The Three ‘rs’ Dominate The Debate In Paris: Risk, Returns And Regulation

By | September 18, 2016

Confidence and caution were competing in the air this year as the key figures in the global hedge fund industry came together in Paris for the 10th annual EuroHedge Summit

Risk, returns and regulation were the three overriding themes dominating the debate among hedge fund industry leaders this year as they gathered together for the annual two-day EuroHedge Summit in Paris last month.

Held at its traditional setting of Palais de la Bourse in the heart of a rather wintry and unsettled French capital on 21-23 May, the 10th Euro-Hedge Summit brought together more than 750 leading figures from the global hedge fund community and the broader finance industry at a time of major changes and challenges across the financial, economic, political and social spheres.

Under the title, ‘Strategies for a Complex World’, a high-level audience enjoyed keynote speeches from The Children’s Investment Fund founder Chris Hohn, Tosca-fund chief Martin Hughes and Balysany Asset Management founding partner Taylor O’Malley � as well as a series of panel discussions covering a wide range of strategy, industry and business issues.

The mood of the Summit was upbeat and a good deal more confident than in the past two or three years � reflecting the generally strong performance of most hedge funds in the buoyant and more settled market conditions of the last several months.

And that positive tone continued into the second day of the event, despite an overnight fall of over 7% in Japan’s previously surging stock markets on 23 May � which caused other global equity indices to falter as well, amid growing concerns that the powerful global equity bull market sentiment of recent months might be running out of steam, and which has helped to create a much less buoyant overall market climate in both bonds and equities since then.

Quantitative easing � and the likely timing and effect of its abatement, ‘tapering’ and eventual withdrawal, particularly in the US, and the consequent impact on all markets and hedge fund strategies � was a predominant topic of concern to managers and investors over the two days, at a time of such extreme monetary policies in the big developed economies.

But there were many other pressing issues on the minds of speakers, panellists and delegates: on interest rates and the increasingly desperate search for yield by investors at a time of record-low returns in government bonds; on currency wars; on sovereign and financial sector indebtedness; on the continued problems in the Eurozone; on inflation and deflation risks; on the likely success or otherwise of Japan’s reflation revolution; on possible bubbles in China, in credit markets and in other risk asset markets; on the possibility of a bond market meltdown; on the likelihood of a ‘great rotation’ into equities; on commodity and energy prices; on the prospects for emerging markets; on the social impact of austerity measures in the EU; and on the artificial nature of global financial markets that remain so completely in thrall to the actions, and inactions, of policy-makers and central banks.

And underlying much of the discussion was the central dichotomy of how to reconcile the fundamentally risk-averse nature of the increasingly institutional investor base that is starting to dominate the hedge fund landscape with the need � and desire � of managers to take increased risk at a time of such rich opportunities across most asset classes and strategy areas.

“The hedge fund industry is doing a disservice to itself by putting risk before return,” said Hohn � one of the most iconic figures in the European hedge fund world over the past decade � in the course of a compelling and very candid keynote address that captured the dilemma facing many managers and investors in the alternative investment industry.

Hohn � whose $5 billion flagship TCI fund is up by some 20% this year and by almost 30% over the past six months � added: “The industry must be prepared to take more risk in the sense of embracing price volatility � but not in the sense of what risk really is, which is permanent loss of capital.”

Underlying Hohn’s address was the sense that successful hedge fund managers over the long term need to be true to themselves as investors and managers of their own money � and should not try to be what they think investors want them to be.
With around $1 billion of his own money in the fund and a long-term annualised return of around 18%, Hohn’s central point that investors in hedge funds are more aligned with the custodians of their
capital than in any other area of asset management had a particular resonance. “Our strategy works � that’s all that I can say,” he said. “People say to me, ‘You’re too controversial, you’re too directional, you’re too concentrated, you take too much risk.’ I say to them, ‘That’s all true; but I make money.'”

