| Frecentese: As long as there are these big macroeconomic issues, it’s going to be hard to care about microeconomics Photographs: Dorothy Hong |
Like some fund-of-funds managers, Citi Private Bank has shifted into consulting mode with its clients, particularly when it comes to hedge funds. In Citi’s case, the move away from a one-size-fits-all, off-the-rack type of offering largely reflects a change in who its clients are and how it caters to them. Following the sale of Citi’s Smith Barney business to Morgan Stanley in 2009, the private bank’s clients no longer include the so-called mass affluent. Now Citi’s clients consist almost exclusively of ultrawealthy individuals and institutions. Since their net worth and clout can probably gain them access to any managers they want, what they really need is advice, says Francis Frecentese, global head of hedge fund investments at Citi Private Bank.
“The way I describe it, in a shorthand way, is that we’re no longer about exclamation marks; we’re about question marks,” Frecentese says. “Instead of going out to clients and saying, ‘You have to buy this or that fund!,’ it’s now about going to clients and saying, ‘What do you have in the hedge fund space? What do you invest in other than hedge funds? What problems are you trying to solve?’ and understanding what their situation is.”
Frecentese says this approach allows clients to build the portfolios that best suit their needs, rather than chase the latest investment fads. “So it’s no longer about those exclamation marks and pounding the table,” he says. “It’s now about asking questions of a client and coming back to the office and figuring out a solution set for that client.”
Frecentese has 20 to 25 people on his team who are focused exclusively on hedge funds. Previously, the investment team that dealt with hedge fund research also had other responsibilities. That team used to tap into the Citi Alternative Investments fund-of-funds business for manager recommendations, but the sale of that group to SkyBridge Capital in April 2010 prompted Citi to build its own research team. Frecentese himself joined in late 2009 from Graystone Research, a hedge fund advisory group within Morgan Stanley that oversaw hedge fund investments on behalf of private clients. He was a global director of manager research while there.
Now the bank has 40 to 50 hedge funds on its approved list, up from 15 to 18 previously, and it custom tailors portfolios for clients. Citi Private Bank manages $250 billion in global assets, with $5 billion invested in hedge funds and about 80 percent of its clients outside of the U.S., mostly in Asia, the Middle East and Europe. “Those regions are a little less well served for what we do, and that’s where the growth is going forward, so we think we’re well positioned for the wealth centers, particularly on the hedge fund side,” Frecentese says.
AR Staff Writer Anastasia Donde recently spoke with Frecentese about his work at the bank over the past two years.
AR: How has your work with clients changed in recent years?
Frecentese: I’d say that Citi Private Bank has changed its approach toward investments generally and hedge funds in particular over the past few years. That’s in part prompted by the events of 2008 and the credit crisis and in part prompted by the spin-off of Smith Barney.
What we’ve done at Citi Private Bank over the past two to three years is head in the direction of advisory services and build out various teams that can provide that advice. And we’ve done that across the board: with traditional investments, private equity, real estate and hedge funds.
So on the hedge fund side, we’ve established a team that we think can give that kind of in-depth advice to clients. We’re no longer focused on offering a set of products. We’re focused on offering a service.
AR: How is the new team different?
Frecentese: The research team was smaller and had various responsibilities. Now there is a dedicated team focused just on hedge funds. A large part of their function is working with clients to figure out what their needs are and then shaping a solution based around that. We now have a bigger and more specialized team that’s very strong and experienced. The average experience of the senior people on the team is 14 years.
We have five strategy specialists and each of them has a team. They all go out and source managers in their space, and that all rolls up into our hedge fund platform, which is a set of 40 to 50 managers that are approved for investments.
AR: What did the platform looklike previously?
Frecentese: There were about 18 approved managers, of which two large managers garnered the most client assets.
AR: How has it changed since then?
Frecentese: We added 30 or more managers to the platform. We’ve also launched HedgeForum Direct, in addition to our feeder fund platform. A lot of our clients don’t really need a feeder fund to invest in hedge funds, so we created another way to access funds, which involves directly investing in the managers.
With HedgeForum Direct, you’re only buying our advice. A lot of these investors don’t need our structuring. So we evaluate the fund, we facilitate the investment, but the client is actually invested in the fund itself. That’s a bit unique: to offer both the feeder fund route and the direct route.
Our structure also allows us to invest in smaller managers. If we come across a $200 million manager and we get $20 million in capacity, we might be able to use that manager in ten different portfolios at $2 million each. For a large fund of funds, a $20 million position is not going to make a dent in its book.
AR: Have your fees changed?
Frecentese: Yes. We’re moving more toward an advisory fee structure, rather than focusing on a transactional-type fee, where you’d be more focused on selling a product. Now we’re selling advice.
AR: Of your approved managers, are clients mostly invested in the same ones or is it a case-by-case basis?
Frecentese: We’ve inherited the managers from the old list, removed some from the platform and added others. In the past two years, clients have been incrementally adding to the new managers. But the focus isn’t on particular managers. It’s on building solutions.
The portfolios that we build are also tied into Citi Private Bank’s views on the market. We see what we do as providing a set of tools. We go to the client to see which tools they need, and we also look internally for our CIO Richard Cookson’s views.
