Albourne is committed to the pursuit of better practice within the Alternatives industry.
In October 2013 Albourne launched the Investor Manifesto, a 10-point plan recommending areas for improvement in hedge fund reporting standards, recommended disclosures, documentation and governance. Many of these topics have been addressed. Subsequently, in October 2018 Albourne published to its clients the Investor Manifesto II, which is a 50-point reference document of interesting ideas across all alternatives, spanning ten general themes that Albourne plans to discuss with investors, industry bodies, managers and regulators. Investor Manifesto II is a starting point for conversations.
Albourne has been leading efforts to promote transparency and encourage better-aligned terms which help to achieve a more consistent and fair share of return between managers and investors. Central to this has been the initiative to focus an industry conversation on the “shape of fees.”
One example is our development of the “1-or-30” fee structure, which we also refer to as “X-or-Y”. “X” represents the revenue a manager needs to operate, while “Y” is the ultimate total fees paid (representing management and performance fees together), as a percentage of gross returns. “X-or-Y” better ensures that total fees paid over the investor’s entire investment horizon equal Y% of gross returns. Albourne nevertheless recognises that one size does not fit all and that no single fee structure offers the optimal solution to all strategies for all investors. Albourne therefore advocates for funds to offer a transparent range of economically equivalent fee ‘shapes’ which serve to meet the wide and varied mandates of investors.
Open Protocol is an industry accepted, consistent reporting template for managers’ risk and exposure information, created with a view to encourage transparency and to enable investors to aggregate exposure information at the portfolio level.
Open Protocol is a freely available template that standardizes how investment managers convey risk information; it is simply a language, not a centralized data warehouse. As part of an independent working group of investors, managers and service providers, Albourne helped launch Open Protocol in August 2011 and is co-chair of its Working Group and in June 2017, Open Protocol was added to the Standards Board for Alternative Investments (SBAI) Toolbox.
The Administrator Transparency Report (ATR) is a comprehensive and consistent reporting template for administrators’ transparency reporting, including independent confirmation of fund assets and liabilities, pricing sources, counterparty exposures and fair value hierarchy level reporting.
Aiming to standardize the ATR across the alternative investment industry, Albourne, as part of an independent working group of investors, managers and fund administrators, helped launch the first ever ATR template in May 2015 which is now part of the Standards Board for Alternative Investments (SBAI) Toolbox. Albourne is promoting the use of the ATR template among administrators in an effort to promote clearer industry standards, minimize administrator-specific nuances and help investors better evaluate their portfolio investments.
Effective March 2018, Albourne added the Review of ATRs in its standard ODD process, following the SBAI ATR template. This initiative has already resulted in Albourne identifying Administrator reporting errors, fund strategy shifts, significant declines in AUM levels etc.
Albourne is an equal opportunity employer keen to promote the adoption of Diversity and Inclusion (D&I) within the Alternatives Industry. Our goal has always been to empower our clients to be the best investors they can be.
We passionately believe that our clients, and the managers they select, will be better investors when they create an environment which welcomes, promotes, and harnesses diversity in its many forms. At Albourne, we have taken steps to evaluate our internal processes to support the diverse global team that we are immensely proud of. Today, Albourne is a global firm, with 11 locations and a 51% male/49% female gender split.
Please watch the following film on Women in Alternatives, as part of Albourne's Diversity and Inclusion Series.
Albourne's Environmental, Social and Governance initiatives (ESG) are aimed at helping clients to understand what their managers are doing in the ESG space.
The integration of ESG into managers’ investment processes are key to creating a more sustainable investment universe. Under the overarching definition of Responsible Investing sits a wide range of approaches.
Some strategies allow the flow of capital to those areas of the economy which create solutions to many environmental and social problems facing the world. In others, ESG factors are becoming more commonly assessed to determine which factors specific investments are exposed to and how that can materiality impact each investment. Investors increasingly understand that each investment has some type of ESG material exposure that can and will impact the investment.
Global investment consultant Albourne Partners announced its revamped News & Initiatives page on www.albourne.com.
Albourne prides itself on its non-discretionary business model which sets it apart from competitors, and its role as an advisor and advocate for better practices within the alternatives industry over the last 25 years. The webpage features press coverage of Albourne in recent years and information on the firm’s key initiatives.
“At launch, this page includes over 20 articles written on Albourne, including hot-off-the-press coverage from HFM on the importance of improving ESG data, as well as a recent piece from Pensions & Investments on the increasing rarity of pure-play non-discretionary consultants,” said Clare Cuming, Head of Communications at Albourne Partners. She added that, “The webpage hosts Albourne’s first public film, Women in Alternatives, which highlights several interviews with leading women in our industry and provides an update on Albourne’s Diversity & Inclusion initiatives.”
Committed to improving the Alternatives Industry, some of Albourne’s key initiatives are:
The new webpage is available at https://www.albourne.com/albourne/news.
