By the AR editorial staff
Photographs by Chae Kihn
| Michael Hintze, Kyle Bass, Peter Briger |
Hedge fund assets may be down 30% from their peak of $2.65 trillion in 2007, and markets have been vacillating during the past year, but speakers at the seventh annual AR Symposium are optimistic they’ll be making lots of money in the year ahead.
“I feel like a kid in a candy store,” said Peter Briger, co-chairman and chief investment officer of Fortress Investment Group. Briger is excited about the opportunities to pick up cheap assets that banks are unloading as economic distress continues. But he’s not the only one who thinks the future looks golden.
Distressed investing, commodities like energy, and suddenly resurgent equities are all great areas for investment, according to the panelists at the event. Meanwhile, macro investors look worriedly at the world as currency devaluations dominate the world stage and debt piles up. In general, they like gold.
“There’s a mathematical limit to the amount of debt you can take on,” said Kyle Bass, the founder of Hayman Advisors. “You can’t keep layering on debt and expect to grow,” he said, speaking specifically of Japan. Bass recently launched a fund to short Japan. In the meantime, he argued, “all roads lead to gold.”
On the business side, managers continue to grapple with demands for more liquidity, disclosure and lower fees, while looking at a future of lower returns. Alexandre Pini, portfoliio manager at Geneva’s Banque Privee Edmond de Rothschild, said that performance has largely eroded over the past 10 years, and it’s unlikely that hedge funds will return the kind of numbers that they became known for. But after the market crash of 2008, investors may just be content with hedge funds that outperform on a relative basis.
State of the industry dissected
Have things gone too far? These days investors are flocking to the largest managers, in many cases cutting funds of funds to go direct, demanding instant liquidity through managed accounts and beating down managers on fees. But it might not help in the long run.
“Large investors are getting the wrong kind of advice,” said Michael Lewitt, president of Harch Capital Management, noting that many continue to invest in multibillion-dollar hedge funds with strategies that have produced subpar returns when properly adjusted for leverage, liquidity, concentration risk and fees. “Investors too often chase returns and don’t really understand that [they] need to be risk adjusted.”
Others were irked by investors’ clamor for managed accounts. “I really have no interest in investing in a manager who is going to put a class of investors ahead of me, and that’s exactly what a managed account is,” said Mark Yusko, CEO and CIO of investment advisor Morgan Creek Capital Management. “Shame on the managers that do it without doing it with the exact same terms as the fund investors have.” And if investors think they’re getting greater liquidity that way, Lewitt invoked John Maynard Keynes to point out that the whole market can’t be liquid at the same time.
Transparency, another investor demand, also comes with a downside, the panelists noted. “Running or looking at or even analyzing a series of managed accounts isn’t necessarily trivial,” said Intrepid Capital Management founder Steve Shapiro about the administrative burden that comes with increased reporting. “I’ve got reams and reams of data coming in every day; what the heck do I do with it?”
Similarly, Yusko warned about sacrificing returns to avoid fees. That can lead to “going direct and getting low returns by using size as a proxy,” he said.
Big doesn’t always mean better, but it can help. “It’s not big versus small. I can’t say that Marathon or someone who’s big is better than a smaller firm,” said Andrew Rabinowitz, chief operating officer of $8.55 billion Marathon Asset Management. “The big institutions sometimes lose their way, but if they have good infrastructure, good risk controls, good compliance and have enough resources to hire the best talent…I think there’s some value add there.”
Or perhaps the industry is just increasingly bifurcated. “There are great small managers and great large managers,” argued Yusko. “There are no great midsize managers,” he said.
Event-driven managers see a spike in M&A activity
Managers at event-driven funds are gearing up for merger arbitrage investment opportunities as they expect the mergers and acquisitions market to continue to thaw out. “Every time you have a recession, M&A falls off a cliff by about 50%. That happened in 2008,” said Thomas Sandell, founder and chief executive of Sandell Asset Management. M&A activity is now up by about 22% this year, he added, while it fell by 39% and 24% in 2008 and 2009, respectively. Merger arbitrage managers now expect hostile takeovers, cross-border acquisitions and company sales targeted at increasing shareholder value in the post-2008 environment.
