A New Alternative Investment: Infrastructure

Institutional Investors are planning to invest directly in infrastructure projects such as fixing roads, bridges, water lines, sewage plants and dams.  Returns on these investments are above their benchmarks.  Ontario Teachers' Pension Plan was up 13% in 2010 versus 4% for their benchmark and Ontario Municipal Employees Retirement Systems was up 10.1% versus 8.5% for their benchmark.  Other investors looking at the $50 trillion market (over the next 25 years) include California Public Employees' Retirement Systems, California State Teachers' Retirement Systems, Abu Dhabi Investment Authority, China Investment Corporation and Government Investment Corporation of Singapore.

The source for this article can be accessed here.

Mutual Fund of Hedge Funds

Hatteras Funds manages $2.1 billion in the alternative investment space.  One of its products is mutual fund of hedge funds.  FINalternatives posted a recent interview with the President of Hatteras Funds, Bob Worthington. Their funds invests in five strategies:  long/short equity, equity market neutral, relative value long/short debt, event driven and managed futures.  The hedge funds have between $25 to $500 million in assets under management.  The mutual fund is diversified with 23 managers in a portfolio of $550 million.  Hatteras thinks that they can manage $5 billion in assets with 35 managers.  The managers have to meet compliance/risk control standards as well as being a good fit in the overall portfolio.

The mutual fund has daily liquidity.  This allows great flexibility in determining a tactical asset allocation.  Hatteras usually does not make adjustments on a daily or weekly basis but they can adjust if market conditions change dramatically.  The fund increases liquidity and transparency when compared to more illiquid fund of fund or hedge fund vehicles but has less risks and returns.  However, the fund gives the investor access to hedge fund strategies.

The article can be accessed here.

Regulated Hedge Funds: UCITS and Mutual Funds

SEI published a white paper on the growth of alternative investments called Regulated Alternative Funds: The New Conventional.  Because of the credit crisis of 2008 and the current Eurozone crisis, more and more investors have clamoring to be able to invest in alternative investments to lower downside volatility and offer returns uncorrelated with long-only mutual funds. In the first 8 months of 2011, $61 billion flowed into these investments. $22 billion (39% of all investment capital) were invested UCITS funds. There are now more than 1,500 UCITS funds managing $254 billion. $39 billion were invested through US mutual funds and ETFs. They now compose 4.4% of mutual fund assets and are growing at a 17% rate since 2007 when they were 2.2% of mutual fund assets. There are approximately 730 of them with 118 launched in 2011. Mutual fund families such as Ategris, BlackRock, PIMCO, Nuveen and First Eagle have funds that invest in traditional hedge fund strategies such as managed futures, long/short, credit, commodities, arbitrage and absolute return fixed income.

Internationally, they are constructed in an evolving vehicle known as Undertaking for Collective Investment in Transferable Securities (UCITS). Success has brought on investors. There are established funds with good returns, transparent investment and risk management strategies, and strong brands. The largest fund is the Standard Life Investments Global Absolute Return Strategies with $13.6 billion in assets under management. Other large funds include Julius Baer BF Absolute Return, Newton Real Return, JP Morgan Income Opportunity and PIMCO GIS Unconstrained Bond.

Within the US, they are launched within mutual fund families and ETFs. The largest are, in order of size, the SPR Gold Shares ETF, PIMCO Commodity Real Return Strategy, Ivy Asset Strategy, and iShares Silver and Gold Trusts. For investors, both structures offer more transparent risk management, liquidity, counter party diversification and limits on leverage. Investors are seeking better returns, lower volatility and to protect capital. Mutual fund families are aggressively marketing to and educating investors and registered investment advisors through white papers, instructional videos, fact sheets, regulatory filings and road shows.

Mutual funds are seeking to increase their fee structure. Alternative asset managers are seeking to have a more varied investor base.

When new products are launched, rules are reviewed. They are on the third iteration for UCITS. In the US, the SEC has stopped approving new funds and ETFs to review the effects of derivatives on portfolios. Within Europe, Luxembourg and Ireland are expecting to conform with UCITS regulations with the bonus of having additional flexibility. This may make them preferable to certain investment strategies and investors.

Demand is growing from sovereign wealth and national pension funds in Asia, Latin America and the Middle East and US institutional, high net worth and retail investors.

SEI's 2011 Private Equity Survey: Investor Demands Since 2008

411 private equity fund managers, investors and consultants participated in SEI's 2011 Private Equity Survey.  Due to underperformance in the years since the credit crisis, fund managers have been providing more transparency and liquidity.  Management and incentive fees have been lowered.  22% of investors are paying lower management fees and 38% are paying lower incentive fees.  37% of fund managers lowered management fees and 11% lowered incentive fees.  Size also matters.  The larger institutional investors were more likely to have their fees lowered while the larger private equity funds were more likely to lower them.  Managers were also trying to make their investors comfortable with their infrastructure, giving them solid performance data and educating them on the portfolio.

Factors to consider when raising capital:

• Have a clear investment philosophy
• More transparency
• Turn client service into asset growth

The source for this article can be accessed here.

Private Equity Firms During the Credit Crisis

Through Global Finance magazine, I was directed to a white paper on Merrill DataSite called Riding Out the Storm:  How Private Equity Firms Survive and Thrive During Tough Economic Times.  The global recession that began in 2007 change private equity investment conditions drastically.  Financing deals grew more expensive as banks tightened their loan procedures.  Company valuations declined as the equity markets tanked.  Deals fell apart.

