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In conversation

Release date: 20 Jan 2014 | Eurex Group

In conversation

Renaud Huck and Margie Lindsay

In this edition of Eurex Institutional Insights, Renaud Huck, Head of Buy Side Relations at Eurex Group talks to Margie Lindsay, Executive Editor of Hedge Funds Review, about her outsiderinsider
look at the hedge fund industry, the state of the industry at the moment and what she believes will be the themes going forwards.

Huck: How did you get started in journalism?

Lindsay: I started at a Canadian publishing company for a weekly oil publication. At that point I looked around and said “what’s the best newspaper in the world? The Financial Times – I should be a journalist for the Financial Times.” So I got a job at the Financial Times.

Three months later Gorbachev came to power and the world changed so there was a lot to write about. Later I was head-hunted to an eastern European publication for a project with the European Commission and candidate countries of the CEE region. The rule was: if I’m going to do this for you, it has to be real journalism. We had an editorial board that supported me really well and was the first publication that had direct quotes from commissioners.

Huck: So that’s quite a transition then from oil, to financial markets to politics?

Lindsay: Journalists are meant to be good at asking questions and the philosophy – of British journalists at least – is that you’re not an expert on anything because if you are the expert you don’t ask the questions. So the idea is that if you’re good at asking questions and good at writing it doesn’t matter what the subject is you should be able to pick it up without any trouble.

Huck: You joined Hedge Funds Review in February of 2008, so a few months later you obviously had a lot to write about. What was it like to be thrown into a new topic, and then have things change so rapidly?

Lindsay: It was a bit like 1989 when every time I came back to the office, another communist country had collapsed. Except this time it was investment banks. But for the hedge funds, it was an exciting time. It was the beginning of a revolution and an evolution in the hedge fund industry. At the time I didn’t appreciate it that much, but when I started, theoretically, the majority of assets under management by hedge funds came from private individuals, fund of funds, and family offices. Today its 80 to 85 percent institutional investors – so in a very short space of time there’s been this big shift. The fund of funds industry has been decimated in  Europe. It’s held together in the U.S., but again, they have had to completely change their models and moved into a different way of operating. Because I was completely new to all of this I didn’t find this odd I just found it logical and accepted it whereas someone else might
have been thinking or clinging on to an old form and an old idea of what hedge funds should be.

“The whole model of how hedge funds operate the relationship with the prime brokers has changed.”


Huck: What was the reason for this move?

Lindsay: The collapse of the banks basically.

Huck: So the internal business model of the prime broker business model changed.

Lindsay: Before “the crisis” the prime brokers used to worry about the hedge funds and whether or not they were a good credit risk. And as soon as the hedge funds started questioning the credit worthiness of their prime brokers the prime brokers didn’t like that.

I remember talking to BNY Mellon quite a few months before the Lehman Brothers incident and they had witnessed billions moving into custodial accounts out of prime brokers. Of course the hedge funds were blamed for collapsing banks because they were pulling assets, but their duty was to their shareholders and their investors – to protect their money.
They were the ones that were caught in the chaos and that was a disaster for them. The whole model of how hedge funds operate the relationship with the prime brokers has changed; the relationship with the fund administrators has changed. Relationships with custodians, who previously weren’t visible to hedge funds, also changed.

“They were treated as though they were the cause of the crisis, when they were actually the solution to the crisis.”


Huck: Segregation models also, have evolved. Before, there were hardly any segregation models whereas now, hedge funds demand that collateral be protected. The old omnibus account is no longer good enough.

Before the crisis, they were regulated but not formally regulated. You had the FCA and FCC but there wasn’t any overarching regulation. Now you have the AIFM directive, you
have Dodd Frank, you have plethora of things that have hit them out of nowhere, and they’re not used to that either. They were treated as though they were the cause of the crisis, when they were actually the solution to the crisis.

Huck: The (then) governor of the IMF, Jack Jesuf, was quite clear that the buy side had nothing to do with the meltdown of the financial system but rather the sell side banks were at fault. The irony being that now everyone is caught in regulation and some may say over-regulation.

Lindsay: In some respects hedge funds have taken up some of the functions of the investment banks. Lending is a good example. Very soon after the collapse of Lehman Brothers, one of the first things I noticed was that anybody who needed trade credit financing under USD 50 million couldn’t get anything from the banks. Suddenly 10 to 15 little hedge funds emerged, mainly in Switzerland, to conduct trade finance to help coffee growers, cotton, sugar, and other commodity producers. These people couldn’t get any trade credit from their banks
so the hedge funds were filling a gap. Thus, you now have asset backed bank lending and other lending types that weren’t offered before.
The questions I suppose are how do you define a hedge fund now? Where does the remit of a hedge fund begin and end?

“But now nobody really knows what’s going to be happening next. It’s like we are on the edge of a really big slope.”