Scott Ostfeld, partner at JANA Partners, said he sees potential for activist investing. “We’re seeing a lot of drivers for deal activity not only on the corporate side, but also on the private equity side,” he said. “Today underperformers can be forced to sell.” Ostfeld added that companies’ boards are much more willing to engage in sale talks these days, and shareholders may also be willing to talk to activist investors. “You also have shareholders who maybe five to 10 years ago were a little bit more concerned about activists, but now they are supporting activists publicly,” he said.
Whether or not the deals will involve activists, panelists said they expected record flow in M&A activity in the coming years. “Our focus right now is on hostile M&A as opposed to necessarily activist-led M&A,” said Michael Weinberger, portfolio manager and partner at York Capital Management. Given the volatility in the markets, it’s become more difficult to decide on a price. As a result, “there is a much bigger desire of companies to go directly to shareholders now, and shareholders don’t trust management as much,” he said.
Some companies have fared better than others throughout the financial crisis, and they’re now in a position to make more acquisitions, said Christopher DeLong, portfolio manager at Taconic Capital Advisors. “Over the next 12 to 18 months, almost all of them will feel the pressure to make a move while assets are still cheap,” he added.
With GDP growth still slow in the industrialized world, much of the action is expected to be in developing countries. “I think in all of its forms, you hear management trying to strategize how to capture some of that growth,” said Weinberger. One of the ways to capitalize on this growth would be through M&A, he said. “You’re definitely seeing an appetite to move into different geographies,” Ostfeld added, noting that GDP growth in developing countries could be 7%–9% and in the developed world it’s only about 0%–2% right now.
Speakers trumpeted Australia’s BHP Billiton’s bid to buy Canada’s fertilizer company Potash Corp. as the biggest merger arbitrage trade of the year. The Canadian government has since blocked the sale, which panelists said would create losses for hedge funds, as they had plowed into the deal. But Potash’s stock price has remained relatively stable, and Weinberger said he thinks the company should be able to find other means to maintain shareholder value.
Energy in the post-BP world
The BP-Transocean oil spill on April 20 dominated news headlines around the world and led many to claim that the demand for alternative forms of energy would skyrocket. But so far it has been a nonevent, serving only to illustrate the risks associated with exploring for oil now that the easiest fields have been largely depleted. “The world consumes a billion barrels of oil every 12 days,” said Josh Fink, chief investment officer and chief executive officer of Enso Capital Management, noting that oil is becoming more difficult and more costly to find as exploration is being pushed to more challenging areas, such as Greenland and Colombia.
Crude oil prices remain strong as the demand for oil from emerging markets continues to increase. hat’s occurring even though alternative energy sources, such as biofuels, wind power and even a surplus of natural gas, are adding to the energy supply at the margins.
“It’s business as usual in terms of what is happening in the energy sector after BP,” said Renatto Barbieri, a portfolio manager who heads the private investments in agricultural commodities at commodity macro hedge fund Galtere. “Although there are a tremendous amount of incentives toward biofuels, there is nothing out there that tells us that biofuels will substitute [for] oil or hydrocarbons anytime soon.”
Government policies around the globe are also putting upward pressure on the price of energy. “The monetization of debt and monetary policy creates an underlying bid on hard assets,” added Tim Flannery, the founder and chief investment officer of Copia Capital, a long/short equity hedge fund that invests in companies along the energy value chain. Flannery is long in engineering and construction companies such as Foster Wheeler and Jacobs Engineering. He also recommended Norwegian offshore drilling company Seadrill.
It’s not just low interest rates that push investors into commodities. Emerging powers like China are buying up large reserves of oil at top dollar, making a good backdrop for crude oil to be sustained at higher prices, according to Fink. Countries like Iran and Venezuela subsidize the price of gasoline for their citizens, pushing up demand and thus the price.
Can alternatives compete in such an environment? Already Brazil powers its cars with ethanol, and China is investing in renewables like wind. Bryan Martin, who co-heads D.E. Shaw’s private equity investments in alternatives, said that historically, technology and alternative forms of energy have been able to catch up and meet demand.
