Spanish investors wax lyrical over new hedge fund industry

It has been a long time coming, but it seems it’s been worth the wait. The Spanish hedge fund industry has taken off with new products already in the market and many others soon to be launched. After years of debate surrounding the introduction of the legal framework regulating the Spanish hedge fund industry, and numerous discussions about the quality of the final regulation itself, fund managers and distributors seem to be happy with what they finally have. For many of the speakers and delegates attending the European Fund Series – Spain conference celebrated in Madrid last month, the new regulation is not just good but “the best in Europe”, with some even going a step further to describe it as “the best in the world”. Coming together The event – a collaboration between BNP Paribas and PWM – attracted the most important manufacturers and distributors present in the market and analysed the opportunities and challenges that the new investment products will present to the country’s fund management industry as a whole. To date, most of the largest players in the market have already launched hedge funds, in particular fund of hedge fund products, that are now trying to push down the distribution network. In order to this, some of the local players have started partnerships and joint-ventures with international fund management houses with years of experience managing alternative assets. Although volumes are still small, the general expectation is that there is significant potential for growth in the medium term, driven not just by institutional demand but, eventually, by the retail sector as well.

Martínez-Aldama: still early days

“Growth [in the new sector] has been slow and linked to all the recent regulatory developments,” says Ángel Martínez-Aldama, director at Inverco, the Spanish association of pension and investment funds. “Only very few institutions decided to launch funds of hedge funds, or single manager funds, at the end of last year and it’s still early days to say how far this can go.” Mr Martínez-Aldama explains that as of May there were only seven hedge funds registered with the regulatory body – the Comisión Nacional del Mercado de Valores (CNMV) – and some 20 funds of funds. “It’s too soon to talk about estimates of future growth and it will very much depend on what managers think a hedge fund should be and what type of risk they are going to have. If the risk profile is very low, then there will be more distribution, but if the new funds have a higher value at risk (VaR), distribution will be more difficult.” He notes that growth rates in Italy since regulation on hedge funds was introduced have been very high because the large majority of products on offer are funds of hedge funds, simply distributing foreign funds with very low risk profiles. “I don’t know if that is how the Spanish industry will look in the future, but that’s something for the gestoras [or fund management companies] to decide,” he said. Late comer Mr Aldama believes that joining the hedge fund trend at a later stage has allowed Spain to learn from other country’s mistakes. He mentions, for instance, Italian regulators’ headache when it came to establishing minimum investment limits for this type of products, and some distribution difficulties experienced in the German market. “We have a framework that in some aspects is more flexible than those in place in Ireland or Luxembourg, for instance when it comes to minimum investments. So I think we are well positioned.” However, he adds, it is unlikely hedge funds end up being a ‘star product’ for Spanish gestoras and distributors, “but it is another product they are now able to offer and it was very important to have it regulated”. Independently of the potential future size of the sector, the introduction of hedge funds in the market has already had a significant impact on all the different players involved. According to Javier Nuñez, chief executive officer (CEO) of the Madrid operation of BNP Paribas Asset Management, everyone wanting to break into this market will have to meet the requirement established by the CNMV. “In many cases this means investment in technology, models, tools and also investment in human capital. So these are the first barriers to entry.” Staying local Mr Nuñez says the collaboration between local and international fund managers in putting together hedge fund products for the Spanish market is happening but mainly in the fund of funds arena. “It’s likely we’ll see single manager funds being launched by traders who might have worked for a bank in the past and also by people who might have a lot of experience in the fixed income area. So in the single manager area I don’t think collaboration with international firms is that necessary,” he explains.

