the retail market and running costs, asset managers can benefit has opened up a new range of opportunities to from a model which is more cost efficient than private investors, it has also made regulators establishing a standalone fund. The funds uneasy – especially in the US. also benefit from an infrastructure that offers The SEC’s jitters about derivatives and lever- additional services provided by Gateway such age are consistent with some of the concerns as audit and company secretary functions.” that the US regulator and other observers have The competitive pressures among the plat- expressed about the turbocharged growth in forms should be positive for investors because liquid alternatives over the last six years. simple supply/demand dynamics ought to These have centred around the belief that be driving down fees. “When the alternative in their pursuit of fresh inflows in an uncertain

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environment for mainstream assets, stand- any possible heavy-handedness in regulation ards of investor protection that have been the is that the majority of managers of liquid centrepiece of mutual fund regulation for over alternative products adhere to the spirit as 75 years may have been compromised. “I am well as the letter of the Act. They add that concerned that we are starting to see some most use derivatives as wholly legitimate risk cracks in the foundation of this framework management tools, rather than as instruments that we should all be thinking about,” said SEC of reckless speculation. commissioner Kara Stein in a speech to the In Europe, too, there are concerns that Brookings Institute last year. over-zealously wrapping retail investors in cot- One manifestation of this is the use of ton wool can create misunderstandings about derivatives by registered funds, which Stein the risks embedded in alternatives. “I laugh described as having “skyrocketed” in recent every time I read an article – sometimes in years, resulting in almost 30 no-action letters very sound publications – warning about risky having been issued by the SEC on the topic of alternative funds,” says Old Mutual’s Pepper. “If leverage generated by derivatives. Stein added you have an account at a private bank you have that the SEC had heard reports of funds using to sign forms certifying that you’re a high risk swaps and futures to achieve notional exposure investor if you want to buy a market-neutral of up to 10 times their net asset value. “I think strategy which has about a third of the volatili- that most would agree that this type of lever- ty of common equities.” age runs counter to the leverage restrictions Some recent evidence certainly implies required by Section 18 of the Investment that alternative investment funds have done a Company Act,” said Stein. She also quoted an creditable job of mitigating rather than inflat- official at the SEC who had described alterna- ing risk. According to Craig Lewis’s empirical tive mutual funds as “bright, shiny objects that study on alternative mutual funds published in are also very sharp and fraught with risk.” March, there is a “widely held misconception Denehan at BNY Mellon recognises that reg- that AMFs use derivatives to take on significant ulators face a delicate balancing act between risk in the search for outsized returns.” allowing managers the flexibility they need to This study reports that “all of the alternative generate positive uncorrelated returns on the fund asset classes we examine have risk levels one hand and safeguarding less sophisticated that are significantly less than standard equity investors on the other. Equally, however, he benchmarks like the S&P500. The relatively low says that the industry needs to play its role volatility levels suggest instead that deriva- in ensuring that investors are able to make tives are being used to expand the investment fully-informed allocation decisions. opportunity set in a conservative manner that “Regulators are certainly looking at the use has been unproblematic.” of derivatives and at imposing some additional All the more reason for the industry to be risk management constraints on registered concerned about a proposed SEC change in investment companies,” he says. “But the REGULATORS ARE regulation issued in December 2015. According industry’s responsibility to explain what these CERTAINLY to the Financial Stability Oversight Council products aim to achieve is paramount.” LOOKING AT THE (FSOC), this aims to “limit the amount of The same is true in Europe, where leverage USE OF DERIVATIVES leverage that registered investment companies levels from one alternative UCITS strategy to AND AT IMPOSING (RICs) such as mutual funds and ETFs may ob- another can be very different. “Leverage rules SOME ADDITIONAL tain through derivatives transactions, strength- can be determined by a fund’s limits, but they RISK MANAGEMENT en their asset segregation requirements, and can also be based on the VAR [value at risk] CONSTRAINTS ON require derivatives risk management programs methodology, where you could have leverage REGISTERED for certain funds”. as high as 200% of notional exposure,” says INVESTMENT The Lewis study suggests – none too subtly Wieringa at CSAM. “It is essential that investors COMPANIES – that the authorities should think twice before understand the difference between the two.” DECLAN DENEHAN, introducing any new legislation that reduces Market participants say that the pity of BNY MELLON the investment freedoms and flexibility of