“It’s been a good place to make money,” he said, referring to private projects in alternative energy. Wind energy has been a cost-effective source of power in places like Hawaii and California, he added.
And while China may be contributing significantly to the demand for oil, it is also exploring alternative forms of energy, and in many areas it is a far more efficient and better producer of alternative energy, said Martin. One example is in wind energy. “The Chinese are now leading with the lowest-priced, highest-quality wind turbines available,” he said. “They are taking the risk on technology and will be a core part of how we make alternative clean fuels competitive.”
Galtere’s Barbieri argued that while the next new technology may be around the corner, consumption rates are still likely to outpace supply in the near future.
“People are not going to change the way they consume, and that means we are going to continue to be an energy-intensive planet,” said Barbieri, which, he added, means there will be tremendous pressure on oil prices and biofuels and a lot of opportunities for investment in hydrocarbons. Over the next five years, he said, “it’s likely to be a one-way street for commodities in general.”
Finding defensive equities
The equity markets have been a tough slog this year, but there’s no shortage of ideas among the top long/short equity players. Leon Cooperman, founder of the $4.8 billion hedge fund Omega Advisors, is bullish on energy companies, Microsoft and E*Trade. “The issue is, what do you want your exposure to be?” he said. “I have a laundry list of things I like.”
Omega Advisors, which was up 12.51% for the year as of October 31, is long Atlas Energy, which owns a substantial portion of land in the Marcellus Shale, a natural-gas-rich rock formation that stretches from West Virginia to New York State. Earlier this year Indian conglomerate Reliance Industries spent $1.7 billion for a stake in Atlas and owns about 40% of Atlas’s operations in the Marcellus, making it an exciting investment, Cooperman argued.
Cooperman is also holding a large position in Microsoft—“They have an earnings increase of over 50%”—and in E*Trade, an opinion held by fellow panelist Michael Karsch, founder of Karsch Capital Management. “We were short E*Trade in 2007, so it’s a big change,” Karsch said. Despite a bleak outlook a few years ago, the company did not go bankrupt and has since cut its balance sheet in half. “It’s a great franchise,” Karsch added. “[There] will be a day when there will be multiple bidders.” Cooperman backed up Karsch’s sentiments. “I totally agree with the E*Trade position,” he said. “It’s a large position for us. Ameritrade or Schwab will buy them in a year.”
Karsch also shares Cooperman’s bullish views on energy companies and is long Williams Companies, a natural gas company. “It’s the cheapest stock I’ve seen in years,” he said. “The company just kicked out its long-term CEO and replaced him.” Plus, there are lots of exciting things happening in the pipeline business, he added.
“We’re pretty upbeat,” added David Craigen of Lansdowne Partners, a London equity-focused hedge fund with $15 billion in assets. Lansdowne is about 80% net long today, with its top 10 stocks making up 70% of its NAV. “We want to own businesses that are impervious to the biggest threat,” he said, referring to China. In Europe, he likes luxury goods companies such as Omega and Swatch. “We want to stay away from Chinese competitors.”
Craigen is also encouraged by CSM, a supplier of bakery ingredients and natural food preservatives, green chemicals and biopolymers. “It’s not a great business, but it’s the best in the sector.” As a hedge, Lansdowne is buying sugar futures and shorting peers.
Reviews on financials were somewhat mixed, although all agreed that the sector is troubled for the foreseeable future. “We’re underweight financials,” Cooperman said. “They’re very challenging. They’re on the government’s shit list and will be for a decade.”
Still, he sees enough opportunity to have a large position in Sallie Mae. “Eighty-five percent of the loans are guaranteed by the U.S. government.”
Hal Schroeder, portfolio manager at Carlson Capital, pointed out that U.S. financials such as Bank of America and Citigroup are extremely cheap, particularly compared with their Canadian counterparts such as TD Bank Financial Group and Royal Bank of Canada. “I’m more favorable to the big players in the U.S. than the big players in Canada,” he said.
The environment is totally different from two years ago, Cooperman said, noting that “2008 was a transformational year for investors. They got their guts kicked out.”
