Seeking alternative investment ideas

Traditionally, the German public has viewed hedge funds and private equity firms with suspicion. But investors’ appetite for instruments that lead to greater diversification of the portfolio is growing. “The trend is to have three pillars in a portfolio – stocks, bonds and hedge funds. By adding hedge funds, volatility goes down, even as returns stagnate or increase,” Dietmar Bahr, a board member of the Federal Association for Alternative Investments (BAI) told delegates. More than 120 hedge funds belong to the association, which promotes the position of alternative investment products in the market. Hedge fund assets in Germany have grown to almost E2bn in 2007, which is of concern to Mr Bahr. Quality concerns “The differences in the quality of hedge funds are likely to increase. And the press will focus on the bad examples to say hedge funds don’t perform.” And some strategies in certain market phases are bound to fail, he said. Mr Bahr’s plea to the industry, therefore, is to invest in hedge funds in the form of fund of funds, as volatility and risks are higher in single funds. Traditional long positions in fund of funds, also with regional strategies like a focus on emerging markets, is the route most investors are taking, while private wealth managers are already putting together portfolios of single funds. “We have to give clients a comprehensive solution rather than single funds. That’s the trend,” agreed Ulrich Gallus, head of wealth consulting and fund of funds at Dekabank. That way, clients could be moved into stocks, a type of investment that is still underrepresented in German portfolios. Investors’ behaviour regarding private equity has changed in the past two to three years due to difficulties in buyouts. While the expectations for returns have gone down with regards to buyouts, the interest in venture capital has been rising. The subprime crisis, however, has fired an interest in hedge funds rather than private equity. Mr Bahr explained this with passive management strategies and the core-satellite approach that investors are taking: “The core will remain in the ‘long’ realm, complemented with satellite approaches. The focus will be on alpha-generating hedge funds that are market neutral and private equity investments that deviate from the correlation data of the bulk of the ­portfolio.” However, the number of hedge funds in Germany is still tiny compared with the US. “The situation in Germany is a little deplorable,” Mr Bahr said. Of roughly E500bn of capital held by classical institutional investors, less than 1 per cent is invested in hedge funds. This is because out of a universe of 10,000 single funds, only 300 to 400 conform to German investment law, said Mr Bahr. Single funds are not ready to subject themselves to strict German legislation. “This is a still-born child, especially if you consider how easy it is for an internationally active fund to get admitted and made available via a certificate.” The growth of the market and of demand is largely a surge in structured products. Ucits III boost Fund managers confirm this trend has received a boost from Ucits III, the EU directive that enlarges the eligible product range for fund managers. “We are discussing the cloning of hedge funds,” said Christoph Hott, head of investment strategies for private clients at private bank Sal Oppenheim, during a panel discussion. Clones are products that track the returns of hedge funds with the help of historical data and computer models. They try to identify investment patterns of hedge funds and reproduce them with liquid instruments. Growth in private equity products – German private equity funds are about E18.4bn – is perceived as “comfortable”. Mr Bahr sees a few barriers for entrance into this area. First, there is sometimes a lack of understanding of the own organisation and of transparency in the sector. Second, there are legal issues such as requirements by the supervisory authority Bafin. Then of course, investments don’t yield returns in the first few years and in-house staff requirements can be quite high relative to the size of the investment class in a portfolio, making it hard to justify. “But one thing is not an issue: that the capacity of investment has been reached. Therefore I see a clear growth potential,” Mr Bahr concluded. “Private equity and hedge funds will continue to grow and cannot be missed in any German portfolio”.

RF