The desire for greater transparency, control over investments and bespoke solutions in the hedge fund space drove private bank Investec to sign sub-advisory agreements with two large firms, Goldman Sachs Asset Management and JP Morgan Asset Management, explains Andrew Summers, global head of product and research at Investec private bank in London. The two firms will each run a hedge fund multi-strategy mandate.
“Every aspect of the mandates we set up with Goldman and JP Morgan has been designed specifically for Investec, the risk target, the return target, the concentration, the liquidity and strategy biases,” says Mr Summers. “It is exactly what we want, rather than having to choose an off the shelf solution from a fund of fund, which is not going to completely match all your requirements.”
When sub-advising, there is also greater level of operational comfort regarding the administration, the custody and the oversight of the assets, he says, explaining that assets will sit in a fund vehicle, which has representatives of Investec on the board and the fund administrator, custodian and auditor will be chosen by the bank.
“With sub-advisory there is greater transparency and we will be able to go to JP Morgan and Goldman Sachs’ offices, we will be able to review all their due diligence, all the managers they select, so we can really understand at very great level of detail all the underlying investments.”
Cost reduction
Despite all these benefits, sub-advisory is also a cheaper solution than funds of funds, says Mr Summers. This reduction in cost is passed on to clients, who will get a superior offering at a cheaper price, he claims. “If you have got enough money to open a sub-advisory relationship, you have probably got enough money to negotiate lower fees.”
The two sub-advisers will select underlying managers, construct the portfolio, and will be responsible for risk management and portfolio management. However, Investec will continue to select single manager hedge funds in-house, as overlays to the sub-advisory mandate.
So far, Investec has offered 10 different funds of hedge funds to clients. Different strategies were blended together to create an overall multi-strategy exposure. But one of the problems of this approach is the risk of over-diversifying and just getting the average market return, says Mr Summers. In order to have a diversified portfolio of hedge funds, between 10 and 15 managers are needed, with a total of 30 managers closely monitored for any possible replacement.
This process is very resource intensive, with a large volume of assets needed, in order to apply the right level of due diligence.
Funds of funds have also clearly had problems during the crisis, through lack of transparency and liquidity. And they are generally more expensive and unlikely to match clients’ requirements exactly.
Communicating change
Investec considers the sub-advisory route the optimal solution, outsourcing to benefit from resources which big companies like GSAM or JP Morgan can bring to the process. Rather than 10 funds with 300 underlying managers, it is better to move to two mandates, a higher and lower risk brief, believes Mr Summers. This solution is more concentrated but still sufficiently diversified for risk management purposes, he says.
The biggest problem with the sub-advisory route is that when creating a bespoke portfolio, there is by definition no track record. Also, there is the issue of having to communicate changes to both advisers and clients.
“A lot of our private bankers and clients are comfortable with our funds, they don’t necessarily see the need to change,” says Mr Summers. “Any change can be unsettling for people, so you need to educate them on the benefits of the move.”
Since the crisis there is more focus on liquidity and risk management, when selecting managers.
“In the case of sub-advisers, what you are looking for in addition is somebody who has a substantial sub-advisory business,” he says, as the risk of awarding mandates to companies which have the large majority of assets in flagship funds is that they will spend the large majority of their time on the funds rather than specific mandates.
“We wanted to choose managers who have a long history of running segregated, bespoke mandates, so you know the whole infrastructure and process was set up to run bespoke portfolios.”
Asked whether his past at GSAM had any influence at all on his decision, he says that when he worked at the firm, he did not really know the individuals involved in this area and adds: “When you scour the market for a blue chip organisation with a long track record and good level of AUM, big team, robust infrastructure and long history of running bespoke mandates for private banks, there aren’t many organisations to choose from.
“There are a lot of new entrants into the market, who all run a small level of AUM, and we deliberately try to avoid those. A lot of people say they would like to go to managers that have a small level of AUM, because they are nimble. I am not sure that is true. For us it was more important to go with a manager who was very well established.”
