April 2015 AlphaFOR INSTITUTIONAL INVESTORS & ASSETQ MANAGERS

Financial ESG factors Technology Something to aim Europe dominates for or crucial? in Fintech growth End of an era EasyJet Are institutions entrepreneurs leaving Start-ups take flight funds behind?

European M&A Into Africa Where are we Investment in the cycle? opportunities

Backing bricks & mortar Clearbell’s Manish Chande on commercial property funds and their sudden attraction

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he hunt for diverse streams of is intensifying, and skill- based risk-adjusted returns are the Holy Grail for all investment Tmanagers. Global Fund Media (GFM) brings you AlphaQ, a bimonthly compendium of investment ideas, skill and talent across all asset classes. Dip into expert articles about investment as diverse as real estate ETFs to the easyJet entrepreneurs making advances in the world of Fintech. We ask whether institutional investors are abandoning hedge funds; what’s the state of play in European private M&A and can the ubiquitous cloud offer risk management? AlphaQ is also a subscription-based online analytical, product development and marketing resource for institutional investors, wealth

E leano r Rost on advisers and investment managers, allowing them to share best-in-class ideas and strategies with their peers through the bimonthly journal. Subscribers will have access to a choice of daily online news on their chosen asset classes delivered to them each morning, plus the opportunity to contribute relevant articles in the bimonthly journal, which is distributed globally to investors.

Managing Editor AlphaQ combines research and analysis into current investment Beverly Chandler Email: [email protected] themes, with manager profiles and directional thinking on global market Contributing Editor James Williams developments. Email: [email protected] Subscribers will also have access to a pool of archived news and feature Online News Editor Mark Kitchen Email: [email protected] articles plus performance data on asset managers from GFM’s suite of Deputy Online News Editor online news sites: Leah Cunningham Email: [email protected] • Institutional Asset Manager Graphic Design Siobhan Brownlow • Private Equity Wire Email: [email protected] Sales Managers • Hedgeweek Simon Broch Email: [email protected] • Property Funds World Malcolm Dunn Email: [email protected] • Wealth Adviser Marketing Administrator • Etfexpress Marion Fullerton Email: [email protected] • Global Fund Data. Head of Events Katie Gopal Email: [email protected] Head of Awards Research Complimentary networking events Mary Gopalan Email: [email protected] Subscribers will be invited to complimentary networking events where Chief Operating Officer Oliver Bradley they can listen to TED-style talks on diverse themes. The first Email: [email protected] events will take place in New York this September and in October. Chairman & Publisher Sunil Gopalan Email: [email protected] Subscribe now and join us as we track the world’s leading investors and Published by asset managers in their quest for solid investment returns. GFM Ltd, Floor One, Liberation Station, St Helier, Jersey JE2 3AS, Channel Islands Beverly Chandler Tel: +44 (0)1534 719780 Website: www.globalfundmedia.com Managing editor, AlphaQ ©Copyright 2015 GFM Ltd. Email: [email protected] All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the publisher. Investment Warning The information provided in this publication should not form the sole basis of any investment decision. No investment decision should be made in relation to any of the information provided other than on the advice of a professional financial advisor. Past performance is no guarantee of future results. The value and income derived from investments can go down as well as up.

AlphaQ April 2015 www.AlphaQ.world | 3 Contents

April 2015 AlphaFOR INSTITUTIONAL INVESTORS & ASSETQ MANAGERS

FinanCial esg FaCTors TeChnology Something to aim Europe dominates for or crucial? in Fintech growth end oF an era easyJeT Are institutions enTrepreneurs leaving hedge Start-ups take flight funds behind?

european M&a inTo aFriCa Where are we Investment in the cycle? opportunities

05 30 33

Backing bricks & mortar Clearbell’s Manish Chande on commercial property funds and their sudden attraction 05 End of an era for hedge funds? 26 Social media for asset managers James Williams examines why pension SEI’s Lori White explains how social www.AlphaQ.world fund managers are ditching hedge funds media platforms such as Twitter and LinkedIn can help investment managers 08 EasyJet entrepreneurs Companies featured in market their businesses Randeep Grewal looks at the this issue: phenomenon of the easyJet entrepreneur 29 The ESG phenomenon • Accenture (other low cost airlines are available) and ESG is increasingly important for • Access China why start-ups are taking flight investors and companies alike, writes • Arabesque Partners Beverly Chandler. New research from • Barclays 11 The rise and rise of Fintech LGT Capital Partners and Mercer • Barings Beverly Chandler reports on Accenture’s confirms that investors are key in • BlackRock latest annual survey on this fast growing pushing this forward • CalPERS sector • China Merchants Bank 30 The spread of liquid alternatives 13 Backing bricks & mortar • Clearbell Capital LLP ’40 Act funds are only part of the liquid Clearbell’s Manish Chande tells Beverly alternatives narrative says Michael • CMS Chandler why commercial property Bernstein of Lyxor Asset Management • Derivitec funds are currently proving attractive to • Deutsche Bank institutional investors around the world 33 A quantitative approach • EQT Partners Arabesque Partners’ Omar Selim makes • Fidelity 14 Hedge fund outlook the case for a quantitative approach to • FinTech Innovation Lab Barclays Strategic Consulting team sustainable ESG investment London reports on the outlook for global hedge • Foundation Asset funds, based on investor sentiment 35 Investing in Africa Management Diane Radley of Old Mutual Investment • Industrial and 17 Plausible alternatives Group, examines how to unlock the Commercial Bank of Declan Canavan, JP Morgan Asset potential for private market investment China Management, describes how in Africa • iShares companies generate higher returns from • Intralinks different types of alternatives 37 Cyber security: A multi-pillar approach • Level39 Intralinks’ Todd Partridge advises a 19 China A-Shares: too big to ignore • LGT Capital Partners multi‑pillar approach to guard against Tim Nash of Access China, examines cyber attack • Lyxor Asset why Chinese A-Shares are simply too big Management an opportunity to miss 40 Cloud derivatives • JP Morgan James Williams meets the Derivitec team • Mercer 21 Challenging the illiquidity myth who showcase how best to manage • Old Mutual Patrick Adefuye, analyses the key derivatives risk through the cloud • Pantheon Ventures findings of a recent Preqin survey of • Permal Group asset managers 43 European M&A • PFZW Beverly Chandler discusses a new study • Ping An Insurance 23 Bridging the gap by CMS with Martin Mendelssohn, which Michael Riak of Pantheon Ventures, • Preqin finds private company M&A in Europe reports on the US retirement crisis and • Rathbones enjoying a major uplift how private equity can bridge the gap • SEI 44 Building assets • Shanghai Stock 25 Virtual real estate James Williams interviews EQT Partners Exchange Beverly Chandler interviews BlackRock’s who have established a new European • SL Advisors Tom Fekete on how the company’s new real estate platform to focus on London • Syz Asset Management iShares product brings illiquid property to and the Nordics • Unigestion the trading table

AlphaQ April 2015 www.AlphaQ.world | 4 Hedge Funds End of an era for hedge funds? James Williams examines why managers are ditching hedge funds.

ince September, CalPERS, and to large-scale outflows. We think it’s more recently Dutch pension going to be the opposite, with more Sfund PFZW, have divested their money coming in.” hedge fund allocations. CalPERS said Not everyone is ebullient on the it spent USD135 million in hedge fund prospects of hedge funds. There are fees in its last fiscal year and USD115 some who believe that the sheer size million the year before. of the hedge fund industry, which now Fees were clearly an issue, as was totals more than 8,000 hedge funds, is the complexity of categorising their overcapitalised, making it harder for hedge fund investments, but the institutions to generate outperformance question is: Are these outlier events from their hedge fund portfolios. Simon or the early symptoms of a more Lack, founder of SL Advisors, was serious problem facing the hedge fund quoted by the Financial Times last industry. Just how much value do September as saying that he wasn’t they really offer institutions at a time surprised by CalPERS’ decision. In when fees and performance are under his opinion, institutional investors are greater scrutiny than ever, especially “When speaking to our mistaken in assuming that hedge fund as more cost-efficient liquid alternative managers will be able to deliver alpha products continue to blossom? investors and prospects when the industry has grown fourfold. “The news came as a surprise to the in the market we do not That is, there are too many industry. For us, generally speaking, managers chasing the same trades. at Lyxor, we viewed the two stories get a sense that this is Finding new sources of alpha has as specific ‘outlier’ events rather than the start of a new trend; become hugely challenging. representing a symptom of a wider quite the opposite.” As a result, manager selection is trend. When speaking to our investors more critical than ever. Separating the and prospects in the market we do Jean-Marc Stenger, wheat from the chaff is a tall order not get a sense that this is the start Lyxor Alternative Investments and even though the largest, most of a new trend; quite the opposite. sophisticated institutions are building These were very specific cases to those forecasts that global hedge fund assets in-house capabilities to run direct two pension funds,” comments Jean- are set to surpass USD3 trillion by hedge fund programmes, the majority Marc Stenger, CIO, Lyxor Alternative year-end and grow a further 7 per cent. still rely on third party consultants and Investments. The report writes: “Institutional multi-managers. Recent reports seem to suggest that investment in hedge funds is set to Shane Clifford is head of global institutions are choosing to keep the increase, with 39 per cent of these business development at Permal Group, faith. In Preqin’s February Hedge Fund investors planning to increase their one of the industry’s leading FoHF Spotlight report, a monthly publication, allocation to hedge funds in 2015.” managers. He notes that institutions it revealed that 26 per cent of investors “We do expect to see more global are becoming more mature in the way plan to increase their allocation to hedge public pension fund money flowing in they allocate. Many have gone through funds in 2015, whilst 58 per cent intend to the industry,” says Bensted. “Both one or two investment cycles and are to maintain their current allocation. managers and investors that we spoke gaining a deeper understanding of the Furthermore, Deutsche Bank’s 13th to when producing the report didn’t value hedge funds can bring to their annual Alternative Investment Survey think the CalPERS decision would lead overall portfolio.

AlphaQ April 2015 www.AlphaQ.world | 5 Hedge Funds

bring something meaningful to the portfolio. I think that’s partly why CalPERS divested their allocations, they probably weren’t ready to make that move. “Second, when simple, more straightforward strategies are used, it should allow investors to avoid paying the usual 2/20 fees. If it’s a long/short equity fund sitting with the overall equities allocation, there is going to be a certain amount of market – is it traditional beta or alternative beta? – and as such, the fees should come down. For these types of strategies, investors should be paying 1.5 per cent and anywhere between 0 per cent and 15 per cent “I think the more interesting question to be in performance fees because there is a clear asked is whether institutions view hedge rationale for doing so. “Both investors and, importantly, managers funds as a separate and distinct allocation are becoming more understanding of that,” or not, and if so, why?” states Stenger. Nicolas Rousselet is Managing Director and Shane Clifford, Permal Group Head of Hedge Funds at Unigestion. In his opinion, it’s not just “raw” underperformance “Should it be a separate allocation or should but a combination of underperformance and it be split up across asset classes? That’s a fees that is leading investors to ask, “Why do I broad conversation that investors are having pay so much to receive so little?” today, as opposed to one of, ‘Are we committed “This is slightly misguided however. Investors to hedge funds?’ have to understand what their ultimate objectives “A lot of the money being allocated to us are. If they are looking to beat a strongly is coming from the fixed income portion of performing market, they should not be looking investors’ portfolios. I think the more interesting at hedge funds, whose aim is to generate non- question to be asked is whether institutions view correlated returns without the long-term support hedge funds as a separate and distinct allocation of the markets, but rather ultra-risky speculative or not, and if so, why?” says Clifford. levered directional funds,” says Rousselet. Indeed, 10 years ago, when institutional Over the last few years, central bank investors like CalPERS started to seriously intervention and a low rate environment has invest in hedge funds, the typical approach was created a situation where hedge funds cannot to work with consultants, do their research expect to outrun the markets. Consequently, and would ultimately end up allocating 5 or this magnifies the fees, creating a perfect storm 6 per cent to a handful of strategies to bring of low performance and high costs. decorrelation benefits; hedge funds were viewed Firms like Unigestion are making strides in as a completely separate asset class. negotiating fees that are more aligned to the The problem with that approach is that investor and which incentivise the manager to it does not necessarily give investors a full perform, not just sit on the picture of how hedge funds can actually work and gather assets. symbiotically with traditional investments “The fee should be paid by investors across equities and fixed income. But as when performance is good, not all the time. Stenger observes, institutions are beginning to Transformation of fees is something we migrate away from this limited use of hedge increasingly see. Managers who operate in the fund strategies, which should help them gain true spirit of what a hedge fund is are happy better long-term insights into the value these to look at this,” says Rousselet. “What we strategies are generating. recommend, and have had some success in “They are starting to integrate hedge funds doing, is a fee structure that rewards managers into their wider portfolios,” says Stenger, when they do well, and doesn’t reward them “and this can achieve two things: First, you when they don’t do well.”

AlphaQ April 2015 www.AlphaQ.world | 6 Hedge Funds

One of the big developments seen in the last five years is “If investors are looking the range of options available to institutions to gain exposure to hedge funds. In times past, the only choice they had was to beat a strongly to invest in the manager’s commingled flagship fund offshore. performing market, They would typically receive a monthly performance update, they should not be the odd newsletter or two, but by and large they were kept in the dark. looking at hedge funds, Today, the situation is far different. Institutions can choose but rather ultra-risky to have funds-of-one, commingled managed accounts, separate managed accounts, they can choose between offshore funds speculative levered directional funds.” and regulated AIFs under the AIFMD, or liquid alternatives Nicolas Rousselet, Unigestion (UCITS and ’40 Act funds). All of these offer something slightly different, and this is good news for institutions as they progress through their investment lifecycle. 10 managers”, compared to a public fund who may come to “We work with a wide spectrum of clients, in terms of us and say “We like the track record of your multi-strategy their knowledge and experience of hedge fund investing. We credit fund but we want you to give us that in a fund-of-one get some that are highly sophisticated and work with us to structure”. construct, let’s say, an event driven mandate containing five “In today’s world, one has to be relevant to an insurance managers. On the other hand we still have clients who are company, a pension fund, an SWF, a multi , etc,” dipping their toe in for the first time. You see these headline adds Clifford. statements that make sweeping generalisations (about Over the coming years, institutions will effectively have no investor disillusionment with hedge funds), but things are choice but to invest in hedge funds. Since the global financial never black and white,” comments Clifford. crisis, investors have enjoyed a golden period as equity One interesting point that Clifford makes is that markets have rocketed and bond yields have dropped to the majority of Permal Group’s clients run both direct record lows. The fact is, that is not a sustainable environment. programmes and multi-manager programmes. Institutions Traditional asset classes will not deliver that same level of are still some way away from having the in-house capabilities performance moving forward so investors have to make to take on hedge fund investment programmes on their own; contingency plans; and hedge funds are the best choice. this is especially true of insurance companies who now find Michaël Malquarti is co-head of alternative investments at themselves needing to respond to Solvency II. Transparency Syz Asset Management. He comments: “Without wanting to is critical, not just in hedge fund allocations but across sound too dramatic, over a longer horizon the performance their entire investment portfolio, coupled with industrial of a balanced portfolio, not only in nominal terms but also strength reporting. in real terms, is likely to be lower than what we have gotten The best way to achieve this is via a managed account used to.” platform rather than relying on offshore funds. “The whole asset management industry has to realise that “We have a managed account platform (PMAP) and the we are coming to the end of a generation where bonds and transparency and preferential liquidity terms that we’ve equities enjoyed boosted returns. In that context, getting managed to achieve is something that institutions have really between 4 and 6 per cent by investing in hedge funds is bought in to. becoming increasingly attractive,” says Alexandre Rampa, “What we say to all of our clients is that we are vehicle co-head of alternative investments at Syz Asset Management, agnostic. The first objective is to understand what the adding: “We are more optimistic about investing in hedge client is trying to achieve by investing in hedge funds. The funds in 2015 than we have been for the last few years. A lot vehicle – whether it’s a commingled fund, a fund-of-one – is of markets are “toppish”. It’s difficult to call the end of the a secondary consideration,” says Clifford. rally but equally it’s difficult to see the US markets get much This increased focus among multi-managers to deliver higher than they are now. The environment is moving away customised, outcome-driven solutions to investors has made from one of holding long, in the wake of liquidity injections, a big difference to the way institutions view hedge funds. to one where it will favour stock pickers and thematic Moreover, the fact that managers are also paying heed to the allocators.” fact that they need to communicate more efficiently, and In conclusion, Lyxor’s Stenger believes that what is now regularly, is helping institutions to get a deeper feel for how emerging as a clear trend is one of hedge funds becoming these investments work. more mainstream: “If the hedge fund industry evolves its fee “It’s hard to generalise what today’s preferred route structure and offers new ways to access strategies, as a result should be. A might come to us and of regulation, there’s every reason to be optimistic on the say, “We want a systematic macro programme containing future growth of the asset class.” n

AlphaQ April 2015 www.AlphaQ.world | 7 Financial technology

EasyJet entrepreneurs…. Randeep Grewal looks at the phenomenon of the easyJet entrepreneur (other low cost airlines are available) and why start-ups are taking flight.

