Australian hedge funds rise as sector struggles

Transcription

1 Australian hedge funds rise as sector struggles Local hedge fund operators are having their time in the sun. TaiChesco by James Dunn It sounds bad. After Britain s shock decision to leave the European Union, global investors withdrew $61 billion from hedge funds worldwide. It was the sector s largest recorded net outflow since the global financial crisis, says research firm evestment. Headlines such as these give the appearance of a hugely volatile sector where sentiment rules. But among Australian hedge funds, where variations on long-short strategies are the dominant, the industry is moving from strength to strength. Daniel Liptak, principal at alternative investment consultancy Arkaba Advisors, says Australian hedge funds are seeing strong flows from throughout the world as investors here and abroad come around to their quality. The stockmarket looks expensive, interest rates are at record lows and bond prices are really high, but investors still need to invest money and absolute return equity strategies look appealing.

2 According to research firm Preqin, long-short or absolute return equity strategies (which promise returns in all market conditions) are by far the most common strategy among local hedge fund managers, accounting for 51 per cent of funds. The next most-preferred strategy equity long bias (where long positions outnumber shorts) is utilised by 19 per cent of managers, while 9 per cent use equity market-neutral strategies (in which long and short positions cancel out). Australian hedge fund managers do not on the whole favour non-equity strategies, with 12 per cent of managers using managed futures/commodity trading adviser (CTA) strategies and a further 10 per cent applying global macro strategies. Opportunities alive and well A bird s-eye view of the sector shows why investors are warming to Australian equity-based absolute return funds. Chris Gosselin, chief executive of research house Australian Fund Monitors, says the average Australian equity-based absolute return fund earned 8.5 per cent over the 12 months to August 31, versus 9.3 per cent for the S&P/ASX 200 Accumulation Index.

3 However, averages can be deceiving, says Gosselin. While almost 60 per cent of all funds have outperformed the S&P/ASX 200 Accumulation Index over the past 12 months, individual fund returns have ranged between -45 per cent and 169 per cent. The opportunities to gain excellent returns are alive and well, frequently with lower risk than the ASX and individual stocks, provided you do your research correctly, says Gosselin. Although the performances can vary wildly from fund to fund, Liptak says the absolute return equity case is all about outperforming the benchmark (or delivering alpha) with far less volatility. Earlier this year I put together a fund of market-neutral funds for a client. Net of fees and construction costs, that fund was showing a return of 12 per cent to 13 per cent a year with 4 per cent volatility, going back to January That s alpha of about 10 per cent a year, with volatility about one-third that of the stockmarket. In a low-return environment that sort of investment makes its own case, Liptak says.

4 If people are just looking at the headlines about hedge fund outflows which basically refers to the US market they re missing the story, he says. Gosselin says an index of 74 equity long-short, equity market neutral and equity 130/30 funds investing in Australia (and potentially New Zealand) has returned 12.1 per cent a year (net of fees) since October That compares favourably to the S&P/ASX 200 Accumulation Index s return of 8.4 per cent a year, with volatility (annualised standard deviation) of 8.7 per cent to the S&P/ASX 200 Accumulation Index s 12.9 per cent. Gosselin s index shows 69.5 per cent positive months, compared with the sharemarket s 62.1 per cent, and the largest fall of the hedge fund index, at 25 per cent, compared with the sharemarket s fall of 47.2 per cent.

5 The average positive monthly return of the sharemarket, at 3.1 per cent, is larger than that of the hedge funds, at 2.2 per cent, but the average negative monthly return of the hedge funds, at 1.8 per cent, is less than the sharemarket s 3.1 per cent. Avoiding large drawdowns and having smaller negative returns makes a significant difference to longer-term performance, says Gosselin. He says absolute return funds have lower volatility and a much higher Sharpe ratio (a measure of how much return a fund has generated per unit of risk), at 0.9 versus 0.4. At the end of August, the Tribeca Global Natural Resources Fund managed out of Sydney topped Preqin s global ranking of long-short equity funds, with a 113 per cent annual return the first time an Australian fund topped global rankings.

6 Looking for alpha These attractive characteristics have not been overlooked. Overseas investors are noticing that some Australian hedge funds are delivering strong returns, when global hedge funds are struggling, says Tim Bolger, chief operating officer of Watermark Funds Management. They re very keen to look for alpha, adjusted for risk, he says.

