Diving into alternatives

Banks and investment houses are busy honing their products for a late autumn chat with advisers and distributors, followed by a January 2007 launch. What is ready for next year’s launch pad may seem predictable to industry watchers, with a swathe of hedge funds, private equity strategies and structured products. But there are a few hidden surprises in there too. Not everybody is looking purely at alternatives. There are also some specialist equity and bond funds being launched into the mix. And wealth managers for ultra high-net-worth individuals are looking at extending asset aggregation services, something which has been technically difficult until now.

One of the most credible overviews regarding new product launching trends comes from Ray Soudah, founder of Swiss-based Millennium Associates, and Europe’s best known independent wealth management M&A and strategy consultant.

Absolute openness

“We are now seeing an absolute openness to a wider range of alternative investment products, such as private equity, hedge funds, other active management strategies and real estate portfolios. All of these are becoming more and more acceptable,” says Mr Soudah.

He stresses that whether we are looking at the private banking or the institutional markets, at the end of the day, all the investment managers and products are serving individual investors.

Although hedge products were first pioneered by private individuals, and have since become something that boards of trustees at pension schemes and foundations are getting increasingly familiar with, much of the momentum is now coming from institutions.

“Demand for these products among private investors is now exploding,” says Mr Soudah. “When the press writes about a private equity fund raising in the market or a new hedge fund, there is always much reaction and excitement among private investors, as there is a lack of good names in this area.”

Up to 50 per cent of discretionary portfolios are now in alternative investments, believes Mr Soudah, with offshore funds accounting for the greater share, and onshore funds yet to catch up, due to the slowness of legislative developments.

The greatest recent change in the market, however, is that alternative products are no longer being pushed by manufacturers and distributors. “The ‘product pull’ is a new phenomenon,” says Mr Soudah. “It used to be a ‘product push’ from private bankers into hedge funds, but now it’s the other way round. Clients are asking the banks: ‘I want to be in this product.’”

Giving money to good managers

Private banks are all allocating money to good managers, which has led to the success of alternatives houses such as the Man Group, says Mr Soudah. “This is one of the reasons why the whole Man story has been such as success. They are huge only relative to their competitors in the hedge funds space, not in terms of money under management.”

Open architecture is today really figuring in the banks’ use of specialist alternatives houses, even though in recent years, they were only paying lip service to this concept. “But the amount of private client money is now so big that the banks can’t find the capacity. That’s the problem for private banks who want to maintain effective portfolio management,” reveals Mr Soudah. “Suddenly, small hedge funds can no longer take the mandate, as they are running too much money to invest properly.”

‘The amount of private client money is now so big that the banks can’t find the capacity. That’s the problem for private banks who want to maintain effective portfolio management. Suddenly, small hedge funds can no longer take the mandate’ - Ray Soudah, Millennium Associates

Structured product issuance is also likely to carry on increasing among wealth managers, calculates Mr Soudah. “These are very attractive to private banks as they can lure clients and also hedge against falling markets.”

Significant market share

These trends are echoed in practice by two of the world’s biggest wealth management institutions, Credit Suisse and UBS. Mr Soudah says these two Swiss banks are the only institutions to have any significant market share in private banking outside their home markets.

UBS Wealth Management now offers private clients a 15 per cent default allocation to hedge funds in their mandates for most risk profiles. On top of that a typical portfolio can contain up to 5 per cent in real estate funds, although private equity cannot yet be included in discretionary portfolios due to regulatory considerations.

Private clients of UBS are currently offered more than 80 hedge fund products in different formats including fund of funds, certificate and single manager. “But I am rather reserved about the widespread use of single managers in the private banking world,” says Hansjoerg Borutta,

Zurich-based global head of hedge fund Investment Solutions for UBS.

“You need a couple of conditions to meet in order to do that properly.”

He cites the recent case of North American hedge fund Amaranth as a demonstration of the perils of investing in a single manager, even if it is a multi-strategy fund. As PWM went to press, it was reported that $4.4bn (e3.4bn) had been lost by the fund after it took a massive position in natural gas prices. But as a result, even a fund of hedge funds investing in Amaranth Advisors has been reported as posting losses.

Mr Borutta’s team is constantly on the look out for new alternatives managers it can use, and has landed a hedge fund linked to commodity investments about a year ago. There are also on-going plans to launch funds investing in Japan and Asia. “There is always demand for Asian funds, but this is a tricky area, easier postulated than executed.” He talks about avoiding the pitfalls of “me too” products, marketed by some of the “usual suspects” in the hedge funds world.