Toscafund’s Hughes � whose firm has also been generating very punchy performance over the past year or so � was in equally frank and forthright form, focusing on the exceptional opportunities for high returns in UK equities that investors should be able to achieve.

Having weathered, like Hohn and TCI, a difficult time in 2008, Hughes and his team have bounced back impressively � through a similar style of concentrated and fairly activist equity investing that has served their investors very well at a time when hedge funds in general have attracted some criticism in the outside media for their low returns relative to equities.

Together, Hohn and Hughes presented compelling evidence of the continued ability of hedge fund managers to maximise returns for investors by taking well-judged risks and embracing opportunity � at a time when many of the pension fund and institutional-type investors that are pouring money into hedge funds are obsessed with minimising risk, minimising volatility, minimising correlation and minimising fees.

And concern over the pressure on returns was exacerbated by the widespread sense of frustration and dismay at the extent of all the new regulations that are being aimed at the alternative asset management industry, both in the EU and beyond.

Speaking at the hedge fund CEOs panel session in which he has participated for several years, Sir Paul Ruddock � the soon-to-retire co-founder of $12 billion London-based Lansdowne Partners � said the influx of regulation was the greatest threat facing the industry.

He described the EU’s Alternative Investment Fund Managers Directive as “creating a far more constrained environment, and creating a lot of uncertainty. As an equity house, I think there’s still a lot of good value to be found in equities � but the major risk to the industry is regulation.”

In all, some 85 leading hedge fund managers, investors and counterparties participated in the EuroHedge Summit � on a series of sessions covering specific strategy areas as well as broader industry and business management issues.

The perspectives and views of leading investors were fully aired throughout the two days of the event� with numerous top-tier investors and key advisers participating from across the full spectrum of the pension fund, sovereign, family office, institutional, private bank, endowment, fund of fund, intermediary, consulting and seeding communities.

Celebrating its 10th year � and taking place in the year when the EU’s controversial AIFMD comes into effect in July, along with numerous other regulatory and market structure changes that will also have an impact on all hedge fund managers, investors and counterparties � the EuroHedge Summit attracted a typically strong line-up of panellists and participants.

The overall purpose of the Summit comprised three principal objectives. The first was to assess the big-picture opportunities, risks and challenges facing the hedge fund industry as a whole � against the
background of the major changes and upheavals taking place in the wider financial world and in the global macro-economic and political scene.

The second was to analyse the prospects in a range of specific investment strategy areas � including global macro, equities, emerging markets, credit, fixed-income, emerging markets, managed futures and quant-based systematic trading.

And the third was to address the many operational and business management issues and challenges facing the hedge fund community � from the perspective of managers, investors and their most important counterparties and advisers.

Besides Hohn and Hughes, the third keynote speaker at this year’s event was Balyasny’s O’Malley � a founding partner at the renowned US-based multi-strategy firm, who is responsible for firm-wide risk management, investment staff hiring and development.

In an address comprising a short formal speech and a more prolonged and informal question and answer session, O’Malley delivered an insightful and entertaining account of the firm’s approach to risk, its approach to developing and managing its multiple teams of portfolio managers, and the development and management of its overall culture.

Among the numerous prominent industry executives taking part in panel sessions over the two days were Cheyne Capital founders Jonathan Lourie and Stuart Fiertz: Stu Bohart, president of liquid markets at Fortress; Martin Estlander of Helsinki-based Estlander & Partners; Cantab Capital Partners co-founder Erich Schlaikjer; Amplitude Capital chairman Karsten Schrder; CapeView Capital founder Theo Phanos; Mako Investment Managers CIO Bruno Usai; Chenavari Capital CEO Loc Fery; Emmanuel Gavaudan, co-founder of Boussard & Gavaudan; and North Asset Management founder George Papamarkakis.

Joining seasoned macro manager Papamarkakis on the big-picture opening macro panel session were: Richard Cookson, head of research at fellow 10-year-old London-based macro fund Rubicon Fund Management; renowned economics commentator and analyst Anatole Kaletsky; and Lucrezia Reichlin, the former head of research at the European Central Bank, who is now professor of economics at the London Business School and founder of the economic consultancy group, Now-Casting.

