The first were the institutionalisation and convergence trends: the way inflows would change the predominately entrepreneurial, boutique business models in the industry for big fund-of-fund groups, multi-boutique houses, and asset managers combining hedge funds, private equity, property, infrastructure and other alternatives with long-only investments, all under one roof.
But there is also disaggregation - a trend just starting to develop among, for example, the more sophisticated Nordic and Dutch investors. Initial “alternatives” buckets are being broken down into distinct strategies which can provide either de-correlation from, or lower beta sensitivities to core exposures. As investors increasingly seek to separate their alpha and beta sources for improved efficiency, these models are likely to supersede the traditional asset-allocation approach.
“I was talking about these developments in the 1990s,” says Alexander Schweickhardt. Before co-founding Hardt he spent nine years building a $1.5 bn (€950m) fund of hedge funds platform at HVB Alternative Investment, and alongside diversified products, in 1999 HVB launched a pure long-short equity fund marketed as a way to improve risk-adjusted returns alongside core long-only equity exposures, rather than a simple “hedge fund allocation”.
Hardt Group’s mission is to offer a way to implement any combination of these alternatives solutions from a single Master-Feeder platform. The group has five alternative investment lines: European private equity mid-market buyout and distressed; venture-style special opportunities; growth-region real estate development projects; traded life-settlement policies; and hedge funds (which are further categorised as alpha strategies, beta strategies and emerging-manager incubator funds).
At the top of the structure is the Gamma Fund – so-called because it brings together distinct alpha and beta exposures. This is where Hardt Group’s seed investor put $600m, with a 10-15 year lock-up, and where two more clients have invested since. The group has offices in Vienna, London and New York, and currently manages around $1.1bn from European institutional investors, and the plan is to expand the clientbase of some of the products into the US this year.
Gamma Fund currently puts 29 per cent in hedge fund beta styles, 25 per cent in hedge fund alpha, 16 per cent in incubator hedge funds, 12 per cent in special opportunities, 11 per cent in real estate, 7 per cent in buyout and 1 per cent in life settlement, and is designed as a one-stop shop absolute-return allocation, targeting Libor+12 per cent over five years. (Since inception it has compounded 43.14 per cent with annualised volatility of 8.32 per cent).
But the structure also allows you to invest in any one of the five main investment lines separately; or in a fund of alpha-style hedge funds, a fund of beta-style hedge funds or a fund of incubator hedge funds; a fund of long-short equity funds, fixed-income hedge funds, or any other strategy-focused selection; your own selection of the underlying hedge funds; or indeed in any combination of the above.
As befits the founders’ backgrounds – New-York based co-founder Jeff Landle also worked at HVB, and was previously head of a $1.8 bn fund of hedge fund series at Commonfund and senior investment officer for alternatives at Blackstone – Hardt Group began as essentially a fund of hedge funds. But from the start there was the distinction between alpha styles (hedged equity, fixed-income arbitrage, event-driven strategies and multistrategy funds exhibiting low exposure and correlations with traditional markets) and beta styles (directional equity strategies and global macro), as well as a focus on identifying and seeding emerging talent (there are currently 14 managers on this “Incubator” platform).
The incubator portfolio offers exposure to hedge fund managers at a time when many believe they are posting their best returns. Because they are brand new, there is no chance that you have money with them via one of your other funds of funds. But the platform also gives end investors discounted fees and a share in fee revenue, which Hardt Group will negotiate without taking any of it away as an intermediary.
“The usual arrangement is a fee break on our initial capital, and 15 per cent of the revenues from the entire asset-base of the fund,” says Dr Schweickhardt (so the seed investor not only gets a share of his own fees, but the fees of every subsequent investor, too). “If the fund makes 10 per cent gross, the return for a fund of funds would be 7.2 per cent, net of its 1-and-20. The end investor in that fund of funds pays another 1-and-10, netting just 5.58 per cent. When we seed 10 managers our fee-break means that if they all make 10 per cent we make 6.18 per cent – even if they don’t raise any other assets. But let’s assume our fund brings in $300m: with these economics, the net return for the investor is 11.85 per cent, net of all our fees. With a revenue share, our client makes more money than even the fund itself on a gross-returns basis.”
