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Through the rear view mirror – hedge funds



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At the Conexus Financial Absolute Returns Conference, delegates were taken through the past decade of hedge fund history, and given insights into some current strategies by some of the best investors in the industry.

With global hedge fund investments sliding from just under $2 trillion in 2007 to under $1.5 trillion through the 2008 GFC, they stand at more that $2.2 trillion today and continue to grow, session chair Travis Schoenleber from Cambridge Associates said.

Compared to the S&P200 Equity Index, the hedge fund industry performed well, and provided some capital protection in the GFC in 2008.

The past five years have not been as good. In 2012, hedge funds represented only about 50 per cent of upside capture in the equity markets, and that figured dropped to less than 50 per cent and down past 33 per cent through to 2014. In 2015 and 2016, the industry was down slightly while the equity markets were up.

Fees have come down over the past decade on the back of declining performance. In 2007 the industry was averaging 19 per cent performance fee and 1.7 per cent management fee; in 2016 the performance fees are down to 16.5 per cent and 1.34 management fee, primarily due to global pressure from investors in hedge funds.

Craig Dandurand, director, debt and alternatives at the Future Fund, outlined his approach to investing.

With a hedge fund allocation of more than 13 per cent of the Future Fund’s portfolios, representing more than $15 billion, Dandurand explained that investors needed to have a clear objective in place.

“Hedge funds remain a real diversifier,” Dandurand said. “The primary approach we have taken with that portfolio, since its inception, is to really think about what makes the most sense in the context of an overall portfolio. Where is that value being generated, and where can we get as much of it as possible? Not a low fee, but as good a value as possible?

Manager allocation

Kate Misic, head of alternatives at Telstra Super and with a hedge fund allocation of more than $650 million, representing about 4 per cent of the portfolio, kicked off with manager allocation.

“We take an approach of investing through outlay multi-strategy managers, and then we add some other managers to try to get to our regional or strategic allocation goals. We’re pursuing very moderate returns. We’re not really trying to shoot the lights out with the program, it’s really about being a diversifier.”

Bruce Tomlinson, portfolios manager at Sunsuper, spoke about how Sunsuper has had a hedge fund strategy for about 10 years. Its allocation to hedge funds is about 6 per cent of its $33 billion portfolio.

“We’re about it being diversifying, and it being a defensive, alternative program, so we’re not looking at growth-like returns; we have separate growth alternatives to do that.

“We have also focused on macro trading strategies; historically, not so much recently, we had a lot of credit – both relative value and also specialist closed-end credit; and then we have a small amount of event-driven and long-short, but that’s less than about a third of the program. So quite defensive, looking for cash plus 4 or 5, minimum fees.”

“There’s no doubt as the GFC rolled through, and then you had central banks and regulators clamping down on banking activity, we really tried to take advantage of banks pulling back and reducing their credit activities, and we’ve looked to invest in a range of credit strategies, effectively bank replacement type strategies, so credit, both more liquid relative value and special sits, closed-end type fund credit, is now almost 50 per cent of our program, and macro is less than 20 per cent. So it’s changed a lot – back in 07-08 macro was more than 50 per cent.”

Misic explained that Telstra Super was already invested in the hedge fund industry over a decade ago through a fund of funds, but moved to manage it itself.

“The first change was a decision to move to manage the asset class directly,” Misic said. “It was driven by too much diversification and too much equity beta that was coming through the fund of fund side.

Global team ‘on the ground’

Unlike Sunsuper, Telstra Super did little work on its hedge fund program through the GFC, and so most of its work in the area has been with the GFC behind it.

“We had a look at how we might have support from consultants and tools, and that’s a big change – moving to specialist alternatives consultants. It has been great for me to have an entire team on the ground globally, my eyes and ears, and also the tools we have in place to be able to monitor and understand our portfolio. The whole industry has evolved and developed very nicely over the last 10 years.”

Since Telstra Super started investing again in 2011, the biggest change has been following the really strong beta returns.

“We’ve been more critical about any new allocations, what the beta allocation are, and really trying to make sure those new funds are trying to diversify under more uncertain conditions.

Dandurand, who 10 years ago was at CalPERS, spoke about the contrast between his experience at CalPERS and his current role at the Future Fund.

“At the time, CalPERS had a fully functioning hedge fund program, but it was one that was in a constant state of flux. It was about having analysis into where we could we generate material value-add for the fund and do it in a reasonably diversified manner, but the emphasis between alpha and correlation really did ebb and flow over time. And so, ironically I think, where CalPERS ended up with its hedge fund portfolio before it ended up with no hedge fund portfolio at all, isn’t all dissimilar to what the Future Fund is trying to do with its hedge fund portfolio.”

“As the portfolio evolved it migrated from more or less a pure long-short equity portfolio to on that had a multi-strat dent, and then in ‘05 and ‘06 we added fund of funds to it, which is kind of the reverse of what people tend to associate with a build out of an institutional fund of fund program.”

He explained that it was part of a core-satellite approach, and included the hiring of nine fund of funds.

“Our lesson from 2008 was that fund of funds can be extremely valuable if they aren’t thinking the same way you are. Our hedge fund portfolio at the time was very heavily multi-strat, very heavily event driven and equity beta centric, and it got hammered.

“The problem with a lot of plans is working out what the next step should look like. Trying to constantly figure out what do we have, what do we need, and how do we get there? And that’s the same thing the Future Fund does, that the alternative portfolios we now have look nothing like it did three years ago when I joined. And it looked then very different to what it did in 2009 when it was created.”

Constant change

On the topic of self-measurement, given the portfolio has been changing so much, he said it’s about working out what the portfolio needs at a given point in time.

“One of the more significant changes in our alts mandate in the three years I’ve been there is the idea that having essentially a significant distress and event-driven, heavily corporate security loan-biased portfolio doesn’t add that much diversification benefit, but it can add unnecessary liquidity, and it can add a high cost and access point to something that, in the context of an overall Future Fund portfolio, doesn’t add that much diversifying value.

“Where are we now? Our view toward macro is that it is one of the rare areas where you can have someone who is congenitally negative about the state of the world and can actually get paid to feel that way. Most other asset managers are predisposed to things getting better, or things growing. I need cranky people in my portfolio.”

Misic outlined that although recent returns have been disappointing, the strategy has achieved its long-term objectives.

“I’ve had performance more recently in line with the industry, in that it’s been disappointing, but since the program’s inception we’ve delivered exactly the objectives of the program.

“In terms of the types of ways that we measure it, we’re constantly turning the portfolio over in our hands and looking at it through all the different lenses that we can to make sure that we’re all over it and understand it the best that we can with the tools that we have.

“What’s getting me excited is constantly getting through the work plan of where we want to take the portfolio now. Trying to find multi-strats that have low beta – it’s not that common – and generally we’ve been finding them and having great dialogue with them.

Working in the smaller level requires far much research and insights, including travel to some more regional areas.

“We travel very extensively. We’re now doing I think six trips a year overseas, and we go to some quite far flung places to try and better understand what’s happening on the ground where these assets and these companies are actually going through some distress,” Tomlinson says. “You’ve go to go beyond New York and London to really understand the opportunities and to underwrite the investment strategies when you’re being pitched them.

“There are wonderful opportunities. We talked about bank deleveraging, and there is excess everywhere and there’s growing stress as we can see. We’re pretty optimistic about the future.”



This article was updated on 26/09/16 to correct the byline.