Nuñez: collaboration is not necessary in the single manager area

However, when it comes to funds of funds, joint ventures with managers with years of experience in other markets and high volumes will be commonplace. “In funds of funds, practically everyone will go hand-in-hand with an international advisor, in our case Fauchier Partners, not just for the management of the fund but also the outsourcing of fund administration, something that’s not easy.” Mr Nuñez says that the next few months will be very important for the future development of the industry and that it is crucial that none of the products being launched fail. “I think that’s why the CNMV is going to look very carefully at every single project presented to them.” He expects the first products in the market will have quite low risk profiles, more focused on low volatility and capital preservation. “But as the market develops, we will see more innovation and more aggressive products.” Antonio Viola, CEO of Altitude Investments, the funds of hedge funds joint venture between BBVA and NewFinance Capital – part of Schroders – thinks the best thing about the Spanish regulatory framework is that it includes every type of investor, from institutional to retail, “and that is quite unique, not only in Europe but also further afield”. Today, Altitude has managed to attract more assets than any other of the gestoras that have launched hedge fund products in the recent past. “We want to be one of the main players in this market, but we have a lot respect for our competitors because we are convinced that the products that are being developed are going to be of very high quality.” At present, institutional investors, including private banking clients, are the main buyers of hedge funds in Spain and some believe retail networks are unlikely to see any major pick up on demand. “To start with, the demand from the retail sector is going to be small because of the lack of knowledge about the product,” says José Manuel Gutiérrez, CEO at CM Capital Markets. “Pension funds will invest in this and we all know that internationally institutional investors represent the vast majority of assets under management in hedge funds.” Facing changes At Ahorro Corporación, director of alternative investments Enrique Pardo believes in a potential growth in retail distribution of hedge funds but identifies several changes that distribution networks and investors will have to face. “I think it is possible to bring the benefits of hedge fund to retail investors. But I also believe that one of the mistakes we are currently making is to analyse the future of the hedge fund sector in Spain based on the potential demand from investors and how distribution networks are going to respond to it,” he says. “We are falling in the trap and we face the danger of becoming prisioners of the distribution networks.” He believes the regulatory framework presents the market with a fantastic opportunity to really develop an efficient, strong and attractive hedge fund sector “and we have to make the most of this opportunity”. At Allfunds Bank, director of investment consulting Borja Largo is also cautious when analysing the possibility of retail investors buying into hedge fund products. He believes that for the time being these products will not attract mass demand, adding that investment funds themselves – which are allowed to invest 10 per cent of their portfolios in alternative assets – will be one of the biggest investors in the new hedge funds. For the retail distribution networks, dominated by the very large banks and cajas, the focus is now on education, not just on the specifics of particular products, but more about hedge funds as an asset class. “Our strategy is to focus on distributing these products in an appropriate manner,” says Mr Pardo. “We don’t want to focus as much on details about the funds themselves, but more on educating our network about hedge funds in general, so they can inform clients about the role these products can play in their portfolios, how can they contribute to increased returns and diversify risk, and also explaining some trade-offs such as less liquidity and lock-ups.”

Viola: Spanish regulatory framework includes every type of investor

Other distributors, such as private banks, are also focusing on improving the knowledge about hedge funds among their staff and clients. “Individual investors in general know very little about hedge funds,” says José Manuel García de Sola, managing director of private bank Banco Banif. “The same happened in 1994 with fixed income funds. People didn’t understand how they worked and panicked when interest rates went up.” He believes the market will eventually get there and grasp the very specific nature of hedge funds and he is positive about future developments in the area.“I am very optimistic about future growth, not just coming from private clients but also retail. I think hedge fund management is the purest form of fund management. The fact that we can talk to clients about absolute returns will attract a lot of interest.” Another issue investors are trying to come to terms with is everything related to fees, especially taking into account that funds of hedge funds are the products that will carry on dominating the market. Mr García de Sola doesn’t think higher fees will put clients off but he adds that in some cases clients will have to familiarise themselves with different fee structures, including front fees. Extra costs “Companies like ours, which operate under an open architecture structure, distribute third-party products and that carries an extra cost,” he explains. “Normally in the hedge fund industry there is no rebate to pay the marketer and clients might need to get used to paying a front fee.” Allfunds’ Mr Largo says: “Distribution is key and distributors need to have some incentives to push this type of product. We will have to find a balance between all the parties involved and I think performance fees are a good way to achieve that. My concern here is that I am not certain if everyone is able to calculate performance fees correctly and if they are not they will have to delegate that to a third party.”

‘Distribution is key and distributors need to have some incentives to push this type of product. We will have to find a balance between all the parties involved and I think performance fees are a good way to achieve that’ - Borja Largo, Allfunds Bank

Another crucial issue that involves delegation is fund administration. The large gestoras will normally have their in-house divisions but in some cases have limited experience in dealing with alternative asset classes and especially hedge funds. “Gestoras moving into the hedge fund sector are facing two challenges. First of all, they have to find an investment adviser to help them with the management of the fund and then they have to outsource the fund administration, mainly to the big players in this market if they don’t have their own,” says Santiago Rubio de Casas, director of fixed income and alternative assets at Invercaixa Gestión. At BNP, Mr Nuñez admits his gestora is very fortunate to have a company within the same group specialised in fund administration – BNP Paribas Fund Services – that has also been chosen as fund administrator by some of other hedge-funds recently launched by competitors. “Choosing the right fund administrator is absolutely crucial, even much more so than choosing your advisor,” he says. “The intention of the CNMV, and our own commitment, is to develop this industry in Spain. At the moment, we are using what we have elsewhere, sending people to Luxembourg and learning from them, but always with the commitment that, eventually we’ll be able to do it from here.”