Will Bryant of Albourne reflects on beneficial changes that would help evolve ESG and give greater value to the field
Plenty has been written over the recent months and years regarding the increasing amounts of capital being allocated to Environmental, Social and Governance (ESG) investment strategies. This has come about on the back of increased investor focus due several different drivers, including a shift of capital to younger generations and increased public and media pressure.
Alongside this there have been several articles on the different approaches to ESG investing. These range from simple screens and tilting strategies, whether exclusionary or positive targeted methods, to integrated approaches where ESG factors are embedded within the investment process, using active engagement as an added tool to further enhance positive change. Thematic and impact investing are included in this spectrum, where measurement of the environmental and social goals is a key output.
These different approaches to the inclusion of ESG or ‘non-financial’ data into the investment process will vary based on the characteristics of the investment strategy or the portfolio manager’s belief in the efficacy of ESG integration. Whatever the approach, one thing that has become increasingly clear in conversations with investors and managers, is that the integration of ESG data in the investment space is here to stay. Investors are increasingly demanding ESG inclusion, asset managers are developing ways to integrate ESG into their processes, and corporates are beginning to grasp the potential long-term security valuation benefits of embedding ESG into their business.
Despite the demand for ESG, one key area is holding back further integration. The lack of standardized non-financial data provided by corporates is the main hurdle for many fund managers to be able to easily integrate ESG into their investment strategies; the proliferation of questionnaires with different approaches is also a growing burden for corporates.
Albourne sits at the intersection of investors and alternative asset managers. From this position we have seen the development of the trends for ever increasing ESG integration and the issues that both fund managers and investors face when focusing on ESG in their processes. Along with the rigorous Investment, Quantitative and Operational Due Diligence Albourne currently completes on alternative funds, Albourne conducts a review of their ESG capabilities. Albourne has integrated ESG into its operational due diligence of fund managers to complement its existing ESG questionnaire, and subsequent report, through which Albourne has been gathering and conveying a manager’s approach to ESG integration for over eight years.
To further widen ESG integration Albourne is looking to promote and support efforts to move towards a standardized approach to data production as part of Albourne Investor Manifesto II, launched in 2018.
Current Situation with ESG Data
One of the key issues around non-financial or ESG data is that it can be difficult to directly correlate this data to security valuation or performance. Much has been written about the impact of ESG data on financial performance. In the 2015 paper1 by Deutsche Asset Management and the University of Hamburg, they reviewed over 2000 empirical studies from the 1970s to present day, finding that ‘roughly 90% of studies found a nonnegative ESG-CFP (corporate financial performance) relation,’ with the majority of studies finding a positive relation.
What remains unclear is how long it may take for this relationship to play out in the underlying securities price. For the hedge fund space, the timeframe for recognition of the ESG characteristics may not be compatible with their strategy or may get swamped by other characteristics for which the security is in the portfolio. This leads many investors to focus on the inclusion of ESG data from the perspective of risk mitigation.
At present the reporting by corporates of non-financial data is voluntary and non-standardized; this often sits within a separate Corporate Responsibility or Sustainability report. The fact that the output is not standardized, unlike the reporting of financial data, makes it hard for investors to be able to easily compare companies with reference to these data points.
The increased demand for the inclusion of ESG data within the investment process has led to an increase in third party ESG data and ratings providers. Many investors, asset managers and other stakeholders are increasingly relying on the reports and ratings of third party ESG agencies to assess, compare and measure ESG performance of their investment universe. Given that the inclusion of ESG data into the investment process is in the nascent stages, there is ongoing development, evolution and even debate around methodology and principles for best practice among providers.
Each of the rating agencies have different methodologies in how they arrive at their scores. This has led to a dispersion of overall scores dependent on the provider, a general lack of clear understanding by many consumers of the differences and ultimately, in our view, a slightly confused landscape. It is estimated2 that the correlation between credit ratings issued by S&P and Moody’s stands at about 0.9, while the correlations between MSCI and Sustainalytics (two the most widely used ESG rating agencies) is roughly 0.3.
It is also worth noting that banks are advising corporates on how to improve their ESG ratings and benefit from positive screening in investor strategies.
Over recent years several initiatives have come about in order to create common reporting frameworks, such as the Global Reporting Initiative, the UN Global Compact and the Carbon Disclosure Project. These sorts of initiatives can lead to companies being more focused on how they perform relative to the criteria of the framework, rather than focusing on optimizing their ESG impact within the framework of their business model.
What the Future Might Look Like
Currently, the biggest hurdle standing between the mass adoption of ESG, possibly after an (increasingly shrinking) investor belief that integration of ESG factors is not relevant, is the lack of consistent data.
What is required is a consistent global approach covering a range of different topics under the ESG umbrella, ideally with some level of third party audit of this data. One standardized reporting protocol, with strict (and possibly regulated) definitions around the different metrics, would be simpler for corporates to produce rather than the plethora of existing reporting frameworks, which are currently the burden of corporate management.
