26/07/2011 Author: Will Wainewright

Platform alteration

As interest in hedge funds from the private wealth sector returns, following the mass withdrawals of 2008, re-tooled private bank platforms are sprouting up to cater for a new breed of transparency-aware high-net-worth investor. But how can hedge funds capitalise, and is it only the biggest funds that need apply?

Hedge funds may have performed better than most during 2008, but this did not stop a certain cooling of relations between the asset class and private wealth investors. High-net-worth money, much of it invested through private banks, deserted hedge funds, leading to a weakening of the platforms themselves. However, the return to health of the hedge fund industry has not passed private banks by, many of whom are feverishly building out their platforms again.

Barclays Wealth, whose ambitious growth plans for its hedge fund arm were exclusively revealed in HFMWeek last week, and Citi Private Bank, which recently launched Hedgeforum Direct to complement its existing $5.25bn HedgeForum feeder service, lead the charge.

For Barclays and Citi, 2008 sparked an overhaul in the way they offer hedge funds. Citi’s HedgeForum has been redeveloped after 2008’s dislocation, while Barclays Wealth has also restructured its offering. “As a result of 2008, clients demanded three core principles from their wealth manager: simplicity, transparency and liquidity,” says Oliver Gregson, Barclays’s head of investment advisory. “We have recently spent a significant amount of time re-vamping our approach to managing multi-asset class portfolios.”

This has resulted in the bank recommending that clients increase their allocations to what they term ‘Alternative Trading Strategies’ from 2% to 13%. That Barclays intends to increase the number of hedge funds, Ucits and funds of hedge funds (FoHF) on its platform by around 25 this year, as revealed last week, shows it means business.

Private banks have altered their platforms in other ways too. Deutsche Bank and Citi all but removed FoHFs from their platforms in the aftermath of 2008, as gating, Madoff and fees turned off investors. “We have decreased our marketing activity for our open architecture FoHF offering in Europe and Asia, as demand for them from our private clients has dropped massively,” says Pascal Botteron, of Deutsche Bank’s Private Wealth Management. Others think the recent decline of the FoHF sector has played a part in the growth of their hedge fund platforms. “A lot of hedge funds relied on investments from funds of hedge funds and have come to private banks in order to diversify away from that,” says Frank Frecentese, head of hedge funds at Citi Private Bank. “That has resulted in a noted uptick.”

“We are seeing funds of funds shrinking as an asset class and being replaced by other kinds of structured hedge fund investments,” observes one fund manager. “If you can get access to a private bank then that can be quite meaningful and provide a very useful distribution platform.” The benefits to managers are clear, and cap intro insiders at prime brokerage firms say more and more money is moving towards the hedge fund platforms of private banks. But how can hedge funds go about getting a prized place on a platform?

Private banks approach the formation of their platforms in different ways. Citi focus on finding the best managers in the strategies and geographies they access, almost as if completing a two-by-two grid. “We are looking for high quality active management,” says Frecentese. “This means getting the most alpha you can get per unit of cost you take on for accessing that alpha.” This mirrors Credit Suisse Private Bank’s “recommended best-product”
approach, which they apply across their offering of hedge funds, Ucits and FoHFs. They launched their portfolio advisory service a year ago, the second part to their hedge fund platform, which offers tailor-made portfolios for clients.

But, alpha aside, for many of the private banks surveyed by HFMWeek, size and track record is key when considering additions to their platform. “Our strategy focuses on the big-name, blue-chip managers,” says Deutsche Bank’s Pascal Botteron. “If you look at the stand-out hedge fund managers, they went through the crisis pretty well. They have the best risk-control procedures and solid systems in place – which is not always the case with smaller funds.”
It is a sentiment echoed by Patrick Schwyzer, a director at Credit Suisse Private Banking. He says: “We take an open platform approach, using a combination of quantitative and qualitative criteria. For FoHFs, it is a minimum of three-year track record, ideally five. With single hedge funds, the very minimum track record is six months if we can use, for example, prior track records, but we prefer at least two years. We also spend time on peer group analysis.” Rhian Horgan, international head of alternative investments at JP Morgan Private Bank, adds: “Today, particularly in Europe and the US, to get the attention of the right auditors, accountants, custodians and prime brokers you need to be quite institutionalised. The smaller managers are having a harder time getting those resources which we think are important in ensuring your assets are safe.”    

It is a tough climate out there for smaller funds – and recent start-ups should forget about securing room on some private bank platforms judging by the stance taken by JP Morgan. “We like to see managers having run capital in a fund format for at least three years before we’ll invest in them,” says Horgan, adding she is unexcited by the flurry of start-ups by prop desk refugees. “We are more conservative and like to see how managers run investors’ capital in a fund format when it is their and their investors’ capital,” she says. “It is a different risk environment.” Not that new starters would have much hope of being big enough – managers on JP’s platform typically run between $750m and $2bn.

However, newer, smaller managers shouldn’t view the private bank platform route as completely closed to them. Barclays’ Gregson is keen to stress that the bank takes a more open-minded approach. “We look very different to other private banks in that we’ll have smaller hedge fund managers on our platform,” he says. “We also think there are a lot of interesting emerging managers out there offering situations where, if one can invest early, they will benefit. For instance, the regulatory environment enforcing change with those coming off prop desks.” The approach seems at odds with the traditional view that private banks tend to play it safe with a small number of big-name hedge funds.

Private banks approach fees in different ways – though, if they charge, are equally keen not to discuss them – but a good general rule seems to be the bigger the platform the likelier it is that hedge funds have to pay to get on it. However, the swirl of private banks currently working on their hedge fund offerings can only be a good thing if it provides further routes to investment.

“As long as managers are able to be effective in using hedge funds to manage risk and access instruments not available on the public market, it should be an exciting place for private clients to invest,” says Horgan, whose bank, JP Morgan, dwarfs the others approached by HFMWeek with its $30bn hedge fund commitments. However, it just shows the range of opportunities available to hedge funds keen to explore this increasingly emerging option.