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www.AlphaQ.world
The rise of the machine in the quest for alpha
INFRASTRUCTUREFocus on transport assets
EQUITY VOLUMEThe ups and downs of trading
REAL ESTATESub-Sahara offers long term returns
PRIVATE DEBTEurope’s emerging
market
CROWDFUNDINGGaining traction
LONG TERM RATE TRENDS
Introducing the Scratchybeards
AlphaQFOR INSTITUTIONAL INVESTORS & ASSET MANAGERSJune 2016
Photo: James Holloway, CIO of Piquant Technologies
www.AlphaQ.world | 2
ED ITOR IAL
AlphaQ June 2016
Managing Editor Beverly Chandler Email: [email protected]
Contributing Editor James Williams Email: [email protected]
Online News Editor Mark Kitchen Email: [email protected]
Deputy Online News Editor Leah Cunningham Email: [email protected]
Graphic Design Siobhan Brownlow Email: [email protected]
Sales Managers Simon Broch Email: [email protected]
Malcolm Dunn Email: [email protected]
Marketing Administrator Marion Fullerton Email: [email protected]
Head of Events Katie Gopal Email: [email protected]
Head of Awards Research Mary Gopalan Email: [email protected]
Chief Operating Officer Oliver Bradley Email: [email protected]
Chairman & Publisher Sunil Gopalan Email: [email protected]
Published by GFM Ltd, Floor One, Liberation Station, St Helier, Jersey JE2 3AS, Channel Islands Tel: +44 (0)1534 719780
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All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the publisher.
Investment Warning The information provided in this publication should not form the sole basis of any investment decision. No investment decision should be made in relation to any of the information provided other than on the advice of a professional financial advisor. Past performance is no guarantee of future results. The value and income derived from investments can go down as well as up.
June’s AlphaQ gives us a cover story on the original robo-
advisers – the systems and algorithms that dictate the trading
in trend following systems. James Williams interviews the key
players in the sector and finds out whether machines can beat the
markets.
Elsewhere in our hunt to bring you new sources of alpha, we
have two types of emerging debt, with Roy Scheepe, Senior Client
Portfolio Manager, Emerging Market Debt, NN IP’s Emerging Market
Debt Hard Currency strategies detailing the sector’s volatile ride,
while Golding Capital Partners’ Oliver Huber discusses Europe’s
‘emerging’ private debt market with James Williams.
More alpha emerges from RMB Westport’s sub-Saharan real estate
fund, while WallachBeth Capital’s Mohit Bajaj writes that short-
selling can be a more effective alternative to using inverse ETFs for
expressing a bearish opinion.
Finally, our regular columnist, Randeep Grewal introduces the
Scratchybeards of Cambridge, soon to have their own reality TV
series once they make it out of Middle Earth. Read Randeep’s
column which brings a whole new perspective to understanding
long term interest rates.
Beverly Chandler
Managing editor, AlphaQ
Email: [email protected]
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www.AlphaQ.world | 3
CONTENTS
AlphaQ June 2016
Companies featured in this issue:• 36SouthCapital
Advisors
• AshburtonInvestments
• Beauhurst
• Deloitte
• GoldingCapitalPartners
• IPES
• InvestEurope
• KFLCapitalManagement,
• ManAHL
• NNInvestmentPartners
• PangolinAsiaFund
• PioneerInvestments
• PiquantTechnologies
• RMBWestport
• Seedrs
• WallachBethCapital
211713
www.AlphaQ.world
The rise of the machine in the quest for alpha
INFRASTRUCTUREFocus on transport assets
EQUITY VOLUMEThe ups and downs of trading
REAL ESTATESub-Sahara offers long term returns
PRIVATE DEBTEurope’s emerging
market
CROWDFUNDINGGaining traction
LONG TERM RATE TRENDS
Introducing the Scratchybeards
AlphaQFOR INSTITUTIONAL INVESTORS & ASSET MANAGERSJune 2016
Photo: James Holloway, CIO of Piquant Technologies
04 News features Thetideisturningforhardcurrency
emergingmarketdebtsaysRoyScheepe,SeniorClientPortfolioManager,EmergingMarketDebt,NNIP’sEmergingMarketDebtHardCurrencystrategies.AshburtonandRMBWestporthaveraisedsignificantfundingforWestport’ssub-SaharanAfricarealestatefund–AlphaQinvestigates,andfinally,InvestEuropeChiefExecutive,DörteHöppner,talksonprivateequityandventurecapitaltrendsemergingacrossEurope.(PicturesScheepe,HoppnerandSimonFifield)
07 Cover story: The rise of the machine JamesWilliamsexaminesmachine
learningandasksdoesithavethepowertopredictalpha?
11 Crowdfunding gains traction BeverlyChandlerinterviewsJeffLynn,
CEOofcrowdfundingplatformSeedrs
13 Keeping it private GoldingCapitalPartners’OliverHuber
discussesEurope’s‘emerging’privatedebtmarketwithJamesWilliams
16 Looking east BeverlyChandlerinterviewsJamesHay,
veteranMalaysianfundmanageronhisPangolinAsiaFundwhichhasenjoyedarollercoasterrideovertheyears
17 Harnessing alpha from transport assets
JamesWilliamsinterviewsDeloitteonitsinfrastructureinvestorsurvey,focussingonreturnsfromtransportassets
20 The long and the short of using ETFs WallachBeth’sMohitBajajwritesonthe
pitfallsoftradinginverseETFs,includinghigh-costandlackofprecision
21 Trading the vol JamesWilliamsreviewsequityvolatility
strategies
24 Introducing the Scratchybeards RandeepGrewal’sregularcolumn
examinestheimportanceofunderstandinglongterminterestratetrends
27 The push and pull of doing business in Europe
JamesWilliamsinterviewsChrisMerry,ChairmanofIPES,ontheregulatorychallengesinEuropefacingUSPEmanagersandtheimpactthiscouldhaveonEuropeaninstitutionalinvestors
www.AlphaQ.world | 4AlphaQ June 2016
ALPHAQ NEWS FEATURE
“It’s a country with a chequered history which
has defaulted in the past and been out of the
international markets for a long time,” Scheepe
explains. “It was very difficult for Argentina to
issue debt but with the new government under
Mr Macri, the launches of various bonds was
a bigger success than most people thought.
Some USD16 billion were issued and the actual
demand was a multiple of that so the positive
momentum that we are experiencing now is
clearly reflected.”
“Argentina has a long way to go but the
yields are undervalued. However, if they take
the right corrective measures it can be more
credible and the bonds can do very well,
although it will likely be a rollercoaster ride.”
Things to look out for which will cause
some of those stomach churning moments
on the rollercoaster include the oil price
and the intentions of the OPEC, the current
developments in the Chinese market and the
intended rate trajectory of the US Federal
Reserve, NN IP says. n
The tide is turning for hard currency
emerging market debt (EMD), says the
USD200 plus billion investment firm NN
Investment Partners. Roy Scheepe, Senior
Client Portfolio Manager, EMD, explains that
the firm has over USD7.5 billion in the sector,
distributed among public funds and tailor-made
mandates for institutional clients.
“One of the current attractions of EMD is
the fact that it offers substantially higher yields
than fixed income bonds of developed markets
which are at an all-time low,” Scheepe says.
“Fixed income investors that would traditionally
buy UK gilts, German bunds and US treasuries
where the low yields are hovering around 0 per
cent and the alternative is EMD.”
Both debt and equity in emerging markets
can be quite volatile, Scheepe points out.
“There is no gain without pain in that sense. In
order to get good results over a longer period
you have to accept that over a shorter period
things can move quite a bit.”
NN IP’s EMD team has seen positive
momentum since mid-January with interest
and reallocation back to emerging markets.
“You have a good combination of allocation
and good returns,” Scheepe says. “It’s supply
and demand.”
Supply is also increasing through new issues
but on balance, there is, Scheepe says, more
demand than supply and it is pushing prices
higher. He also comments that EMD covers a
big range of fixed income asset classes sub-
categorised into hard currency debt, mainly
denominated in US dollars, sovereign or
corporate debt and then also local currency
debt with its added forex risk and returns.
“There are gains and losses to be made in
local currency,” Scheepe says. “Especially in
local bonds which have done very well year
to date, which is quite different from 2015
when these bonds dropped substantially. The
year to date good performance is a rebound
from the disappointing results from last year,”
Scheepe says.
More recent excitement was the May
re-entry of Argentina to the bond markets.
Emerging market debt comes back into fashion
“There is no gain without pain in that sense. In order to get good results over a longer period you have to accept that over a shorter period things can move quite a bit.”Roy Scheepe, EMD
www.AlphaQ.world | 5AlphaQ June 2016
Various divisions of FirstRand Bank have
given rise to the business of RMB Westport,
a sub-Saharan real estate developer, focusing
on Nigeria, Ghana, Angola and the Ivory Coast,
with ambitions to be the best developer and real
estate investor on the African continent.
RMB Westport CEO, Simon Fifield explains
that the firm launched in 2008 as a joint
venture between developer Westport, run by
Michael O’Malley and Dale Ramsden, and the
investment banking division of FirstRand, RMB.
Fifield says: “We have been going since 2008,
with assets under management in our first fund
of USD256 million and now the first close of
Fund II with just under USD250 million.”
Fifield was running the real estate
investment banking business at RMB and
realised that the bank needed to be more
intentional about what it did on the continent
in terms of real estate. “At the time we were
very SA-centric and felt that things had gone
well for us in our own back yard. We wanted
to look at expansion opportunities on the
continent in a more focussed manner than what
we had previously done, ” he says.
Initially, he and his team undertook a lot of
macro-economic research and then followed this
up with in-country visits. “Out of that process,
we came to a few key conclusions: firstly, that
there is a large demand-supply mismatch in real
estate in certain areas on the continent, and
secondly, that this opportunity could best be
capitalised on by developing retail, commercial
and industrial assets to meet such demand.”
With a mandate to play across the capital
structure the next step for RMB was to ascertain
whether its African real estate expansion
should focus on debt, equity or both. “Equity
was preferable as we didn’t think we could
get the right risk-adjusted returns for debt,”
Fifield says. “We wanted to be in the equity
space and, importantly, we believed that key
to unlocking value was the ability to develop
greenfields assets.”
“It was immediately obvious that we required
partners who were appropriately skilled and
experienced in developing on the continent,
and we were very fortunate to find a highly
compatible outfit in Westport, led by Michael
O’Malley and Dale Ramsden,” Fifield says.