Over recent years there have been isolated efforts to gain this standardized data in individual areas within ESG. Efforts include the Greenhouse Gas Protocol3 and the UK Gender Pay Gap4 reporting, both examples provide standardized well-defined ways to explicitly show data in an objective, quantifiable manner.
There is still very much a place for corporates to provide their own Corporate Responsibility or Sustainability report or integrate this information within their annual report. This demonstrates to their stakeholders how they view their activities from an ESG perspective and how it fits within their own specific business model. However, this should sit alongside a standardized display of objectively defined data.
The auditing of this data is also a key step in the confidence that investors can take when using the output. As with the provision of traditional financial data, non-financial data should be treated to the same level of oversight and verification.
The requirement for the reporting of non-financial data is increasing, what is currently voluntary is going to become required by many stock exchanges and regulators. There needs to be a coordinated approach across national agencies to avoid a fragmented reporting landscape. Ideally the industry needs to avoid the adoption of more than one approach as is seen in accounting standards (whereby investors need to be proficient in both US GAAP and IFRS methodologies).
Within the EU there is a will to create regulation around the standardization of reporting on ESG topics, whereas in the US the approach seems to be to let the market naturally encourage companies to make adequate disclosures. This is likely to lead to a wide variety in quantity and quality of data as corporates can report in different formats. Currently corporates in the US must disclose material items, however what is material is currently at the judgement of directors.
A standardized approach would maintain a place within the industry for the existing ratings providers who are taking that data and using their own proprietary methodologies to distil the data into an actionable approach.
From Albourne’s perspective the above outline for the future of ESG data provision looks very similar to the creation of the Open Protocol5. That is because the aim and need are very similar, both are looking to standardize the reporting of information. The standardization of the information would allow for simple collection, collation and comparison of relevant data points.
The use of standardized comparable ESG data by investment managers would then be defined by their interpretation of materiality and applicability within their relevant strategy, with the aid of frameworks such as SASB6. Allowing managers to continue to evolve their investment approaches and to be able factor in all information that is relevant and material to an investment – the key to any investment strategy.
Texas Employees Retirement System, Austin, rehired Albourne as hedge fund consultant,a webcast of the pension fund's board meeting Wednesday showed.
The $28.7 billion pension fund issued an RFP in March as part of the normal process of putting the services up for bid every few years. ERS' general investment consultant NEPC was the other finalist.
Texas ERS originally hired Albourne as its first hedge fund consultant in 2011.
Separately, the pension fund returned a net 5.3% for the year ended June 30, below its policy benchmark return of 6.1%. For the three, five and 10 years ended June 30, ERS returned an annualized net 9.2%, 6.2% and 8.9%, respectively, compared to their respective policy benchmark returns of 8.7%, 5.9% and 8.9%.
The ranks of pure-play alternative investment consulting firms are thinning as the consulting industry consolidates and firms add money management to their services, a trend that winnows investors' choices and opens up consultants to potential conflicts of interest. Faced with increasing competition from general investment consultants and pressure from asset owners to reduce fees, alternative investment consultants are adjusting by merging with other consulting firms or augmenting services with higher-profit money management and managing discretionary assets.
A review of Preqin's top 20 list of nondiscretionary investment consultants and Pensions & Investments' database revealed only two pure-play alternative investment consultants that do not manage capital: Albourne Partners Ltd. and TorreyCove Capital Partners LLC.
As part of the $56.5 billion Los Angeles County Employees Retirement Association’s search process earlier this year for a specialty investment consultant for hedge funds, illiquid credit and real assets, the Pasadena, Calif.-based pension fund scored bidders on potential conflicts of interest. LACERA in March hired Albourne Partners Ltd. as the best fit. Albourne had scored the highest of three finalists based on a number of factors that also included fees and services offered. Among its strengths, LACERA officials noted that Albourne was solely focused on alternative investments and that it had the least potential conflicts because it has a pure non-discretionary advisory model. The other two finalists derived a portion of their income from discretionary clients.
Please refer to the full article for further details.
Albourne Partners is expanding its focus on environmental, social and governance factors by incorporating ESG into its broader operational due diligence process.
The consultant, which oversees over $500bn in alternative advisory assets, has some 75 staff dedicated to ODD, who will now start asking all managers they review about their approach to ESG. The ODD team will focus on how hedge fund managers incorporate ESG across various metrics, including operational set-up and resources.
Following the insurance losses from catastrophic events worldwide in 2017 and 2018, the Standards Board for Alternative Investments (SBAI), whose members include both managers and institutional investors in alternative investments, has published “Valuation of Insurance-Linked Funds”, a document that provides guidance for investors conducting due diligence on funds that invest in (re)insurance-linked investments (“ILS Funds”). The document, developed by a working group of institutional investors, investment managers, and investment consultants – including Albourne Partners – is the first in a series of Toolbox Memos on ILS Funds to be published by the SBAI.
