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James Williams, Hedgeweek

Great work amidst challenging times


Firstly, let’s start with a positive message. As the latest Hedgeweek USA Awards event in New York on 15 September showed once again, the energy and creative dexterity of hedge fund industry participants remains undented by the continuous intervention of regulators and central bankers. Hedge funders are a hardy bunch, and it was great to see so many engaging conversations during the course of the evening. 

Everyone, from managers to prime brokers, lawyers to risk practitioners and fund administrators, plays a vital role in the hedge fund industry and their attendance at the awards event was testament to the great work being done. 

That said, the hedge fund industry does face challenging times. Average hedge fund performance has largely lagged major market indices. Investors continue to hold hedge funds up against the S&P 500 and use it as a leverage tactic to lower fees. To date, the HFRI Fund Weighted Composite Index is up +3.46 per cent, having gained a modest +2.76 per cent over the last 12 months. By comparison the S&P 500 has gained 17.32 per cent over the last 12 months. 

Managers are starting to feel the pressure, and it"s not just at the smaller end of the spectrum. As Bloomberg reported on 27 September, industry veteran Richard Perry of Perry Capital fame has decided to close his main fund after 28 years, telling Bloomberg that "it hadn"t been working for the last couple of years". 

According to Preqin"s latest survey of more than 270 hedge fund managers, 52 per cent reported that investors are more negative about the industry compared to 12 months ago, and 43 per cent identified investor demands for more favourable fees as a key driver of change in the industry, up from 28 per cent in December 2015. 

According to the Preqin survey, the majority of hedge fund managers are currently forecasting low single-digit gains for 2016 as a whole, with the median predicted return just 3 per cent. No fund manager surveyed by Preqin expects to return 8 per cent or more across 2016 as a whole. 

Hedge funds have every right to be realistic, but aiming for mid-single digit returns somehow feels cautious, as if managers are investing with one foot on the brake. Yes, it is an incredibly crowded market. Yes, finding the next best trade is impossibly hard. But that"s what the best in the business are meant to do. 

Jack Seibald, Global Co-Head of Prime Brokerage, Cowen Prime Services – winner of this year"s award for Best North American Prime Brokerage – made several interesting observations when giving his introductory speech at the awards. 

He said that hedge funds have historically aimed to deliver outsized returns regardless of market conditions, and by understanding that outsized returns also generally required greater risk or volatility of those returns. 

"In recent years, however, results have been underwhelming," said Seibald. "From the beginning of 2009 through the end of last year, the HFRX Global Index is up roughly 15 per cent, or about 2 per cent annually over the period. While the equity segment of the index performed better over the same time frame, this still lagged the nearly 15 per cent compounded annual return recorded by the S&P 500 including dividends."

One of the reasons for this lagging performance, in Seibald"s view, has been the dramatic rise in the prominence of institutional investors in hedge funds and the influence this investor class has had on manager behaviour. 

"It"s apparent to lots of industry observers that many managers, in an effort to attract and appease these large pensions and endowments, assumed a posture of reduced risk in their portfolios. Essentially, these managers appear to have been `retrained by these investors and the very large allocations they make, and become asset gatherers rather than alpha generators." 

Ultimately, performance, or rather outperformance, matters. 

It"s therefore crucial that active managers, and particularly hedge fund managers, remember how to shoot for outperformance. Too much focus on that well-worn phrase `risk mitigation", and less on performance, "is a key reason the industry finds itself at this crucial juncture," said Seibald.

One fund manager (among many; average performance says nothing about the quality of managers) that has certainly bucked the trend in recent years is Hathersage Capital Management LLC. Winner of this year"s Best Macro CTA , Hathersage"s G10 Macro Access Strategy has generated 20.15 per cent annualised returns since 2011, whilst the G10 Daily Access Strategy has returned 13.09 per cent annualised. 

The Hathersage portfolio management team draws on its immense market experience, having seen first-hand, many of the extreme moves that have happened in Foreign Exchange since the 1980s.  

"We give careful consideration to central bank monetary policy, political situations, cross border flows and technicals to generate trade ideas for the portfolio, while always keeping a close eye on liquidity conditions," explains Bill Lipschutz, CIO and head of portfolio management. 

The Hathersage portfolio is generally constructed to have a strong directional view, but as a consequence of imbedded convexity, also typically performs well if there is an extreme move the other way.  "We anticipate there will be some excellent opportunities in Q4 related to several key events including a potential Fed rate hike, BOJ easing, an Italian referendum and US Elections," adds Lipschutz. 

Spotting a good trade is a skill that investors are willing to pay for and whilst portfolio managers take a measured approach to building positions, any help they can get from their prime broker is welcome. One firm that is successfully leveraging its research capabilities is Wedbush Securities – voted this year"s Best North American Hedge Fund Research Provider. Specifically, the research team sits within Wedbush Capital Markets, generating daily reports that focus on companies commonly overlooked by those who cater more to larger established managers. 