Distressed investing in an off year
Distressed managers were able to take advantage of the plethora of defaults last year as the economy struggled to regain its balance after 2008. This year the default rate has dropped significantly and has forced traditional distressed managers to look outside bankruptcies for opportunities. While those opportunities have helped boost the returns of distressed hedge funds—one of the best-performing strategies of 2010—managers are also excited about the looming wall of debt that will be maturing over the next five years, creating a rich opportunity set for investment plays in bankruptcies.
“Ninety percent of highly leveraged companies were able to amend and extend their loans last year,” said Jason Mudrick, chief investment officer at Mudrick Capital Management, a distressed hedge fund that manages $150 million. “These companies should have restructured, but they were able to scoot by.”
These highly leveraged companies are now enjoying a low interest rate environment and lax covenants, but that will come to an end as these new loans mature and companies are forced to restructure.
“Most of these companies do not feel the need to focus on these problems right now, which means they will all come to market at the same time,” said Chris Pucillo, headof Solus Alternative Asset Management, a $2.7 billion distressed and credit-focused hedge fund. “I am not sure the high-yield market is robust enough to handle the maturing wall of debt.” He added that collateralized loan obligations—which have been about 50% of the demand for new issuance over the past four years—are being phased out and will have a big impact on the number of defaults over time.
Regardless of how many companies may be forced to face their day of reckoning in the future, distressed managers are finding many opportunities to take advantage of now in structured credit, trade and litigation claims, the debt of companies in liquidation and the more traditional defaults and restructurings in small to midsize companies.
“There is a lot of structured credit that is in liquidation, particularly with failed financial institutions like Lehman Brothers,” said Jody LaNasa, founder and managing partner of Serengeti Asset Management, an $800 million distressed debt hedge fund. “Basel 3 will also force banks to sell off their structured credit and will lead to a cleansing of banks’ balance sheets,” he argued.
Dave Sherr, the founder of the $2.4 billion One William Street Capital Management, agrees. “Structured credit is not a trade where there is a limited horizon,” he said. “These assets no longer conform to the risk mandate for these institutions, and there is a need to transfer the risk to holders who have an expertise in underwriting complex structures.” He added that his firm is particularly focused on distressed residential and commercial mortgage-backed loans and securities, where there has been an increase in the number of delinquencies, but also where the market has yet to realize its losses. “There are five to six million delinquent homes in the U.S.,” Sherr said. “This is a process that won’t transition smoothly.”
Macro: timing the next bubble
Speaking just hours after the U.S. Federal Reserve Board announced its decision to buy $600 billion in assets—QE2 in market parlance—Paul Podolsky, a portfolio strategist at $85 billion Bridgewater Associates, said the United States is now in a “debt crunch” and there are only three solutions: printing money, defaulting or redistributing wealth.
“For the next couple of years, you watch the Fed’s quantitative easing, and you watch the trade-off between those three different choices, and they’re all terrible and they’re all unpleasant,” said Podolsky, noting that the government has been going back and forth between printing and defaults, and that higher taxes are likely next. “For holders of wealth it creates a very difficult situation to actually preserve that wealth.”
One result of government economic intervention may be bubbles. “QE expectations have been extraordinarily high, and we think by and large they’re priced into a lot of assets’ valuations,” said Anna Titarchuk-Berman, the senior credit strategist for Forum Asset Management, which is neutral on stocks and recommends gold but said her firm doesn’t own it because she doesn’t consider it an appropriate hedge fund investment. “You’re given money for free, and you are enticed to buy…QE does present to us this opportunity to buy optionality in asset classes where we think the bubbles are forming.”
Pro-growth policies are also weakening the dollar. “They’re using inflation expectations as a cyclical tool to get the economy out of its rut, and we think that’s dangerous,” said Karthik Sankaran, a principal at currency-focused fund manager Covepoint Capital Advisors. “It’s problematic for the dollar, and it drives people outside the United States absolutely nuts.”
So, what to use? “There is no safe currency,” said Podolsky. “What’s safe is recognizing the currency shifts and redenominating a portfolio on a mix of those countries that do not have a debt problem, and in hard currencies, things like gold—very primitive sources of money—make a lot of sense.”