The initial seed capital for the business
came from RMB. Hard core development skills
were brought in from Westport, which had
been operating as a successful development
management business out of Nigeria, and whose
principals, O’Malley and Ramsden, had spent
their careers developing real estate in Africa.
The first close for Fund I occurred in 2011
and the final close came in 2012. Subsequent to
this, Ashburton was launched, and, as the third
party fund asset management business within
FirstRand, has, in addition to raising the capital
for the funds, become an institutional partner
to the team.
Fifield reports that currently, there is
pressure from a macro-economic perspective,
but despite this, the track record established in
Fund I to date, and the compelling long term
investment thesis of accessing Africa’s themes
of increasing urbanisation, a burgeoning middle
class and growing consumerism, through a
position as a landlord, has resulted in, what he
calls ‘pleasing’ demand for Fund II.
The target size of Fund II, with an eight
year fund life, and target returns of 20-25
per cent in US dollars after fees and carry, is
USD450 million.
“With gearing of 50-55 per cent at the
project level, Fund II will invest in projects
totalling approximately USD1 billion, which
is very similar to what we built in Fund I,”
says Fifield.
“Furthermore, because our business model
fully integrates investment professionals with
highly competent in-house development
professionals, we are confidently able to manage
all aspects of the development risk associated
with deploying large sums of capital in Africa”
Fifield says. n
ALPHAQ NEWS FEATURE
Finding returns in sub-Saharan real estate
“We wanted to be in the equity space and, importantly, we believed that key to unlocking value was the ability to develop greenfields assets.”Simon Fifield, RMB Westport
www.AlphaQ.world | 6AlphaQ June 2016
ALPHAQ NEWS FEATURE
The recent Invest Europe 2015 European
Private Equity Activity report found that
private equity investment into European
companies increased by 14 per cent to EUR47.4
billion in 2015, along with high fundraising and
exit activity.
Dörte Höppner, Chief Executive of Invest
Europe, the trade association for GPs and LPs,
explains that strong supply and demand is
supporting this growth pattern. “As in every
market, supply and demand is what is creating
the growth,” Höppner says. “Both are high.
Private equity is an alternative asset class and
as such characterised by generating stable and
high returns over the longer term.”
According to the data, almost 5,000 companies
across Europe benefited from private equity
and venture capital investment last year. Of
these, 86 per cent were small and medium-sized
enterprises (SMEs) and nearly half of the total
attracted private equity funding for the first time.
“Demand size is driven by issues that
all companies face,” she says. But small
to medium-sized enterprises have had a
particularly tough time since the global
financial crisis.
“They can go to a bank,” Höppner says, “but
post the global financial crisis, many have the
experience that some banks have to turn them
down or it becomes much more expensive to
get debt financing. A number of them are more
interested in alternative ways of funding and
looking into private equity.”
The figures don’t reveal a huge jump in
European private equity investments, but
as Höppner says, it is not suitable for every
company. “Each side needs to evaluate each
other very carefully before each makes its
decision,” she says. Höppner also believes that
over a decade of a low yield environment has
driven institutional investors to asset classes
that generate higher returns than others.
For institutional investors, private equity offers
higher returns, but not, Höppner says, higher
risk. “If you speak to the investors, those who
have invested for a long time in private equity,
they say the risk is not there at all, because they
diversify across different managers and regions.
“One thing that could be perceived as a
disadvantage is that it is a long term asset class,
so maybe it’s more illiquid than other asset
classes. However, there is a secondary market so
the asset class is not illiquid. Private equity is not
about speculation. It’s a long term investment to
invest in companies in the real economy.”
A couple of years ago saw the association
adding infrastructure funds to their membership
and a new trend they are seeing now is Fintech.
“Many of our members are talking about
Fintech with interest and many of them have
invested in this sector. We will see how it will
evolve over time, but it’s not going away any
time soon,” Höppner says.
For her, private equity is all about people.
“When you are identifying investment
opportunities, it is important to have the right
contacts and know the industry sector and then
once you are invested then you need to take it
to the next level by being an active owner – it’s
beyond just putting in capital,” she says.
Invest Europe, a non-profit organisation, is
based in Brussels and seeks to represent the
industry at a new level to monitor what the
EU institutions and policymakers are planning
in terms of regulatory developments. The
association also has professional and ethical
standards for the industry and gathers data on
the European venture capital and private equity
industry, most recently the 2015 European
Private Equity Activity report.
Höppner says: “Going forward we are
increasing our data activities and so in the future
we will be issuing performance and economic
impact data to benchmark the performance our
industry delivers and what effect we have on the
economy. We want to show how the companies
our members have invested in are contributing
to the European economy.” n
Invest Europe sees private equity increase
Dörte Höppner, Chief Executive of Invest Europe
www.AlphaQ.world | 7AlphaQ June 2016
The rise of machine learning
strategies has gained momentum
in the last couple of years,
leading some in the funds industry to
postulate that predictive analytics will
define the best managers going forward,
rather than size of assets under
management.
Of course, strategies such as
systematic CTAs have long been using
machines to assist in trading and
determine entry and exit points in the
markets without human intervention.
But the difference today is that
systems are now learning as they
trade. Whereas an average quantitative
fund might run a bunch of back-tests
once a month to see how the model
is performing and determine whether
any changes need to be made, the next
generation of machine learning engines
are capable of learning as they trade.
One of the industry’s more well-
established fund managers, Man AHL,
announced last month that the Oxford-
Man Institute (OMI), the academic
institute for research into quantitative
finance, would be expanding its focus
on machine learning. Man AHL,
together with the University of Oxford,
intends on making OMI a hub for
machine learning and data analysis by
enhancing its research team with the
Department of Engineering Science’s
Machine Learning Group, a body of
around 20 leading machine learning
researchers.
The idea is to facilitate the cross-
pollination of ideas according to Dr
ART IF IC IAL INTELL IGENCE
The rise of the machine
JamesWilliamsfindsouthowmachinelearningstrategiesareusingpricingpatternstodrivereturns.
www.AlphaQ.world | 8AlphaQ June 2016
ART IF IC IAL INTELL IGENCE
Management, a Canadian boutique CTA, when
talking about the firm’s approach to machine
learning. “We look back through 14 years of
historical data in the very same way that we
did the first day we launched the strategy at
the end of 2013. Our predictive models, which
collectively are referred to as ‘Krystal’, will,
broadly speaking, see similar patterns today
as they did yesterday. However, by doing this
every day, over time some patterns drop out,
some become more prominent and that’s how
Krystal learns to trade and predict which way
the markets will move.”
The science of prediction is moving forward,
computational power is moving forward, and
the quality and volume of data is moving
forward. “You can crunch through enormous
amounts of data today and find very subtle
patterns that are tradable,” adds Sanderson.
James Holloway is CIO of Piquant
Technologies – a multi-strategy quant fund
based in London. Piquant Technologies’ Pegasus
Fund launched in 2013 and has delivered stable
and diversifying returns annualising at just over
10 per cent. Last year, Piquant’s assets grew
fourfold on the back of a successful 2014, which
saw Pegasus return 19.87 per cent.
“We try to get data from a wide range of
sources,” says Holloway. “We’ve built everything
internally so that we can effectively monitor
and process all of that data. We are not
economists. Indeed, many of us are trained
in the sciences. This means that we view data
as being literally that; empirical observations
from which we try to extract some kind of
information, rather than using data to try and
support a pre-existing model. We let the data
build its own model and our systems then adapt
to it accordingly.”
Machine learning and artificial intelligence
are ultimately the same thing. Intelligence, says
Holloway, can be defined to some extent as:
“Being conscious of your environment, being
able to observe it, take those observations,
process them and come to decisions about how
you want to act.”
Once a decision has been made, how does
it affect you within your environment? Is the
outcome good or bad? As humans move from
childhood to adulthood, their decision-making
skills improve as their life experience expands.
However, human ‘intelligence’ varies from
person to person, even though we all have the
same senses: eyes, ears, etc.
Anthony Ledford, Man AHL’s Chief Scientist,
who was quoted as saying: “Man AHL has
been actively researching machine learning
techniques and applying them in client trading
programs for several years. Our partnership
with the OMI directly connects us with cutting-
edge quantitative finance research and the
opportunity to collaborate with world-leading
academics in the field.”
Sandy Rattray, CEO of Man AHL, adds: “At
Man AHL, we have been investing in machine
learning research for many years as we see
great potential to actively enhance our business
and deliver value to clients. We believe that the
enhanced focus of the OMI on machine learning
and data analytics will be strongly supportive
to the ongoing evolution of quantitative
investment strategies. In particular, the growth
of new techniques as well as new forms of data
clearly provides an enormous opportunity set in
coming years.”
“We retrain our predictive models every
day,” says Dave Sanderson, CEO of KFL Capital
“You can crunch through enormous amounts of data today and find very subtle patterns that are tradable.”Dave Sanderson, KFL Capital Management
www.AlphaQ.world | 9AlphaQ June 2016
ART IF IC IAL INTELL IGENCE
that background noise. Collectively, the noise
would cancel out and the weak signal would
become sharper.
“We run multiple strategies that the model
observes across multiple markets, constantly
learning and determining which strategies to
act on. But in order to learn, the creator has to
imbue the system with values. Just as humans
learn based on the values of parents, teachers,
one needs to set a framework for the system
to operate within. It needs to know ‘There be
dragons’ in certain market conditions so as not
to make a bad decision.
“Sticking within the value framework
facilitates the model’s learning about what the
current environment is doing, and helps us
adapt to changes. For example, current market
conditions may be illiquid and expensive to
trade… what does that actually mean? The
With the Pegasus Fund, its senses are the
different trading strategies that it employs. The
‘intelligence’ component relates to how the
engine takes information from the environment
and processes it i.e. how it observes data.
The majority of information is useless.
Human brains absorb a huge amount of
information, but act on very little. We filter out
a lot of noise. This is possible because over time
our brains learn how to filter out what is of use,
and what is not.
Apply that to a mathematical model, using
its senses to observe data, filter out the noise
and when to act on data to make decisions, and
that is what is meant by artificial intelligence.
As the model makes decisions it learns through
experience.
“The more observations you have on
something the more it reinforces the strength
of a signal. But interestingly, above a certain
threshold, the stronger a signal becomes,
the less information it conveys to us about
the future.
“Statistically, something carries more
information when it is a rarer event, and for
us that makes it a weaker case for investment.
A machine can observe so many signals that
some will always be classified as ‘rare’. We then
have the interesting job of discerning which
rare signals are potentially very meaningful
and which are not: because if they are they
can be highly lucrative. Strong signals that
are frequently observed, are going to be less
profitable because there will be other people
trading them too, but combine enough of
the weaker signals together and the situation
becomes much more advantageous.
