Matthew Feargrieve considers the opportunities and challenges that the virus presents for alternative asset managers in Switzerland
With the COVID-19 pandemic representing a Black Swan event for fund managers worldwide, the onslaught of the virus will be a test of the hedge fund industry’s ability to deliver returns that are uncorrelated to the markets. In this article we consider how Switzerland, the world’s number 5 for hedge fund management, is positioned to help investors ride out the market turmoil.
According to a 2019 report prepared by the Zurich School of Management and Law (ZHAW), the two predominant investment styles pursued by hedge fund managers based in Switzerland in 2018 were long/short equity and CTA/managed futures, two discrete strategies that have had very different fortunes over 2018 and 2019.
Managed futures funds suffered huge outflows in 2018, and long/short equity funds experienced redemptions in 2019 that were four times the value of outflows in 2018, with managed futures seeing some inflows in the second half of 2019 as refugees from equity sell-offs sought alternative strategies and asset classes. Additional investment into CTA/managed futures in the latter half of 2019 was driven by investors anticipating the end of the long-running bull market.
In long/short equity and CTA/managed futures, investors may find some respite from the relentless downward trend of global markets following the rise of the coronavirus. Both strategies enable the manager to hedge against bear markets, through the use of stock shorting and financial instruments such as futures contracts.
The week ending 28 February 2020 saw the largest single-week outflow from global equity funds ever recorded: some GBP1.6 billion was withdrawn by panicked institutional investors, according to Calastone’s February Fund Flow Index, mainly from actively-managed funds, whilst passive index funds saw net inflows, mainly from retail investors.
These exiting institutional investors will need a new home for their investment monies, and long/short equity and managed futures seem set to benefit from increased allocations. Financial reports have shown long/short equity managers making significantly smaller losses than comparable benchmarks. In other words, whilst down overall on January returns, they have been outperforming the market.
This is welcome news not just for investors but for the hedge fund industry itself, which over the past decade has suffered reputational damage, prominent closures and asset outflows caused by under-performance in a bull market and notoriously high fees. According to Hedge Fund Research, equity-focused hedge funds in 2017 gained an average of 13.7%, whilst the S&P 500 stock index climbed 29%, a gap that has been fairly consistent since the 2008 financial crisis.
This consistent under-performing by hedge funds of soaring equity markets over 2017-2019 (to which equity long/short funds were a big contributor) has also been a bugbear of alternatives managers based in Switzerland. But this trend looks set to change as the crashing market opens up opportunities for managers to short virus-hit sectors (airlines, hotels) and go long on others (Netflix, internet gaming companies). Given that the most common investment strategy for alternatives managers in Switzerland is long/short equity, the sector seems poised to benefit from significant inflows for the duration of the coronavirus crisis.
The experience of CTA/managed futures managers in Switzerland could be more uncertain. The number of managers in Switzerland adopting this strategy increased significantly between 2012 and 2018 and, given the huge outflows from funds pursuing this strategy over 2017-2019, Switzerland as a financial centre has a significant over-exposure to managed futures, one of the biggest in the European alternatives industry.
It remains to be seen whether this exposure will be reduced by inflow of monies that are newly-exited from global equity funds; the recent poor performance of managed futures may well leave investors more willing to invest in long/short equity and other equity-focused alternative strategies. Swiss-based managers of funds pursuing CTA/managed futures strategies will be hoping that the market turmoil caused by the virus will be widespread and long-lasting enough to force investors to seek out managers with the skills to offer hedging through financial instruments like futures contracts, not just shorting and other equity-focused techniques.
Switzerland: a haven for flight capital?
As the country that is home to the second-largest number of hedge fund managers and investors in Europe (behind the UK), Switzerland’s alternative asset management industry seems set to meet the profound investment challenges being thrown down by the COVID-19 epidemic, by providing global investors with a dynamic universe of uncorrelated investments.
You can read more about Switzerland as a centre for alternative asset management in our article here:
MATTHEW FEARGRIEVE is an investment management consultant. You can read more of his blogs here: https://medium.com/@matthewfeargrieve