AlphaWeek Q&A: Oliver Fochler, Managing Director, Stone Mountain Capital
AlphaWeek spoke with Oliver Fochler, CEO of Stone Mountain Capital, a boutique alternative investment advisor providing alternative investment research, structuring and public and private placement, about some of the trends he is seeing in alternative asset fundraising.
GW: Oliver, Stone Mountain Capital raises money for 4 main asset classes - hedge fund, private debt, private equity and real estate. On the hedge fund side specifically, what can you tell us that end investors/allocators are increasingly asking for?
OF: A lot of money is still flowing to the larger managers - $1bn plus AUM, good track records over time. They are still absorbing inflows based on their brand and size. However, the larger the funds are in the same strategy, the more crowded the trade gets. Equity hedge plays (long short, market neutral, merger arbitrage) constitute ca. 70% of the overall hedge fund AuM, but are crowded and don’t deliver what they used to, so what we’re seeing is niche strategies like volatility plays get more attention from investors; many of these funds have lower AUM but have performed quite well, even if they are younger firms.
GW: What about demand for systematic strategies?
OF: Traditional systematic players like CTAs have the same problem as traditional discretionary managers – they’re playing in a space where there are crowded trades. The fundamental problem is that volatility is at all-time lows. CTAs have long volatility and short bias strategies, and the problem is when vol is so low - due to central banks asset purchase programs, for example - the systematic CTA strategies enter negative carry territory. At our firm around 15% of the assets we raise are in tactical strategies like quant/systematic or global macro. Those strategies are typically used for achievement of uncorrelated alpha, diversification of traditional equity and fixed income portfolios and the improvement of risk/return profiles. The area is in demand over the last two year despite mediocre returns and we managed to source a set of high performing tactical trading managers in order to satisfy investors demand.
However, the large central banks are now stopping or slowing their quantitative easing programs, which will have an impact on the volatility. These events have a significant impact on the market, so there is an anticipation that systematic CTAs and global macro focussed on fixed income and rates are well placed to capture alpha from the unwinding of QE.
GW: Stone Mountain recently published some research on the private debt market and how you’re seeing investors increasingly looking at this as a separate asset class. We see lots of firms raising private debt funds, but is there already too much money chasing too few deals?
OF: No. In fact, we’re just at the start of allocations to this strategy. The Alternative Credit Council recently said in a paper that the global private debt market is on pace to reach $1trn in AUM by 2020. Contrast that with hedge funds, which have, depending on which data provider you use, around $3trn in assets and private equity, which has around $3trn, and you can see the opportunity. Indeed, the majority of the capital SMC raises is in credit and private debt – a very large proportion, around 85%.
As an asset class, it’s also an interesting mixture of hedge funds and private equity type features. On the liquid end, a lot of direct lending strategies give liquidity up to 1 month with notice. That makes it easy to raise capital, but there’s a asset liability mismatch for the manager due to longer duration of the underlying loan portfolios. On the other hand, the illiquid strategies, have terms of 3-10 years, like a typical private equity fund structure. Investors come from 2 allocation perspectives; those which allocate their private debt commitments to their fixed income bucket, which stay typically on the liquid side and those who include it in their private equity allocation. However, many institutional LPs we know started their own private debt allocation bucket outside of fixed income and private equity and the establishment of funds of private debt funds evidences the maturing of the asset class.
In the US, hundreds of managers and platforms are playing in this space. The ratio of bank lending to non-bank lending is around 20% traditional banks, 80% shadow banking. Europe is 5-6 years behind the US, so the ratios are inverted (80% or more is bank lending, and 20% or less by non-bank lending). Europe has lots of different countries with different accounting standards, so the lending industry has to develop a regulatory framework to allow a fund manager to market and lend across the bloc, which we have for banks and seeing established under ELTIF for infrastructure debt and AIFMD for asset managers in general. Lending in different counties means different legal frameworks partially in favour of the lender and workout structures; you need people on the ground with local language skills to originate, underwrite, manage and workout. So, there is still plenty of opportunities in the space, particularly in Europe.
GW: Are there any specific trends from a geographical perspective, or indeed an investor type perspective when it comes to risk management?
OF: In Europe, the traditional offshore hedge fund model – a Cayman or British Virgin Islands fund structure – is losing some lustre. A lot of EU investors prefer European onshore structures – Luxembourg, Ireland, Malta. However, from a European investor perspective, US based strategies seem to perform better, for example US credit assets have a certain spread – in a positive sense - over European assets, so these are still attractive to European investors, but they want access to the strategy via an EU domiciled share class. It’s hard to market a Cayman fund in Europe these days. The ICAV in Ireland is of course seeing a lot of success as it satisfies the offshore and onshore requirements of investors in the EU and US equally..
GW: What do the end investors you speak to think of Bitcoin? Indeed, what do you think?
OF: We’re bullish – we invested our own capital into a bitcoin product in 2016. We are seeing a 6x return on this trade. Since June and July of this year we’re now seeing a lot of interest from the largest of the institutional investors – SWFs, insurers, pensions, institutional asset managers. They’re interested in investing in cryptocurrencies in the form of a fund or a financial product. The crypto market capitalisation is today $175bn; it was $2bn just 2 years ago. Bitcoin is around £94bn of that, which is itself a large market capitalisation. Until the summer, the investor base was largely technology and retail money, etc. Not anymore. There are ca. 75 hedge funds active in the space with the tendency for 40 more this year alone.
GW: There are more than 1,000 cryptocurrencies out there. That’s not sustainable, is it?
OF: There are almost 1200 cryptocurrencies with a tendency to grow as every of those ICOs constitutes a new entrant. No – in my view only the largest 3-5 of these cryptocurrencies will survive. Bitcoin is important because you can’t separate it from the blockchain. It’s a p2p payment solution. And, from a value perspective, it’s resisted regulatory interference so far. China banned Bitcoin trading – indeed, all ICOs - and look where we are; trading at or near all-time highs ($5,600 at press time). Ethereum is another interesting one – it’s more of a platform to build smart contracts, although a lot of the ICOs are done on the Ethereum blockchain. These 2 are the largest and have around $130bn of the $175bn ICO market between them. It’s getting too large to be ignored these days.
The major risk is that the US outlaws cryptocurrencies. The current market is not a threat to fiat currencies, but if it keeps growing at the current pace, central banks and regulators might look differently at it. Taxation is the other issue – companies and individuals need to pay tax in government issued currency. Most countries haven’t decided what it is – currency or commodity. When they do, we’ll see increased regulation, which is a good thing, but as a decentralised currency, no, I don’t think it can be shut down.