Hedge fund investing - vetting hedge funds for investors who demand transparency
Investors are attracted by the alpha potential hedge funds represent, but not as keen on what historically has been a lack of transparency. With Asian hedge funds newer to the scene than their peers in North America and Europe, it’s natural for investors to be curious about how UBS Hedge Fund Solutions (HFS) selects the funds it invests in – and how those funds are themselves managed.
Before he joined UBS HFS, Adolfo Oliete, was at a single-manager hedge fund. “We didn’t share anything at that time,” he says. “But I’ve seen an evolution in my time on this side of the fence in a multi-manager hedge fund. Our size and scale at UBS HFS help. Hedge funds view us as a trusted partner, so we do get all the transparency that we require for our own decision-making and on behalf of investors.”
Transparency is a bit like data in that once you have it, what matters most is what you do with it. If a hedge fund holds 1,000 securities for example, it’s not especially relevant to have thorough insight into each of them. It’s more important to understand the holistic risk.
“We aim to understand the risks at a portfolio level, in terms of exposure and attribution of where the returns are coming,” says Oliete. “Conditional investments from us are dependent on that type of transparency, and that’s negotiated ahead of time. We’ve had to work very hard on that over the last five or six years in the region because transparency has been viewed as a bad thing for a long time – you don’t know where information is going, and you don’t really trust what people do with that information. Once the hedge funds understand who we are and what we do with that data, and how tightly we control that data, we receive transparency. And we provide our investors with a lot of aggregated risk and exposure metrics. Generally, we receive position level data from some managers, but in most cases we collect data on the top positions that have the potential to move the needle.”
Oliete says he and his team have a bias to invest in managers that are locally-based, mostly in Mainland China where they pursue substantive research themes bolstered by visits to companies and factories – in other words, hedge funds that really dig into the weeds.
“We focus on managers that have large research capabilities and ideally are based in Mainland China so they can easily access those companies,” he says. “We’re underwriting the strategy, portfolio and risk management, and also the people at the hedge fund and how knowledgeable they are. We meet with the management, analysts – we want to know the whole team at the hedge fund.”
We don’t shy away from saying no to a hedge fund if we’re not comfortable with some of the principals, or if they’re unwilling to implement what we suggest is necessary for them to grow into the institutional space.
Educating hedge funds
As the number of hedge funds in Asia and Mainland China increases, Oliete and his team find themselves investing time in educating the principal players at the funds on matters such as the operating infrastructure of the firm and running a business beyond investments.
“We want to be certain that the funds are set up for success as companies and capable of handling the sophisticated needs of institutional investors, which is something that has taken a little bit of time in the region,” Oliete says. “Sometimes when you look at the hedge fund industry in Asia as a whole, it’s obvious that it has developed very quickly. There’s still work to be done. However, funds appreciate our partnership because we provide that expertise and share the necessary nuance of what it takes to appeal to institutional investors, and what those investors expect in a fund.”
Oliete is impressed with the talent pool at Asian hedge funds, but his team does expect a fund to accept that there is room for improvement when it is pointed out to them, and will commit to that improvement over time if they want to work with UBS HFS.
“It’s important that we not compromise very high bar that we have set for operational due diligence at UBS HFS,” says Klingenberg-Timm. “We don’t shy away from saying no to a hedge fund if we’re not comfortable with some of the principals, or if they’re unwilling to implement what we suggest is necessary for them to grow into the institutional space.”
Within UBS HFS, a separate team focuses on operational diligence in order to avoid conflict. “If I really like something from an investment perspective, I cannot be the one to judge the hedge fund’s infrastructure, operational controls, and so forth. It doesn’t matter what I think – if the hedge fund doesn’t pass the standards set by that team, we don’t invest at that time. We don’t necessarily walk away – we help them try to fix it before so we can invest without compromising our standards.”
“The desire for hedge funds to go with a partner that applies global standards when it comes to due diligence and best practices matters enormously,” says Klingenberg-Timm. “I think that’s one reason why investors will rely more on partners like us to actually invest into hedge funds and in Asia. It’s a huge market, but some of the standards are still developing because these funds have not been around for 20 years. Maybe not even for 10 years, and global institutional standards are not always applied from the start. Sometimes they can’t be because the asset base is simply not big enough to warrant such a setup. We understand that, but we need to see that the willingness is there to reach the institutional level that we would like to see in any global fund we invest in.”
The give and take with hedge funds, and the willingness to educate willing students as it were, is “probably what some investors will be looking at when they decide that they’d rather access the opportunity in Asia through us rather than working directly with the hedge funds,” says Klingenberg-Timm.
In fact, we have some large sovereign clients in APAC that do know where to find these funds, but they do not want to do the operational due diligence on their own. They’d rather defer to a team with a global platform, and with people who do this every day all around the world.
In search of alpha: Asian hedge funds in focus
When you look at the alpha per unit of risk that you can capture in a good Asian hedge fund manager, it’s far better than what you’ll see anywhere else.
In some of our portfolios, around 40% of our equity allocation is directed toward Asia.
UBS Hedge Fund Solutions
UBS Hedge Fund Solutions (HFS) offers a wide range of hedge fund solutions including commingled products and customized discretionary products, as well as portfolio advisory and strategic advisory services. The firm is headquartered in Stamford, Conn., with additional offices in New York, London, Zurich, Hong Kong, San Francisco, Shanghai, Tokyo, and Krakow.
As of 1 October 2020, HFS currently manages approximately USD 35.9 billion and has allocated over USD 275.5 billion since inception. UBS Hedge Fund Solutions (HFS) was founded in 1994 and is a wholly owned subsidiary of UBS Asset Management (Americas) Inc.
HFS is the second largest hedge fund manager globally (Source: HFM InvestHedge Billion Dollar Club, published March 2020).
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