As fund of hedge funds struggle to find a role, Franck Dargent, deputy chief executive officer and global head of business development, Amundi Alternative Investments, explains in this sponsored Q&A how Amundi has positioned itself to take a consultative, advisory role, as the Alternative Investment Fund Managers Directive comes into force.
HEDGE FUNDS REVIEW: How would you characterise the landscape for hedge fund products, particularly fund-of-funds products, within Europe? What is changing?
Franck Dargent: The environment has been transitioning since 2008 in many different ways. It has been transitioning from investment into fund of hedge funds to single hedge fund investment; from offshore investment hedge funds into onshore fund of ones or segregated funds; it’s been transitioning from private banks, large distributors to institutions. It has also been transitioning from off-the-shelf type products to tailor-made solutions. A lot of changes are happening and we want to be ahead of that.
HEDGE FUNDS REVIEW: What does that mean for a company like Amundi? How are you changing what you do?
Franck Dargent: We are changing what we do in so many different ways. We need to keep in mind what investors are expecting from hedge fund investments. They want to have a stable and sustainable return over time, they want to have it relatively uncorrelated to other asset classes and they want to be able to dampen the volatility of the overall portfolio. This is what we have to deliver. We have to stick to those expectations. That’s the first point.
Then we have to do it in a very safe and secure way – in a totally different way to how it was done before the global financial crisis.
We took the decision at Amundi – a strategic decision – to move from offshore commingled hedge fund investments into onshore dedicated funds, which could be a combination of either managed accounts on our platform or stand-alone funds.
We have decided to transfer our managed account platform to Dublin ahead of the Alternative Investment Fund Managers Directive (AIFMD) coming into place in July.
We have set up with some managers who were unfit to go onto the platform for many different reasons, but we wanted to keep those names, especially in relatively complex strategies or strategies that use a lot of legal documentation, International Swaps and Derivatives Association documentation, with many counterparties. It was much easier to actually ask them to set up a dedicated fund for us, but always onshore in Europe.
We have transferred not only the fund of funds but also the underlying funds in which we are invested onshore.
We now work in a much safer legal environment, and we control all operational risk as much as possible. We have an integrated and aggregate view of our risk allocation and where the returns are coming from. We also have the capacity to rotate the portfolio much quicker than we could before 2008.
These changes are about delivering a set of returns, of uncorrelated returns and the ability to dampen the volatility of the portfolio. We have moved away from offering off-the-shelf fund-of-fund products to something that is much more of a dedicated solution, moving from an asset manager role to an advisory role.
We listen first to the needs and constraints of an investor, which are always very specific in terms of return expectations, volatility constraints, correlation expectations and regulatory environment.
On the regulatory environment, a lot is changing with the arrival of the AIFMD. We are probably among the first asset managers in the hedge fund industry to be up and running for the directive. We welcome the arrival of that directive and we think it will help to fix a lot of issues in terms of making sure you have equal treatment among shareholders.
A lot of changes are happening in a good way, but there are also constraints, such as Solvency II or Basel III requirements. We also have to adjust the way we run our portfolios and the level of transparency that we could give to the investor, not only to give a better view and better understanding to the investor, but also to cope with these regulatory requirements that will soon come into place.
HEDGE FUNDS REVIEW: Why is it important for institutional investors in Europe to have onshore regulated structures? And will this open a new source of assets for the hedge fund community and for Amundi?
Franck Dargent: We think so. Basically you have two ways to invest into hedge funds. Either you do it the old way and invest into offshore commingled hedge funds. A lot of investors are still happy with this but you are basically blended with other investors who sometimes have side agreements with the hedge fund. This will not be allowed in Europe. If you set up a hedge fund in Europe, then there is a strict requirement to treat all of your shareholders equally. You cannot allow one big shareholder into your fund to redeem before the others.
Second, [in Europe] it is necessary to have an independent valuation agent and there are also requirements to have a depositary and trustee. This creates a secure environment in which you will be investing, compared to the offshore investment.
There was a proxy way of handling those risks – to invest in the Ucits space. It brings a level of comfort that investors are expecting, but it also comes with a lot of constraints in terms of concentration risk and in terms of the type of assets you can deal with. For example, you cannot deal with physical commodities. You have a lot of constraints in the way you’re running your portfolio that you would not have in the AIFMD environment.
We are expecting the AIF products to become some kind of label in a complementary way to the Ucits label, offering the same level of safety as the Ucits label is offering, but with the flexibility and agility of a typical hedge fund in the offshore space to run the strategy.
HEDGE FUNDS REVIEW: Are managed account platforms and the managed account structure going to be more or less popular in future?
Franck Dargent: We’re expecting it to become more and more popular because it’s a quick and easy way to make sure you’re investing into a secured operational setup.
But it does not exempt you from making full due diligence on a lot of issues. For example, what is the legal environment and what is the legal structure of the managed account platform? Is it an offshore or an onshore managed account platform? Is it a buy-side or a sell-side managed account platform?