“The engine at the core of our strategy
absorbs hundreds of thousands of market
statistics every day, allowing the portfolio
to adapt to changing market conditions.
The engine understands how to use this
information and make predictions about
direction, risks, costs, and liquidity,” explains
Piquant’s Holloway.
One could think of Piquant’s model as
operating like an old fashioned radio, scanning
the airwaves. Every now and then it hears a
whisper of noise through the static – a weak
signal. Taken on its own, it is hard for the
model to know whether the signal is meaningful
or not.
But imagine if you had 1000 different radios,
tuning in to the same frequency, all listening to
Intelligence can be defined as: “Being conscious of your environment, being able to observe it, take those observations, process them and come to decisions about how you want to act.”James Holloway, Piquant Technologies
www.AlphaQ.world | 10AlphaQ June 2016
ART IF IC IAL INTELL IGENCE
of reference is very small. That’s why young
people don’t get to vote!
“What our engine tries to do is accumulate a
vast amount of experience by observing lots of
different market environments using data that
goes back to 1970. That’s nearly five decades
of different economic conditions to learn from.
Our engine genuinely learns. We have gone to
great lengths to remove human bias as much
as possible. We aren’t just showing investors a
bunch of back-tests that prove the strategy’s
validity. We don’t data mine,” says Holloway.
At KFL Capital Management, Sanderson
confirms that in addition to the algorithmic
decisions Krystal is making when it finds a
signal, as many as 100 decisions are made
to determine which markets to trade, which
variables to look at, which data to give the
algorithm and which trade management
techniques to employ.
With all those parameters chosen, Krystal
then scans the futures markets to find the
patterns in the noise. It does this every day,
leveraging the experience it has built since
inception using historical data to ‘learn’ to make
predictive trades. Such is the complexity of the
decision-making process that in Sanderson’s
view “it would be hard, in my opinion, for
quants to suffer from the sort of crowded trades
that discretionary fund managers face, given
that there are so many decisions it makes as
it learns.”
This is far from an easy exercise. Machine
learning strategies will tend to be quite volatile,
making substantial gains one year and losses
the next, giving investors a rollercoaster
experience. Reflecting on periods when Krystal
loses its ‘mojo’ as it were, as was the case in
2015, Sanderson says: “Does that mean Krystal
doesn’t work? That we don’t have the statistical
power we thought we had? The only logical
answer to that is unless you do something in
live trading that’s worse than your entire back-
tested period, there’s no reason to think that
it doesn’t work. There’s nothing in our current
performance that we don’t have what we think
we have, but it’s very hard to convince investors
of this; it’s hard for them to take a long-term
view on things.”
Machine learning strategies are a product of
their time; a sign of the enormous processing
power of computers.
“This has become the cutting edge of
investing in our view,” concludes Holloway. n
more it observes and makes decisions, the more
it learns,” comments Holloway.
At KFL Capital, Krystal was created by Dr
Gary Li. Prior to KFL, Li was a co-founder and
CTO of Pattern Intelligence Inc, a company
specialising in machine learning for the oil
sands industry.
Krystal looks only at price data, as does
the engine at Piquant Technologies, and using
a dozen different algorithms a prediction is
made on each market twice a day. At each
new prediction point, the current position is
replaced with the new position. Predictions are
made on each market throughout the day. At
each new prediction point, the current position
is replaced with the new position.
“If you look at all the statistical models,
the majority of them do not work. We looked
at all the most interesting models that have
ever been created and we tried them all but
none of them could crack the financial data set
and this is why: the relationships in financial
data constantly change. The relationships in
Thermodynamics do not change.
“Also, when patterns get strong enough they
get arbitraged away and disappear.
“Gary thought he could overcome the
challenge by looking at the data differently
to find repeatable patterns. We don’t look for
strong patterns but very subtle patterns, and
we are confident that these patterns will repeat
themselves a slight majority of the time. We
have a 99 per cent confidence that a pattern
will repeat itself 55 out of 100 times.
“We live trade over a period of time and
then back-test it. We want to see 100 per cent
symmetry between the back-tested trades and
the live trades as a way to prove the validity of
the strategy,” outlines Sanderson.
Where machine learning or predictive
modelling becomes particularly intriguing is
how a complex set of algorithms and thousands
of lines of code actually knows when to make a
decision or not.
To help explain this, Holloway relates it
back to real life. How do we human beings
make decisions? Really there are three ways:
flip a coin, conform to a set of established
rules, or make decisions based on personal
experience.
“Experience is preferable to the first two
options. The problem, however, comes when
your experience is limited; you are more likely
to make bad decisions because your frame
www.AlphaQ.world | 11AlphaQ June 2016
The first quarter report for 2016 from
specialist fast growth company data
provider, Beauhurst, on the UK’s high
growth companies and investors found that,
while deals in general are down, crowdfunding
platforms, with their high visibility and
disruptive impact, show no sign of letting
up, topping investor rankings for the most
individual deals.
According to Beauhurst, crowdfunding
platform, Seedrs, was the most active investor
in the first quarter of 2016 with 37 fund
raisings.
The firm was founded in 2009 by two MBA
graduates of Oxford’s Said Business School, Jeff
Lynn, CEO and his co-founder Carlos Silva.
“We saw, and continue to see, a big market
failure in early stage capital markets if you
look at how businesses of all sorts from super
high growth technology companies to retail
consumer companies raise their initial equity
capital,” Lynn explains.
“The existing world is opaque and scattered
and we saw an opportunity to make it
transparent and more efficient, and give access
to this asset class to a wider range of investors.”
The problem facing early stage investors is
that building a portfolio in the space takes a
lot of time and a lot of money. Lynn says that
a platform like Seedrs solves that issue by
allowing investors to invest as little or as much
as they like (from GBP10) and by handling all
of the legal and administrative work.
The pair set up their venture in 2009, when
the global financial crisis’s impact was just
being appreciated.
“The timing was interesting,” Lynn says.
“But, peculiarly, it had less of an impact than it
might have done as we were in this early phase
of digital revolution which led to more and more
people starting their own businesses. There was
a generational shift as people wanted to create
value for themselves as entrepreneurs, and we
were just jumping in at an early stage. In many
CROWDFUNDING
Crowdfunding gains support
BeverlyChandlerinterviewsJeffLynn,CEOofSeedrs,theUK’smostactivecrowdfunder.
www.AlphaQ.world | 12AlphaQ June 2016
CROWDFUNDING
which is variable at about 4-5 per cent, and
investors pay a carry on successful exits – once
the investor has his or her capital back, there is
a 7.5 per cent carry on any profit the investor
make from the investment.
The Beauhurst report shows that funding is
down significantly in the high growth company
sector in the opening quarter of 2016, but
crowdfunding is holding up a little better.
“We offer a more efficient and effective way
to raise investment capital than other methods
and so we are growing in terms of market share
as more investors and businesses are coming
to us – we are less cyclical and correlated to
broader market trends.”
Landbay P2P lending has been one of the
successful businesses that have used Seedrs. It
is the fastest growing P2P lending platform and
has a partnership with Zoopla. Seedrs has raised
some GBP2-3 million for them. Another highlight
is the firm which makes a healthier alternative to
ice cream, Oppo, to be found in a freezer cabinet
near you, which has also received its funding
through the Seedrs platform.
“Because part of our platform involves
getting a wide base of investors from a number
of different backgrounds it works for broadly
understood businesses,” Lynn says. “So true
biotech tends not to be for us, nor complex
enterprise software.”
Asked how scalable crowdfunding can be,
Lynn argues that there is no harm in starting
relatively small. “If you have many billions we
are a small channel, but if institutions want
to get exposure there is plenty of opportunity.
We want to talk to anyone who is interested as
there are a number of types of campaigns we
can do with the capital behind us. We often see
later stage deals which won’t work as well, but if
we had lead investors or underwriting in place,
it becomes easier. In a year or two we should
be big enough by deal volume as a platform for
larger institutions to come in.” n
ways, the global financial crisis made customers
and the press more receptive to alternative
finance models than they might have been.”
In terms of how the Seedrs business has
grown, the firm measures it on the basis of how
much has been invested through the platform
and that figure stands at roughly GBP125 million.
“In the context of broader capital markets,
it’s a drop in the ocean,” Lynn says. “But if you
look at early stage equity generally, you are
looking at a market where historically there has
been GBP1-2 billion invested in the UK in start-
up companies per year on average, so we are
doing 5-7 per cent of that at the moment.”
And the firm is enjoying stellar growth of
300 per cent a year. “We are a financial services
company, a technology company, and backed by
venture capital, and we are ambitious to expand
the market share and to grow the overall size of
the market,” Lynn explains.
Seedrs funds through full range equities only,
no working capital debt, and has a wide range of
types of industries on its platform, from a super
high growth technology company to things like
restaurants, retail services and businesses.
“It’s a high risk asset class, but for those
which work the returns can be substantial.
The rule of thumb is that 80 per cent of early
stage businesses will fail, but so far only 10 per
cent of businesses who have raised through us
have failed,” Lynn says. “Give it time though;
the failure rate will be significantly higher. One
of the peculiar things about this asset class
is the way you get big winners is if you have
highly ambitious entrepreneurs and businesses
and if you are not failing you are not taking
enough risk. We are a lot less interested in
the percentage of businesses that fail than the
magnitude of our successes.”
Lynn explains that, as a broad generalisation
about this asset class, eight in ten businesses will
fail to return capital, one in ten will do just about
alright, while one in ten will be a big winner.
“If you have a big portfolio you should
be able to see an overall portfolio return in
excess of other classes,” Lynn says. “This is an
appealing asset class from a returns basis.”
“Crowdfunding is an opportunity for
investors who are looking for meaningful growth
in whatever their portfolio is to get diversified
and inexpensive exposure to an outstanding
asset class.”
Fees on the platform are a commission from
the companies that raise money from Seedrs,
In many ways, the global financial crisis made customers and the press more receptive to alternative finance models than they might have been.”Jeff Lynn, Seedrs
www.AlphaQ.world | 13AlphaQ June 2016
Back in April this year, Golding Capital
Partners (GCP), one of Europe’s
leading independent asset managers for
private equity, private debt and infrastructure
with nearly EUR5 billion in assets under
management, was awarded its latest private
debt mandate.
The EUR100 million mandate came from
TÜV SÜD Pension Trust to assemble and
manage a portfolio of private debt investments
in a dedicated managed account.
With EUR2 billion of capital commitments,
GCP is at the vanguard of investing in the
private debt asset class, with 50 per cent of its
investments targeting the mature US market, and
roughly the other 50 per cent targeting Europe.
