The breadth of allocators to HSBC range from retail class investors putting in a minimum of $25,000 to advisory mandates that start at $20 million. Five funds of funds manage over $3.6 billion with an additional $4 billion being run in institutional and private client mandates. The remainder is managed through advisory mandates and older legacy assignments. The continuing recovery in the hedge fund industry offered an opportune moment to discuss investing and portfolio management with Tim Gascoigne, Global Head of Portfolio Management, and Peter Rigg, Global Head of the Alternative Investment Group based in Geneva, at HSBC Private Bank’s headquarters in St James’s Street, Mayfair.
The winding down of the crisis bookends a decade of rising trading volumes in markets and the development of new instruments, particularly in derivatives and structured finance. But product innovation isn’t where Gascoigne or Rigg see the best investment opportunities right now. Instead, they believe that a focus on the basics – research, manager selection and liquidity – is what will generate the best returns for investors.
Decline in competition
“If you look at credit markets in the last 10 years there have been many different ways people can trade and a lot of derivatives that have been launched,” Rigg says. “But given where we are now it is less likely that there will be new fangled ways of investing. The big change is the decline in competition from investment bank proprietary trading desks and the good opportunities for hedge funds to make money from plain vanilla strategies. The dominant thing for the next couple of years will be grinding out good returns from the traditional strategies because the competition isn’t there and the spreads on the trades are very wide.”
Gascoigne, who runs day-to-day portfolio management, says that during 2003–2008 hedge funds were competing with investment banks for both investment positions and personnel. “Hedge funds are in a very good position to generate higher returns,” he says. “With less money chasing investment opportunities there is no need for managers to reinvent themselves and chase new strategies. There are good returns to be sourced by managers in the traditional hedge fund space using arbitrage approaches.”
In 2009, HSBC found a number of attractive hedge fund buying opportunities, particularly with managers that were closed but reopened. Among the managers HSBC got new capacity with were Lansdowne Partners and SAC Capital. Gascoigne used the opening with top managers to shuffle the pack in different strategy buckets, notably long/short equity, while increasing allocations to CTAs by a few percentage points.
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HSBC’s selection process is run by a global research team located in Hong Kong, London, New York, Paris and Sydney. They meet and rate managers on a scale from 1 to 5 with a grade of 3 or higher required to get on the recommended list. Both operational and investment due diligence are done with the former having right of veto. The investment committee, comprised of Gascoigne, Rigg plus the three regional heads of research, confers monthly. The approved investment list (See Fig. 3) amounts to around 200 funds and it is used by both the advisory and discretionary businesses. When a decision to invest is made a middle office team executes the trade.
“What Tim and I bring to the table is experience,” says Rigg. “In 1998, we had a similar situation to 2008 where we had big redemptions and we had to meet them. We learned a lot about simple things like keeping portfolios liquid. Compared to others, we find good funds but we don’t like to invest in lock-ups except at the margin and certainly not as a large part of the portfolio. That discipline really helped us.” The process looks regularly outside the group to the experience of other hedge fund investors and does case studies to build on best practice.
Rigg, based in Geneva, works on the client side, and focuses on customer relationships. Gascoigne, who trained as a portfolio manager and gained experience on the institutional pension side at Mercury Asset Management before joining HSBC in 1996, focuses on investment decisions. His key responsibility is performance on the discretionary side and the fund of funds is the core of that. Faraz Sultan, based in Geneva, is global head of the hedge fund advisory. “It is very consistently applied approach,” says Rigg. “We just have different ways of delivering the hedge fund service to the clients.”
The fund of funds flagship is the HSBC Global Hedge Fund, a multi-strategy offering, launched in 1996. It has around 45 managers in the portfolio and AUM of over $2 billion. Its biggest risk budget by strategy is in long/short equity at some 35-40% with smaller exposure to multi-strategy and equity market neutral managers. The fund’s annualised return is 7.8% over 14 years. It outperformed the fund of funds sector over 2008-2009 falling 16.6% before recovering 12.2%.
The bank’s fifth and latest fund of funds opened in May 2009 with the launch of the HSBC Distressed Markets Fund. It is aiming to tap the valuation opportunity in the credit cycle and has raised $200 million. The fund, which invests mainly in corporate credit, has generated performance in each of its first 10 months and is up a cumulative 14.4%. The fund has 14 managers and its mandate to be quite liquid means that the allocation to classical distressed mangers is low. Initially, the fund generated gains being long credit, but it has recently begun to invest more in relative value credit.
The first fund of hedge funds, launched in 1995, was the HSBC Multi-Advisor Arbitrage Fund. With AUM of $200 million, it has 18 managers and invests in relative value rather than directional strategies. The fund invests in factor driven equity market neutral as well as a variety of arbitrage components (statistical, fixed income, convertible and merger) which account for around one-half the fund’s risk budget. There is also exposure to relative value credit.
Two other fund of funds are more specialised in nature with very different liquidity profiles. The HSBC Special Opportunities Fund, launched in 2007 and now with AUM of $300 million, targets the less liquid end of the hedge fund universe. Among its 15 managers are some activist funds but distressed is the bigger source of allocations owing to the attractive opportunities for that strategy now.
A source of diversified alpha
The second of the more specialised funds is HSBC Trading Advantage which invests in systematic trend followers. In launched in late 2006 and has attracted $300 million, which is invested in ten underlying funds. Like CTAs generally the fund did well in 2008, gaining 12%, but suffered a 7.5% drawdown in 2009. Its low correlation to market beta and other funds of funds has resulted in an annualised return of 9% since inception. Clients typically use it as a diversified source of alpha to complement long-only or other more diversified funds of hedge fund investments. The fund has a slight London-CTA bias with allocations to BlueTrend and Winton Capital, among others.