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Hermes boutique launches long/short equity fund of funds

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UK - Hermes BPK Partners, the $2.1bn (€1.5bn) fund of hedge funds manager within the BT Pension Scheme-owned Hermes Fund Managers, has launched its Hermes BPK Global Equity Hedge Strategies with $550m from an unnamed large European institutional investor.

The move reflects a trend for fund of hedge fund providers to respond to institutional investors' demands for single-strategy and customised portfolios, rather than traditional off-the-shelf multi-strategy funds of funds.

The new product seeks to capture two-thirds of the global equity markets' upside while limiting the downside to one-third.

Matteo Dante Perruccio, chief executive and founding partner at Hermes BPK Partners, said: "In our view, hedge funds are simply a method of exploiting traditional asset classes while having the potential to significantly alter the risk profile of that asset class.

"Long/short equity funds, with their ability to adjust exposures across the market cycle, provide investors with a much-needed flexibility to manage the extreme gyrations we are currently seeing in the markets."

The product is conceived as a risk-reducing replacement for or complement to long-only equity portfolios, rather than a pure 'absolute return' portfolio or the fixed income proxy that diversified hedge fund portfolios are sometimes sold as.

"While the traditional approach to de-risking has been to shift allocations to fixed income - a strategy that has worked well for a number of years - many institutional investors now recognise we are at or near the end of a three-decade bull market in bonds, which may not represent an attractive entry point for a meaningful purchase of fixed income assets," Perruccio said.

"Investors recognise they have too much equity beta, but many also have a concern about moving wholesale from equities to alternatives - it's not the same intellectual voyage for every investor."

One challenge facing the investor that decides to use long/short equity in this way - targeting a market exposure in a range of 30-60% - is to decide how much beta to allow individual underlying managers to run, and how much variability they can deploy in that exposure.

Long/short equity covers a multitude of strategies, from bottom-up stockpickers who tend to run net exposures of +40-80%, through market-neutral funds that limit their exposures to -10% or +10%, dedicated short-sellers and top-down market-timers whose exposure can swing quite rapidly from positive to negative, to event-driven managers who attempt to isolate their ideas from market exposures.

Hermes BPK's fund does not exclude any of these sub-strategies and does not focus on the traditional stockpickers who would run a similar market exposure to the one the product itself is targeting.

"This is a challenging mandate - one-third of the downside with two-thirds of the upside - so that required some degree of asset allocation and active management beyond the investor simply buying a long/short equity index," said Perrucio.

"Our due diligence is narrow and deep because our job is to understand intimately how each of those managers are going to perform in different scenarios. That means the types of managers we have are very specific within their sector.

"So we have one manager who trades very actively, but he trades in the UK equity markets, and we know he is particularly focused on protecting his downside, for example. Given that specificity, we can manage portfolio risk with manager selection, diversification and position sizing."

Hermes BPK's new product offers the new fee structure that it announced early in 2011, designed to better-align with investors' interests: any performance fees taken in positive years over a three-year period will be returned if, after a review at the end of that period, they are found to be unearned due to performance falling below the high-water mark in subsequent years.

Asked to compare this fund-of-funds approach to managing equity downside with the deployment of a simple derivatives overlay, Perruccio chose to stress the "partnership" element.

"Most investors are more comfortable with a partner, but they also benefit more, arguably, because they don't enhance their knowledge with an overlay," he said.

"Increasingly, we find institutional investors want knowledge transfer: they have a huge equity book, and sitting with us to hear what these managers are saying about the markets is invaluable to them."

Hermes BPK already offers strategy-specific funds of funds in credit restructuring and trading-orientated funds.

"We will definitely be developing more of these thematic products," Perruccio added.

 

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