Jersey Private Funds

With effect from 18 April Jersey is introducing a new regime in respect of private funds - simplifying the regulatory regime, and extending the benefits of flexibility and speed across Jersey’s private funds space.

Under the Jersey private funds regime:

  • All funds with up to 50 investors will come under one simple regime.
  • The regulatory framework will be consistent across the private funds space, extending the current benefits of Jersey’s existing very private regime to all private funds.
  • A fast track 48-hour regulatory approval process will apply, with no prior approval of promoters or key persons being required.
  • The features and operation of private funds will be relatively unconstrained, with a variety of legal vehicles being able to be used, funds being able to be closed- or open-ended, requirements for Jersey connections being relaxed, and offering documents being permitted, but not required.
  • Private funds will be able to be promoted to “professional” and other “eligible” investors, with the eligibility criteria being both straightforward and relatively broad: for example including those whose ordinary business is managing, holding or advising on investments, as well as persons who can meet certain asset or investment thresholds (such as making an investment of at least £250,000 (or currency equivalent).

Alongside the various elements of flexibility, appropriate regulatory oversight will be maintained. This will be achieved through a requirement for a Jersey-regulated ‘Designated Service Provider’ to be appointed to all Jersey private funds, following the trend of focusing regulation on a key service provider, rather than the product.

French Elections

With the Dutch elections over, the Euro has breathed a sigh of relief. As Geert Wilders’ nationalist Freedom Party fell short in the parliamentary elections on March 15, the euro gained nearly one percent against the US dollar, albeit on a day when most currencies strengthened versus the greenback. While Wilder’s party suffered a spectacular collapse in polls in the immediate run up to the election, there was never any serious concern that he would be running the Dutch government. By contrast, the upcoming French Presidential election in April has the potential to be a much bigger source of volatility for the euro, as well as other currencies, equities and bonds.

France votes in two rounds. Round one takes place on Sunday, April 23, and the top two vote getters will proceed to the second round on Sunday, May 7. On both days, the French government will issue an exit poll at 8:00 pm Paris time (7:00 pm London, 2:00 pm New York and 1:00 pm Chicago) with a preliminary projection of the winner. It appears likely that one of those two top vote getters will be Marine Le Pen of the National Front who promises, among many other things, to hold a referendum on France’s memberships in the European Union (EU) and in the Euro currency that spans 19 countries. As such, a Le Pen victory holds the potential to roil the markets in the way that the surprise Brexit vote did in 2016.

On the face of it, she seems unlikely to win. Recent polls have put her at 20-30% behind her most likely second round opponent, the pro-European centrist Emmanuel Macron (Fig.1). She trails her next most likely second round opponent, the center-right Francois Fillon, a former Prime Minister, by a 10-20% margin (Fig.2). Fillon is also pro-Europe.

Culture Change

Dr. Janet Yellen’s term as Chair of the Board of Governors of the Federal Reserve (Fed) System ends in early 2018. While she could be reappointed for another four-year term as Chair, reading the tea leaves in Washington D.C. suggests a scenario where we may see a person from a business career take over the gavel. And not just as Chair. There are three vacancies on the Board of Governors, and we also expect a new Vice-Chair in the summer of 2018. That is, there is a potential for five new board members on a seven-member board, and some or all of those seats could be filled with business-career credentialed individuals instead of persons with academic or central bank experience.  This could usher in a major cultural change at the Fed. Such a cultural shift might make a very big difference in how decisions about interest rate policy may be made.

Our intuition is that more business experience on the Fed Board of Governors and fewer economists will shift the debate away from academic interpretations of monetary policy and increase the focus on the interplay of rates and debt. More specifically, the high debt loads in the U.S. will create a bias for lower than otherwise rates, so that increases in debt-service expenses do not derail an economic recovery. Over the long haul, if this scenario prevails, a bias toward lower rates relative to inflation is likely to also lead to a weaker trend for the U.S. dollar as well.

Editor’s Letter

UCITS compliant hedge funds go from strength to strength in what is a European success story. Assets have surpassed $300 billion, or 10% of global hedge fund industry assets of around $3 trillion. Granted, most hedge fund assets still come from US institutions, allocating to Cayman or Delaware vehicles, but not all managers are able or willing to distribute to the US.

