Research

European Investor Perspectives – Geneva 2018

Altinvestor Europe 2018 is Eurekahedge’s second European asset owners’ event and the fourth of its kind across Europe and APAC regions, delivering exclusive insights from family offices as well as institutional asset owners on exploring alternative assets and optimising portfolio returns. The event is aimed at facilitating a private environment for candid discussions between investors and to serve as a melting pot of ideas connecting Europe’s leading institutional investors under one roof.

The first day of the event was geared towards large asset owners such as pension funds, while the second day focused on single and multi-family offices. Some of the key highlights from the event, ranging from ESG incorporation into investor portfolios to the opportunities arising in the blockchain and crypto asset space are discussed below. 

How high returns, diversification and ESG go hand in hand

The first day of the event started with an opening presentation from one of the largest pension funds in Denmark, highlighting how ESG investing could be beneficial for the success of pension funds over the long term. Active ownership by engaging companies directly to support climate resolutions continued to be one of the key strategies of the pension fund.

Over recent years, the fund has divested from coal mining, oil and gas companies, as well as avoided investing in companies for reasons including labour and human rights issues, poor corporate governance, exposures to tobacco or controversial weapons. On the other hand, the fund’s impact investments in renewable energy ended up as some of the best performing components of the portfolio.

Figure 1 exhibits the performance of the Eurekahedge ESG Fund Index, a custom index tracking funds within the Eurekahedge database which employ ESG frameworks over the recent years. The index generated an annualised return of 6.60% since the end of 2012, trailing behind the MSCI ACWI ESG Leaders which gained 7.97% per annum, while outperforming the broader hedge fund industry as represented by the Eurekahedge Hedge Fund Index which returned 5.11% per annum over the same period.

Figure 1: Performance of the Eurekahedge ESG Fund Index
 

A panel discussion on Day 2 also put an emphasis on the importance of ESG with some real examples of how ESG overlays could help investors identify potential troubles for a company down the road. The lack of a universal standard for ESG remains as one of the major challenges for ESG investors as definitions could be very divisive and quantification of the ESG impact is difficult. On top of that, some ESG ratings are based on self-reported data by companies themselves, raising concerns over conflict of interest.

Finding Alpha in a low yield environment

Following the opening presentation on Day 1, a panel discussion involving representatives from pension funds and investment consultancy firms took place. The discussion brought focus to the low yield environment which has persisted for years following the global financial crisis in 2008 and made it challenging for asset managers to yield high returns. Fund managers have been searching for various methods to improve their returns, from using alternative asset classes such as structured products, to modifying their portfolio allocations to compensate for the low rates environment.

Some asset managers adjusted their portfolio by increasing allocations toward alternatives, with mixed views regarding hedge funds, as some managers used hedge funds to gain access to unlisted companies and various complex strategies, while other managers expressed concerns regarding the ‘black box’ investment strategies adopted by some hedge fund managers, which lacked transparency. However, there seemed to be a consensus that asset managers should look into Asia and emerging markets in general to generate higher returns amidst the low rates environment across developed markets. Investment-grade bonds from emerging markets, in particular China, attracted notable interest from the participants of the panel discussion.

Figure 2 illustrates the 12-months rolling alpha of the Eurekahedge Hedge Fund Index and the Eurekahedge Emerging Markets Hedge Fund Index against the underlying equity markets as represented by the MSCI ACWI (Local).

Figure 2: 12-months rolling alpha of hedge funds against the MSCI ACWI (Local)
 

Hedge fund fee structure remained as one of the major concerns for investors allocating, or considering to allocate into hedge funds, yet the majority of investors participating in the panel discussion expressed that they would be willing to pay high fees to hedge fund managers who deliver good performance. The hedge fund managers tracked by Eurekahedge have exhibited a trend of lower fees in recent years, with newly launched funds charging lower fees to attract investors and raise capital. On average, hedge funds launching in 2018 charged 1.38% management fee and 15.63% performance fee, noticeably below the ‘2 and 20’ fee structure the industry was famous for.

Table 1: Average hedge fund fees by launch year
 

Year Performance Fees (%) Management Fees (%)
2012 16.23 1.46
2013 14.89 1.34
2014 15.26 1.35
2015 14.38 1.29
2016 15.44 1.31
2017 15.39 1.22
2018 15.63 1.38

Private equity and venture capital in India – opportunities or red flag?

The economic growth of India has been one of the focal points for asset owners looking to invest in emerging markets, yet the volatility and complexity of the country’s markets have been deterring less familiar asset owners from directly investing into the country. A presentation brought by a single-family office based in Bangalore tried to cast light on this subject, as well as share the opportunities and challenges investors might face.