KYLE BASS ON WHY DEBT MATTERS
Japanese, European and U.S. debt levels are awful, but Switzerland looks okay
| Kyle Bass: You can’t keep layering on debt and expect to grow |
Hayman Advisors founder Kyle Bass is more convinced of his bearish macro views than ever, but he—and his investors—are still waiting for the doomsday events to happen.
Bass repeated his thesis that if the world’s largest economies continue to run up huge deficits and pay for them by printing money, they could be on the path to significant currency devaluation, ultimately leading to inflation or even hyperinflation and then default.
Bass pointed to Japan as a prime example of a country whose debt far exceeds government revenues, and he has put his money where his mouth is, having launched a short-biased Japan fund earlier this year. He thinks Japan’s debt problems are so severe that the country will default within the next few years, and the yen, along with several other currencies, will be devalued. (Until then, however, the fund is losing money.)
“There’s a mathematical limit to the amount of debt you can take on. You can’t keep layering on debt and expect to grow,” said Bass of Japan, which is spending far more than its revenues even as the tax-paying population shrinks. “They’ve put themselves in a checkmate position.”
Bass doesn’t think the financial prospects for highly indebted European nations are much better, pointing out that the ratio of government obligations to revenues is still far too high in many countries, especially the so-called PIIGS—Portugal, Italy, Ireland, Greece and Spain.
Greece, for example, “has no chance of making it,” said Bass. “They will restructure in the next few years. It’s just a question of when and how big the disparity of the loss.”
But he had some rare optimistic words about Switzerland. “When you look at the rest of the banking system [apart from Credit Suisse and UBS, which became multiples of GDP], they don’t have banks go down,” said Bass. “Do you know why? Because the officers and directors of the bank become personally liable for the assets of the bank. So the give-a-shit factor is pretty high.”
America’s debt problems also aren’t as dire as those of Europe, said Bass, but they are nonetheless troubling. He said officials have told him the Fed is likely to print $5 trillion to $7 trillion.
A few hours after Bass’s speech, the Federal Reserve announced a plan to buy $600 billion of U.S. Treasury bonds.
“These guys are like a bunch of kids in the basement with a chemistry set, throwing some things together and seeing what the results of the experiment are going to be,” Bass said. That will lead to exporting inflation by printing money, he said, resulting in large cross-border capital flows and big moves in foreign exchange rates.
Worse, Bass said, the Congressional Budget Office’s economic outlook is unrealistic. The CBO, he said, assumes 6% nominal GDP growth and 10-year Treasury bills at 4.5% by 2014 and full employment by 2015. “If you were to draw up a utopian scenario, there it is,” Bass said of how Washington expects a $9 trillion deficit, which he believes is a gross underestimation. “I can tell you right now this is not going to happen.”
“We have two or three years to get this right,” said Bass of America’s fiscal woes, noting that Washington doesn’t have a Plan B if printing more money doesn’t work. “Unfortunately I’m not optimistic about it.”
And he does not believe politicians will solve the problems. “Every time I leave DC, I’m demoralized,” said Bass. “What’s going on there? The answer is: They don’t know what’s going on.”
Bass did note a silver lining to multiple sovereign defaults.
“When this happens, it will be the time to go all-in and be long,” said Bass, advocating the purchase of long-term government debt, equities and newly adjusted currencies. “That will be the time when you create generational wealth, but you have to make sure you have some capital to invest when that happens.”
Lawrence Delevingne
HINTZE FEARS REGULATION, LOVES THE MARKETS
The founder of CQS is optimistic, despite what he views as regulatory overreach
Michael Hintze: If you want to be realistic, it’s extend and pretend |
Michael Hintze, founder of the $8 billion London hedge fund CQS, and a Conservative Party backer in the U.K., is more worried about regulation than just about anything else. “Regulation is the greatest single uncertainty and risk in my view, more so than even the money supply,” he said, citing the new U.S. financial reform legislation as an example. “People love to say if we don’t regulate, we’ll have a rush to the bottom. Look, I’m all for rules. Without rules markets don’t work. But not 2,000 pages of rules as we’ve got in the current Dodd-Frank Act. Those 2,000 pages need to support 160 regulations,” he said. “And by the time you do get around to reading the various bits of it, the legislation’s flawed; those 2,000 pages then need to support another 160 regulations.”
