Swiss institutions are looking to diversify their alternative allocations in a bid to improve yield and meet their long-term liabilities. Real estate, private equity and infrastructure funds (and co-investment deals) are a major part of their portfolios with hedge funds still viewed with a degree of caution.
Recently, asset managers like Swiss Life Fund Managers have responded to investor demand by launching the Swiss Life REF European Real Estate Living and Working vehicle, targeting housing, healthcare, office and retail assets. Swiss Life said the fund will invest in "B locations in A cities and A locations in B cities", an approach known as the ABBA strategy. Real estate assets now account for 21 per cent of Swiss Life's total AUM.
Part of the reason for Swiss appetite for real estate (and indeed global investor appetite) is that it provides them with a demonstrable route into green, more sustainable investing. The sustainable Swiss real estate fund of Credit Suisse Real Estate Investment Management is a SIX-listed fund that invests in 44 properties in Switzerland with a total value of CHF 2.25 billion and is the fifth largest Swiss real estate fund. Every building fulfills the requirements of the "greenproperty" quality seal developed by Credit Suisse Real Estate Investment Management for sustainable property.
"The hedge fund industry in Switzerland is now in competition with many different asset classes, like private equity and infrastructure funds. As such, in order to raise clients' interest, hedge fund managers need to excel in terms of delivering on clients' objectives when using them in their portfolio allocation: i.e. consistent, decorrelated returns," says Achraf Goneid, Senior Analyst at Syz Asset Management.
"Hedge funds have been viewed as not performing too well and expensive by some Swiss institutions and they've been looking more at private capital strategies: private equity and private debt have received a lot of attention, as have systematic hedge funds and CTAs, which have come back into favour," observes Christian Nauer, CEO of SwissAnalytics.
One such hedge fund is QCAM Currency Asset Management, an independent Swiss financial services provider with a primary focus on currency management. Based in Zug, QCAM was founded in 2005 and currently manages approximately USD3 billion in currency volatility and global macro strategies and bespoke currency overlay mandates. It is regulated both by the Swiss Financial Market Supervisory Authority (FINMA) and the US Securities and Exchange Commission (SEC).
QCAM's FX long/short volatility program is called v-Pro & v-Pro Dynamic. It has a nine-year track record, a Sharpe ratio of 0.88 and is market neutral in its trading style. The v-Pro strategy returned 20.06 per cent in 2015, whilst v-Pro Dynamic generated 43.35 per cent positive performance.
It is currently available as a Luxembourg-domiciled SICAV-SIF and as managed account. The UCITS-version of the strategy will go live soon. The main difference between the two versions is that v-Pro Dynamic uses around twice the leverage of v-Pro, although the underlying investment strategy remains the same.
"Since our inception we always have been focused on currency management as the main pillar of our business activities. For us, the world's most liquid market with USD5.3 trillion daily turnover offers a host of opportunities and we feel investors want to speak with specialists offering this dedicated and in-depth expertise," says Thomas Suter, CEO of QCAM Currency Asset Management.
Andre Meyer heads up investor relations and structuring at QCAM Currency Asset Management. He thinks that interest in all alternatives will build over time as Swiss investors turn to a range of strategies both liquid and illiquid, systematic and discretionary, to better protect their assets against changing global economic conditions. He observes that aside from the very largest Swiss pension funds, most institutions take a FoHF-like approach to investing in hedge funds.
"There aren't that many who invest directly with single managers, they prefer to take a multi-manager approach," says Meyer.
This might explain why Swiss investors have remained slightly reticent with respect to hedge funds given that many were badly impacted in 2008. The reason for relying on external consultants and FoHF advisors in the first place, however, is because of size and capacity constraints. In the US, Canada and the Nordics, it is, says Meyer, a different numbers game in terms of the personnel they have for their allocation programmes.
"They have dedicated alternative investment teams where they analyse the managers, do the due diligence and allocate accordingly. But for the mid-tier pension funds in Switzerland, they prefer to go the FoHF route where the FoHF manager has in-depth experience analysing managers on behalf of the end investors," says Meyer.
One such management group is Pictet Alternative Advisors, an independent arm of Swiss private bank Pictet Group, which manages north of USD18 billion in alternative assets. Nicolas Campiche is CEO of Pictet Alternative Advisors. In his view, it is a fairly positive backdrop for hedge fund investing, both from a tactical and a secular point of view. Indeed, 48 per cent of institutional investors surveyed in a new Barclays Prime Services report (Turning the Tide: 2017 Global Hedge Fund Industry Outlook and Trends) confirmed that they plan to increase their allocations in 2017, compared to 33 per cent in 2016.
"In traditional asset classes there are low expected returns, hence the attraction of hedge funds that can potentially provide diversified sources of returns to investors. This seems to be confirmed by the higher level of demand we are seeing on the hedge fund side. In our funds, many investors are looking to increased their allocations," says Campiche.
