Counterparty risk concerns diminish while bearishness on eurozone grows, Aksia survey shows

Operational Risk
10 Dec, 2012

Hedge fund manager concerns over counterparty risk appear to have abated despite increasingly bearish sentiment that Greece will exit the Euro while Spain and Italy will be forced into default or restructuring, a survey by Aksia has revealed.

Just 36% of managers have established CDS triggers on counterparties in place compared with 50% in 2011. Furthermore, those that maintained triggers have set higher limits with 67% imposing triggers above 400 basis points compared with 57% last year.

Paradoxically, bearishness on eurozone countries is on the up. Seventy three percent of managers said a Grexit was more likely than not, up from 60%. Similarly, the prospects for Spain and/or Italy defaulting/restructuring rose to 63% from 42%. Despite this, managers are bullish on European equities with 63% expecting a positive performance for the EuroStoxx.

Given the exposures several European banks have to struggling EU countries, such complacency is an unwelcome development. Any fall-out from the eurozone is likely to lead to contagion at banks, and while there has been a temporary respite in the single currency’s woes, counterparty risk should remain high on managers’ agendas.

Nonetheless, fewer managers (52%) envisage a large-scale sell-off of assets by European banks compared with 83% in 2011. This comes as the Bank of International Settlements revealed eurozone banks have drastically cut cross-border exposures to sovereign debt in Greece, Italy, Portugal and Spain to $201 billion from $1 trillion in early 2010.

“The majority of banks which are major players in prime brokerage are US banks with the exception of Deutsche Bank, Barclays and BNP Paribas. Many of the respondents do not feel the eurozone crisis currently poses significant counterparty risk,” said Jim Vos, CEO at Aksia.

Most managers are confident market liquidity will remain stable with 91% predicting liquidity will stay the same or increase over the next 12 months. Sixty percent told Aksia liquidity conditions have remained stable or improved since last year.

This is probably explicable by the bullish macro sentiment at most managers with bulls outweighing bears by a 3:1 ratio. In terms of strategies, long/short equity managers were the most bullish (84%) while relative value managers were the least (50%).

The majority (88%) of respondents believed the US housing market had bottomed while emerging markets and gold are the asset classes expected to deliver the strongest performance in 2013 with one third of managers predicting double digit returns.

In terms of investors, public and corporate pension plans are bolstering their exposures to alternatives with 68% and 61% seeing increases from these respective groups. Funds of funds’ decline appears to be continuing with 63% reporting a fall in allocations.

“We see pension funds continuing to allocate to hedge funds. Long-only equity represents the largest risk in most pension funds and many are using lower volatility, lower beta alternative assets as a way to de-risk their portfolios. In terms of funds of funds, I anticipate further decline because a lot of people who used to work at these organisations, who have the knowledge and skills necessary to manage hedge fund investments, are now working at pension funds, sovereign wealth funds and consultants,” said Vos.

As institutional-sized investors continue to allocate amid substandard performance, fee discounts are becoming ever more commonplace. Sixty-eight per-cent of respondents said they offered an option for discounted fees. Investors obtained these discounts if they agreed to longer lock-ups (40%) or made a substantial capital allocation (34%).

“Fees will continue to come down. Many end users will also get fee breaks in exchange for putting cash into newer managers, or if the ticket is sufficiently large. Additionally, given the modest amount of money beneficiaries receive from their pensions,   plans negotiating better fees is a form of social justice for retirees,” commented Vos.

Risk reporting appears to remain unchanged. Eighty-two percent of managers send detailed risk reports to investors while 49% piped risk data to third party risk aggregators. Some 23% of managers provided clients with access to their full portfolio. Transparency has improved markedly at hedge funds since 2008. An AIMA/KPMG survey revealed 82% of investors had become tougher on transparency. Hedge funds appear to have taken note with 84% telling AIMA/KPMG they had bolstered transparency to investors.

In what appears to be a reinforcement of industry consensus, the majority of managers told Aksia the JOBS Act will not result in any changes towards their marketing activities. However, small fund managers were most likely to change their marketing strategy whereas large managers remained unsure.

Vos, however, expressed concern about the JOBS Act. “Most managers are unlikely to advertise aggressively. Unfortunately, I expect less reputable managers, who cannot raise institutional assets, to exploit the liberalisation around advertising and marketing. Such a development will hurt the industry in the long-run because it will be the less-than-successful managers which advertise the most. It could hurt retail investors and damage the reputations of managers, who have chosen not to advertise,” he said.

Aksia polled 168 managers representing $900 billion in hedge fund AuM.

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