7 In the global context, Bolger says a Sharpe ratio above one is considered outstanding: he says Watermark s peer group of about half-a-dozen market-neutral funds have an average Sharpe ratio of 1.6. Rodney Sebire, head of alternatives research at Zenith Investment Partners, says the best funds in the absolute return equity space have been able to build up strong long-term track records. The two standouts would be Richard Fish s Bennelong Long-Short Australian Equity Fund, which has returned 18 per cent to 19 per cent a year since 2003, and Phillip King s Regal Funds Management extension (150/50) strategy, which has been a 20 per cent-plus-a-year proposition over a long period of time (inception in 2009). They would be the two most successful home-grown funds, and they ve got really strong global recognition, says Sebire. The Bennelong Kardinia Absolute Return Fund is another popular long-short fund. It s never 100 per cent long, it s looking to achieve double-digit rates of return, benchmarked against the RBA cash rate, but even it is pretty much considered a mainstream fund now, says Angela Ashton, director at specialist alternatives investment consultancy Evergreen Consultants. Since inception in May 2006, the Bennelong Kardinia Absolute Return Fund has returned 11.7 per cent a year, yielding 7.6 per cent above its benchmark. The long and the short Another hedge-fund area gaining a lot of interest from local investors is the managed futures/commodity trading advisers (CTAs) sector. It takes long or short positions in futures contracts across asset classes such as commodities, bonds, currencies and equities, in only the most liquid markets, to exploit trends and price momentum. Managed futures/ctas have come into the spotlight in recent years because they are agnostic over market direction, and should be able to produce stable returns in rising and falling markets, says Sam Morris, senior investment analyst at Lonsec Research. These strategies are long if the trend is rising, and short if the trend is falling, whatever the asset class or market. Since the global financial crisis, this space has seen pretty steady growth in Australia. They don t take a macro view, they performed well in the GFC because they were short risk when the markets tanked, and then signals on the models turned around and they went long equities as markets reflated. Morris says retail, SMSF and high net worth (HNW) wealth is flowing steadily into this area.

8 The big funds in this area are global managers that are accessible through the major platforms, such as Winton Global Alpha Fund (linked with Macquarie), Aspect Diversified Futures Fund (linked with Colonial First State), Man AHL Alpha and AQR Managed Futures Fund. Managed futures is now a widely accepted sector, and it s global exposure that can give an Australian portfolio the low correlation to equities that it needs, says Sebire. In that sense it s a bit like global macro funds. It s actually difficult in these sectors for a manager from the Australian time zone to do a really good job. There is one very good macro manager, GMO, in Sydney, but generally it s problematic, he says. The independent financial adviser market is one group that is using managed futures/cta funds more than ever, says Ashton. The low-return environment in the mainstream asset classes has allowed this kind of fund to show its worth. The big adviser groups are starting to use the big funds like Winton on the approved lists. Allocating to skill The driving force of diversifying portfolios that are heavily weighted to Australian shares and property may be increasing interest in hedge funds in the retail, SMSF, HNW and family office sectors, but super funds on the whole seem indifferent. An ASIC report from 2015 found the Australian hedge fund industry held just under $96 billion of assets, or less than 4 per cent of four total managed fund assets, with $84 billion in single-manager funds and $12 billion in funds-of-hedge-funds. According to the Australian Prudential Regulation Authority (APRA), at June 2016, the nation s superannuation system held total super assets of $2.11 trillion, with just 4.1 per cent of that invested in other assets, a category that includes hedge funds and commodities. Super funds were late starters in the sector following family offices and HNW investors into hedge funds in the late 1990s and have looked mainly overseas to the big managers for their exposures. However, in recent years another investment approach has provided an interesting contrast: that of the nation s sovereign wealth fund, the Future Fund. From the outset, Future Fund which began its investing life in mid-2007 turned the usual approach of such vehicles to asset allocation on its head. Instead, Future Fund s statement of investment policies envisioned 30 per cent of its holdings in tangible assets defined as property, infrastructure and utilities, in listed or unlisted form and 20 per cent in alternative assets, which included skillbased hedge fund investments.