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alternative investment products. Insisting that track record,” notes a recent report published AMFs do not expose investors to undue risks, by Goldman Sachs Asset Management (GSAM). this advises that “policymakers engaged in “Thus, they have generally experienced only rulemaking concerning the use of derivatives MAYBE THE LIQUID one prevailing market environment – a bull eq- may want to use this study as input for their ALTERNATIVES uity market coinciding with a period of steadily considerations.” MARKET IN THE US declining interest rates. For this reason, we be- HAS TO A DEGREE lieve it can be difficult to know what to expect DEFINING THE LIQUID BEEN A VICTIM OF from these funds as market conditions change ALTERNATIVES UNIVERSE ITS OWN SUCCESS. over the longer term.” Maybe the liquid alternatives market in the US ITS RAPID GROWTH The report adds: “We believe investors has to a degree been a victim of its own suc- HAS GIVEN RISE considering alternative mutual funds, also cess. Its rapid growth has given rise to a highly TO A HIGHLY known as liquid alternatives, face a quandary: diverse range of investment strategies, which DIVERSE RANGE the number of offerings has grown rapidly, has in turn created some controversy and con- OF INVESTMENT but useful information about these strategies fusion over the definition of alternatives. This, STRATEGIES, WHICH is lacking. Many investors are trying to assess say market participants, is one area where the HAS IN TURN liquid alternatives using traditional mutual fund US market for liquid alternatives differs notably CREATED SOME evaluation methods, when we believe these from Europe’s alternatives UCITS space. CONTROVERSY AND investments do not fall neatly into traditional “Because UCITS come with far stricter limits CONFUSION OVER mutual fund strategy classifications.” on concentration and the use of leverage, THE DEFINITION OF The numbers speak for themselves. At the investors have a very clear understanding of ALTERNATIVES end of April 2016, according to Morningstar what they are buying in the UCITS space,” says data, there were 673 liquid alternative funds a representative at BNY Mellon. “The US has across 17 sub-strategies. Of these, more than far greater flexibility in the way funds can be a fifth (150) were categorised as multi-alterna- structured, which is one reason why in the US tive, a larger share than the long/short equity you often see highly complex multi-manager strategies (140) that are generally regarded structures with several managers within a as the staple of the alternative fund universe. single regulated fund,” BNY Mellon says. “This These were followed by non-traditional bonds is popular with investors because it provides (109 funds), managed futures (56), market-neu- exposure to a blending of strategies and tral (51), trading-leveraged equity (47), option returns within a single product.” writing (33), bear market (27), long/short credit Perhaps. But the regulator in the US is (21) and multi-currency (16), with a hotchpotch becoming increasingly uncomfortable with of others making up the balance. the way a growing number of alternative To make life easier for investors faced with mutual fund managers have used (and perhaps this bewildering array of strategies, few of abused) the 1940 Funds Act to reach retail which have a track record stretching back more investors. “In some ways, it appears that regis- than five years, GSAM has created what it calls tered funds have slowly drifted towards a more the LAI MAPS, which look at liquid alternatives flexible and permissive disclosure regime,” through a “hedge fund lens”. said SEC commissioner Stein last year. “This This narrowed the universe of truly liquid drift increasingly places the onus on the retail hedge fund-like products from 637 to 333, investor to figure out whether a fund is right sub-divided into five strategies more immedi- for him or her. And the retail investor, who gen- ately familiar to hedge fund investors – equity erally tends to be less sophisticated in financial long/short (103 funds), tactical trading/macro matters, might not even understand what he or (84), multi-strategy (75), event driven (39) and she needs to know to make that decision.” relative value (32). This dilemma is aggravated by the fact that “We believe a categorisation framework the liquid alternatives asset class is a relatively which mirrors what has been adopted by new option for retail investors. “Few liquid the hedge fund industry may help investors alternative funds have more than a five-year construct more diversified portfolios and set

hedgefundintelligence.com 19 LIQUID ALTERNATIVES/2016 IT’S EASIER WHEN CHOOSING FROM THE BEST ALTERNATIVE UCITS more realistic risk and return expectations to those they may be accustomed to in the pri- DISCOVER 7 HEDGE FUND EXPERTS IN THEIR RESPECTIVE STRATEGIES for their LAI allocations,” GSAM explains. “By vate space. “We believe this is inaccurate,” says paring down the LAI universe into hedge fund- K2. “Information from Morningstar supports like peer groups, we believe the returns of LAI this assessment, showing that such established mutual fund peer groups and the hedge fund hedge funds as Wellington Management, AQR indices could be more comparable.” Capital Management, Coe Capital Management, Chilton Investment Company, Loomis Sayles, THE CONUNDRUM OVER Jennison Associates, Chatham Asset Manage- PERFORMANCE FEES ment, Graham Capital Management and York Confusion over definitions and categorisations Registered Holdings all participate in liquid apart, there may be other pitfalls awaiting less alternative fund structures. Sub-advising man- experienced investors expecting hedge fund- agers may be attracted to liquid alternative like risk-adjusted uncorrelated returns in the mutual funds because of a desire to diversify liquid alternatives space. Some argue, for ex- their investor base and to obtain a stream of ample, that the fee structure in the market has inflows from the retail market.” the potential to act as a drag on performance The growth of the liquid alternatives market by failing to provide the sort of incentives has also attracted the attention of overseas that hedge fund managers are given through managers, as has the potential of the broader 2+20 fee arrangements. Managers in the liquid US asset management industry. As Allen & alternatives space in the US are generally Overy says in its introduction to a recent Chenavari7 prohibited from charging performance fees, update on the 1940 Act Fund, “any manag- 1 Canyon European Long/Short except in the case of limited offerings of funds er seeking additional streams of AUM must Event Driven, Credit Credit of hedge funds or funds of private equity funds consider the depth and breadth of the US retail to so-called sophisticated investors. market, which is estimated to have more than The prohibition of performance fees in the $33 trillion in investible assets.” Of this total, Capricorn2 6 ’40 Funds Act is one reason why a manager like notes the Allen & Overy briefing, 1940 Act Long/Short Equity Tiedemann Merger Arbitrage Old Mutual has chosen not to enter the liquid Funds hold over $18 trillion, with more than Emerging Markets alternatives market. “We have looked at the US, 40% of US households owning interests in at 5 but the problem there is the risk of negative least one 1940 Act Fund. To put the size of the Winton3 Och-Ziff Long/Short Equity US selection bias because you’re not allowed to 1940 Act Fund market into a global perspec- CTA Diversifi ed Special Situations charge a performance fee,” says Pepper at Old tive, it is equivalent to more than 50% of the Lyxor4 Mutual. “We don’t see the value in using up our worldwide market. CTA time and capacity to generate alpha without being paid for it. That only makes sense if you THE GROWING US PIONEER IN ONE OF THE FASTEST BEST ALTERNATIVE MANAGERS have a very scalable strategy.” RETIREMENT MARKET FUND SELECTION GROWING UCITS PLATFORMS IN A RISK-CONTROLLED UCITS More broadly, Pepper says that the absence The US mutual fund market is likely to become SINCE 1998 WITH MORE THAN $2BN AUM* FORMAT of the performance fee incentive in the US considerably more attractive to the investment Visit lyxor.com or contact [email protected] liquid alternatives market can magnify tracking THE GROWTH OF management industry over the foreseeable error between flagship strategies and their THE LIQUID future. In her speech to the Brookings Institute Lyxor’s Alternative UCITS Platform is the result of more than 18 years of analyzing and selecting the best hedge funds in the industry, taking into account the pedigree of the manager, the performance engines, the operational structure and the risk monitoring process. regulated equivalents. “A number of funds of ALTERNATIVES last June, SEC commissioner Kara M. Stein said 1 Canyon Capital Advisors LLC, 2 Capricorn Capital Partners UK Limited, 3 Winton Capital Management Limited, 4 Lyxor Asset Management, 5 Och-Ziff Capital Managment Group LLC, 6 Tiedemann Investment Group funds in the US have put together dumbed MARKET HAS ALSO that over the next 35 years, the share of the Advisors LLC, 7 Chenavari Investment Managers. down ’40 Act versions of flagship strategies ATTRACTED THE US population aged 65 or over is projected to often generating much less alpha,” he says. ATTENTION OF increase from 15% to 22%, which means there “Investors in these funds need to be aware that OVERSEAS will be close to 85 million Americans with a THE POWER TO PERFORM they may be buying something very different MANAGERS, AS retirement to fund by 2050. from the flagship product.” HAS THE POTENTIAL “That’s a big shift,” she said, adding that it In its report on “dispelling the myths” about OF THE BROADER also coincides with what former SEC chair- ETFs & INDEXING • ACTIVE INVESTMENT STRATEGIES • INVESTMENT PARTNERS liquid alternatives, K2 Advisors dismisses the US ASSET man Arthur Levitt has described as “an era of suggestion that the best managers are de- MANAGEMENT self-reliance” for American retirees, as it does *Source : TOP 10 UCITS Platform by HFM Week (Jan. 2016); Figures as of May 30th, 2016. terred by the absence of incentives comparable for pensioners throughout the developed world. THIS COMMUNICATION IS FOR PROFESSIONAL CLIENTS ONLY AND IS NOT DIRECTED AT RETAIL CLIENTS. Not all advisory or management services are available INDUSTRY in all jurisdictions due to regulatory restrictions. None of the hedge fund experts mentioned herein (“HF”) take any responsibility for the accuracy or completeness of the contents of this document any representations made herein, or for the fi nancial performance of their own strategies. Lyxor Asset Management (Lyxor AM) and each HF disclaims any liability for any direct, indirect, consequential or other losses or damages, including loss of profi ts, incurred by you or by any third party that may arise from any reliance on this document. Each HF is neither responsible for or involved in the marketing, distribution or sales of the Fund nor for compliance with any marketing or promotion laws, rules, or regulations; and no third party is authorised to make any statement about any of the relevant HF’s respective products or services in connection with any such marketing or sales. Lyxor Asset Management, Société par actions simplifi ée, having its registered offi ce at Tours Société Générale, 17 cours Valmy, 92800 Puteaux (France), 418 862 215 RCS Nanterre, is authorised and regulated by the Autorité des marchés fi nanciers (AMF). This communication is issued in the 20 hedgefundintelligence.com UK by Lyxor Asset Management UK LLP, which is authorised by the Financial Conduct Authority in the UK under Registration Number 435658. IT’S EASIER WHEN CHOOSING FROM THE BEST ALTERNATIVE UCITS

