Hedge funds are back. At least, that’s the consensus from most of the data providers that track the returns delivered by the industry. Greg Winterton spoke to Johann Ropers, Head of Hedge Funds at AXA IM Prime, to get his thoughts on the current state of the space.
GW: Johann, let’s start with how the industry has been doing this year. What are some of the reasons that hedge funds generally seem to be off to a good start?
JR: Dispersion, Dispersion, Dispersion.
Quantitative easing created a very difficult environment for hedge fund strategies. When volatility is suppressed, relative value opportunities are tight, and it is difficult for hedge fund managers to extract value. Now that we are out of that period and we have moved to a phase of quantitative tightening, with divergences between global economies on top of this, relative value opportunities are back and hedge funds strategies are performing well. We expect this opportunity set to continue to improve in the months to come.
GW: Moving on to manager selection. What are some of the qualities that AXA IM Prime looks for in managers (and funds) when building portfolios for your clients?
JR: We try to combine two aspects: alpha generation and longevity. Alpha is not static, and our job is to identify managers that have the capacity to extract this alpha over a long period of time. This requires exceptional investment talent of course, but not only this. The infrastructure of the managers is key. Managers need to invest in their infrastructure to maintain a set-up which enables them to extract this alpha. That is not cheap and requires an important investment from managers – we are looking for the ones that have that perseverance and are ready to make this commitment.
GW: Portfolio construction now. At what point does AXA IM Prime look at overlapping exposures and say, ‘that’s enough’? For example, you may have a US equity long short fund, and then you have a CTA that trend-follows US equities. Some would characterise them differently, but that’s two equities exposures there.
JR: This crowding effect has become a crucial element to understanding risk. This is especially true with the multiplication of multi-manager pods. These funds are often trading the same stocks in a similar manner, which amplifies trends.
To avoid being dependent on this, we took the view two years ago that looking at our allocation manager-by -manager was too restrictive and decided to consolidate all our trades, instrument by instrument, into a global book. That approach enables us to analyze our positioning in an aggregate view rather than manager-by-manager and it forces us to think in term of bonds, stocks or futures rather than in terms of strategy or manager exposure. We think it is key if you want to understand factors rotation, flows but also the level of risks taken in your portfolio.
Crowding is certainly an issue amongst hedge fund managers but overdiversification is as well. Too many managers are lacking convictions and are overly diversified. Portfolios are over-hedged, and returns are muted. We want our managers to have convictions and make sure that these convictions are reflected in their position sizing.
GW: Are there any interesting trends emerging at a regional level? Are any countries or areas hotbeds for up-and-coming talent, and why?
JR: Contrary to most of our peers, we are very excited about the opportunity in Asia and especially the emerging managers in the region. Most allocators are focusing on US or Europe and consider Asia as complex. It is true. The region has a multitude of currencies, political regimes, regulations and barriers to entry are high, but a new generation of managers is emerging, and they are extremely talented. They have been trained in the best funds, have often been used to the best practices in term of infrastructure and they understand the region. We like these talents and are ready to support them with the launch of their funds. Returns from these emerging managers are often excellent and the satisfaction of helping them to build their business is without comparison.
GW: Lastly, Johann, hedge funds struggled during the ZIRP era. Whether rates go back to zero any time soon is anyone’s guess, but what’s your message to investors in terms of how to best use hedge funds as part of a broader asset allocation strategy?
JR: Hedge funds offer investors access to competitive absolute performance (levels depend on the risk profile each investor is prepared to absorb) that diversify traditional asset classes while maintaining a good liquidity profile. For this reason, we believe excluding them from an asset allocation is a missed opportunity. Once included in a portfolio, timing this allocation is also very complex and requires specific skill sets. We believe that maintaining ~15% allocation to hedge funds across the cycle is a great starting point.
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Johann Ropers is Head of Hedge Funds at AXA IM Prime