The private equity firms that did well during the recession followed these basic practices:

• Apply sound business discipline to their investment practices
• Good personnel
• Portfolio diversification
• Have proprietary deals
• Overseas investments
• Stellar professional reputations

The firms that did not do well made these mistakes:

• Difficulties fund-raising
• Lack of due diligence on portfolio companies
• Pay too much for debt
• Did not add value to portfolio companies
• Disorderly change of management at portfolio companies

In the future, the paper concludes that private equity firms should concentrate on their core strengths, reduce their debt and practice honesty and fairness to weather the next economic crisis.

When Will Asset Correlation Break in 2012?

According to Ned Davis Research, the monthly returns of eight diverse asset classes has become correlated almost 50% of the time when compare against the Standard & Poor's 500 Index.  In the 1990's, they never had the same returns.  The assets are MSCI indices for international and emerging markets stocks, spot gold prices, copper futures, three and ten year US Treasuries, the Euro and the Reuters-Jefferies CRB commodities index.  The correlation of large cap US stocks to the S&P 500 is at 85%.

According to Jane Buchan, chief executive of Pacific Alternative Asset Management, at the 2012 Reuters Investment Outlook summit the correlation will break at some point.  The key question is when.  She thinks that healthcare and technology sector stocks should diverge. Investors should position their long/short investments to take advantage of this.

According to FX Concepts LLC, a foreign currency hedge fund, the high correlation in 2011 was caused by low interest rates globally, the increase in the money supply by the Federal Reserve Bank and central bank support for the Japanese Yen and Swiss Franc.  For the Group of 10 nations (Belgium, Canada, France, Italy, Japan, the Netherlands, United Kingdom, United States, Germany and Sweden), the trading range for their currencies is within 6%.  Historically, it has been 20%.

The source for this article can be accessed here.

Institutional Investors Favor Long/Short Equity, Macro and Special Situations in 2012

The following chart was published on Pensions & Investments Online website from Deutsche Bank's 2011 Institutional Survey.  1 in 4 institutional investors will be adding to its hedge fund investments in 2012.  Long/short equity, macro and special situations seem to be the most popular.  Distressed and long/short credit are the least.

The source for the article can be accessed here

Success Factors for a Buy-side Analyst

As a member of the New York Society of Security Analysts, I was invited last week to listen to a panel talk about the buy-side and how to succeed in it.  There were four speakers:  Subrata Ghose, CFA, Lauren Lambert, CFA, Stanley Lee, CFA and Thierry Wizman.  Their points can be boiled down as follows.

Ghose is an equity research analyst at Lord, Abbet & Co.  To be successful, he must:

• Simplify his research for the portfolio manager to make decisions
• Be objective
• Have conviction in his opinions
• Be quantitative
• Talk to the entire supply chain of the company (vendors and clients)
• Not hide when wrong

Lambert is a portfolio manager at AllianceBernstein and former Director of Research for Non-US equities at Bessemer Trust.  She added the following points:

• Be excellent with clients
• Do not be too narrow i.e. do not just follow your stocks
• Learn about other asset classes

Lee is a portfolio manager for Neuberger Berman and runs the (David) Greene Group All Cap Intrinsic Value strategy.  His items were:

• Have conviction in your stocks
• Understand the industry and economic environment
• Have good ideas that make money
• Sell ideas in a simple manner

Wizman is the Director of Research at Artha Capital.    His notes were not targeted towards success factors but more of the difference between buy-side and sell-side.  They were:

• Buy-side is exposed to many opinions from the sell-side.  The sell-side analyst is by himself.
• Buy-side can have conditional opinions or change opinions easily
• Buy-side has continuous exposure to a small audience.  Sell-side has a large audience.
• Buy-side becomes portfolio managers.  Sell-side becomes Directors of Research.

Institutional Investors Favor Emerging Markets and Alternative Investments

In an article published by Pensions & Investments, the Deutsche Bank 2011 Institutional Survey shows that investors are planning to shift their capital into the emerging markets and alternative investments (commodities, hedge funds, private equity and real estate) over the next year.  They will be moving out of the US stock and government bond markets.  The survey was conducted for 101 investors with $1.2 trillion in assets.

The source for the article can be accessed here.

As Revenues Fall in Equities, So Does Headcount

Investment banks have been reducing headcount in their European Equities Departments as a result of decreasing profitability because of the ongoing Eurozone debt crisis.  Trading commissions are being reduced because of the rise of electronic execution firms.  The daily average capitalization of stocks being traded in European markets have fallen 58% since 2007.  Unlike US stocks, European commissions are calculated based on the capitalization multiplied by a basis point rate.  They are not based on the number of shares.  The average rate in 2009 was seven basis points.  In 2006, it was nine basis points.  Total trading commissions have gone from 10.7 billion Euros in 2008 to 8.9 billion Euros in 2011 according to the Tabb Group.

Europe's top traders were Credit Suisse, UBS, Morgan Stanley and Deutsche Bank.  They have approximately 8% to 11% of the business in 2010.  Regionally, Europe was 35% of the banks' revenues.  The US accounted for 55% and 10% was from Asia.    Banks that have laid off equities staff include Unicredit, Bank of America, Credit Suisse, UBS, Royal Bank of Scotland and Nomura.  One firm bucking the trend is Barclays.  They are not reducing their European Equities staff.

Some alternative business models include specialization and outsourcing.  Mediobanca added an eleven person team in London that covers financial stocks.  Unicredit hired Kepler Capital Markets to provide sales, trading and research for some stocks.

The source for this article can be accessed here.