Mainstream credit strategies such as senior
secured loans and mezzanine loans, unitranche
loans (which combine senior debt and
subordinated debt), as well as distressed debt,
are the primary focus of GCP’s investment team.
Oliver Huber is Managing Director and Head
of Private Debt at Golding Capital Partners.
Since 2003, the firm has created six private
debt fund-of-fund portfolios and has witnessed
first-hand the speed of evolution of the private
debt market in Europe.
“The US market is a much deeper and bigger
market, it is more developed and has been used
by institutional investors for the past 20 or 25
years,” he says. “That’s why all of our fund-
of-funds and managed accounts are targeting
around a 50 per cent allocation to the US. That
said, we always advise our clients to diversify.
Europe’s private debt market has evolved since
the financial crisis when banks started facing
problems. More recently, Basel 3 regulation has
made it more difficult for them to invest large
amounts in leveraged loans or leveraged credit.
“They have tighter liquidity and risk capital
requirements and the void has been filled by
private debt funds.”
PR IVATE DEBT
Keeping it privateGoldingCapitalPartners’OliverHuberdiscussesEurope’s‘emerging’
privatedebtmarketwithJamesWilliams.
www.AlphaQ.world | 14AlphaQ June 2016
PR IVATE DEBT
“We go to the conferences and we cover the
US private debt market extensively to find the
best mid-market managers. We have an existing
network of managers who come back into the
market every three years, on average. There are
managers we’ve allocated to who performed well
through the crisis and we know how they behave
during a market downturn,” states Huber.
Herein lies the rub when it comes to Europe.
A large number of private debt managers have
only been operating post-crisis and have no track
record of navigating through a downturn. In
other words, the loans they issue to companies
and PE groups have not been stress-tested and
that makes sourcing talent more challenging.
“We invest 50 per cent of our capital in
Europe so we have to be absolutely confident
in management teams who don’t necessarily
have the track record of those in the US. Every
week there are new managers coming to market
but we have to be sure that we are putting the
right chips on the table. You don’t want to make
mistakes when selecting managers who might
only have a two or three year track record.
“We always think to ourselves, ‘What would
that portfolio management team do if they were
faced with another crisis like 2008? Would they
be capable of taking the keys and restructuring
companies and manage the portfolio through a
downturn?’” explains Huber.
Between 2003 and 2007, when GCP first
started raising capital from clients it was largely
a bank market with a small number of funds
The private debt market in Europe has grown
from a few years ago when there were maybe
30 fund managers in the market to now, where
there are probably 70 to 80 fund managers.
Huber estimates that 80 per cent of private
debt is used in mid-market private equity
finance transactions while the other 20 per
cent is used to finance run-of-the mill corporate
transactions, such as companies turning to
non-bank financing to raise capital for R&D
purposes, expansion purposes and so on.
There has been an incredible rise in demand
among institutional investors to access this
market. According to Preqin, as of March 2016
there was USD186.5 billion in dry powder among
private debt fund managers. Some USD18.5
billion in capital was raised by Europe-focused
direct lending funds in 2015 and in 2016, 46 per
cent of investors surveyed by Preqin said they
planned to increase their private debt allocations.
The trick, however, is knowing how to find
the best managers. Since 2003, GCP has built
an extensive network of managers in the US
and Europe. Its EUR2 billion of aggregate assets
invests in a total of 70 primary funds.
“Europe has been somewhat of an emerging
market over the last five years but at the
same time institutional demand for alternative
sources of yield has been driving growth on the
capital allocation side. With a low interest rate
environment and alternatives getting slimmer
and slimmer, pension funds and insurance
companies have looked at the private debt asset
class more intently. Some see it as a part of
their alternative allocation bucket, but some
also see it as an addition to their fixed income
bucket to get a current yield component with
senior debt risk,” says Huber.
He adds: “We have access to approximately
70 primary funds, but we also have access
to the secondary market where we buy fund
stakes at discount from other LPs; this is an
even harder market for investors to try and
access, especially in the US market. In Europe,
some of our more active clients could possibly
invest in primary funds by meeting managers
and building their own network and monitoring
funds etc, but this is not easy.”
Many of the US managers in GCP’s network
do not come to Europe to raise capital. They
don’t need to. They are quite happy to raise
money in the domestic US market. The fact
that GCP gives investors access to these hard to
reach managers is a clear value proposition.
“It’s a growing segment and where most of the action is in Europe at the moment.”
Oliver Huber, Golding Capital Partners
www.AlphaQ.world | 15AlphaQ June 2016
PR IVATE DEBT
our fund-of-funds and our managed account
mandates; I’d say there’s probably a 90 per cent
overlap,” adds Huber.
Working with experienced investment teams
is necessary for investors who might be looking
at the private debt space for the first time. As
mentioned earlier, the European market has
flourished in a relatively benign post-crisis
environment where few funds have hit the skids
and suffered loan defaults. But as Huber rightly
observes, those conditions will not last forever.
“We have to be confident that European
managers have the skills not just to source
the right deals but demonstrate an ability to
manage the portfolio during a crisis. Do they
have the right team to roll up their sleeves
and do what they need to when the market
turns? That is what we remain mindful of when
investing in the European market,” he says.
When it comes to selecting funds, Golding
Capital Partners take a bottom-up approach
where the quality of the management team
takes precedent over the asset class. The main
criteria is not whether they should be investing
in mezzanine loans, senior loans, unitranche
loans but that aside, it’s worth noting that the
unitranche market is particularly vibrant at
present, with Huber confirming that this is
where a large number of private equity funds
have been going to finance buyout deals.
“It’s a growing segment and where most of
the action is in Europe at the moment. We need
to be there because that’s where a large part of
the private debt deal volume is. Nevertheless,
we’ve just re-invested with a small-cap
mezzanine fund in France. This is illustrative of
the bottom-up approach we take to identifying
the best managers. Even though it’s hard to
overlook unitranche loans when building
investments in Europe, we always advise our
clients to look at the whole spectrum to build a
balanced portfolio,” says Huber.
Looking ahead, the private debt market
would appear to show no signs of slowing down.
Managers are raising significant assets and,
more importantly, putting those assets to work
to support private equity activity. However,
Huber concludes with a cautionary message:
“If the private equity market slows down
because of a recession or market decline it will
affect private debt growth. This is a cyclical
market, which people tend to forget. But there
is still a long-term structural trend for further
growth in this asset class in our view.” n
complimenting bank transactions. These funds
invested in mezzanine loans that filled the gap
between the equity and the bank debt.
The first two fund-of-funds it launched
were, as a result, primarily invested in US and
European mid-market mezzanine funds.
When the market changed post-crisis, and
the dust settled as the private debt market
re-emerged, GCP had built a well-developed
network and track record within mezzanine
funds but quickly evolved.
“We were first movers into unitranche loans
and senior loans. This is the main direction the
market has taken since the crisis. We now have
six private debt fund-of-funds and a number
of segregated managed accounts. The market
is still only 13 years old and there are a lot of
new allocators in this space; but very few can
claim to have the length of experience we have
garnered,” opines Huber.
With respect to the TÜV SÜD Pension
Trust mandate, GCP has already made two
investments in the senior loan and mezzanine
market segment and the plan is to make further
investments to three more debt funds.
For those investors wishing to allocate
with GCP, there are plans later this summer
to launch its seventh fund-of-fund product. It
started fund raising for its sixth fund-of-funds in
2014 and closed it at the end of 2015.
“Our funds are typically open for one
and a half to three years. At the same time,
when we do our first closing, typically at the
EUR100-120 million level, we make our first
capital commitments and then we scale it up
accordingly. By the end of 2015, our sixth fund
completed its final closing with EUR413 million
and we’ve been making investments over the
last two years,” confirms Huber.
If an investor is willing to make a large enough
allocation of EUR50 million or more, and has a
view on how they would like to invest in private
debt (eg European senior secured loans), GCP
will set up a managed account akin to TÜV SÜD.
This allows the investor to drive the strategy
by deciding on what funds they want, and don’t
want, in the portfolio. With every other investor
who goes down this road, GCP discusses every
fund investment to help the investor arrive at
the most appropriate decision.
“They can decide what strategies they
like, what fund managers they like, and have
a discretionary view on what goes into the
portfolio. Typically we invest in parallel between
www.AlphaQ.world | 16AlphaQ June 2016
ASEAN MARKET
At assets under management of
USD77 million, the Pangolin
Asia Fund punches above its
weight, having survived a somewhat
rollercoaster ride through the ASEAN
markets since 2004.
The fund has enjoyed good up years
and limited down years, particularly
given the markets in which it invests,
and this year is looking stellar with
a return of 10.54 per cent to the end
of April.
James Hay, the fund’s founder
and manager, explains that emerging
markets haven’t been the flavour of
the month over recent years, hit by
collapsing commodity prices, and the
impact on tourism of the lost plane
MH370. There have been record net
capital outflows from emerging markets
since 1988.
“We are in a depressed time in
emerging markets in our part of the
world,” he says, but predicts growth
this year in Indonesia and Malaysia of
about 4 per cent.
“Which is excellent,” he says,
“Because it means that the there is a
resilience within ASEAN.”
The news is not all bad, Hay
says, citing the 670 million people
in the ASEAN markets, all potential
consumers. “They all want a house,
two cars and high cholesterol just like
the rest of us,” Hay says. “People’s
lifestyles are changing as people
are moving from the paddy fields to
the factories.”
His fund focuses on consumers
within the area and avoids palm
oil and timber for ethical reasons
and other commodities due to
their unpredictability. The fund is
currently invested 15 per cent in
Singapore, 31 per cent in Malaysia, 32
per cent Indonesia and 22 per cent in
Thailand.
“We try to find real businesses
with net cash on their balance sheets,
trading too cheaply,” Hay says, and his
fund’s presentation emphasises that
research is everything.
“At Pangolin we consider
ourselves to be a research house
that occasionally buys some stocks.
If there’s no-one in the office, we’re
probably out seeing companies.”
A recent success for them has been
a Malaysian stock, Poh Huat, a firm that
exports furniture, largely to the US.
“When my colleague found them,
their market capitalisation was USD17
million, too small even for us, but my
colleague said you have to see it and so
we started buying it. I thought if I can
only spend USD1,000 dollars here, it’s
a good way to spend USD1,000 dollars,
and it ended up becoming about 7 per
cent of the fund.”
