Tue, 04/02/2014 - 10:09
“We are a centre of expertise for hedge fund investments,” states Jean-Marc Stenger, CIO for Alternative Investments at Lyxor. “When clients come to us, they want access to experts in relation to strategy selection, manager selection and portfolio construction – those are our three main areas of expertise.”
A lot has changed in the hedge fund industry since Lyxor was established in 1998. Pre-2008 hedge funds were mainly the preserve of private investors. Post-2008, a new paradigm has emerged, one in which institutional investors now dominate. Their needs and requirements for hedge fund investing are unique and wide-ranging. Lyxor has always taken an institutional approach, even in the early days, placing great emphasis on operational due diligence in the managers it selects, risk monitoring and transparency. Consequently, the firm’s growth trajectory has largely mirrored the evolution of the alternatives industry.
As Stenger goes on to explain, regardless of how institutions invest in hedge funds what they need is access to expertise; choosing between a commingled managed account, a commingled FoHF or a dedicated FoHFs is secondary to this.
“We put in front of clients the right level of expertise that they need to achieve their specific investment needs. We have clients who talk only to our strategists, clients who talk only to our hedge fund analysts, and clients who talk to our portfolio managers,” says Stenger.
Lyxor has, then, come a long way in a short space of time where it started life as a managed account platform provider; one that has since grown into the industry’s largest commingled platform with close to USD12billion in AuM.
“Between 1998 through to the mid-2000’s most hedge fund investors were private individuals who were eager to invest in the best managers but needed help accessing them. To them, transparency and risk were secondary considerations,” says Christophe Baurand, Head of Alternative Investments. Performance was king.
Transparency and risk management are two key pillars on which Lyxor’s success has been built. By raising the level of hedge fund investing through its platform of managed accounts, Lyxor pre-empted the institutional trend that was to follow.
“When institutions finally decided to enter the hedge fund space they wanted to feel comfortable with respect to the operational and risk management aspects of their investments. Their performance expectations were slightly lower but more sustainable. High single digit returns were acceptable to them provided there was strong risk management in place,” says Baurand.
After 2008 they became the primary investors into hedge funds. For Lyxor, this acted as a catalyst. The firm was ideally placed to support institutions with a myriad of solutions depending on each investor’s level of sophistication.
“One of the key reasons for our success was linked to our strong focus on performance as well as a focus on risk and operational issues. Since its infancy, Lyxor has focused on these issues simply because the risk requirements of investors were heavy; making sure the operational set-up of clients’ investments was robust, making sure there was transparency across their portfolio to show what was going on at the individual fund level, not only in terms of performance but also risk,” says Baurand.
The net result is that whereas in 1998 Lyxor had no pension fund clients, today institutions account for approximately 80% of the firm’s assets. This applies not only to its managed account platform but also its FoHF business. Indeed, Lyxor’s expertise in manager selection has made it one of the industry’s top 10 FoHF managers with around USD9billion in AuM. Moreover, its hedge fund advisory business has helped to attract customised mandates like the one from CalSTRS, the 2nd largest public pension plan in the US.
The secret behind the success of Lyxor’s FoHF business is built on precisely the same principals as its managed account business. It understood that in order to survive in the new paradigm portfolio and risk monitoring and the ability to provide enhanced transparency were fundamental requirements.
“We have adapted our client service standards to institutional-quality. The transparency available to us means we can provide clients with detailed risk and performance reports where perhaps other FoHF firms cannot. Institutions won’t invest in anything unless they understand the strategy in detail, understand all of the risks, because by definition they are investment professionals. It’s not therefore purely about focusing on performance,” adds Baurand.
The rotation from private money and a focus on performance to institutional money where the focus is more on risk management, transparency and diversification, as well as performance, has therefore enabled Lyxor to grow in tandem with the institutionalisation of the hedge fund space.
What has also been key is Lyxor’s ability to provide clients with an “a la carte” menu of solutions. The trend has shifted from what was largely a diversified FoHF approach to more of a solution-driven approach, either by investing directly in managers or via managed accounts.
Within its FoHF division Lyxor runs two flagship commingled FoHFs and one thematic FoHF that focuses on emerging markets. Stenger confirms that around 70% of the USD9billion in AuM is in dedicated FoHF mandates which the team build specifically for each client, with the other 30% in its commingled funds.
“We have the capability to build truly customised portfolios for investors based on a given risk/return objective. A big part of the assets we manage are invested on the Lyxor MAP but sometimes we invest directly with the manager if it’s better suited for the investor to achieve their objectives. We are solution-agnostic. What is critical to us is developing the best solution for any given client,” explains Stenger.