Dear, dear Europe, occasion and who continually surprises by Poor slow, dying decaying Europe, simply still being alive. What will the future bring? However I am beginning to wonder if reports A spiral of misery, of Europe’s death are greatly exaggerated; and Lacking the dynamism of America, (whisper this quietly) the spark of future growth Missing the growth of Asia, might be driven by the fundamental precepts of Will Europe soon be the forgotten continent? the European Union. Earlier this week I spent a day in Shoreditch t does not take much reading of the financial with a friend at his start-up – 30 staff and press, bank research or, heaven forbid, the profitability in a year. The day started in a local Iblogosphere, to come to the conclusion that café with a breakfast meeting with the back-end Europe is the continent destined to perpetual server team – approximately 16 people. Around misery. The ‘soon to be forgotten’ continent; the table were , Irish, Italians, Poles – the Dowager aunt who is invited to every family frankly nationalities from all across Europe.

AlphaQ April 2015 www.AlphaQ.world | 8 Financial technology

In fact the biggest complaint of my friend is “Young entrepreneurs, young the lack of heavy software engineering skills available in native Brits. Interestingly the ‘front- developers and young end’ team of user interface and graphics design companies, rather than allow was more heavily skewed with Brits. themselves to be restrained Later in the week I visited Level39, which is Europe’s biggest Fintech incubator (160 plus by local rules and regulations, start-ups and counting). I mentor or advise are simply getting on easyJet a number of companies there. And again the profusion of European nationalities is flights and flying to wherever astonishing. But not just European, a couple of regulations are easiest.” my favourite teams have members from India, Randeep Grewal Canada, New Zealand or Australia. And during the week I had dinner with the CEO of a UK Adtech start-up. The company also provide some of the mentoring that some has developers and data scientists in Poland, start-ups have lacked. Combine this with some Belarus and Spain (as well as the UK). entrepreneurs who have had successful exits It appears that young entrepreneurs, young and I am beginning to sense that over the next developers and young companies, rather than ten years more money will circulate within the allow themselves to be restrained by local rules start-up community in Europe. and regulations, are simply getting on easyJet1 Europe historically has had a glass half flights and flying to wherever regulations are empty attitude. However in a number of easiest to start up a business or to find developers. areas Europe, or at least parts of it, are Let me also let you in on a little secret: many becoming world leaders. For instance it is of these entrepreneurs and developers are as almost impossible to attend a start-up event in talented and as technically adept as equivalent London these days where crowd funding is not entrepreneurs and developers in Silicon Valley mentioned. Additionally various government or elsewhere. What they do sometimes lack is projects are also encouraging a ‘can-do’ attitude. experience or mentors/advisors with experience I have never met an entrepreneur who thought around them. But give them a chance and, in fund raising was easy; but having seen start- some cases, a couple of burnt fingers in their ups for rather a long time I am beginning to first and second start up and they are going to feel that the path to raising A and B rounds is be good – in fact extremely good. becoming more established in Europe. Their attitudes and understanding of Obviously the basic right of ‘freedom business has also changed. Call it the ‘ADD’ of movement’ was enshrined in the EU (‘Apprentice’ and ‘Dragons Den’) generation constitution. However, perhaps the true but many have started absorbing the concept genius of this ‘right’ is only now becoming of entrepreneurship, pitching and profit and obvious. What strikes me about these easyJet loss from an early age. The first episode of The entrepreneurs and developers is that they Apprentice aired on the BBC on 16 February are relaxed and comfortable in each other’s 2005, whilst Dragons’ Den premiered in the UK company. They are not economic refugees but on the BBC on 4 January 2005. The history rather talented people looking for the best place of Dragons’ Den is interesting – the original to do business. They are the dynamism that Japanese show (‘Manê no Tora’ (Money Tiger)) drives any society forward. only ran for three years (2001 – 2004) whilst Currently their favourite locations are in the UK it is in the vocabulary of many London, Berlin, Stockholm and Warsaw2. In teenagers. Indeed some schools run their own a bygone age the merchant entrepreneurs of Dragons’ Den competitions. the era would have travelled from London to Another issue always raised in Europe is the Birmingham or Manchester or the Yorkshire lack of funding for the critical A and B rounds mills. The present generation happily jump on – Europe seems to be able to fund seed rounds easyJet to pop to Barcelona or Milan or Croatia but there is often a gap after that. However I am for a few hours or a couple of days. seeing more and more US venture capitalists Furthermore several of the companies setting up shop in London. Perhaps this will have 24x7 pan-European chat rooms running

AlphaQ April 2015 www.AlphaQ.world | 9 Financial technology

on Skype via which they coordinate their aerospace industry without recognising Airbus teams. Interestingly it does not occur to many or Rolls Royce. of the entrepreneurs that they are building Though Tesla might be gaining the headlines, multinational companies on day one – indeed any analysis of the global industry has to include many have not known anything but the EU Volkswagen, Mercedes and BMW. But that is not for their whole adult lives and it does not all, the renaissance of the British motor industry even occur to them that they are jumping – with Rolls-Royce (owned by BMW), Bentley international borders, customs or regulations. (VW) and JLR (Jaguar Land-Rover – a unit of And increasingly every EU politician and Tata) shows that the revival is deeper than one every EU state will have to ask themselves might expect. More interesting in some ways are the simple question – ‘if growth depends on two of the ‘forgotten’ motor companies in Europe young entrepreneurs how do we change our – Renault with its alliance with Nissan, and Fiat regulations and environment to attract them?’ with its merger with Chrysler. The simplicity of the question belies Similar global champions and forgotten the implications. If you, as a country, or a global giants can be found in numerous other state/province or city, put up cumbersome industries in Europe. The new Apple watch restrictions and regulations the entrepreneurs may be getting attention – but this is perhaps will simply jump on a plane and go to London a reminder that the European (mainly Swiss) or Berlin or elsewhere in the EU. Frankly, the watch industry has dominated the luxury watch implication gives me great hope for the future. segment for decades. In technology Silicon An entrepreneur or a developer moving, for Valley might get attention but most phones are example from a southern European country to powered by chips from ARM, and contain chips London, even if for a few years before returning from a variety of other European companies. In home, is also important for the social attitudes business software one has to assume that SAP he takes back home. If he has been able to may just possibly have been doing something start a business without red tape or hindrance right to become the global giant it is. in London he is surely going to challenge why Travel on any low cost airline (or ‘peanut he cannot do the same in Milan, or Athens or airline’ as they used to be called) across Europe Barcelona. And the movement of entrepreneurs during a weekday and you will see people in is indeed in both directions. A few years ago business attire flying to meetings. Numerous I met a young Spanish entrepreneur who was supply chains across Europe are not restricted using his apartment in London as the base of a to national boundaries. These supply chains start-up. An enthusiastic team of half a dozen include those linked to the capital markets. A were busy poring over their screens in the Spanish entrepreneur can as easily hire a Swiss lounge. More recently he has moved back to bank in London to raise money from German Spain – will he tolerate local regulations that investors as from local sources of capital. stop him there? Meeting both listed and unlisted businesses, The unlisted start-up sector is possibly a it has become increasingly clear over the ‘canary’ that is reflecting what is happening last few years that more and more European more generally in European commerce. companies have a changing attitude – and are A decade ago if I wanted to meet smaller gaining the dynamism and attitude that drives listed companies in Europe I would struggle. prosperity. Part of this is simply by travelling, Sometimes I would meet companies that had and being exposed to investors across Europe not met non-local investors for a period of time. (and indeed the US), companies are becoming On one memorable occasion I met a company Footnotes: more savvy. But also hiring staff from across (a leader in its field across Europe) that had not 1. Other low cost airlines Europe changes attitudes within companies. are also available but met ANY investor for five years. easyJet appears to be the The job of an investor is to appreciate these Now however listed businesses are also more Entrepreneur’s choice. opportunities early and invest as the attitude 2. There are also a confident to undertake roadshows in London, number of other ‘hot’ change leads to increased dynamism, growth Frankfurt, , Madrid or Stockholm. And locations but some of the and prosperity. The macro environment companies that I speak the engineering first (as opposed to marketing- to regularly are keen that dominates the headlines but an attitude change led) approach of many European companies I do not give away their is a once in a generation opportunity to find favourite places to find has created some global champions. For highly skilled technical investment opportunities… instance it is impossible to consider the global staff. … and long live peanut airlines. n

AlphaQ April 2015 www.AlphaQ.world | 10 Financial Tec hnology

The rise and rise of Fintech Beverly Chandler reports on Accenture’s latest annual survey on this fast growing sector.

entures based in the financial technology year, Fintech investment increased at more sector (Fintech) saw huge growth than three times the rate of overall venture Vglobally over 2014, according to a new capital investment. survey from Accenture entitled The Future of The US dominates the Fintech universe but Fintech and Banking. Europe experienced the highest growth rate, Global investment in Fintech ventures tripled with an increase of 215 per cent to USD1.48 from USD4.05 billion in 2013 to USD12.2 billion billion in 2014. The UK and Ireland accounted in 2014, with Europe being the fastest growing for more than 42 per cent of the European total, region in the world. The report found that last as investment in the region rose from USD264

AlphaQ April 2015 www.AlphaQ.world | 11 Financial Tec hnology

million in 2013 to USD623 million areas for growth. Within the next two in 2014. years, 32 per cent say their banks will In the rest of Europe, the regions create a corporate venture arm. that experienced the most significant The report shows that banks are levels of investment in 2014 were the also open to collaboration with their Nordic countries at USD345 million, peers and with organisations outside the Netherlands at USD306 million and of their industry, to more effectively Germany at USD82 million. adopt innovative technologies, with “The massive investment in Fintech all survey respondents saying they are shows that the digital revolution is well willing to do so. Furthermore, 60 per advanced in financial services, and it cent of respondents say they are open is both a threat and an opportunity for to sacrificing current revenue in order banks,” says Julian Skan, Accenture to move to new business models. managing director overseeing the The Accenture report was launched FinTech Innovation Lab London. at the FinTech Innovation Lab “Fintech is empowering new London, established by Accenture competitors and start-ups to move in 2012, which is a collaboration into parts of the banking business but, “The massive investment between Accenture and financial paradoxically, it is also helping banks in Fintech shows that institutions, and is supported by the to create better, more convenient Mayor of London, the City of London products and services for their the digital revolution Corporation and Innovate UK. clients. It is also leading to increased is well advanced in It is designed to nurture early-stage cooperation between traditional financial services, and it companies from the UK, Europe and banks and innovative start-ups and elsewhere that are developing new technology businesses in a way that is both a threat and an technologies for the financial services can result in totally new business opportunity for banks.” sector. Since the launch of the FinTech models and revenue streams.” Innovation Lab London, the 14 Julian Skan, Accenture More worrying is the finding that companies that have passed through many banks are not dealing with the programme have raised more than the Fintech revolution head on. The USD35 million in new investment, survey found that of 25 senior banking Of the banking executives signed nearly 50 contracts to do executives involved in technology interviewed, 44 per claimed that business with banks and increased innovation, 72 per cent of the their banks did not invest enough in revenues by 170 per cent. respondents felt their banks have a innovative technologies, and while all The 2015 Lab participants are: fragmented or opportunistic approach to of the respondents believed that legacy Atsora, Cytora, Duco, Pontus Networks, dealing with digital innovation, and 40 technology presents an issue to their Ripjar, Torusware, and xWare42. Their per cent thought the time it took their organisations, only half said their bank innovations include a web-based organisation to deploy new technology had a strategic approach to replacing programme for real time geopolitical is too slow, either negatively impacting its old technology. risk assessment, solutions that help their ability to realise value or providing However, looking forward three- small business owners manage their no net benefit at all. fifths of survey respondents believed finances, and faster data exchange and The vast majority also believed that that banks and new competitors will reconciliation technologies. they lack the skills and culture needed coexist by providing differentiated The FinTech Innovation Lab London to succeed in the digital age. Among offerings, or the established banks will is modelled on a similar programme respondents, four out of five said that acquire the new players. that was co-founded by Accenture and when it came to skills and culture, A majority of respondents (72 per the Partnership Fund for New York their banks are only “somewhat” or cent) expected their banks to increase City in 2010. The Partnership Fund for “minimally” equipped for the digital age. investment in technology innovation is the USD110 million In addition, although 80 per cent see over the next two years. Some 56 per investment arm of the Partnership working with start-ups as a valuable way cent said their banks would explore for New York City (www.pfnyc.org). to bring new ideas to their business, 56 open innovation, such as opening up In 2014, Accenture also launched the per cent claim that their organisational their intellectual property, assets and FinTech Innovation Lab Asia-Pacific in cultures need to change in order to expertise to outside innovators to help Hong Kong and the FinTech Innovation work effectively with start-ups. generate new ideas and discover new Lab Dublin in Ireland. n

AlphaQ April 2015 www.AlphaQ.world | 12 Real estate Backing bricks & mortar Clearbell’s Manish Chande tells Beverly Chandler why commercial property funds are currently proving attractive to institutional investors around the world.

he recent launch of a UK centric real estate fund from Clearbell Capital LLP saw it reach its hard cap and Tbe oversubscribed, raising a total of GPB400 million in equity plus GBP100 million in co-invest. Manish Chande, senior partner at Clearbell Capital LLP, explains that the investors were mostly pension funds, endowments and high net worth individuals attracted by Clearbell’s gross target rate of return of 18 to 20 per cent and 1.8 x to 2 x multiple. Apart from the demand, Chande reports that the other interesting thing about the launch was the spread of investors who came in from the US, Australia, South Africa, mainland Europe, as well as the UK. Clearbell’s recent experience simply highlights a new phenomenon – institutional investors globally are focusing on real estate at the moment. Chande says: “It’s mainly because institutional investors are quite picky about where they invest, so as a result they generally favour experienced fund managers with a long track record.” He also feels that investors have more capital to commit because they are beginning to see distributions come through from earlier funds now that many of the problems caused by the financial crisis have been absorbed. Low interest rates and low returns from other asset classes makes real estate an attractive investment class as well, Chande says. Other drivers come from quirky events which have caused change, such as regulation change. The requirement “Institutional investors are quite for Australian workers to put aside more of their income into their pensions has meant the Aussie superannuation funds picky about where they invest, so are flush with capital. as a result they generally favour There has also been a wider dispersion of investor groups than before. “You are getting in a much wider, diverse base experienced fund managers with a of investors than before,” says Chande. Formerly the US long track record.” dominated but Asia-Pacific investors are now arriving at Manish Chande, Clearbell the table. Real estate is also benefiting from the drop in returns from hedge funds over the last few years as investors realise personal service, Chande feels, which is crucial for investors that real estate returns have been improving. who don’t have the expertise to source and manage real “Also, fund managers are offering more products and estate investments. are more flexible in the products they offer” Chande He has also observed that pension fund investors have to says. “There are not just closed-end funds but also make up the shortfall from previous years around the global separate accounts, or co-investment alongside other fund financial crisis so they are prepared to look a little further commitments and that has attracted more investors as well.” up the risk curve. “Real estate is a good way of doing that,” Fund managers provide investors with a decent and says Chande. n

AlphaQ April 2015 www.AlphaQ.world | 13 Hedge funds Hedge fund outlook Barclays Strategic Consulting team reports on the outlook for global hedge funds, based on investor sentiment.

he hedge fund industry, in general, has had a difficult Investor trends – planned changes to hedge fund few years since the financial crisis. Performance allocations Thas been challenging, assets are harder to raise and In order to get an understanding of investors’ sentiment retain, and the regulatory bar continues to rise. Additionally, toward hedge funds in the coming year, we asked them investors are more sophisticated and, as a result, more how they planned to adjust their hedge fund allocation as a demanding. percentage of their portfolios in the coming year. As can be The Barclays Strategic Consulting team published in seen in Figure 1, while the overall sentiment toward hedge February an annual Outlook report, entitled What Lies funds remains bullish (2.5x more investors are looking to Beneath, that analysed major developments in the hedge grow allocations than the ones looking to reduce them), fund industry to assess the evolving value proposition of there is definitely some cooling off of sentiment toward hedge funds, key investor themes, and the asset raising hedge funds, since this ratio was 6.5x in our 2013 survey and landscape for 2015. 5x in 2012. The following excerpt looks at the investor allocation When looking at investor responses by investor channel preferences / outlook aspect of this content piece. in Figure 1, there seems to be a consensus around keeping The analysis is based off a survey of ~450 investors with allocations largely the same, as only Family Offices and ~USD6 trillion in total AUM, as well as in-depth, one-on- Private Banks in our sample indicated they might make a one interviews with ~30 investors. In total these investors meaningful change in their allocations – this suggests that represent about USD1 trillion in hedge fund AUM, or about 2015 may be a year of keeping the ‘status quo’ on hedge a third of the hedge fund industry. Nearly half (46 per fund allocations. Insurance companies appear to be the least cent) of the investors were institutional, i.e., Pensions, motivated to change current allocation levels. Endowments & Foundations (E&Fs), Insurance Companies, Sovereign Wealth Funds (SWFs), and their investment Investors’ hedge fund strategy preferences consultants / advisors. Just over one-quarter (26 per cent) of We asked the investors in our sample to tell us which hedge the sample consisted of Fund of Hedge Funds (FoHFs), and fund strategies they planned to grow, reduce or hold their the remainder (28 per cent) were private investors (Family allocations steady to. Figure 2 shows the list of strategies that Offices and Private Banks / Wealth Managers). appear to be the most in favour based on the net difference

