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Source: Le temps as of 30-03-2020

Many hedge funds take advantage of the “coronakrach” and earn billions. However, the sulphurous reputation of this branch of finance does not correspond to reality. A profound transformation is underway

  • EMMANUEL GARESSUS, ZURICH @garessus

Bill Ackman, gérant du hedge fund Pershing Square Capital Management, a gagné 2,6 milliards de dollars en un mois en profitant de la baisse.

Billionaire Bill Ackman, a Wall Street legend and manager of the hedge fund Pershing Square Capital Management, bought $27 million in instruments to protect against a fall in equities in January. It took profits last week with a gain of $2.6 billion in just one month, according to Barron’s magazine. This kind of stock market success is common in this particular universe.

And now? With shares plunging, the financier, who is calling for a 30-day shutdown of U.S. production, is buying Starbucks and Hilton shares, which have fallen more than the indexes.

“The current environment will serve as a test for this industry as well as all active funds,” says Beat Wittmann, founder and partner of Porta Advisors in Zurich. He said he was confident about alternative investments, including hedge funds, and equities (private and public).

Long years of modest growth

It is true that hedge funds suffer from their image. Aren’t they called hedge funds? As in so many other areas of the economy, “in hedge funds, perception differs from the reality of professional investors,” says Nicolas Nussbaum, Managing Director, head of hedge funds and liquid alternatives at BlackRock Europe and the Middle East (EMEA). The world leader in asset management is also very active in alternative investments. BlackRock manages $54 billion in hedge funds globally, three-quarters of which are through offshore funds (Cayman structures) and a quarter into more regulated UCITS funds.

Since 2000, assets managed by hedge funds have declined only twice, in 2008 and 2018. “At the end of 2019, this branch of finance was around its historical peak of $3320 billion,” adds Nicolas Nussbaum. It is therefore incorrect to talk about the death of hedge funds, even if the performance of some funds has often disappointed and their fee structures encourage many investors to distance themselves from it. Swiss pension funds often favour private markets (debt, infrastructure, private equity), unlike private banks and family offices.

MANAGING DIRECTOR, HEAD OF HEDGE FUNDS AND ALTERNATIVES AT BLACKROCK

“We are seeing a generalized reduction in the sail. Leverage is down sharply”

Two negative years

The growth of this alternative segment is slow but real, even if the inflows of funds are negative. Since 2000, the best two years have been 2006 and 2007, with $126 billion and $195 billion, respectively.

Hedge fund fees have been reduced in recent years. They are generally 1-1.5% fixed fee and 20% performance fee. There is also a better alignment of managers’ compensation.

In 2019, the yield averaged 9.3%, after a loss of 3.5% in 2018, according to a Study by Barclays. During this year, the shares (S-P 500) gained 29%.

The performance of regulated and liquid UCITS structures can sometimes be lower due to their constraints, according to BlackRock. These funds, which represent less than 30% of the industry, are purchased mainly in the countries of the European Union: France, Germany, Italy, Spain, but also in some countries in Asia and South America.

The classic offshore represents more than 70% of the total and offers generally monthly liquidity to investors. “This helps smooth out the volatility that takes place during the month and seizes more opportunities,” says Nicolas Nussbaum. There is therefore a choice between liquidity and investment opportunities.

The goals of hedge funds

The purpose of hedge funds is misunderstood. The purpose of a hedge fund is not to earn more than a stock market index. “The objective remains to offer a performance of conventional assets (equities, bonds), up and down,” recalls Nicolas Nussbaum.

During the early days of the coronavirus crisis, “hedge funds, although generally down for the month, managed to cushion the blow against market indices,” the official said. “I am hopeful that some will be able to capture opportunities and rebound faster than traditional investments. They probably won’t wait for a market turnaround to generate performance, unlike conventional funds,” says Nicolas Nussbaum. The challenge is on.

Demand remains strong and robust, according to BlackRock, from sophisticated private clients in key markets such as Switzerland, the United Kingdom, Nordic institutions and Middle Eastern sovereign wealth funds. The most sought-after solutions in these regions belong to traditional offshore rather than the more regulated UCITS funds, but some UCITS strategies have also succeeded.

Caution at UBP

The year 2020 had started well for hedge funds, but the speed of the price collapse took everyone by surprise. The quest for cash has become a priority. “We are seeing a generalized reduction in the sail. Leverage is falling sharply, especially in quantitative funds (based on algorithms) and multi-strategy platforms,” confirms Nicolas Nussbaum. Compared to equities, hedge funds held up well in the first few days, before falling under the weight of a repeat of the shocks. In March, the average decline was 7-10%, and 13% since the beginning of the year. Traditional indices are down 20-30% over the same periods.

Uncertainty about resilience will be partially removed at the end of the month, as most strategies are valued on a monthly basis. But the manager is optimistic: “The players will adapt to the new realities. Opportunities necessarily result from periods of dislocations such as those we go through.”

Some players remain cautious: at UBP, a leader in alternative investments, the share of hedge funds in portfolios has been reduced, according to Michael Lok, the group’s chief investment officer. This proportion was 10% at the beginning of the market crisis. “We decided to reduce it to 5%, considering that the performance was in line with our expectations but that their potential for rebound was limited. We will reconstitute these positions later,” he says. The Geneva establishment, as part of active portfolio management, has therefore not decreased this percentage for performance reasons.

Two promising strategies

Two types of strategies should bounce back and get the better of the game, according to the head of BlackRock. The first is mergers and acquisitions arbitrage, which should benefit from the narrowing of the spreads between the current market price and the price at which the company will be sold. However, all managers must ensure that transactions remain viable. They will be if their nature is strategic. Otherwise, they may not withstand shocks such as the one in 2008 or 2020. “Our experts ask management to assess the viability of the deal,” says Nicolas Nussbaum. Some will be postponed, but not cancelled. Contracts sometimes make it very difficult to cancel a transaction. By 2008, many acquisitions had withstood market stress. The fact that these strategies are deconstruced from the markets should attract the attention of investors.

The second type of interesting strategy at the moment is the strategies for arbitrage of relative value in the bond, due to the dislocations observed in this market. It is about taking advantage of inadequate prices on the interest rate curve or differences between spot and forward prices. The Fed’s decisions should reassure stakeholders about their financing capacity. “These two strategies should be able to generate added value without being too impacted by market management,” notes Nicolas Nussbaum. Quantitative strategies, on the other hand, seem to be suffering particularly at the moment, in his view.

Features of the 2020 crash

The 2020 crash, however, differs from that of 2008. At the time, the alternative had major excesses, in terms of leverage and risk management. The current situation is healthier, more regulated too, stronger players. The size of the players has increased at the same time. Managers with more than $5 billion account for about two-thirds of the industry’s assets, BlackRock estimates. Risk management tools are also more developed. However, the uncertainty is the same. The velocity of flows is considerable, partly due to the emergence of “quants”, which account for 20% of the hedge fund industry, according to the manager. “They suffered last week by reducing their financial leverage all at the same time,” he notes.

It’s not going to be a good time.

 

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