Going into 2023, the hedge fund industry seems to be at an inflection point — and UBP’s Kier Boley is okay with that.
Boley and his team are rapidly exploring a new investment landscape that holds promise for active management, which is a huge structural shift in a market where beta had reigned for more than a decade, to the detriment of many traditional hedge fund strategies.
In 2020, Boley joined UBP as co-head of Alternative Investment Solutions (AIS) alongside John Argi after more than 20 years at GAM Investments, where he also headed the alternative investment services team. From his London offices, he has seen more than a few market cycles and is now as optimistic as ever, having guided UBP’s alternatives portfolio through the recent uncertain global macroeconomic environment.
“The Fed is telling everyone that we will be at higher rates for longer and the equity market isn’t listening,” he said in a recent interview with Alternatives Watch. “If the S&P 500 drops back to its long-term expected return level then peoples’ asset allocation levels will need to change. We think the S&P returns will continue to compress going forward.”
UBP manages $16 billion worth of assets in alternatives as of year-end 2022.
And even while in 2022 equity hedge funds in particular were challenged, there is a glimmer of optimism for Boley, who can see hedge funds returning to their knitting this year after a long hiatus.
This year he expects yields are going to become attractive and many investors will return to credit. Much of his focus is on those macro/systematic areas that are long volatility and non-correlated to equities and bonds. Then, Boley said, even if there is a recession macro managers should still benefit from that.
“Opposite to what is claimed, the majority of hedge funds tend to give you short volatility and negative skew and that’s what drives people crazy,” he added. “We focus on those managers that can demonstrate positive skew, and so once investors go through a bear market like 2022 and they see their hedge fund portfolio did well, then they are more likely to see understand the benefits of alternatives.”
UBP’s AIS core business is within customized bespoke solutions and developing the overall asset allocation mix for each client. They advise that hedge funds should act as a replacement for assets where an investor is over concentrated and looking to lower risk. There is still work to do in de-risking client investment portfolios, in Boley’s opinion.
All this follows a collective sigh of resignation amid the hedge fund industry between 2010 and 2020 as it seemed as though the policy response to the Great Financial Crisis of lowering rates and quantitative easing would go on forever.
“If you look back pre-2010, you have policy makers who believed that free markets allocated risk capital efficiently. That just meant there was a real cost of capital that decided who were the winners or losers,” said Boley. “For hedge funds, it meant it was good to trade the spread between the value of assets.”
Thanks to inflationary trends particularly, Boley finds that the price of capital is now normalized, and with that investors now get that “real dispersion between good and bad companies, good and bad credits, good and bad currencies” and essentially a realignment in good and bad hedge fund strategies.
"We focus on those managers that can demonstrate positive skew, so once investors go through a bear market like 2022 and they see their hedge fund portfolio did well, then they are more likely to see understand the benefits of alternatives."
In speaking with managers, he finds most agree that at mean reversion to longer term volatility levels at between 18 to 25 for equities should be an optimal environment for active hedge fund management. UBP tends to analyze hedge funds’ expected returns for the next 18 to 24 months this is driven by a component analysis just as though one is an equity investor.
Three components of returns that UBP considers are — passive beta, strategy alpha (the excess return of the manager and the peer group) and then unique alpha to the manager.
We decompose the return between those managers,” he said. “Some managers are minimal beta and generate the majority of their returns from strategy and manager alpha. These managers can charge higher fees.”
Over time all of these components wax and wane because different factors impact returns. For UBP, the challenge is to identify where the headwinds/tailwinds are at any moment in time.
Going forward, the expectation is for the long/short equity funds that has a large beta component is understandably going to be much more volatile. The dispersion of alpha within the strategy should increase, while manager dispersion should widen as well. Boley said the team would prefer to invest with an equity market neutral manager and the same could be said within long/short credit as well.
UBP’s in-house quantitative team developed proprietary models that break out each of the components in order to figure out how much of the return is alpha that can’t be explained simply by various factors.
He serves within the qualitative research team and meets with managers regularly.
“We typically have between 70 to 80 managers on our Recommended List. Of this list, we usually construct focused portfolios of between 5 to 15 underlying managers,” Boley said. “In terms of research meetings, we tend to conduct around 500 to 700 per year, which varies based on potential investment interest.”
The team is primed to identify the barriers to entry for that unique alpha to be sustainable and protected from competitors. Looking at popular strategies such as multi-strategy, it isn’t a matter of who the portfolio managers are because they move around a fair bit; Boyle argues that assessing the risk management team is much more influential for a strategy’s long-term success.
The darling strategy of 2022 was multi-strategy, and that has been the main hiring center for the industry as of late; accordingly, Boley finds more large firms bringing multiple managers and teams in house. He suspects that remaining in-house at a multi-strategy firm remains attractive for PMs as most investors prefer established management groups rather than start-ups.
Investor demand for longevity (UBP usually requires a three-year track record) in turn may spawn new fund launches in the future as managers become established under the umbrella of large multi-strategy firms. But those new funds still face a real challenge of having enough capital from day one to survive. Boley reckons that figure is between $200 million and $400 million.
That said, as the hedge fund industry gets ready to reinvent itself yet again, Boley and his team remain committed to make sure they are there in the right manager and the right strategy — one investment commitment at the right time.