From a tactical point of view, Campiche is of the opinion that the current environment creates a number of opportunities.
"The first that springs to my mind is the expected volatility in markets this year, which should be sustained by a number of things, such as he political environment in the US and Europe, which I think hedge funds will benefit from.
"Secondly, we view the interest rate trend in the US as a long-awaited change in the environment, which should benefit some hedge fund strategies," comments Campiche.
Sourcing alpha generators
There are a number of things that Pictet Alternative Advisors will look for when building a portfolio. Aside from allocating to the right strategies, of more importance is identifying the right managers. This sounds obvious but it is very difficult to implement. A FoHF manager needs to identify very specific expertise among managers, such as sector-specific equity long/short managers with expertise in trading the energy sector.
"It could include identifying a manager who is able to benefit from a barrier to entry. For instance, we view expertise in running distressed strategies as a clear barrier to entry. Executing these strategies successfully is not something that a large number of managers can do. If we can identify such a manager, operating in a niche area of distressed debt where there are still inefficiencies to exploit, we think that is a way to generate alpha today.
"We also look for managers that have some kind of proprietary process in the quantitative space and have the ability to generate new signals for alpha generation," explains Campiche.
Experience is also an important element when looking under the hood. Has a manager only generated alpha in a bull market over the last few years or have they traded through an entire market dislocation phase where they've been able to stress test their strategy?
The latter, says Campiche, can be helpful, but warns that it can also be detrimental to a manager's ability to generate alpha; he notes that following the '08 crash some managers reduced their levels of risk.
"There is no magic bullet to finding the best managers. That said, we are trying to be more sophisticated in terms of analysing the track record, identifying the source of returns, benchmarking managers to passive strategies and really trying to nail down what has made a difference in the past and is likely to repeat itself in the future," confirms Campiche.
Building a due diligence risk framework
For institutions – Swiss or otherwise – that decide they want to directly allocate to hedge fund managers, it is critical that the due diligence they perform on the manager is ongoing and not just focused on the pre-allocation phase. This is even more important given the rising trend towards institutions investing in more esoteric strategies such as bank loans, distressed credit, etc, where the assets tend to be Level 3 assets and hard to value.
This is something that SwissAnalytics can support clients with, both in terms of investment due diligence, and, following its recent merger with Castle Hall Alternatives, operational due diligence.
As investors search for yield, credit and private asset strategies have become much more popular. These strategies are, however, much more complex operationally. "What we find most consistently challenging is custody and confirmation of existence of assets, and valuations," explains Nauer. "To what extent can investors rely on independent providers being involved? Does the administrator, for example, have access to independent sources of information?
"We see an increasing number of independent fund administrators being appointed by managers, which is encouraging, but in the closed-ended fund space a lot of information is still being provided by the manager. There is also no independent pricing being done by the administrator."
There are ways around this, as investors can demand additional checks and balances. Take private capital funds, for example. While there will typically be no independent custody of assets, there are usually independent providers involved which can be used to seek independent verification of information: for example, there will often be law firms involved who will hold copies of the deal agreements, providing at least one way of independently verifying the asset(s).
"With respect to private debt structures, in many cases there are loan agents servicing the loans, which, if independent third parties are appointed, can provide another route to sourcing information on the underlying loans in a fund portfolio. We are consistently surprised when we find administrators not completing independent asset existence checks for all or at least part of a portfolio, instead relying on documents forwarded by the manager," add Nauer.
He believes that investors, generally, are more reluctant to vote with their feet and force change once they've already allocated to an open-ended fund manager, particularly in Switzerland where perhaps there is a cultural trait that causes institutions to take longer to warm up to the investment manager on a personal level.
"The Swiss tend to be more loyal than other cultures. Investors are more willing to give the benefit of the doubt. That's fine but what we advise is, `Have a consistent framework and policy to determine at what point in time enough is enough. Force yourself to make a decision.'
"Ultimately, the investor has to be sure that the investment continues to be consistent with their objectives based on liquidity, the amount of leverage etc.," comments Nauer. "It is always tough to exit a manager. However, if a manager's strategy evolves from excellent to a more mundane `good enough', investors incur the opportunity cost of not redeploying capital to a new manager who is truly `excellent'."
He says that the key aim is to ensure that an investment's asset can be independently verified and checked, and that the manager is sticking to the investment guidelines. "If the manager says they are independently verified on a regular basis, who is doing that work, and what procedures are performed? And if they are using independent third parties, are they truly independent – bringing professional skepticism and active engagement – or are they just rubberstamping things? Who is driving the decision as to when to recognise that sometimes an asset needs to have a write-down?" questions Nauer.
Complex strategies require simple communication
Jonas Stark is the CEO/CIO of Blue Diamond Asset Management, a market neutral statistical arbitrage hedge fund that focuses predominantly on trading equity volatility based out of Pfaffikon, Switzerland.
