One industry source has their hedge fund assets under management across the UBS Group at $36bn in January 2005. Not only are the hedge fund assets large, but they have been fast growing too – up more than 50% in a year. The year on year increase in assets – at $13bn – would be large enough to qualify as the world’s 7th largest fund of funds operation on its own. As it is, UBS Group is the world’s largest manager of hedge fund assets.
The Hedge Fund Journal has written recently about the success of UBS Global Asset Management, and UBS O’Connor, part of the Alternative & Quantitative Investments Platform of UBS’ Global Asset Management business group, is also an acknowledged leader in its’ fields.
A part of the UBS hedge fund story that is not as well known is the hedge fund advisory group that is part of the UBS Wealth Management capabilities in the UK.
UBS Wealth Management provides a broad range of products and services individually tailored for wealthy clients around the world via its global branch network (see box on p ). The UBS client advisors aim to build strong personal relationships, and those are combined with the resources that are available from across UBS, helping the advisors provide a full range of wealth management services – from asset management to estate planning and from corporate finance advice to art banking. UBS Wealth Management in the UK offers an open product platform giving clients advice around a wide array of pre-screened, top-quality products from third-party providers that complement UBS’ own lines.
The London office of UBS Wealth Management forms part of the recently formed European Wealth Management business (see box on p ). The business was launched in early 2001, and is aimed at wealthy clients resident in the five target countries of France, Germany, Italy, Spain and the UK. In just under 4 years, UBS has built this business to a total of 838 client advisers managing £37bn of client assets (of which £16bn are in the UK), through 42 offices.
Tim Bell, a Managing Director of UBS Wealth Management and head of the Alternative Investment Solutions Team in London, explains that the UK business was originally formed around the top-end of the market, focusing particularly on option strategies for executives with significant stock concentrations. Since then, however, the business has expanded to cover the full range of pension, estate planning and investment advice to wealthy clients across the board. Appropriately, as it was to serve successful City and hedge fund traders, it is sited cheek-by-jowl with GLG Partners and Moore (Europe) in London’s Mayfair district.
One of the distinctive elements of the European Wealth Management operations is that senior management are not necessarily career private bankers. Indeed the current Chairman and CEO, Wealth Management & Business Banking, 40 year-old Marcel Rohner, was previously Group Chief Risk Officer at UBS. Bell says that the investment advisors are open-minded too, and that from the top the professional staff have been encouraged to behave as entrepreneurs and “think outside the box”.
UBS’ wealth management professionals are keen to emphasise the bespoke nature of what they do for clients. There is not an expectation that hedge funds will be included in clients’ portfolios. “Our four-step advisory process enables us to get to grips with our clients’ needs and to follow through with a suitable asset allocation that is consistently reviewed, ” says client advisor Jonathan Lanceley. “The suitability aspect really is very important, particularly in relation to hedge funds: there is absolutely no presumption that they are appropriate for all our investors.” He continues, “The first step is to profile the client, and for this part we take account of all the client’s assets, even if they are held by another wealth management house. We always seek to advise on the totality of the client’s wealth. We can complement the existing assets held, wherever they are being managed. Through this first step we get to understand the client’s needs. The second step of our process is to construct a portfolio and propose that to our clients. Usually there will be revisions and some to-ing and fro-ing. The third step involves implementation of the process, which is often not straight-forward; for example there may be complex structures that need to be put in place. The fourth stage, I can’t over-emphasise, is the most important. It is the consistent review of the client’s on-going needs and requirements. We have to take account of changes in the client’s circumstances as well as those of the markets. We see this review process as the absolute key to the high quality, advisory role that we are looking to provide for our clients.”
So whilst there are product specialists for hedge funds, and indeed for each traditional asset class, the hedge fund element will be an integral component of a carefully constructed portfolio and is not seen internally as a product to be pushed, or some bolt-on addition. The advisors see themselves as “sitting on the same side of the table as their clients.” Rather, where the UBS wealth management advisor to the client sees a fit for them, the advisor can draw on the expertise within the group to help with selection of strategies and funds. The hedge fund specialists act as a single point for sourcing the product, from screening managers, doing due diligence and hedge fund research to securing capacity. As with the provision of investment capability in any format under the open-architecture model, sourcing hedge funds at UBS Wealth Management is an objective process.