Some managers run UCITS parallel to ’40 Act funds in the US, but UCITS can appeal to more managers. No special structuring is needed to receive performance fees from a UCITS. And the potential to offer weekly or bi-monthly dealing in a UCITS contrasts with the strict ‘40 Act requirement for daily dealing. The UCITS risk constraints can comfortably accommodate many strategies. For instance, the diversification criteria, capping positions sizes at 10%, need not apply to many developed government bond markets, which can leave more latitude to pursue macro strategies. Customisation can also be obtained by asking managers to sub-advise managed accounts under the umbrella of a UCITS fund.

The advent of UCITS IV - introducing greater flexibility - in 2011, spawned the growth of so-called “Newcits” but some hedge fund strategies have been structured under UCITS III for at least 20 years. A significant number of managers now launching UCITS have been around for 30 years or more. Though rising barriers to entry have arrested some launches, our 2017 UCITS Hedge Award winners range in size from around $10 million to several billions. The smallest funds tend to be part of larger groups, however. Some funds outsource to a range of service providers, including some very visible platforms – such as Lyxor, MontLake or Deutsche, and some virtually invisible platforms in the form of white label infrastructure providers that maintain a lower profile.

Will India Trump China as US Policy Shifts?

Neighbours and rivals, China and India have the distinction of being the world’s two most populous nations. With between 1.3-1.4 billion people each, they account for 36.5% of humanity. The similarities largely end there. Over the past three decades, China has become more prosperous than India, with an economy five times larger. While India’s 4-8% growth rate has been solid, it lags China’s red-hot pace, which has topped 10% for much of the past few decades.

However, this dynamic has begun to change. Since 2015, India’s economy has begun to pull ahead of China’s (Fig.1).

The drivers of China’s economic miracle, namely: a productivity-enhancing transition from being rural- to urban-based, and the impressive build-up of infrastructure, are past the point of diminishing marginal returns. In addition, the country is awash in debt. China’s total debt (public plus private) has grown to levels comparable to those in Europe and North America, and this portends slower growth. By contrast, India’s rural-urban transition, while well underway, is less advanced than China’s and could boost India’s productivity for many years to come. India’s debt ratios are only half of China’s and have not been growing during the past decade (Figs.2–4). This, too, could set the stage for many years of solid growth in India that could begin to exceed that of China as we move into the 2020s. We note, however, that short-term growth in India could lag China’s as a result of the damage to the economy from Prime Minister Narendra Modi’s withdrawal of high-denomination currency notes in an effort to crack down on the country’s vast shadow economy.

UK Lending Funds in the Post-Brexit Environment

While the Brexit vote might have injected a note of political uncertainty into the future of the United Kingdom, and while the falling pound has raised the spectre of inflation again, many of the fundamental investment stories that support inward investment to the UK remain in place.

Interest in the UK as a market for investment does not seem to have dissipated: speaking purely from the Prestige perspective, we have continued to see enthusiasm for lending strategies focused on the UK in the wake of the Brexit vote, with both website traffic and site visits from foreign investors reflecting an interest in both the uncorrelated nature of lending, and the stability of the value of the assets against which lending is secured (e.g. British farmland).

Foreign clients, if anything, see an opportunity from the weaker British pound to increase their exposure to the UK. While we have seen this in the short term from the rise in the price of UK-listed companies, there is also considerable interest in the long-term prospects for the UK economy and yields to be earned from effectively managed lending strategies. Interestingly, enthusiasm for UK lending strategies from abroad far outstripped domestic demand throughout the Brexit news cycle. But why is this the case?

The UK as a destination for loan finance
The UK has always been regarded as one of the top prospects for foreign direct investment – international money flowing into the property sector is just one indicator of this. Lending funds, which have been expanding their share of the alternative assets market as government bond yields have hit correspondingly negative territory, represent both an uncorrelated source of returns and, in the case of the rural sector, bring the additional attraction of loans often secured against prime UK farmland.

Man FRM Early View

At the end of last month’s piece we concluded with some gnomic optimism about hedge funds’ alpha this year, and as this may have come as a surprise, we thought to pick up where we left off.

