By Franck Dargent, Sylvie Dehove and François Bocqueraz, Amundi Alternative Investments
The 2008 financial crisis has called into question long-established models once considered the foundation of the asset management industry. At a time when convergence between traditional and absolute return strategies and managers is accelerating, hedge fund industry participants are also facing a barrage of new challenges, such as heightened regulatory scrutiny, calls for a stricter alignment of investor and manager interests, and a greater emphasis on good governance/responsible investing. This adds to the existing pressure on fees and to demands for greater value for money from increasingly sophisticated end-investors.
Amundi AI believes this creates a unique opportunity for growth for global asset managers able and willing to take on those challenges. Talent, considerable size and resources, and strong adaptability at investment firms are all critical factors to cope with those new realities. A true global, multi-asset open architecture, together with an unabated drive to implement innovative changes in one’s operational set-up and product offering, are bound to remain the proper recipe for success in the years to come.
Today, investors’ search for stable income and total return solutions is made increasingly difficult in a context of low interest rates, uncertainties over sovereign risk and sudden reversals of risk on/risk off episodes. However, it is our belief that such an environment also offers promising prospects for unconstrained strategies, active management and, generally, multi-manager investment products.
In the past five years, investors have experienced strong performance out of their fixed-income portfolios/exposures courtesy of massive interventions by central bankers.With the German 10-year Bund yielding close to 1.25%, one can reasonably assume that the recent bull run is largely exhausted; although unlikely soon, the doomsday scenario is a major correction in core fixed-income portfolio allocations, whose probability and timing is anyone’s guess. However, this asymmetric risk between little carry and potential spikes in interest rates reinforces an ever growing appetite for alternative sources of returns.
Distortions in financial markets, coupled with higher correlation to political and macro events, make most asset classes much less predictable and, at times, largely disconnected from economic fundamentals.
Alternative investments are among the rare options that deliver on their promise of consistent risk-adjusted returns in most market conditions while also providing hard-sought diversification. In 2013, we expect a favourable environment for most hedge fund strategies with fundamentals and arbitrage opportunities coming back in favour (due to relatively better liquidity, low yields and a decrease in risk aversion) and a slight acceleration in global growth.
Amundi AI recommends a decrease in duration risk and less emphasis on stressed credit in anticipation of the end of the fixed-income credit cycle. At the same time, it sticks to an increased sensitivity as it aims to participate in the equity up cycle with 15% targeted returns for the year ahead. (This generally translates into being overweight in directional equity-related strategies while looking for less beta-driven or unorthodox investment ideas in credit/yield strategies. In addition, it remains constructive on CTA and global macro, but invests opportunistically (as a function of the level of volatility).
Amundi AI thinks alpha differentiation in 2013 will be achieved through high-conviction trades; this means greater portfolio concentration and investments with skilled fundamental managers. It also favours investments that exhibit idiosyncratic risks and/or benefit from carefully selected illiquidity premia. As always, the firm implements its largest allocations through its Irish platform wrappers, offering a now time-tested, controlled and secured environment.
Hedge funds do the job
In times of increased uncertainty and low rates, hedge funds are an essential element for any portfolio. Few investments are behaving as a true diversifier and booster of performance outside alternatives. However, in the wake of the financial crisis, performance has been below historical standards and has lagged long/only options. Many hedge funds have shifted their investment paradigm towards a lower use of leverage and somewhat less sophisticated trades or strategies, and have often adopted stricter liquidity requirements. All of this has had an impact on total performance at a time when political risk has left them often wrong-footed or made reading markets more difficult. It is therefore up to hedge fund managers and their promoters to convince sceptical investors that their ability remains intact to generate double-digit returns and, ultimately, outperformance with low correlation to main asset classes..
Amundi AI believes it is over a three- to five-year investment horizon that the alternative investments’ value proposal is vindicated: asymmetric performance, controlled drawdowns and consistency throughout different macroeconomic cycles prove to be the winning factors. Using the average return/volatility of 10-year US Treasuries, the S&P 500 index and the HFR index over different time periods, hedge funds’ volatility is relatively muted, unlike traditional asset classes. Furthermore, they were more profitable than equities in the past two decades and under severe market stress (September 2007 to August 2009).