Whatever the level of interaction between the hedge fund specialists and client, it is very clear that the client relationship belongs to the client advisor of UBS. “We have a model where UBS staff members can work together, “says Lanceley, “and interests are totally aligned for the client, client advisor and product specialist.”
In examining the suitability of hedge funds for their clients in the UK, UBS look at five areas. The first two involve the related elements of expected return and volatility. Quite often new investors are looking for unrealistically high returns from hedge funds, and it is important to manage their return expectations. According to UBS, it has to be explained that hedge funds are about superior, risk-adjusted returns that compound over time, rather than out-and-out returns. Integral to this is the third element, which is liquidity, which has to be matched with the fourth element, which is the investment time-horizon of the client. Investors should expect to be paid a premium for those investment strategies that are less liquid, but at the same time they may have to endure volatility along the way and the discomfort of not being able to access their money. Some clients are comfortable with that for a part of their investment portfolio, others not. “A client can have a need for 50% liquid assets, but that leaves 50% that can be in illiquid investments like hedge funds,” says Tim Bell. “There has to be a genuine degree of comfort for the client to be involved in venture capital or the less liquid hedge fund strategies.” Finally, the income needs of the client have to be taken into account, as hedge funds do not pay out dividends or coupons like ordinary shares or bonds. This goes back to the appropriate strategic asset allocation for the client to ensure that their requirements for income are served suitably.
London-based Tim Bell is head of the Alternative Investment Solutions Team within the UK unit of UBS Wealth Management. The team specialises in advising UK clients of UBS Wealth Management in all aspects of hedge fund investments, working closely with the client advisors at UBS. In doing so, Bell has a chance to observe the hedge fund industry from a vantage point that has few equivalents. In a wide-ranging interview The Hedge Fund Journal obtained uncommon insights into this dynamic sector from a leading practitioner.
How do you think about hedge funds conceptually and their place in the asset mix?
In our view hedge funds are not an asset class. Rather we think of them as a more efficient means of investing in traditional underlying asset classes, enabling a more flexible approach to the management of risk. The way in which they differ from ordinary investment funds is that they can use leverage, derivatives and short selling as risk management tools in order to help preserve capital. In the hands of skilled practitioners these tools enable risk/reward to be skewed in favour of the investor. You might not think that leverage is consistent with the concept of capital preservation. Remember, though, that hedge funds can also de-lever (i.e. put part of the portfolio in cash) and will tend to vary their degree of leverage according to the risk/reward trade-off, and their level of conviction around the opportunity set at any one time. It is just like turning the volume control on an amplifier up and down, and is entirely consistent with skewing risk/reward in favour of the investor.
As for the place of hedge funds in the asset mix, they play an important role in terms of diversifying portfolios by virtue of their relative lack of correlation to traditional equity and bond indices. They are therefore an important tool in terms of our ability to optimise risk/return characteristics of portfolios, and so reduce the level of volatility. In addition, experience tells us that during periods of economic dislocation, the correlation of supposedly unrelated asset classes tend towards one. There are certain hedge fund strategies that tend to prosper at such times, in particular those that are long volatility or capable of picking up on short-term trends. These strategies in particular help to damp the “tail risk” in portfolios.
Clients have been risk averse in the period since the bursting of the tech bubble. We have had a lot of work just enhancing the cash holdings of clients. The level of interest rates in the UK is very relevant here. Often the hedge fund holdings are there to provide an uncorrelated cash-plus return, and we have to use Sterling LIBOR as our base level. I would say that we have experienced more appetite for risk in the last year or so, but wealth management clients remain cautious overall.
What sort of exposures do you typically recommend for clients?
