The colossal Madoff fraud, orchestrated at the expense of many investors around the world, combined with widespread gating imposed by hedge funds last year, heavily restricting redemptions, have painfully brought to the fore the importance of having a robust due diligence process. Risk management, especially within alternative investments, is now firmly on private banks’ agendas.
At major Zurich-based player Julius Baer, advisers are no longer allowed to recommend single manager hedge funds or single manager private equity funds. “This is now our new in-house policy as we don’t think these products are suitable for our clients,” says Yves Robert-Charrue, head of funds and product management at Bank Julius Baer. Moreover, now that the bank has split from its asset management arm, and GAM is no longer its in-house alternatives provider, there are no specific internal recommendations to make, he says.
All the funds of funds managed by the firms with Madoff exposure were systematically banned from the Swiss bank’s selected fund list at the beginning of the year, says Mr Robert-Charrue. The bank also made further investments to improve hedge funds of funds operational due diligence. “We want to make sure we select only those funds of hedge funds that have a very thorough and very clear investment and selection process in order to minimise any risk,” he says. Bank Julius Baer has stated that it did not have any Madoff products on its recommendation lists, nor did Julius Baer branded funds and distributed funds have any exposure to Madoff. The only exposure to Madoff was through external managers the bank was custodian for and through some self-directed clients.
The regulated hedge fund space is also gaining traction and it is hailed as an interesting evolution by Mr Robert-Charrue. “We do tend to prefer hedge funds expanding into Ucits III, to the traditional managers moving into that area, as they are just more experienced with shorting, and more exotic type of instruments,” he says. “We have made some recommendations in that space, but we are doing that gradually because we want to see some track record first.”
Because of this development, the fund selection process in the so-called long-only arena needs to borrow some of the techniques used in the hedge fund space, says Katia Coudray, head of manager and fund selection at Union Bancaire Privée (UBP), the Swiss private bank reported to have an overall exposure to Madoff funds of more than SFr1bn (€660m). This is a remarkable admission, bearing in mind the circumstances.
“When selecting a hedge fund strategy wrapped in a Ucits III structure, you are really working like you are analysing a hedge fund,” says Ms Coudray, responsible for setting up the long-only fund selection business at the bank in 2001.
“Absolute return means anything and nothing,” she says. “You have really to clarify with the manager what kind of investment objective he has in terms of performance, risk or maximum draw-down.”
The long-only team leverages on existing in-house research on the hedge fund side. The bank admits the hedge fund team was responsible for selecting Madoff-related funds. But there are also important differences to take into account when analysing a Ucits III fund, for example the structure of the equity swaps and the counterparty used, says Ms Coudray.
The liquidity aspect is also paramount and the analysis of the portfolio needs to make sure that it will be able to face inflows and outflows at least twice a month. Currently, two Ucits III sophisticated funds are included in the UBP’s preferred list of 120 funds – which span across equities, commodities, absolute return funds and marginally, fixed income – but there are a few more in the pipeline, says Ms Coudray.
“There is demand for hedge funds that offer higher liquidity, transparency and investor protection, and the Ucits III format is meeting those needs,” she says. UBP has decided to liquidate the New Castle Market Neutral US Equity fund. New Castle Partners is currently embroiled in insider trading allegations in the US. The fund was distributed in some EU countries through Ucits III vehicles, which UBP maintains “offer a safe regulatory environment to investors.” The bank says the entire amount invested will be returned to clients.
According to Christoph Blaettler, head of portfolio management at Vontobel private bank, what gained importance after the crisis “was the whole risk management process and the concept that a fund needs to be analysed over the full market cycle, not just in a bear or bull market.”
The bank, which Mr Blaettler says was not affected by the Madoff events, works closely with Harcourt Investment Consulting, the funds of hedge funds supplier and part of the Vontobel group, which decided to transfer its operational due diligence to its risk management team, in order to improve fund monitoring. The fund and manager selection process is made by the alternative investment committee at Vontobel, made up of private banking and asset management people and Harcourt acts as an adviser, explains Mr Blaettler.