DISCOVER 7 HEDGE FUND EXPERTS IN THEIR RESPECTIVE STRATEGIES

Chenavari7 1 Canyon European Long/Short Event Driven, Credit Credit

Capricorn2 6 Long/Short Equity Tiedemann Emerging Markets Merger Arbitrage

5 Winton3 Och-Ziff CTA Diversiﬁ ed Long/Short Equity US Special Situations Lyxor4 CTA

PIONEER IN ONE OF THE FASTEST BEST ALTERNATIVE MANAGERS FUND SELECTION GROWING UCITS PLATFORMS IN A RISK-CONTROLLED UCITS SINCE 1998 WITH MORE THAN $2BN AUM* FORMAT

Visit lyxor.com or contact [email protected]

Lyxor’s Alternative UCITS Platform is the result of more than 18 years of analyzing and selecting the best hedge funds in the industry, taking into account the pedigree of the manager, the performance engines, the operational structure and the risk monitoring process. 1 Canyon Capital Advisors LLC, 2 Capricorn Capital Partners UK Limited, 3 Winton Capital Management Limited, 4 Lyxor Asset Management, 5 Och-Ziff Capital Managment Group LLC, 6 Tiedemann Investment Group Advisors LLC, 7 Chenavari Investment Managers.

THE POWER TO PERFORM

ETFs & INDEXING • ACTIVE INVESTMENT STRATEGIES • INVESTMENT PARTNERS

*Source : TOP 10 UCITS Platform by HFM Week (Jan. 2016); Figures as of May 30th, 2016.

THIS COMMUNICATION IS FOR PROFESSIONAL CLIENTS ONLY AND IS NOT DIRECTED AT RETAIL CLIENTS. Not all advisory or management services are available in all jurisdictions due to regulatory restrictions. None of the hedge fund experts mentioned herein (“HF”) take any responsibility for the accuracy or completeness of the contents of this document any representations made herein, or for the fi nancial performance of their own strategies. Lyxor Asset Management (Lyxor AM) and each HF disclaims any liability for any direct, indirect, consequential or other losses or damages, including loss of profi ts, incurred by you or by any third party that may arise from any reliance on this document. Each HF is neither responsible for or involved in the marketing, distribution or sales of the Fund nor for compliance with any marketing or promotion laws, rules, or regulations; and no third party is authorised to make any statement about any of the relevant HF’s respective products or services in connection with any such marketing or sales. Lyxor Asset Management, Société par actions simplifi ée, having its registered offi ce at Tours Société Générale, 17 cours Valmy, 92800 Puteaux (France), 418 862 215 RCS Nanterre, is authorised and regulated by the Autorité des marchés fi nanciers (AMF). This communication is issued in the UK by Lyxor Asset Management UK LLP, which is authorised by the Financial Conduct Authority in the UK under Registration Number 435658. LIQUID ALTERNATIVES/2016