9 Following this strategy, and beginning its investment program in the midst of a fullblown global investment crisis, made Future Fund a major player in hedge funds right from the outset. At one point, Future Fund had 20 per cent of its portfolio in alternatives, mostly in skill-based hedge fund strategies. But it has dialled that back, to 13.7 per cent at June 2016, which represents a hedge fund portfolio of more than $16.8 billion easily the largest such program in Australia. But Future Fund has faced the bugbear of hedge fund investors trying to identify where skill actually exists, and where it doesn t, discarding managers who it decides do not exhibit skill and redirecting those funds to managers who do. Zenith s Sebire says Future Fund s allocation is closer to the ideal than that of the super funds. We think that having 15 per cent of a portfolio in hedge funds is appropriate. Where we construct portfolios for our implemented portfolio consulting clients, we generally have an allocation of about 15 per cent to hedge funds, he says. Sebire sees the hedge fund allocation as a diversifier and a source of returns. Ideally, we try to identify assets that are going to perform differently when equities are going down we re looking for returns that are independent of what the equity market is doing, he says. In a low-return, low-interest-rate environment, this becomes even more pressing an issue than ever. If the market returns are going to be low, to do better than the market return you ve got to be doing something significantly different to the market. In the heyday of hedge funds, 2 plus 20 was the norm: the hedge fund manager charged an annual management fee equivalent to 2 per cent of assets, plus 20 per cent of any outperformance generated over the fund s benchmark. Investors put their foot down If you tried to put a 2-plus-20 fund in front of the big dealer groups investment committees, they d laugh at you, says Sebire. Since the global financial crisis, investors have been less and less prepared to put up with that, and there has been a lot of fee compression, driven by advisers, researchers like us, but ultimately, by investors. Globally, says research firm Preqin, lower recent performance, high-profile redemptions and increased concern from investors on the issue of fees have influenced many hedge fund managers to bring their fees down.

10 Preqin says only 35 per cent of the hedge funds it monitors worldwide still use 2-and- 20: the average management fee is now 1.57 per cent, although the performance fee remains high at per cent. New funds have had to move even lower to compete, with average fees of 1.53 per cent and per cent respectively, Preqin says. A low-return environment only heightens the increased fee sensitivity. You can t charge 2-plus-20 if you re delivering 6 per cent to 7 per cent, says Sebire. We have a rule of thumb on what s fair and what s not: if the manager wants to keep 1 per cent, they ve got to give the client 5 per cent. We think about 20 per cent as a manager share is fair. Sebire says the performance fee may be on the way out, noting several British funds that have opened recently that charge a flat fee of basis points, with no performance fee. We re hopeful that is a trend that will continue, he says. Morris says the big managed futures funds still have hefty performance fees, but fee structures have come down. At present they are: Winton Global Alpha Fund annual fee of 1.88 per cent plus performance fee of 20.5 per cent; Aspect Diversified Futures Fund annual fee of 1.61 per cent plus performance fee of 20 per cent; Man AHL Alpha annual fee of 1.85 per cent plus performance fee of 20.5 per cent; AQR Managed Futures Fund annual fee of 1.3 per cent plus performance fee of 10 per cent. Liquidity the key Before the GFC, much discussion of hedge funds centred on what lock-up conditions on investors money were fair. This has gone the way of the 2-plus-20 fee structure: liquidity is essentially a requirement in the Australian hedge fund marketplace. Anyone offering a retail fund cannot have investors locked up for any significant length of time. There are a variety of methods managers use to manage liquidity and redemptions, but the market looks for and rewards greater liquidity. In particular, retail investors need daily liquidity, if they can find it. Liptak says there is a huge untapped demand for absolute return funds with the liquidity of a stock exchange listing. I was involved in the $100 million raising for the Absolute Equity Performance Fund Limited listed investment company last year, and I was very surprised by the massive demand.

11 Liptak knew there would be strong demand for the fund (ASX code: AEG) because it was offering access to the same investment strategy and manager as the Bennelong Long-Short Australian Equity Fund, which is closed to new investors; but even so, he got a shock. We could have raised multiples of the $100 million capacity we had. The amount of calls from investors was staggering people wanted absolute return funds but they needed them with the liquidity of the stockmarket, he says. When we said, We can t give you any more of AEQ, they asked, What else is out there apart from yours? It showed me that there is a whole untapped market out there that wants access to quality absolute return long-short funds, either through the LIC or exchange-traded fund market.