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HSBC AM building ‘beta constraint’ HF portfolios

Bank’s $20bn HF investment arm is eyeing macro, CTAs and a number of hedge fund strategies
14 July 2021
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    Bank’s USD20 billion HF investment arm is eyeing macro, CTAs and a number of hedge fund strategies

    The hedge fund investment unit of banking giant HSBC is zeroing in on “risk-off” strategy types as it looks to achieve a low beta to both equities and fixed income.

    HSBC Asset Management, which had around USD20 billion in hedge fund AuM, advice and oversight as of the end of March, is building what hedge fund chief, Richard Berger, calls “beta constraint” portfolios.

    The medium-term outlook for traditional asset classes may be disappointing, especially compared with what has been achieved in the last ten years post-GFC when risk asset prices were sustained by extraordinary monetary policies and inflation stayed low,” said Berger, global head of hedge funds at HSBC Asset Management.

    “Another challenge for portfolios that we think – will become increasingly pertinent over the coming years is the impact of inflation. We think that asset allocators will increasingly see inflation as a force to factor in when thinking about allocations.”

    To mitigate these risks Berger’s team of 19 – which is made up of 12 analysts and seven portfolio managers – is looking to invest more in what it considers “risk-off”, such as macro or systematic strategies, including CTAs.

    Yet, Berger added that simply building up portfolios of macro and CTAs during this risk-off period carries limitations, and that his team will also seek to invest other hedge fund strategies.

    “Usually when HF investors think purely about diversification, they tend to focus only on macro and CTAs. We think this approach is fine but has some limitations and carries some risks. It can be improved. CTAs exhibit indeed on a medium to long term basis a zero correlation to traditional asset classes. But the inflection point is sometimes painful,” said Berger.

    He said that when transitioning from a period favourable to risky assets such as equities, into a risk-off period, trend followers will start first by generating losses and only when the trend is well-established that they will benefit from it.

    “On an historical basis CTAs have made money during bear equity market phases not necessarily by being short equities but by being long bonds. In the current environment of low interest rates, the upside on fixed income is limited,” he said.

    CTAs that have made money on bear equity markets that last more than a few weeks or months may not also be able to repeat that under current market conditions.

    “Markets are much quicker and more brutal to reverse, hence the need to react and to reposition very rapidly, which is not always beneficial to traditional medium to long term trend followers,” Berger explained.

    Beyond CTAs and macro managers Berger believes there are other sources of diversification in the HF universe. “Not only are other strategies typically low correlated to traditional asset classes they are also generally low correlated to each other. We like the diversification benefits of gathering these strategies together in a diversified portfolio”.

    He said some multi-strategy funds offer a wider range of opportunities, a good consistency of returns, low volatility and contained drawdown – while maintaining low correlation to equity and fixed income due to their market neutral approach and their usually tight risk management.

    “Some low net equity and credit l/s managers can also produce low correlated returns while maintaining a nice level of performance. Market neutral managers also belong to this category, as well as some systematic managers and arbitrage strategies such as M&A, stat arb, cash/future or CB arb,” he said.

    Manager selection

    Berger’s hedge fund unit has around 75-80 per cent of its USD20 billion in capital in bespoke products, with the remainder in its FoHF products. His team also advises a hedge fund platform business where private banking clients in Asia can invest in roughly 45 external hedge fund managers. Currently, there are USD2.7 billion in assets on that platform.

    For its traditional FoHFs – like its flagship FoHF – the firm tends to have 22-24 managers with a position ranging from 3-7 per cent of the fund’s assets.

    “We have an investable list of around 125-130 hedge fund managers and the line-up is constantly being updated,” he said.

    Berger is in charge of strategy allocation with all trades reviewed by an investment committee of five, of which Richard is co-chair alongside global CIO of HSBC Alternatives.

    Manager research is conducted by analysts that are split by strategy, apart from Asia where they are generalists. A team of operational due diligence professionals that works across all of HSBC’s alternatives investments operates independently to Berger’s team.

    “As we are quite big we want the research to be efficient so we tend to invest at least USD50m in one manager to start. And we cannot be more than 20 per cent of each fund,” said Berger, who added the firm can invest at launch but it’s likely to be with someone who is going to be USD500m at least.

    “We have large assets with well-established multi-managers and as we know them well, when a star trader is leaving to set up on his own it allows us to be fast in approaching and booking capacity, pending due diligence of course,” he said.

    HSBC Asset Management also operates an internal hedge fund marketplace meaning that it can recycle capacity and stay within what it deems to be the best funds. This works with clients able to get the opportunity to take capacity on redemptions from other clients.