“For much of the last century,” said Stein, 2000. These statistics indicate that for- “people have thought of retirement as a eign-owned management companies, and espe- ‘three-legged stool’ – social security, a pension, cially European-owned companies, are readily and personal savings. However, for many accessing the US regulated fund market.” families, at least one leg of the stool has disap- peared – the pension. And the two other legs ASSET-RAISING CHALLENGES have become a bit more wobbly.” IN THE US The result, Stein added, is that Americans The principal challenge for European managers expect more and more of their retirement with their eyes on the US liquid alternatives income to come from personal invest- Declan Denehan, market remains distribution. “How successful ments. “Most Americans will make such liquid alternatives managers have been in selling liquid alterna- investments through mutual funds and ETFs business head, tives to US investors has often depended on [exchange-traded funds],” she said. the access they have had to distribution chan- BNY Mellon Small wonder, then, that this market holds nels,” says a representative at BNY Mellon. considerable appeal for non-US manage- BNY Mellon explains that historically, Euro- ment groups. According to a guide to market pean alternative managers have accessed US access to the US for regulated fund manag- investors via private placement, which requires ers published by the Investment Company larger hedge funds to register with the SEC and Institute (ICI) in October 2013, overseas fund make various regulatory filings. More recently, managers have enjoyed reasonable success he says that European managers have been in accessing US investors via Regulated exploring a range of other options. One is via Investment Companies (RICs). acquisition, which has been the favoured route “As of June 2013, $2,153.17 billion of the total into the US market for some managers. value of US open-end investment company A second has been via the establishment of assets, which represents 15.8% of open-end their own mutual funds under the terms of the assets, were managed by foreign-owned invest- 1940 Act, which imposes the same regulatory ment advisers or their affiliates,” this advises. standards on all managers, irrespective of “These figures compare with approximately whether they are managed by local or overseas $897.69 billion, or 12.6%, as of June 2000. For firms. According to the ICI guide on access to closed-end RIC assets, approximately $63.5 the US regulated market, “although the inves- billion, which represents 23.2% of closed-end tor protection requirements of the 1940 Act are RIC assets, are managed by foreign-owned strict, there are several areas that are not sub- investment advisers as of June 2013. These ject to detailed regulation in the United States figures compare with approximately $22.48 in contrast to many other countries. The 1940 billion, or 16.19%, as of June 2000.” Act does not impose high capital, residency, “More specifically, European-owned or US place of business requirements, and the managers represent the largest segment of absence of requirements in these areas contrib- foreign-owned managers of RICs,” adds the utes to the ease of access foreign firms have to ICI report. “As of June 2013, $1,616.17 billion the United States. The initial seed capital for a of the total value of US open-end RIC assets, new fund that is required under the 1940 Act which represents 11.9% of open-end RIC assets, is only $100,000, and the 1940 Act does not were managed by European-owned investment require RICs to have directors or managers who advisers or their affiliates. In comparison, are residents or citizens of the United States. as of June 2000, European-owned manage- A RIC also can be administered outside of the ment companies managed $716.78 billion, or United States. As a result, it is easy for a foreign 10.06%, of open-end RIC assets. For closed-end firm to establish RICs in the United States.” RICs, European-owned investment advisers Straightforward, perhaps. But not necessar- or their affiliates managed $49.3 billion, or ily cost-effective. “The US market is eye-water- 18% of closed-end RIC assets, as of June 2013, ingly competitive,” says BNY Mellon. “Although compared to $16.46 billion, or 11.85%, in June the pools of money that managers can access

22 hedgefundintelligence.com 2016/LIQUID ALTERNATIVES

are vast, you need to achieve a highly competi- competitive,” this advised. tive total expense ratio to be attractive because This, added to the regulated nature of ‘40 there are so many players within the distri- Act products, means that strategies are likely bution chain – in addition to the distributor, to differ from flagship funds or UCITS products. there is the fund promoter and the sub-advisor. “Lastly,” the research paper advised, “opera- Funds in the US require more costly operating tional demands can be hefty, including daily systems than their UCITS equivalents, together valuations, new interfaces with US service with added corporate governance.” providers, and time-zone differences.” The costs associated with distribution in the The economics of distribution in the US have US means that granular distribution analysis is also made the market for liquid alternatives becoming increasingly important for managers. a notoriously difficult nut even for local new- “Through our Albridge Solutions and Analytics comers to crack. “If you can establish a three subsidiary we have been seeing more hedge year track record and you have access to the funds and traditional managers asking for right platforms and distribution channels, you more detailed analysis on where their product can attract significant assets in the US market,” is being distributed,” says BNY Mellon’s Niu. says a BNY Mellon representative. Without a “This gives them a much better understanding demonstrable track record, entering the US of the areas their sales staff should be focused market can be prohibitively expensive. on in their dialogue with RIAs.” In the meantime, the market for liquid A third option for European managers alternative products on either side of the attracted by the potential of the US is to access Atlantic remains dominated by a small group the market in a sub-advisory capacity on an of the largest managers. “Analysis we did existing fund platform. This is the route that recently showed that something like 70% has been selected by IPM, for example, which of the US CTA mutual fund market remains last September added its systematic macro dominated by about five funds,” says Societe strategy to Blackstone’s $1.4 billion Alternative Generale’s Dollery. “The alternative space in Multi-manager fund. Europe is still similarly dominated by some “We’ve been gaining traction rapidly in very large funds.” the US, where investors have a very good Others agree. “We would consider critical understanding of systematic macro strategies,” mass in the liquid alternatives space to be $200 says IPM’s Nydahl. “Today, the US accounts for million and over,” says Niu at BNY Mellon. At or about 35% of our total AUM, compared with below that rather modest minimum, the surviv- close to zero a few years ago, and given that al rate of many of the new managers breaking the US accounts for more than 50% of global into the market may be limited. “While I expect hedge fund assets, I see no reason why this AUM growth to be strong, I also think we will share should not increase further. In the case see some headlines about a lot of the smaller of ’40 Act funds, given the quite different reg- funds closing if they are unable to achieve the ulatory framework, we feel more comfortable scale they need,” says Denehan at BNY Mellon. operating in a sub-advisory role to a manager like Blackstone with proven experience of A BROADER RANGE OF distributing ’40 Act products.” ALTERNATIVE UCITS STRATEGIES Approaching the US market will require During the initial phase of the market for careful cost-benefit analysis, as BNY Mellon ad- THE ALTERNATIVE alternative UCITS and liquid alternatives, one of vised in a recent paper entitled Split Decisions: SPACE IN EUROPE the most frequently expressed concerns about Institutional Investment in Alternative Assets, IS STILL SIMILARLY its growth prospects was that it would restrict published by BNY Mellon and FT Remark in DOMINATED investors to the most liquid strategies, denying June 2016. “While the asset-raising opportunity BY SOME VERY them access to some alternative products is sizable, players must remember that man- LARGE FUNDS that ought to play a key role in constructing a agement fees are lower than typical alternative ANDREW DOLLERY, well-diversified portfolio. products and a fund’s expense ratio must stay SOCIETE GENERALE As a Regulatory Brief published by PwC in