Despite his concerns, Hintze remained optimistic about the investment environment.
“There’s a load of money out there,” he said, noting that the first round of quantitative easing by the United States and the U.K. had a positive effect on both credit and equity markets.
“I’m basically long,” said Hintze. “Why am I happy about the equity markets? I do have faith in the global economy. Balance sheets are being repaired. In the S&P 500 there’s a significant amount of cash still on the balance sheets.”
And while he had harsh words for global regulators, Hintze acknowledged that the unique regulatory environment that has been created out of the crisis has created opportunities. “They really have not wasted a good crisis,” said Hintze of the regulators. “They’ve used this [crisis] to go into very peculiar places, in my view. That’s led to a very interesting regulatory environment.”
The new rules are likely to affect hedge funds in unintended ways. They will change hedge funds’ ability to trade with investment banks and diminish risk capital, Hintze said, referring to the Volcker Rule. “The good news for us in the hedge fund world is that the money is coming our way,” he said.
Hintze also believes distressed investors will have a plethora of opportunities to choose from in the next three to five years.
“Why have there not been many high-profile bankruptcies out there? It’s because there’s been a lot of debt-for-debt exchange,” said Hintze. “That’s the nice way of putting it. If you want to be realistic, it’s extend and pretend.”
Hintze noted that the European distressed sector is particularly rife with opportunities. “The S&P shows that 80% of European LBO companies are behind in the EBITDA projections; 22% of those guys have defaulted. Thirty-three percent have breached covenants. And 18% have received [equity] injections,” he said. “The next three to five years is when the rubber will hit the road. I think there’s going to be enormous opportunity down the road.”
Hintze is nonetheless worried about the U.S. Federal Reserve. “We are in a situation where the U.S. currency is the global reserve currency. If you are the reserve currency and you are doing quantitative easing, what does that do to the rest of the world?”
And he came out strongly against further regulation of the financial industry. Despite his concerns about central banks and regulators, however, Hintze noted that markets evolve naturally, and after each crisis, people get smarter. Hintze pointed to Long Term Capital Management, which had to be rescued by the banks in 1998. “Do you think anybody will lend again the way people lent to LTCM?” he asked.
“Absolutely not,” he asserted. “The world has become smarter. We don’t need people doing regulation over regulation to make it better.”
“This is, frankly, for me, a very exciting world. People say the liquidity trade’s over, and I guess on one level, the macro trade’s over. But the micro trade is just starting to begin.”
Suzy Kenly
BRIGER FORESEES A GREAT LIQUIDATION
The Fortress co-chairman feels “like a kid in a candy store,” predicting he’ll reap immense profits buying distressed assets
Peter Briger: It didn’t all get fixed over the last two years with regulators waving their wands |
If you think the financial sector has stabilized since 2008, think again. The market is poised to experience a wave of liquidations among financial institutions unlike anything that has come before, according to Peter Briger, co-chairman and chief investment officer of Fortress Investment Group. “We’re going to see more financial asset liquidation, more debtor/creditor enforcement and more creditor-to-creditor litigation over the next five years than we’ve seen in the sum total of the last 100 years,” Briger said in his keynote address. “There’s going to be lots of litigation within the capital structure that’s going to make many people winners and many people losers who didn’t necessarily expect it,” he said, describing the scenario as a dream for credit investors.
Fortress has already been aggressively taking advantage of such opportunities. “I feel like a kid in a candy store. We’re buying assets today at prices that lead to unlevered returns that we never thought possible,” said Briger, who added that he doesn’t believe the best opportunities lie in the public credit markets. Rather, he views his role as that of a “financial services garbage collector,” snapping up busted hedge funds, failing banks and generally taking advantage of institutions that want to shed noncore businesses—and conducting these sales via privately negotiated transactions. Briger highlighted a few of the firm’s recent investments, including its acquisition of American General Financial from AIG and the portfolio of defunct hedge fund firm D.B. Zwirn & Co., among others.