Everything really revolves around the client and client needs. However, where hedge funds are suitable, we do advocate the need for diversification of risk within hedge funds, both in terms of manager risk and strategy risk. For most clients this means that they will invest through fund of funds. UBS in Zurich has an entire team dedicated to sourcing and due diligence on both internal and external (i.e. non-UBS) fund of funds to ensure that we can offer high quality fund of funds for our clients in the UK.
What are the advantages to you in being part of the UBS Group?
An all-powerful brand, first class clients, and a deep global team. The value of that brand is simply beyond compare when it comes to working with the hedge funds, and we do everything we can to ensure that we behave with the utmost professionalism and integrity in our dealings with the funds in order to uphold our name and reputation in the market. Our clients are really integral to the quality of the brand as well, as the hedge funds will associate our name with a very high quality, stable and well-advised investor base. As for the team, we work closely with our colleagues in UBS Wealth Management in Zurich which has a formal joint venture with other parts of the UBS Group. Whilst we share due diligence within the Group it is very important that each unit negotiates its’ own capacity.
Do individual team members or teams in different offices specialise in which hedge funds to cover?
We do specialise in terms of the types of business we undertake. The focus of UBS Wealth Management in Zurich is global coverage of the fund of hedge fund universe, with the emphasis being on more discretionary business. The focus on the team in the UK is more around the advisory business. The strong growth of hedge funds in London means that the UK team is ideally situated to maintain local coverage of hedge funds in London, while broader geographical coverage is assisted through the formal joint venture between UBS Wealth Management and other parts of the UBS Group.
For which strategies have you seen demand in the last year?
We strongly believe in networks as a resource. In fact our network of clients is amongst our best resources. Remember our clients include many that are sophisticated investors in their own right, and some of them are hedge fund managers themselves. In the last year I’d say they have been pointing us towards commodity and energy funds as you would expect. We have also seen demand for event-driven hedge fund strategies, particularly special situations funds and funds that get involved in re-structuring.
What new developments are you seeing amongst single manager hedge fund firms?
We are witnessing three distinct trends across three different strategies. First, many equity long/short funds are starting to roll out ‘long-only’ funds managed by hedge fund managers. A contradiction in terms, you might think? The short side of a long/short hedge fund is there to reduce volatility and produce a superior risk-adjusted return. But when you look at the performance attribution over time of most equity long/short hedge funds, far more alpha tends to be derived from the long book than the short book. Furthermore, a long-only hedge fund is still free to use derivatives and can lever or de-lever the portfolio, both of which are important tools in risk management. Remember that hedge fund managers are simply entrepreneurs building a business, and a natural constraint to the size of an equity long/short fund is the liquidity of the short side of the portfolio. With that constraint removed, the business can grow much larger; in addition, in an ideal world the long-only fund should just be the long side of the existing hedge fund portfolio, so there is very little extra work involved for the hedge fund manager. They can just scale it up, and more and more firms are doing that. The important thing is that such portfolios should still be managed on the basis of absolute return rather than tracking risk against a benchmark. There seems to be growing demand from investors for this, and we can well understand why.
A second trend involves the event-driven funds, which are beginning to move more into illiquid investments in search of alpha, thus overlapping with the private equity firms. The recent publicity given to hedge funds hiring professionals from private equity firms is indicative of this. Again, to us it makes total sense. The private equity vehicle offers the best possible IRRs from illiquid investments, but they are illiquid, complex to administer, and subject to investment cycles. Therefore all but the very largest private investors are best served by going through a fund of private equity funds. A less liquid hedge fund (say, one with a three year rolling lock-up) offers a more flexible means by which investors can access a combination of liquid and illiquid investments, with some diversification across the investment cycle and certainty of redemption dates. Usually the returns will not be as good as measured by IRRs because the cash cushion required for liquidity purposes is usually dilutive, but the investor has the advantage that more of their investment is probably put to work at any one time as it is constantly reinvested.