It says a lot about the type of manager who will be on board. It says a lot in terms of stability of the manager, and it says a lot in terms of the philosophy of constructing your platform, of ‘cherry-picking’ your managers.
You will have to review the sales providers of the platform, and you will have to review the legal documentation. You will have to review the prime broker names – the number of prime brokers that are being used by the platform. You will also need to check the available capacity to invest in each single manager on the platform, and also what kind of assets and the stability of assets per manager because the more you allocate to each manager on the platform, the better off you will be or the lower the administration and operational fees will be. There are a lot of issues that you will need to check.
HEDGE FUNDS REVIEW: How do you see advisory functions developing and changing over the next year or so? How are you changing what you do?
Franck Dargent: We believe it will be more and more prominent. Basically, the driver is that a lot of institutions are currently reviewing the way they allocate. We are moving from a world in which alternative investments were a small pocket within a big portfolio – anywhere between 5%
The traditional allocation has been evenly split between bonds and equities with a small pocket for alternatives. Then, during the crisis, pension funds realised that actually 90% of their risk was coming from that 60% equity allocation. They also feel very uncomfortable with the level of volatility of equities. At the same time, the yields are around 1%. People have been reminded that there is actually sovereign risk, and it is not something that can be overlooked. Now the level of yield is probably not paying for risk, even for credit risk.
A lot of institutions are questioning not only their alternative buckets, but how they can review the whole model and have a much more risk-driven approach to the way they allocate within their portfolios. We see a lot of advanced institutions transitioning from satellite allocation to spreading hedge fund investments over the portfolio. It could be through a single hedge fund investment, but it also could be through fund of funds that would basically deliver a different set of return and risk.
Typically, what we see is a request for an arbitrage type of portfolio to replace the fixed-income allocation, but with much less exposure to directional risk on rates. A bucket for global macro and commodity trading advisers, which will be a kind of cover against systemic risk or the risk of a resurgence of inflation or a strong pick-up in yields, unexpected types of risk in your portfolio inversely correlated with other asset classes.
When you want to take directionality, you would typically do so through equity or credit. Now people are injecting long/short equity or long/short credit into their equity portfolios or into their equity buckets because it helps to dampen the volatility within that directionality bucket of the portfolio.
HEDGE FUNDS REVIEW: How does Amundi cope with the different needs, different risk structures of the various institutions? Do you have products that you can offer them? Is it all about customisation?
Franck Dargent: The only constraints we impose universally across the portfolios is that everything is invested into a European-domiciled and preferably into an Irish-domiciled fund. Obviously the managers can be American, European or Asian. The other constraint being able to consolidate the overall positions within our risk system because we want to be able to provide an aggregated view of the risk to the investor.
Then we customise everything. We have a team with a dedicated portfolio manager, a dedicated team of analysts, client services and legal personnel. This team is sitting with the customer, listening to the customer’s needs, requirements and constraints. Sometimes it could be: “Build something new for me; this is my portfolio and it has to provide that set of return,” or “I would like to be de-correlated with that kind of equities market.” Then we will come up with something new but will fit into the existing portfolio.
Sometimes, as happened recently, an institution came to us and asked: “This is my hedge fund allocation. What do you think about it? Knowing that I have traditional long-only portfolio, which looks that way, what do you think of each single manager and what do you think of the portfolio itself. What do you think of the portfolio taking into account my overall asset allocation?’
You need to be able to step back from being strictly an alternative investment manager or a hedge fund allocator and become an adviser, and be able to forge your own opinion, be able to run a lot of quants and models and make qualitative assumptions as to how you can optimise the overall asset allocation, not only the way you will spread over the hedge fund allocation.
HEDGE FUNDS REVIEW: One thing institutional investors want to see are lower fees. How do you keep your own fees low?
Franck Dargent: We’ve been extremely aggressive on the issue of fees. We understood that we had to significantly lower the fee level, all the more so since the returns were somewhat disappointing during the past two years.
We have cut fees not only at the fund of fund level but we have also cut fees significantly when someone invests into our managed accounts. At the managed account level, our fee level is the same fee level as the benchmark fund except when we improve the liquidity on our platform. Then we will add on 15 basis points. It is extremely aggressive. Then, at the fund of fund level, anything that is above 50bp for a size of $50 million, for example, and 10% performance fees is too expensive. That gives you some idea of where we are.
HEDGE FUNDS REVIEW: Are high-net-worth (HNW) individuals looking at something different?
Franck Dargent:There are common features with the institutional investors. For instance, the environment is a common feature. The environment is one of extremely low-yield asymmetry on fixed-income allocation, volatility of equities, commodities and emerging markets.
Equities had a fantastic bull run, but then the Nikkei lost 7% in just one day. There is volatility.
