Attracting novice investors
Since the beginning of 2004 two new investment companies operating as funds of hedge funds (FOHFs) have become listed on the London Stock Exchange, swelling the progress of a new theme in institutional hedge fund investment in the UK.
Though the international universe of hedge funds, whether single strategy or FOHFs, runs to thousands of funds, listed investment company FOHFs number only 21 – 11 in London, eight in Zurich and two in Toronto.
There are many open-ended FOHFs listed in Dublin but they are often funds domiciled perhaps in an unfamiliar offshore location which are seeking, for marketing purposes, the gravitas of a well regulated European environment. Such funds do not generally have a live secondary market.
By contrast, the experience of the London listed companies has been that there is healthy market turnover. This is a great benefit to investors in hedge funds – a sector where lack of liquidity is an acknowledged problem and a factor likely to discourage investors, whether institutional or retail, who are not as yet comfortable with hedge fund investment.
According to Jamie Murray, marketing director at HSBC Republic, this stream of launches has arisen because the UK has historically been closed to the open-ended hedge fund structure. “People discovered they could have something similar through a listed company which is ISAble, SIPPable and able to be distributed onshore – all the things you need to allow people to invest in the UK.”
As he points out, the sector has to date concentrated on diversified portfolios which will be of interest to both the high net worth retail investor and the smaller institution – both categories which may be interested in a low commitment first step into a FOHFs as a diversification vehicle.
Added advantages of the listed companies are daily liquidity and a low entry threshold. Where with a listed company you can buy and sell a single share for T+3 settlement via CREST, many offshore FOFs have a minimum investment approaching €500,000, and offer only monthly or quarterly redemptions.
The ease of dealing, coupled with the reassurance of a vehicle which is subject to the UK listed company regulatory regime, provide considerable comfort to investors.
In terms of tax, it is hard to make a general comparison between listed investment company FOHFs and offshore hedge funds, as the taxation regime will depend on both the investor and the domicile and structure of the offshore fund.
A feature of recent launches has been the tendency to hedge currency exposure. This follows a two-year period during which the rise of the pound against the dollar has damaged investment returns to UK investors. Says Mark James, sector analyst at ABN Amro: “The institutions buying are almost exclusively UK-based. These are London listed, sterling denominated, sterling hedged, sterling friendly vehicles”. Globally, British institutional investors lag behind their counterparts in continental Europe and the US in terms of the percentages they are prepared to invest in hedge funds. Perhaps one could conclude that the recent growth of the listed funds sector has opened a floodgate.
One problem with listed investment companies has traditionally been the discount. This issue was partly to blame last year for the winding up of Henderson Absolute Return Portfolio, launched in 2001, whose shares fell to a big discount after disappointing performance.
In the present climate, at least, the new breed of listed companies seems to have been effective in dealing with this problem. Most lay claim to ‘aggressive discount control’ measures. These may involve a variety of arrangements. The HSBC companies liaise with market makers to buy back from time to time any excess of stock. They can also redeem at the directors’ discretion up to 25% of the shares in issue every six months. As a result they have typically traded at around a 2% discount recently.
Thames River Hedge+ allows investors to redeem at 95% of NAV every six months for up to 25% of the company if a specified discount threshold is breached and at the directors’ discretion. Shares in Hedge+ have traded mostly at around a 5% premium since the company’s January launch.
Though there are investment company FOHFs listed in London, Zurich and Toronto, the London seems to be providing the main energy. Altin AG, listed in Zurich in 1996, became listed on the London Stock Exchange in December 2001. The company’s main reasons were to raise its profile and also to improve liquidity. So successful has this strategy been that the discount has narrowed from 20% two years ago to around 1% currently and annual market volumes by number of shares traded (see Table 1) have switched between 70% via Zurich in 2002 to 70% via London in 2003.
Anecdotal evidence suggests that institutions are increasingly prepared to deal in hedge funds through this type of listed vehicle. Major shareholders at launch listed in the Dexion Equity Alternative prospectus included insurance companies Pearl, CIS and Reliance Mutual, the South Yorkshire local authority pension fund, and private client groups Rathbone, Rothschild, Credit Suisse and Merrill Lynch.
Murray says the HSBC funds are currently targeted at “those who are not familiar with the sector or who only want to put a small amount in”, though as time goes on and investors become more experienced he thinks LSE could see more specialist, single strategy companies launched.
More entrants are certainly expected in this market, according to James at ABN AMRO. In its 2003 year-end statement ISIS Asset Management announced that they had reached heads of agreement to acquire an equity stake in start-up hedge fund manager Cardinal Asset Management. The move will give ISIS exclusive distribution rights on white-labelled products in the UK and Europe, and a listed hedge fund could well be on the cards. The group believes that the institutional hedge fund market is set to grow and that listed funds “look an interesting model in the UK”. Due to its accessible entry level these funds also have appeal in the retail sector.
Thames River will also consider another step into the market. Ken Kinsey-Quick, head of multi-manager products thinks that towards the end of the year “something with more of an income slant – an alternative to bonds”, could be in the offing.
At HSBC Republic Murray says that they “might launch more”, though if regulation in the UK opens up to allow tax-efficient open-ended funds, that could prove a cheaper and simpler way to bring diversified FOHFs to investors.
James points to the quality of investment management behind recent launches and the innovative solutions which have addressed the issue of discount and currency exposure. His conclusion is positive: “A number of institutions are using these vehicles as their first entry to hedge funds. There is clearly an appetite for this structure.”