A high-level session focused on whether investors would keep faith with hedge funds at a time when performance has generally been lagging equity indices comprised Penny Aitken from the family office group FQS set up by ex-Renaissance Technologies man Robert Frey; Alexandre Col, head of asset management at Banque Prive Edmond de Rothschild and one of the savviest hedge fund allocators; Martin Kllstrm, the portfolio manager for allocations to hedge funds at AP1, the huge Swedish national pension fund; and Max von Bismarck, partner and CEO for Europe at SkyBridge Capital, the big US investor group.

In addition, a closing investor-focused session at the end of the Summit on the best way to invest in hedge funds featured another top-quality line-up of investors and their advisers, comprising: Larry Powell of the Utah State Retirement Fund; Aurum Funds CEO Kevin Gundle; Tim Gascoigne of Allenbridge; Chris Redmond of Towers Watson; and Joe McCarthy, the CIO of multi-family office group Islandbridge.

Other well-known and experienced hedge fund investors on other panels during the course of the event included Sanjay Tikku of King Abdullah University of Science and Technology, Lisa Fridman of PAAMCO, Patric de Gentile-Williams of Man Group seeding arm FCA Capital, Hilmi Unver of Notz Stucki and Heath Davies of Signet Capital.

Sessions dedicated to equities, credit, CTAs, emerging markets and ‘off-piste’ strategies featured a mix of established and newer names covering a broad spectrum of differing approaches in their respective strategy areas � including Adelante, Skyline and Insparo in emerging markets; RiverCrest, CQS, Whitebox Advisers and BTG Pactual in equities; Harmonic and Altiq in managed futures and quant macro; BlueBay, Advent, SCIO and PVE Capital in fixed-income and credit; and Cygnus, Plenum, Armour and Active Earth in the ‘off-piste’ strategies arena.

Among the experts from the public sphere tackling the thorny and complex subject of regulation over the two days were Jiri Krol, director of regulatory and government affairs at global hedge fund industry association AIMA, and Peter De Proft, the director general of EFAMA (the European Fund and Asset Management Association).

And the many business and operational issues covered in a packed programme included a session on how hedge funds are adapting for the imminent start of OTC derivatives clearing on exchanges � which featured Aron Landy from Brevan Howard and Pat Trew from CQS, two of the most experienced and highly-regarded hedge fund risk managers in the industry.

Overall, the mood of confidence at the opportunities facing hedge funds across an array of markets, asset classes and strategy areas was mixed with a degree of caution at the potential for regulators and policy-makers to constrain hedge funds and trigger market corrections, through ill-thought-out regulatory measures and policy moves that could serve to constrict returns for investors at the very time when they need them most.

CEOS: CHARTING A WAY THROUGH TURBULENT WATERS

A panel of senior hedge fund executives came together to discuss the future direction of the industry and the challenges facing individual firms, in a session appropriately subtitled ‘Charting the way forward’.

Returning from the previous year were two of London’s best-known hedge fund CEOs: Jonathan Lourie, founder and CEO of Cheyne Capital Management; and Sir Paul Ruddock, co-founder and chief executive of Lansdowne Partners.

Joining them on the panel for the first time were Stu Bohart, the president of liquid markets and senior managing director for strategy at $55.6 billion US giant Fortress Investment Group; and Martin Estlander, the founder and CEO at longstanding Finnish-based managed futures house Estlander & Partners.

Kicking off the conversation, Lourie recalled the bullish stance he had taken during last year’s panel � and pointed out that, for Cheyne at least, his optimism had turned out to be justified. “Last year, I felt vehemently that there were good times ahead,” he said. “We’re focused on credit and last year was a great year for us. And I think there’s still some juice in the lemon to be squeezed.”