Discretionary vs advisory solutions
Investors have two routes available when choosing to avail themselves of a dedicated FoHF portfolio – discretionary or advisory. The majority of mandates, says Stenger, are discretionary where Lyxor agrees with the client on their investment objective “and it is our duty to implement top-down investment ideas and manager selection in the portfolio.
“Our advisory business is a big trend, particularly in the US. Here, we explain to investors why we think there might be opportunities in a particular strategy and which funds we think it would make sense for that client to have in their portfolio. It’s more of a consultancy-based approach. We perform all of the manager and operational due diligence but the final decision on whether to buy the fund rests with the client. If they agree then we decide with the client either to invest directly in the manager or, if they want a segregated investment, to set up a managed account. This advisory approach is being taken with CalSTRS,” says Stenger.
In order to achieve an outcome-driven solution, Lyxor constructs its portfolios using a top-down approach. The first step involves having a clear idea of the prevailing macro environment and how this will impact traditional asset classes. Next the team builds its views on specific investment strategies, taking into account the key drivers of performance. The subsequent investment themes then enable Lyxor to take the next step of manager selection.
“We look for the best managers that we believe are best placed to express these specific investment ideas. If you were to do performance attribution in our FoHF portfolios, probably around 60% derives from our top-down investment approach while the remaining 40% comes from the skill of the selected manager.
“We do not build portfolios simply by adding managers and hoping for the best. The ideas expressed in each portfolio are our ideas. The strategy and the selected managers are ways to express those investment ideas,” stresses Stenger.
This certainly sets Lyxor apart from the competition and it’s the ability to leverage its managed account platform that has allowed it to prosper.
Using the Lyxor MAP to meet institutional needs
“Our investors expect performance, and they expect solutions. As an asset manager, the way we see the managed account business is not to be a supermarket but to provide our investors with a selected universe. Manager selection is key in our business model. Currently we have around 80 managers on the commingled platform. They represent a mix of established and smaller managers, mainstream strategies and more innovative ones,” says Lionel Paquin who heads up the Lyxor MAP.
In 2013, managers on the platform returned on average 7%, above the HFRX index, with improved liquidity. Another mark of the platform’s success is to look at the performance of FoHF mandates. Here, confirms Paquin, performance has been “outstanding”.
“All of our FoHFs – both commingled and dedicated mandates – have exceeded their objectives. Ten mandates have returned more than 7% on a year-to-date basis. Regarding strategies, long/short equity funds on the MAP were up 16% (as of end-December) while event-driven and special situation funds were up around 14% (as of end-December).”
Aside from superior manager selection, managed accounts as a ‘performance engine’ allow institutions to meet their risk/return goals because of their inherent flexibility.
“Managed accounts are an exciting solution. Things can be changed, negotiated, optimised such as fees, cash, socially responsible investment guidelines, leverage, liquidity etc. Managed accounts are a place where solutions can be implemented,” says Paquin.
Stenger adds that Lyxor’s FoHF team uses managed accounts as a superior tool to make investment decisions. The transparency they offer allows the portfolio manager to determine if the level of risk in the portfolio needs to change, the duration risk in the portfolio etc.
“Having that transparency allows us to know how to act and which manager within a given FoHF portfolio we need to overweight or underweight and deliver the target performance we have in mind. Managed accounts allow us to implement these adjustments on a real-time basis. They are a superior asset allocation tool,” says Stenger.
Institutions increasingly want their hedge fund allocations to be assimilated into their overall investment portfolio. The goal is to have a consolidated view of risk. Rather than separate investments, long/short equity funds sit within the equity bucket, credit long/short, fixed income arbitrage funds sit within the fixed income bucket etc. That’s all well and good, but as Paquin states, to achieve this investors need transparency:
“We see more and more requests from investors on how to aggregate their hedge funds within their overall risk budget. Managed accounts are the ideal solution for that. They are becoming more of an institutional investment solution.”
At the cutting edge of hedge fund investing – and right now only the preserve of the biggest institutions with the deepest pockets – is what Baurand refers to as the infrastructure solution. This is part of the firm’s hedge fund advisory service. Institutions open a separate account with a manager, plug in a risk tool and have a third party, i.e. Lyxor, risk monitor that account on their behalf. This is being done for the likes of PGGM and CalSTRS and Baurand sees it as an important trend going forward.
“This is exactly what we do for our own FoHFs internally. What we realised was that we could extend that service and give investors the same level of support for investing into single manager mandates by providing an infrastructure solution. Ultimately, what the client wants is a solution whereby they get a single aggregated risk report – it’s about integrating hedge funds into their overall portfolio,” explains Baurand. “We’ve become a one-stop shop for hedge fund investing. To be successful requires having a comprehensive solution-based offering.”