The firm had a p/e of three and net
cash and asset backing worth more
than the share price at that point
as it owned land. “As the Ringgit
depreciated, which it did sharply
in the last two years, their orders
went through the roof with the same
margins,” Hay says. “But the amount of
volume they did rose substantially and
other people noticed it so the market
capitalisation went up to USD100
million last year and we sold it. The
value to our portfolio has been huge.”
Investors in his fund have
traditionally been high net worth
individuals but increasingly they
are getting investments from US
institutions.
“US institutions come to us because
they understand the long term and are
not so bothered about the quarterly
figures,” Hay says. “They understand
it’s a good story. Our main problem is
that they have too much money and
we can’t take USD30 million or more
as they would then be too big a part of
the fund. We have one US institution
which has broken all its internal rules
to invest with us.” n
Looking eastBeverlyChandlerinterviewsJamesHay,
veteranMalaysianfundmanageronhisPangolinAsiaFundwhichhasenjoyedarollercoasterrideovertheyears.
“They all want a house, two cars and high
cholesterol just like the rest of us. People’s
lifestyles are changing as people are moving
from the paddy fields to the factories.”
James Hay, Pangolin Asia Fund
www.AlphaQ.world | 17AlphaQ June 2016
Transport assets remain one of the
best performing sub-classes within
the infrastructure space, with ports,
‘other transport’ assets and rail/metro assets
performing well. According to a new survey by
Deloitte entitled A Positive Horizon on the Road
Ahead? European Infrastructure Investors
Survey 2016, the average internal rate of
return (IRR) for ports, rail assets and airports
is between 10 and 12 per cent. Pipelines and
telecoms have also performed strongly.
But while more than 50 per cent of investors
surveyed felt that transport assets had indeed
fared well, the overall feeling among investors
is that they need to slightly reduce their
return expectations. Over the last five years,
92 per cent of respondents said that their
infrastructure investments had proved resilient.
However, whereas their target IRR in 2013 was
12 to 14 per cent, in 2016 the target has been
lowered with 43 per cent of investors predicting
returns of between 10 and 12 per cent; hence
why transport assets come out on top.
“The infrastructure asset class continues
to perform strongly and provide stable, secure
returns. We expect this to continue through
a period of more steady evolution in the
infrastructure investors market over the years
to come. The market is maturing in terms of
people’s understanding of it and what it offers.
It has proven to be a resilient asset class,
particularly in the core space where returns have
been solid, predictable. Investors who allocated
at the right time have done very well from a yield
and an IRR perspective,” says Jason Clatworthy,
infrastructure M&A partner at Deloitte.
Infrastructure funds, including direct
investors (large pension funds who prefer not
to invest as LPs in funds), are currently sitting
on an estimated EUR200 billion in assets
and ‘dry powder’ as they look to source the
best deals. From the demand side, there is
INFRASTRUCTURE
Harnessing alpha from transport assets
JamesWilliamswritesontheinvestmentpotentialoftransportassets.
www.AlphaQ.world | 18AlphaQ June 2016
INFRASTRUCTURE
and harvest long-term cash flows for investors.
While there are plenty of new infrastructure
projects in Europe, a lot of infrastructure funds
prefer to target well-established assets that can
generate cash flows right away.
They aren’t, says Clatworthy, hungry
to chase deals such as HS2 in the UK, the
construction of which commences in 2017 and
is estimated to take 20 years to complete.
What infrastructure funds really want is to
buy an operational asset like an airport, a port
or a distribution network. In that regard, the
UK is very mature in terms of the privatisation
of those kinds of assets. Clatworthy says that
Europe is catching up quickly but the level of
privatisation in mainland Europe compared to
the UK remains substantially lower.
A lot of big assets in Europe sit within the
regulated utility space. These are starting to be
sold, however, such as energy grids in the Nordics
owned by Vattenfall and Fortum, although the
former is still largely owned by the Swedish
government at present. As more European
regulated assets are privatised, going forward,
the easier it will be, from a legal and regulatory
perspective, to commit to greenfield projects that
can be backed with private investment.
Asked why transport assets, in particular,
had proven to be a resilient asset class over the
years, Clatworthy points to the fact that original
catalyst was the privatisation of UK rolling stock
companies (‘RoSCos’). Abbey National sold
Porterbrook, Royal Bank of Scotland sold Angel
Trains and HSBC sold Eversholt. When RBS sold
the business in August 2008, infrastructure funds
that were willing to take a bit of a risk yielded
the benefits; Arcus Infrastructure Partners and
AMP Capital Investors were two such funds that
formed a consortium to acquire the asset.
“Infrastructure funds that moved quickly
purchased these assets at relatively good prices.
Fast forward six or seven years and those funds
have done a lot of work with the assets to prove
the concept that they can generate enormously
predictable cash flows. When it then came to
selling these kinds of assets, direct investors
said: ‘That’s exactly what we want’. This has
resulted in a lot of competition to acquire the
assets, and funds have been able to sell them at
high multiples,” explains Clatworthy.
This has happened for rail assets and airport
assets, allowing transport, as a sub-sector, to
deliver consistently strong internal rates of
return to investors.
no issue. It is the supply side that is under a
bit more pressure as investors look to deploy
a wall of capital, with Clatworthy noting that
“infrastructure investors remain keen to see
an increase in deal pipeline, both via the
secondary sale markets but, importantly, also
in the greenfield space, should regulators of
governments facilitate this more readily.”
He says that demand dynamics are creating a
bit of a price bubble in some areas of the asset
class, but that there are new entrants “coming
into this space all the time”.
“The only question is, because it’s very specific,
whether the supply of deals gets far outstripped
by demand from capital. There is a challenge of
putting dry powder to work. That said, we are
starting to see first generation infrastructure funds
reach maturity, some of which are recycling assets
out of these funds,” says Clatworthy.
First generation funds include early funds
launched by Macquarie Infrastructure and Real
Assets (MIRA), such as the Macquarie European
Infrastructure Fund, a EUR1.5 billion wholesale
investment fund that launched in 2004.
One of the issues for infrastructure funds that
have launched more recently is that the landscape
has become more competitive. As is also the case
in real estate investing, there are lots of funds
competing with sovereign wealth funds and large
pension plans to purchase infrastructure assets
“These deals are happening on the continent, but the UK still leads the way; that’s where most of the transport assets are being sold.”Jason Clatworthy, Deloitte
www.AlphaQ.world | 19AlphaQ June 2016
INFRASTRUCTURE
such as the Borealises of this world.
In fact, the strategy of getting hold of core-
plus assets, making enhancements to them over
a number of years and then selling them to the
market as core assets and realising a healthy
yield, was popular when some of the first
generation infrastructure funds launched years
ago. When they were buying assets back in
2001, 2002, many those deals were originated
out of private equity deals and being put into
infrastructure fund portfolios. Clatworthy sees
similarities with what is happening today in the
mid-market where a lot of core-plus deals bring
infrastructure managers into contact with PE
managers.
One particular deal is for TCR – a Belgium-
headquartered leasing business that leases
ground support equipment for aviation. “That
is a classic example where both a couple of
infrastructure funds and PE funds are competing
to bid for that deal,” says Clatworthy.
Of course, one of the upsides of focusing
on more niche areas of infrastructure is that
managers have more of an opportunity to hunt
down less-crowded deals at more attractive
prices. The level of competition is giving them a
chance to be more creative.
“I also believe that smaller infrastructure
funds have to innovate to justify their fees and
one of the ways they are doing that is to look at
more complex deals eg a carve-out from a big
utility company as opposed to a pre-packaged
deal. Or, looking at assets which, with a bit of
careful planning and work, could be made to
look like infrastructure assets; putting long-
term contractual structure around it to deliver
infrastructure-like cash flows,” adds Clatworthy.
This is not just competition; it is justification
of a fund’s existence.
Within Deloitte Europe, a monthly conference
call is held, which typically comprises 60
partners across Deloitte’s European offices. The
purpose of this call is to share with Deloitte’s
clients the most up-to-date information on
European infrastructure deals as managers scour
the marketplace to put their money to work.
If transport assets – and infrastructure assets
at large – continue to deliver strong returns
relative to other asset classes, there is every
chance that more infrastructure funds will
look to jump on the bandwagon. How investors
respond to further competition will likely
then determine which funds enjoy accelerated
growth, going forward. n
In France, Deutsche Bank acquired a rail
leasing company called Akien, which shared a
lot of the characteristics of UK RoSCos, while
in the aviation space, airports such as Toulouse,
Nice and Lyon have all been privatised (or are
currently in the process of being privatised),
not to mention Budapest airport.
“These deals are happening on the continent,
but the UK still leads the way; that’s where
most of the transport assets are being sold.
New entrants tend to look at the UK to do an
investment deal because it’s a more mature
market, more transparent. I would say the mix
of deals that we work on currently is one third
UK, two-thirds Europe; so the UK alone has a
big share of the market in transport assets,”
confirms Clatworthy.
One of the survey’s findings was that mid-
market funds face much stiffer competition from
private equity groups as well as direct investors.
Some 56 per cent of large infrastructure funds
– defined as those with billions in assets and
willing to write tickets of GBP500 million-plus for
deals – viewed other large infrastructure funds as
their main competition, with 10 per cent citing
private equity.
By contrast, 50 per cent of mid-market
funds – defined as those running more specific
mandates and willing to write tickets of
GBP100 million to GBP500 million for deals
– viewed other infrastructure funds as their
main competition, while 25 per cent cited
private equity.
Also, the very largest funds and direct
investors tend to focus more on core deals
than core-plus deals. One of the trends that
infrastructure investors expect to see over the
next couple of years is increased innovation
in deal sourcing, with mid-market funds in
particular seeking to avoid auctions where
prices are more influenced by direct investors.
“Once you get into the mid-market space,
what you tend to see is that a lot of the funds
that can’t compete in the big ticket deals are
having to innovate a lot more and generate
ideas on what could, economically, be regarded
as an infrastructure asset, even if it isn’t, on
the surface, a ‘pure’ infrastructure asset. That’s
when you see some of these funds operating on
the edge of private equity,” says Clatworthy.
Some funds like EQT Infrastructure, for
example, are more at the private equity end of
the risk spectrum when it comes to defining
infrastructure, compared to more classic funds
www.AlphaQ.world | 20AlphaQ June 2016
TRADING ETFs
With over 2,500 US-listed ETF
products replicating nearly
every investment strategy
imaginable, the value in ETF usage
to institutional investors has become
more prevalent than ever. With the
market swinging several percentage
points in either direction, many
investors looking to gain additional
return on capital have employed
levered ETFs, short positions in
ETFs, and inverse ETFs to benefit
from market declines; as well as more
complex arbitrage positions involving
shorting both the levered and the
inverse levered ETFs to benefit from
leverage decay.