A third trend involves the arbitrage funds, which are constantly challenged as to where to go to find superior risk adjusted returns. Merger arbitrage and convertible arbitrage, while still relevant, no longer offer the core returns for these funds that they did during the 1990’s and early 2000’s. The major M&A deals announced in early 2005 have tight spreads and offer little grist for the arbs in a low interest rate environment, while the decline in equity market volatility and lack of new convertible issuance mean that traditional convertible arbitrage is also difficult. Both these strategies are now more peripheral, but do provide good returns in selective deals. The principals themselves have to be ever more inventive and fleet of foot as to where and how they deploy capital in order to maintain returns; it is really a constant process of reinvention. We are seeing many of the traditional arbs moving into some derivation of equity long short, or credit long/short strategies, either by rolling out separate funds or, as is more often the case, by integrating them into their existing funds. As more and more strategies are included, so these firms become increasingly multi-strategy in their approach.
When we first started this business, there were far fewer hedge funds, and many well established names. If you were a high quality investor, it was possible to strike up a relationship with, say, ten top-tier managers, all of whom had long, proven track records, and it felt as though the job waspretty much done. It was a tight-knit circle and very different from today.
The fact that there are so many more hedge funds today means that we have to do things differently. Our preference is for teams of people who have a proven track record in their particular field of expertise. At its most basic we have to believe the team really are money-makers, and we do prefer teams over reliance upon one key individual.
But that is rather an over-simplification as there are many other factors that we have to take into account. First of all, we have to look at the whole business model of the hedge fund and how it fits together. What is the rationale for its being a hedge fund in the first place, where does the team come from, and how long have they worked together? What is the background of the individuals and what experience do they have of the hedge fund industry and the particular strategy in which they operate? How have they set up the business, how much money have they invested in the business and the fund itself? How do they find investment ideas and how do they get into the portfolio? When are they taken out again? How is the portfolio constructed? Who are their current investors, and if they are at an early stage of evolution, do they know how they are going to build their investor base? Is the fund yet viable? What is the opportunity set in their particular universe and how is this likely to vary? How much money does the fund intend to raise and at what point will they close to further investment? Who are their service providers and on what basis were they chosen? How is the team remunerated, and how are non-principals remunerated? What has been the turnover of personnel? This list of questions could go on for ever, but it gives an idea of the sorts of things we look at – just for the first meeting!
There are a few backgrounds that make it easier for us to allocate to new managers. A new manager in an existing fund is a first preference for us. Second, we like the hedge fund organisations that provide an umbrella to new funds – it makes the assessment of operational issues so much easier. As a third order of preference we can take seriously identifiable teams breaking away from existing hedge funds. Brand new entrants come fourth in the ranking. These are the sorts of things we look for in new managers, but we also try not to box-off managers.
What do you consider are key questions when you interview hedge fund managers?
To us, the key question for a hedge fund is what they expect their business to look like in three to five years time. You would not believe the number of managers that do not have a properly thought out answer to this, yet if we were to come on board as investors, we have to look to the future.
Sometimes an unusual question can be very revealing. In a relatively new fund, an interesting question to ask is one such as “How long did it take you to negotiate your prime brokerage agreement”? This question is often greeted by a very puzzled look, followed by concern at wondering what the right answer might be! If the response is that all prime brokerage agreements are the same so they just sent it back by return post, this is indicative that the fund has not taken good advice as such agreements tend to start off rather one-sided in favour of the service provider and should be properly negotiated.
I also like to ask managers “Given your remit why are you set up as a hedge fund?” There are many managers that can answer that straight away, but there are still some that have not made the link between their mandate and portfolio structure.
You mentioned that you can learn from a fund’s losing months, in what way?
Actually we are much more interested in what a fund can learn from their own losing months, rather than what we can learn from it. There is no free lunch, hedge funds have to take risks and not all risks will work out. The most important thing for the fund is what lessons can be learned,and what they will change going forward so as to improve their chances of succeeding next time where they failed the last. There is nothing wrong with losing months, and most of the time it is entirely rational. From our perspective, we want to know that there was no error of judgement in putting on the positions that went wrong, and that applicable risk controls were followed in order to minimise the damage. For example, only in February we could look at how risk arbitrageurs coped with the Biogen/Elan situation.