Michael Hamer, Partner and Senior Analyst at Albourne Partners, said: “The process for valuing reinsurance investments is a very important aspect of due diligence, given the high levels of uncertainty that can arise after large loss events. Investors also need to understand the differing ways in which funds deal with this uncertainty, including the use of side pockets and other mechanisms that may reduce the risk of unintentional value transfers between investors. We look forward to contributing to the SBAI’s future work in this important area of investment.”
Members of the SBAI ILS Working Group include representatives from Aberdeen Standard Investments, Albourne Partners, CPPIB, Elementum Advisors, Future Fund, Hiscox Re-insurance Linked Strategies, Nephila Capital, PGGM, PIMCO and Varma. The Toolbox Memo can be accessed here.
Sean Crawford joins in Connecticut, as the alts consultant boosts San Fran office with Spencer Edge.
Albourne Partners has hired the former CIO of the New York Metropolitan Transportation Authority, HFM InvestHedge has learnt. Sean Crawford joined the Connecticut office last month. Albourne, which advises on $500bn in alternatives assets, has also boosted its ranks in San Francisco, bringing on board Spencer Edge.
Albourne Partners Ltd. has been around for a quarter-century and advises institutions who collectively invest more than $500 billion in alternative assets. So when Albourne this month, for the first time, made it mandatory for the roughly 650 hedge funds one of its teams monitors to answer questions about their approach to environmental, social and governance issues, it highlighted a shift the industry is struggling to cope with but can’t afford to ignore.
Steve Kennedy, the partner who leads Albourne’s ESG initiatives, said hedge funds can tackle the issue “from a lot of angles.” Albourne still has an optional questionnaire that hedge funds can choose whether to answer. The mandatory part comes when the firm is hired by an endowment or pension fund to conduct due diligence on a fund’s operational risks.
EuroHedge sits down with Albourne Partners co-founder Simon Ruddick to discuss fraud warnings, allocating in the aftermath of Lehman and shifting the conversation on fees.
The collapse of LTCM and Bernie Madoff’s fraud: events that occurred almost a decade apart with little in common, except that they played a key role in cementing Albourne’s credibility as a leading investment consultant for hedge funds. In February 1998 the London-based firm produced a document that was hugely bearish on fixed income arbitrage. It was one of Albourne’s first strategy reports, drafted by Hitoshi Nagata, whose hedge fund, Cambridge Financial Products, had recently closed and returned investor capital because of the limited opportunity set. Unlike other pieces of research, which were only shared with clients, Albourne widely distributed its concerns on fixed income arb, which played out a few months later when hedge fund giant LTCM saw the value of its trades drop by 50% as a result of Russian currency devaluations and a flight to US treasuries.
“It wasn’t luck that we wrote that, it was skill, but what was luck was that we gave it to everyone we knew,” explains co-founder Simon Ruddick. “In the summer of 1998 that was the whole story and we had this document from February pointing out all the issues, so that was a huge leap in credibility.”
The second “leap” took a bit longer to play out, although it also started in the last quarter of 1998, when the consultant began to warn people about Madoff. They took a similar tack in disseminating their views, telling “everyone”, not just clients, that they should avoid Madoff. Ruddick recalls that they were “teased enormously” by their peers for talking about something that, at the time, didn’t seem to materialise. “If you keep going on about something, it sounds like you were wrong,” he says. Eventually – a decade later – they were proven right, once again boosting their status in the hedge fund advisory world.
Right but wrong
The raison d’être for setting up Albourne was also an example of Ruddick and his colleagues being right at the wrong time. Founded in 1994 by derivatives traders Ruddick and Guy Ingram, who had worked together at Westminster Equity, Albourne was established to help a small group of clients assess the risks in their portfolios. This select group of allocators was already too sophisticated to use a FoHF and just wanted some advice, says Ruddick, adding that from there, they “just over-extrapolated”.
“We were absolutely convinced, in 1994, that institutions would want advice to be able to top up their direct investments. That was at least six years too early, but it meant that everything we did was in preparation for such a day, with that type of client base, that type of sophistication and transparency. So we were quite fortunately placed when that’s the way the world went.”
Among the ways Albourne differentiated itself was that it researched hard-closed funds as well as those raising assets, unlike some of their competitors, who only focused on funds they could put client money into. Their approach served them well during the crisis, Ruddick says. “In the fourth quarter of 2008 no one was closed. All the top funds reopened, and we were allocating client money to firms that were previously impossible to get into.
“That helped our clients, but also those funds, who thought it was a miracle to be getting money at that time.”
Alphatraz and Opera
The aftermath of the crisis was sobering for many reasons, but was a reminder of what Albourne wanted to focus on. Ruddick recalls the firm’s corporate planning committee gathering after the collapse of Lehman Brothers. At prior meetings, the discussion had always been around how the consultant could continue on its 50% annualised growth trajectory, but post-Lehman it was obvious that such a focus was inappropriate.