hedgefundintelligence.com 23 LIQUID ALTERNATIVES/2016

2014 explains, “launching liquid alts is not as At Societe Generale, for example, Dollery simple as repackaging existing private fund says that he is encouraged by the diver- strategies into a mutual fund”. Restrictions sification of new launches he has seen in on the use of derivatives and short selling, the UCITS market over the last 12 months. twinned with strict liquidity requirements, “We’ve seen everything from convertible means that a number of familiar alternative bonds to CTA and global macro, so there strategies and asset classes are not feasible has been a healthy variety in the range of within a mutual fund structure, adds PwC. “Not strategies being offered in UCITS format,” he surprisingly, the primary strategies currently says. “Aside from illiquid or highly concen- employed in liquid alts tends to be global trated strategies such as activism, most macro, long/short equity and managed futures, strategies are now adequately represented while private equity, venture capital, timber- in the UCITS space.” land, infrastructure and merger arbitrage are Dollery echoes a number of other market not viable options.” participants when he says that one of the The relatively narrow range of strategies most active areas for new fund launches available to investors in the early days of this year is the quant space. He points to the the alternative UCITS movement meant that example of a strategy like the Tiber CTA, a some of the larger institutions involved in the short term systematic trading fund, which has market needed to flex their own muscles in launched recently via the Mortlake platform. order to persuade managers to broaden their According to ML Capital, “Tiber Capital’s repertoire. Take the example of Credit Suisse Diversified Program trades 25 global futures Asset Management (CSAM), which now has markets using 18 algorithms and aims to meet some $11 billion invested in offshore funds different investors’ risk and return require- and alternative UCITS. ments. The Program trades with varying CSAM’s Wieringa says that CSAM has been time frames (intraday to medium term, with investing in alternative UCITS since 2009, an average holding period of 4.5 days) and launching its first multi-UCITS fund of funds strategies (momentum, volatility breakout, in August 2010 and adding a second, slightly pattern recognition, mean reversion and more dynamically managed strategy the tactical trend). Returns are independent of the following year. “We now have over $1 billion movement of financial markets and show low in those two funds, in addition to other client or negative correlation to other asset classes.” funds invested directly in UCITS products.” Quant strategies have also been increas- “If we can access a hedge fund strategy ingly popular in the US liquid alternatives more cheaply and in a more liquid fund then market over the last 12 months. “The winning we would obviously prefer to do that via a strategies this year have been managed UCITS version,” says Wieringa. “Our buying futures, and the most striking success story power both in Europe and the US has meant in the US market has been AQR, which has that we have been able to persuade a num- raised a tremendous amount of money over ber of managers to launch UCITS versions of the last 12 months,” says BNY Mellon’s Niu. their strategies. This was important for us IF WE CAN ACCESS AQR’s Managed Futures Strategy had net back in 2010 when there was a limited range A HEDGE FUND assets of some $13.25 billion at mid-year. of UCITS funds available to us, but there is STRATEGY MORE now a much wider selection in the market.” CHEAPLY AND IN A THE RISE AND RISE OF RISK PREMIA While investors and third-party platforms MORE LIQUID FUND The market for smart beta, factor-based or say they would like to see a broader supply THEN WE WOULD risk premia products has been one of those to of new funds in strategies other than long/ OBVIOUSLY PREFER attract the most attention among managers short equity, the consensus is that the range TO DO THAT VIA A and investors in the UCITS space. of products available to UCITS investors is UCITS VERSION “The rise of alternative beta is one of the now more diversified than it has ever been, DIRK WIERINGA, strongest trends we’re seeing among new and that it is becoming more so by the day. CREDIT SUISSE UCITS launches this year,” says Dollery at

24 hedgefundintelligence.com Conviction is paramount

Financial markets are prone to periods of heightened volatility, like an ocean, shaken at times by strong winds and storms. To successfully navigate during such periods requires expert knowledge. IPM’s investment models have been designed to withstand market volatility, maintaining conviction to profit when markets converge back to their fundamentals. Only robust vehicles thrive in harsh waters.

Find more information about our approach at ipm.se or contact us at [email protected]. PHOTO: ANTHONY HEARSEY

IPM Informed Portfolio Management was founded in 1998 with the purpose of delivering robust investment strategies with a systematic investment process to institutional investors. Today, IPM is primarily recognized for its multi‐asset systematic macro strategy, but also for its Smart Beta equity strategy, both building on similar investment principles.

IPM is regulated as an AIFM by the Swedish Financial Supervisory Authority (Finansinspektionen), and registered with the U.S. Securities and Exchange Commission as a foreign investment advisor since 2011, and as a CPO/CTA with the Commodity Futures Trading Commission since 2013. LIQUID ALTERNATIVES/2016