In recent years, Central Bank policies have dominated the developed markets. Since the European Central Bank (ECB)’s decision to expand their asset purchase programme two years ago, these policies have been aligned to the point that asset class correlations moved up to levels last seen in the aftermath of the Global Financial Crisis, significantly above the levels that prevailed almost without interruption between 1991 and 2007. As a business, Man cares about CTA performance, and consequently keeps a sharp eye on this correlation, because when it is low, CTAs have historically done better, and some of their worst years coincide with the higher levels. It isn’t hard to see why this relationship persists: low correlation means that volatility-scaled portfolios can run with more exposure because diversification is higher. Well, with synchronised central banks the markets were monothematic, macro opportunity was thin and CTAs did poorly.

Managing Event Risk in 2017

Event risk provided some abrupt market turnarounds in 2016, emanating from political processes such as the Brexit referendum and US elections. This year is shaping up with the potential for even more turbulence from event risk – and not just from politics, but possibly from changing patterns in economic data and even the weather.

Characterising event risk
We like to categorise event risk into three distinct types. First, there are “binary dates,” such as elections, with near-certain potential for a divergent outcome. Second, there are “information dates,” which are typically data releases, and which have the ability to surprise with an unexpectedly extreme data point. Finally, we have “surprise!”, where neither the date nor the event/outcome is anticipated. Surprises can come from political statements, military actions, or natural disasters, as a few examples.

Here, we look at each category and provide some commentary around potential dates to watch in 2017. Then, we will explore a few different approaches to managing event risk, highlighting sophisticated options.

Editor’s Letter - Issue 120

The defining qualities of a “hedge fund” were traditionally held to include: offshore domicile; freedom from regulation; secrecy; restricted investor base; substantial manager co-investment; performance-related fee structures and an unconstrained investment mandate including the ability to hedge. Yet with every passing year most of these attributes, which we touch on in turn, are becoming less unique to hedge funds.

All sorts of funds, including long only ones, use offshore domiciles, and it is onshore-domiciled liquid alternative hedge funds - mainly ’40 Act funds in the US and UCITS in Europe - that have seen fastest asset growth in recent years.

Onshore and offshore jurisdictions alike permit unregulated fund structures, but we seldom see seasoned hedge fund managers using them. Hedge funds are usually regulated, albeit somewhat more lightly in some offshore fund domiciles. Hedge fund managers are nearly always regulated at least as heavily as other asset managers dealing with the same classes of investors.

Regulation is one source of portfolio transparency, along with most audit reports, some administrator reports, exchanges’ reporting requirements, and investors’ due diligence demands.  A black box hedge fund is rare indeed.

Many hedge funds restrict access to variously defined professional/sophisticated/qualified investors, but many hundreds of millions of individuals outside these criteria have indirect exposure via pooled savings such as pension funds, and can invest directly through liquid alternatives.

US mutual fund managers’ holdings of their own funds have been disclosed since 2005. This has revealed that significant proportions of them are “eating their own cooking”, but clearly not to the same degree as hedge fund managers, some of whom have returned external capital altogether and become family offices.

Outsourcing Trading

Being an asset manager in today’s market can be a bruising experience. Margins are shrinking and fees are under pressure, while operating costs have grown out of proportion. This is happening in tandem with unpredictable markets, making alpha creation for clients exceptionally difficult. Cost-saving opportunities have to be identified wherever possible in a way that does not compromise the integrity and success of the business. Linear Outsourced Trading has sponsored this paper to look at some of the trends which are pushing asset managers towards outsourcing their trading desks to third parties.

The cost burden
It is no secret that active asset management returns have not been in line with investor expectations. In a forceful indictment, the UK Financial Conduct Authority (FCA)’s Asset Management Market Study Interim Report stated that active asset managers routinely underperformed their benchmarks after fees. It also questioned why the industry’s fees had not fallen as competition proliferated, something which has occurred in the passive fund sector, where there has been a race to the bottom on investor charges. All of this has contributed to the enormous growth in lower-margin passive products, which, despite a fivefold increase in the UK since 2005, are still expected to gain market share.


Subscribe to Commentary