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FRM’s Current Preferred Hedge Fund Strategies
In its latest outlook, FRM, Man Group’s $19.5 billion fund of hedge funds and managed accounts business,  identifies three potential sources of return for hedge funds. The preferences that FRM expresses are based on a specific market outlook.


Cautious Welcome For JOBS Act Proposals
New rules under the proposed JOBS Act are expected to bring dramatic changes to the marketing of hedge funds in the United States.

If there are no such things as coincidences then this dialectic was meant to be seen.  Two opposing views on the oil price came into "Hedge Fund Insight" with 24 hours. Take a read and take a view.

Views On Oil Price Diverge

 

Oil Price To Continue Rising

Says Angelos Damaskos, CEO Sector Investment Managers - read his case here.

Oil Faces Risk Of New 2012 Low

Says Stephen Pope, Managing Partner of Spotlight Ideas - read his case here.


Gold Miners To Outperform Gold
It was quite surprising how well the gold view worked over the last weeks. Obviously, it was greatly supported by the major financial powers of this world. Firstly Mr. Draghi with the announcement of the “unlimited” purchase of government bonds in the Euro-Zone followed by Mr. Bernanke who announced a further disguised QE3 which focuses on the purchase of MBS to the tune of 40 billion US-Dollar.

Physical gold did make the move and begins to tackle the former resistance levels around 1800 followed by 1900. The whole focus continues on gold as investors are assessing the real impact of the money printing on both sides of the Atlantic. However, there are more forgotten sides to the gold trade which are not in the limelight of investors.


Mr Bernanke Goes For Broke
By Stephen Lewis, Chief Economist, Monument Securities

At his press conference yesterday following the FOMC meeting, Mr Bernanke was intent on pointing out that monetary policy is no panacea.  This has been his constant refrain recently, a plea for clemency perhaps in any judgment of the Federal Reserve’s limited success in meeting the terms of its mandate.  Yet, the Bernanke-led Fed continues to act as though it still believes monetary policy alone can turn round the US economy and restore it to full employment.  That is the logic of the FOMC’s decision, should the labour market not improve substantially, to ‘continue its purchases of agency mortgage-backed securities (MBS), undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in the context of price stability’.  This statement presupposes that Fed asset purchases will eventually bring about the desired strengthening in the labour market.  The FOMC does not countenance a situation where the Fed might continue its asset purchases until the cows come home, without achieving the substantial improvement in labour market conditions that it seeks.  Yet, this is a scenario that those who monitor the Fed’s actions increasingly regard as plausible, if not probable.

Seed Capital for Hedge Funds

Contributed article from Ka Ng, CAIA and AVP at Merrill Lynch

Time and again, studies on hedge fund performance indicate that smaller, emerging funds outperform their larger brethren because they are more nimble, being able to get in and out of positions without moving prices; and have the ability to build focused portfolios.  Even with this evidence, emerging managers are finding it difficult to raise money.   The situation has been exacerbated by Dodd-Frank legislation, causing proprietary traders at banks to spin-off into hedge funds and prohibiting banks from investing in funds.  More funds are chasing less investment capital.  Also, the HFRI Fund Weighted Composite Index returned negative 4.8% in 2011.  Investors want access to the higher returns of emerging managers. These pressures are causing managers and investors to turn to an alternative:  seed capital. 

According to a research report from Larch Lane Advisors LLC, seed capital is a multi-year commitment in emerging hedge funds.  Larch Lane has been a provider of seed capital since its inception in 1999.  It has seeded twenty-five hedge funds.  Seeders (either from an investor or a hedge fund seeding vehicle) give small funds a stable asset base that will not be withdrawn at the first sign of a drawdown.  This helps attract other investors.  Fund managers may receive assistance in operations, risk management, marketing and business development.  Seeders can receive a share in the fund’s management and performance fees, full transparency, risk control and ability to monetize their investment.

The three main seeding arrangements are equity ownership, revenue sharing and hedge fund platform.  In equity ownership, the investor actively helps manage the hedge fund from a business point of view only.  Investment decisions are still made by the manager.  Seeders can profit by being bought out by the manager or another investor or the manager may grow large enough to be brought to the public markets.  The Tiger Cubs are the most prominent funds in this category.  They were seeded by the famous investor Julian Robertson of Tiger Management.  He invested $25 million for a 25% equity stake.   The Dutch firm IMQubator is another investor using this type of transaction.  In January, they announced a joint venture with Synergy Asset Management to source emerging managers in Asia.

In revenue sharing, the arrangements are variable but they all have one goal – to enhance returns.  A seeder’s investment is improved by the fund’s revenues.  As the fund attracts more assets under management, the seeder’s returns increase.  Additionally, the manager pays a percentage of the revenues (usually around 20-25%) to offset the “2 and 20” fees paid by a regular investor.  Below is an example of how the return on investment increases as the assets grow.

Source:  “Hedge Fund Seeding:  A Compelling Alternative.”  Larch Lane Advisors LLC, 2011.

Terms of the agreement between seeder and hedge fund may include a limit on the amount of fees shared with the investor or the investor may pull out its capital after the seeding arrangement is completed and still retain the revenue flows.  FRM Capital Advisors has used revenue sharing agreements in seeding funds such as WestSpring Advisors and Beechbrook Capital according to an article in the hedgefund journal.  FRM Capital Advisors’ parent is Financial Risk Management, a fund of funds with more than twenty years of experience. 

Hedge fund platforms are offered by large hedge funds and financial institutions.  They provide a platform with marketing and operational expertise.  The investor has control over the manager’s business and investment process.

