David Bell, Craig Stanford, Mark Levinson and Travis Schoenleber
by Greg Bright
Liquid alternatives and highly liquid retail hedge funds, alternative beta, new benchmarks, performance comparisons, education and, inevitably, fee structures featured in a recent hedge fund roundtable. Participants were David Bell, the CIO of mine wealth + wellbeing (formerly AusCoal), consultants Craig Stanford of Ibbotson and Travis Schoenleber of Cambridge Associates, and macro fund manager Mark Levinson of MST Capital.
The popularity of 1940 Investment Companies Act funds (‘40 Act’) funds in the US, which are liquid alternatives vehicles that fit within the SEC’s guidelines for retail investors, is expected to spillover into Australia, according to the roundtable on hedge funds which took place in Sydney early August.
Mark Levinson, a principal of MST Capital, said: “Highly liquid hedge funds are coming, but investors need to be aware of what they are buying. In the US, because of the regulations, they can be a subset of the strategies used by their better-known flagship funds. The legal construct of these funds means there are all sorts of constraints, including liquidity, use of leverage, custody arrangements and performance fees, which can lead to limitations.”
ASIC has already indicated that it would be watching this space following a survey of managers it undertook last year which showed that a lot of them were intending to launch new liquid alternatives funds.
Hedge Funds Week
The AIMA Australia Hedge Fund Forum, followed two days later by the annual Hedge Funds Rock awards and music night, are the centerpiece of what is known as Hedge Funds Week in Sydney in mid-September. The AIMA forum is at the Sofitel Sydney Wentworth on September 15 and Hedge Funds Rock and Australian Hedge Funds Awards on September 17 at the Ivy Ballroom Sydney.
David Bell, CIO of mine wealth + wellbeing, said they did not represent a new asset class, but rather another way to bring hedge fund strategies to the retail market.
“The problem that arises,” he said, “is to do with education. Financial literacy all around the world is chronically low. If it’s the advisors who are creating the model portfolios for them, that’s one thing. But if it’s mum and dad investors who are being targeted that raises questions about their level of understanding.”
Bell, who is also a former asset consultant and fund manager, was working at Colonial First State in the late 1990s and early 2000s when it launched its foray into the hedge fund world with considerable marketing fanfare. The campaign was successful on the institutional side but not so successful in retail. But other managers, such as Hedge Funds Australia, were more successful so there may be retail appetite now, especially because of the lack of yield available from traditional asset classes.
He added, however, the funds management industry had not developed a usable framework for investors to quantify the cost of liquidity or illiquidity.
Travis Schoenleber, a managing director of Cambridge Associates, said that any regulation which attempted to protect investors from risk can limit the manager’s ability to capitalise on the potential returns associated with taking on those risk. Alternatively that regulation may limit a manager’s ability to hedge various risks. There is potential for investors to lose out by investing in regulated highly liquid hedge fund alternatives rather than directly in hedge funds.
Craig Stanford, head of alternative investments at Ibbotson, who is also chair of the education committee for AIMA, said he believed there was too much focus on liquidity in portfolios. There was space for less-liquid instruments, especially for big super funds that should have a long term investment horizon and relatively predictable payouts.
Some managers are prepared to reduce their fees for investors who are willing to lock up their funds for longer periods. Some super funds were also looking to reduce the fund’s MER by going passive in the liquid asset classes. Replication strategies, or hedge fund beta, are also becoming popular.
Stanford said that, ideally, the liquidity offered by a portfolio should match the liquidity of the underlying investments. “In Europe for instance we are seeing convertible bond funds for retail investors that offer weekly redemptions. In a stress environment, it is highly unlikely that the fund could meet those terms because the underlying market is simply not that liquid”
Alternative and smart-beta strategies have proven increasingly popular in equities, perhaps helped along by the Government’s MySuper regulations, and, more recently, in bonds because of the likelihood that interest rates will rise – probably soon in the US and less soon in Australia.
Levinson observed that not all hedge fund strategies could be replicated by systematic quantitative managers – especially illiquid or discretionary strategies such as distressed debt. You still have the same systematic risks as the underlying assets.
Stanford said that it was easy enough to replicate hedge fund returns on a backward looking basis, but this does not mean you can replicate them in future and that is what counts for investors, “I’ve never seen a bad back test,” he added, “they won’t show it to you”.
A lot of market anomalies decay over time, Bell observed, “but I enjoy financial innovation and super funds should always be on the lookout for new risk premia”.
“When I think of hedge funds I think of active risk management,” Stanford said.
Hedge fund managers tend to have greater dispersion in their performance numbers than long-only equity or bond managers, putting extra pressure on the investor to make a good manager selection.
“Strategy dispersion is not a problem,” Schoenleber said, “investors want strategy dispersion because that is what helps to diversify portfolio risk. What investors need is the expertise and ability to select top managers within strategies. You don’t want to be invested in median hedge fund managers.” Bell added that you needed to look beyond the absolute numbers to assess manager skill with hedge funds, and this was where good investors could add value for their clients.
Australian hedge fund managers have long complained that super funds are more likely to invest with offshore managers than local ones, even within the same strategy grouping. But each of the roundtable participants agreed there was a good range of investment-grade Australian hedge fund managers. “I can think of 10 or 12 off the top of my head,” Bell said.
Two reasons often cited are the weight of money from big super funds (being unable to invest in small managers) and the lack of due diligence done locally by the offshore specialist advisors. Stanford said that the allocations to hedge funds by Australian investors were lagging other countries. There was “massive distrust and general skepticism” of hedge fund managers in Australia, he said. This was exacerbated by the push for lower fees by big super funds, Bell added. To discard a hedge fund strategy because of high fees was “ridiculous, because the net return after fees is what is important”, Stanford said.
Similarly, asset allocation has evolved considerably by big super funds, although the “labeling” of asset classes has not. Bell said that a lot of people in the industry were frustrated by the ‘growth’ versus ‘defensive’ labels but there did not appear to be a solution.
“A technical piece of work should be done because it’s a global problem,” he said. “No system has a perfect approach in assessing and delivering retirement outcomes.”
Stanford added that the growth/defensive discussion was confusing. “Any asset can be defensive if you buy it cheaply,” he said. “Placing things in buckets is confusing.”
Because of relatively benign markets domestically for a long time, Australian investors perhaps did not see the need to invest in alternatives. But, looking forward, Schoenleber said, most people were not going to get the same good returns.
“Lower prospective return expectations for simple stock and bond portfolios make this a compelling time to revisit the inclusion of alternatives within portfolios. The addition of liquid alternatives to the world of hedge funds benefits investors by creating more choice and driving down legacy hedge fund fees. Investors have more tools than ever before to add value and hedge risk. It’s a great time to be an investor.”