Huck: You’re absolutely right. Investment banks had a very broad role and hedge funds a very limited role, now you can see the hedge funds have extended their territories, for example towards capital intro which, for a long time, was a subset of the investment banking world. It’s quite interesting to see how things evolve. Some of the capabilities that the banks had before, they now don’t find attractive to fulfil. So hedge funds are saying “well maybe this is closer to what we could do and that’s it”. Is that then the big theme since 2008?

Lindsay: One of them. You have the prop desks disappearing from the investment banks; you have hedge funds becoming market makers where they weren’t before and hedge funds becoming members of exchanges which they wouldn’t have considered before. They’re moving into completely different territories, at the same time because their investment bases
changed into this institutional framework, investors had already pushed hedge funds into transparency and better operations. The investment community asked for this long before the regulators got there. But now nobody really knows what’s going to be happening next. It’s like we are on the edge of a really big slope.

Renaud Huck
Head of Buy Side Relations,
Eurex Group

Huck: Absolutely. The very nature of their investor-base has changed. For example, pension funds require more disclosure, more openness and more transparency. They want to be in a position to have a good reading of the investment vehicle and the investment structure that they invest in.

Lindsay: You need look at it globally too. Investors are far more interested in hedge funds and alternatives and will have 20 percent or more of their portfolio in alternatives in the U.S., most of which will be hedge funds. In the U.K. the proportion is approximately 15 to 20 percent, whereas continental Europe is still scared of hedge funds because they think they’re the evil incarnate. Asian investors are approaching U.S. levels in terms of the proportion they allocate to alternatives. All of this with the backdrop of growing regulation around the world.

One of the unintended consequences in the U.S. is the passing of the jobs act which now has lifted the 80 year old ban on general solicitation and advertising for hedge funds so all of a sudden you have all of the U.S. hedge funds going to market and being very open about what
they do and how they do it, whereas in Europe it’s still closed, and we are talking about transparency and so what’s wrong with that?

“ So all of a sudden you have all of the U.S. hedge funds going to market and being very open about what they do and how they do it, whereas in Europe it’s still closed.”


Huck: So there’s a new market opening up in the U.S.?

Lindsay: Yes and no. A great many of the hedge funds I talk to understand their end investor now is actually the guy on the street who invests in pension plans and insurance plans. This is fuelling transparency too though these are still complex financial organisations and hence not easy to understand in the simplest terms. Hence you have to be a qualified investor to invest in them.
It doesn’t mean hedge funds are going to commission TV ads and billboards in New York, but they are allowed to be more open about what they can publish about their performance figures which they were never allowed to do.

Huck: I think that by broadening the horizon, normally you introduce a level of competition, but also you introduce a level of diligence and homework that investors have to do. What’s keeping these guys awake at the moment?

Lindsay: For a hedge fund, the thing that’s always kept them awake at night is how to make money. It’s all about performance, that’s the key to everything.

Huck: I think regulation is a big issue that’s keeping them awake. There is no revenue coming from equities. Fixed income yields are at rock bottom, so there is no revenue coming from short dated or long dated paper. Currencies are very volatile, but volatile without any volume and the commodity space is also volatile without significant production. On top of this you have an arsenal of regulation which brings little tangible returns.

Lindsay: And particularly in Europe where they can’t make up their minds what they’re doing – there’s no clarity. The AIFM directive might have come into force but nobody actually knows
what it means because there are so many question marks against so many parts of it. Everybody wonders why all the hedge funds are sitting around not doing anything not thinking that they simply don’t know what to do yet until everything’s clarified. The economies and the markets might be total messes but what’s interesting is that I could
probably name 10 hedge funds for every strategy that are performing well.

This article was firstly published in our „Institutional Insights“ magazine. Interested in reading more about current trends in the buy side industry, background articles, interviews with experts and more? Then take a look at the third edition of our latest Eurex Group publication.

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Huck: What does it mean though for the smaller guys, what does it mean for new entrants?

Lindsay: When you talk to a multibillion dollar hedge fund they will tell you that you never start with billions in assets. Perhaps you start with a few million or a few hundred million. The difference now is because of the level of institutional money involved and the resulting
compliance requirements; you’re expected from day one to have a certain minimum structure for operations. If after 12 to 18 months you’ve only raised USD 100 million it’ll be difficult to survive because of the overheads you have as a small business. And let’s not forget, these are small businesses and not just a guy in a back room trading at a computer.

The industry is very worried that new talent will just wither and die if they don’t have some help so you do have some seeding places. They don’t do as much as everyone else wants them to do but it’s hard. What you are seeing is some of the big houses are bringing in
complimentary strategies and people so if they have a good idea, instead of setting up on their own, they might come into a bigger established hedge fund and start that way.

“The worst thing that could happen is regulation and compliance that stops the industry fostering new talent.”