Despite the perception that government lending, coupled with consolidation among many financial institutions, has finally created some stability, Briger believes the sector is nowhere near as stable as people believe it to be. “We went through the longest and most intensive easy money environment of our lifetimes,” he said, adding that it will take some time for markets to get back to normal. “It didn’t all get fixed over the last two years with the financial regulators waving their wands,” he said. Instead, Briger believes the true extent of problems within the financial industry are only now beginning to come to light, and that consolidation and liquidations will continue for the next few years.
According to Briger, assets for sale in the market already total $1.6 trillion—a figure that blows away the total of combined assets that were liquidated during the two biggest financial liquidations of the past century: the savings and loan crisis and the Asian default. “Just look at Royal Bank of Scotland. They’ve gone out publicly and said they’re going to liquidate that bad bank over the next two years—roughly $450 billion,” said Briger. “They’re going to liquidate more stressed loans, real estate and structured finance alone than either the S&L or Asia crisis.” He believes the number of assets for sale will climb to between $5 trillion and $10 trillion. “If you look at what’s going on right now, it is a full-scale asset liquidation that is just gearing up.”
For his part, Briger is predicting that many financial institutions will go bust and governments will have to sell their assets. That may sound like a doomsday scenario to some, but for Briger, it’s pay dirt.
Britt Erica Tunick
WHAT INVESTORS WANT
The power balance between investors and managers has finally shifted. “Investors are demanding more transparency, negotiating fees and terms, and looking for advice on building direct portfolios,” said Brian Gavin, senior managing director at Blackstone Alternative Asset Management, which is now the largest fund of funds in the world. Since many pension funds are investing directly in hedge funds, funds of funds need to be offering something extra in order to retain these clients.
One popular offering—customized portfolios—received mixed reviews. Gavin said that about half of Blackstone’s $32 billion assets under management is in customized accounts, where clients get to choose their underlying strategies instead of investing in an off-the-shelf fund. Two large pension fund clients recently asked Blackstone to build portfolios for them of hedge funds that have less than $1 billion in assets.
But Tim Berry, co-head of hedge fund investments at Private Advisors, said that the industry tends to go through fads and that customization could be one of them. Some speakers also said it would be easier to rebalance within a pooled fund of funds.
Speakers agreed that funds of funds should be nimble and provide access to more off-the-beaten-path managers and strategies. Many pension funds that are going direct are investing in brand-name managers, leaving it up to funds of funds to find lucrative emerging managers. “That’s what we’re there for,” Berry said.
“We’re looking for integrity, motivation and talent, and assets under management isn’t a very good proxy for those things,” said Jim Berens, managing director and sector specialist at Pacific Alternative Asset Management, a $9.6 billion fund of funds. He agreed that finding the up-and-coming managers who may not yet have a long track record or significant assets is an important role for a fund of funds.
Moreover, many of the star managers are getting close to retirement age, noted Alexandre Pini, portfolio manager at Geneva’s Banque Privée Edmond de Rothschild, which invests $11 billion in hedge funds. “You need to find those [emerging] managers because you can’t wait for the large ones to retire,” he said.
Even though many institutional investors are going direct, they are not bailing from funds of funds, said Jaeson Dubrovay, co-head of advisory services for the Americas for consulting firm Aksia. Most are building portfolios with a combination of single-manager hedge funds and funds of funds. But the latter have to offer customization, transparency and advice on going direct. “They [investors] should be able to unwrap the portfolios and see the exposures. They are using firms like Blackstone and Bridgewater to offer advice,” Dubrovay said.
Berry said that Private Advisors, which has $3.7 billion in assets and manages both hedge fund and private equity multimanager portfolios, is primarily interested in event-driven and distressed hedge fund strategies right now. Gavin is focused on opportunistic trading managers, fundamental strategies and long/short commodities funds, as well as some event-driven funds for Blackstone. PAAMCO is capital structure agnostic, but Berens said the firm likes event-focused, macro-aware, value-oriented managers.
Pini said that performance has largely eroded over the past 10 years. “The perception is that performance is no longer around and the equity market has been flat for the last 10 years,” he noted.
“If for the next few years hedge funds deliver 6% to 7%, investors will be pretty happy,” Berry added. “The very best asset classes are cash and patience right now.”
Anastasia Donde