Special opportunities
Whereas the founders have long experience with hedge funds, the Group has no internal expertise in private equity buyout or property development – let alone oil refineries and Brazilian forestry products, the sectors where the portfolio’s venture-style special opportunities operate. These are offered through exclusive joint ventures – the first of which covered private equity buyout with the UK’s Kingsbridge Capital Advisors. Hardt Group seeded the company for a 92 per cent equity stake in 2004, giving the founders an option, linked to performance hurdles, which was subsequently exercised to leave Hardt Group as a 49 per cent stakeholder.
Deals, focused on the central and Eastern European mid-market, tend to have a two-to-three year lifecycle, and the first exits started coming through towards the end of last year: Austrian banking group Hypo Group Alpe Adria International delivered an annualised net IRR of 45 per cent and German cable operator EWT Multimedia 116 per cent.
Shortly after private equity and incubator hedge funds were added to the platform, Hardt signed another joint venture, taking a 49 per cent stake in Bay Gate Investment, which is developing a 40-storey commercial tower in Dubai. More recently Hardt Group acquired 55 hectares of commercial land next to the Borispol Airport in Kiev, Ukraine.
“We bought before Ukraine and Poland got the Euro 2012 soccer championships and before Ukraine joined the World Trade Organisation,” says Dr Schweickhardt. “The value of our land has already exploded.”
Finally, the longer-term, more illiquid side of the Hardt Group portfolio was rounded out by two special opportunities investments, again in the form of joint ventures: Vienna-based oil refinery firm Petromaxx Energy Group and Luxembourg-incorporated Global Wood International, which harvests and mills wood in Brazil and is developing a factory in China which will engineer flooring products.
“Special opportunities is focused on commodities at the moment,” says Dr Schweickhardt. “These are great assets, negatively-correlated with all our exposures to the financial markets, but we remain really flexible in this portfolio.”
The fact that the private equity, real estate and special opportunities all deliver back-ended cash flows rather than daily mark-to-market pricing makes it hard for new investors to appreciate the correlation benefits that the Gamma Fund exposures are giving them.
Even day-one Gamma Fund investors have only just started seeing their first buyout exits, and the Dubai tower is due for completion later this year. Each new Gamma investor gets a different portfolio as they participate in new private equity and venture-style deals, and until exits are realised those assets are carried at cost in their specially-tailored reports.
This means that when they look at month-to-month performance, rather than seeing a true representation of their portfolio’s NAV, they are effectively seeing the returns of a fund of hedge funds plus a cash commitment – a problem for investors who need to integrate their Gamma exposure into their own risk-monitoring or accounting systems.
The effect is starkly revealed if you plot the Gamma Mach 3 Series 0 segregated portfolio against the HFRX Global Hedge Fund Index (see chart above). For the first two years, while private equity investments are being carried at cost, both correlation and beta to hedge funds remain relatively high, but during year three, the Gamma line both steepens and smooths significantly as the private equity gets to work and the exits come in.
“This is one reason why we are adding the life settlement strategy, to bring the de- correlation right from the beginning,” says Dr Schweickhardt. “At the moment every time a new investor comes onboard he has two years’ of correlation with the hedge fund world, while his other investments are held at cost.”
The secondary market in life-settlement policies returns around 15 per cent annually and exhibits zero correlation with traditional financial markets – but it is also fairly liquid and can be marked-to-market. The Group’s in-house financial engineering experts have provided a structure that is tax-efficient for European investors for the Hardt Group Life Settlement Fund, which will be managed by another joint-venture partner, this time based in the US. Dr Schweickhardt expects it to join the suite of Gamma products before the end of the third quarter this year.
With this piece in place, Hardt Group will have a fully-rounded platform of alternative investments, structured to meet the needs of a wide range of investors. It can be used as a ready-made, high-octane but consistently de-correlated exposure to a diversified range of alternative alphas, betas and liquidity premia; or as a source of standalone alpha, beta and liquidity premia to augment existing portfolio exposures.