“I started the meeting by saying, instead of talking about 50% growth, why don’t we talk about how we potentially manage a business through what could be a severe corporate-life-threatening decline and [prioritise] the best interests of our clients as well as trying to secure employment for our colleagues, given it’s their livelihood and the livelihood of their dependents.”
He describes the experience as salutary and sobering, adding that while he wouldn’t want to repeat it, it brought home the idea that corporate responsibility went far beyond bonuses and dividends. A slightly more bizarre anecdote Ruddick shares from the days following Lehman’s collapse relates to a client event called Escape to Alphatraz, held at Alcatraz Prison, which had been planned for months and included convict-style jackets to be handed to clients.
“I remember thinking, it’s slightly awkward because this might be the end of the world...when’s a good time to hand out the convict jackets?”
Albourne’s themed events are not simply a way to show the world the company’s quirky culture, they serve a distinct purpose – arguably to push their clients, and the industry, forward on the path to institutionalisation. Among the things born out of the crisis were administrator transparency reports and Open Protocol, a risk reporting standard initially dubbed ‘Opera’, launched in 2011. Ruddick is keen to stress that the industry had started considering what was best practice before the crisis, evidenced by a hedge fund working group which evolved to become the Hedge Fund Standards Board (and since renamed the Standards Board for Alternative Investments).
He adds: “2008 was a huge wake-up call and it triggered a lot of changes that we were passionate about. Some of them happened quickly, some of them happened slowly and some of them have absolutely not happened at all.” He emphasises that many of the problems that led to the last financial crisis have returned. “It concerns me deeply that we have not learnt the lessons that really count and matter from 2008.” These include high levels of leverage and weak lending documentation related to structured products which are now parked in money market funds and other products sold to the mass market.
“If the last financial crisis felt scary, we will literally have seen nothing yet. A financial crisis gets most scary when retail investors realise it’s happening.”
Regulators, frustratingly, have the wherewithal to model and manage systemic risk but are failing to do so, he says, due to a lack of harmonisation and cooperation between jurisdictions.
And what is Albourne’s take on the sector’s underperformance over the last few years? “With institutional money and their longer time-frames, there is less flight of capital risk than in the past,” says Ruddick.
“The more stable capital base and greater amounts of capital have been paradigm shifts which mean the rational expectation of return is smaller now.”
While investors should have moderated their return expectations, he caveats that performance should not have been as disappointing as it has been. Ruddick says that the performance of the “Fangs” – Facebook, Amazon, Apple, Netflix and Google – has made active managers, and hedge funds in particular, look like “charlatans”, but that this is a phase and not a paradigm shift.
“The key thing for hedge funds at the moment...is there is less tail risk in hedge fund portfolios than in a long bond portfolio. Hedge funds are a phenomenally complicated way of earning almost no money, but they are still just about worth it.”
He predicts that hedge funds will do well out of the next crisis, not because of their holdings at the time, but because of their ability to react in the aftermath. “People like to think that hedge funds should gain during a crisis – if markets go down, hedge funds rise – but it is completely coincidental what they’re holding. Their job is not to guess what others will do and do the opposite, their job is to be smarter than everyone else if there is a spike of inefficiency in the market and use their more flexible mandate to profit. The best time for them is immediately after a disruption and the reversion to a long-term norm or equilibrium.”
He likens hedge funds to hyenas “poking around in the aftermath of a kill and scavenging returns.”
Fees and future innovations
Investor disappointment with the less-than-meaty returns of 2014, 2015 and 2016 tipped the balance and allowed Albourne to bring to fruition a campaign it had started much earlier – creating a more equal conversation around fees. At the end of 2016, Albourne and one of its largest clients, the $155bn Teachers’ Retirement System of Texas, revealed a new fee structure, 1 or 30. The ‘or’ structure is designed to ensure that allocators receive 70% of alpha or outperformance generated by managers, while also guaranteeing the latter a fee – the higher of performance or management – regardless of returns generated. Having conquered that industry bone of contention, some might think Ruddick would be content to take a step back from pushing for further reform. They couldn’t be further from the truth. In October, Albourne unveiled its second Investor Manifesto (IMII), having released an initial tome in 2013.
The document, revealed during Albourne’s annual meeting in London, contains 50 proposals designed to improve the alternative asset management industry for the benefit of investors and fund managers, with Ruddick stepping down from Albourne’s executive committee to focus on championing the initiative. Given the number of proposals on the table, Albourne doesn’t anticipate delivering all of them and intends to spend the next 12 months carrying out further consultations with clients and managers to determine what to focus on. Ruddick is fiercely committed to the sector and “passionately” convinced that hedge funds are good for Albourne’s clients and for the world. But he is also never one to shy away from speaking his mind and has some strong views on how a number of Europe’s heavyweights have involved themselves in the political debate around Brexit.
