Providing a safe pair of hands

Leading listed alternatives player Man Group – currently in the midst of acquiring rival hedge funds operator GLG in a deal that will boost assets managed by the combined entity to $63bn (€51bn) – is unusual amongst its peer group.

Much of the new money flowing into its funds has been coming from private banks’ clients rather than traditional institutions such as hedge funds.

The Swiss-based group’s head of distribution John Bennett points out that core business for Man has always come from high net worth individuals, with institutional flows only gaining strength following the acquisition of RMF in 2002. But there has been an even more important driver since the crisis.

“In terms of which provider is preferred by private clients, there is a great deal of comfort in going to houses which are a safe pair of hands,” ventures Mr Bennett, a ten-year veteran at Man, who previously worked as a client adviser in the wealth management sphere.

“Many people are going into funds for the first time and want to see an institutional infrastructure, so it is the bigger players who can come through.”

The core of Man’s offer is now through managed accounts, which the group hopes to expand through its buzzwords of transparency, liquidity and control. In fact the group’s high-profile liquidity during and immediately following the 2008 crisis – while other funds set up gates – meant many investors were using the house as a cash machine and funds under management dropped by 50 per cent.

Yet today, it is impossible to sell non-liquid hedge funds to private banks. Man gives clients a choice of 75 managers, which it hopes to eventually expand to 100. Private clients typically require a fund delivered in the Ucits format, says Mr Bennett. “This offers extra regulatory oversight, a passport into the UK for distribution and is a lot easier to talk to clients about.”

There is also a huge tax advantage for UK residents, with Ucits funds treated under capital gains rather than income tax regulations. Products currently highlighted for private clients include the internally managed AHL quantitative CTA fund (see below) and a long-short equity fund giving access to 12 managers and offering downside protection in a Ucits structure.

Despite positive rumblings, Mr Bennett believes the days of private banks having a high ‘default’ setting of 15 to 20 per cent for hedge funds in discretionary portfolios are behind us. “The hedge fund concept is now part of investor consciousness – it’s not ‘do we do it,’ but ‘how much do we allocate?’”

Yet it’s impossible to just “just chuck a blanket over the industry” and arrive at standard allocations, preferring instead for each client to be individually treated according to risk appetites and expected returns.

Equity culture

There is however a danger of over-allocation to equities – rather than hedge funds – which he detects in many private clients’ portfolios. “There is a strong equity culture, some say too strong, particularly in the UK,” senses Mr Bennett. “A 70 to 80 per cent equity allocation in a portfolio does not represent diversification.”

He sees the advent of Ucits structures as a “quantum shift” in investing. “Through Ucits, you can start to diversify portfolios in a more efficient manner,” he believes. “They are democratising the investment world. It’s like putting another club in the golf bag.”

While Man has an excellent relationship with the private banking world, there are many hedge fund groups which do not, says Dan Mannix, head of business development at partnership RWC.

This 45-strong London boutique, running $2.5bn recently made headlines by poaching a leading fixed income team from Schroders, a pillar of the UK financial establishment. Schroders, clearly impressed by RWC’s audacity, has since taken a 49 per cent stake in the boutique.

RWC originally gained exposure to the wealth management world through launching a convertible bond fund, which took advantage of a broader palate of Ucits rules for fixed income investing.

Newer funds

Today it is accommodating newer funds, such as its US absolute return long-short strategy in similar fund structures. This product raised $500m in just six months from discretionary private banking platforms. There are also teams specialising in UK equities, European equities and once derided TMT stocks.

“We take the business of client management very seriously,” says Mr Mannix, who, like the Man sales force, also saw an over-exposure to equities among wealthy individuals, although he believes this is changing slowly.

“It’s not enough to just have good performance and then expect wealth managers to notice you and book their clients into your funds. You have to work with Goldman, Rathbones, Credit Suisse and UBS. They all need high levels of transparency, liquidity and service,” he adds.

This means not just identifying the correct hedge fund strategy, but packaging it in the required currency classes, offering rebates to distributors and making sure the product is saleable in all major European markets.

There has also been a sea-change since the early days of “guided architecture”, when private banks would only deal with a handful of big-brand groups, which could provide a range of products, where performance was less important than access and reputation.

“You don’t need to be a big brand any more to operate in this space,” he says. “You need the best managers in class, matched with the operational platform. As a private bank these days, you get kudos for buying boutique funds for clients.”

Due diligence from fund of funds players has increased “by about 200 per cent,” says RWC’s CEO Peter Harrison. Often, before the Madoff disaster, dialogue between private banks with external managers was almost non existent, with amateurish levels of scrutiny from many.

“There is one major bank in Europe, which didn’t used to do due diligence properly at all. This time round they sent two people to our office for two days,” he reveals.

External due diligence

But this level of due diligence, almost unheard of amongst some fund of funds players, was already being conducted by selectors with a manager-of-managers model, commissioning external groups for individual, segregated mandates and then distributing funds through private banks.

