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5th FERI Hedge Funds Investment Day

8 September 2016

Panel discussion (L-R) Moderator: Mr Uwe Lill, Managing Partner, Gesellschaft für Finanzkommunikation mbH, Frankfurt; Mrs Stephanie v. Oertzen, Director Alternative Investment, Siemens Financial Services GmbH, Munich; Dr Dirk Rüttgers, CEO Do Investment AG, Munich; Mr Thomas Zimmer, Member oft he Board, FERI Trust Luxemburg.

What is the Right Way?

Offshore or UCITS Hedge Funds?

Marcus Storr, Head of Hedge Funds, FERI AG

A few years back, hedge funds and alternative investment funds were a highly unpopular and unfavourable choice for investors in Germany. However, many institutional investors and family offices are now considering investing in absolute return funds and hedge funds. What changed their minds in such a short span of time? Low to negative yields in traditional asset classes have left no choice for investors but to consider alternative investments that provide absolute returns. The investment trend is more towards European-regulated UCITS funds as compared to offshore funds.

Trends in Europe-based hedge funds

Post-financial crisis, the assets under management in Europe-based offshore hedge funds remained unchanged, but the UCITS space witnessed some serious developments with current assets being 10 times what they were back in 2009. Currently, assets under management in both the offshore and UCITS space are almost the same, with several hundred billion invested in each. This behaviour surely signifies that after the financial crisis, European investors are seeking more liquidity and prefer to be in a more regulatory-driven environment. It is highly questionable whether this development is something to get worried about or be happy about. UCITS funds surely provide relatively good liquidity and portfolio transparency, but at the same time they add implicit costs and create complex fund structures. Most importantly, UCITS regulations restrict the investment universe which translates into lower performance of UCITS funds than their offshore counterparts.

Performance tracking error: UCITS versus offshore

Four years back, FERI carried out a detailed quantitative performance and risk analysis of UCITS and offshore funds using data from 2005 to 2011. We found that the performance of UCITS and offshore funds in the Equity Hedge strategy tracked quite closely to each other, but the results were disappointing for other strategies as offshore funds performed better than the UCITS funds, creating a higher tracking error between them.

In August 2016 we updated our previous empirical analysis using a time period from 2005 to 2015. We had a quiet hope in our hearts that the tracking error would have been minimised but the results were even more disappointing, as we almost lost our old friend ‘Equity Hedge’ on the way. The largest tracking error was seen in Relative Value and Event Driven strategies, followed by Tactical Trading and, though to a minor extent, Equity Hedge. These results again support our previous claim that UCITS funds have a relatively restrictive investment universe, which is reflected in their performance when compared to offshore funds.

Perception: only offshore funds have problems

It is often perceived that only offshore funds can gate their funds for investors, but the reality is that, based on their prospectuses, UCITS funds can also gate their funds. Another misperception is that UCITS regulations would save the UCITS funds from any kind of fraudulent losses but the reality is also different.

For example, during the Madoff scandal, UCITS funds were as badly hurt as the offshore funds. UCITS funds offering the strategy were severely affected by the Madoff investment scandal and those UCITS funds stopped redemptions right after the scandal. After fighting the case for four years, investors were only able to recover one-sixth of their investments from those funds.

Both UCITS and offshore hedge funds are useful in their own way. UCITS funds work well in dedicated liquid strategies such as equity long/short, merger arbitrage, CTAs and global macro strategies. On the other hand, offshore funds can be invested across all the strategies. The final remark from my side is that thorough due diligence and an understanding of the underlying risk factors is the crucial point when investing in either UCITS or offshore hedge funds.

Innovation is the Foundation for Systematic Investing

Harold M. De Boer, Managing Director, Transtrend BV, Rotterdam, Netherlands

Part I – A changing world

Technological advance

I started my career at Transtrend – it was at that moment a research project – in 1989. In 1992, I had a telephone on my desk. Then it grew into a mobile handset, and I was very proud of this, because you could then connect with someone else. Could you imagine something like that in 1992 or 1989? When we were communicating, I wrote a column every week for a newspaper, and I had to send it by fax, and then the journalists over there had to retype the whole thing again. When we were connecting with exchanges, you would look at the homepage, on the Internet; we had brochures being sent by the exchange – only in 1992.

In 2007, in the stock exchange, you still had floor traders. Nowadays in the New York Stock Exchange they have to ask people to walk there for a picture, because otherwise there would be no one. The same goes for cars; there was not even an emission scandal to be worried about! Toxic fumes were just allowed. You paid for your car with cash, now you use a card.

You did your shopping in real shops, or your wife did the shopping; the Internet is where you do it right now. What could you buy at Karlstadt with one mark in 1998 – sorry, 1982? How many things could you buy at Karlstadt? I would say, not a lot. In 2014, the whole chain was bought for one euro. Times are a-changing. And beware, it doesn’t stop here.

Part II – Active Risk

Defining active risk as tracking error

This is very relevant when we talk about active risk in investing. There is the Dutch National Bank; here you have the Bundesbank, which watches over investors, for instance, pension funds and so on, and they have to take active risk into account. It works like this: they say, if there’s a pension fund, you have to do a whole analysis, and you use an index, a stock index or a fixed income index, in your calculation of historical performance and historical risks. Then any deviation from that index, anything you do differently to that, will add an additional risk to the equation; that risk is called active risk.

Your risk gets higher if you deviate from the index that you’ve been calculating with. And that means for a pension fund, many investors are almost obliged to use those kinds of passive investments, getting close to the index. This whole idea is a pure academic truth, and you have to all remember that academic truths are always true only under certain conditions. And one of the conditions here is that the past reflects the current – or, said otherwise, that the world does not change.

Changing composition of equity indices

So there’s a very nice theory about why to use indices and so on, which is completely true if the world does not change, and we just saw that now and then some things change. Not only do people get older, but many other things change too. What’s the consequence of that? Well, if the world changes, look at the S&P 500 at this moment – what are the largest firms in it, market cap-weighted? Number one is Apple, okay, founded in 1976, but how large was it in the index in 1992? Microsoft, founded in 1975; how large was it in 1992? Facebook, founded in 2005. This is the same index, and we were checking the same index – well, there were a lot of changes there.

Evolving activities of index constituents

Let’s bring our focus to Germany and to the DAX. Number two is Siemens – okay, old company, always in there since 1847, but SAP was founded in 1972, and how large was it in 1990? Does anyone know? I don’t think it was a big firm then. Without computers there was not a lot to SAP. Let’s look at Siemens more closely. Their Telegraphen-Bauanstalt used to make electrical telegraphs and telegraph lines – are they still making them? I hope not, because you won’t sell very many. They used to make electrical generators, electrical trams and trolley buses; I walked around Frankfurt and this area, but I didn’t see a lot of these anymore.

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