Holding hedge funds to account
Bond yields sit at historic lows, growth is sparse and equities aren’t cheap. The result: a search for yield in credit assets and for alpha in liquid alternative investments.
And, as Daniele Spada of Lyxor Asset Management’s investment advisory services observes, larger allocations leads to more focus on how alternatives relate to traditional assets and a desire to manage them more flexibly.
This is what is behind the most pronounced trend in hedge fund investment over the past five years - the disintermediation of the diversified fund of funds. But selecting hedge fund managers and dealing with their service providers and counterparties is a full-time job. Lyxor argues that there is a solution that both optimises the advantages of selecting individual strategies while simplifying the tangle of exposures it entails - the managed account platform (MAP). And, having worked with PGGM to set up a bespoke platform in 2010, it can claim major European pension fund backing for the concept.
With a normal LP fund, you subscribe to an entity which, although legally separate from its manager, commingles investors’ money, and uses counterparties and an administrator selected by that manager. With a managed account, the responsibility for all of that falls to you as the holder of the account, which is segregated. The manager is merely your trading adviser.
On a MAP, you can have several managers advise one account - either your own, or one run by a third party, like Lyxor, which will commingle you with its other clients (while segregating you from the managers’ non-Lyxor clients). PGGM has built its own ‘Institutional Managed Account Platform’ (IMAP) based on Lyxor’s infrastructure and 15 years of know-how. MAP users basically get a single multi-strategy hedge fund, but driven by the industry’s best single-strategy traders. Lyxor likes to call it “transforming boutique risk into institutional risk”.
The key thing is that the account is now yours. Instead of waiting a month for a two-page report, you see the full portfolio, daily, with a three-day operational lag. “This is the world of long-only mutual funds applied to the world of alternatives,” says the head of Lyxor’s MAP, Lionel Paquin.
Once you have all that data, you can use it to “make your hedge fund exposures talk to the rest of your balance sheet”, as Paquin puts it. To facilitate this, Lyxor is building a web-based front-end for its MAP, a project greatly influenced by what it has learned from PGGM. The initial model provided aggregated data and analytical tools for the managed account, which could then be exported into the client’s own systems, but now Lyxor is working on infrastructure that would also work the other way around, enabling the client to upload the rest of its portfolio to the analytical toolbox of the MAP.
And this need not be a passive analytical exercise. This is your account, so you can negotiate your own acceptable risk limits and securities against which to judge style drift or breaches. On the Lyxor MAP, this is the responsibility of Lyxor’s risk department. CRO Eric Talleux says that “passive breaches” of these agreements are “part of everyday life” and usually perfectly innocent, partly because Lyxor prefers to negotiate “quite tight” agreements to facilitate a regular flow of information.
“We don’t only calculate, monitor and report risks to our clients,” says Paquin. “We also manage them. If there is a breach of a trading limit, or a sudden spike in the CDS spread for one of our counterparties, the right decision may be to do nothing, it may be to move cash, it may be to re-negotiate a specific agreement. What matters, is that we know about the breach and can take the necessary action. In a fund of hedge funds, by the time you find out - if you find out at all - it may be too late.”
If, like PGGM, you have a dedicated MAP, this opens up considerable freedom. Do you have ESG guidelines? Fine. Specific liquidity needs? You can exclude the adviser’s most illiquid positions. Or, as Lyxor co-CIO Nicolas Gaussel points out, you can define your hedge funds’ position limits to avoid the “crazy” 49% capital requirement under Solvency II that assumes they are a homogeneous black box.
Isn’t this a headache for the managers? Maybe - but Lyxor’s MAP has still attracted over 100 top-flight names and adds 25-30 strategies each year, with recent additions from Paulson, Brevan Howard and Traxis Partners.
“Our platform offers access to new investors, either because their institutional requirements are met by the platform, or because of the marketing capability we have in regions where these managers have no presence,” says Paquin. “But there are operational burdens for the manager, for sure, and we have to be persuaded that they have the infrastructure to feed us what we need.”
Things are made easier by the MAP’s open architecture for service providers. Its relationships with three administrators, 11 prime brokers and five additional market counterparties means that most hedge fund managers won’t have to deal with completely new counterparties.
This works for the MAP, too, making it simple to switch in the event of trouble but also providing what Paquin calls “the ideal context” to negotiate terms with everyone in the value chain - something he says only really became apparent while working with PGGM. “It’s about large institutions partnering with one another to create negotiating power,” he says.
PGGM is a tough enough negotiator with its hedge fund managers but, before, it would have been those managers negotiating with the counterparties. Now, of course, it is they who are the counterparty’s clients.
“Negotiating with PBs requires experience,” says Paquin. “But it’s also about scale. We have multi-billion dollar relationships with our biggest PBs and that adds up to a lot of negotiating power. We’ve been able to open dormant accounts for diversification. Can you imagine starting from scratch and asking a major PB to open a dormant account? They wouldn’t answer your phone call.”
Pension funds that are not major European trend-setters like PGGM might be wondering if Lyxor would answer their calls. “PGGM didn’t want to strike a deal, they wanted a partnership with another institution,” says Paquin. On the day it won the PGGM mandate Lyxor lost out to Man Group’s MAP with Bavaria’s BVK. Man’s Pfäffikon-based team shared BVK’s language, but Lyxor also picked up on concerns that its time might be monopolised by PGGM.
That may or may not be fair - in any case, it only applies to investors interested in the intensive kind of dedicated MAP that PGGM has built. A commingled MAP is just as useful for the medium-sized pension fund or the consultant who wants to add value for clients with more intelligent deployment of hedge fund allocations (the Lyxor MAP has already won mandates, thanks to inclusion on Mercer’s buy list, and global head of business development Christophe Baurand says he is making good progress on this front). There are also other ways in which investors can exploit Lyxor’s hedge fund capabilities: a mandate won in late 2011 will see it assist CalSTRS with a dedicated global macro portfolio, for example.
The two blue riband clients are emblematic of the direction Lyxor wants to take. Asia is increasingly important, but it is Europe and the US that are considered most ripe for both alternatives and the MAP story. The firm is taking its full range of products beyond its traditional markets of France, Belgium, Spain and Italy and into Northern Europe, and focusing on the MAP, which it feels is a genuinely unique and world-leading product, in the US. After 15 years arguing for the concept, the team clearly feels that its time has come. And, as Baurand puts it: “PGGM on one side of the Atlantic and CalSTERS on the other certainly helps to raise the profile.”