Figure 1: Investor trends – 2015 planned changes to HF allocations by investor type

Private Private Public Family E&F Insurance Average bank pension pension office 2015 2014

Increase >5% 3% 3% 10% 6% 6%

31% 45% Increase 3-5% 9% 6% 8% 7% 7% plan to plan to increase increase Increase 0-2% 50% 20% 29% 16% 9% 17% 18%

Stay the same 50% 57% 49% 51% 63% 83% 56% ~2.5X ~6.5X

Decrease 0-2% 9% 14% 7% 13% 9% 13% 7% plan to plan to Decrease 3-5% 7% 2% 3% decrease decrease

Decrease >5% 3% 1% 1%

Source: All figures refer to Barclays Strategic Consulting survey results only

AlphaQ April 2015 www.AlphaQ.world | 14 Hedge funds

Macro, suggesting some investors are inclined to believe they Figure 2: Investors’ HF strategy preferences

are over-allocated to them. Decrease Increase Net Inc. / Dec. Figure 3 shows a list of hedge fund strategies that Event Driven - Equity -5% 23% 18% are likely to see relatively less support in 2015 from the -7% 25% 18% investors in our sample. That said, Credit – Long / Short, Equity Low Net / Mkt Neutral -3% 19% 16% Credit – Distressed and Equity Sector-focused strategies

Highest Investor Interest Event Driven - Activism -4% 18% 14% all seem to have a significant percentage of allocators looking to grow allocations (16 per cent+). Similarly, when Multi-Strategy -9% 22% 13% looking across the broad investor categories, there were two Equity Long/Short -9% 22% 13% strategies where there is some misalignment: Structured Systematic - CTAs -3% 16% 13% Credit is much more in favour with institutional investors

Emerging Markets -3% 15% 12% while Equity Sector-focused is much more in favour with private investors. From another lens, it appears the larger Event Driven - Credit -5% 17% 12% investors in our sample (>USD3 billion in hedge fund AUM) Credit – Direct lending -5% 16% 11% are more bullish on Managed Futures, Quant Equities, and Fixed Income Relative Value -3% 14% 11% Quant Macro than smaller investors (not shown), likely due to benefits of these strategies as diversifiers. Source: All figures refer to Barclays Strategic Consulting survey results only

Figure 3: Investors’ HF strategy preferences Projected 2015 flows by investor type Decrease Increase Net Inc/Dec The Strategic Consulting Market Model, which is based on

Credit – Long/Short -8% 18% 10% all the inputs described so far in this study, suggests that in

Equity Sector-focused -6% 16% 10% 2015 the HF industry will receive ~USD40 billion in net new

Credit – Distressed -8% 17% 9% flows, with a range of USD20 – USD60 billion (Figure 4). Our

Systematic - Volatility Trading -2% 10% 8% estimate for net new flows in 2015 is about 50 per cent less than the 2014 flows of ~USD76.4 billion*. The USD40 billion Systematic - Managed Futures -3% 11% 8% estimate is ~1 per cent of 2014YE AUM, which means that Tail-Risk Protection 0% 6% 6% this would be the lowest level of net flows into the hedge Credit – Structured -7% 12% 5% fund industry since 2009. Systematic - Quant. Macro -3% 7% 4% We anticipate institutional investors, primarily pensions, Systematic - Quant. Equities -3% 7% 4% will be responsible for ~55 per cent of the industry’s net Commodity -6% 9% 3% flows in 2015. The balance (USD18 billion) is expected to Equity Short-biased -2% 4% 2% come from private investors, led by Private Banks / HNW Credit – Convertible -2% 4% 2%

Lowest investor interest individuals. Notably, we expect that the largest inflows will Equity Long-biased -12% 13% 1% come from Private Banks / HNW – making this year the first Source: All figures refer to Barclays Strategic Consulting survey results only since before the financial crisis in which pensions have not been the largest source of net new money into the industry. (for each strategy) between the percentage of investors planning to grow allocations and those looking to reduce Projected 2015 ‘money-in-play’ by HF strategy them. Event Driven – Equity, Global Macro, and Equity Low Although our projections for net flows in 2015 are lower Net / are the three strategies that seem to than net flows in 2014, there is still a significant opportunity have the strongest investor interest. These strategies were available to hedge fund managers to grow their asset base. at or near the top of the list based on investor sentiment in This is due to our expectation, consistent with previous 2014 as well and have more interest in 2015 from private years, that most of the asset raising opportunity in 2015 is investors than from institutional investors (not shown). likely to continue to emanate from reallocation of assets Additionally, private investors are more bullish across from one manager to another versus new flows into the all strategies on this page than institutional investors. Only industry. Direct Lending and Fixed Income Relative Value had more Figure 5 shows our projection of the total ‘money-in- interest from institutional investors than from private play’ (e.g., the total asset pool available to hedge fund investors (not shown). Finally, although all these strategies managers looking to grow their AUM) of USD400 billion, appear to have a relatively high level of net interest, of which USD360 billion (~90 per cent) is likely to come there are three strategies in Figure 2 where a significant from reallocations. This is higher than our 2014 projected percentage of investors are looking to reduce allocations. reallocations of USD285 billion and the main driver for the These happen to be the three that are the most broad-based increase is an uptick in projected annual investor portfolio on this page – Multi-strategy, Equity Long / Short and Global turnover (from 11 per cent to 13 per cent). Figure 5 also *Source: Hedge Fund Research

AlphaQ April 2015 www.AlphaQ.world | 15 Hedge funds

Figure 4: Projected 2015 flows by investor type

Net Flows (’07 – ’15E)1 2015 Expected Flows by Investor Type ($bn)

Private Bank / Public Pension 195 Private Pension HNW2 / SWF

15 11 12 9 10 7 76 71 6 64 6 55 60 34 40 20 Family Office E&F Insurance

-131 8 7 -154 6 5 4 2007 2008 2009 2010 2011 2012 2013 2014 2015E 3 2 0 % of Prior 13% -8% -9% 3% 4% 2% 3% 3% 1% Yr HF AUM Source: Projections are based on Barclays Strategic Consulting 2014 Market Sizing Model ; 1. Historical data is from HFR ; 2. Private Bank/HNW includes prop capital from HF managers 3. According to HFR

Figure 5: Projected 2015 ‘money-in-play’ by HF strategy

Projected ‘Money In Play’1 by Investor Type ($bn)

Average Equity Hedge Event Driven Multi-strategy 40 400 ~160 14 140 360 125 ~120 ~70 7 50 ~60 53 7 60 43 ~50 ~40

Reallocated New Total Reallocated New Total Reallocated New Total Reallocated New Total ‘In Play’ ‘In Play’ ‘In Play’ ‘In Play’

Global Macro Credit Fixed Income RV Systematic / CTA / Volatility

~75 ~55 61 4 65 40 5 45 ~55 18 2 20 ~25 19 1 20 ~25 ~35 ~15 ~15 Reallocated New Total Reallocated New Total Reallocated New Total Reallocated New Total ‘In Play’ ‘In Play’ ‘In Play’ ‘In Play’

Source: Barclays Strategic Consulting 2014 Market Sizing Model ; 1. The strategy flow projection model was based on variables the team took into account including the sample’s responses towards 2014 allocation / strategy preferences, estimated turnover, overall strategy breakdown and total industry HF Assets

shows how the total ‘money-in-play’ is Global Macro for its diversification The Barclays Strategic Consulting likely to be distributed by hedge fund benefits. team develops industry-leading strategy, based on the sub-strategy • Credit, FIRV, and systematic content, driven by primary analysis, level investor preferences described strategies should be prepared to on the HF industry and its participants earlier. Some highlights: fight for reallocations (~USD7 billion (e.g., HF and FoHF managers, • Equity Hedge is expected to receive in cumulative new flows). In this institutional investors, investment USD14 billion or 35 per cent of net last category, CTAs are likely to see consultants). It also provides flows, compared to 63 per cent in renewed investor interest due to management consulting services to HFs 2014. their recent strong performance. and asset managers on business topics • Event Driven and Multi-strategy are Across all of the strategies, those with such as the launch of a new strategy, projected to receive USD7 billion a fundamental approach appear to marketing effectiveness, product each in new flows. be more in favour than those with a development and organisational • Investors are still interested in systematic approach. efficiency. n

AlphaQ April 2015 www.AlphaQ.world | 16 Insurance Plausible alternatives Declan Canavan, JP Morgan Asset Management, describes how insurance companies generate higher returns from different types of alternatives during this period of low yields.

s bond yields remain at record lows, How much is enough? more and more insurance companies Historically, a relatively small investment in Aare considering how to change their alternatives has had a disproportionate effect investment allocations to improve general on insurance portfolio returns. Regulation account returns. Constrained by fiduciary duties and the industry’s fiduciary responsibilities and strict regulation, insurers have to find have combined to concentrate insurance ways to boost portfolio returns without taking investments in the least volatile and most liquid on significantly more beta exposure or risk. asset classes. So an incremental allocation to Alternative investments seem in many respects illiquid assets like alternatives may consume an to constitute, for lack of a better term, the best outsized portion of an insurer’s total adjusted alternative for insurance portfolios today. capital – capital available to cover unexpected Alternatives have the potential to deliver Declan Canavan, losses – but it can also deliver comparably large idiosyncratic alpha in an environment where managing director and diversification benefits and a hefty premium for the outlook for traditional asset classes is client portfolio manager liquidity. for alternatives EMEA uninspiring. Indeed, the increased interest at JP Morgan Asset A business argument reinforces the logical in asset classes such as infrastructure debt Management argument of complementing a liquid portfolio and private credit by insurance companies is core with an allocation to illiquid alternatives. testament to this hunt for yield, despite the Many alternative investments generate much fact that investing in such asset classes requires of their alpha over lengthy holding periods. greater scrutiny and analysis – evidently an With their long-dated liabilities, life insurers exercise insurance companies are willing to in particular have an institutional capacity for undertake. the patience required for an investment of that A few reasons why insurance companies nature to pay off. The long view gives them the might want to consider reassessing their flexibility to rebalance alternatives distributions alternative allocations include: according to market conditions, creating a • Much of alternatives’ return derives steady source of value over time. Moreover, by from their liquidity premium. Insurance consistently investing surplus premium income companies, with their relatively predictable through rising and volatile markets, alternatives’ cash flows and generally ample liquid good years can offset weaker years. reserves, are well positioned to earn it; • A small allocation to alternatives can deliver The trade-off: liquidity in the balance large diversification benefits to portfolios Liquidity is the public insurance company’s heavily concentrated in traditional fixed proverbial double-edged sword. For the income. policyholder, the risk lies in not having enough. Capitalising on alternatives’ potential, however, The opportunity cost of excess liquidity is demands a recognition of alpha’s constantly potential portfolio returns foregone from not evolving nature and disciplined due diligence investing in illiquid higher returning assets. that identifies those managers most skilled at Following the credit crisis, the balance of capturing it. Consistently and patiently applied, liquidity shifted toward policyholders. Life such due diligence can drive returns well above insurers and Property & Casualty companies a company’s cost of capital. Less rigorously (P&C) have provisioned in excess of the most executed, it can expose the insurance investor extreme annuity redemptions and catastrophic to the underperformance always implicit in the losses in recent history. The Geneva pursuit of high alpha. Association, an industry think tank, reports

AlphaQ April 2015 www.AlphaQ.world | 17 Insurance

that life insurers remained cash flow positive despite the Figure 1: Expected long term dispersion of surrenders caused by the financial crisis. manager returns

Likewise, the stresses of the hurricane year of 2005, 25% 25th %ile and 2013, in the aftermath of Superstorm Sandy, did not Median 20% 75th %ile challenge robust P&C liquidity. Even as they maintain 2015 Equilibrium Assumption 15% this liquidity cushion, however, a persistent low yield 10% environment challenges public companies to preserve their 7.75% 6.00% 6.00% dividend, and a rallying raises expectations 5% 5.25% 4.50% 4.75% 5.00% that they will increase it. 0%

-5% Caveat venator: hunter beware The compelling potential of alternative investments for the -10% Equity Event Diversified Macro Relative PE/ US real hedged driven value estate insurance investor comes packaged with a warning label; the Source: JP Morgan Asset Management . HF manager returns are taken from Bloomberg as of potential is compelling only for the top managers. Indeed, Sep 17 2014. PE and Real Estate historical quartile returns are taken from Cambridge Associates data as of March 31 2014 effective alternative investing adds a fourth leg to the classic strategic triangle. Besides the three basics of sound traditional investing – formulating a coherent strategy, diversifying Figure 2: 2006-2012 performance effectively through the business cycle and rebalancing by fund size rigorously – adding alternative assets to an insurance portfolio Dispersion between top and bottom quartiles 1,250 bps 1,030 bps 870 bps 590 bps requires access to the top managers. Conventional wisdom 20% First Quartile Median Third Quartile holds that the supply of attractive deals is the limiting 18% 17.2% 16.9% dynamic in alternative investing. Contrary to this we have 16% 16.2% 14% found that the supply of capable managers is a more relevant 12.9% 12% 12.0% 11.0% factor. A vibrant economy will always generate attractive 10% 10.0% 9.3% deals, and their sources will always vary. The ability to hunt 8% 7.5% 7.0% 6% 6.6% down these attractive deals and the foresight to recognise 4.7% 4% them will always be the scarce resource. 2% In other words, manager selection when allocating to 0% Lower/middle Middle market Upper middle Mega funds alternatives is critical because the dispersion between top market market Source: TA Associates and Preqin Performance Analyst as of 12/31/2014. Represents North and bottom quartile managers in alternatives is significantly American and European buyout, growth and turnaround funds. Lower / middle market is defined as $500 million or less; middle market defined as $500 - $2,000 million; upper middle market more pronounced than public markets. Figure 1 shows the defined as $2,000-$5,000 million; mega funds defined as $5,000+ million spread of returns between top and bottom performers across various hedge fund styles, private equity and US real estate as compared to the tight spread of returns in US long only equity • Manager selection is always important but even more so funds. In some instances, returns between top performing and at the small/mid end of the market where there is less worst performing managers differ by as much as 20 per cent, transparency and less public data; making median performance less important than individual • Sub-optimal manager selection will over the long run track records and underscoring the importance of state of the erode the portfolio benefits of allocation to alternatives; art due diligence. • For insurance companies who do not have the primary in-house research and due diligence expertise in investing Private equity: a tale of dispersion in PE, a strategic partner to screen the available manager Looking more closely at private equity investing, we universe is critically important. can see not only that there is a wide dispersion between managers but also depending on the market segment there is The right fit identifiable dispersion trends. The upside of alternative investment is clear, but it calls for As we can see from Figure 2 (looking at vintage years careful attention to the downside. Alpha itself is transient, from 2006-2012) the average return of lower/middle market and its pursuit calls for superior manager skills and acute private equity funds has generated higher average returns investor vigilance. Capturing it consistently demands insight than upper middle market funds. However, the lower market and flexibility. Insurers have the resources to identify funds exhibit greater return dispersion and have significantly and retain the top talent and the scale to spread their more adverse manager selection risk. positions effectively across the spectrum of alternatives. The implications for PE investors are clear: With discipline and methodical persistence in finding and • Investment objectives in terms of return and risk tolerance monitoring their investment partners, they can make the should be clearly mapped to market segment at the outset; most of their allocations. n

AlphaQ April 2015 www.AlphaQ.world | 18 China China A-Shares: Too big to ignore Tim Nash, founding director of Access China, examines why Chinese A-Shares are simply too big an opportunity to miss.