Societe Generale. “To some extent this rep- THE IMPORTANCE OF resents the infiltration into Europe of a very QUALITY CONTROL successful US theme where investors have The consensus among all market participants been attracted by products with a low fee in is that it is critical that the industry as a whole the 50bp to 100bp range. We think this will remains vigilant against any loosening of the continue to be a feature of the UCITS market, high standards that have been set in the alter- where managers will focus on offering sys- native UCITS space. tematic, simpler and lower volatility versions “As investors seek more complex products, of their flagship products.” we think that one of the challenges will be At Old Mutual, Pepper agrees. “We think Donald Pepper, continuing to ensure that the liquidity profile the development of risk premia products managing director of underlying products is in line with UCITS offering market neutral exposure to various of alternatives and regulations,” says Jain at Goldman Sachs. “It is investment themes will be very interesting essential that asset managers and platforms institutional, Old for the alternative UCITS market,” he says. are thoughtful about their fund launches, and Mutual Global “Because 70% or 80% of the returns can be therefore about protecting the UCITS reputa- explained by systematic exposure to these Investors tion and brand.” themes rather than granular single stock pick- The obvious way to prevent this happening, ing, you can pile these products high and sell say market participants, is to ensure that them cheap. They can also be wrapped in ’40 investors have an absolutely clear understand- Act funds without performance fees.” ing of the product they are buying. That is This reflects a more general trend across usually straightforward enough in the case of an industry where containing or reducing fees an equity long/short strategy, but can be con- are becoming paramount for investors. “I siderably less so in the world of debt or credit. think investors are prepared to accept more As Dollery at Societe Generale says, this is modest returns of 3% or 4% in this environ- because credit is a good example of an asset ment, but they’re not prepared to pay hedge class that can lend itself to liquid as well as fund-style fees to generate those returns,” illiquid strategies. “Credit can mean a number says Wieringa at CSAM. “This is why risk of different things to different people,” he premia strategies with flat fees of 100bp or says. “It can mean trading cash instruments, less have done so well.” which in the case of high yield bonds can be As low cost, uncorrelated and highly liquid tricky for strategies offering daily liquidity. funds, risk premia-based strategies and UCITS Alternatively, it can mean centrally-cleared look like a match made in heaven. The same derivatives such as credit default swaps cannot be said for some other strategies which (CDS), which have brought credit into the continue to be unsuitable for inclusion within alternative UCITS fold because they are more funds requiring weekly liquidity, still less for liquid. We recently launched a UCITS product those promising daily liquidity. “The red line which is called a credit fund but it won’t be for us is always around the issue of liquidity, trading cash bonds. It will focus purely on because this is where the most obvious mis- centrally-cleared CDS.” match lies between UCITS and their underlying It is easy to see why higher yielding fixed investments,” says Societe Generale’s Dollery. income should be becoming increasingly “We would never look at a fund that trades a appealing to investors. According to an update highly illiquid strategy.” published in July by Schroders, some 36% Others agree. At Credit Suisse, Wieringa of global government debt now trades at a describes liquidity risk as being “front and negative yield, while 77% yields below 1%. As centre” of investors’ misgivings about the risks Schroders says, “unless you believe in a signifi- associated with the rapid expansion of the cant deflationary bust, owning these securities alternatives UCITS space. “It is absolutely es- makes little sense.” sential that the UCITS brand does not become Little wonder, against that backdrop, that al- tarnished by any liquidity mismatch,” he says. ternative credit products have become increas-

26 hedgefundintelligence.com 2016/LIQUID ALTERNATIVES

ingly popular among investors engaged in an Commissioner Stein’s concerns echo those increasingly challenging hunt for yield. “One of the Financial Stability Oversight Council of the strategies we think is going to attract a (FSOC), which calls in its most recent annual lot of attention over the next few years is loans review for “robust liquidity management prac- and debt, although they don’t often fit into tices” for mutual funds. This would involve the liquid alternatives because of the illiquidity of “establishment of clear regulatory guidelines the underlying assets,” says a representative addressing limits on the ability of mutual funds at BNY Mellon. to hold assets with very limited liquidity.” In the US in particular, this unnerves regula- Among other initiatives to tighten up protec- tors which are uneasy about the potential for tion for retail investors, the FSOC is also calling managers attempting to shoehorn strategies for “enhanced reporting and disclosures by such as bank loans into alternative mutual mutual funds of their liquidity profiles and funds which are only allowed to hold up to liquidity risk management practices.” 15% of their assets in illiquid securities. In The SEC has already suggested some her speech to the Brookings Institute last measures aimed at addressing the liquidity June, SEC commissioner Kara M. Stein was conundrum. In September 2015, it issued explicit about the regulator’s unease about proposed rules for mutual funds and ETFs de- the inclusion of illiquid strategies in products signed to enhance liquidity risk management which are – by definition – intended to be by funds, provide new disclosures regarding liquid. Since late 2009, she said, assets in bank fund liquidity, and allow funds to adopt swing loan mutual funds and ETFs had increased by pricing to pass on transaction costs to entering almost 400%. and exiting investors. “Yet, many of the underlying loans in these As with the SEC’s concerns about deriv- funds may take over a month to actually atives, a number of industry participants settle,” she said. “If it takes over a month to believe misgivings about liquidity may be over- settle, it is reasonable to wonder how the fund egged. In its recent report on “dispelling the could possibly meet the seven day redemption myths” associated with the liquid alternatives requirement in the Investment Company Act in market, K2 Advisors comments that in 15 times of market stress.” event-driven funds that it monitors, “roughly Stein added that the portfolios of some 58% of the portfolios’ holdings could be fully bank loan funds contained collateralised loan liquidated within one to five days, 62% within obligations (CLOs). Others were almost entirely five to 10 days, and 67% within 20 days. For made up of illiquid bank loans. “How is this the 27 global macro funds we monitor, roughly happening?” she asked, rhetorically. “Funds 95% of the portfolios’ holdings could be fully have relied on an interpretation that allows A CONVERGENCE liquidated within one to five days, 96% within them, for example, to base the 15% standard BETWEEN AIFMD five to 10 days, and 97% within 20 days (all as on when a contract price is struck to sell the AND THE UCITS at January 2015).” underlying bank loan and not on when actual DIRECTIVE WOULD K2’s conclusion is that “some trading strat- settlement of the loan occurs, which is when BE A VERY POSITIVE egies are less liquid by nature, such as certain the fund would actually receive cash and DEVELOPMENT, specialist credit funds, but in general our transfer ownership of the loan. “Unfortunate- AND IN PRACTICE analysis suggests these represent the minority. ly, I am not sure that retail investors have IT IS ALREADY As such the supposed advantage of illiquidity received the memo that interpretations of HAPPENING TO A may in practice be very limited.” liquidity rules have changed beneath their feet DEGREE BECAUSE for certain funds. Not only that, retail investors THE REGULATIONS UCITS REGULATION: may not even receive disclosure about risks re- ARE ALREADY ENOUGH IS ENOUGH? lated to this extended settlement period. Over QUITE SIMILAR Whether or not Europe could also see reg- time, this 15% liquidity standard has arguably DANIELE SPADA, ulatory pressure to tighten standards in its become more of a compliance exercise than a LYXOR ASSET equivalent of the liquid alternatives market true restriction.” MANAGEMENT is open to question. Most appear to think this

