Previously published by Elevator.
Editor, Patrick Gruhn discusses the impact of the current world financial crisis on the Alternative Investment fund Industry with Julian Stockley- Smith, Joint CEO of Geneva based JP Fund Services SA
In Tom Wolfe's 1987 book "Bonfire of the Vanities", lead character high flying investment banker Sherman McCoy is a self stylised 'Master of the Universe'. Wolfe recently describes how the mantle has shifted from Investment Bankers to Fund managers in a New York Times article (September 2008) and we can reflect on whether they are likely to suffer the same fate as those from the investment banking industry.
Question
Most people with investment experience have a clear understanding of the role of mutual funds but it appears there is some confusion to what an alternative investment fund is; can you give a brief review of the differences?
Answer
A mutual fund is a pooled investment structure normally for retail investors. It is restricted in what it can invest in, for example 'long only equity', and is subject to strict regulatory and reporting obligations and definitions that differ depending on jurisdiction.
Alternative Investment (Hedge) funds were developed 50 years ago to give more flexibility to investment strategies using derivatives and other trading instruments; in return they are restricted to investments from sophisticated or accredited investors and not subject to strict regulatory oversight regarding trading strategies. The use of the word 'Hedge' in the name is rather misleading as they generally are not set up as 'hedged' investment structures; another reason 'Alternative Investment Strategies' is increasingly being used.
Question
Well, it's an understatement to say the financial markets are in uncharted territory. As a service provider to this sector what are your observations on how the current financial crisis has affected the Fund industry to date and how has it affected your business?
Answer
Alternative investment fund performance has broadly reflected trends in the global financial markets and although some managers employing contrarian investment strategies have generally performed very well in the current turmoil, the industry has not been immune to plummeting values. Research indicates that alternative investment funds in 2008 have (on average) borne losses equating to 18 – 20% of assets under management however this looks rather good when compared to financial market indices, for example the S&P 500 and the CRB commodities index were down around 40% on the year. There have been casualties and there are estimates that the assets in alternative investment funds will decrease by 30 – 50% compared to the beginning of 2008 from a combination of market losses and redemptions. Anecdotal evidence suggests that many investors are withdrawing from funds not because of poor performance but because it is one of the most liquid parts of their investment portfolio. Combine this with the bad press surrounding rogue managers like Bernie Madoff, even though he wasn't running a fund, and it still looks challenging for the industry going forwards.
From a business perspective, as a service provider, we still find many investment managers looking to establish hedge funds but are generally waiting to see where the markets are going to settle, there is an additional challenge to secure investment capital. However, we also see opportunity as investment managers look for lower cost solutions and to outsource activities previously undertaken 'in house'.
Question
There seems to be mixed press about alternative investment funds, is it warranted?
Answer
There are a couple of points to note; the alternative investment fund industry in general does not run an effective public relations campaign and it is restricted by law from any form of mass marketing. Couple this with the fact that fund managers often revel in the mystique and air of complexity that surrounds the industry and the result is a target for media sensationalism, disgruntled investor groups and politicians looking for someone to blame for the demise of financial market stability around the world. Assets in alternative investment funds only equate to around 10% of assets in global equity markets, not all use leverage in their trading strategies and their role in affecting equity market drops by short selling is questionable; in reality they are probably more a victim of system failures like others, rather than causing it.
Question
Are we seeing the beginning of the end for the alternative investment business?
Answer
No; and even in these market conditions, it appears that fewer 'alternative investment strategy funds' are closing than expected. Pension and superannuation funds, institutional investors and high net worth private investors will continue to need avenues of investment in the future, ''alternative investment structures' are currently important vehicles to make it possible to target specific sectors in an efficient and increasingly transparent manner. Some pundits estimate there is around 3 trillion dollars of investable cash awaiting appropriate timing to re-enter the market place. We have been pleasantly surprised by the consistent level of inquiry for new funds from managers looking to take advantage of opportunities exposed by current markets.
Question
There are suggestions we need to see stronger regulation over hedge funds, do you agree with this approach?
Answer
We would be very supportive of more sensible application of regulation in general; on one hand we're overburdened with compliance for money entering funds as many investors are excluded from a full range of investment choices for their own 'protection'. If we assess the effectiveness of the global regulatory environment encapsulating mutual funds, many investors argue that if current results reflect effective regulation, they'd rather do without it.
It is interesting to observe the generally overzealous nature of regulators and burdensome costs forced upon professionals who follow the rules while regulators often bypass those who ignore all common standards of honesty and decency. New York Democratic Rep. Gary Ackerman, summed up many people's thoughts through his comments related to the Madoff inquiry and the role of senior SEC officials when he stated "You couldn't find your backside with two hands if the lights were on... You have totally and thoroughly failed in your mission,"...
We would prefer to see more enforced use of independent directors, independent fund administrators and independent brokers; just as entry barriers for investors are excessive, controls over investment manager accountability are worryingly absent. Investors should be sure that adequate, independent safeguards are in place before they invest.
This is an opportunity to improve a successful industry; a fund is the only way to develop a scaleable investment pool into which people can invest.
Question
Given that you expect the ongoing success of this sector of the industry, what changes do you anticipate and where do you see yourselves in this?
Answer
It is clear that there is increased cost consciousness in setting up and running alternative investment funds. Some elements of the industry are complacent and poor returns are exacerbated by the high level of establishment and running costs of funds precisely the premise upon which our business is built . From an investment perspective, managers are likely to take a cautious approach to investing with lower levels of leverage and less focus on chasing pure alphain illiquid assets; redemption terms will more accurately reflect the liquidity available in difficult market conditions. Investors, on the other hand, should conduct significantly increased due diligence on investment managers, investment structures and documentation; greater transparency will be essential.
From a macro perspective, the industry is likely to trend towards a concentration at top end and bottom end levels of assets under management with larger multi strategy funds and increasing numbers of smaller single strategy or asset class funds.
Our company is ideally placed to service the new breed of hedge fund manager who will demand a reasonably priced structure in a short amount of time. We are also ideally positioned with our ability to provide the requisite, well regulated independent administration, auditing and banking services that will become market norms.
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