What you would expect from absolute return or alternative investment or hedge fund investment is first to have an investment that will preserve capital, capable of absorbing shocks in the market. Second, you’re expecting this investment to deliver a stable stream of return over time. You don’t want any nasty surprises. Third, you would like it to be uncorrelated with your traditional asset classes.
In those respects we think that the needs and expectations are very similar. But, with some institutions, we can afford to have a completely customer-driven and solutions-driven approach because of the size they can invest and because of the complexity of issues they have to handle – not only in terms of regulation. There are a lot of issues we have to take into account that can be properly addressed only through a tailor-made portfolio solution.
For HNW individuals, it’s a question of wealth. You have very HNW individuals who behave like institutions; they work in a very complex environment. Then we will offer a bespoke approach. For the typical HNW individual with a much smaller size to invest, we completely reshuffled our open-end fund of funds offer – we have streamlined it and we have regrouped it.
We will be offering three absolute return fund of funds covering the whole spectrum of risk return from a product, which will target to deliver Libor plus 4% over five years with a volatility of 3%: a very stable type of a risk/return profile. Then a medium-range product and something that will be more aggressive with a 10% return and 8% volatility target.
HEDGE FUNDS REVIEW: Flexibility, liquidity, transparency, operational risk management – are all of these equally important for investors?
Franck Dargent: It very much depends. Typically, pension funds will tell us transparency. Sometimes we see a portfolio where you have 40 or 50 different clients or sometimes there is a portfolio just in a couple of names.
The reason why transparency is so important is that it helps your understanding of the overall portfolio. It’s like a puzzle: transparency really helps you to fine tune and to make sure that the pieces of the puzzle fit into the portfolio, and will fit exactly with the rest of the puzzle. Otherwise you will have something you won’t be really able to know what to expect from in terms of distribution of return. Transparency for us helps us to precisely design a portfolio that completely fits into a global allocation.
Pension funds or life insurance companies have a long-term horizon, but liquidity is important because the environment is changing. It’s not because you need to redeem every week but, when the environment is changing so quickly, you want your investment manager to be in a position to rotate the allocation quickly. In order to do so, you need to have your investment in relatively liquid funds. You should not sacrifice everything for the sake of liquidity, obviously. We are blending how we construct our portfolio. We are blending, typically, monthly funds of one with a 35-day notice period, with monthly and weekly managed accounts, with weekly and daily Ucits funds. We request the liquidity to be higher where we are taking more directional risk because then we want to be able to deleverage or de-risk the portfolio quickly.
You do not need to have very strict rules, such as I will invest only in two-weekly or I will invest strictly into monthly funds. You need to have a good blend. You need to understand why liquidity could be necessary in that investment, if you go too liquid in another strategy, you will give up some premiums. That’s our job basically as a fund of hedge funds manager.
HEDGE FUNDS REVIEW: Looking at your role within the European hedge fund world, how do you see Amundi developing and meeting the challenges of a changing environment?
Franck Dargent:In Europe, you basically still have a very active pool of investments, which is based in the pension funds industry, in the UK, Benelux and Scandinavia. These investors have basically taken the route of directly investing into single hedge funds, sometimes using consultants to help them do so.
However, they have probably overlooked the fact that it may not be the cheapest approach for investment. We still believe fund of funds have a lot to offer, not only because they can negotiate rebates with hedge funds. They provide access. They provide simplicity.
When you invest in single hedge funds, then you go through a lot of complexity. You need to take into account a lot of different liquidity terms and redemption terms. There is a lot of legal and operational work involved. There are a lot of indirect and hidden costs that are usually ignored.
We need to reposition what a fund of funds can offer. We especially need to demonstrate how credible we can be in offering tailor-made solutions, not only as a pure alternative product provider, but as someone able to look at the overall portfolio and find the solution that will best fit the overall asset allocation.
Then the AIFMD is coming into effect in July. We have done a lot of work ahead of the directive. In 2010 we started to transfer all of our fund of funds from offshore into Dublin. All of our fund of funds are now domiciled either in Ireland or France or Luxembourg. They are regulated by the Central Bank in Ireland, the Autorité des Marchés Financiers in France or the Commission de Surveillance du Secteur Financier in Luxembourg
Then we decided also at the invested fund level to transition and to move from offshore commingled hedge funds into dedicated funds or managed accounts in Dublin. We complement that with allocations in the commingled European funds whenever we think they provide a different type of investment strategy, a different style that helps to improve the overall robustness of the portfolio.
HEDGE FUNDS REVIEW: Do you see a good future for Amundi and for the asset management business?
Franck Dargent:Yes. We are convinced the more that environment drags on, the more institutional investors will come to us, will come to absolute return managers, solutions providers and firms that are able to demonstrate that they are bringing
real value in terms of advice. We see that trend developing.
There will be increasing need for absolute return solutions, single funds, fund of funds and a novel review of a portfolio. So, we are very optimistic about that.
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