As a consequence, liquid alternative investments’ promises of absolute and stable returns with low correlation to main asset classes remain extremely attractive. Flexible allocation (net exposure and duration) and idiosyncratic opportunities (specific events such as bank deleveraging or corporate special situations) are generating alternative sources of returns compared with traditional long/only investments. At current valuation levels, the risk/reward ratio offered by hedge funds in ‘asymmetric trades’ in the equity and fixed-income sectors is a most welcome source of diversification.
FoHFs – a model under fire?
Many institutions in continental Europe, in particular mid-sized institutions, had only a few years’ experience of fund of hedge fund (FoHF) investments prior to the 2008 crisis. By contrast, their US peers had been longstanding and successful investors with hedge funds and FoHFs for many years.
To a certain extent, the classic commingled FoHF business model is having a difficult time regaining traction. Yet, hedge fund databases and industry surveys show that assets under management in the alternative space are moving towards new highs. In Q1 2012, the hedge fund industry exceeded $2 trillion for the first time in its history, and had reached $2.25 trillion by the end of the same year, according to HFR (see Global Hedge Fund Industry Report – Q4 2012).
Most growth came from North America, followed by Asia, where institutions continue to allocate to FoHFs across various liquidity profiles. Continental Europe continues to lag behind with few new large allocations; for example, according to a 2012 survey of more than 100 French institutions conducted by Morningstar France, only 16% of respondents said they expected to allocate to alternative investments in the coming years. Domestic investors are also reluctant to invest via the classical commingled FoHF model; instead, they are considering UCITS and managed account solutions.
In this context, FoHF participants must drastically evolve by amending their investment philosophy and process to address new market risks and challenges such as information asymmetry between investors and hedge funds. It is worth pointing out that one of the main advantages of setting up a more controlled and investor-friendly environment is that it forces self-discipline on managers to reduce many misconceptions about hedge fund investing. This creates an opportunity for experienced and responsible players.
When it comes to comparing the relative advantages of investing direct vs through a FoHF, many investors tend to overlook the additional costs linked to direct investment including, but not limited to, the costs of consulting services, custody, administration, legal work and staffing, whereas the key benefits of a FoHF are not taken sufficiently into consideration in terms of benefits of scale in manager fees and liquidity terms negotiation, diversification, access, established track record, depth of the due diligence team, portfolio construction and monitoring, and seamless switching – especially when a managed account platform is being used for the underlying investments.
Professional hedge fund participants adhere to a responsible world
In the past couple of years, the financial industry in Europe and in the US has seen an unprecedented wave of regulatory initiatives designed to mitigate systemic risk at the regional or global level (UCITS IV, EMIR, AIFMD, Solvency II, Basel III, Volcker rule, Dodd Frank Act).
Regulation is now a key theme: typical offshore non-regulated hedge fund investments are garnering somewhat less interest or even being avoided, specifically by European investors.
Fully embracing its responsibility as one of the most prominent asset managers worldwide and a dominant player in Europe, the Amundi Group welcomes the upcoming implementation of AIFMD in addressing the political constraints and need for protection of some institutional investors. It believes AIFMD will have a major impact in boosting the absolute return landscape in Europe.
Unlike UCITS funds, AIF products offer great flexibility, as far as investment guidelines are concerned (eg with few restrictions in terms of concentration, leverage or short selling). They can accommodate almost all types of alternative investment strategies. As such, AIF products allow for greater risk tolerance, are less costly, and can be more attractive in terms of return expectations. AIF’s flexibility does not come at the expense of investor-friendly requirements such as independent valuations and the use of depositary whose responsibilities include asset verification/control. These latter elements fix major flaws revealed by numerous hedge fund blow-ups, and should give the most cautious investors enough comfort and confidence to reconsider the actual merits of hedge funds.
In 2010, Amundi Group engaged in a wide range of changes, with the redomiciliation in Europe of all its multi-manager funds and underlying investments. The latest ESMA recommendations were taken into account when building Amundi Al’s Irish platform in order to be up and running when AIFMD comes into force in July 2013. Taking this a step further, it has set up the best operating framework possible: its robust service providers, SS&C GlobeOp (administrator) and Bank of NY Mellon (depositary) are external and fully independent.