“The crowning irony of Brexit, if it happens, will be that those who voted for it will suffer the most while those hedge fund managers that funded it will most likely benefit as they run businesses with US dollar-denominated revenue and a sterling cost-base.”
For Mark White, real assets are starting to come into their own. “It’s the most interesting asset class to be in as far as I’m concerned,” he says.
Formed in 1994, Albourne is a specialist alternative consultancy focusing on complex activity, including hedge funds, private equity, real estate, and real assets. White joined the firm in 2008 to build out its real assets practice. Now he oversees a team of nine dedicated analysts, conducting due diligence on investment managers, doing portfolio construction, and running day-to-day operations. He helps build portfolios from scratch and revamps existing ones, as well as advising on direct and co-investments, and managed accounts. According to White, he’s helped clients build and oversee (since Albourne is non-discretionary) roughly $21 billion in real asset portfolios.
Albourne has published its second Investor Manifesto setting out “game-changing” proposals to reform the alternative asset management industry for the benefit of fund managers and investors.
The document, which contains 50 recommendations, was unveiled on the first day of the advisory firm’s annual meeting today.
Points from the manifesto that are likely to prove particularly popular with hedge funds include a change to the US tax code that would make multi-year crystallization fee structures more tax efficient and the formulation of templates for permanent capital structures.
Other key proposals include the development of an identifier database covering all industry participants and the creation of a standardised means of corporate-level ESG reporting.
Investors are improving fee alignment with their asset managers, renegotiating old fee structures and ensuring they pay only for skill, a panel of experts told the Fiduciary Investors Symposium at Stanford University.
Albourne Partners chief executive John Claisse has helped asset owners such as the $140 billion Teacher Retirement System of Texas develop a new structure for hedge fund fees with a 1-or-30 model. Under this system, investors agree to pay more for alpha than the traditional 20 per cent. And although investors prefer to only pay for excess returns, under this model they also pay a fixed management fee to enable the manager to “keep the lights on” during periods of underperformance. Crucially, the management fee is an advance on future performance fees – managers need to earn the management fee back before they receive performance fees.
“We were set a goal to put in shape a structure that was easy to explain and where Teachers retained 70 per cent of alpha,” Claisse recalled.
He also noted that investors shouldn’t pay high fees for systematic strategies.
“There are now many ways to access underlying drivers of hedge fund strategies through risk premia,” he told delegates. These strategies have created an investable alternative that is liquid and transparent and makes it easy for investors to assess whether they are genuinely getting alpha. “The pressure on hedge funds to justify returns has never been greater,” Claisse said. “Don’t pay for expensive beta, pay for skill.”
Two years ago, Albourne Partners Chairman Simon Ruddick described the fees hedge funds charge as the “elephant in the room.” Disappointing returns and a lack of transparency about levies meant investors were at risk of losing interest in the market, he warned.
Mark Gilbert caught up with Jonathan Koerner, the partner at Albourne who devised the arrangement, by telephone from Norwalk, Connecticut. Following is a lightly edited transcript of their conversation.
MARK GILBERT: Hedge fund fees have been coming down for a while now, with Hedge Fund Research figures showing average management fees dropping to about 1.43 percent this year, while incentive fees are down to about 17 percent. Your proposal for a 1-or-30 structure has gathered pace, with more than 60 hedge funds adopting it by the end of last year. What’s the current tally?
JONATHAN KOERNER: There are 77 that I know about and are confirmed. There are certainly some out there that I don’t know about. We have clients that are actively pursuing 1-or-30 or x-or-y structures across their portfolio but have decided to keep the results private.
MG: In the event of a massive outperformance, it seems like the investor can lose out compared with traditional previous structures?
JK: This structure won’t always benefit investors, but it will benefit them when the manager underperforms. In a way, the 1-or-30 is an insurance policy. The premium is paying extra fees when the manager truly outperforms. But that is the only condition under which the investor pays more. The protection the investor buys is avoiding the risk of overpaying for underperformance.
Conversations about environmental, social and governance (ESG) factors with hedge fund managers circa 2011 were painful – there was “complete silence” from most firms in the industry, Stephen Kennedy, a senior portfolio analyst at Albourne Partners, recalls.
Fast forward to today, and although some managers still look blankly when ESG is raised, the situation has improved somewhat, he says. “[ESG] has definitely been more of an area where some groups have done a decent amount in terms of finding the data sources, thinking about it and how they want to integrate that without altering their basic, initial investment process.”
More importantly, investors have also been stepping up their focus on ESG, in terms of the stocks they choose to hold as well as the conversations they have with third-party managers.
“The number of conversations with our clients is increasing. Almost every European investor has some level of interest in this and many more US investors are talking about it,” says Will Bryant, a partner and portfolio analyst at the consultant.
The fact that more US investors are starting to show interest is significant, he adds, given that the majority of hedge fund capital still comes from there.