The use of inverse ETFs, which
rely on swaps or derivatives to benefit
from a decline in the value of their
underlying benchmarks, has grown
substantially over the past few years.
The hedge fund and high frequency
trading communities have gravitated
towards inverse ETFs because of the
short-term tradability of many of
these products.
Many long-only portfolio managers
will buy the inverse ETF to hedge
their portfolios, because they cannot
physically short stock. In this scenario,
they would buy the inverse ETF to
hedge a portfolio of stocks they own,
allowing them to obtain downside
protection. Often times when the
market is selling off, we will see
investors buy the inverse ETF (aka ‘the
short’) as a means of capturing some
quick gains, and then sell out of the
position at the end of the day.
It is important to note that these
instruments should only be used as
a short term play by sophisticated
investors who understand the
structure, costs, and risks associated
with these funds. Inverse ETFs can
be very expensive to hold over a long
period of time as many of them carry a
high expense fee, and the decay factor
of the underlying swaps can negatively
affect the investor’s performance.
Investors have shorted stocks for
decades, and now it is commonplace
to apply the same strategy to ETFs.
While the concept is the same, there
are some additional considerations
when shorting an ETF versus shorting
a single stock. An ETF’s assets under
management are a significant factor in
an investor’s ability to short the fund.
Not every ETF is shortable and many
ETFs are not easy to borrow.
When shorting an ETF, the investor
must borrow stock from another party
to facilitate their short position. If
there is limited availability to short
a stock, the cost to borrow can be
restrictive to the end-user. For more
broad-based funds, such as SPY, IWM
and QQQs, it is easier to apply short
positions because of the abundance
in availability of these ETFs, thus it is
simpler to borrow.
However, for a newer fund with
only 100k shares outstanding, shorting
stock is not an option, since there
aren’t enough shares in the market-
place to facilitate a short position. For
more liquid funds, it may be a more
cost efficient option shorting an ETF,
rather than buying an inverse ETF,
particularly over a longer time horizon.
Thus, shorting SPYs and paying
25bps over the course of a month
could prove to be a cheaper option
over buying an inverse S&P ETF and
paying almost a 1 per cent expense
fee. However, if investors are looking
for inverse exposure to a sector or
benchmark and there aren’t ETFs
available to short and/or borrow costs
are too high, inverse ETFs can be a
powerful tool for tactical exposure. n
The long and the short of using ETFs
MohitBajaj,DirectorofETFTradingSolutionsatWallachBethCapital,writesonthetacticalwaysinstitutionalinvestorscanuseETFsto
gaininverseexposure…
“Many long-only portfolio managers will buy the inverse ETF to hedge their portfolios, because they cannot
physically short stock.”
www.AlphaQ.world | 21AlphaQ June 2016
Diego Franzin is Head of Equity
Europe, Pioneer Investments,
a global investment firm
with EUR224 billion in assets under
management (as of December 2015).
The firm has been managing bottom-
up stock selection portfolios in Europe
since 1996, but over the last five
years, Franzin had been thinking
about the problem of how to deliver an
asymmetric-type portfolio product to
equity investors that are sensitive to
drawdowns.
With the recently introduced
European Equity Optimal Volatility
strategy, Franzin thinks he has found
the solution.
“The strategy will be managed
utilising Pioneer Investments’
established European Equity Research
portfolio as the backbone of the fund,
determined by bottom-up analysis of
the market. We have a wide team of
analysts looking at individual industry
sectors to generate alpha,” Franzin says.
“In another part of Pioneer
Investments, we have a large asset
allocation team who take top-down
views on the market. They provide
a view of the world in terms of fixed
income, FX, equities. The third, and
most important building block of
the strategy, which was the missing
piece of the puzzle, is an actively
managed volatility component, which
we implement through options and
futures,” says Franzin. The aim is
to deliver an asymmetric profile and
higher risk-adjusted returns than the
equity market in isolation.
Volatility has been dampened for
the last five years or more, due in large
part to central bank intervention to
stabilise global markets following the
financial crisis. This has led to a golden
period of equity and bond returns, but
there are growing fears that volatility
will increase, going forward.
“Whether central banks’ objectives to
dampen volatility have been desirable
is a matter of debate. In my opinion,
if a price moves from A to B as a
result of new information, the smaller
incremental move (degree of volatility)
more often is better than one huge
move every five years,” says Jerry
Haworth, CIO of London-based volatility
specialist, 36 South Capital Advisors.
He thinks that by suppressing
volatility, central banks have created
VOLAT IL ITY
Trading the vol JamesWilliamsdiscoversthefinerpointsoftradingvolatility.
www.AlphaQ.world | 22AlphaQ June 2016
VOLAT IL ITY
an environment such that when
volatility eventually does return, it is
not going to be benign at all.
Investors are conscious of this and
are looking to add volatility strategies –
otherwise known as tail risk strategies
– to their portfolios to reduce potential
drawdowns by actually delivering non-
correlated returns; in other words,
making money during periods of rising
volatility and falling equity markets.
This is what Franzin is hoping the
European Equity Optimal Volatility
strategy will deliver.
“The path towards a rate
normalisation is likely to be volatile
for risky assets and, understandably,
risk conscious equity investors
are concerned about the volatility
associated with a traditional equity
strategy. As an asset class, volatility
can offer unique diversification
benefits. The inverse correlation of
equity versus volatility is stronger
than equity versus fixed income. The
correlation over the last year of the
MSCI Europe versus fixed income is
-0.3, whereas the MSCI Europe versus
volatility is -0.8,” he says.
The European Equity Optimal
Volatility strategy is a blend of
bottom-up stock picking, a top-down
macro view of the world, and actively
managed volatility.
“I stress the word ‘blend’ because we
are not just using a volatility overlay.
Sometimes we will play volatility in
certain countries and sectors more
than in other countries and sectors and
therefore positions will be mixed in the
portfolio alongside our stock picks.”
In that sense, Pioneer’s new strategy
differs from minimum strategies which
typically follow a quantitatively-driven
approach to invest primarily in stocks
based on their historical volatility.
By combining models to forecast the
volatility regime with Pioneer’s view
of the markets, a quantitative and
qualitative assessment of the situation
is taken. Franzin points out that
unlike minimum variance strategies,
for example, that target low volatility,
Pioneer’s European Equity Optimal
Volatility strategy “aims to optimise the
risk/reward ratio, not just lower the risk”.
Asked how he views the current
volatility regime, Franzin responds: “We
expect that in the medium term the
market will not be directional, but will
be dominated by shocks in volatility.
Our expectation is that we are entering a
‘low, low regime’, meaning low inflation
and low growth. The market, in our
view, will be range-bound interspersed
with big moves in volatility.”
At 36 South Capital Advisors,
the primary goal is to sit back, wait,
and profit from rising volatility. The
more volatility there is in the market
the better.
Last August, for example, China
provided a good opportunity to make
returns when China’s central bank,
the PBOC, allowed the RMB to devalue
by nearly 2 per cent against the US
dollar in a bid to support its cooling
economy. In January this year, Chinese
shares fell by 7 per cent, prompting
a suspension of trading, as investors
panicked over China’s manufacturing
numbers, which contracted for the
tenth straight month.
“Volatility tends to occur mostly
when the markets are falling. You do
have upside volatility, but generally,
the biggest volatility is reserved for
the downside. That characteristic –
that volatility rises when markets fall
– means that any investment in long
volatility strategies is, by definition,
counter-cyclical to traditional assets
and that’s what makes volatility a
unique asset class,” explains Haworth.
To further expand on the
counterintuitive nature of volatility,
people will typically look back at
historical volatility as a guide to the
future. In recent times, the VIX Index,
which measures volatility in the
markets, has been largely range-bound.
This lulls people into a false sense of
security. The more benign the markets,
the less likely volatility will rise. In
fact, the opposite is true.
Just as people in California become
more and more convinced that an
earthquake is less likely to strike as the
years go past, the fact is the probability
of it happening keeps on rising.
The team at 36 South scans the
markets for mis-priced assets and buys
out-of-the-money options, typically five-
year options. The more confidence the
market has that volatility will remain
low, the cheaper the options are priced.
“We scan the financial markets for
what we think are undervalued options,
put them in the portfolio, and wait.
When volatility starts to creep up, that’s
when the portfolio should make money.
“We like to think of ourselves as
trappers. The lower the price of traps
(in other words, options contracts),
the better for us. When people are
most complacent they are willing to
write optionality at the lowest price.
The best example of this is some
Japanese institutions who, in the 90s,
felt that the Japanese equity market
was infallible. They were selling five-
year options at next to nothing. Then
the Nikkei collapsed. The options,
previously sold cheaply, became very
expensive and the selling institutions
lost an inordinate amount of money.
“When long-dated options are cheap,
this is one of the best tells I’ve seen. It’s
a bit like the canary in the coal mine.
When it happens, it tells us that options
“The path towards a rate normalisation is likely to be volatile for
risky assets.”Diego Franzin, Pioneer Investments
www.AlphaQ.world | 23AlphaQ June 2016
VOLAT IL ITY
He adds that the fund’s net long bias is
around 50 per cent and its gamma exposure
is 18 per cent – gamma refers to how much a
derivative contract will gain for every 1 per cent
move in the market.
“We typically trade three month and six
month options and futures contracts in the
portfolio. That is to maximise the gamma. We
prefer to focus on shorter-term volatility within
the major indices in Europe,” confirms Franzin.
The fund managers at 36 South make use
of a proprietary model called the Quadrivium
methodology, which identifies ‘high potential’
ideas. There are four pillars to this approach:
thematics, technical analysis, market sentiment
and quantitative metrics. From this, ideas are
generated and filtered to determine which
themes to trade.
A short-list of opportunities are then ranked
by the remaining Quadrivium factors based on
a technical, fundamental and sentiment point of
view. This ensures that only the most robust “high
potential” ideas are proposed for the portfolio.
The biggest risk in the market is that bond
and equity prices fall at the same time. History
has shown that for a disproportionately large
period of time, bonds and equities have indeed
moved in lockstep. If there is another risk
aversion ‘event’ in the market, bonds have
got nowhere to go and this is what concerns
investors, in Haworth’s view. Indeed, such a risk
aversion event might be created by a collapse in
the faith of credit, causing bond yields to rise as
bond prices fall alongside equities.
“This is an asymmetric trade. The more
extreme the downside gets the more profits
tend to snowball. A systemic shock to us is the
equivalent of a bush fire. All the animals get
spooked and they run into the traps we’ve laid.