n November last year, the Shanghai Stock Exchange opened up to foreign retail investors for the first time, Icreating an opportunity for fund managers that Goldman Sachs called ‘simply too big to ignore’. With nearly 1000 listings in Shanghai and over 1600 listings in Hong Kong, the two stock exchanges individually rank sixth and seventh globally. However, the historic connection made between them on 17 November 2014 has effectively created a mega-bourse that is second only to New York in terms of market capitalisation. Whilst stocks on Hong Kong’s exchange (H-shares) have always been available to global investors, stocks denominated in Chinese yuan (CNY) on the exchanges in Shanghai and Shenzhen (A-shares) had been restricted to mainland Chinese citizens and a limited number of ‘Qualified Foreign Institutional Investors.’ The Shanghai- Hong Kong Stock Connect programme has now created a ‘through train’ that allows retail investors to buy A-shares through Hong Kong, and vice versa. Tim Nash There is clearly a considerable way still to go. For now, there is a cap on purchases of A-shares through Hong Kong of CNY13 billion per day and CNY300 billion in total , and Opportunities corresponding limits on purchases of H-Shares through Yet, despite such short-term swings, there are good reasons Shanghai of CNY250 billion in total and CNY10.5 billion to be positive about the outlook over the mid to long-term. per day. So far, only 70 per cent of the companies listed in “These swings offer interesting opportunities for fundamental Shanghai and 15 per cent of those listed in Hong Kong have stock pickers to buy companies with solid fundamentals been approved for the programme. And, until the Chinese that have been indiscriminately sold off,” says Dale Nicholls, markets are included in global indices like the FTSE, portfolio manager of the Fidelity Special Situations Fund. A-shares will not be an option for funds like global index “Looking forward, the development of domestic mutual trackers and global actives which use those indices as a funds and increased foreign investor buying, as the benchmark. Chinese government introduces more reform to open up This is not a short-term opportunity. As Michael Liang, its capital markets, will mean higher participation in the chief investment officer of Foundation Asset Management, A-share market.” puts it: “People should not expect to make a killing A-shares are already the largest component of China’s overnight.” The young market is notoriously volatile: equity market. They have historically outperformed northbound traffic through Hong Kong to Shanghai hit the H-shares, and since the start of 2014 they have seen an daily cap when Connect launched, but dropped to CNY2.6 overall increase of 37 per cent. billion two days later. The last month has seen both the Chinese wealth per capita is expected to double over the biggest fall in the A-shares market since 2009 – a drop of 5.4 next ten years and its economic growth rate has settled at a per cent in a single day – and a 3 year record, with a 15 per sustainable 7-8 per cent which is almost unrivalled by any cent gain in just ten days. other market. Shanghai listings already include household

AlphaQ April 2015 www.AlphaQ.world | 19 China

developed markets, and Chinese companies have had to adjust to lowering rates of national economic growth over the last couple of years. Only about 6 per cent of the companies listed in Hong Kong are foreign. The vast majority are businesses incorporated in either mainland China or Hong Kong in roughly equal measure. Many of the companies listed in Shanghai are also listed in Hong Kong but A-shares and H-shares rarely trade at the same level, so Connect provides opportunities for arbitrage. The Chinese markets have rallied since mid- November, but not because of large new inflows of capital through the Connect programme. The increase in investors’ appetite for risk is a result of: the Central Government taking steps to address issues around property and local government debt recalls; and the Central Bank injecting liquidity into the economic system. In other words, the real value of A-shares lies not in any immediate activity (or lack of it) in the market, but rather in the broader trajectory of the Chinese economy. In that context, Ronald Wan, managing director at China Merchants Securities, says that the Connect programme is: “A key step in the government’s plan to reform the country’s capital market and financial system, and a crucial part of China’s broader and structural economic reform.” names like Ping An Insurance, China Merchants Shanghai Stock For 2015, Ke says: “We anticipate the Bank, and Industrial and Commercial Bank of Exchange operational costs of Chinese companies to come China. A-shares offer investors an opportunity down and their profitability to increase as the to acquire a stake in companies like these Central Bank makes several more interest rate that have exceptional medium to long-term cuts and the price of oil and other commodities prospects. falls. In addition, the economic slowdown is Winston Ke, manager of Baring’s China putting pressure on smaller players, presenting Asia Fund, points out that foreign investments leading firms with an opportunity to grow their in China have so far been concentrated market share.” on a handful of targets such as the Daqin Many of the A-share companies are State- Railway (a 650 mile link between China’s Owned Enterprises (SOEs), which according to leading coal mining centre, the Capital City HSBC have a high average debt to asset ratio of and North China’s largest port) and Guizhou 65%. The continued reforms and privatisation Maotai (producers of the distilled liquor that of SOEs are thus expected to have a positive China uses at state occasions). “This reflects impact on the value of the Chinese markets. foreign investors’ limited understanding of the Now is a time for stocktaking with a view to China-Asia market,” Ke says. Vast numbers of longer term returns. As Mona Shah, Portfolio attractive stocks remain to be discovered as Manager at Rathbone Multi-Asset Portfolios, that understanding develops. concludes: “A combination of China’s out of Furthermore, A-shares are now the cheapest favour status and willingness to drive an open they’ve been since the 2008 financial crisis. economy could make this an interesting entry The low valuations are a result of China shares point for those with a long-term investment historically underperforming compared to more horizon and a stronger appetite for risk.” n

AlphaQ April 2015 www.AlphaQ.world | 20 Secondaries Challenging the illiquidity myth Preqin recently surveyed over 50 managers of dedicated secondaries assets to find out about their activity in 2014 and to assess their outlook for 2015. Patrick Adefuye analyses the key findings from these results.

014 was not only a record year for Patrick Adefuye, secondaries transaction volume, but has manager – funds of funds & secondaries also been recognised as a record year for 2 at Preqin secondaries fundraising; an aggregate USD29 billion was secured by the 27 secondaries funds that reached a final close during the year, the highest ever annual amount of capital secured. As a result, two-thirds of secondary managers surveyed expect to deploy more capital in the asset class in 2015 compared to the previous year (see Figure 1). A further 27 per cent indicated that they expected to maintain their level of spend in 2015.

Pricing It is clear that the secondary market is awash with capital, from the managers of secondaries funds, fund of funds vehicles with allocations gaining exposure to it. Inevitably, pricing is to the secondary market and opportunistic impacted by this strong demand for funds on institutional investors that are capable of the secondary market. Survey respondents indicated that the average price paid for buyout funds purchased on the secondary market was Figure 1: Expectations for the amount of capital to be 90 per cent of NAV, although this can be as low deployed in the secondary market in 2015 compared as 70 per cent of NAV for mature assets. to 2014 In 2015, 45 per cent of respondents indicated that they expect the price paid for 6% buyout funds on the secondary market to More capital in 2015 increase (discount to narrow), while 48 per compared to 2014 cent expect it to remain the same. Given the 27% expected increase in spend from the majority Same amount of capital of respondents, strong pricing does not appear in 2015 as in 2014 to be deterring buyers. Not only is there capital available to pay more (on a dollar basis, as 67% Less capital in 2015 well as on a percentage to NAV basis given compared to 2014 that NAVs are also rising), there is also the willingness to do so, as the sentiment towards private equity and particularly buyout funds is positive given the strong environment for exits Source: Preqin Secondary Fund Manager Survey, February 2015 and distributions.

AlphaQ April 2015 www.AlphaQ.world | 21 Secondaries

Secondary market sellers Figure 2: Managers of secondaries funds’ Managers of secondaries funds were asked expectations for the amount of debt usage in the secondary market in 2015 to indicate which groups of investors would be selling funds in 2015, with pension funds cited by 42 per cent of respondents, as shown 0% in Figure 2. Pension funds have become Increase in debt usage in 2015 compared to 2014 increasingly comfortable using the secondary 34% market in recent years in order to achieve their desired portfolios. Banks and insurance Same amount of debt usage in 2015 as in 2014 companies (cited by 36 per cent and 29 per cent of respondents respectively) are also expected to be prominent sellers in the year ahead, both for 66% Decrease in debt usage in 2015 compared to 2014 regulatory reasons. Preqin’s research team is in daily contact with institutional investors in order to identify new sellers and update the investment plans of existing investors. Sellers are classified into two groups: Source: Preqin Secondary Fund Manager Survey, February 2015 • Likely and opportunistic sellers that have pro-actively begun a process to sell funds Figure 3: Breakdown of likely and opportunistic secondary market sellers’ portfolios by vintage year or are generally open to approaches from buyers (and frequently have sold stakes 45% 41% before) and; 40% • Possible sellers, which are investors that are 35% either over-allocated to a particular asset 30% class and could consider the secondary market to rectify this, or investors that have 25% put new investments on hold and therefore 20% 19% 17% 16% may be reviewing one or more of their 15% manager relationships. Proportion of funds 10% Analysis of the portfolios (specifically private 6% 5% equity) of likely and opportunistic sellers show 2% interesting results that further illustrate their 0% Pre-1997 1997-2000 2001-2004 2005-2008 2009-2012 Post-2012 motivations for considering the secondary Vintage year market. Figure 3 shows the vintage year spread of the portfolios of likely and opportunistic Source: Preqin Secondary Market Monitor sellers profiled on Secondary Market Monitor Leverage and shows that these investors are most One concern regarding the higher prices being exposed to funds that are 7-10 years old, paid for assets is the impact this may have on accounting for 41 per cent of all funds held by returns and that returns for assets bought on these investors. the secondary market in this current climate Funds of vintage years 2005-2008 are are likely to be lower than previous years. considered the sweet spot for most secondary Anecdotally, it appears that secondary market buyers, as funds of this age are typically at buyers have turned increasingly to leverage to their realisation phase returning capital to improve returns. investors. Interestingly, likely and opportunistic While the majority of fund managers that we sellers have significant exposure to funds spoke to did not use debt for acquiring funds (81 that are 10 years old or more, representing per cent) or in funding a drawdown (89 per cent) 38 per cent of funds held by these investors in 2014, debt is likely to play a bigger part in the and therefore, in most cases, past their pre- secondary market in 2015. Thirty-four percent agreed life-time. Collectively, these funds have of respondents expect debt usage to increase in a total of over USD100 billion in remaining, 2015, while the remaining 66 per cent predict it unrealised value. n will remain the same. No respondents expect the This is an extract from the Preqin Private level of debt usage to decrease in the coming year. Equity Spotlight, March 2015.

AlphaQ April 2015 www.AlphaQ.world | 22 Private equity Bridging the gap Michael Riak, head of US defined contribution at Pantheon Ventures, reports on the US retirement crisis and how private equity can bridge the gap.

uch has been written on Research2 published recently by the issue that Americans Pantheon’s Quantitative Research Mare not saving enough for Team into this topic found that, based retirement and what that may mean for on the historical dataset employed, the quality of life of millions of Baby private equity would have added Boomers, and succeeding generations, potential significant alpha – 3.16 per as they enter retirement. Rightfully cent annualised – and diversification so, this has been raised to the level of benefits when added to a portfolio a national debate with even President of public equities during the sample Obama weighing in1. period (1992 to 2014). The problem, however, has layers of complexity. It is not just how The saving crisis much money is being saved but the The vast majority of people in the behaviours that stand in the way US, 86 per cent in fact, believe the of achieving adequate saving levels. American nation faces a retirement And it is not just what plan sponsors, crisis, according to a report from amongst others, may need to do to “The vast majority of the National Institute on Retirement educate and encourage people to save Security (NIRS)3. more. The problem is also obtaining people in the US, 86 The NIRS study also revealed that adequate returns, cost-effectively, in per cent in fact, believe 75 per cent of Americans are highly retirement accounts. The deepest layer the American nation anxious about their retirement outlook. of this problem therefore is not how Further, NIRS findings calculated much is saved but are we doing enough faces a retirement that 92 per cent of households are to optimise the potential for portfolio crisis, according to a financially unprepared for retirement4, performance? and that nationally there’s a retirement The evidence suggests we are not. report from the National savings gap in the range of USD6.8 A performance gap exists between the Institute on Retirement trillion to USD14 trillion between two major forms of retirement savings: Security.” what those individuals have saved and defined benefit, where the employer what they will need in order to retire. manages the assets and assumes Michael Riak, Pantheon Ventures For those on the eve of retirement – responsibility for investment decision ages 55 to 64 – the shortfall comes to making, and defined contribution, or USD113,000 per household5. 401(k) plans, where that responsibility introducing alternative investments Future retirees cannot confidently rests with the plan participant. such as private equity to 401(k) rely on their personal savings, such The data shows that defined plans could be one of the answers as 401(k) plans or IRA accounts, to benefit (DB) plans have historically to bridging the performance gap and maintain their standard of living in outperformed their defined addressing the shortfall in retirement retirement. Last fall, the Center for contribution (DC) peers. In our view, incomes. Retirement Research at Boston College6 a contributory factor is that for many Pension funds in the US allocate a reported that households nearest years DB plans have, in contrast to significant portion of assets to equities. to retirement had lower 401(k)/IRA DC plans, incorporated ‘alternatives’, Understanding the risk-return impact balances in 2013 than 2010. including private equity, within their of private equity to a diversified The Federal Reserve’s 2013 Survey portfolios with a targeted objective portfolio is crucial to the investment of Consumer Finances reported of generating alpha. We believe that strategy of multi-asset fund managers. that the typical working household

AlphaQ April 2015 www.AlphaQ.world | 23 Private equity

approaching retirement (ages 55 to plan (This calculation assumed that equity, in retirement vehicles such as 64) had USD111,000 in 401(k)/IRA $5,000 is invested per annum over 401(k) plans. In our view, if private balances compared to USD120,000 in a period of 35 years, returning on equity makes sense for DB pension 2010. Furthermore, only approaching average 7.9 per cent per annum for plans, surely it has to make sense in half of US households have 401(k)/IRA a DB plan versus a 6.8 per cent per DC and IRA savings products, too. balances at all. annum for a DC plan). With the help of advisers, Additionally, Boston College appropriate structures to incorporate research reveals that more than half Bridging the gap private equity options within DC plans of US households do not have enough Managers with long-standing can be selected that can potentially retirement income to maintain their experience of investing in private provide plan participants with access to standard of living even if they work markets have been exploring how to the asset class’ attractive returns. longer than the average retirement age bring alternative asset classes like Everyone is going to retire at some of 65. When you factor in households private equity to 401(k) plans. In point. It doesn’t seem logical that further away from retirement, future our view, making it happen will rest one group gets access to a different US retirees have some way to go to on solving some key principles – fair allocation mix that appears to be build up adequate balances to enable treatment of all participants and returning roughly 30 per cent more at them to maintain their retirement. preserving their ability to make plan retirement than a portfolio managed choices on a daily basis. directly by their neighbour who The defined benefit experience and In regard to the first, plan doesn’t have the choice of accessing the performance gap participants in a private equity DC the same mix. In our view, getting For many years defined benefit plan programme will invest at different alpha-generating returns into DC sponsors have incorporated alternatives times, unlike a DB investor who plans offers potential significant alpha such as private equity, infrastructure makes a capital commitment at and diversification benefits that may and real assets within their portfolios. the beginning of a fund’s life and, make a perceptible difference to the Indeed, a typical US DB public pension typically, stays invested through to quality of retirement for millions of plan may allocate roughly 9 per its maturity. The amount of fees and Americans. n cent of their plan assets to private the investment profile for a later plan equity, according to research from participant investor will therefore Sources: 1 President Obama speech at AARP Washington The Private Equity be different to those of an earlier DC headquarters, February 23, 2015. Council7. The performance advantages investor. Additionally, maintaining a 2 For the full methodology of the Pantheon InFocus, “Should an Investor’s Portfolio measured on a historical basis stand plan participant’s ability to make daily Contain Private Equity?”, March 2015, please out: the private equity component8 choices so that he is not disadvantaged visit www.pantheon.com. 3 National Institute on Retirement Security, of those plans returned 13.7 per by making an investment into illiquid “Retirement Security 2015: Roadmap for cent against 7.8 per cent from public assets is a key concern. Policy Makers – Americans’ Views of the 9 Retirement Crisis”, March 2015. equity component , based on median Also important is the incorporation 4 National Institute on Retirement Security, ten year annualised returns as of of the facility for investors to switch “The Retirement Savings Crisis: Is it worse June 30, 201410. daily within a private equity DC than we think?”, June 2013. 5 The Huffington Post, “Americans are $6.8 It’s a different performance picture solution, and for this, of course, trillion short on retirement savings”, with defined contribution plans. CEM accurate daily pricing is required. December 29, 2013. 6 “401(k)/IRA Holdings in 2013: An Update from Benchmarking Inc looked at that These matters may not be legally the SCF”, Center for Retirement Research at differential and found that DB plan enshrined, but are nonetheless, in our Boston College, September 2014. 7 The Private Equity Growth Capital Council: annualised performance was ahead of view, important to address. Creating Public Pension Fund Analysis, October 2014. DC plan returns by 1.1 per cent11 over transparent and auditable operational 8 Pension fund private equity investments are reported as time-weighted returns and, the 17-year period ended 2013. processes is the final piece of the typically, net of management fees and carry. This gap can make quite a difference jigsaw. Opening up private equity 9 As measured by the S&P 500 Index Total when compounded over a multi-year investing to DC plans requires systems Return. 10 Private Equity Growth Capital Council, period. Pantheon compounded this and processes that are transparent “Private Equity Performance Update”, returns differential over a 35-year time period and auditable to the very highest as reported through June 2014. Pension funds included in the PEGCC report are among to reflect the lifecycle of a typical standards. the top 50 largest pension funds in the US. retirement plan and calculated that These pension funds do not fully represent the performance of private equity investments in this amounted to a pension pot worth What to expect going forward? the entire universe of pension funds. nearly 30 per cent less for an investor We believe there will be a gradual shift 11 CEM Benchmarking Inc 17 years ending 2013. Returns are the compound average of annual with a DC plan than for his peer with by DC over time towards allocating averages. There were 3,037 US DB plan and access to a defined benefit pension capital to alternatives, including private 2,020 US DC plan observations.