To reflect the changing focus of clients regarding ESG, Albourne is evolving its own efforts in this area. Over the last year, the specialist consultant, which advises on more than $400bn in hedge fund assets and $50bn of other alternative assets, has changed its ESG-focused questionnaire and has developed a new set of ratings for those managers that incorporate ESG into their investment process.
The Standards Board for Alternative Investments (SBAI) has established a North American Committee of leading alternative investment managers and institutional investors to direct the SBAI’s efforts in the region. The SBAI is the global standard setting body for the alternative investment industry, supported by approximately 200 managers and investors overseeing $3 trillion.
The North American Committee (NAC) was set up in March 2018 to help the SBAI direct its efforts in North America, including identifying local issues for inclusion in the SBAI’s studies and working groups, supporting the SBAI’s North American roundtables, communicating with SBAI members, and driving increased participation in the SBAI process among North American alternative investment managers and institutional investors.
Hedge funds need to be more flexible with fee arrangements and respond to investor demands for fee alignment, said Albourne Partners chief executive John Claisse, who pointed to the ‘1 or 30’ fee structure the consultant helped develop with Teacher Retirement System of Texas (TRS) as an example.
“When it is working, there is an elegance,” Claisse said, speaking at the 11th-annual Investment Magazine Absolute Returns Conference, which was held in Sydney on September 14, 2017. “You are tapping entirely into your share of alpha, and paying for skill.”
As Albourne partner Jonathan Koerner explained in the case study on the $140 billion Texas Teachers, the 1 or 30 structure always pays a 1 per cent management fee or a performance fee of 30 per cent of alpha, whichever is greater. However, following periods when the 1 per cent management fee exceeded 30 per cent of alpha, an investor pays less to bring its share of alpha back to 70 per cent.
Essentially, when alpha is not sufficient to cover the 1 per cent management fee, that fee is paid as an advance on future performance fees.
“What we’re hearing from asset owners is that 1 or 30 revolutionises the conversation,” Claisse said. “It simplifies the focus to [put it] on alpha, and there is an elegance to that. Credit to TRS, they are not just doing it for their own benefit. Ultimately, it stabilises the business model of the manager, which is good for every investor.”
He says some large sovereign wealth funds are asking all their managers to consider these structures.
Furthering this, Albourne has conducted a survey, which 350 funds have completed. It found that more than 40 per cent have adopted a 1 or 30-style fee structure or are considering it.
Claisse said the beta hurdle and performance fee share are negotiable.
“This is not a one-size-fits-all,” he explained. “There are a lot of different types of fee structures for different strategies, but the important thing is they are all focused on the alignment of fees. It’s not the level but the shape of fees that’s most important.”
Albourne commends SBAI for its guidance on Standardised Total Expense Ratio (STER). The SBAI STER calculates a single, standardised expense ratio to facilitate better understanding, comparison and monitoring of fees and expenses across alternative investment funds. A unique and important feature of the new STER methodology is that it includes the costs of research bundled with dealing commissions (often referred to as “soft dollared research costs”). Thus, the STER allows the comparison of a fund’s structural costs on an “apples to apples” basis (i.e., providing additional transparency to which operating expenses are allocated to the fund or conversely borne by the manager). The STER was developed in response to needs amongst institutional investors for a standardised tool to compare and monitor structural costs between alternative investment funds and over time.
To make it useful for comparison purposes, STER excludes incentive fees which will fluctuate as a function of performance and trading related costs that will vary significantly and depend on the specific investment strategy. Given the benefits of a simple, consistent and transparent comparison of costs among funds and peer groups, the SBAI encourages the industry to start to use the STER methodology.
Alternative investment consultant Albourne Partners has been named as the sector’s most influential name in HFMWeek’s annual investor Power 30 rankings, as it leads the charge on fee innovation and transparency.
Albourne’s efforts in promoting a new ‘1 or 30’ fee structure, which sees managers earn either a 1% management fee or a 30% share of alpha-generated performance over a benchmark if that becomes greater, has been tipped as a hugely significant move by prime brokers and managers canvassed for HFMWeek’s research highlighting the industry’s 30 most influential investor-related firms.
Well over 50 hedge fund managers are implementing the new fee structure which Albourne has been pushing alongside long-standing client, the Teacher Retirement System (TRS) of Texas.
A number of other investors are also asking managers for similar deals.
Albourne advises clients with over $400bn in hedge fund and other alternative assets and given its reach, alongside its work on fees, it has knocked the Abu Dhabi Investment Authority (ADIA) off the top spot.
ADIA, which manages over $800bn, takes the number two spot, while the $814bn China Investment Corporation, another sovereign wealth fund with over $100bn invested in hedge funds, sits in third position.
A recent HFMWeek poll of 200 managers found that half of them were “seriously considering” moving to a 1 or 30-type model.