We can capture animals on the one hand or
uplift our traps and sell them back to the general
store on the other hand. Any systemic shock has
the potential to be a Lollapalooza bonanza for us;
a multi-profit event,” remarks Haworth.
This is precisely why Pioneer has launched
the European Equity Optimal Volatility strategy,
to help smooth out the volatility in investors’
portfolios by actively trading the asset class and
deliver an extra level of returns when markets
start to wobble.
As Franzin concludes: “We want to be able
to offer our clients a return over the long term
that is similar to the market but with low
volatility to help them sleep well at night.” n
are worth buying and that volatility is around
the corner. That’s how we view the current low
volatility regime,” explains Haworth.
To continue Haworth’s trapper analogy to
explain volatility trading, the quality of the
trap is really a function of time. A three-month
option is nothing but noise and does not have
long enough to trap an animal. The longer the
option contract, the more time it has to work.
“The traps we are setting are stainless steel,
not iron. If you give me enough time, my
probability of being right goes up exponentially.
“Say I buy a stainless steel trap for GBP10,
lay it down and some time later notice that
the price of the traps in the general store
(marketplace) is now GBP100. I can then sell
my trap back to the general store. Even if I
catch an animal I might only capture GBP50,
so it makes more sense for me to lift the traps
and sell them back to the general store; in this
case, investors who believe that trapping is now
the best game in town (because volatility is
climbing),” says Haworth.
Of course, this is counterintuitive because at
that point it’s probably the worst game in town,
but 36 South would have monetised at the
end of any given high volatility period, simply
because it laid its traps early.
“We don’t sell options if the price rises from
GBP10 to GBP20. We’re not in the business of
doing that. If it rises to GBP50, maybe we will
sell, otherwise we will sit and wait for the price
to reach GBP100.”
Unlike 36 South, who are a pure volatility
player, Pioneer Investments employs a shorter-
term volatility strategy. The way the team
actively manages volatility will be dictated by
the volatility regime at any given time.
“Sometimes we will be long volatility,
sometimes short depending on if we think
volatility will rise or fall. What we want to try
and do is generate alpha from volatility based
on our view of the volatility regime and also
generate alpha based on our view of the market.
“The position we have today in the portfolio
is long volatility but in recent weeks the market
has been selling volatility. We think the market
is weak so this makes it hard to rationalise why
people are net sellers at the moment. We expect
volatility to be higher than it has been over
the last couple of years. We just don’t think
the situation is as rosy as the market seems
to suggest based on the discounted price of
volatility today,” comments Franzin.
Jerry Haworth, CIO, 36 South Capital Advisors
www.AlphaQ.world | 24AlphaQ June 2016
COMMENT
Keynes, the towering figure of twentieth
century economics, was affiliated with
Cambridge. Tolkien, who was born nearly
nine years later, is best known for his works of
high-fantasy such as The Hobbit and The Lord
of the Rings, and his affiliation to Oxford.
Tolkien described seven families of dwarves
in his chronicles of Middle Earth. What is
perhaps less well known is that there was
an eighth family – the Scratchybeards of
Cambridge…
Not desirous of more contact with the
world of Man than is strictly necessary, the
Scratchybeards ascend from their mines,
deep under the soils of the Fens, but once a
generation, when a new King is appointed. At
this time the King takes all the gold they have
mined over the previous reign, sells it through
their representatives amongst men and buys
perpetual bonds at the prevailing interest rate.
The income from these bonds is used to
purchase wine, beer, axes, shovels and weapons
– for dwarves like nothing more than gold
mining, drinking and fighting. The capital gain
over the previous reign is used for a great feast.
Due to splendid foresight by the great dwarf
King Gimli, the dwarf currency is fixed against
the US dollar.
Introducing the ScratchybeardsRegularAlphaQcolumnistRandeepGrewalcallsonMiddleEarthtoexplaintheimportanceofunderstandingthelongtermtrendininterestrates.
www.AlphaQ.world | 25AlphaQ June 2016
COMMENT
over on 25 January 1961 when the effective
Federal Funds rate hit 0.13 per cent. As laid
down by the laws of the Scratchybeards he
had dutifully exchanged all the family gold for
perpetual bonds. Sadly those bonds has lost
22 per cent per annum since then; there was
silence as he explained this meant they had lost
99.4 per cent of their fortune under his tenure –
less than 0.6 per cent remained.
There is nothing angrier than a dwarf who
realises he has lost his wealth – and the air was
soon thick with axes and clubs flying towards
Siegfried. Some say he died of his wounds or
of shame before the first axe hit him – others
are not so sure; what all do agree on, is that
Siegfried the Hapless was dead by the end of
that day. Having lost over 99 per cent of their
fortune there was insufficient wine to fill a
thimble for each dwarf. When dwarves expect
a drink, anticipate a drink and look forward to
a drink, they are not best pleased when they
are denied a drink. There had been bitter rows
and recrimination that night. There was much
wailing, many arguments and several brawls
before, rather sulkily and in a foul temper, the
dwarves tramped off to their mines.
Haggard bore unique insight amongst
dwarves for he knew deep inside that the
returns achieved on the Scratchybeard bond
portfolio was due to no remarkable skill or
aptitude. Indeed he appreciated that he had no
greater investment skill than King Siegfried. The
magic of Middle Earth had merely conspired to
bequeath the Kingship to Haggard when bonds
were at peak yields. Looking now at young
Methedras, and recognising that bond yields
were at a generational low, Haggard wondered
what he should advise…
Clearly it is unlikely that any family office,
pension fund, endowment or sovereign
wealth fund is going to be precisely following
the investment policies of the Scratchybeards.
Furthermore it is unlikely, except in the magical
world of Middle Earth, that perpetual bonds are
going to be priced off the Fed Funds rate – but
the numbers are helpful to show the dramatic
By a bizarre coincidence of fate and magic
the days of these generational handovers have
coincided with peaks and troughs of the Federal
Funds Rate. Thus, on 22 July 1981, Haggard
‘The Lucky’ took over the kingship. On that day,
the dwarves carefully and discretely gathered in
the darkest, deepest cellar of the oldest college
in Cambridge. Reluctantly, and with much
moaning, all the dwarves handed over their
gold. In exchange they received perpetual bonds
yielding 22.36 per cent, that being the effective
Federal Funds Rate on the day.
So it came to pass that after having fought
one too many battles with the Orcs, Haggard
Scratchybeard decided that his best days
were past him and passed on the kingship to
his nephew Methedras on 30 December 2011
(history notes that the effective Federal Funds
rate was 0.04 per cent on that day). As he was
still alive (after all he was nicknamed ‘The
Lucky’), on his retirement Haggard was called
upon to give account.
Drinking from a gold tankard, he reported
that the family fortune had compounded by 23
per cent per year under his tenure. Since most
of the family did not understand sophisticated
finance, Haggard explained that their capital
had grown 559 times during his reign. There
was no need to say more as the entire tribe
screamed, shouted and cheered. Nothing
delights dwarves more than knowing they are
wealthy. Though dwarves are known for their
drinking prowess, even for them, having 559
times more wine than at the last Coronation,
was a challenge. (Haggard did consider
explaining that inflation had eroded some of
the purchasing power, but shrewdly figured
that after the hundredth barrel of mead, no one
would particularly care).
Dwarves are not generally known for their
introspection or their thoughtfulness. So
perhaps it was the finest mead that could
be procured in Cambridge, or the look of
innocence in the eyes of Methedras, that made
Haggard reflect on the last time he had been in
this college cellar. The old King, Siegfried the
Hapless, had been brought in on a stretcher, his
body having been seared in battle by the fire of
the Great Dragon Smaug. On that day, 22 July
1981, Siegfried gave an account to the gathered
dwarves in a quiet whisper as the lifeblood
drained from his body.
It had been a sombre occasion. Barely able
to lift his head the King reported he had taken
“Without an awareness of the long term trend of interest rates it is very easy to confuse luck with alpha and haplessness with unforgiving markets.”
www.AlphaQ.world | 26AlphaQ June 2016
COMMENT
the retirement date approaches (the so called
‘glidepath’ approach). And then on retirement,
or soon after, invest in an annuity or mainly
in fixed income assets. Both the lump sum to
convert to an annuity and the income from
an annuity are impacted by prevailing interest
rates. Clearly rates of 0.13 per cent (as on 25
January 1961) are going to generate different
retirement income from rates of 22.26 per cent
(as on 22 July 1981).
Many pension funds follow a similar
approach on aggregate for their pension fund
contributors i.e. gradually switching to more
fixed income in the portfolio as the average age
of their pension contributors increases. Similar
thoughts about risk and return permeate the
thinking of other long term investors.
Of course more than just interest rates
conspire to impact returns – we ought to
consider inflation, demographics, globalisation,
financial leverage and many other factors. But
ultimately all of these other factors will impact
the rate set by the Fed.
Given the generational lows of interest rates,
surely the key question for all investment
committees is what will be the impact of an
uptrend in rates for their portfolio? At the very
least it would seem prudent to consider if a fixed
income portfolio comprises short duration or
long duration bonds (or indeed perpetuals as was
the case with the Scratchybeards). The valuation
of other long duration asset classes – particularly
property but also equities – is also driven off
assumptions on interest rates and inflation.
One may not be able to time the market
but that does not mean that one should not
spend time thinking about the future path of
the market. There are many approaches to
investing but the single biggest questions right
now for long term investors has to be ‘over the
next twenty years do you expect interest rates
to be higher or lower’? And how are you going
to position your portfolio as a consequence?
Not considering these questions, yet allocating
funds to fixed income or long duration assets
in the present markets, is akin to following the
Scratchybeard investment policy under the
reign of Siegfried ‘The Hapless’. n
Randeep Grewal (pictured) is a portfolio
manager for the Trium Multi-Strategy Fund.
This article is written in a personal capacity;
the views and opinions are those of the author
and do not necessarily reflect those of Trium.
swings in the interest rate cycle. Both Ireland
and Belgium having issued century bonds this
year. Last year Mexico issued a 100-year bond,
whilst Canada and Spain both issued 50 year
debt. There has been previous issuance by
China (1996), the Philippines (1997) and Mexico
(2010). Nonetheless the issuance of ultra-long
dated or undated bonds is relatively rare.
I hope that the story about the
Scratchybeards provokes thought about
asset allocation policies over long investment
horizons. Interest rates trend over periods
much longer than the tenure of the average
fund manager or investment committee. That
which appears constantly in the background
can become taken for granted – and embedded
in the orthodoxy. Without an awareness of the
long term trend of interest rates it is very easy
to confuse luck with alpha and haplessness with
unforgiving markets.