    The firm’s flagship FoHF is currently up 2.91% April YTD after a few strong years of performance, returning 8.25% in 2019 and 13.89% in 2020.

    Key risks of investing in hedge funds

    The value of investments and any income from them can go down as well as up and investors may not get back the amount originally invested. Past performance is not a reliable indicator of future performance.  

    There are several key issues that one should consider before making an investment into hedge funds. The risk specific to this type of investment may include, but are not limited to:  

    • Regulation: The hedge fund industry is lightly regulated, with the majority of funds domiciled in offshore jurisdictions. Regulation is more prominent at the investment adviser level, those based in the UK are regulated by the Financial Conduct Authority and/or the Prudential Regulation Authority and many in the US are regulated by the Securities and Exchanges Commission. However, it should be noted that these funds themselves are generally classified as “unregulated” and are not typically subject to the same levels of scrutiny and protection as a traditional investment fund. A thorough due diligence process can mitigate these concerns. For these reasons, these funds can generally only be offered to experienced and sophisticated investors.
    • Gating: In event that redemptions requests on a particular dealing date is much higher than the normal level and full satisfaction would jeopardise the longer term portfolio balance, a gate or partial execution of redemption requests may be implemented generally on a pro-rata basis. Gating essentially provides a floodgate to temporarily relieve the pressure of unloading fund assets in big amounts at inappropriate market conditions.  
    • Side pocket: There may be instances when certain assets in a fund portfolio could become less liquid and the fund manager may segregate these illiquid positions from the main portfolio into a side pocket (or a separate vehicle). Generally, the side pocket is self-liquidating, i.e. selling down the illiquid positions once market liquidity returns. There may not be a fixed timeline for the redemption of the side pocket and investors may receive no payments in some cases.  
    • Suspension of redemption: Suspension of redemption is a temporary halt in exiting the fund during a given redemption window. This is a stronger measure than gating because there is no dealing for the fund. This is generally used under special circumstances such as when liquidity conditions have markedly deteriorated in a short period of time or when there are heavy asset outflow such as the loss of a core investor. Typically this would lead to a restructuring of the fund or other plan to ensure an orderly liquidation of assets on basis of equal and fair treatment to all investors. 
    • Capacity: Hedge fund managers identify a certain amount of capital where they can effectively and successfully manage the fund on behalf of their investors. Once the assets of the hedge fund reach this level, the managers tend to close the fund to new investment in order not to dilute the return to the existing investors. Therefore, the majority of the longer-running “star” hedge funds are now closed to new money and investors are not able to access them. However, long term investors who have built a strong relationship with the hedge funds over time are often favoured when capacity becomes available.  
    • Transparency: Many hedge fund managers are wary of regularly publishing their positions in the belief that this will remove any advantage that they have over their peers. This can pose a problem to the investor, as he or she cannot be certain to which stocks, geographies, markets or even strategies he or she will be exposed to when investing in the hedge fund. However, trusted investors who have built strong relationships with the hedge funds can access this information for the majority of funds, enabling thorough monitoring of the investment.  
    • Liquidity: Hedge funds typically have much longer dealing cycles than traditional investment funds. Depending on the strategy being utilised, a hedge fund may only allow subscriptions and redemptions on a monthly or quarterly basis. Furthermore, some hedge funds have long lock-up periods, where an investor is not permitted to redeem from the hedge fund unless a period of 6 months, a year or even 2 years has passed. Some may allow a redemption before the lock-up period is over, but the investor would have to pay a hefty penalty to be able to do this. Some hedge fund managers may also operate a redemption gate, where they place a limit on the amount of shares that can be redeemed during any set period. The objective of these terms is to provide the manager with a stable capital base that enables them to execute strategies they would not otherwise be able to. Such strategies can provide a better risk reward ratio than would be available to a more liquid fund.
    • Access: Hedge funds operate larger investment minima than traditional investment funds. Investors are often unable to access a hedge fund unless they were willing to invest US$500,000 to US$2million, implying that only wealthy individuals, who can meet those minimum investment requirements, would be able to access hedge funds. However, investing through fund of hedge fund products or managed accounts can provide access to these managers with greatly reduced minima.
    • Tax: Due to the nature of hedge funds and their domicile, an investment in one of these vehicles could have tax implications for the investor. Therefore, tax advice must be sought by the investor prior to investing in any hedge fund.
    • Manager failure: Over time, a number of hedge funds will close or fail, due to weak performance or operational difficulties. An investor must take this into consideration before making an investment, seeking professional advice to help minimise the risk of investing in a fund that is likely to fail.

    Important information

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