Sean Trager runs the prime brokerage division. He says that in addition to providing research with intrinsic value to its emerging manager client-base, Wedbush is continuing to focus on bringing a wider of array of products to the table beyond just equities. "For a volatility arbitrage fund that trades options, for example, we can look at the portfolio and offer a futures hedge that the manager may not have held previously," comments Trager. 

Any value-add that a service provider can offer its clients is appreciated in this environment. 

One way for hedge funders to raise their profile and try to stand out from the crowd is to develop a more consistent communication strategy. Edelman – voted this year"s Best North American PR Firm – works closely with a roster of high-profile hedge fund clients to develop and execute strategic communication programmes that "raise visibility and enhance reputation". 

Edelman has 250 people in New York alone working on social media and as Mike Geller, Executive Vice President & Head of Alternative Asset Management, Financial Communications & Capital Markets comments: "I think we will see continued adoption of social media but it will likely always be measured and strategic. Our capabilities continue to grow, as do our credentials. We learn a lot from our clients and the more hedge fund managers that we take on with a variety of different strategies and goals, the better we become." 

"Our positioning is pretty straightforward within the PR space as it relates to alternatives. We bring to the table a fighting squad with a core competency within the industry. We add to that the breadth and reach of the biggest PR firm in the world," adds Rich Myers, General Manager, Edelman Financial Communications and Capital Markets.

Part of the toolkit to build awareness and deliver a positive message to prospective investors is also to appoint third party marketing firms. More managers are now doing this as they recognise the importance of having in place not only an effective communication strategy, but a wider brand strategy. 

"There"s enormous intellectual capital available to the hedge fund industry as it relates to marketing that many managers completely ignore," suggests Kyle Dunn, CEO at Meyler Capital, voted this year"s Best US Third Party Marketing Firm. "We are highly aware of the regulations that exist. Some of the largest managers are now using video content on their websites, so things are steadily changing. You can talk about your brand attributes at length – video or otherwise – without the need to fixate on performance (and potentially fall foul of regulations)." 

He says that to build a brand one needs to build awareness consistently over time – social media engagement, talking to the media, speaking at conferences, etc. "You can"t consistently drive awareness if you"re not creating interesting, dynamic information," says Dunn. 

One trend that has emerged in recent times, in parallel with fee compression, is the move towards better system integration as managers look to optimise their operating models. With so much regulation and compliance reporting to contend with, relying on 10 different systems to glean data no longer cuts the mustard. 

Financial technology providers have long been aware of this and are working with fund managers to centralise their data using an integrated system; one that enables employees to work with the same consistent set of data for all critical tasks. 

By doing this, one can drill down into the detail to see exactly where the summary numbers that are presented to the end user originated from, says Bennett Egeth, President of Broadridge Investment Management Solutions (this year"s winner for Best Data Visualisation Firm), for example.

"Using visualisation tools, if the COO sees that the amount of risk budget in certain trades or sectors is higher/lower than expected, for example, with a click or two he can see where that data come from and get an answer without needing people to go off and research it," adds Egeth.

There"s no doubt that technology is making managers" lives easier, as well as reduce operational risks. FundCount – this year"s winner for Best Fund Accounting & Reporting Systems Provider – offers a range of reconciliation tools, automated workflow processes and compliance alerts to improve operational efficiency within hedge funds. "The regulatory changes that are happening in the industry – more transparency, having a clear audit trail, etc – all play to FundCount"s strengths," says Mike Slemmer, Chief Operating Officer of the Americas. 

He confirms that FundCount has recently added reporting and operational control features, and upgraded its client tools. "We now have an enhanced online community function that gives clients instant information to questions and enables clients to share information with one another. They also have access to our Report Encyclopedia, which is a huge database of report templates that our clients have built. They can co-brand these reports for use on their website and other marketing. Client service has been a big focus for us in 2016," confirms Slemmer. 

In conclusion, it is important to point out that as managers continue to embrace more technology they maintain a robust cybersecurity posture. The SEC are looking hard at this and issuing deficiency letters to managers whose cybersecurity processes and procedures, included in the WISP, are not of a high standard. 

"People will have programmes in place but may not review them or may not even know what is contained within them. It"s important that clients maintain sound programmes that they can explain to the regulator, should they be examined. It"s important to emphasise the need for managers to adopt and follow policies as a firm," comments Anand Mohabir, Senior Principal Consultant at ACA Aponix, winner of this year"s award for Best North American Cybersecurity Firm.

Not that cybersecurity issues only apply to fund managers. Global exchanges have to be particularly vigilant as they represent a far bigger target to hackers and cyber criminals. 

"The US Government declared critical financial market infrastructure to be systemically important to the economic infrastructure of the US. That puts us on a high pedestal and means the US Government looks closely at what we are doing. We are subject to a lot of scrutiny so we have to take cybersecurity very seriously," says Chuck Mack, AVP, Deputy Head US Equities at Nasdaq – winner of this year"s award for Best North American Trading Venue.

Thankfully, the pace of technology is keeping pace with regulatory change and making managers" lives as easy as possible. With performance such a key issue right now, managers need all the help they can get with non-core tasks, so that they can focus on the job at hand: generating much needed alpha.

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