HedgeNews Africa sits down with Meredith Jones, a director of prime services, capital solutions, at Barclays Capital, on a recent trip to South Africa. Based in New York, Jones has also worked previously at analytics company PerTrac and as director of research at a fund of hedge funds, and has a broad knowledge of investor appetites and trends in the global hedge fund industry. Barclays offers prime brokerage to hedge funds in the African markets via Absa Capital Prime Services, part of subsidiary, the Absa Group.
HNA: You recently held the BarCap Marquee Investor event in New York. What is investor appetite like at the moment?
MJ: Investors have started to come off the sidelines. There is still a tremendous amount of cash out there. In 2008 some investors were more worried about Madoff than about the market dislocation. That had a tremendous impact on hedge fund investing in the last two years.
We now see more people looking to make allocations than redemptions.
HNA: Is there increased interest from global hedge fund allocators in the African markets?
MJ: There’s growing interest for emerging markets in general and Africa specifically. We polled 200 investors in our recent BarCap Strategic Consulting Investor Survey and found that in 2011, 16% are looking to allocate to emerging markets and only 5% are looking to redeem.
HNA: Why is the region of interest, and should hedge fund managers in this part of the world be encouraged?
MJ: The numbers don’t lie and historically speaking, the performance is there. Our statistics show that Africa-based hedge funds delivered a compound rate of return of 10.81% annualised for the five years ending September 2010, while Africa-investing hedge funds have gained 4.31%. That compares with the S&P 500 at 0.64% for the period, the MSCI World at 1.85% and HFN emerging market hedge funds index at 8.13%. And Africa-based funds have produced these performance numbers with better Sharpe and Sortino ratios than the indices.
The changing demographics, growing populations and GDP projections in Africa help to make the case. Obviously there is this competing idea that there may be an emerging market bubble. But there are always bubbles. Hedge funds should mitigate losses on the downside, they should protect capital and many have actually done that.
HNA: Do you expect to see more hedge funds launching that are focused on this part of the world?
MJ: There are a large number of global emerging market managers that focus on Asia, the Middle East and Latin America – and there are those who focus wherever there is opportunity. A lot are looking at establishing their Africa capability in the next five years. But there is a distinction when it comes to being based in Africa – our information suggests that managers who are based here will do better than those that simply invest in Africa but are based elsewhere.
Assuming the market doesn’t derail, we expect to see a lot of talent coming off the sidelines, it will be a more conducive atmosphere – a cycle of available capital and talent coalescing nicely in the hedge fund market place in the next 12-18 months.
HNA: The industry has been through a particularly difficult time. Are there signs that is now coming to an end?
MJ: It has been a very difficult environment for everyone. Even the guys that have performed well have had a difficult time – those that did well in 2008 were treated like ATMs for example. In a way many funds were punished for doing well while those with middle-of-the-road or even poor performance not as much.
The industry has also had difficulties to overcome from a reputational point of view. It has been a difficult situation with no inflows and performance under pressure, amid regulatory uncertainty globally. Despite that, for the first time at our BarCap conference in New York in October there was a much more positive mood amongst managers and investors.
A lot of what has been happening in the industry is psychological – we have had to deal with a difficult market, regulation, as well as general anger and resentment post the 2008 crash. Investors have been more hesitant to get back in the game.
HNA: Does the hedge fund industry deserve the bad reputation it has been battling against?
MJ: In 2008 the average hedge fund lost about 14% to 20%, depending on which index you look at, compare that with equity markets down 40-50% and that’s positive. To make up a 50% drop you need to return over 100%, whereas hedge funds have needed to make much smaller incremental gains to gain ground back. There is a realisation that hedge funds are not magical, not perfect. And there is a lot to be said about coming back from a much smaller deficit.
HNA: There is an ongoing concern in emerging and frontier markets, notably Asia and Africa, about attracting hot money flows – where investors can leave as fast as they arrive. Is that a risk for the hedge fund industry with the current global focus on emerging markets?
MJ: The problem with hot money is that it takes up incredible resources. The manager ends up managing for redemptions rather than managing a fund to generate the best returns. But I would be surprised to see a lot of hot money coming to Africa – rather, we expect a more sophisticated institutional investor and strategy-specific fund of funds that have to differentiate themselves. The amount of due diligence, perceived risk and travel involved make it impractical to place a large amount of hot money in Africa funds. There could also be inflows from emerging market funds of funds, especially since many investors don’t always have the resources to make diversified single-manager allocations.
HNA: What advice can you offer funds in this part of the world that are looking to attract international investors?