The alternative investment industry in India has come a long way over its fairly short history of just over two decades. Before the turn of the century, the majority of the transactions were small venture capital investments involving foreign funds. Following that, the industry kept growing, with increasing deal sizes and more sectors developing. The pre-financial crisis period saw notable growths in the manufacturing, consumer, and real estate sectors, while the post-financial crisis period saw the focus shifting towards digital businesses and e-commerce. It wasn’t until this period that the domestic fund population began to proliferate.

Over the past decade, most of the venture capital investments in India have not generated great returns and trailed behind similar investments in Silicon Valley and China. Depreciation of the Indian rupee, combined with various challenges including market opportunities taking longer to mature, lack of exit opportunities, and lack of growth capital post-early stage venture severely weighed on the performance of Indian venture capital investments. Nevertheless, the fundamental shifts in economy over the last four years, strong government reforms, growing ticket sizes for deals, and abundance of opportunities in various sectors will continue to make India attractive for asset owners with sufficient risk appetite in the future.

Credit risk sharing and ILS – unique exposure to credit risk

Among the alternative asset classes sought after by family offices and pension funds present in the conference, credit derivatives and insurance-linked securities (ILS) were particularly noteworthy.

Investing through credit risk sharing transactions allows asset managers to share the risk of credit losses in the place of banks, in return for a fixed premium. These transactions would help the banks maintain their regulatory capital ratios, as well as contribute to a sustainable financial system by reducing concentration risks in the banking sector. Demands for credit risk sharing has increased over the recent years as investors hunt for ways to gain exposure to credit risk which could generate returns similar to equities at a lower risk level.

In the same vein, the ILS and reinsurance industry has seen robust asset inflows over the recent years, despite the major losses incurred by the 2017 Atlantic hurricane season. ILS were seen as sources of diversification since they are correlated to natural catastrophic events rather than the global economy. Figure 3 illustrates how ILS hedge funds generate returns that are largely uncorrelated to the global equity markets. Generally, ILS hedge funds underperform traditional hedge fund strategies in terms of pure returns, but the low volatilities and market correlation may earn them a place in an institutional investor’s portfolio.

Figure 3: Performance of the Eurekahedge ILS Advisers Index
 

Crypto assets – decentralised, secure, scalable

Crypto assets featured prominently in the news last year, thanks to the gravity-defying price rally of Bitcoin and other crypto-currencies throughout the year, only to see half of their market cap wiped out in the crash earlier this year. Despite that, interest level among institutional and retail investors remained high, with the crypto-currency hedge fund industry seeing new funds launching and healthy investor allocations throughout the first three quarters of 2018. In fact, a Zurich-based family office believed that the bursting of the crypto bubble was not necessarily a bad thing for the sector in the long run, as it prompted regulators and exchanges to further scrutinise listed coins, and led to the declining number of flawed or fraudulent projects and ICOs. Supported by the number of talents attracted to the fast-growing field of blockchain technologies, crypto assets may become one of the major asset classes in the near future.

Figure 4 illustrates the performance of crypto-currency fund managers tracked by Eurekahedge over the last few years. Despite the abundance of crypto-currencies on the market, the Eurekahedge Crypto-Currency Hedge Fund Index remains highly correlated to the price of Bitcoin, indicating that the majority of the crypto hedge funds tracked by the index still possess rather high exposure towards this particular crypto-currency.

Figure 4: Performance of the Eurekahedge Crypto-Currency Hedge Fund Index
 

Long term equity investment approach

While other asset managers were looking at various alternative asset classes to generate returns, one London-based family office went against the grain by focusing on a more traditional asset class: equities. The family office allocated roughly 70% of their portfolio into large-cap equities, with the remaining 30% split into cash, credit, commodities and properties to provide some liquidity and generate after-tax income to replenish their reserve assets. The family office has employed the strategy which focuses on quality and value since World War II, by picking the leading companies with sustainable competitive advantages in their respective fields. Contrary to how most institutional investors seek diversification, the family office maintained a highly concentrated portfolio over a long period of time, under the assumption that even if markets have significant pullbacks, they will invariably recover over time.

Figure 5 provides the annual returns generated by hedge fund managers utilising equity strategies, and comparing them to the industry average performance encompassing all hedge fund strategies. Fund managers with long-biased equity strategies managed to generate 9.24% return per annum since the end of 1999, as opposed to the 8.54% annualised return posted by their peers utilising long/short equities strategies, which employ short positions to hedge downside risk. As seen in the figure below, in periods of market downturn such as 2008 and 2011 long-biased portfolios are likely to post steeper losses compared to their hedged counterparts. This drawdown risk might deter some asset owners with lower risk appetite from employing a long-biased and less diversified strategy.

Figure 5: Annual performance of equity hedge funds
 

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