AlphaQ April 2015 www.AlphaQ.world | 24 Real estate Virtual real estate Beverly Chandler interviews BlackRock’s Tom Fekete on how the company’s new iShares product brings illiquid property to the trading table.

lackRock’s iShares has made a but, while it might be possible to use bold stab at creating real estate it, it introduced credit risk into the Bfunds that are an effective portfolio which was not appropriate. substitute for buying physical real So they use short-term inflation-linked estate with the launch of the iShares government bonds. MSCI Target US Real Estate UCITS ETF The final index, designed to reflect and the iShares MSCI Target UK Real the portfolio, is used for the ETF. In Estate UCITS ETF. this case, the MSCI physical real estate The names might not trip off the benchmarks are rebalanced every six tongue, but they are indicative of the months to update the volatility and underlying structure of the funds that debt-to-equity characteristics of the allow the investor to achieve the risk portfolio. and return profile similar to a physical The MSCI index data for these real estate fund, with the liquidity and strategies is available as far back as ease of a UCITs-compliant ETF. 2001. Over that period, the volatility Tom Fekete, head of product for of REITs was 24 per cent while the iShares in EMEA explains: “The volatility in this portfolio was 12 per objective is to help investors invest in cent. The iShares US real estate ETF physical real estate. Clients like to have has a beta-to-equities ratio of 41 one part of their asset allocation in real “REITs are very compared with equities, while a pure estate but there has been no investable correlated with equities, REITs exposure would be 94. For the benchmark.” UK product, the beta-to-equities ratio The IPD Index allows some degree because they are is 48, compared with 111 for REITs. of access to real estate but you can’t equities. They move in “The resulting ETFs have a much lower buy the underlying properties. The tandem with equities, correlation to equities, which brings other tried and tested route has been diversification,” Fekete says. through REITs. and the volatility is like The new product is aimed at four “REITs are very correlated with equities.” types of investors: individuals who equities, because they are equities,” want exposure to property but only Fekete says. “They move in tandem Tom Fekete, BlackRock have a small amount of capital to with equities, and the volatility is like invest; private banks and multi-asset equities.” fund managers, who previously had To address this problem, the team volatility, and reducing the correlation few liquid ways to access real estate in at iShares realised that on the balance to equities. This is achieved by portfolios; closed-end real estate funds sheet of most REITs there is property screening the portfolio of REITs, giving who keep a cash reserve to deploy for on one side and equity/debt exposure higher weighting to the least volatile the next opportunity; and institutional on the other. stocks. The debt-to-equity ratio in the investors such as pension funds and Fekete says: “If I invest in a REITs resulting portfolio is then calculated to insurance companies who may invest equity and debt, the performance of determine the average proportion of in physical property but also require a my portfolio over time should be the debt across the REITs portfolio. degree of liquidity. same as if I had bought the property.” Fekete and his team saw that the Fekete says: “There is nothing like The first step is to screen for REITs typical debt instrument in a REIT is these funds on the market today and that hold physical real estate and low duration debt. To mimic that, they we see potential to expand the range to then address two objectives: reducing looked at the corporate bond space other regional property markets.” n

AlphaQ April 2015 www.AlphaQ.world | 25 Social media Social media for asset managers SEI’s Lori White explains how social media platforms such as Twitter and LinkedIn can help investment managers market their business.

he rise of social media platforms 71 per cent of employees at financial firms had like LinkedIn and Twitter has been breached their firms’ social media policies. Tunprecedented over the last couple of years. LinkedIn now has some 313 million users Choose the right format and platform and in Q2 2014 its revenues rose by 47 per Platforms like Twitter are publicly accessible cent to USD534 million reported the Wall Street and free for anyone to use. As a result, any Journal on July 31 2014. communications on Twitter are regarded McKinsey estimates that there is a GBP772 as “retail communications” and should be billion opportunity for business to use carefully vetted to ensure their appropriateness. social media. LinkedIn, by contrast, offers the end-user more All of us use social media in one form or control. They can establish a group and invite a another but when it comes to applying it to the select audience, screening members to confirm Lori White, marketing workplace, the asset management industry has regulation counsel, SEI their suitability. Such a channel might be used remained largely apathetic. This would appear to convey information about corporate events, to stem from a fear of falling foul of compliance seminars, share market insights, distribution in what has become a tightly regulated market. of white papers. And indeed, provided an One of the pillars of any asset manager’s employee has a professional – not public – marketing strategy today should include Twitter account, these announcements can also social media but it’s important to understand be shared effectively. the potential roadblocks. This prompted SEI “From a compliance perspective it’s very recently to publish a brief on the subject important as to which channel is being used. entitled Stepping in to Social Media, in which The way the rules are written, the audience is eight tips and considerations are presented for critical in terms of what level of information and investment managers. disclosure is required. There are very distinct “I think it’s true to say that all asset differences made for an institutional audience, managers have been reluctant to get into an intermediary and financial professional social media. From a compliance perspective, audience, as opposed to a “Mom and Pop” there’s a lot less control over the way investor audience. You may not be intending to information is broadcast and who you, as reach a retail audience but the regulator will ask a firm, are communicating with,” says Lori “Is this clear and balanced as a message that White, marketing regulation counsel, SEI. “The could reach retirees, widows and orphans?” reluctance has largely been from compliance “That’s where different channels make a officers as they look to get comfortable difference. With a LinkedIn group you can complying with existing regulation.” control your audience and invite only those that The Financial Industry Regulatory Authority, you want to reach. That makes a big difference Inc. (FINRA) published more substantial from a compliance and review perspective,” guidance recently and the Financial Conduct explains White. Authority (FCA) in August this year established Large asset managers have a well-developed the Social Media Charter in light of the fact that social media presence. They often have a

AlphaQ April 2015 www.AlphaQ.world | 26 Social media

effective because they’ve got a captive audience interested in their expertise. They’ll talk about what’s happening in the markets, related strategies that they are employing for their fund. But this doesn’t necessarily mean that such information has to be filed with FINRA,” says White, who continues: “One strategy we’ve devised in advising clients is making the distinction between firms and products and that helps differentiate content. Registered product-specific messaging in the US has to be filed with FINRA. Market-related content may be regarded as high-level.” If the social media channel is in the name of the fund, for example, then all of that information would be pulled in to the offering and solicitation around the fund. Whether they do general market commentary or fund-specific reporting, all of that is under the purview of the SEC and FINRA. “However, if the firm establishes a portfolio manager as the Twitter account holder, and they keep huge retail investor base so the way managers might only want to use messaging at a high level without they approach a social media strategy Facebook for corporate branding crossing over to promote the firm’s is going to differ markedly to more and culture, philanthropy, that kind funds, that simplifies the regulatory institutional-focused private asset of thing. The messaging should oversight; nothing needs to be filed. managers; for these managers, they have nothing at all to do with fund That’s one of the recommendations need to weigh up the pros and cons of performance, strategies etc,” comments we’ve been making to firms. It guards using Facebook, LinkedIn etc; what Ross Ellis, Vice President and Managing against the specific advertising of their will the potential rewards be versus Director of the Knowledge Partnership product,” confirms White. the potential risks of running a social in the Investment Manager Services By and large, any fund-related media strategy? division at SEI. content that is shared by a firm will Ultimately, it depends on who the This is a useful rule of thumb when need to be filed with FINRA. There is manager’s end investors are as to how thinking about tailoring content. a pre-approval and cost of filing that far they embrace social media. Social-driven platforms like FaceBook comes with this. Each tweet covering “Here in the US, firms like Vanguard are best used for building a corporate new fund launches, performance or Fidelity, which are much more identity. Business-driven platforms like figures – whatever it may be – will retail-oriented, have a strong Facebook LinkedIn provide the opportunity to add to the overall filing costs. In such presence. But I think it’s more brand- take ownership of a particular market circumstances, firms might be better oriented than product-specific,” strategy or investment style, building off developing higher level messaging adds White. content that is more authoritative and that could perhaps be tied back to thought leadership in tone and content. other materials being produced; Categorise your content It’s best to think about product presentations, surveys, white papers. Question marks remain over how much information on one hand versus high- information a private fund manager will level information on the other. Create common sense guidelines want to put out to the world at large. “We see some portfolio managers Creating social media guidelines One mistake and all of a sudden a who are interested in social media for all employees to follow is manager’s reputation is ruined. and who already have, say, 5,000 critical.. Considerations about “Private equity and hedge fund followers on Twitter. That seems to be non-public information, client-

AlphaQ April 2015 www.AlphaQ.world | 27 Social media

sensitive information; these have social media channels, we – and by Third party content to be controlled to protect a firm’s we I refer to the legal, compliance and Although not unique to social media, reputation. Therefore, it is important marketing group referred to earlier – the SEC has nevertheless stated that to educate all employees on what is train those spokespeople who intend to if someone redistributes third party personal versus what is considered be the lead communicators. information then they have adopted professional and business-related. “It makes sense to have a few key that content and must therefore “When you cross that line, there individuals in place who are trained, take responsibility for it. Any social needs to be another level of policies who understand the value and the risk, media strategy must therefore and procedures in place to have those and we constantly check back in with have a careful vetting process and actively using social media for business those individuals,” confirms White. be absolutely sure that copyright understand the parameters. The “What we’ve found, in general, is infringements are not made. One guidance we’ve gotten from the SEC that people have Twitter accounts should also be mindful of the sources and FINRA so far – the rules around both for personal and professional of third party content. advertising and sales materials – are purposes,” adds Ellis. “Sometimes they “I like to look at who the being extended. It’s not unlike setting will tweet something in a professional publications are: if it’s the Financial up a website 10 years ago. There’s a capacity without having switched Times, the Wall Street Journal, these real reputation risk to firms for not accounts so they’re now speaking are credible sources. If it’s a blog that knowing what information is being as a representative of the firm even we don’t know anything about then pushed out. Our guidelines here at though they’re still using their personal we’ll need to do more research on that. SEI are constantly evolving based on account. You need to have mass People have the misperception that the experiences we build from using training for all employees but keep it anything on the web is free to grab. different social media channels,” tight in terms of who the firm elects as The reality is, any third party firm will comments White. spokespeople. Our advice at this stage have terms and conditions for using White goes on to make an important is that it’s best to err on the side of information; educational material is point when developing internal caution.” fine, but in other cases there may be a guidelines. Compliance, legal and fees issue,” states White. corporate marketing executives should Record keeping Another point to remember: a social come together to form a working Record keeping is a fundamental media user might have a subscription group to vet any issues that arise from piece, from a compliance programme to a particular source. However, if a using social media and develop best perspective, that has to be put into link to an article is tweeted, anyone practices. place before any social media strategy who is not a fellow subscriber to that “It’s a balancing act. As a lawyer is executed. A number of third party source will face a dead-end and be I prefer not to be too constrictive firms have sprung up recently to prevented from accessing the content. with specific rules but social media address the requirement of having That isn’t a regulatory violation guidelines remain a grey area. It’s to capture and store all social media but defeats the purpose of sharing always a risk analysis of what makes content. information via social media. sense from a social media messaging In the US, FINRA already has Asset managers today need to start perspective, is it worth pursuing an email retention requirement for thinking about their social media something and what will the likely registered advisors whereby all of a strategy and consider the above impact be?” firm’s emails need to be captured for points. Take care to establish sensible record keeping. The same is now true guidelines, put the right protocols in Provide appropriate training of social media content. Even if they place and train relevant staff, establish Training is critical in terms of satisfying are being submitted and pre-approved, a record keeping function for all social the regulators. Firms must show that there is still a separate requirement for media content and tailor content they’ve got the controls in place and record keeping, says White. depending on the channel and the type that employees have been educated “We use a third party vendor of investor being targeted. on how to communicate via different whose system basically captures “From a compliance perspective it’s channels. everything. This allows compliance important to get the right individuals “At the employee level, we’ve to go in and review all social media together, to look at what guidance created web-based training so communications, including third party there is, to see what other firms that everyone can have a basic content, generated by the firm. It all are doing, and to take a practical understanding of what’s personal versus needs to be available and accessible, approach. It’s time for the financial what’s business. Then as groups come just like any other communication put industry to look more closely at this,” up with specific strategies to target out by the asset manager,” says White. concludes White. n

AlphaQ April 2015 www.AlphaQ.world | 28 Environmental, Social & Governance The ESG phenomenon ESG is increasingly important for investors and companies alike, writes Beverly Chandler. New research from LGT Capital Partners and Mercer confirms that investors are key in pushing this phenomenon forward.

esearch from LGT Capital Partners “When investors select and Mercer in March found that managers these days, Rmost institutional investors believe environmental, social and governance (ESG) most will enquire about a factors improve risk-adjusted returns and play manager’s ESG practices an important role in alternative investment allocations. and take that into account The survey of 97 institutional investors in awarding mandates. For in 22 countries, also found that most believe alternatives, this amounts to ESG improves risk-adjusted returns and is an important aspect of risk and reputation 75 per cent of the institutional management. Entitled Global Insights on investors.” ESG in Alternative Investing, the research focused on why and how institutional investors Tycho Sneyers, LGT Capital Partners incorporate ESG considerations in alternative asset classes. managing partner at LGT Capital Partners, The key conclusions included the fact that explains: “This is because different asset ESG factors are actively considered by a large managers invest in different asset classes. PE majority of institutions investing in alternative managers typically buy a controlling ownership assets, with some 76 per cent using ESG criteria in companies they own for four to six years, so when investing in alternative asset classes. they have both the power and the investment Some 57 per cent of respondents believed that horizon to make ESG matter. Equity focused incorporating ESG criteria has a positive impact hedge fund managers typically hold smaller on risk-adjusted returns, while only 9 per cent positions in companies and for shorter time believed that it lowers them. horizons, which makes ESG implementation There was strong support for issues that more difficult. And a hedge fund that purely have the potential to impact a company’s long- focuses on foreign exchange trading probably term risk, reputation or overall performance. can do very little on ESG at all.” Topics such as carbon intensity, controversial Looking forward, Sneyers believes that ESG weapons and bribery and corruption garnered will become even more important. “There is strong support, while exclusion criteria, such as a clear trend that a growing number of asset alcohol or tobacco, were rarely considered, by owners takes ESG into account,” he says. “A those surveyed. vast number of large pension funds has become More than half, at 54 per cent, of a signatory to UN PRI.” institutional investors who incorporated ESG What is key is that investors are driving criteria into investment decision-making, had the growing ESG incorporation. “Investors are done so for three years or less, which suggests pushing asset managers to follow suit,” Sneyers rising expectations for investment managers says. “When investors select managers these over time. Greater clarity on techniques and days, most will enquire about a manager’s strategies for ESG incorporation would help ESG practices and take that into account investors progress more quickly. in awarding mandates. For alternatives, this Different types of asset managers had amounts to 75 per cent of the institutional different views on ESG. Tycho Sneyers, investors.” n

AlphaQ April 2015 www.AlphaQ.world | 29 Liquid Alternatives The spread of liquid alternatives ’40 Act funds are only part of the liquid alternatives narrative says Michael Bernstein of Lyxor Asset Management.

iven the proliferation of news articles year-to-date has been good. The plan is to grow and headlines on ’40 Act alternative the UCITS offering methodically, bringing on Gmutual funds in recent months, one board quality managers with good risk-adjusted would be forgiven for assuming that the whole returns,” confirms Shah. debate surrounding ‘liquid alternatives’ was Last February, just before ESMA published unique to the US. Of course, nothing could be its updated guidelines on ETFs and UCITS, further from the truth. Lyxor launched the Lyxor/Tiedemann Arbitrage Firstly, Europe’s alternative UCITS market Strategy Fund, a merger arbitrage strategy run has been growing year-on-year for the by TIG Advisors. It was a wise decision. In a past six years. Secondly, leading managed little over 12 months the strategy has grown to account platform providers such as Lyxor approximately USD650 million. The version of Asset Management have been offering Winton Capital’s Diversified Program has more liquid alternatives to institutional investors than USD215 million and the Lyxor/Canyon since 1998. Credit Strategy Fund, a credit long/short This is not a new phenomenon. And nor is strategy, has assets north of USD190 million. it reserved exclusively for ’40 Act funds. That This shows that demand for liquid said, given the size and importance of the US alternatives is significant among institutional financial markets, it’s understandable that the investors, to whom Lyxor exclusively caters. opportunity for retail investors to get access to That three UCITS funds have garnered north of hedge fund strategies has become big news. USD1 billion alone is revealing. “We’ve been offering liquid alternatives “UCITS broadens the potential buyers for to the institutional marketplace for over 15 the products that we have. There are certain years,” says Michael Bernstein, head of North investors that are limited to investing only American business development at Lyxor Asset in UCITS vehicles. We have the manager Management in New York. “Sometimes these relationships in place, so it’s actually rather terms get conflated and people start to associate easy for us to provide this structure for that the term liquid alternative exclusively with ’40 sector of the market. It’s complementary in Act funds and retail investors. many ways to offer UCITS funds alongside “We want to make the point that lots of our existing non-UCITS hedge fund managed different investors have an interest in liquid accounts,” comments Bernstein. alternatives and there are many different One might logically conclude that if US vehicles that qualify, managed accounts being hedge fund managers are offering UCITS- one of them.” compliant versions of their offshore strategies Kunjal Shah is a senior investment in Europe, then surely it makes sense to launch professional at Lyxor, having joined from Arden standalone ’40 Act funds to capture US retail Asset Management this September. investors. “Liquid alternatives has been part and parcel The argument for this, however, is far of what we do from day one and we’ve now more nuanced. The US mutual fund market is started to extend our offering to include UCITS- enormous, highly complex and highly regulated. compliant managed accounts. Performance of One cannot draw many comparisons to UCITS, the three UCITS funds that we’ve established other than the fact that both require managers