Huck: So the fund has already this infrastructure in place?

Lindsay: Yes it’s not exactly seeding but it’s similar to seeding. Some of the big houses are doing that internally with the guys inside the big houses spitting out to do their own strategies as well.
Don’t forget that most invest almost all of their personal wealth in these funds, and it’s not just on the performance side, they’re putting it in as working capital to make sure they have the right kind of infrastructure and the right kind of staff before they can get to the next level. But it is very tough so for these guys, the worst thing that could happen is regulation and compliance that stops the industry fostering new talent.

Huck: What is the industry doing to help itself?

Lindsay: Very little. It’s a collection of individuals that don’t really work well together. There’s no real mechanism to do that but you have some big seeders such as Blackstone, Goldman Sachs and Man Group. Basically if you have the will to do it, the correct strategy that’s coherent and explainable, you should be able to succeed. But you have to have a lot of start-up capital to start doing it. It’s the same attrition rate that you get for small businesses, probably about 10 to 15 percent fail, and I think the difference pre-crisis to post-crisis is that before it took longer to fail now it’s pretty obvious within 12 to 24 months whether you’ll succeed or not.
And you get caught in a catch 22 situation where the institutional investors aren’t interested unless you have a 12 month, 18 month, 24 month track record, but you can only do that if you are able to do the marketing for the fund to raise the assets you need which required the infrastructure to be in place.

“We’re seeing funded administrators and prime brokers offering services to emerging managers because they are the ones that are going to be the black stones in the bridge waters of the
future – so it’s a good investment.”


Huck: So it’s a matter of surviving the first 12, 18 and 24 months?

Lindsay: Exactly. Institutional investors are beginning to understand this catch 22 situation faced by niche emerging managers. They understand that on dayone you’re not going to have the operational infrastructure in place because you can’t afford it yet. But if you can show them a plan of how you’ll grow and put this infrastructure in place it goes a long way to comfort to them into investing in you. We’re seeing funded administrators and prime brokers offering services to emerging managers because they are the ones that are going to be the black stones in the bridge waters of the future – so it’s a good investment. But you have to pick the right ones – the good ones will survive.

About the interviewee

Margie Lindsay began her journalistic career at the Financial Times covering North Sea Oil and then moving into writing about business, finance and economic issues in the still then communist Eastern Europe, following the region through the transition into democracy.
After leaving the Financial Times, Lindsay developed and edited a magazine for the European Union preparing the first wave of candidate countries from Eastern Europe for membership. Lindsay is also the author of several books on a range of financial and business subjects. She has experience working in television filming and producing news reports on East European economies. Lindsay became editor of Hedge Funds Review in 2008, just before the Lehman crisis and was made executive editor in October 2013.


Huck: That’s where Hedge Fund Lions’ Den comes into the picture. Can you explain the premise behind the show, why you’re doing it and what you hope to achieve?

Lindsay: Together with Eurex Group, we wanted to produce programming in a very personal way to show what some of these problems really are. These guys are not just passionate about what they do but are really committed and good business people who are up against really
tough problems. What they (and viewers) can do is learn huge amounts from some of the biggest names in the business who have taken funds from zero to billions of dollars. The show answers the question of how you make yourself into a sustainable hedge fund and we thought doing that through a reality TV programme would be much more fun, and much more instructive to the industry as well as to investors.

Huck: It’s the crystal ball question now. Based on the last couple of years, what will be the big themes in 2014 and 2015?

Lindsay: As far as the hedge funds are concerned, it’s still going to be performance, they need to get that performance up and actually even if you pick the right fund and you have the performance, it’s still a very tough environment for them to work in. You don’t know what the Fed is going to do, you don’t know what other central banks are going to do next and I think they’re coping really well.
It’s also going to be about getting regulation under control. U.S. regulators are becoming a bit impatient to see that EMIR is not making a lot of progress  because ESMA is teetering. I think by the end of next year most likely ESMA will give clearer signals about the regulation and during 2015 we will see more enforcement of asset classes being regulated.
It will of course have an impact on the buy side but I think it will have a positive impact. What makes this industry of interest is the story behind the investment strategy. A good story capturing investment and capturing returns at a time when there aren’t many big events such as elections means the very nature of the quality of the portfolio manager that makes the difference.
I really think you’re going to see a lot more money flowing into hedge funds and I think gradually a lot more of that money is going to be flowing into the smaller hedge funds rather than the big guys which is what’s happening now.

Huck: Why?

Lindsay: Because the larger hedge funds are getting very close to capacity or have hit capacity. Smaller managers can be much more nimble, and usually are not necessarily taking more risks but because of their size they can take more profit so you get a higher performance figure
from them.

The opinions in this interview are those of Margie Lindsay and do not necessarily reflect the opinion of Hedge Funds Review.


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