hedgefundintelligence.com 27 LIQUID ALTERNATIVES/2016

is unlikely and unnecessary. “It’s true that the governed by considerably more flexible financial services industry is highly creative guidelines. “Many of the loans and debt and innovative,” says Spada at Lyxor, who is strategies, as well as anything with a private not worried about abuses being allowed to equity or retail feel, will still end up in AIFs creep into the UCITS market. “But the rules rather than UCITS,” says a BNY Mellon repre- on alternative UCITS are very tight and clear, sentative. and managers offering complex and less That may be. But a number of market liquid strategies can do so via the AIFMD participants are vocal about the desirability instead.” of combining AIF and UCITS regulation. Following a series of amendments to Serge Houles, “I wish and hope that the European the original UCITS Directive, managers and head of client portfolio regulator would look at merging AIFMD their service providers could be forgiven management, Informed and UCITS to create a single global for complaining of regulatory and acronym passporting system,” says Houles at IPM. Portfolio Management fatigue. The good news, they say, is that the “The existing dual system is complicated for (IPM) most recent reincarnation of the regulatory managers and investors to navigate, and framework has been relatively painless. given the traction of UCITS-compliant versus UCITS V, which was published in August 2014 AIMFD-passported funds, in such a scenar- and transposed into national law in March io UCITS might be the sole regime going 2016, amended a handful of issues relating to forward.” manager remuneration, the depository func- Others agree. “A convergence between tion and administrative sanctions, none of AIFMD and the UCITS directive would be a which caused much friction in the investment very positive development, and in practice management industry. it is already happening to a degree because “UCITS V was not too disruptive, and the the regulations are already quite similar,” decision not to impose any hard cap in the says Spada. manager remuneration provisions was sensi- As Spada points out, Lyxor is well-posi- ble,” says Dollery at Societe Generale. “As for tioned to comment on the difference in inves- the new guidelines on depositories, because tor preference for the two because it offers a prime broker is seldom appointed as a alternatives UCITS as well as AIFMD products sub-custodian for a UCITS fund the increased on its platform. Today, he says, Lyxor has depository liability is unlikely to have much eight strategies on its alternative UCITS of an impact on our business.” platform and four on its Luxembourg-based So successful have UCITS become that they AIFM platform. But he adds that while Lyxor are now regarded around the world as offer- is actively looking to add to the repertoire of ing the highest level of investor protection. alternative UCITS it offers investors, it has no “UCITS have achieved a gold standard which plans at present to extend its AIFMD offer- funds authorised under AIFMD would very ings. “This is because 90% of the requests we much like to enjoy,” says a represenatative receive are for alternative UCITS,” he says. at BNY Mellon. “AIFs still haven’t enjoyed One of the principal differences between the levels of success that were forecast AIFs and UCITS is that while the AIFMD gov- back in 2014. Even though they are a highly erns the fund management company, UCITS regulated product there still appears to be focuses on governing the fund itself, which an investor preference for alternative UCITS industry participants say is a much more because of the standards they have set with sensible approach for investors. regard to governance and liquidity.” “Don’t quote me on this,” says one. “But Although there has been some speculation I can’t help thinking that regulation of the about continued convergence between UCITS asset management industry is shaped more and AIFs, BNY Mellon and others point out in the interests of the regulators themselves that as they are intended for professional than on behalf of the investors it is sup- rather than retail buyers, AIFs will remain posed to protect.”

28 hedgefundintelligence.com SOCIETE GENERALE PRIME SERVICES

THIS COMMUNICATION IS FOR PROFESSIONAL CLIENTS ONLY AND IS NOT DIRECTED AT RETAIL CLIENTS.

SOGE_CIB_1502_EUROHEDGE_205x272_GLOBE_GB.indd 1 15/02/2016 12:14 Invested in solid solutions for liquid alternatives.

As investor demand accelerates for liquid alternatives, many investment managers are being challenged to keep pace. BNY Mellon can assist with an innovative, end-to-end solution that LIQUID ALTERNATIVES/SPONSOR PROFILES supports the operational, ﬁ nancing, visibility and technology needs of liquid alternatives. From the logistics of fund launch to the complexities of daily fund management, we seek to enable liquid alternative funds to move ahead and make the most of their investments.

Lead sponsor BNY Mellon

Liquid alternative funds are playing a larger role in investor portfolios and asset managers of all types are responding by developing more liquid alternative products and strategies. This, in turn, is creating more demand for services to help asset managers create and administer. BNY Mellon and its affiliate Pershing have a solution to fill this need. BNY Mellon Asset Servicing provides custody, administration services, operational infrastructure support and regulatory support to funds of all types. Pershing Prime Services provides prime brokerage, financing, servicing and platform access. Together, they draw on expertise from both sides of the business to launch, administer and grow liquid alternative products. www.pershingprimeservices.com www.bnymellon.com Pershing Prime Services provides stable counterparty strength, extensive access to lendable securities, alternative sources of finance, dedicated client service, robust reporting tools, global execution and custodial solutions through the integrated platform of BNY Mellon. Pershing Prime Service is a service of Pershing©2016 LLC Pershing LLC. Pershing Prime Services is a service of Pershing LLC, member FINRA, NYSE, SIPC, a wholly owned subsidiary of The Bank of New York Mellon Corporation (BNY Mellon). Trademark(s) (member FINRA/NYSE/SIPC), a BNY Mellon company. belong to their respective owners. For professional use only. Not for distribution to the public. BNY Mellon is a global investments company dedicated to helping its clients manage and service their assets©2016 The Bank of New York Mellon Corporation. All rights reserved. BNY Mellon is the corporate brand for The Bank of New York Mellon Corporation. The Bank of New York Mellon is supervised and throughout the investment lifecycle. We deliver investment management and investment services in 35 countriesregulated by the New York State Department of Financial Services and the Federal Reserve and authorised by the Prudential Regulation Authority. The Bank of New York Mellon London branch is subject to regulation by the Financial Conduct Authority and limited regulation by the Prudential Regulation Authority. Details about the extent of our regulation by the Prudential Regulation Authority are available and more than 100 markets and currently have $29.5 trillion in assets under custody and/or administration,from and us on request. Products and services referred to herein are provided by The Bank of New York Mellon Corporation and its subsidiaries. Content is provided for informational purposes only and is not $1.7 trillion in assets under management. BNY Mellon is the corporate brand of The Bank of New York Mellonintended to provide authoritative ﬁ nancial, legal, regulatory or other professional advice. Corporation (NYSE: BK). Additional information is available on www.bnymellon.com. Follow us on Twitter @ BNYMellon or visit our newsroom at www.bnymellon.com/newsroom for the latest company news.