This structural transformation was completed in 2012; Amundi AI is now managing the sixth-largest platform with $4.3 billion of AUM, and posted the strongest annual growth (87% in 2012, according to HFMWeek, as of 28 March 2013).
The challenge in regulating alternative investments is to balance legitimate regulatory and public policy concerns regarding systemic risk and customer protection, without impairing alpha generation or adding new costs which would eventually be borne by investors. On the back of its scale, reputation and Amundi’s long-term relationship with premier service providers in the industry, the Amundi investable platform of onshore funds addresses all of the above in a very effective way. Amundi AI offers flexibility and control while keeping costs on a tight leash.
Beefing up alignment of interests with investors
In the aftermath of the crisis, fees have come under considerable pressure as fierce competition to keep existing capital gives much power to stable investors. Today, calls for less onerous hedge fund compensation than the traditional 2/20 fee structure seem de rigueur as managers vie to win new inflows from large institutions.
Although there seems to be a very weak relationship between management fees and net fund performance, one must, however, question whether performance fee structures reflect a fair deal between managers and their clients. The alternative investment industry has yet to rethink the way performance fees are accrued and crystallised. The most typical structure (annual crystallisation, 20% profit share with a high watermark) is being questioned and we see the growing appeal of payment structures with investor-friendly features such as clawbacks, deferrals, dividend payments or longer crystallisation periods, which are all better aligned with institutional investors’ long-term investment horizon.
Navigating this new environment and capitalising on its fee-bargaining power with managers, Amundi Al has updated its pricing structure. This positive change aims at responding decisively and favourably to investors’ increased sensitivity to costs. Amundi AI offers very competitive pricing, not only at its FoHF level, be they commingled or dedicated, but also at the level of its managed account platform. To break with the industry’s habit of adding large add-on fees, and subject to a minimum aggregate investment size of $5 million, the Amundi AI managed account fees are equal to:
- The reference fund benchmark fees (BF) if liquidity terms are aligned
- BF + 15bp if liquidity terms are improved
- BF + 50bp if leverage is enhanced
Need for experienced intermediaries with adjustable offering
Due to the many structural changes affecting our industry, there is a blurring of the traditional frontiers between hedge funds and absolute return portfolios. There are also growing similarities between traditional long/only managers and hedge funds, while absolute return strategies are now offered through a large variety of structures and wrappers, which include classic commingled offshore hedge funds, UCITS/Newcits, managed accounts, funds of one, investable hedge fund indices and replicators, hedge fund ETFs and other listed products.
In our view, institutional sponsors in our industry have considerably evolved towards more ‘self discipline’. Fund marketers are no longer promoting undifferentiated off-the-shelf products to all intermediaries and end-investors alike; they rather propose multiple bespoke advisory services and solutions to better respond to clients’ needs and particularities.
Offering for high-net-worth clientele
Historically, Amundi AI managed an extensive range of commingled products for all client types, covering all sorts of multi-manager funds, including diversified multi-strategy products and a series of concentrated and/or thematic portfolios, using either a single strategy or a small group of strategies. This legacy range of commingled products was fully streamlined to avoid any overlap between products. This brought immediate benefits for intermediaries and end-investors alike: greater simplicity and transparency.
To service the high-net-worth segment through high-end distributors, such as private banks, Amundi Al has built a selection of flagship products with clear and distinct profiles. This selection covers most investor needs in terms of target risk/return objectives and liquidity terms. These carefully designed products share one common feature by addressing three basic requirements: (i) capital preservation, (ii) consistent returns by smoothing market shocks, and (iii) long-term wealth accumulation.
Offering for institutional clientele
Amundi Al currently manages 14 large dedicated portfolio mandates for institutional investors. From its 20 years’ experience of investing in hedge funds, customised solutions rarely rely on static approaches and overly diversified portfolios: dynamic allocations and high conviction are key in the portfolio-management process.
As a buy-side platform, Amundi AI exclusively implements its convictions through a stringent selection of high-calibre, ‘best ideas’ managers. Thus, in 2012, Amundi AI notably added to its platform blue-chip managers such as Blue Mountain, Canyon, Aristeia, GSAM, BlueBay, Fortress Macro, PIMCO, BlackRock R3 and Pentwater.
