Magazine Issues » November 2009

EXECUTIVE INTERVIEW: in it for the long haul

Matteo Perruccio (pictured) believes pension schemes will support the hedge fund of funds model. But the CEO of Hermes BPK Partners warns that another asset bubble could reveal how short-sighted some funds are, finds Nick Fitzpatrick

perrucio.jpgThe hedge fund world, after being savagely culled by the crisis but exonerated from the blame for causing it, appears to be bouncing back. Two large UK pension schemes have given hedgies a vote of confidence in recent months. The USS, a scheme for university staff, is to invest 20% of its £23bn (€25.7bn) portfolio in 25 funds, while the West Midlands Pension Fund, one of the UK’s largest local government schemes, has invested £40m in a fund of hedge funds.

For some hedge funds, the importance of pension scheme investors has been amplified over the last year. Their longer-term outlook means money sticks far better on average than investments from private individuals.

“Institutions are more long term in their outlook meaning the money is more sticky,” says Matteo Perruccio, CEO of Hermes BPK Partners.

Hermes BPK is a recently launched fund of hedge funds business owned by the British Telecom Pension Scheme, one of the UK’s largest pension funds. It is operated by Hermes Pension Fund Management, the executive arm of the scheme.

A hedge fund would be hard pushed to find itself in a better place – not just seeded by a well-known pension plan, but promoted by it to boot.

But the beginning for Hermes BPK was not auspicious. Perruccio’s first day at work for Hermes coincided with the collapse of Lehman Brothers, and the partnership had not yet been formed.

Hermes had already committed, however. Feeling its strength lay in asset allocation rather than direct money management, the plan to form a limited liability partnership went ahead with Hermes as 61.5% owner, and partners Perruccio, Mark Barker and Gregory Knott with the rest.

Perruccio, previously co-CEO of Olympia Capital Management in Paris, spent six years working at Pioneer Global Asset Management before that. This is where he met Barker and Knott.

Big backing
The three partners were close to signing a deal with another provider before meeting Hermes.

“The good thing about partnering with Hermes is that when we are marketing to other institutions and we can show that we manage money well for the BT Pension Scheme, then that is our calling card for other pension schemes and institutional investors,” says Perruccio.

The benefit for BT is that as Hermes BPK manages more money externally, it can be benchmarked against a competitive universe ensuring best-in-class performance for the scheme.

Perruccio knows he’s in a lucky position – and it’s not just down to the backing of BT’s pension fund.

“As a new firm we are fortunate to not have short-term considerations and legacy issues in the portfolios, such as redemptions, legal issues or side pockets. If you follow the ‘80/20 rule’, it means that one legal problem in your portfolio requires 80% of your time to deal with it…”

The hedge fund of funds industry has been hampered by such issues. Naturally enough, Perruccio is optimistic about the industry, despite the damage to its reputation. But he acknowledges that much went wrong.

“In the fund of hedge funds universe, somewhere along the line we translated ‘consistent positive returns’ into ‘uncorrelated absolute returns over time’. When the crisis hit and the absolute returns were proven to be illusory, investors were inevitably disappointed.

“However, we need to keep in mind that the crisis was a major historical event and it would be naïve for investors to think their products would protect them entirely from problems in a major market disruption like 2008.”

He says that although the promised absolute returns did not materialise, fund of hedge funds were down on average approximately 20%, while the equity markets were down double that. Pension funds that chose to hold only funds of hedge funds in 2008 – at the worse point of the crisis – would have been much better off now than those holding only equities.

But there was also the problem of liquidity, which the slippery money of many individual investors inflamed.

“Many fund of hedge funds began to focus more on asset gathering than on investment management and their models became diluted and compromises were made to attract different client segments,” he says.

“Originally the model was intended to provide diversification and strong risk-adjusted absolute returns. But as the focus turned to asset gathering the trend was to offer higher liquidity to acquire high-net-worth clients, who wanted more liquidity in their fund holdings.

“This led to a mismatch between the less liquid assets that fund of hedge funds were forced to invest in to obtain higher returns in a low volatility environment, versus the higher liquidity offered to clients at the fund level.”

Many wealthy individuals may have fled, but a lot of institutional investors, Perruccio says, have maintained their hedge fund holdings and some are even putting more money in. Many institutional investors remain positively disposed towards the asset class, he claims.

Being associated with a good brand will help a fund of hedge funds develop an institutional client base, Perruccio believes. Brand, along with reputation, is the common denominator that allowed funds to grow before the crisis. Those that didn’t have these got stuck in the €3bn-€5bn range.

Hermes BPK will run two funds initially. One is a restructuring fund that focuses on distressed credit and restructuring opportunities.

“We believe this is a good place to be because of the historical size of distressed debt and dislocations in the market,” says the CEO.
It has nine to twelve underlying managers and targets mid-teen returns. The fund has raised $345m (€234m).

The other fund will be approximately $1bn in total and is currently 85% invested. It is a more traditional multi-strategy fund, containing macro, credit, long-short and other strategies. There will be approximately 30 managers when it is fully invested by year end.

Perruccio adds: “We are averse to risk and will likely underperform in a bull market but outperform in a bear market.”

In terms of manager selection, he points out that Hermes BPK’s head of operational due diligence, Vincent Vandenbroucke, has an absolute veto over a manager, which cannot be overridden.

The pricing’s right
Perruccio is particularly proud about the pricing model that Hermes BPK applies. “We are the first fund of hedge funds that we know of to launch a share class with a three-year pricing model. This aligns us more with our institutional investors.

“We will only take one-third of the performance fee at the end of the first year, and the remaining fees are held in escrow.  If the following year we are below the watermark we won’t take the other two-thirds until we are above it.”

Administratively, the fee structure presented many challenges. For operational reasons it can be difficult for funds of hedge funds to treat investors fairly. For its fee model, Perruccio says a deep knowledge of series-shares accounting came in handy for Hermes BPK. Every time an investor comes into a fund a new fee is created that has to be kept track of.

Fair treatment of investors is just one of the lessons learned by hedge funds during the financial crisis and the industry is still to arrive at an overall solution for this and other problems, such as the safety of client assets put up as collateral.

A tighter regulatory environment may suggest regulators do not trust the industry to strengthen its processes itself – particularly when markets turn around. Hedge funds can have short memories.

“The industry tends to be short-sighted and unfortunately I see this occurring again with people believing that we are once again in a sustainable rally.

“It feels to me like we are creating another asset bubble. With this in mind we have a special fiduciary responsibility as investment managers of pension assets. We must remain cognisant every day that we are managing grandma and granddad’s money.”

©2009 Funds Europe