For further information/ Mark Aldoroty Declan Denehan TeHsing Niu e/ [email protected] e/ [email protected] e/ [email protected] t/ 201 413 4445 t/ 212 635 6754 t/ 212 635 6579

Lead sponsor Societe Generale

Societe Generale Prime Services part of the Global Markets’ division of Societe Generale Corporate & Investment Banking is the bank’s Prime Brokerage business, offering a unique combination of execution, clearing, custody and financing services. It is truly multi-asset and multi-instrument across Listed Derivatives, Equities (Cash/ synthetic), FX, Fixed Income and OTC Cleared. As the world’s leading derivatives broker, the Prime Services business offers unrivalled access to 125+ markets and exchange venues; offering both agency or principal execution, and extensive value added services. The full service platform offers access to significant securities financing capabilities, extensive capital introduction and best-in-class cross-margin capabilities as well as straight-through-processing with an industry leading post-trade platform aligned with Societe Generale extensive research product.

For further information/ Andrew Dollery, Director, Societe Generale Prime Services e/ [email protected] t/ +44 (0) 207 676 8138 w/ https://cib.societegenerale.com/en/our-offering/global-markets/prime-services/

Associate sponsor Goldman Sachs

The Goldman Sachs Group, Inc. is a leading global investment banking, securities and investment management firm that provides a wide range of financial services to a substantial and diversified client base that includes corporations, financial institutions, governments and individuals. Founded in 1869, the firm is headquartered in New York and maintains offices in all major financial centers around the world.

For further information/ Neha Jain, Executive Director, Securities Division Goldman Sachs International, Peterborough Court, 133 Fleet Street, London EC4A 2BB e/ [email protected] t/ +44 (0)20 7051 3064 w/ www.goldmansachs.com

30 hedgefundintelligence.com SPONSOR PROFILES/LIQUID ALTERNATIVES

Associate sponsor IPM

IPM Informed Portfolio Management (IPM) was founded in 1998 with the purpose of delivering robust investment strategies with a systematic investment process to institutional investors. Today, IPM is primarily recognised for its multi-asset systematic macro strategy, but also for its Smart Beta equity strategy, both building on similar investment principles. IPM’s investment strategies are based on economic theory and rely on the belief that market prices fluctuate around the true fundamental value of financial assets. IPM designs novel approaches to model these movements and then captures the resulting profit. The investment process is systematic using a broad set of fundamental information as inputs. Based in Stockholm, IPM has 47 employees of which close to half are involved in research and investments. The company’s reach is increasingly global with investors in Europe, Asia, the Middle East and North America. IPM is registered with the financial regulators in Sweden and the US.

For further information/ Serge Houles, Executive Director, Head of Investment Strategy e/ [email protected] t/ +46 8 506 859 68 w/ www.ipm.se

Associate sponsor Lyxor Asset Management Group

Lyxor Asset Management Group (“Lyxor Group”) was founded in 1998 and is composed of two fully-owned subsidiaries(1)(2) of Societe Generale Group. It counts 600 professionals worldwide managing and advising $127.3bn* of assets. Lyxor Group offers customized investment management solutions based on its expertise in ETFs & Indexing, Active Investment Strategies and Multi-Management. Driven by acknowledged research, advanced risk- management and a passion for client satisfaction, Lyxor’s investment specialists strive to deliver sustainable performance across all asset classes. www.lyxor.com

(1) Lyxor Asset Management is approved by the «Autorité des Marchés Financiers» (French regulator) under the agreement # GP98019. (2) Lyxor International Asset Management is approved by the «Autorité des Marchés Financiers» (French regulator) under the agreement # GP04024. * Equivalent to €114.5bn - Assets under management and advisory as of end of June 2016

For further information/ Amber Kizilbash, Head of Sales and Client Strategy Lyxor Asset Management e/ [email protected] t/ +33142133131 w/ www.lyxor.com

Associate sponsor Morgan Stanley

Morgan Stanley is a leading global financial services firm providing a wide range of investment banking, securities, wealth management and investment management services. With offices in more than 43 countries, the Firm’s employees serve clients worldwide including corporations, governments, institutions and individuals. For further information about Morgan Stanley, please visit www.morganstanley.com.

For further information/ Federico Foglietta, Executive Director Morgan Stanley, 20 Bank Street, Canary Wharf, Floor 01, London, E14 4AD e/ [email protected] t/ +44 20 7425 3539 w/ www.morganstanley.com

hedgefundintelligence.com 31 Invested in solid solutions for liquid alternatives.

As investor demand accelerates for liquid alternatives, many investment managers are being challenged to keep pace. BNY Mellon can assist with an innovative, end-to-end solution that supports the operational, ﬁ nancing, visibility and technology needs of liquid alternatives. From the logistics of fund launch to the complexities of daily fund management, we seek to enable liquid alternative funds to move ahead and make the most of their investments.

www.pershingprimeservices.com www.bnymellon.com

©2016 Pershing LLC. Pershing Prime Services is a service of Pershing LLC, member FINRA, NYSE, SIPC, a wholly owned subsidiary of The Bank of New York Mellon Corporation (BNY Mellon). Trademark(s) belong to their respective owners. For professional use only. Not for distribution to the public. ©2016 The Bank of New York Mellon Corporation. All rights reserved. BNY Mellon is the corporate brand for The Bank of New York Mellon Corporation. The Bank of New York Mellon is supervised and regulated by the New York State Department of Financial Services and the Federal Reserve and authorised by the Prudential Regulation Authority. The Bank of New York Mellon London branch is subject to regulation by the Financial Conduct Authority and limited regulation by the Prudential Regulation Authority. Details about the extent of our regulation by the Prudential Regulation Authority are available from us on request. Products and services referred to herein are provided by The Bank of New York Mellon Corporation and its subsidiaries. Content is provided for informational purposes only and is not intended to provide authoritative ﬁ nancial, legal, regulatory or other professional advice.