Billionaire Bill Ackman, Wall Street legend, manager of the hedge fund Pershing Square Capital Management, bought $ 27 million worth of protection against a fall in stocks in January. It took profits last week with a gain of 2.6 billion in just one month, according to the magazine. Barron’s. This kind of stock market success is common in this particular universe.
And now? The shares having plunged, this financier who requests a complete halt in American production for thirty days buys Starbucks and Hilton shares, which have fallen more than the indices.
Also read: These hedge funds that profit from the coronavirus
“The current environment will serve as a test for this industry as well as all active funds,” said Beat Wittmann, founder and partner of Porta Advisors in Zurich. The latter says he is confident about alternative investments, including hedge funds, and stocks (private and public).
Long years of modest growth
It is true that hedge funds suffer from their image. Are they not called hedge funds? As in so many other areas of the economy, “in hedge funds, the perception differs from the reality of professional investors,” said Nicolas Nussbaum, Managing Director, head of liquid hedge funds and alternatives at BlackRock in Europe and Middle East (EMEA). The world leader in asset management is also very active in alternative investments. BlackRock manages $ 54 billion in hedge funds globally, three quarters of which through offshore funds (Cayman structures) and one quarter in more regulated UCITS funds.
Also read: Hedge funds gain from playing the “Parasite”
Since 2000, the assets managed by hedge funds have fallen only twice, in 2008 and in 2018. “At the end of 2019, this branch of finance was gravitating around its historic peak, at 3320 billion dollars ”, adds Nicolas Nussbaum. It is therefore inaccurate to speak of the death of hedge funds, even if the performance of some funds has often disappointed and their cost structures encourage many investors to distance themselves from them. Swiss pension funds often favor the private markets (debt, infrastructure, private equity), unlike private banks and family offices.
Two negative years
The progress of this alternative segment is slow but real, even if the inflows of funds are negative. Since the year 2000, the best two years have been 2006 and 2007, with $ 126 billion and $ 195 billion respectively.
Objects of many critics, the costs of hedge funds have been reduced in recent years. They are generally 1-1.5% fixed costs and 20% performance costs. There is also a better alignment of the compensation of managers.
In 2019, yield averaged 9.3%, after losing 3.5% in 2018, according to a Barclays study. During this year, equities (S&P 500) gained 29%.
Read again: Hedge funds looking for investors
The performance of UCITS structures, regulated and liquid, can sometimes be lower due to their constraints, according to BlackRock. These funds, which represent less than 30% of the industry, are bought mainly in the countries of the European Union: France, Germany, Italy, Spain, but also in certain countries of Asia and South America.
Conventional offshore accounts for more than 70% of the total and offers investors generally monthly liquidity. “This smooths out the volatility that takes place during the month and seizes more opportunities,” says Nicolas Nussbaum. A choice therefore has to be made between liquidity and investment opportunities.
The goals of hedge funds
The purpose of hedge funds is misunderstood. The purpose of a hedge fund is not to earn more than a stock market index. “The objective remains to offer an uncorrelated performance of conventional assets (equities, bonds), upwards and downwards,” said Nicolas Nussbaum.
During the first days of the coronavirus crisis, “hedge funds, although down for the month generally, managed to cushion the blow compared to market indices,” said the official. “I am hopeful that some will be able to capture opportunities and bounce back faster than traditional investments. They will probably not wait for a market reversal to generate performance, unlike conventional funds, “says Nicolas Nussbaum. The challenge is launched.
Demand remains strong and robust, according to BlackRock, from sophisticated private customers in key markets such as Switzerland, the United Kingdom, Nordic institutions, and sovereign wealth funds in the Middle East. The most sought-after solutions in these regions belong to traditional offshore rather than the more regulated UCITS funds, but certain UCITS strategies have nonetheless also succeeded.
Caution at UBP
The year 2020 had started well for hedge funds, but the speed of the collapse in prices took everyone by surprise. The quest for cash has become a priority. “We are seeing a reduction in general airfoil. Leverage is down sharply, especially in quantitative funds (based on algorithms) and multi-strategy platforms, ”confirms Nicolas Nussbaum. Compared to equities, hedge funds held up well for the first few days, before dropping under the weight of repeated shocks. In March, the decline averaged 7-10%, and 13% since the start of the year. Traditional indices are down by 20 to 30% over the same periods.
Uncertainty about resilience will be partially removed at the end of the month, as most strategies are valued on a monthly basis. But the manager is optimistic: “The actors will adapt to the new realities. Opportunities necessarily arise from periods of dislocation like the ones we are going through. ”
Some players remain cautious: at UBP, a leader in alternative investments, the share of hedge funds in the portfolios has been reduced, according to Michael Lok, group investment director. This proportion was 10% at the start of the market crisis. “We decided to bring it down to 5%, considering that the performances were in line with our expectations but that their rebound potential was limited. We will reconstitute these positions later, ”he said. The Geneva establishment, within the framework of an active management of the portfolios, therefore did not decrease this percentage for reasons of performance.
Two promising strategies
Two types of strategies should rebound and be successful, according to the head of BlackRock. The first is arbitration in mergers and acquisitions, which should benefit from the narrowing of value spreads between the current market price and the price at which the company will be sold. Any manager must however ensure that the transactions remain viable. They will be if their nature is strategic. Otherwise, they risk not resisting shocks such as that of 2008 or 2020. “Our experts ask management to assess the viability of the deal,” said Nicolas Nussbaum. Some will be postponed, but without being canceled. Contracts sometimes make it very difficult to cancel a transaction. In 2008, many acquisitions had weathered the stress of the markets. The fact that these strategies are uncorrelated from the markets should attract the attention of investors.
The second type of strategy that is interesting right now relates to strategies for arbitrating relative value in the bond, because of the dislocations observed in this market. This is to take advantage of inadequate prices on the interest rate curve or spreads between spot prices and futures prices. The Fed’s decisions should reassure the players about their financing capacities. “These two strategies should be able to generate added value without being overly impacted by market management,” notes Nicolas Nussbaum. Conversely, quantitative strategies seem to be suffering particularly at the moment, in his opinion.
Special features of the crash of 2020
The crash of 2020, however, differs from that of 2008. At the time, the alternative presented major excesses, in terms of leverage and risk management. The current situation is healthier, more regulated too, the players more solid. The size of the actors has increased in parallel. Managers at over $ 5 billion represent about two-thirds of the industry’s assets, BlackRock estimates. Risk management tools are also more developed. The uncertainty is the same, however. The velocity of the flows is considerable, partly due to the emergence of “quants”, which represent 20% of the hedge fund industry, according to the manager. “They suffered last week by reducing their financial leverage all at the same time,” he notes.