AlphaQ April 2015 www.AlphaQ.world | 30 Liquid Alternatives

that falls on the shoulders of the investment advisor,” says Shah. According to a survey released by Deutsche Bank in September 2014, From Alternatives to Mainstream Part Two, total assets managed by ’40 Act mutual funds reached a record high of USD257 billion by end-2013, representing over 60 per cent growth for the year. Through May 2014, that figure had grown a further 18 per cent to over USD300 billion. These are still small numbers within the overall context of liquid alternatives. For example, Lyxor’s managed account business has an AuM of approximately USD12 billion. To further extend the menu of options to its institutional investors, last year Lyxor introduced a new Institutional Share Class on “We want to make the point that lots of its platform; something that is now available to approximately 40 per cent of the 80 or so different investors have an interest in liquid managers on the platform. alternatives and there are many different This new share class was created to vehicles that qualify, managed accounts cater specifically to investors who didn’t want to pay the weekly liquidity premium being one of them.” on offer (alongside transparency and risk Michael Bernstein, Lyxor Asset Management oversight). Bernstein notes that the message of transparency and risk oversight really resonated with investors but that the weekly to provide daily liquidity terms. What many US liquidity proposition was something that most hedge fund managers appear to be doing in the institutions felt they didn’t need at the time. ’40 Act space is take on sub-advisory mandates, “The rationale was, “You’re charging a in a managed account format, as part of a premium for these features of a managed wider multi-manager product overseen by an account but we don’t want to pay a premium investment advisor. for weekly liquidity that we don’t plan on using. “There’s a huge difference between being a Can you offer us the transparency and risk sub-advisor to a multi-manager ’40 Act product oversight without charging us for the liquidity?” and establishing a standalone product. The “That led to us creating the institutional benefit of the former to a manager is that they share class, which basically charges nothing can tap into the growth of this market segment over and above what the manager already without having to potentially cannibalise their charges. The only way we make fees is by existing business. It’s not something an investor negotiating a share of the fees with the can access directly. It’s a good introduction to investment manager. The investor pays the the ’40 Act space,” adds Bernstein. same amount yet as well as getting transparency Also, from a compliance perspective, the and risk oversight they still get monthly strategy doesn’t need to be fully ’40 Act- liquidity; it just requires a larger minimum compliant even though the multi-manager investment of USD5-10 million,” confirms product as a whole has to be. That gives a little Bernstein. more leeway to managers, says Shah, as it is the This is perfect for the mid-tier institution investment advisor who has to handle all the that is not big enough to command its own fee operational aspects. breaks with managers directly and wants the “All the sub-advisor has is a managed additional benefits of transparency, etc, in a account with specific guidelines that they managed account but who doesn’t want to pay a must follow. The other important point is weekly liquidity premium. that the manager doesn’t have to worry about There can be little doubt that one of the distribution. Like operational oversight, primary drivers for investors moving more in

AlphaQ April 2015 www.AlphaQ.world | 31 Liquid Alternatives

to liquid alternatives is the negative experience fund or UCITS could be a way for investors to of 2008 when many were impacted by ratings put excess cash to work for a higher return. and suspensions. Nobody wants to go through It depends on the investor’s investment that again. philosophy. What role do daily, weekly or Investors want to know that if they need monthly liquidity structures play?” says Shah. access to cash, they can get that access. “It Bernstein says that institutions are could also be a cash management reason. taking a barbell approach to building Plenty of investors are sitting on cash and alternative exposure. liquid alternatives could be a good option to To the right of the barbell, investors want get enhanced returns vis-à-vis access to long-term investment strategies that funds,” says Shah. are more at the illiquid private equity-like end That there are so many products available of the spectrum i.e. distressed credit, special to investors today is a positive for the industry. situations strategies etc. Indeed, hybrid fund What’s interesting with ’40 Act funds in structures, incorporating dual layers of liquidity, particular is that many of these products can have become increasingly popular for investors collect assets without long track records. That happy to lock up part of their capital over a separates them from long-only ’40 Act funds longer time horizon to harvest the illiquidity that absolutely rely on track records and a premium potentially on offer. certain degree of stability. To the left of the barbell, they want exposure “There’s enough demand out there for to more liquid strategies that have historically something new and different, such that people only been available in relatively illiquid are willing to take a punt on something that’s wrappers. not necessarily proven. However, what I foresee “That’s what’s under pressure here. These is a situation where eventually there will be liquid alternative strategies give investors more products than the market demands and exposure to those hedge fund strategies but many of the products currently being launched with more liquidity. It’s becoming harder for won’t be successful,” suggest Bernstein. managers to defend their turf if they only offer What seems to be emerging in the hedge quarterly or semi-annually liquidity. fund firmament is a richer, more diverse fund “What we are seeing is a push towards ecosystem where investors can avail of different this liquid end of the spectrum. However, as liquidity terms. This is the effect that liquid you move towards there you are sometimes alternatives is having. Where once the decision giving up investment opportunities. You can’t was binary – one either chose an illiquid necessarily run a strategy in a daily liquidity offshore structure or a liquid managed account format that has historically been running structure – there are now myriad options. offshore in a semi-annual liquidity format. As Shah warns, however, investors have to Indeed, some strategies are just not suitable analyse fund structures on their own merits. to invest in for enhanced liquidity, such as Are they being compensated for reduced activist strategies. volatility or for greater illiquidity? “Expanding on Kunjal’s earlier comment, “There are funds out there that deliver good at what point on the liquidity spectrum is the risk-adjusted returns for low volatility and those right cost benefit for the investor? Institutions have a place in portfolio construction. Then at are either going all the way to a daily liquidity the other end of the spectrum you have private ’40 Act vehicle or, in some cases, stopping equity funds that offer more of an illiquidity short of that and opting for a weekly or premium that investors can exploit. monthly managed account, which should in “I think that’s where institutional investors theory provide them with attractive richer come into play; where do they need liquidity? opportunity set. What level of returns do they need to achieve “It’s now about deciding what degree of based on the liquidity profile of different liquidity the investor wants, and at what cost. investments? Then they can construct their That’s the new analysis that investors are now portfolio accordingly. making. Daily, regulated fund structures are “There is a trade-off between liquidity and attractive in theory but investors need to realise returns. You could put your cash into money that they may come at a cost of performance,” markets yet get close to zero returns. A ’40 Act concludes Bernstein. n

AlphaQ April 2015 www.AlphaQ.world | 32 Environmental, Social & Governance A quantitative approach Arabesque Partners’ Omar Selim makes the case for a quantitative approach to delivering outperformance through sustainable ESG investment.

ondon-based Arabesque Partners going to look. Go out there and think the quality of the portfolio falls and was established by founder and about how five to 10 years from now performance is impacted”. LCEO, Omar Selim in June 2013. the industry will have likely changed’,” “We don’t want to use ESG It is one of the first asset managers to says Selim. “A team of academics information to negatively impact bring a robust, quantitative approach and research staff was put together performance. On the contrary, what to sustainable investing to deliver from the universities of Oxford, our clients want us to do is use that market outperformance to investors. Cambridge, Stanford, Maastricht and information specifically to drive The Arabesque Systematic Fund the German Fraunhofer Society for the performance and reduce risk. In and Arabesque Prime Fund launched advancement of applied research.” collaboration with the University of in August 2014. To date, both have The project was split into three Oxford, we published a meta-study on outperformed the MSCI AC World Index themes: the first was asset allocation. all the available research on ESG and by 5.05 per cent and 2.88 per cent Looking ahead, the concept of fixed published that study in September respectively. This places Arabesque income products – which make up 2014 – From the Stockholder to the within the current top 10 percent 60 per cent of portfolios – delivering Stakeholder: How Sustainability Can of best performing European funds, a steady 7 per cent per annum is Drive Financial Outperformance. according to Morningstar analysis. unrealistic. The problem with fixed “Our research was to try to At the heart of the investment income is that there is a theoretical understand the impact of sustainable philosophy is the ability to use maximum price; once you hit rates of investing on the portfolio – is it comprehensive ESG research in tandem zero per cent, there’s nowhere else to go. positive, is it neutral, or is it negative? with active portfolio management and “If you look at five-year German We tried to analyse companies’ as Selim is keen to stress: “We are not bunds, you have to pay money to hold behaviour on a range of environmental using ESG data merely to please ethical them (yielding -0.06 per cent). It’s topics – water consumption, production investors at the expense of performance. one of the most underestimated issues process, wastewater management and We use ESG information to generate facing investors. The point is, things so on. We analysed the governance outperformance. We are suitable for will change. Institutions are going to structure of the company, we analysed all global investors, not just ESG have to find a new home to invest and the social aspect; how they treat their investors.” global equity is the next best thing. employees. We found a correlation There is substantial academic The idea we had was to construct between those parameters and expertise behind Arabesque, whose something as solid as possible to outperformance of the stock price,” advisory board is made up of CEOs capture that fixed income money,” explains Selim. and leading academics in quantitative says Selim, and in effect, try to deliver This research took two years to finance and ESG research. Not that smooth, low-volatility returns akin to complete. this happened overnight. fixed income. The third theme was instrument The genesis of Arabesque dates back The second theme was non-financial selection. Futures and derivatives were to 2011 when Selim was working as the information. There is plenty of public immediately ruled out. Head of Global Markets for Institutional information available on socially To get the full benefits of an Clients (EMEA and Eastern Europe) at responsible investing. This has led ESG portfolio using non-financial Barclays. some asset managers to build simplistic information requires true stock “One of our SWF clients approached funds that remove defence stocks, ownership. But this is not about us and said, ‘I want you to research tobacco stocks, etc, but as Selim points individual stock picking and building how asset management in the future is out, “when you take optionality away overweight positions in the top 10 most

AlphaQ April 2015 www.AlphaQ.world | 33 Environmental, Social & Governance

favoured companies; rather, it is about we do not short. We never bet against a developing themes that provide access company. Also, we use no FX overlay. to a broad, optimal range of stocks. “At the end of the day what we give Come June 2013, Selim left you is a model that allocates between Barclays and in a management buy-out whether you own the stocks or not; established Arabesque Partners. the system allocates money according The two Arabesque funds are to the overall best exposure. It’s about based on rigorous systematic models, finding the best combination of stocks the Arabesque team maintaining to deliver the best overall risk-adjusted its research links with the leading returns,” explains Selim. academic institutions Selim worked The filter process that screens the with whilst at Barclays. Professors from universe of 1,000 stocks to find the Cambridge University did the validation best combination resembles that of an of the financial models, for example. Arabesque geometric motif; this, says To highlight the quality of the Selim, was the inspiration for the name team, Anja Mikus is the CIO, having of the firm. previously worked as CIO for Union “We are not using This is heavy duty research- Investment, Germany’s largest pension driven, systematic investing to deliver fund (USD250 billion) for 14 years. ESG data merely to outperformance in the most attractive, There are three levels to the please ethical investors well-governed stocks. What makes Arabesque Process. Arabesque’s approach unique is that Level one is the pre-selection at the expense of when using ESG data, companies are process. This involves systematic stock performance. We not merely singled out on the basis selection across a universe of 77,000 use ESG information of one aspect of ESG. Rather, the stocks using 200 ESG indicators and systematic model tries to find the best over 100 market criteria to create an to generate ESG combination in stocks, says Selim: index of over 1,000 blue chip stocks. outperformance.” “Companies like BP, for example, This is known as the “Arabesque Prime have excellent governance but are League”, the index on which both Omar Selim, Arabesque Partners less good on safety. We have hundreds funds are based. of questions that we go through, and Level two is , works on the principals of what people the system then assigns each stock a which has its roots in New York. The think companies should be worth number. The higher that number is the fundamental stock selection process rather than what they are actually higher up the matrix it moves.” was originally developed in 1999 worth. This approach, in conjunction Selim says that Arabesque currently by Professor John B Lightstone and with Arabesque’s proprietary Adaptive has accumulated investor interest of was employed to manage more than Risk Technology – which dynamically more than USD1 billion, “which we USD1 billion for Morgan Stanley; this adjusts the exposure to equities hope to close within 12 months”. company – 5 Star rated by Morningstar between 0 per cent and 100 per cent “The days of risk-free 7 per cent – was acquired by Arabesque in 2014, depending on market concerns – brings fixed income returns are gone. What with Professor Lightstone now a further refinement and selects 100 we are trying to do at Arabesque member of Arabesque’s Advisory Board. stocks with the objective of minimising Partners is build equity in a way that The objective here is to identify the the portfolio’s risk. can capture a part of fixed income 300 best companies from the index, This additional third level is used by reducing risk. This is a new way the components of which go into the in the Arabesque Systematic Fund. of investing, for all investors, not Arabesque Prime Fund. Whilst the Arabesque Prime Fund just those who are looking for ESG Various quantitative equity is rebalanced quarterly, the ART investments,” says Selim in conclusion. screening filters are used in the model. methodology means that cash and Both funds offer daily liquidity. As These include: liquidity, forensic equities are managed on a daily basis well as being UN Global Compact- accounting, United Nations Global in the Arabesque Systematic Fund. compliant they are also compliant Compact (UNGC) compliance, ESG, “We use a conditional VaR model with UN Principals for Responsible balance sheet, and business-activity. to manage risk in the portfolio and Investment (PRI). Management fees Level three is momentum we have no concentration risk. The for the Arabesque Systematic Fund are recognition. This is essentially maximum allocation of any one name 0.82 per cent and 0.32 per cent for the behavioural finance, where the model is 1 per cent. We use no leverage and Arabesque Prime Fund. n

AlphaQ April 2015 www.AlphaQ.world | 34 Africa Investing in Africa Diane Radley, CEO of Old Mutual Investment Group, examines how to unlock the potential for private market investment in Africa.

frica has an abundance of investment areas: private equity, continent has an extraordinary pool of opportunities driven by economic infrastructure – its IDEAS natural resources. Currently, Africa has “A its demographics, its raw Managed Fund, for example, is an 60 per cent of uncultivated arable land. materials and agricultural land. These open-ended fund and a market leader The opportunity set is just enormous opportunities need to be unlocked by in renewable energy – development if we can open that up. Clearly, that investing into infrastructure-related impact such as affordable housing and relies on infrastructure development to products. The ability to unlock that education, which is addressed through get product to market,” says Radley. potential will offer significant returns its range of Development Impact to investors over the long-term,” Funds, and agriculture. Agricultural investment comments Diane Radley, CEO at Old Infrastructure is vital to the opportunities Mutual Investment Group. development of Africa’s economy That 60 per cent figure can be The perception of Africa among if it is to attract more significant explained by the fact that a lot of the investors has long been that of the foreign direct investment. To explore land in Africa is still cultivated in small Dark Continent. But the continent is investment opportunities, OMIG runs a lots by subsistence farmers. It’s very fast becoming a key emerging market. series of such funds in a joint venture small-scale. OMIG uses an agriculture Sub-Saharan Africa’s economic output, with Macquarie Group called African model that buys up multiple lots of for example, is estimated to grow from Infrastructure Investment Managers land and then consolidates them to USD1.415 trillion in 2013 to USD1.607 (AIIM). As at 30 June 2014, AIIM was increase productivity by increasing the trillion in 2015 and USD1.844 trillion managing USD1.21 billion of AUM. overall yield. by 2017 (according to the IMF World AIIM now has a 14-year track record in “At the moment, most of our private Economic Outlook Database). Africa African infrastructure investments. market funds (excluding property) as a whole is estimated to grow its Radley is passionate about the target a 7 per cent annualised return. economic output from USD2.15 trillion sheer potential Africa has to offer It’s an attractive long-term return for in 2014 to USD2.382 trillion by 2016. moving forward and confirms that investors. These funds typically have With a rapidly growing middle global investor appetite in exploring an investment time horizon of ten class, reduced political risk and sustainable investments within Africa’s years. We currently have two funds. We improved corporate governance, the private markets is on the rise. run a purely South African fund called opportunities that exist across sectors A recent survey compiled by Ernst the Futuregrowth Agriculture Fund and such as agriculture, infrastructure & Young (2014 Africa attractiveness we also have the Old Mutual African development and sustainable housing survey) reveals that since 2011 Agriculture Fund, which is pan-Africa,” and education are significant. Africa has moved from the #8 ranked explains Radley. Old Mutual Investment Group destination to last year being the #2 Lease yields in Africa are very (OMIG) has been on the continent ranked destination in terms of investor attractive compared to other parts of for 170 years. It is the oldest asset attractiveness. So there is definitely an the world: 8 to 9 per cent compared to manager and the biggest private increased level of confidence. If you 2 to 3.5 per cent in the US and 1 to 2 manager in Africa. It runs a range of combine that with political stability per cent in Western Europe. funds, with a particular focus on sub- and the compelling investment story When running private market funds Saharan Africa, managing both listed -projected GDP growth is forecast to be in Africa, the key to success is having and unlisted assets in traditional asset 7 to 8 per cent over the next five years a wide footprint. These are long-term classes through to private market – and demographics story and one can investments and problems/challenges investments. understand why. are inevitable. In that regard, Old “Within private markets we manage “There are 1.1 billion people in Mutual is well positioned. approximately USD5 billion in sub- Africa. In the next 30 years it will “We can mediate quite easily Saharan Africa,” confirms Radley. have more working age people than without having the challenge of not The firm focuses on four main either China or India. In addition, the being resident in the country. In that