With banks still not lending, the opportunities are to be found in alternative credit strategies, and hedge funds are offering an attractive alternative to long-only investing, he said, adding: “Overall, I think we’re in a pretty good environment.”

Ruddock agreed that the past 12 months have generally seen improved hedge fund performance compared with the previous few years. But he observed that there are challenges on the horizon – notably the Alternative Investment Fund Managers Directive, which comes into force in July.

He described the AIFMD as “creating a far more constrained environment, and creating a lot of uncertainty. As an equity house, I think there’s still a lot of good value to be found in equities � but the major risk to the industry is regulation.”

Bohart described the Directive and other regulatory initiatives as “unnecessary hassle”, and suggested the result might be that investors are driven towards the larger firms with the bigger infrastructures. Estlander said that while he does not inherently support increased regulation, “I think getting the clarity is a good thing.”

“Most regulatory costs are borne by the manager; you can’t pass most of it on [to investors],” noted Ruddock. But he identified the threat of a remuneration cap for European asset managers in Europe as the bigger concern. “It does threaten our ability to retain talent versus the US, Singapore or wherever,” he argued. Unlike Fortress, Lansdowne has “no interest” in moving into the retail space, he said, and Ruddock does not believe the regulatory safeguards being imposed are necessary when dealing with institutional clients.

“We have to get away from governments deciding who can make money or not � or the talent will go elsewhere,” agreed Bohart. Turning to the issue of liquidity, he pointed out that different liquidity profiles and fund structures suit different investment strategies.

“I think credit investors should be willing to lock up their money; there should be a match,” he said. “Some investors still ask for liquidity when they know it doesn’t suit the investment. They put themselves in harm’s way.”

Ruddock argued that the UCITS format is “not appropriate” for hedge funds, citing onerous regulatory requirements and the danger of a liquidity mismatch between the portfolio and the terms offered to investors.

“It’s increasingly important in certain markets � including France � to have an onshore fund. In France, Cayman is a four-letter word,” said Lourie. “I think the idea of being onshore and liquid is very product-specific � it doesn’t make sense for all strategies � but I hope it grows in a sensible way to be a larger part of the market,” he added. ”

We have a very good regulator in Finland,” said Estlander. “Onshore products are accepted and used by both retail and institutional clients, and investors appreciate what hedge funds do for them. So hopefully the AIFMD will do the same for Europe more widely, and help change perceptions.”

The executives, all senior figures within well-established businesses, were asked to assess the feasibility of setting up a new hedge fund outfit from scratch in the current environment. ”

I really believe it’s about the talent � if you’re a talented stock-picker, you should stick it out and go it alone,” said Lourie. “When we interview people, we often get the excuse that it’s too hard for them to do it on their own. I want to see people who don’t want to join Cheyne � and I want to entice them to work with us.”

“The skill of running money is not the same as the skill of running a business,” observed Bohart, adding that many of today’s leading firms were established “when there was structural alpha to be had”. It is far tougher to launch as an independent firm in the current climate, so a partnership with a larger firm can be beneficial, he said.

Estlander launched his business with as little as $250,000, and is now managing $1 billion. “I would encourage people to have a go at setting up on their own, but it will be hard work � so teaming up with a larger firm is probably a good way to do it,” he agreed.

“It’s the same old story: you need seed capital, and you need good returns,” said Ruddock. “There’s always something going on in the markets that could discourage a launch,” he added – pointing out that Lansdowne’s initial pool of commitments equated to just $40 million, rather than an expected $140 million, thanks to the 1998 Russian financial crisis. The firm now manages around $11 billion.

The discussion then turned to the issue of succession planning � a timely subject, given that Ruddock is due to retire from Lansdowne at the end of this month. “It’s difficult to replace a founder/CEO, because we couldn’t even begin to look until we’d told our investors it was happening,” he said. But Ruddock added that he was confident the business would continue to run smoothly after the transition.

“You have to differentiate between a star manager � an alpha generator like [Moore Capital founder] Louis Bacon �