He confirms that whilst Blue Diamond's investor base is global, there are some family offices in Switzerland that are showing interest in managers such as Blue Diamond who are able to offer strategies with a low correlation to equity and bond markets.
"We have a track record of more than five years, we have USD400 million in AUM, and as we grow we are starting to see more interest from family offices," says Stark.
Asked whether he thinks Swiss investors are shy post-allocation, when it comes to questioning the manager, he replies: "The institutional investors in our fund all have a good understanding of what we do. Should there be style drift, or we do something we said we weren't going to do, they will question it, regardless of whether they are located in Switzerland or anywhere else in the world. It's important to note that Swiss investors are global; there is a wide mix of nationalities working at these institutions.
"Ultimately, it's important that investors understand what you do. There is always risk inherent in any hedge fund strategy, and no strategy is guaranteed to make money all of the time. If investors understand why the strategy makes money, and what the risks are, they are more likely to stay with a manager (even during periods of poor performance)."
Building a clear line of communication is something that Blue Diamond Asset Management has focused carefully on over the years. "We are very transparent with our investors but we are not transparent at all to the outside world. We have a good dialogue with them. We talk about the strategy and we are fortunate in that our investors are sophisticated and provide their own input on where we can improve the strategy," adds Stark.
Investors appreciate this fluid approach and whilst it might sound obvious, lack of transparency and communication is still often cited as a key issue by hedge fund investors. Blue Diamond, for example, conducts quarterly calls with investors and produces updates when there are big movements in the markets. "This way, investors have a better understand what works and what doesn't work in the strategy.
"When it comes to raising assets and keeping assets, being transparent and keeping investors updated on what you do as a manager is a key success factor. Over time it builds a lot of trust in the relationship," he says.
One approach that QCAM Currency Asset Management takes to build a close alignment of interests with investors lies outside of the fund product and is more of a customised solution, which in simple terms provides active currency overlays for investors' portfolios.
"We are seeing a lot of interest in this solution. It might be used by an investor with, say, a 90 per cent passive currency hedge in equities and fixed income currently who wish to take advantage of currency moves in the future to generate additional return.
"They come to us to provide an overlay solution, which is typically a rules-based approach based on the needs of each client. We've seen good traction in this and we expect this to continue over the near-term," explains Meyer.
The discretionary manager – a dying breed…?
Increasingly within the investment management industry, more and more strategies are becoming systematic and quantitative in their approach where investors have to put their faith in algorithms and complex machine learning strategies that have limited discretionary input.
In some ways this is advantageous as it strips out the emotion and the myriad behavioural biases that plague even the very best portfolio managers. But in other ways it makes it harder for investors to know when to redeem. How do they know when to trust the machine and when not to?
This places managers like QCAM in a strong position. Unlike many FX-focused managers, they are completely discretionary in their approach.
"On the one hand it is a challenge because we are not mainstream in the eyes of investors but on the other hand it is quite interesting to operate in such a niche as I believe it offers an advantage, over time, and a way to differentiate us from other funds in the market," says Meyer.
"We are positioned to be long volatility in the portfolio, overall, so low volatility regimes do not favour the strategy at present. The recent US elections produced some volatility in the currency markets in November and December but it has since reduced. That said, investors understand that there aren't always going to be dislocation opportunities. The vPro and vPro Dynamic strategies are a diversifier and recently investors have been generating more returns from other parts of their portfolio. They view us in a wider portfolio context for this reason, not on a standalone basis."
In the world of systematic trading, Blue Diamond, which has seen its AUM climb from USD150 million to more than USD400 million, positions itself to investors by bringing to the table a singular focus on equity volatility. It is a highly targeted approach to avoid investor confusion and to try and stand out from the crowd.
"Whilst we run a systematic strategy, one of the key success factors is that we've adapted the strategy over time," says Stark. "We've conducted quantitative research on the market to improve the strategy over time and harness new opportunities as they've arisen.
"It's important to try and constantly improve how you trade the markets. The team is always seeking out new opportunities. Also, we've spent a lot of time getting our operational processes to a very high level. We have two dedicated programmers that work on model calculations, reconciliations and so on. Everything from fee reconciliation to cash management and reporting to clients is fully automated. That is something that investors really appreciate when they visit us.
"A good operational infrastructure allows us to better work with clients and focus on the investment strategy rather than get caught up in daily operational tasks that offer no value add to the investor."
Campiche concludes by highlighting the fact that Pictet Alternative Advisors has evolved to become much more granular at analysing the track record of the manager rather than his skill-set; in other words, the work has become a lot more quantitative.
"We have become more adept at constructing portfolios to better balance the risks and understand where and when we should allocate to certain managers. It is like putting together a jigsaw puzzle; you want each piece to fit and to play a specific role in the portfolio. That is something we've increasingly focused on over the last few years."