“Quite bluntly, Madoff could not have happened with the manager-of-managers model,” says Rob Williams, chief sales and marketing officer at Skandia Investment Group (SIG). “We employ our own custodian and transfer agent,” he says. These back office functions are outsourced to third parties such as Citi and BONY by Skandia, whereas they were being conducted internally by the Madoff operation.

“Giving mandates to managers also gives us a lot of oversight to prevent blow-ups happening in our funds,” explains Mr Williams, adding that SIG’s 45-strong investment team gets to know managers so well before investing that any scope for error is limited. There is generally no rush to bring products to market, he says.

A “relatively low percentage” of the $18bn invested in SIG’s multi-manager strategies is currently lodged in alternative strategies. One of the avenues for private banks to buy into this area is through long-short funds, contained in Skandia’s Strategic Best Ideas range, first launched in 2007.

This gives access to managers such as Cazenove, Artemis, BlackRock, Gartmore and SVM. Although longer-term numbers are more compelling, Skandia admits the fund can lag in strongly rising markets. Recently it

has had less than full exposure to equities because its underlying managers are not completely bullish. The fund is also marketed as less volatile than competitors.

The rationale for choosing fund managers is purely investment-based says Mr Williams. “We are not purposely looking for big brand fund managers, but for an investment manager with a proven capability of managing a portfolio within this concept.”

There are few houses with a strong track record in UK long-short equities, so recruiting managers can be a challenge. “A lot of people do it, but there are few with sufficient skill to give the mandate to for this fund,” adds Mr Williams.

A separate alternatives fund of funds, giving access to 12 different strategies, including global macro, infrastructure and absolute return, was launched in 2008, offering managers such as Commerzbank, Aviva Investors, Fulcrum and JPM Highbridge.

“These are more names which you might associate with the alternatives space,” says Mr Williams, whose sales team also offers real estate funds managed by houses including US Reit specialist Cohen & Steers, appointed to run a $250m mandate for Skandia five months ago.

“It is in line with our business model to identify highly talented investment managers, who don’t have a strong footprint in our distribution markets,” he says. These markets include the UK, Spain, Germany, France and the Nordic markets, with South East Asia also gaining prominence.

Increasing presence

Although Skandia’s footprint is still fairly small in the alternatives sector, Mr Williams believes it will inevitably grow, with the ability of the investment group to introduce new concepts, which can in turn leverage new investment regulations.

“We are good at taking a relatively esoteric strategy, wrapping it in a regulated entity and bringing it to the market with our brand,” he says. “For investors who are cautious about getting into the asset class, the strength of comfort of our brand, with the research behind it, is quite encouraging for them.”

Yet banks remain very conservative about allocating assets to alternatives. “The type of strategies being bought are still quite vanilla,” says Mr Williams. “We are not yet seeing a massive demand for alternative strategies in Europe.”

Diversified AHL offering keeps man group flying high

Although Man has been gaining some reputation as a fund of funds player, its historical strength has always been in the AHL franchise. Formerly independent but brought wholly in-house during 1994, this was one of the original black-box-led CTA advisers. But it is once again gaining popularity in the current climate.

Simply explained, AHL gathers several thousand data items each trading day and then, through historical analysis, uses a computer model to predict future return patterns, making trades through derivative instruments such as managed futures.

The flagship fund is up by around 5 per cent over 2010, while most major markets have lost ground. “We are looking backwards and picking up on trending behaviour,” says AHL portfolio manager Keith Balmer. “This works particularly well in crisis periods, when there is clear directionality.”

The philosophy is based on constantly updating technology to ensure speed of trading and execution and improving modeling quality. “The investment strategy has stayed the same over the years. It is quant, systematic, exploiting momentum, but on a much wider set of markets than most competitors. We have the most broadly diversified portfolio in the CTA space,” he claims.

The main change has been a move to electronic trading over the last seven to eight years.

Gone are the brightly-coloured jackets of traders operating on the Liffe exchange, once situated close to Man’s Sugar Quay headquarters, so called because the group was a fully fledged commodity trader before making the transformation into a hedge funds firm.

The move to electronic trading for 70 per cent of transactions, combined with a large internal execution team which finds the lowest price for “big ticket” trades, helps keep returns edging up.

“Algos allow us to be more efficient and help keep costs down,” says Mr Balmer, referring to the unstoppable trend of algorithmic trading, which has taken the hedge funds world by storm.

Every group has its star fund manager, but Man’s is particularly high profile. “AHL generates an awful lot of fee income for the group,” comments Mr Balmer. “We have previously been compared to an aircraft flying on one engine. But if you’re only going to have one engine, it’s a good one to have.”

The fee income from AHL has however, been one of the main contributors to Man’s war-chest, permitting the purchase of a trophy group such as GLG, which does not have quant capacity. “This fits nicely,” says Mr Balmer. “It will allow a more balanced group to emerge.”