AlphaQ April 2015 www.AlphaQ.world | 35 Africa

sense, footprint is critically important Development impact funds when managing these private market This dedication to sustainable investing investmentsIn one of our infrastructure is well illustrated in OMIG’s Development funds we had an investment in NLPI Impact Funds which aim to deliver through which we had one of our what it refers to as “double-bottom-line- railway concessions nationalised and it returns”: a commercially acceptable was important for us to have stakeholder return and a positive social impact. intervention at the government level to As a pioneer in private market get issues resolved. Investors need to investments, OMIG offers the only know that,” says Radley. affordable housing fund (the Housing Impact Fund South Africa) as well as Infrastructure opportunities the only educational fund (Schools Current infrastructure spending in and Education Investment Impact Africa is estimated at USD50 billion a Diane Radley Fund). The reason for establishing year. Two thirds of the funding comes these funds is clear: to address Africa’s from African governments, 8 per cent socioeconomic problems. The main from multilateral and bilateral donors Africa infrastructure investment. The focus of the Schools and Education and the rest from the private sector. investments we’ve made, to date, have Investment Impact Fund is on Nevertheless, on that projected level largely focused on road, railways, developing independent low fee-paying of spending, the funding gap is still airports and energy infrastructure schools in South Africa. estimated to be USD45 billion a year. projects (wind and solar). “Our education fund portfolios To highlight just how much “We were, for example, one of the comprise various types of education infrastructure development is needed: developers of the Beit Bridge project. We investments; it maybe an investment • Only 32 per cent of people in sub- recently handed the completed bridge into physical infrastructure, investment Saharan Africa have access to over to the Zimbabwe government after into a school operator that operates electricity; managing the concession for 20 years. affordable schooling (private schooling • Less than 25 per cent of sub-Saharan Our focus with these funds really does not government-funded schooling). We Africa’s road network is developed; span the entire infrastructure complex,” would also look to fund maintenance • Sanitation investment is less than 0.1 confirms Radley. infrastructure in non-private schools per cent of total infrastructure spend. The SAIF and AAIF funds were where the government would be the Radley notes that OMIG uses two launched in 2000 and 2004. AAIF is primary counterparty,” says Radley. preferred models when it comes to a USD186 million private equity fund Sustainable housing and agricultural making infrastructure investments. which was fully committed in early projects are big areas of focus right The first is the public/private 2009. AAIF2 had its final close on 30 now according to Radley, although partnership model, where the September 2011 with commitments of OMIG is also having discussions as to government supplies the concession USD500 million. These funds typically how to improve Africa’s healthcare and OMIG, as the Investment Manager, have an investment time horizon of 10 sector. Regardless of the investment provides some of the funding as well to 16 years. focus, OMIG applies the same as the skills necessary to complete the At the heart of OMIG’s investment sustainability ethos. infrastructure project on time. We use philosophy, across all the private “It’s about making decent returns third party developers; a case in point market funds it manages, is decently. Our investment philosophy is the Lekki Toll Road in Nigeria where sustainability. Within agriculture, for for all our fund investments is that you bring the developers in, you put example, care is taken to avoid land they add to the planet, not subtract. All the project together, you get part of the contamination and that sustainable our energy projects are renewable and investment and you deliver the project. farming practices are adhered to. designed to generate returns whilst at The second model, used to a lesser “As long-term investors, if we are the same time helping the continent to extent, is the funding of third party going to successfully generate attractive achieve its energy targets. infrastructure assets where government returns for our investors it has to be “By investing in schools, housing is not involved. done without any key sustainability and infrastructure, we are not only “All of our infrastructure funds in risks hitting our investments. For supporting the development of the AIIM are almost fully invested but us, it’s critical that we apply socially continent and making a lasting, we are planning to raise a new fund responsible investing in any of our positive impact on the social landscape, either later this year or in early 2016, long-term private market investments,” but also ensuring sustainable returns which will focus on sub-Saharan emphasises Radley. for investors,” concludes Radley. n

AlphaQ April 2015 www.AlphaQ.world | 36 Cyber security Cyber security: A multi-pillar approach Intralinks’ Todd Partridge advises a multi-pillar approach to guard against cyber attack.

n light of high-profile hacking events, where the likes of JP Morgan, Home Depot, and, Imost notably, Sony suffered significant losses of information, it is incumbent upon organisations to think more holistically about governance. Enterprise must put in place a security framework that incorporates people, processes, and technology. This is especially important for hedge fund managers, who share sensitive portfolio and investor information with various counterparties across external networks. These data-transfer channels are potential weak points for hackers to exploit. Todd Partridge is an executive at Intralinks and thought leader in the cyber security realm. The governance framework referred to above forms one of four pillars of secure enterprise collaboration that Intralinks incorporates into everything they do. Briefly, the three other managing access to important information on pillars, which Partridge describes in his recent those devices?” says Partridge. blog (Better Safe than Sony’d: 4 Pillars for More on that last question shortly. Secure Collaboration), are: Another area of increased attacks, and • Sharing Process Control: This focuses on one that largely explains the high-profile how clients control information access. breaches referred to at the top of this article, • Content Lifecycle Control: This centres on is that of hackers exploiting weak links within defining capabilities needed for organisations organisations. to control content, from creation through to As Partridge points out, the resulting how it is shared. investigations into those attacks revealed that • Technology Infrastructure Security: After it was employees, consultants, or other outside the information sharing rules have been entities who had previously approved access implemented, a service provider has to the corporate networks who proved to be been selected, and a solution has been the weak link. This is something that hedge implemented, the organisation must ensure fund managers, who add and subtract different that all facets of that solution remain secure. counterparty relationships through a fund’s In Partridge’s view, one of the biggest threats to lifecycle, need to be mindful of; not updating hedge funds right now is mobile attacks. their network security and removing old users “The increased desire of employees to be on a regular basis could lead to an unwanted mobile and accessing data on various mobile security breach. devices, represents an area of cyber security “These types of issues – use of mobile that lots of businesses are at risk from: How are devices, potential weak links within the system, they managing mobile devices? How are they use of consumer grade tools – are becoming

AlphaQ April 2015 www.AlphaQ.world | 37 Cyber security

“The increased desire of organisation can control what mobile devices can be used. employees to be mobile “You can put in place unique PIN and accessing data on codes for each mobile device, which various mobile devices, adds another layer of security to make sure you are validating the represents an area of identity of the user(s) before they are cyber security that lots authenticated by the system,” says Partridge. of businesses are at Through a programme called risk from.” Enterprise Fabric, Intralinks is establishing technology partnerships Todd Partridge, Intralinks with best-of-breed vendors in mobile security. The most recent was with a compliance reports managers need to firm called MobileIron, a mobile device stay in compliance,” says Partridge. management vendor. MobileIron acts as a protective shell for users who have more important and firms need to have Fundspace model the Intralinks SecureMobile application the right safeguards in place,” explains Fundspace is a vertically focused on their iPad, for example. Partridge. collaboration application that runs A hedge fund’s IT team knows “What we try to do with Intralinks on the Intralinks platform specifically that all the Intralinks applications, Fundspace™, and encourage our to allow fund managers to share like Fundspace, are running inside clients to do, is take a four-pillar sensitive information about their MobileIron. If, for any reason, they approach to secure collaboration. funds. Approximately 14 of the 25 need to wipe that data off the device, Our premise is that organisations largest hedge funds use the platform to they can do so without impacting need to find safe tools and safe ways interact with investors and share files, personal files. MobileIron gives them to share information outside of their safe in the knowledge that there is a the ability, remotely, to shut down organisation. To do that, one has to full audit trail. access to the data by removing the put in place a plan that addresses all “We provide a high level of security file(s) entirely. four pillars: enterprise governance, around customer and fund-specific This is particularly important to sharing process, content lifecycle data that is going to be shared on the maintaining the integrity of a hedge management, and technology and platform. Managers can review fund fund’s security network. After all, if infrastructure security that holds all marketing materials prior to going an employee leaves their iPad on an that information.”. on the platform and have granular aircraft, for example, and it contains Every innovation that Intralinks control over whether or not people sensitive files, the organisation is going develops is done so by addressing all (i.e. investors) can view content to want to ensure that either the data four pillars. online. Maybe they are allowed to is secure from an access perspective, download it. Maybe not. We implement or, at worst, can be eradicated at the Maximum compliance rights management capabilities as click of a button. Let’s say a hedge fund is going well, meaning that even if a manager “Our technology can prevent data through a re-certification process provides someone with the ability from being opened. MobileIron goes with an auditor (or any other key to download a fund prospectus, our one step further by wiping the file service provider). Regardless of how security technology stays with it. completely,” explains Partridge. complex that process may be for the “At any time, the fund manager There are still a large number of fund, Fundspace is able to provide can un-share that data and shut it firms – hedge funds included – that all the compliance data and resultant down from anywhere in the world, if share information with clients via reporting needed for the CEO or COO needed,” notes Partridge. email. In many ways this is archaic. to know that they are fully compliant As mentioned, mobile device attacks Anyone who picks up a misplaced at any point in time. present a serious threat to hedge funds. mobile device has the potential to “They can access this report and Intralinks has responded to this by easily access confidential information. see for every single exchange of increasing mobile security measures on information who those parties are. the platform. One of these measures A layered approach to security That’s what we mean by enterprise is device pinning. If an Intralinks What Fundspace allows is the ability governance. Our platform provides the user accesses data remotely, the for fund managers to avoid using email

AlphaQ April 2015 www.AlphaQ.world | 38 Cyber security

altogether and share information in a secure fund suffer a serious cyber attack, providing environment. evidence of the steps taken to prevent the The fund manager is then able to control breach could at least soften the blow and offer who can access what data. If it’s too sensitive, some degree of understanding from investors. maybe they’ll decide that prospects can only “There’s a big difference between an view their fund information online. organisation that took steps within their “The next layer is where the fund manager means to protect their clients’ data from being allows prospects to download their fund breached versus a company that, for any variety prospectus. When they do, we have security of reasons, did not. It’s something we try to embedded with the document that controls stress with our clients. In a business where what a user is able to do with the file once it’s you are sharing sensitive information there are downloaded. Maybe we restrict the user from tools, such as those we offer on Fundspace, that printing it, or copying and pasting text. can mitigate the risk,” says Partridge, adding: “Layer three is what we call information “No one is naïve enough to think that they rights management. For any files that are can’t be breached. There are organisations out downloaded, specific permissions are embedded there, somewhere, that, if they want to, can and unknown to the user. We don’t want it to dedicate the time and resources to attacking be hard to share information; we just want it your network and sooner or later they’ll find to be secure. Every time that file is opened a weakness, some way in – whether it’s a it effectively ‘phones home’ to the Intralinks technology route or, as I mentioned at the top platform and says ‘Person X is trying to open of the article, exploiting the weakest link.” this file’ which is fine because they have It is therefore incumbent upon the fund permission to do so when online. If they try to to define their own governance around access it offline, they will be prevented from risk tolerance. What is the most important doing so. information they need to secure, and how often “The final layer is that, in the event of do they audit what is being secured? By having leaving the iPad on a plane and someone that governance structure in place, managers tries to impersonate the owner, IT staff can can start to tie together the technology tools to immediately revoke access to all necessary files support it. in the click of a button,” explains Partridge. “They have to first decide on the rules Add MobileIron on top of this, and one gets a that determine what types of information are good sense of how secure Intralinks Fundspace allowed to be shared with what types of users – has become as managers look to get on top of administrators, custodians, etc. Next they can their security issues. align the technology to support that. Finally, once they’ve aligned the technology to support Take heed of the Sony attack those rules, they need a compliance policy in The Sony attacks that led to enormous swathes place to ensure they are protected. of personal data being leaked into the public “Rules. Technology Alignment. Compliance. domain are a stark warning to hedge funds. The At a high level, those are the areas to focus on,” consequences of investor information being says Partridge. accessed and used for nefarious purposes would Whether it’s the SEC, FINRA, or another cripple any hedge fund. The financial liability regulatory agency, managers need to would be manageable; the potential litigious demonstrate that any of the information they fallout and resultant lawsuits, such as those share doesn’t end up in the wrong hands. facing Sony, would not be. “It used to be enough to have compliance “Sony has already put aside approximately reports that showed access to files. That’s not USD15 million to deal with numerous lawsuits enough anymore, concludes Partridge. “Now that have arisen from the recent hacking you need to be able to show who accessed the incident. Could a small or mid-sized hedge fund file and when the system sent out a notification manager afford to do that? Can they be sure that a new file was in the system. Compliance that USD15 million would not have a material reports have to deliver a lot more information impact on their fund? It’s unlikely,” says detailing every electronic communication Partridge. that occurred on the Intralinks platform for a One caveat to this is that, should a hedge particular fund.” n

AlphaQ April 2015 www.AlphaQ.world | 39 Financial technology Cloud derivatives James Williams meets the Derivitec team who showcase how best to manage derivatives risk through the cloud.

he central philosophy behind the up a company, and then I will provide them to firm is to make it as easy as possible you’,” recalls Kaye. “Tfor people in the financial industry In 2011, Derivitec Ltd was born. Initially, it to provide validated risk management reporting. started life as a derivatives analytics software That includes everyone from small hedge funds vendor. “Then I started to do some deep-dive to global sell-side institutions,” says George market research into who in the market was Kaye, founder and CEO of Derivitec. successful and why. There were two points that We are speaking over coffee in the club clearly stood out in my mind: ease of use, and lounge of Level39 at 1 Canada Square, Canary scalability,” says Kaye. Wharf; a hot bed of innovation in what is “On both counts the cloud became the Europe’s largest technology accelerator for obvious solution. It would allow us to scale the start-up companies, spanning everything from costs of the offering with the cost of delivery financial technology to cyber security and retail to the client. That’s how Derivitec came into technology. its present form; as a cloud-based provider of At the heart of the Derivitec model is the derivatives analytics. ability to analyse a portfolio of derivatives “I didn’t make the point of using the cloud exclusively via the web, with no need for users to differentiate myself, it was simply the right to go through the time and ongoing costs of platform for what I wanted to do. In terms of a system install. This is about leveraging the other people in this space, there are others who cloud to optimise portfolio risk management. are providing services from the cloud but most of No other risk management firm is taking this the incumbents are using it as an add-on to their approach; especially one as focused as Derivitec core offering. Ours is what you would call a pure is on derivatives risk. cloud solution whereas others allow you to scale With a PhD in theoretical physics from the out the compute from your physical location University of Cambridge, Kaye has amassed a into the cloud; it’s added on top of the software wealth of experience as a quantitative analyst license. We do everything from the cloud.” (“quant”) in . He worked for Although these are early days – the Derivitec seven years at Credit Suisse before joining the Risk Portal only officially launched at the end Derivative Analysis Group of Goldman Sachs of 2014 – there are already over 100 users. in 2006. It was here that Kaye helped build Roughly one third of these are US-based hedge a methodology for model risk analysis of the funds and sell-side institutions (commercial firm’s equity derivatives positions before moving and investment banking). Private banks are also on to join the Quantitative Analysis Group of showing interest in using the application for UBS in 2010. their HNW clients to monitor their structured It was in the spring of that year that Kaye portfolios. decided to take time out to write a book on “Our target market is hedge funds but what’s derivatives: The Value of Uncertainty – Dealing nice is that people have found all sorts of other with Risk in the Equity Derivatives Market. ways to use our solution. That’s one of the great “Coincidentally, at that time a couple of things about the cloud. Because it’s ubiquitous former colleagues from Credit Suisse set up you’re not pigeonholed at all,” says Kaye. their own hedge fund to trade equity derivatives Derivitec is certainly turning heads. Not only in the Asian markets and they wanted to use was it recently voted by Business Insider as one some of the models I’d put together for the of Europe’s 15 most innovative finance start- book. I replied by saying: ‘Well, they’re not ups, it was also voted one of the 2015 Hot Ten quite industrial strength yet so I’m going to set Fintech companies by FinTechCity.