MJ: You need a competitive edge to be attractive to the right investors. Many investors don’t have sufficient resources to make direct investments – it’s almost impossible for them. The average investor is taking six to eight months to do their due diligence – it is not a small process, you need ample resources.
My advice to managers is to get the biggest leverage out of what they do – do as much as you can with what you have. Be strategic about which events you go to. It is not a quick or cheap trip to Europe or the US. Look at putting white papers out into the market, conduct webinars to save yourself and investors travel time and money. Make sure you are in the right databases, as opposed to being on a plane all the time. The initial stages of the due diligence work can be done for free, investors don’t have to be on site. Pick the low-hanging fruit and worry about the rest later. Education can be done long distance.
Managers should also be doing due diligence on themselves. There are free resources out there in the market – download the AIMA due diligence and do it on yourself, fill in the gaps, don’t wait for investors to tell you. Do reference and operations checks. Make sure you are ready for when the money comes, or you have waited for nothing.
HNA: Hedge fund managers in South Africa can run sophisticated hedge fund strategies due to the deep and liquid markets, but those operating in the rest of Africa have limited hedging tools at their disposal. Is this a problem for investors?
MJ: Downside protection is important for investors, whether that means traditional hedging or not. It could be stop losses and other types of active management. Managers need to demonstrate the ability to mitigate losses, they don’t have to be straight long and short.
HNA: Size has long been an issue for investors looking to allocate to this part of the world, as many funds here are small on a global scale. How can smaller managers position for growth?
MJ: All managers go through a cycle. The key for managers is to have a plan for a soft close and a hard close and to stick to it. You need to know where to add additional staff so that the investment minds can spend the time needed in managing the fund. You need to be able to articulate that to investors. A lot of strategies don’t have unlimited capacity. It is an industry wide issue – a merger arbitrage manager must state if he sees limited merger arbitrage opportunities for example. Managers have to do a good job planning for growth.
HNA: It has been a trend for investors to allocate to bigger managers in the current climate. Is this still the case?
MJ: We have seen a flight to size, not quality. There are good marquee managers, but the herd mentality is often not the way to go. We are seeing more seeding and early-stage investing – these are all good signs. Around 37% of investors we surveyed invested with managers with less than US$100 million in assets in the past year. And that’s good news for this part of the world as the vast majority of emerging markets hedge funds and African funds are considered small – under US$100 million.
HNA: What about using third-party marketers to raise your profile in other markets?
MJ: Managers need to do extensive and thorough due diligence on the people they choose to do business with. You must realise that marketers will be the face of your fund. If they are too aggressive and don’t back it up with the knowledge, it can sour things for a fund. It is incumbent on managers to do serious referencing.
HNA: UCITS funds have been a strong growth area offshore. What is your view on UCITS funds and other “retail” products for the hedge fund industry?
MJ: I am not a particular fan of UCITS. I see them limiting creativity over time. There are other ways to get liquidity and transparency rather than putting structures in place that limit your hedging and speculation capabilities.
People look at regulation as protection. They see UCITS as a guarantee, but there are no guarantees in investing. There have been a lot of inflows from Europe in to UCITS funds but US investors thus far couldn’t care less.
A fair number of managers don’t want glorified retail money – the US introduced hedged mutual funds back in 1999 and to date there are only about 40 in the country.
Managers who have the time, infrastructure and resources can look for retail and non-retail money. But most have to make a choice – you can’t do everything well. Managing a separate account or a UCITS is not an insubstantial amount of work.
HNA: Africa-based managers have waited a long time for meaningful capital inflows from offshore investors. Some that had offshore capital faced withdrawals in 2008. When can they expect to play a meaningful role in global portfolios?
MJ: It is critical for managers here not to lose patience. The tide is turning, but it doesn’t turn on a dime. It is early in the process and patience is called for. You need to keep posting positive numbers in line with your risk-reward profile.
When I first started in this industry you’d see one or two guys with a Bloomberg in a townhouse. Now you need an organisation behind the person. Compliance and operations are very important post-Madoff. The majority of larger managers have the structures in place. The mid-tier guys with the performance and the track record need to build it out to meet the requirements of due diligence. That can be the ultimate downfall.
HNA: Do you expect a good investment climate for hedge funds?
MJ: We don’t live in a perfect world. Hedge funds were created with the mind that most markets are not always easy. They did well in 2008. It is up to them to reach the next level. If there is a bubble in emerging markets, manage through it. It will separate the wheat from the chaff. There are plenty of medium and long-term opportunities. Copyright. HedgeNews Africa – October 2010.