Capacity is clearly becoming a problem. “Looking at hedge fund groups, some of these fund managers are in a nice situation, as they can choose whom they want as an investor,” says Mr Borutta. “Practically, this is a prudent move, as hedge funds need to know their customers.” Mr Borutta says most hedge funds are co-operative in

supplying information to UBS, although working with them is a very different job to selecting and monitoring long-only managers.

Managing relationships

“There is a slightly different approach in the way you manage a relationship,” reveals Mr Borutta. “You can’t just put up x number of hedge fund managers on the shelf and and then face the problem that you don’t get enough demand. But you still have the same amount of work and the same admin burden. It is more of a long-term business on the hedge funds side.”

‘Looking at hedge fund groups, some of these fund managers are in a nice situation, as they can choose whom they want as an investor. Practically, this is a prudent move, as hedge funds need to know their customers’ - Hansjoerg Borruta, UBS

Because the funds are far less liquid than standard equity or bond funds, it is vital to try and maintain a relationship, even through difficult times, though not at all costs. “It take longer to dismantle, but you can do it if there are serious issues,” says Mr Borutta. “On both sides, long-only and hedge funds, we try and have a long-term relationship with our chosen partners, but that doesn’t mean we are not ready to replace them, if we need to do so.”

Despite their increased push into the alternatives arena, you won’t catch the big distribution houses claiming that other strands of asset management are dead. In fact most of the products put through the UBS Investment Solutions factory are certainly not hedge funds.

Always creating new funds

However, this does not mean that funds created by leading houses are just buying and holding stocks and bonds. “We are always trying to create new funds,” says Jean-Francois Pinçon, head of international distribution at Crédit Agricole Asset Management in Paris. “The motto of our chief investment officer is that rather than creating new sources of alpha, it should be all about finding new beta, and that can mean anything that is to do with volatility.”

One particular trademark of Crédit Agricole is to take a product which has been successful in its French home market, and then roll it out through a newly launched version via broader distribution channels across Europe.

This is a distribution strategy which has also previously been honed by DWS, Germany’s premier investment brand, which often uses its home teutonic market as a testing ground for Europe. Its Luxembourg-registered Ucits III funds have a habit of looking strangely familiar.

UK specialist house Artemis is also about to launch three equity funds from the Luxembourg stage in a broadly similar move.

And this will soon be happening with CAAM Volatilitée Action, a pure volatility arbitrage product successfully sold in France by Crédit Agricole. Mr Pinçon believes that European private bankers in particular will have a particular appetite for this type of product.

Specialist know-how

US wealth manager Northern Trust is another house which is leveraging its home market expertise by introducing its know-how to new countries. “In the US, we have been looking at structured products. We are not an investment bank, so we do it on an open architecture basis,” says Nick Ring, head of wealth management services EMEA for Northern Trust. “Clients are increasingly expecting us to come to them with investment ideas,” he adds, reflecting Mr Soudah’s view that there is a new “pull” coming from private clients, with a keen appetite for innovative products.

‘Fifteen years ago, a wealthy family would have given their money to perhaps a couple of managers. But that is no longer the case. If you have eight different managers for long only products and fixed income, plus some hedge funds and private equity, then aggregation becomes an issue’ - Nick Ring, Northern Trust

“We have been using our team in Chicago, going to the US market with structured exposure to equity markets, and now we can use that same team for European markets. We are in the early stages of this development,” says Mr Ring. Northern Trust is also in the process of developing a tax-friendly enhanced cash management product for European clients. “We are just starting the process of drawing up a tax matrix in Europe,” he adds. “This is very straightforward in the US, but needs to be done on a country-by-country basis in Europe.”

But there is also more to launching new services than just finding the best investment vehicles. Alongside offering them investments, the main part of Northern Trust’s European wealth management strategy involves helping clients monitor their often complex portfolios and investment affairs.

Branching out

“Fifteen years ago, a wealthy family would have given their money to perhaps a couple of managers,” says Mr Ring. “But that is no longer the case. If you have eight different managers for long only products and fixed income, plus some hedge funds, private equity and funds of funds, aggregation is an issue. It used to be a case where you could pay somebody just to type in a couple of statements. Now with private equity, there are issues of valuations and managing cash calls.”

Many families are struggling with the very notion of calculating and monitoring their net worth, believes Mr Ring. That’s why Northern Trust is now promoting its institutional custody platform, used to service pension scheme assets in the US, to private clients in Europe. And for those clients who already get their custody elsewhere, Northern Trust is launching its new record-keeping service.

“Now we can pull in data from third parties and aggregate on a security level, even if we are not the custodian,” reveals Mr Ring. “That is the next level in data aggregation.”