COO Connect Editorial: Interview with Robert Leonard, head of capital services at Credit Suisse
Despite hedge funds having their second down year in four years, investors remain bullish about their prospects, according to Credit Suisse’s annual global hedge fund survey. Based on responses from 600 institutional investors with $1.04 trillion in hedge fund investments, the survey provides an excellent insight into the ongoing trends affecting the industry. COO Connect Editorial speaks to Robert Leonard, head of capital services at Credit Suisse in New York, about the findings.
COO: Which strategies appear to be in investors’ sights in 2012?
Leonard: Global macro, according to the Dow Jones Credit Suisse indices, was up over 6% last year and investors appear confident it will continue to weather the volatile and challenging markets as it is a very flexible strategy. While long/short equity underperformed and there was a high degree of correlation between long/short equity and equity benchmarks last year, investors appear to be confident that it will return to form. The macroeconomic conditions are changing and many investors believe this will help long/short equity deliver less correlated returns. Many investors perceive that, especially relative to developed markets, many Asia-Pacific (APAC) and emerging markets sovereigns and corporates still present strong fundamentals and healthy growth prospects. A majority of investors indicated that they intended to put money to work in Asia and emerging markets strategies, and also in US for that matter, where they believe the global economic recovery is going to continue.
COO: CTAs and fixed income arbitrage are also much sought after by investors. Why is this?
Leonard: CTAs have historically been viewed as one of the more uncorrelated strategies in the hedge fund universe. Given that correlation was a big concern in 2011, we anticipate more investors are seeking out strategies that deliver uncorrelated returns. Fixed income arbitrage has also seen an ascendency, as investors look to capitalise on some of the dislocations caused by the sovereign debt crisis. Buzzwords for institutional investors today are uncorrelated, low volatility and long-term, and these are all offered by fixed income arbitrage. Fixed income arbitrage is not the sexiest strategy for high-net worth individuals but it is well suited for institutional investors and their needs
COO: Most reports suggest hedge fund size attracts assets. The findings in the Credit Suisse report suggested otherwise. Do investors care that much about hedge fund size?
Leonard: I believe investors do care about size. There is clearly a minimum critical mass in terms of assets under management (AuM) that investors care about, which is usually around $100 million. In 2011, our global team spoke to many investors who said they were more comfortable allocating to the bigger names. However, more and more investors are also looking at slightly smaller, mid sized firms, which are nimbler and can enter certain markets and make trades that don’t move markets. Investors say they are actively looking at funds with between $500 million and $2 billion AuM. However, at the beginning of 2011, investors said the same thing but the euro crisis led to investors becoming less enthusiastic about emerging managers, and eventually went back to the perceived safety of larger managers. It will be interesting to see what happens in 2012.
COO: The survey highlighted counterparty risk is very important. Do you believe some investors were complacent about this issue from the tail-end of 2010 up until summer 2011?
Leonard: Some investors underestimated the potential contagion effect the eurozone crisis was going to have on the global financial system. During the same survey last year, the sovereign debt crisis was on peoples’ minds but I don’t think investors appreciated the full scale of the impact it could have on counterparties and other financial institutions, particularly in Europe. I would not call it complacency but, some investors did not fully appreciate the risk implications to other global markets. Furthermore, the collapse of MF Global also moved counterparty risk to the top of investors’ agendas. What is clear since 2008 is that counterparty risk is taken much more seriously. Pre-2008, a lot of investors were not that familiar with their hedge funds’ counterparties. This is no longer the case. Investors will perform intense due diligence on their counterparties and regularly review their CDS spreads. Investors want to know as much as possible about the banks and examine intensely how safe their assets are.
COO: Are investors concerned about excessive regulation and whether this will lead to performance drag?
Leonard: Investors are questioning how some of the smaller managers are going to cope with the increased regulation. Hiring more compliance staff and counsel is going to ramp up costs and this could disproportionately hit the smaller companies. However, a lot of the proposed rules are not set in stone, which is causing further uncertainty for managers and investors. Nevertheless, hedge funds are getting prepared.
COO: Do you anticipate further consolidation in the industry?
Leonard: Yes, I do. There are a lot of operational costs and returns have not been spectacular so I do anticipate more consolidation in both the hedge funds and funds of hedge funds (FoHFs) space. At the same time, we are seeing a significant number of new hedge fund launches come to the marketplace and receive a strong reception from investors. There is still excess capacity in the FoHFs space and most investors expect further consolidation as the business model evolves. FoHFs are no longer the off-the-shelf products they used to be but now offer bespoke consulting and advisory services to larger institutions. The largest FoHFs are doing very well as are the boutique and specialised FoHFs. It appears that there is room for consolidation in the middle segment of the industry however.