A hedge fund seeding vehicle specializes in investing in emerging funds.  According to one source, the number of seeders has dropped from 100 to 20-30 in third quarter 2011.  They close two to four deals annually and the average size of an investment is $10-30 million.  In addition to the advantages of direct investing (share in fund growth, higher return potential, transparency and risk controls), a vehicle gives investors manager diversification, access to co-investment opportunities and returns equivalent to private equity but with better liquidity.  The 800 pound gorilla is the Blackstone Group.  It raised $2.4 billion for the Strategic Alliance Fund (SAF) II in 2011 according to HFMWeek.  Other large firms include Reservoir Capital ($1 billion), Protégé Partners ($750 million) and Goldman Sachs Asset Management ($500 million).

Current investing conditions are favorable to the growth of seeding arrangements.  They allow investors to participate in the fee structure of managers and the on-going growth of the hedge fund sector.  A seeded fund attracts other investors and allows the seeder to benefit greatly by the increase in assets under management.   In addition, investors gain exposure to the higher returns of emerging managers.   Anyone with a longer time horizon will find this an attractive investment as three years is the standard lockup period.

Early View of Last Month from FRM

Fund of funds manager Financial Risk Management (FRM) produces a monthly “Early View” reviewing the hedge fund and market themes and sector performance for the previous month. 

The highlights for April 2012 were:

"We had been concerned that the hedge funds with low market beta were too slow to rebuild risk through the first three months of this year, but the reward for prudence has been apparent through April when these hedge fund managers benefited from their cautious positioning and focus on capital preservation.
 
Looking ahead, we anticipate that managers with short horizon, tactical trading styles are likely to weather thecurrent environment well. Credit and Equity Long-Short managers across regions have been finding more things to do despite the macro headwinds. We believe that the increase in dispersion will benefit these managers and allow them to build more balanced books."

Strategy summary for April 2012

Directional Trading
• Early estimates show that Systematic Trading managers ended the month in positive territory despite the intra-month volatility. The main contributor to performance was long exposure to bonds. The largest detractor for the month was long exposure to equity indices.
• Discretionary Trading managers produced a wide range of returns. Overall, managers have retained a low level of risk and have focused on short duration, tactical trading.

Equity Long-Short
• Despite the strong intra-month reversals, the average Equity Long-Short manager produced flat returns. Overall, net and gross exposures stayed at the same level though managers tended to refresh the ideas in their books. Towards the end of April managers generally covered the shorts that had worked well at the start of the month.
• The latest earnings season data has surprised on the upside in the US; some select longs in Financials were contributors in April (eg JP Morgan). US Equity Long-Short managers are increasingly focusing on domestic names over international companies in an attempt to capture the regional outperformance.
• European Equity Long-Short managers generated decent returns despite the comparatively weaker earnings data. Managers have cited the increase incorporate activity and company-specific news as the main drivers. 

Specialist Credit
• The early estimate data suggests that Specialist Credit managers are likely to end the month with flat to positive returns. Refinancing events are expected to be a positive contributor in April. Bearish managers with short exposure to European sovereigns and financials are also likely to have had a strong month.
• US credit markets appear to be showing signs of de-correlating from Europe. This is a positive for managers as it allows them to benefit more from company-specific drivers rather than macro factors. An example of this is US new issuance which has continued to be robust despite the increased concern over European sovereigns.

Relative Value
• Relative Value managers posted mixed returns in April. Event Arbitrage managers struggled to add value as deal activity continued to be muted. Those involved in special situation deals also tended to suffer mark-to-market losses.
• Performance was flat in aggregate for Convertible Bond Arbitrage managers. Valuations came under pressure as outright investors became net sellers for the month. The increase in volatility, however, was positive for gamma trading.
• Statistical Arbitrage managers also ended the month flat. Early estimates indicate that, technically-oriented models (eg Momentum) tended to outperform fundamentally-oriented models (eg Value). Some managers reduced the allocation to their value-driven models during the month in line with their risk management
strategy. 

FRM’s flagship fund of funds showing good relative performance

Financial Risk Management’s long term record as a fund of funds manager is reasonable. The only significant blip on the record was the one shared by most funds of funds, that is, a big loss in 2008. Like all serious funds of funds the firm makes a large effort in risk measurement and understanding of the risks taken on behalf of their investors. There has been a pay-off for  that effort since the end of 2008 as the FRM flagship fund, the Absolute Alpha Diversified Fund, has out-performed the typical multi-manager hedge fund product last year and this.   

The relative performance has been good in the year to date. The whole of the monthly/annual track record is shown below.

Despite losing months in May and June, FRM’s AA Diversified Fund is still up for the first half of 2010. It should be borne in mind that the Diversified Fund is over $2bn, so degrees of freedom are less than those of smaller funds. For comparison, the Barclay Fund of Funds Index is down 1.4% and the HFN Fund of Funds Aggregate Index is down 1.27% over the same period.  It is noteworthy that FRM’s multi-manager fund lost only 1.54% in May, a month in which single manager hedge fund indices were down over 2 ½ %. So tail risk was curtailed for the fund of funds as an investor would hope for a mature single manager hedge fund.

This year the Fund will have benefitted from exposure to statistical arbitrage managers as volatility went up, and more significantly from the allocations to macro/directional managers (with the exception of a Top 10 allocation to Moore Global Investments). Relative performance will also have been helped by the portfolio level hedges applied by FRM which are used to limit the equity beta exposure of the fund-of-funds.