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Weekly Unit Pricing Gives Hedge Funds Access to Untapped Wholesale Market, FRM Australia Says

Posted: 07 Dec 2011

In order to access the untapped wholesale/platform market, hedge funds must move to weekly unit pricing, says Richard Keary, CEO of FRM Australia.

“If you accept the reality of the wholesale market, the platform/wrap paradigm, then local hedge funds need to be able to fit in with the processing requirements of that distribution platform,” Keary says. “At this point in the cycle, a hedge fund that prices monthly and takes three weeks to release that information is not helping their cause at all.”

Keary notes that many domestic, boutique hedge funds in Australia use separate custodians and administrators, and that moving to a weekly pricing model would “double” costs, a cost that should be borne to access the retail market, which currently amounts to around a third of the AU$1 trillion managed funds industry.

“The manager should pay the costs out of their own pocket,” Keary says. “If they can’t, then you don’t have enough capital in the business. To the extent that the wholesale market is a big market, it still uses platforms, and the financial planners are the real intermediary of performance. They want to industrialise the business and run everything through the wrap.”

Keary also attributes the relatively benign uptake of hedge funds—between 5-10%—by superannuation funds and retail investors to how “institutions of wealth management” shape the market in Australia.

“The way wealth is set up in Australia is not conducive to this,” Keary says. “I call it the ‘institutions of wealth management,’ which may be the role of the research houses and consultants. Not the research houses and consultants per se, but the role they play. The institutions of wealth management may be the way products get distributed, for example, wraps in general. They’re not conative to niche boutique-type outcomes. As a consequence, you get a lot of plain vanilla, reasonably homogenous investment offerings that just don’t actually deliver any potential benefit of diversification. This works in periods when equity market beta is rewarding investors, but really, for the last ten years, this hasn’t been the case. People scratch their heads and say why can’t I do better than this, but the institutions of wealth management limit the choices they can make.”

The institutional investor market—mainly the superannuation funds—will not, by and large, be in a position to make a play with smaller domestic hedge funds because of their capacity constraints. This means that smaller funds must make a play for the wholesale market.

“In fairness to the institutions, if you’re a AU$30 billion superannuation fund and the way wealth is set up in Australia and you’re judged on your costs, to give your money to a domestic hedge fund with a AU$200 million capacity when you can give your money to an offshore player with AU$20 billion capacity, that’s a rational decision,” Keary says.

FRM Australia is an adviser and manager of a fund of hedge fund called FRM Sigma. In the last 12 months, FRM has raised about AU$30 million for the Sigma product, most of which has come from high account balance individual investors.

“They’re dealer groups that have basically set up their own multimanager funds,” Keary says. “Rather than hold all of clients’ assets on a wrap, they’ll use a custodial arrangement, set up a fund, and the fund buys units in the product. You’re seeing that happen a lot more with dealer groups with AU$200 to AU$400 million in assets. Therefore, with those sorts of groups, you deal with the custodian.”

However, Keary says the aim is to have FRM Sigma included on wrap platforms. The fund is already priced weekly, but is still working through technical specifications to meet distributors’ approval.

“We use J.P. Morgan as our custodian/administrator,” he says. “We have to deal with things like the timing of distributions, timing of tax statements, which again is problematic if you’re a small boutique. It’s an uphill battle.”

To Keary’s analysis, the wholesale market in Australia is polarising, a bifurcation that may permit new opportunities for boutique hedge funds to thrive.

“At one end, you have a huge bubble of mass distribution networks around the banks and the insurance companies and so forth, where it’s all about having the maximum number of financial planners and the mass amount of cross-subsidisation, and at the other end you have a much larger number of smaller players. The independent licensees will typically have higher account balance clients who realise that they don’t want to be industrialised in the big network world. They have an appetite for more niche investments.”

Keary says the slow growth in hedge fund uptake was not due to overly proscriptive regulations, calling the Australian system “probably as sensible as any regulatory system in the world,” but perhaps could be attributed to a lack of consumer advocacy.

“Consumers are probably their own worst enemy,” he says. “They don’t ask for much and they don’t get it and then wonder why not. If consumers were actually prepared for good-quality financial advice, then maybe the incentive to bundle products and advice in big distribution networks wouldn’t be as strong, but possibly because consumers don’t want to pay for investment advice, the only solution for an industry to have a profit pool is bundle product advice and distribution. The more it happens, the harder it gets for niche players to actually get any distribution.”

(RA)

If you have any comments about this story or news tips, contact Christopher Gohlke in New York at cgohlke@globalcustodian.com or Janet Du Chenne in London at jduchenne@globalcustodian.com.