A further illustration of how Lyxor brings innovation to the market is the institutional share class it recently introduced. Because of its size and experience, Lyxor can negotiate more favourable fee terms on behalf of its investors, in exchange for monthly liquidity and a larger initial allocation – typically between USD5-10million.
Paquin confirms that part of Lyxor’s future strategy is to focus on less liquid strategies in areas such as distressed debt, and building more concentrated portfolios. Another area of evolution will be to add early-stage managers, something that Lyxor commenced this summer with the onboarding of Paris-based Melanion Capital, an innovative long/short dividend futures strategy which is only available to investors through the managed account.
“The managed account model is about making something more institutional. We have revenue sharing in place with Melanion Capital meaning any investors who allocate to the fund and accept a three-year lock-up will receive not only performance-related returns but also a share of overall revenue. The early-stage manager space is one in which we are likely to take more strategic initiatives,” comments Paquin.
AIFMD – the next stage of evolution
Nathanael Benzaken, Deputy Head of Alternative Investments at Lyxor, is particularly excited by the growing institutionalisation of hedge funds and sees the AIFM Directive, now transposed across Europe, as the next major catalyst for growth, both for Lyxor and the industry as a whole.
Already this year hedge fund performance has improved thanks to a return to fundamentally-driven markets. Factor in that investor demand is growing as the need for portfolio diversification and higher yielding investments gathers momentum, and the introduction of the directive could be a game changer. Overnight, institutions have a new access channel. Previously, the only option for investing into hedge funds was offshore. The UCITS wrapper offers some opportunities but it is not universally suitable for all managers and strategies. The AIFM Directive changes all of that.
“We see AIFMD as a catalyst in the sense that it doesn’t come with any trading limits. Investors can access hedge fund strategies onshore that run precisely the same as their offshore counterparts – they are identical. Investors can now access onshore EU regulated funds that deploy a genuine hedge fund strategy without any structural limitations,” says Benzaken. “With these three forces – fundamentally-driven markets, increased need for diversification among investors, the AIFMD as a new access channel – then we might well be at the dawn of a new growth in AuM driven by inflows and, hopefully, continuing performance.”
Lyxor is now in the process of supporting managers under the AIFMD by providing management company services. And it’s easy to appreciate why the firm is well positioned.
As a piece of regulation, what AIFMD does not do is address the inherent risks of hedge fund investing such as reputation, style drift, liquidity risk (e.g. gating, side-pocketing), fraud, misrepresentation to clients etc. Those risks remain, even if a manager becomes compliant under AIFMD. By contrast, these very risks are the ones that Lyxor has continuously addressed throughout its evolution.
What this creates is a situation where the manager is regulated under AIFMD and the fund is effectively regulated – because of the myriad operational, transparency and risk controls in place – by Lyxor. “Combine the two and you’ve got the most robust solution for institutional investors,” says Benzaken.
Under AIFMD, Lyxor will act as the AIFM on behalf of non-EU managers by availing themselves of the managed account platform. As a natural extension of the managed account model, each AIF will sit on the platform with Lyxor as the AIFM controlling the investment mandate and then delegating the duties out to the external manager i.e. someone based in New York.
Instantly, this will help non-EU managers access the European market, without having to become an AIFM and incur the costs of establishing an EU presence.
“The ability to offer this management company solution is a very exciting opportunity. Clients want the choice to access non-EU managers, and at the same these managers still want access to European investors.
“Expect to see our first single-manager AIFs going live most probably as early as Q1 2014,” confirms Benzaken.
Lyxor’s first foray into AIFMD will, however, be with its multi-manager solutions.
“Our approach to multi-manager investing has always been aligned with the spirit of AIFMD,” says Stenger, citing Lyxor’s emphasis on strict risk guidelines, independent risk management and a culture of transparency and comprehensive reporting. “Through the AIFMD, investors will be able to access the performance of our flagship strategies in a regulated, onshore format starting in Q1 2014.”
Thanks to its commitment from day one to focusing on risk management, transparency and operational due diligence, Lyxor has evolved from being a leading managed account provider to a multi-faceted, multi-solution hedge fund investment expert. The AIFMD now represents the next exciting step in the firm’s evolution.
“It’s about anticipating trends and adapting to them. Regulation is a key trend and if we want to be successful tomorrow we have to be able to provide onshore solutions to investors who traditionally invested offshore. This is the next big opportunity for us. We want to be the first to offer robust AIFMD infrastructure to our clients. It’s the next part of the multi-faceted business we are building,” concludes Baurand.
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