Since the end of 2007, the global hedge fund industry has been in a state of deep despair. The start of the new millennium marked incredible growth in alternative strategies, mainly driven by inflows from US-American investors.
Today, we can see that this growth was accompanied by grave omissions from a corporate governance, compliance, transparency and risk management perspective, which resulted in growing disillusionment for investors regarding their expectations and confidence as time progressed. Looking back, the Lehman Brothers collapse and the Madoff scandal in 2008/2009 marked the low point for the hedge fund industry, with many investors turning their backs on so-called offshore products that were mostly domiciled in relatively unregulated regions, such as the Cayman Islands. The high demand for solutions with low correlation to the traditional asset classes has not abated at all, however, and it is the current interest environment, above all, which is increasingly prompting investors to rethink their allocation decisions with regard to alternative investment strategies.
UCITS funds are reshaping the landscape
Today, the introduction of so-called UCITS funds, which have been on the market since 2008, enables investors to gain access to liquid hedge fund strategies that are completely regulated and fully compliant with transparency requirements. Over the past three years, especially, the volume of UCITS funds that map alternative investment strategies and are registered in Luxembourg or Ireland has seen sharp growth, and currently amounts to 220 billion euros (Chart 01).
In recent surveys, numerous investment banks have confirmed that institutional investors are increasingly discovering and investing in market-neutral equity strategies – i. e. investment strategies with very low effective exposure to the equity market – instead of bond investments, as they offer an attractive risk/return profile. Added to which, market-neutral products generally offer clients relief from the need to make timing decisions, as these strategies basically aim to generate positive returns during all phases of the stock market cycle.
“The financial crisis of the past years has changed the world in many respects, and these changes have started to influence product development.”
A further key lesson learned in recent quarters is that international investors are regaining confidence in the European stock market. In a survey conducted by Deutsche Bank in the first quarter of this year, 53% of the interviewed investors plan to increase their exposure to fundamental long/short equity strategies, i. e. market-neutral equity strategies, and to event-driven strategies, whose investment principle is based on the occurrence of specific events, such as corporate acquisitions (Chart 02). Neither the earnings momentum in Europe nor the restructuring potential in many European countries have yet reached their limits. In addition, we “The financial crisis of the past years has changed the world in many respects, and these changes have started to influence product development.” expect hopes of possible mergers and acquisitions, especially among US companies, to persist. Many international investors are, moreover, still significantly underweight in Europe.
Transparency and understandability
Recent years have shown that numerous hedge fund strategies have failed to live up to investor expectations, especially in phases of falling markets. The reasons for the tangible disappointment are manifold, but it is mainly due to the fact that many of the equity strategies often paid for performance with tangible beta and corresponding leverage, and the derivatives purchased to hedge the strategies did not perform as predicted by the underlying models when the markets fell. Added to which, risk management models have since proven to be inadequate in many cases.
“By launching a market-neutral European equity hedge fund in 2009, Allianz Global Investors decided to bundle its research capacities in a product that benefits from both rising and falling share prices.”
The financial crisis of the past years has changed the world in many respects, and these changes have started to influence product development. Weekly liquidity, for example, is absolutely essential these days.
Market-neutral hedge fund strategies at Allianz Global Investors
By launching a market-neutral European equity hedge fund in 2009, Allianz Global Investors decided to bundle its research capacities in a product that benefits from both rising and falling share prices.
Performance of the Allianz Discovery Europe Strategy Fund after deduction of costs has been 6% p. a.* (over the past three years) with very low volatility of just 4% (also annualized).
The Allianz Discovery Europe Strategy fund is based on a very rigorous risk management model, to ensure product volatility is contained within the strictly defined range. A total of eight factors are monitored constantly, and checked for compliance with the respective, narrowly-defined budget specifications. In addition to the very low portfolio beta, which must be virtually zero, and corresponding net exposure to equities of +/–15% maximum, these factors include clear limits for individual stock, sector and country allocations. 2008 and 2011 were very challenging years, which especially demonstrated how this investment approach can protect our clients against losses when paired with clear risk management.
“Additionally, our portfolio managers consult the global research platform of Allianz Global Investors to identify underlying trends and themes that can be used as sector ideas or even country trades.”
Our portfolio managers focus solely on searching out successful companies for inclusion in the respective long portfolio. At the same time, the investment team builds up the “short side” with companies expected to run into difficulties caused by changes in the market over the medium to long term, resulting in lower-thanaverage performance. The stocks that are sold short are procured in advance through corresponding securities-lending transactions. As such, the investment approach in the underlying portfolios is implemented entirely without the use of derivatives.
Additionally, our portfolio managers consult the global research platform of Allianz Global Investors to identify underlying trends and themes that can be used as sector ideas or even country trades. It is these transactions, in particular, that have tangibly contributed to the success of the strategy in recent years, since Europe is still a very heterogeneous market, and thus offers manifold different sources of alpha.
Since 2010, Allianz Global Investors has offered its Allianz Discovery Germany Strategy Fund, a special market-neutral product with strong focus on small and mid caps, that reflects our expertise at picking stocks – and German stocks, in particular.
The successful market-neutral equity long/short approach adopted by Allianz Global Investors can be described as clear, fundamental conviction at the individual stock level, paired with strict risk management and the exclusion of derivatives in the underlying portfolios (Chart 03).
* Performance through 31 March 2014