HEDGE FUNDS REVIEW: What is Prime Capital’s business model and how does it add value for investors?
Werner Humpert: Prime Capital is an independent financial services and asset management company specialising in alternative investments, especially hedge funds and infrastructure investments. It services institutional clients in Europe, predominantly in the German-speaking countries and Scandinavia, usually with individual solutions.
The management team and other investment professionals offer a unique combination of capabilities as an investment team with a long-standing track record in fund of hedge funds (FoHFs) and single manager hedge fund advisory, as a platform and structuring provider with a strong legal and transaction management background, and as a risk management and operational due-diligence expert with treasury and auditing backgrounds. The service offering is modular, allowing for the delivery of a specific service or a combination of solutions. The expertise in each of these capabilities is available across the organisation, with cross-fertilisation of services offered by each team combining to give added value for investors.
HEDGE FUNDS REVIEW: What are your views on the German hedge fund market?
Werner Humpert: The majority of German investors have had painful experiences in hedge funds. Some began to allocate between 2006 and 2007 and ended up with FoHFs in 2008. The lack of liquidity, transparency and insufficient performance combined with disproportionately high fees created a negative impression of the entire hedge fund industry. The adverse attitude adopted by the domestic press and the domestic political environment combined to nurture a negative attitude to hedge fund-related investment activities. As a result, many regulated institutional investors with politically driven advisory boards offloaded their entire hedge fund exposure.
Meanwhile, there are more than 20 institutions with substantial hedge fund holdings. The investments are a mix of allocations to FoHFs and direct investments to single managers. Ucits funds have a limited allocation.
Reasons for this split of interest are obvious. German investors have learned that hedge funds are not exchange-traded funds that they can buy and sell quickly. Furthermore, German investors understand that returns in this asset class are bound to a certain amount of illiquidity. Regulatory rules focusing mostly on providing liquidity may hinder a fund manager in a few strategies, depending on the use of relevant investment arrangements to preserve capital.
Managed accounts – meaning non-commingled vehicles – are used selectively by larger institutional investors. These investors have a significant interest to select the prime broker, administrator, auditor and other service providers on their own and want full transparency and control of the assets. Smaller investors look for commingled solutions on banking platforms where liquidity is the main consideration.
Based on the current low-yield and high-volatility environment and the ongoing political and economic uncertainties, we still see a demand from German investors for non-traditional investment strategies with a strong risk management focus. Whether hedge fund managers will be able to win a substantial share of this demand will depend on their ability to deliver stable and satisfactory returns, possibly with a low correlation to other asset classes, provide structural solutions compliant with existing and upcoming European regulations, and offer more transparency and a fee structure that corresponds with realised rather than projected results. However, participation in the hedge fund industry is highly selective with only few, but substantial, investments.
HEDGE FUNDS REVIEW: How will European regulation help or hinder the development of hedge funds?
Werner Humpert: In general, the tightening of rules for insurance and pensions companies in Germany and Europe – through Solvency II or other rules in the pipeline – will certainly have an impact on the hedge fund industry. All holdings in asset classes with limited liquidity and/or transparency will most likely be reviewed by European investors. This might require those with scarce resources and minor holdings to reduce or dissolve their investments. On the other hand, larger investors might decide to dedicate necessary resources to allocation to alternatives and increase investment in hedge funds to take advantage of their superior risk/return profiles.
We tend to have the same view on the Alternative Investment Fund Managers (AIFM) directive. Managers who are willing to dedicate the necessary resources needed to set up a European-compliant fund, or team up with a local provider of an AIFM Master fund such as the one Prime Capital intends to offer, could potentially benefit. This could be by winning market share and allocations from managers who are not able or not interested in complying, or from a growing market that might potentially develop based on growing acceptance of hedge funds in a regulated environment.
HEDGE FUNDS REVIEW: How is Prime Capital positioned in the German hedge fund market and in Europe overall?
Werner Humpert: Prime Capital offers advice and implementation in all four dimensions of hedge fund investing, creating value for an investor. These include: 1. superior conceptional advice, manager selection (FoHFs and single manager hedge funds) and portfolio construction; 2. portfolio monitoring and risk measurement and control; 3. design and setup of an investment architecture optimised for the required legal, regulatory and tax environment; and 4. actual operation and administration of a specific investment infrastructure. Only such a client-specific consolidation platform can offer an environment without any conflict of interest, which cannot be achieved when investing into a product from a bank or manager platform.
While most competitors focus on advising and reporting, Prime Capital is convinced that a modern approach to hedge fund advising and management has to provide maximum transparency and control down to the single manager level or position level, whichever is possible and adequate in a specific situation. Only on the basis of maximum transparency, meaningful quantitative analysis and qualitative advice can risks be truly measured and managed.
HEDGE FUNDS REVIEW: How is the role of FoHFs evolving?
Werner Humpert: In the long run, the majority of investors will need advice on selecting and constructing a portfolio of hedge funds, but not necessarily in the format of FoHFs.
It is a normal evolution in every asset class that investors get more experienced and comfortable over time and so begin to invest directly to complement existing core investments or to replace FoHFs. Furthermore, with the trend of allocating the majority of money to a limited number of very large single manager funds, especially well-known multi-strategy funds that are attracting the majority of inflows, the pressure on FoHF managers to justify additional cost levels will grow.
A second trend is the evolution in the structure of hedge fund investments. The customary co-investment into offshore FoHFs has revealed many structural problems – a lack of transparency, high costs and limited liquidity. These shortfalls are examples typically seen since the financial crisis began. This has driven many investors to negotiate segregated accounts with the FoHF managers rather than to buy the offshore fund itself. While control over the assets still remains with the manager, the liquidity risks associated with other investors can be eliminated with the added benefit of higher, but restricted, transparency. The current solution for substantial investors is to set up manager access through an onshore platform controlled by the investor, with an FoHF manager as adviser.
HEDGE FUNDS REVIEW: How is Prime Capital meeting the demands and expectations of investors, particularly through its Prime Capital Asset Management (PCAM) Blue Chip fund?
Werner Humpert: First of all, our business model is based on advising institutional investors on investing into hedge funds through FoHFs as well as directly into single manager funds. In this respect, Prime Capital is not only an experienced asset manager, but can also provide the necessary expertise for constructing an optimal investment structure, risk management and meaningful reporting. With this unique combination of expertise, we are confident in meeting the demands of our investors and surpassing their expectations.
The PCAM Blue Chip fund has developed over time from a client-specific solution to a product – the only non-customised product from Prime Capital. The fund is not a classic FoHF product but rather a reference portfolio for our expertise. By launching PCAM Blue Chip in 2007, Prime Capital aimed to overcome the typical weaknesses of classic FoHFs even before those weaknesses were exposed to investors during the financial crisis. These issues included high fee levels, insufficient manager due diligence, a hyperactive top-down management approach and the false promise of liquidity. For our clients that were not willing or able to hold all hedge fund positions directly, we designed a pool of hedge funds with the features that our experience told us would lead to superior performance.
From October 2007 to September 2012, the basket achieved an annualised return of 6.85%, with an annualised volatility of only 6.5%. Over this period, it has achieved yearly performance within the top 10% of its class and has been recognised with various awards. We believe these results were achieved by focusing on thorough manager due diligence and selection, the construction of a concentrated basket with emphasis on risk-based portfolio optimisation and a moderate fee structure. This approach can also be viewed as a top-level summary of how we try to meet the demands and expectations of our clients as an adviser.