By Peter Kuster, Finews Editor

There are several parallels between the hedge fund boom prior to the financial crisis and the current wave of interest in private markets. However, the hedge fund industry has undergone significant change over the last 20 years. Fees have fallen, transparency has increased, and the barriers to entry for investors are higher. Chris Perret and Luca Michienzi of Wellington Management explain to finews how the business works today.

Anyone following the current private markets boom who has been familiar with the financial markets for some time cannot help but be reminded of the golden age of the hedge fund industry before the 2008 global financial crisis.

Just as back then, providers are promising the ‘democratisation’ of an attractive asset class offering superior performance, low correlation and appropriate diversification relative to traditional assets, by opening up access to it for retail investors via dedicated vehicles. Such vehicles – much like the ‘funds of hedge funds’ of yesteryear – are springing up like mushrooms and are, of course, managed by the ‘best talent’.

‘Democratisation’ and strong growth of an asset class

As was the case back then, the strong growth of this not particularly transparent market is raising concerns today, for instance when some investors realise that the liquidity of private debt vehicles is limited and their funds are tied up for longer than they would actually like.

There is also a parallel with the increased scrutiny from regulators, prompted by the boom, regarding potential risks to financial stability. The reason for the US Federal Reserve’s first bailout in recent financial market history was not a bank, but LTCM. The hedge fund, led by Nobel laureates, was bailed out by US banks in 1998 as part of a concerted effort by the Fed to avert the risk of destabilising the financial system. This also led to the sector being viewed critically by the public.

Decades of hedge fund expertise

That was a long time ago, and the hedge fund industry, which operates in the shadow of private markets, has faded from the headlines in recent years. finews wanted to find out how the business works today and met with Chris Perret and Luca Michienzi [finews.ch], Head of Diversifying Strategies and Head of Wealth and Family Offices (German-speaking Switzerland) respectively at Wellington Management. Perret has been with the asset manager for 16 years, initially in the fixed income division and, since 2019, working exclusively on hedge funds. Michienzi joined the firm in 2017 from UBS Asset Management.

Wellington serves institutional clients and financial intermediaries and has been active in the hedge fund sector for 30 years. With more than 40 billion dollars in assets under direct management, the asset manager ranks among the 15 largest hedge fund firms in the world.

The investment teams pursue over 40 different strategies across the long/short equities, macro & fixed income and credit sectors. This is also reflected in its two main products: two multi-strategy funds. The US East Coast-headquartered asset manager, which was founded almost 100 years ago and is owned by its 180 partners, has a long-standing track record in this area too. The long/short strategy focusing on financial sector equities, launched in 1994, is still on offer.

“Yes, the industry has changed significantly since the financial crisis,” confirms Perret. There has been a high degree of institutionalisation and standardisation. This has led to a marked increase in transparency, for example through monthly reports. In return, the fees – which used to be exorbitant – have fallen. “This is also because the ‘funds of hedge funds’ structures that used to be common have practically disappeared, in favour of multi-strategy vehicles. Funds of funds proved to be inefficient, partly because they took too long to react to new developments.”

Several factors drove the consolidation following the financial crisis: the crisis had revealed that some managers were merely using credit to boost market performance, or were even engaging in fraudulent practices. The promise that hedge funds would show only a weak correlation with traditional assets proved to be hollow. The plunge in interest rates also exposed a number of business models as unsuitable for all market conditions.

“As a result, many providers disappeared; funds were withdrawn or reallocated to those hedge funds that actually lived up to their claims during the crisis,” recalls Perret. The requirements for risk management and transparency have increased significantly.

This institutionalisation has also meant that the barriers to entry for investors are now significantly higher than they used to be. Michienzi speaks from personal experience: “It is a rather demanding and lengthy process, both for investors and for us as managers, before we can begin managing the assets.” On the other hand, investors gain a better understanding of what they are investing in, enabling them to grasp the objective and the risk associated with the various strategies. Perret adds: “In the past, investors used to queue up for certain managers; a lot of money was chasing a few investment opportunities. Today, it’s exactly the opposite.”

From Michienzi’s perspective, 2022 was a turning point for the industry: that year, investors suffered heavy losses on both equities and bonds. “Many hedge funds delivered a decent, positive performance at that time. Since then, interest in the instrument has increased significantly again, including here in Switzerland, and its reputation has improved.” Switzerland had already played an important role for the sector in the past, for example as a hub for funds of funds.

Perret highlights another important point. “Hedge funds have proven in recent years that the concept works. They provide investors with a relatively high absolute return without increasing the volatility of the overall portfolio.”

The status of ‘talent’ – that is, hedge fund managers – has also changed. According to Perret, many of the previously independent hedge fund managers have joined larger players in the wake of institutionalisation. “They can continue to operate independently there, but are embedded within the structure of the bank or asset manager.

Today, as back then: ‘War for Talents’

Wellington recognised this trend early on. “For 25 years, we mainly promoted talent from within, but since then we have opened up and also recruit externally,” notes Perret. One thing, at least, has not changed: he speaks of the ‘war for talent’, a term that industry representatives were already keen to use 30 years ago.

Another trend is that the very large institutional investors are beginning to build their own multi-hedge-fund platforms. Perret does not see this as a threat; on the contrary. “We can assist them in this with our expertise.”

Perret has little time for passive investing (which requires little or no talent). “The performance of such products is rather modest; our aim is to generate a significantly higher return for clients after fees.”

And what about the relationship with private markets? “We’ve noticed a recent rise in interest from investors who are somewhat frustrated with private equity because exiting those investments has long been difficult,” says Perret, who also emphasises that his hedge funds are only permitted to invest in liquid assets and therefore not in private markets. Ultimately, however, it is up to the client to decide which market they wish to invest in – after all, Wellington offers both.