www.auda.de

A matter of Combination

Particularly in response to smaller institutions and wholesale managers new product solutions and wrappers for private equity and hedge funds have become increasingly important.

Constantin Rinn, Director Auda (Deutschland) GmbH

Alternative Investments have been in the focus of institutional investors across Europe for several years. Experienced alternative investors with no regulatory and liquidity constraints have used private equity as an alternative to public equities benefiting from a significant out-performance. Hedge Funds have been considered as an alternative to bond investments yielding higher returns at a similar level of risk as measured by volatility.

Today most European institutional investors have just tipped the toe in the water of alternative investing. And it has been particularly the larger ones which have been at the forefront of change. For example, the average German insurance allocates less than 0.5% to hedge funds with the top twenty accounting for the vast majority of total investments. Given their regulatory and liquidity constraints the primary goal for those investors has been diversification. By adding alternative investments investors can diversify away from their traditional balanced and in many cases fixed income tilted portfolios. Modern portfolio theory suggests that this essentially results in a more efficient overall portfolio with an improved risk-return profile.

During the last months markets were undergoing a sharp and sometimes chaotic correction. The sub-prime mortgages sector was a major driver of the credit crunch with spill-over effects on virtually all other major markets. Recent hedge funds’ bailouts had huge media attention. Initially, fixed income funds were in the focus. But in August 2007, particularly those hedge funds which followed quantitative trading strategies suffered. Many of these funds were supposed to be rather low-risk, market-neutral but failed to deliver during an extreme and largely un-expected trading environment: financial markets’ dislocation and a dry-up in liquidity caused them to de-leverage and sell off the more liquid and profitable positions.. Other hedge funds, however, were able to take advantage of the squeeze. Year to date returns of global hedge fund indices continue to be significantly positive and going forward the current market environment suggests strong last quarter results. On the private equity side, the credit crunch has impacted investment banks’ ability and willingness to provide the financing for deals in pipeline. The majority of the deals, however, is likely to be secured as break-fees would be costly, banks would forego a substantial highly profitable business and the fundamental case seems to be largely intact. Global growth seems to continue to be very strong and healthy. It is widely expected that banks remain committed to providing financing but seize the opportunity to off-load their books, raise interest rates and bring the fees back to more reasonable levels. However unfortunate these financial markets’ turbulences have been they seem to be only brief set-backs in a long-term upward trend for alternative investments. It has been a healthy correction after a time when risk taking was virtually not rewarded and highly leveraged investing became the last management fad. The re-pricing of risk particularly in fixed income and structured products is on-going. Whilst it is not yet known what the appropriate price for some of these products is, virtues such as disciplined and humble investing with a focus on value creation and unique trading strategies are back in investors’ favour.

Today, institutional investors are becoming the most important source of funding for alternative investment managers. Their demand is largely driven by asset liability management and long-term allocation targets rather than short-term market timing. Institutional demand has proven to be resilient and less prone to behavioural aspects of investing than it is the case for individual investors. Simultaneously wholesale managers, private banks and wealth managers continue to ramp up their alternative investments allocation. The growing importance of these knowledgeable investors is a key driver for the whole alternative investment industry’s current phase of institutionalisation and consolidation. Particularly in response to smaller institutions and wholesale managers new product solutions and wrappers for private equity and hedge funds have become increasingly important. Key areas of interest of these investors are access to top managers for smaller investments, optimized cash management for committed but not yet contributed private equity capital, regulatory and tax-wise clean solutions, and relatively attractive liquidity terms.

A concept used by large institutional alternative investors is to view private equity and hedge funds investments in combination. This approach has now been transferred so that private equity and hedge funds investments are combined within one innovative product structure and has been implemented into a part II fund governed by the Luxemburg law (alternatively within a structured note). This structure will invest into a broadly diversified global private equity fund of funds. Simultaneously, the product will invest into a broadly diversified rather low-risk multi-strategy/multi-manager fund of hedge funds. The result is an optimized investment into private equity including the necessary, absolute return oriented cash plus management within hedge funds. By blending both asset classes an efficient allocation to private equity will be achieved, volatility and draw-down risk are reduced.

Assuming a 15% IRR on the private equity funds, a performance of 8% p.a. on the hedge funds and a 12 years maturity this product would yield a total net of fees return of 10% p.a. and a 3.3 multiple whilst completely avoiding the J-Curve-effect. The return pattern would be impressively smooth exhibiting no negative year and yearly returns between +4.5% and +20.2%.

In addition, yearly liquidity will be offered. In the case of a sell order, the seller would get the quoted price for the hedge funds exposure and for the private equity exposure the minimum of the most recently quoted price or the achievable price in the (secondary) market. Furthermore, the part II fund will have a daily price and can be booked into a traditional investment account as well as eligible mutual and institutional funds.

This innovative structure offers for smaller institutional investors and affluent individuals a unique and very convenient way of getting access to top private equity and hedge funds managers. Institutions with yearly investments into private equity between 100k and 3 million are the typical target group. The structure allows for even smaller lot sizes and based on clients’ feedback this might be an ideal tool for private banks and wealth managers. These smaller investors could build up a diversified alternative investment portfolio whilst not sacrificing underlying funds’ quality. Yet they would avoid the cumbersome administrative burden usually associated with alternative investing, particularly private equity.

Contact Information:
Auda (Deutschland) GmbH
Harald Quandt Haus
Am Pilgerrain 17
61352 Bad Homburg v. d. Höhe
Germany

Tel: +49 (6172) 402-801
Fax: +49 (6172) 402-809
Email: audagermany@auda.net
Internet: www.auda.de
Managing Directors: Franz Bichlmaier, Horst Bennin

The Harald Quandt family founded Auda in 1989 in New York to assist them to manage their hedge funds and private equity investments. Today, Auda is a fund manager overseeing investments of 5.0 billion US dollars invested in 22 private equity and hedge funds. Since 1994, Harald Quandt Holding has been offering institutional and wealthy private investors in Germany, Austria and Switzerland access to a selected range of fund of funds in private equity and hedge funds. Since 2001 Auda (Deutschland) GmbH is responsible for client relationship and business development in the German speaking countries.

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