Going forward, Amundi AI will continue to expand its capabilities in ‘hosting’ dedicated/segregated managed accounts or funds of one – in order to address a growing demand in the space coming from large and mid-sized institutions. These institutions continue to look for solutions to optimise their existing investments in primarily offshore, commingled alternative/absolute return products. They are looking for experienced gatekeepers who are able to reformat their investments into dedicated, transparent and better controlled fund ‘wrappers’.
In addition, in order to better respond to institutional investors’ desire to group traditional and alternative absolute return funds together, Amundi AI is currently expanding its research and selection capabilities beyond pure alternative investments to cover the entire spectrum of absolute return strategies.
Finally, a high level of disclosure should be provided in order to manage the portfolio according to client expectations, and as a means to better share relevant information with investors. Building on its regularly expanding client-servicing capabilities, Amundi Al is moving fast to offer investors more options to customise their portfolio reports. Its reporting services will cover Basel III and Solvency II requirements, as well as the needs of UK and German taxable investors.
Amundi AI can now claim to be recognised as the best European-domiciled platform in terms of operational and investment performance, the quality of its line-up of managers and service providers, and client satisfaction.
Since its inception, the firm has invested heavily and continuously to reshape its investment venues and processes. On the back of operations already geared to the new regulatory environment, its investment professionals can invest with confidence and are up to the challenge of delivering strong, risk-adjusted performance despite low interest rates. To be true to the absolute return space’s promises in terms of low correlation to equities and bonds, its objective is to deliver an average annualised return of 8% over the next five years with annual volatility of less than 5%, all of this with satisfactory liquidity.
Amundi Al is targeting an ambitious growth plan for its investment platform, as it sees itself becoming the partner of choice in the construction and monitoring of robust, transparent and bespoke absolute return portfolios for major institutions worldwide. The firm is currently managing $11.2 billion of assets, out of which $4.3 billion are positioned on its platform. It is driven by high-conviction ideas, constant innovation and its team’s commitment to further strengthen Amundi’s image as a global leader in the field of absolute returns.
To find out more visit www.amundi.com
Deputy Chief Executive Officer and Global Head of Business Development – based in Paris. Email: email@example.com
Before joining the company in 2008, Franck has held various positions in Crédit Agricole group. In 2006, he was named a Senior Advisor of the Sales team of Calyon covering French Regional Banks. Franck joined Crédit Agricole Indosuez Securities (Japan) in Tokyo in 1999, where he was promoted Head of Financial Institutions Sales in 2002. He began his career at Andersen Consulting in 1988, before moving to the middle office of Société Générale North Pacific Branch from 1989 to 1990. Franck is a graduate of HEC (1988). In 2005, he launched the Rainbow Bridge foundation supporting sustainable development projects in favour of women and children in catastrophe-stricken areas.
Deputy Chief Investment Officer, responsible for client dedicated portfolios/investment mandates – based in Paris. Email: firstname.lastname@example.org
Sylvie is a specialist hedge fund allocator with 15 years’ experience in this industry. She has experienced all facets of investment functions such as selection and due diligence and risk management from her time at Lyxor, and portfolio management. In her role, Sylvie is responsible for client dedicated portfolios/investment mandates, and for defining the Strategic Asset Allocation for the firm. Prior to joining the company in 2007, Sylvie worked at Amundi Investment Solutions, where she was promoted Head of the Paris Investment Team, and played an active role in the creation of the alternative managed account platform. Sylvie holds a post-graduate degree (DESS) in International Financial Management (1998) from IAE (Institut d’Administration des Entreprises).
Global Head of Due Diligence, Chairman of the Selection Committee – based in New York. Email: françois.email@example.com
François has 13 years of capital markets and hedge fund experience, including 11 years in a selection and due diligence role. Prior to joining the company in 2005, François spent four years in Structured Alternative Investments with Lyxor Asset Management. In January 2005, he became Head of the Long/Short Equity & Event Driven desks, managing a team of nine people and monitoring more than 85 hedge funds. François holds a Master’s degree in Management with a specialisation in Finance from the ESCP-EAP European School of Management and a Diplom Kaufmann from the Europäische Wirtschaftshochschule Berlin.