Our house view at Citi Private Bank is that markets will continue to be volatile and that we’re in a low-growth environment. So we’ve been focusing on eight managers in particular that we think are well suited for a low-growth, high-volatility environment. In a lot of cases, clients have been looking for tactical trades, so we’ve been offering those eight managers as a portfolio to clients. It’s up 7 percent through the end of 2011.
AR: What kinds of managers are in this portfolio?
Frecentese: There are relative value, CTA, global macro and trading long-short managers. I think it’s an interesting portfolio both tactically and strategically because it has very low beta to the markets, so it’s a pretty alpha-rich portfolio. It’s doing well because it’s designed to play spreads between securities instead of directions of those securities.
AR: What do you think of tail risk funds or other volatility trading strategies?
Frecentese: We don’t use them. There are some that make sense, but it’s generally difficult to implement because you’re basically paying an insurance premium and need to wait for that cataclysmic event for that insurance premium to pay off. In markets like the ones we have now, everyone wants that, but in a normal environment, it’s a difficult structure to maintain.
We rely on our managers to protect capital, and we rely on our portfolio structure to put strategies together in a way that guards against major drawdowns and fat-tail events.
AR: Is your portfolio skewed toward any particular strategies right now?
Frecentese: Our motto is, all strategies, all geographies, at all times. The goal is to have anything we may need to build a solution for a client. With the managers we have on the platform now, we believe we can answer 80 to 90 percent of our clients’ needs.
AR: How many managers did you let go of from the old platform and why?
Frecentese: About a dozen. Some had operational issues or investment issues. In some cases it was performance related. In some cases we didn’t see what the manager was doing that was different, and to get on our platform, you need a differentiating factor. And they need to demonstrate to us that there is a link between that differentiating factor and incremental return.
The portfolio was previously heavily skewed toward one event-driven manager, but we have been reducing our exposure there because of poor performance, so our weight to this manager has come down, and clients were also upset with the bad performance, so they have been pulling out. We’ve been steering clear of managers that have a lot of embedded beta in their portfolios.
AR: Are you planning any additions or subtractions to the platform right now?
Frecentese: We’re happy with where we are, though there will always be some turnover.
AR: Do you think hedge funds are doing their job in terms of performance?
Frecentese: It depends on how you view the job of hedge funds. Whether they’ve done their job will depend on whether you consider them to be absolute return vehicles, in which case they haven’t, or whether you consider them to be relative return vehicles, in which case they have. We’d fall into the latter camp.
We’ve gone from a world of 800 hedge funds to a world of 8,000 hedge funds in the past ten years, and alpha is finite. You have ten times as many managers, and it’s difficult to come up with unique trades. Now on our platform we’re looking at a small subset of managers that are coming up with unique trades and are generating alpha, but it’s become more difficult to find that.
A little bit of a silver lining is that managers have managed to protect capital. If you look at a year like 2008, the average hedge fund manager was down in the high teens, and the markets were down 34 to 50 percent, depending on the market you’re looking at. It’s tough to get excited about being down 17 to 18 percent, but when you look at the alternative — being in long-only, for example — it’s a relatively good return.
AR: Can you describe some of your work with clients of late?
Frecentese: A lot of clients, when we talk to them, think in terms of two dimensions — risk and return — while we have to make them think in terms of other dimensions. For example, we have a client who is a large real estate developer in New York, and we can take into account that his net worth is very illiquid. It’s basically tied up in real estate. So we can take the characteristics of that investment into consideration when we build him a hedge fund portfolio.
AR: How do you measure performance?
Frecentese: We look at each client’s portfolio and its goals, which we have benchmarked to various indexes. We also look at the performance of the platform as a whole.
AR: Have you let go of any of the managers that you’ve added so far?
Frecentese: No. We’re really looking for managers that we think will be on the platform for a while. We want to establish relationships for the long term.
AR: What are you or your managers doing about the economic situation in Europe?
Frecentese: We’re checking with our managers to determine what their exposures are and keeping close tabs on that. It depends on what we mean by “if Europe gets worse.” Is it Italy defaulting? A broad European default? If so, you’ll see a credit crisis that’s going to roll over to the U.S., hedge fund counterparties potentially disappearing, and then all hell breaks loose.
Some of our macro managers think that there are some positive signs. Certain managers think that since the problems have spilled from the periphery to the core, the core will now have to do something about it because they are at risk. It’s on their doorstep as opposed to being a relatively remote problem.
Other managers have much more of a bearish view. Obviously, nobody knows the way Europe is going to go. Some managers are just sitting on the sidelines.
AR: Good returns have been hard to come by in 2011. What are you seeing from your managers?
Frecentese: You see global macro doing relatively well and, at the other end of the spectrum, long-short having a bit of a struggle. It’s this risk on/risk off environment that we’ve been in over the past four years now, and I’m not sure that that’s going to end anytime soon. As long as there are these big macroeconomic issues, it’s going to be hard for the markets to care about microeconomics. That’s been a struggle for managers focused on security selection because the market doesn’t really care about security selection right now.
AR: How are you affected by the bank as a whole and its stock volatility in recent years, if at all?
Frecentese: It hasn’t affected us much, except that the stock that we get as part of our compensation has gone down. The good news is that Citi is one of the best-capitalized banks in the world right now. So it’s a safe harbor now, whereas we were in the eye of the storm just a few years ago. AR