What criteria do you use to come to the decision to redeem from a hedge fund?
We think it would be wrong to have hard and fast criteria. Interestingly, performance is often not a factor. Some of the main reasons why we redeem are that a fund has got too large and we feel that they have lost the ability to be innovative and nimble as a result. Turnover in key personnel is often another reason.
We think the selling decision is more important than the buying decision. You must remember that we are not a fund of funds. We expect to be invested in a hedge fund for some time, and unlike some funds of funds we do not feel the need to be seen to be doing something.
What else is current amongst single manager hedge funds?
Broadly I would say that not enough managers are taking risk. For equity long/short I see their role as making money in bull phases for equities and to preserve capital otherwise. Returns in the last year have not been enough to fulfil that.
How do you disseminate the information you gather?
We provide a quarterly letter to our hedge fund investors with a fairly detailed analysis of performance of each of the funds, a commentary about the hedge fund markets, and observations about the industry as a whole. We also provide very regular performance updates, although we encourage our clients and client advisors alike not to pay too much attention to short-term data. That can be hard sometimes as I see one or two managers a day normally, and more when I am on a trip somewhere, so there is a lot of information to digest.
Do you see any difference between hedge funds operating in Europe and those based in the United States?
Over recent years the US-based managers have been inclined to take more risk. I’d say that this is because the Tiger-model is more dominant amongst long/short managers [the managers that learned of hedge fund management at Julian Robertson’s firm tend to have larger balance sheets and a more consistent net exposure to markets than other managers]. Another point is that American managers are more likely to stick to their losing equity positions whilst European-based managers will cut, particularly on the shorts. American managers seem to have more conviction about their shorts, and ultimately have been more successful on the short-side.
On the other side of the business, you are also more likely to find risk-assuming investors (clients) in the United States. So investors like endowments will live with more volatility and risk from a hedge fund where they are invested. They will ride through losing months, whilst some European investors are just intolerant of any losses.
The pace of growth of the hedge fund industry in Europe, together with the cross-fertilisation that is taking place as more and more US hedge funds open up offices in Europe – and Asia for that matter – means that there is really very little difference now in terms of culture between the two centres. The differences that exist relate more to the time-zone and the local opportunity sets. The big shift we are seeing at the moment is with the US event-driven funds as they shift their business towards Europe, growing their London offices in search of better risk-reward opportunities both in distressed debt and corporate restructuring in Europe.
Institutional capital has dominated the flows into the hedge fund business in the last year or two. How does this affect the way private banks invest in hedge funds?
We suggest a broadly diversified base exposure to hedge funds to our clients as a first step, and that can be your typical institutional-style multi-manager product. Then we might propose complementary hedge fund allocations, and that is where a smaller scale offering can come in. There is space in the industry and in our clients’ portfolios for funds of hedge funds that exploit niche strategies, and those that concentrate on particular investment strategies. These smaller funds of funds have less capacity problems, and can aim for different risk profiles than the mainstream products. An example could be a fund of funds that specialise in funds that trade in currency markets. One of things we try to do for client portfolios is to give a chance to make money in all market conditions. So we like to blend different investment philosophies
Maybe the problem is not so much about finding capacity, but rather finding good talent! The good news is that the talent pool continues to grow as talented portfolio managers leave existing hedge funds to set up on their own. As for us, we go back to the point about our brand, our clients and our team. We position ourselves as a premium investor and believe that we benefit because of our reputation and ability to source talent translates into an ability to offer our clients access to exceptional hedge funds and funds of funds where it is suitable for their needs. In particular we develop our relationships with closed funds, in the expectation that over time, as their investor base turns over, we will be offered the chance to participate. For such funds we offer a stable capital base and an opportunity for them to diversify their investor base.
In terms of industry capacity I’m very optimistic. There is a lot of investment talent out there. The combination of that talent and the innate entrepreneurialism of the managers gives a lot of potential.