Referred to by Albourne as an ‘or’ structure, the use of a management fee recoup can also be applied to a larger or tiered management fee, while the performance hurdle calculations can also be modified, by using a longer investment horizon, for example.
Disclosure: The 2017 HFM Investor Power 30 List is a subjective compilation based on the opinion of HFM editors and consequently, the results may no longer be current or applicable. Albourne Partners is not in position to know how many firms HFM considered for this award, but the firms that appear on this list were judged on criteria such as: pushing for more consideration of environmental, social and governance factors; demanding customised structures or co-investments; leading the charge for better alignment of interest between managers and LPs; its activities over the last 12 months; opinions of managers and prime brokers.
SBAI, the organization previously known as Hedge Fund Standards Board (HFSB), the global standard-setting body for the alternative investment industry, has become Co-Chair of the Open Protocol Working Group. The Open Protocol template standardises the collection and representation of risk information of hedge funds and other types of investment funds, and currently is used by funds with over $1 trillion in assets under management. Open Protocol, which is an open standard which all investors and managers are free to adopt, will be added to the HFSB Toolbox. The Toolbox complements the HFSB's standard-setting activities by providing additional guidance on practical issues to managers, investors and fund directors. The materials available through the Toolbox serve as a guide only and are not formally part of the Standards and the HFSB's "comply-or-explain" approach. Open Protocol will become the fourth item in the HFSB Toolbox, following the publication of the Cyber Security Memo, Administrator Transparency Reporting and the Standardised Board Agenda.
Open Protocol was developed in 2011 by a working group of leading investors, managers and other industry stakeholders to improve alternative investment fund transparency and to aid investors in aggregating their exposure across funds. The Open Protocol Working Group will continue maintaining and developing the template to ensure it remains up to date. The working group will be co-chaired by Albourne Partners and the HFSB. In addition to the HFSB joining the working group, Callan Associates, the investment consultant, has also joined.
Dame Amelia Fawcett, Chairman of the HFSB, said: "Better risk disclosure by investment funds has been a priority for both investors and regulators in recent years. Investors are looking continuously for better ways to aggregate risk information about their investments in order to improve overall portfolio risk management. Regulators have also started collecting data to assess potential systemic risk concerns. Open Protocol allows investors to harness data with aggregate risk exposures, while managers can streamline their own reporting to investors."
Simon Ruddick, Founder of Albourne Partners and Trustee of the HFSB, whose firm initiated the Open Protocol project in 2011, said: "We are delighted that Open Protocol has found a home with the HFSB. The HFSB provides a strong platform to take the work forward and is well-positioned to share the Working Group's expertise on risk aggregation with the regulatory community, as well as help their efforts in addressing potential broader systemic concerns."
Bruce Cundick, Chief Investment Officer at Utah Retirement System (URS), a Trustee of the HFSB and an Open Protocol Working Group member, said: "URS uses Open Protocol data to aggregate risk. This allows us to better understand and manage the risks we take in our overall portfolio on behalf of our plan holders."
Henry Kenner, Founding Partner & CEO, Arrowgrass Capital Partners and a Trustee of the HFSB, said: "Open Protocol has formed part of Arrowgrass' comprehensive suite of information offered to investors for a number of years, reinforcing our commitment to transparency. We believe that such a protocol provides a consistent, industry-wide approach to risk and exposure reporting, benefitting both managers and investors alike."
The HFSB was formed in January 2008 as the standard-setting body for the alternative investment industry, bringing together managers and investors globally to help determine how the industry should operate. It is custodian of the Hedge Fund Standards, which create a framework of transparency, integrity and good governance for the industry, facilitate investor due diligence and complement public policy. The HFSB also provides practical guidance to investors and managers in areas such as fund governance, standardised transparency and risk reporting, and cyber security through its HFSB Toolbox. The HFSB is supported by more than 125 alternative investment managers with approximately $1 trillion in aggregate assets, and by more than 60 institutional investors investing over $800 billion in hedge funds. The Hedge Fund Standards and the full list of signatories and supporters are available at www.hfsb.org.
*Please note that in September 2017 the HFSB was renamed to Standards Board for Alternative Investments (SBAI)
At HFMWeek’s European Hedge Fund Services Awards 2017, Albourne Partners won in the category of ‘Best Overall Advisory Firm.’
Disclosure: The awards are an annual fixture and consequently, the results may no longer be current or applicable. For the HFM European Hedge Fund Services Awards 2017, a total of 135 companies were shortlisted across 50 categories. For the category Best Overall Advisory Firm, 11 companies were shortlisted, and Albourne Partners came on top based on the following criteria:
*Summary of business model, including countries of operation, client numbers and turnover/profit; Summary of business growth in 2016/2017
*Development of chosen category's offering in 2016/2017 - examples of product innovation and how the company has dealt with challenges (e.g. regulation) over the last year
*Detailed information on how the company has dealt with customer retention and new client wins