AlphaQ April 2015 www.AlphaQ.world | 40 Financial technology

“Ours is what one would call a pure cloud “The first thing somebody will do when Derivitec team, left to right: Jon Hodges, solution. We do everything from the cloud. looking at a solution like ours is compare the chief technology There’s no license fee. It’s a pay-as-you-go data against their own data stream; if you’re officer; George Kaye, model,” says Kaye, stating that the objective wrong by any magnitude, one basis point, founder and CEO; Marc from the outset was to make the Derivitec Risk 50 basis points, it’s game over. The level of Tuckmantel, head of product development; Portal as efficient and scalable as possible. precision needed is all about getting every last Anthony Grocott, head One of the key problems that firms face with detail correct,” states Kaye. of sales. existing non-cloud based solutions is install, Derivitec uses a number of standard industry and the associated ongoing costs. By powering models that derivative traders on both sides everything from the cloud, all the client needs of the Street are accustomed to. The number to have is access to a web connection. As the of workhorse models is not that huge for software is upgraded it becomes automatically the simple reason that they have got to be initiated the next time the client logs in to absolutely robust and bulletproof. the portal. “We use models which calibrate to market “You can be on any operating system, and that industry participants know and any device. All of that infrastructure and understand. On top of that, however, you have expertise, the quality of the analytics and the to have all the data flowing in. There has to be quality of data we offer, is available on tap. a process around that and the application has That is a massive advantage, and for us, a key to be built and tested. It needs to be available differentiator to other existing solutions on the worldwide, it needs to be automatically market,” says Kaye. scalable, the data itself needs to be essentially The engine that runs Derivitec’s risk analytics limitless so you need to have horizontal scaling is quite simply enormous. After all, it has taken capabilities; it goes on and on. So in terms the best part of two solid years to construct. The of the actual scope of the solution we have minutiae are manifold but vital because as Kaye created, it is very substantial,” explains Kaye. points out, “they could make or break a sale”. Market data is consumed from Thomson

AlphaQ April 2015 www.AlphaQ.world | 41 Financial technology

Reuters and a company called Xignite in the “Our target market is hedge US and is presenting being expanded further. If a client wishes to price intra-day, live or funds but what’s nice is that on a 15-minute delay, Derivitec is able to people have found all sorts integrate with front-office APIs routed to their of other ways to use our preferred vendor. Currently, asset class coverage applies to solution. That’s one of the equity derivatives and fixed income vanillas great things about the cloud. – swaps and futures. That will be extended shortly to FX options and flow exotics, with Because it’s ubiquitous Kaye noting that it has also had a request for you’re not pigeonholed at all.” basic commodity options. George Kaye, Derivitec “All of these asset class extensions will be done in conjunction with clients so that we have a clearly defined scope of how much coverage we need to have. Fixed income bonds To test the security of the front-end, will be included in due course. We are talking Derivitec used two third party validations. The with a company about the provision of the first was with a company called Veracode that reference data to support that asset class,” performed static code analysis and dynamic confirms Kaye. code analysis, which, as Kaye explains, Derivitec generates standard risk reports “basically involves getting robots to attack your that include all the usual Greeks one associates network. This lasts for a full week. We came out with derivative risk, as well as stress tests and with a 99 per cent pass rate so we are now PCI- will soon be providing historical and parametric compliant. (Variance/Covariance) VaR. What is especially “On top of that we brought in a consultant powerful, however, is that end-users are able to to try and hack the system and they found no drill right down into the analytics from which areas of vulnerability.” the headline numbers derive. Back-end is all to do with how the data This is particularly important for investors is stored, levels of encryption, how data is and is something that start-up hedge funds, separated out – one-way encryption versus in particular, can use as a real point of two-way encryption. And then there’s the host, differentiation. They could, for example, invite which in Derivitec’s case is Microsoft Azure. prospective investors on to the platform so There is a fairly widespread misconception that that they themselves can check the numbers, having a server in the office is more secure than look at the underlying risk metrics within the having it in the cloud. “This is totally wrong,” report, and get a deeper understanding of that states Kaye quite categorically. manager’s approach to trading risk. “Having the systems in a remote location “Users are free to generate risk reports any is very secure and remember, Microsoft is time they wish. My record is two minutes!” says probably more focused than any other firm on Kaye, flashing a grin. “One can take an Excel security surrounding its physical installations. spreadsheet of portfolio trades, upload it to the So, I would actually say that hosting solutions portal, go to the risk reports section, click run on the cloud is a more secure option.” and it’s done. It’s very fast. We are currently Moving forward, Derivitec hopes at some working on putting together standardised point to establish a footprint on the east coast reports that could be provided as a service via of the United States; understandable given that secure email.” many of the world’s largest hedge funds are Security is a massive issue facing the hedge located there. Asked as to what the future goal fund industry as the level of cyber attacks of the firm is. increases. For firms like Derivitec, who “The global ambition is that we become the operate entirely in the cloud, great emphasis hosted risk management platform of choice for has been placed on making the platform as the derivatives industry, supporting the main impenetrable as possible. The firm views asset classes across global markets. We want security in three blocks: front-end, back-end people to view Derivitec as the benchmark for and host. validated risk management,”concludes Kaye. n

AlphaQ April 2015 www.AlphaQ.world | 42 European M&A European M&A Beverly Chandler discusses a new study by CMS with Martin Mendelssohn, partner at CMS, which finds private company M&A in Europe enjoying a major uplift.

MS’s 2014 recently published study of is more political and general risk attached to European M&A in private companies new economies and in Europe they see an old Creveals a major uplift in deal value recovering economy – Europe has infrastructure across the region. Martin Mendelssohn, partner and is stable. It’s seen as a good place to put in M&A and corporate finance at CMS in the your money.” Currency risk has also been UK says: “One of the interesting things is that working in favour of the dollar and the pound, investment into Europe has been greater than although, going forward, that may change with people realise in 2014.” Europe’s new commitment to quantitative easing. Popular comment cites growth in BRIC “That may change over the next nine months” countries or new economies but the statistics Mendelssohn warns. “It’s too early to tell.” tell a different story. “The statistics show global CMS’s study also reveals two particularly M&A was up 45 per cent in value over 2014, notable pro-seller trends. “What we have seen of which Europe accounted for 41 per cent is that in our business of buying and selling in value and a rise of 5 per cent in volume,” private companies a lot of the push and pull on Mendelssohn says. who takes the risk in the sale of a company has The boom in inbound deals in Europe has changed” says Mendelssohn. largely stemmed from North America with, The survey showed significant use of locked- Mendelssohn says, 1200 deals with a value of boxes and warranty and indemnity (W&I) USD320 billion over 2014, the highest inbound insurance. Locked-boxes fix the price of a deal figure into Europe since 2001 in both value without reference to any completion accounts and volume. adjustment and 2014 saw the greatest use And while 61 per cent of inbound activity in consumer products and business services came from the US, some of it went the other deals. W&I insurance provides a solution way too, with outbound European activity into for the ‘warranty gap’ where sellers who are the US also improving. not prepared or able to give warranties and “The North American economy is more indemnities can provide a package which will vibrant, more self-sufficient than where it was enable buyers to make warranty claims against three years ago” Mendelssohn says. “There the insurer. In 2014, W&I insurance was used primarily in private equity, real estate and infrastructure fund deals. “The combination of availability of insurance and fewer price adjustments all means that sellers are doing rather well in terms of come backs, which are few, when they sell companies. This is a marked development over the last few years, particularly in 2014” Mendelssohn says. n

“The statistics show global M&A was up 45 per cent in value over 2014, of which Europe accounted for 41 per cent in value and a rise of 5 per cent in volume.”

Martin Mendelssohn, CMS

AlphaQ April 2015 www.AlphaQ.world | 43 Real estate Building assets James Williams interviews EQT Partners who have established a new European real estate platform to focus on London and the Nordics.

t the start of 2015, EQT Partners, player and compete with the heavyweight US a Scandinavian private equity firm, PE houses. Aannounced that it was moving in to Both Fernandez and Rackind worked the real estate sector to pursue opportunistic at Hines, a global real estate investment, and value-add opportunities across Europe. development and management company. After Two industry specialists were brought in to Hines, Rackind joined Meyer Bergman before establish the platform: Edouard Fernandez moving on to Cambridge Place Investment and Rob Rackind, co-founders of Wainbridge, a Management where he helped put together a boutique London-based real estate investment USD1.5 billion pan-European portfolio. In 2008, advisory firm. they both met in London and decided to join “We’ve kept most of our team together. forces to take advantage of the global downturn. We will be bringing on board a pan-European “We felt there was going to be a huge amount director and a Nordics director and the idea is of capital going into core assets in a flight to for EQT to be Europe’s leading PE firm with a safety, in particular the cities of London and large real estate presence. Most of the existing New York. We wanted to take advantage of real estate groups in Europe are backed by US that by using our hands-on development and private equity firms; the Carlyle’s and KKR’s of asset management experience, taking non-core the world. The market is missing a European PE product, fixing it up to make it core and then player,” says Fernandez. selling it into the more liquid market,” says Combined, the two firms have extensive Fernandez. experience in the marketplace. Since it was Ultimately this led to the establishment of established in 1994 EQT has raised 17 funds Wainbridge with backing from two cornerstone equating to EUR22 billion in capital. It has investors: Kyrill Pisarev and Mikhail Serdtsev, more than 300 institutional investors and a who between them acquired 50 per cent of network of 200 industrial advisors. This should Wainbridge. This enabled Fernandez and benefit Fernandez and Rackind in terms of Rackind to raise a London Value Add fund that sourcing deals and building relations with went out and invested GBP170 million. this network of group CEOs and presidents. “We then established a mezzanine lending As for Wainbridge, the management team has fund: Wainbridge Special Situations. We sensed transacted on more than 23 million square feet an opportunity in the New York metropolitan in European real estate. “We’ve worked on 60 area where the market had turned around, different projects in all asset classes and we particularly for residential developments, and have experience investing across the capital there was absolutely no financing available. structure; preferred equity, equity, mezzanine We were doing land loans, bridge loans, loans. We’ve transacted in more than 13 development loans, etc. That fund is still doing European countries,” confirms Fernandez. very well. We also took on third-party projects, Fernandez and Rackind joined EQT on taking over buildings from existing developers 1 January 2015 and are already analysing and revamping them, doing all the asset opportunities to put capital to work. The management. investment strategy will, says Fernandez, be “As we became more institutional – for value-add and try to match EQT’s strategy in example we brought in Morgan Stanley Western Europe as closely as possible. Although Alternative Investment Fund as a co-investor the platform will have a pan-European remit, in one project – our goal was to launch a pan- the aim is clear: to become a leading global European institutionally-backed investment

AlphaQ April 2015 www.AlphaQ.world | 44 Real estate

management platform. At the same time our HNW investors weren’t as keen on commercial (compared to residential) projects. By 2014, because we wanted to focus on raising institutional assets we split ways with Wainbridge. We have kept the third-party asset management mandates,” says Fernandez. As Fernandez and Rackind were about to embark on the first round of capital raising for a new fund, focusing on UK commercial real estate, they were presented to EQT by Fredrik Elwing the ex-managing director of Greenhill. The chemistry worked and the result was a partnership agreement to join EQT and build out its real estate business line. “We share the same values – they take underperforming companies and make them great and we, hopefully, do the same with real estate assets!” says Fernandez with a hint of humility. “We firmly believe in the absolute lack of To start off with, EQT plan on pursuing a value-add strategy, which refers to the sourcing supply in London’s office market and don’t of transitional assets and the re-positioning anticipate interest rates going up anytime of these assets to core products. Since 2008, in cities such as London, there has been very soon across Europe.” limited real estate development, creating Edouard Fernandez, EQT Partners supply/demand imbalances in micro markets i.e. markets within markets. As Fernandez explains: “We spend a lot This is what Fernandez means by identifying of time looking at micro markets. These are the best transitional assets and applying hands- areas that are attractive because of changes in on asset management expertise to turn them occupier trends (we are seeing that in the TMT around. sector for example), because of obsolescence Aside from London and other parts of the of stock. We look within those areas for UK, the strategy will focus on the Nordics to transitional assets: assets that need work to leverage the penetration that EQT already has re-position them, to micro-manage in order to in that market. Other market opportunities get the leasing up. that look attractive in terms of generating “Anything from tearing the building down alpha over the medium term include France, to giving it a new façade, installing new MEP in particular Paris, Spain, Italy and to a lesser (mechanical, engineering, plumbing), maybe it’s extent Benelux. a vacant building that just needs an effective marketing campaign. That’s what we refer to Build to core strategy as hands-on asset management. It helps to Part of the strategy will be to search out differentiate us from many of our competitors commercial real estate in the UK with say a 7 who rely on third-party operating partners.” per cent secondary yield (compared to a 4 per EQT will look for these transitional assets cent primary yield). across Western Europe and it’s fair to say that “To find those opportunities we would need Fernandez and Rackind have got the track to look within Greater London, not central record to make it work. Over the last two years London. Rather than rely on the markets at Wainbridge, the team has transitioned 1.5 for increased rental rates, we would work to million square feet of office space in London, reposition the assets by physically improving managed 203 tenants, created 39 lettings, them, improving the leasing structure, etc. If we conducted seven rent reviews, and been can reduce the yield gap to primary by one per involved in 378 lease events. cent or more we’ll make a healthy return on the

AlphaQ April 2015 www.AlphaQ.world | 45 Real estate

investment; this is what we refer to as Potential risks ‘Build to Core’,” says Fernandez. Within some of the larger opportunistic The strategy will focus exclusively real estate groups there are still IRR on commercial real estate. After all, targets of 20 per cent or more – a this is what Fernandez and Rackind figure that Fernandez says seems to are specialists in. Offices make up 40 have been set in stone many years ago per cent of all real estate investments – but investors should be aware that in Europe, followed by retail, which Europe is not a distressed continent. makes up 23 per cent, and then other Yes, there are structural weaknesses asset classes; logistics and distribution, in markets such as Spain and Italy hotels, etc. As far as residential but it is not a pan-European issue. In projects go, Fernandez said that they other words, to shoot for those types would consider office to residential of returns, the investments have to be conversions. way out on the risk curve. Investors “We have done a lot of residential are best advised to do their homework development projects in our time but pursuing real estate debt opportunities and check what the fund components it requires a dedicated, local team and in 2015. Over the last two years the are before diving in: a case of Caveat that’s not our primary focus right now. market has grown from EUR10 billion Emptor. To be clear, we’re not house builders. to EUR49 billion. This number is likely “My sense is that the risk reward We can imagine ourselves acquiring to continue to increase given that an balance is a little bit out of kilter. portfolios of private rental sector estimated EUR350 billion of debt is There are some investment groups who residential but we certainly won’t be set to mature over the next two years. think they are taking less risk when out there developing new speculative Good news for Fernandez, as it will the opposite is true, versus those who residential projects,” confirms present a plethora of new assets to think they are going to achieve higher Fernandez, who goes on to explain why pick up. returns when the opposite is true there is still reason to be bullish on “Sovereign wealth funds, pension because there aren’t enough distressed London. funds and endowments are increasing opportunities. “Firstly, it is the largest investment their weighting towards RE funds “I don’t see too much geopolitical market in the world and is therefore in their portfolios so we think we’ll risk in Europe right now. I don’t think the most liquid market. A lot of that continue to see more money coming the Spanish or UK elections are going liquidity is in the core, core-plus in to Europe, looking for the core to impact the real estate market much. market. There are opportunities, not products that we are aiming to create. The idea of Greece exiting the euro is necessarily in central London, but in We don’t think there’s going to be not as great a risk as it was previously undersupplied sub-markets outside show-stopping growth but we do feel and then there’s EU monetary policy. of central London close to strategic that the fundamentals look good for The ECB has said it will do whatever transport hubs, primarily in office the next few years, based on our is necessary to encourage growth. We developments; these transitional asset approach to identifying value-add don’t see them putting the brakes on opportunities are what I referred to as opportunities. You’re looking at a 2.5 anytime soon so interest rates will our ‘Build to Core’ strategy. per cent difference between prime and remain low for quite some time,” “Secondly, yields have dropped a bit secondary yields for office space across opines Fernandez, adding that the only but the gap between secondary yields Europe. The highest it’s ever reached is other category of potential risk is the and prime yields is still at historical 3 per cent,” notes Fernandez. unknown unknowns; that is, Black highs. The gap between bond rates and Aside from picking up real estate Swan or tail-risk events that no-one RE yields is also still at historical highs. debt from banks as they continue can predict. We firmly believe in the absolute lack to deleverage, there will also be Fernandez and Rackind will be of supply in London’s office market and opportunities to acquire buildings taking EQT’s industrial approach to don’t anticipate interest rates going up outright. This is something that building out the real estate platform anytime soon across Europe.” Wainbridge has already done, with the aim of ensuring its long-term The signs are that investor interest purchasing office buildings from Nama, success. in real estate debt has ramped up Lloyds and RBS. As Fernandez points “We create our own value and are as they search for alternative yields. out: “If the building is in the hands of a less reliant on the volatility of the According to a CBRE 2015 Investor bank it has some issue that needs to be markets. We take a private equity Intention’s Survey, 32 per cent of addressed; the more complicated the approach to real estate investing,” says respondents said they would be issue the better it is for us.” Fernandez in conclusion. n

AlphaQ April 2015 www.AlphaQ.world | 46