Traditionally the fixed income parts of
portfolio are used to preserve capital (i.e. are
considered ‘low risk’) and have low volatility;
while the equity component contributes capital
gains. However it is worth reflecting that
Siegfried the Hapless lost over 99 per cent of
the family wealth through fixed income over
20 years; whilst Haggard made 559 times over
30 years (a return that most equity portfolios
would have found hard to beat).
The traditional advice for an individual
investing in a pension for retirement is to
gradually switch from equities to bonds as
Randeep Grewal
www.AlphaQ.world | 27AlphaQ June 2016
PR IVATE EQUITY
US private equity managers are
facing opposing push and pull
factors when it comes to doing
business in Europe, requiring them to
weigh up the costs of regulation versus
the rewards of raising potentially
significant assets.
The main push factor is, of course,
the AIFM Directive. Most PE managers
are now familiar with this pan-European
directive, but the different ways it is
interpreted among EU Member States, is
proving to be confusing.
For example, if a US private equity
group were to market alternative funds
into Germany or Denmark, they would
need to have an appointed depositary
in place before they could begin
any marketing activities. This is not
required in other EU Member States
such as the UK.
“What this means for a manager
who has been present in Europe for a
number of years is that even if their
fund is not a European-based AIF, they
must appoint a depositary to market
in those two countries. We service a
lot of European private equity fund
managers, but one of the main impacts
of the introduction of AIFMD has been
to introduce our depositary services
to US private equity managers,”
says Chris Merry, CEO of Ipes, an
independent private equity fund
administrator.
US managers quickly come to
realise that this so-called harmonised
directive is anything but, and that
Europe is a regulatory jigsaw with
broad areas of overlap but plenty of
nuances when it comes to marketing
funds and reporting on them. As Merry
relates, when Ipes has discussions
with managers in the United States
they typically ask, ‘Why is it that only
Germany and Denmark require a
depositary in this way?’
“Clearly, Germany is a big source
of capital and investment and large
US private equity funds often have a
number of existing German investors.
So they are discovering the impact
that AIFMD has on the way they do
business,” says Merry.
The push and pull of doing business in EuropeJamesWilliamsinterviewsChrisMerryofprivateequityadministratorIpesontheproblemsfacingUSprivateequitymanagersinEurope.
www.AlphaQ.world | 28AlphaQ June 2016
PR IVATE EQUITY
Previously, alternative funds (both hedge and private
equity) relied upon reverse solicitation where the investor
would contact the manager, not vice-versa. This has
now become very much a grey area. There is a degree
of risk aversion among PE managers and a desire to do
things properly.
“What is happening now is we will be appointed by the
manager as a ‘contingent depositary’. What this means is you
can put our name into your fund raising documents, and if
you then go on to raise assets from German investors we will
act as the depositary … and if you don’t, then we won’t,”
explains Merry.
Another point of confusion, which is part of the ‘push
factor’, is the reporting that goes with marketing funds
into the EU.
Every manager distributing his funds into Europe needs to
file an Annex IV report, which depending on the size of the
fund can be annually, semi-annually or quarterly. In theory,
Annex IV reporting to different European regulators should
be the same but there are different quirks between different
areas of reporting, different file formats. “And when we
explain that to fund managers, the impression they have is
that Europe is a far more fragmented market when it comes
to raising assets than they perhaps thought.
“As a result, US managers need to factor in the cost of
complying with regulation, the cost of operating with a
depositary, to determine whether or not it is economically
viable to come to Europe to raise money,” remarks Merry.
The purpose of AIFMD is to benefit and protect
investors. But it is a less than desirable situation if AIFMD
effectively closes off part of the asset management world
to European institutional investors, and a classic example
of the unintended consequences of regulation. It ends up
potentially harming investors’ ability to source and allocate
to high quality US alternative fund managers.
But there are also pull factors at work, with an
increasingly high level of demand among European
institutions to allocate to US private equity funds. They want
exposure to a full range of global investment opportunities to
give their end investors the best possible returns – and US
talent is an integral part of this.
In 2015, to underscore the level of demand, 689 private
equity funds closed with USD288 billion of aggregate capital.
According to the 2016 Preqin Global Private Equity &
Venture Capital Report, North America, as a region, has
enjoyed a resurgence in investor appetite, with 70 per cent
of investors surveyed by Preqin viewing it as providing the
best private equity opportunities in 2016.
More importantly, US managers are looking closely at
Europe and competing for deals on the continent. Strong
investor interest and fund allocations can sometimes be a
double-edged sword for private equity managers because
it can lead to bottlenecking, with managers competing
to execute the same deals. This leads to higher company
valuations, in the buy-out world at least, and makes it harder
for managers to put their dry powder to work.
As a result, managers have to be even more focused in
sourcing unique deals beyond North America, and Europe, in
that sense, offers fertile ground, but there is a caveat to this,
as Merry explains:
“We are seeing more US managers coming in to Europe
competing for deals. US managers like to come through
the UK – same language, trading partners, etc – but the big
issue now on everyone’s minds is what could happen if the
UK decides to leave the EU? We were out in New York just
recently and the two topics of conversation that dominated
at the macro level were Brexit and the US Presidential
elections, and at a more granular micro level, they wanted
details on how AIFMD works and the nature of reporting.
“We are already seeing investment decisions being put on
hold until the result of the referendum is known,” he says.
Merry says that allocations to private equity by European
investors are rising in the same way as they are globally.
Larger investors want to invest across the globe, not just in
Europe. “I’m sure the connection has not yet been made but
we see some hesitation among mid-market US funds around
the AIFMD and reporting barriers. Consequently, a number
of mid-market US managers are choosing not to raise money
from European investors, even though the demand is there.
The risk is that European investors might potentially not
have access to as wide a range of US manager talent as
they might like.
“US managers need to factor in the cost of complying with regulation to determine whether or not it is economically viable to come to Europe to raise money.”Chris Merry, Ipes
www.AlphaQ.world | 29AlphaQ June 2016
PR IVATE EQUITY
“The overriding feeling that I get
from US PE managers, because of the
‘pull’ factors cited above, is that they
are bullish on Europe,” says Merry.
Nevertheless, asset servicers such
as Ipes play a vital role in terms of
educating fund managers on the
intricacies and costs of operating
funds in Europe. In that sense, Ipes
has worked to develop an automated
Annex IV reporting service to facilitate
as much as possible the ease of doing
business in Europe.
“We take away the burden of
reporting, the burden of compliance,
but there is still a lot of questioning
and confusion as to why some EU
countries operate differently to others.
For the very largest PE funds, they can
cope with it as they have the resources,
but for the mid-market funds, they
have to be careful when it comes to
evaluating the cost/benefits of doing
business in Europe.
“What we can’t take away,
unfortunately, is the cost of appointing
a depositary, of filing different reports
under Annex IV, and of registering funds
in different jurisdictions across the EU.
The investment manager has to carefully
consider these costs and then determine
how much capital they realistically
expect to raise,” explains Merry.
Indeed, institutional investors who
previously allocated more to public
equity funds and mainstream funds
are coming in to the alternative fund
space and bringing that same mindset
to question the investment manager on
PE fund costs; what are the manager’s
costs, what fees are they paying to
service providers etc?
There is, says Merry, a greater desire
to understand where money is being
spent, and that in turn is leading PE
managers to scrutinise their costs even
more closely than before.
“If there’s an extra layer of fees and
compliance costs to doing business
in Europe, versus raising capital in
the US and Asia, managers have to be
completely on top of that and make
sure it is worth absorbing those extra
costs,” he says.
Ipes currently has approximately 30
US private equity managers who have
appointed them as their depositary to
successfully market their funds into
Denmark and Germany.
Generally speaking, Ipes is
approached when the fund manager is
putting his plans in place to approach
investors in Europe. If they are a
well-established large fund, they are
more likely to move quicker than a
manager who is coming to Europe
for the first time and needs to more
closely scrutinise the costs before
moving forward.
“At any one time we have
conversations with a large number of
clients, but they proceed at different
speeds depending on the likelihood of
raising assets as per their fund strategy
and investment proposition.
“The amount of money being
invested into private equity funds has
increased year-on-year since 2009,
but the majority is still going to the
largest funds. There’s less money being
raised by start-up funds. If you’ve got
a good track record you’ll raise money
for your next fund. If you’ve got a less
than average track record you’ll find
it difficult. That drive towards quality
and better returns is exactly the same
drive that I think is pushing some of the
sovereign wealth funds to invest directly
into their own deals,” observes Merry.
One theme that Ipes is increasingly
seeing is co-investing, whereby LPs will
allocate a percentage of capital into the
fund, and retain the right to allocate a
percentage of capital directly to certain
deals; not every deal, just one or two.
The arrangements around private
equity investing have today become
more varied and more complex. A
few years ago, everyone signed up
to the same LP Agreement. Today,
it’s a lot more nuanced; different fee
arrangements, founder share classes,
co-investment deals and so on.
Increasingly, LPs want customisable
investment solutions.
Add to this increased LP complexity
the operational burden to marketing
funds into Europe, and Merry thinks
that in the coming years the drive
towards appointing independent fund
administrators by US private equity
managers could accelerate.
“Across Europe, approximately 65
per cent of private equity managers
outsource administration. In the US,
that figure is more like 35 per cent.
In Europe, it’s higher partly because
of regulation but also because of
investors. LPs want GPs to go out
and source the deals, manage the
portfolio companies and drive the
returns, but they also want them to get
an independent specialist to handle
administration,” comments Merry.
In some respects, this could prove
to be a useful primer for US fund
managers. If they get comfortable
working with an independent
administrator, the vagaries of AIFMD
and doing business in Europe might
start to look less ominous; which in turn
will satisfy European investor demand.
In conclusion, one jurisdiction that
has moved quickly to try and make
Europe a more attractive place to set
up private equity funds is Luxembourg,
who earlier this year introduced the
Reserved Alternative Investment
Fund (‘RAIF’).
The RAIF regime, which will
essentially replicate the specialised
investment fund (SIF), will not
be subject to supervision by the
Luxembourg supervisory authority,
the CSSF, and will be reserved for the
structuring of AIFs that appoint a duly
authorised AIFM.
“Luxembourg has been a popular
jurisdiction over the years for holding
companies, SPVs, but the funds
themselves haven’t gone there in any
great numbers. The introduction of
the RAIF is the latest effort to entice
private equity managers to set up funds
in Luxembourg rather than just holding
companies.
“It has a flexibility that could attract
people but we’ll have to wait and see
how that translates into fund numbers.
It’s something to update our US clients
on, and it certainly looks like a good
structure,” concludes Merry. n
