By: Andrew Saunders, Director, EFX Prime Services, Member, AllAboutAlpha.com Editorial Board
An asset management firm that is ubiquitous in the fixed income and pension fund world, BlackRock is a world-leading alternative asset management franchise. The growth came from a combination of strategic acquisitions and internally incubated strategies. From this leadership position, the firm is uniquely positioned to offer insight on future trends with regards to adoption of alternatives and how asset management firms – specifically although not exclusively hedge funds – must evolve.
Sharing these insights is Ms. Barbara Novick, one of the founders of BlackRock and Vice Chairman. From the firm’s inception she has headed the Global Client Group with responsibility across the product platform and across distribution channels, and in her current role, as special advisor to the Chairman, Ms. Novick provides advice on strategic projects including organization and M&A. She also spearheads the firm’s efforts on Government Relations and Public Policy.
Q1: Whether by strategic design or twist of fate, BlackRock is now the largest manager of alternative investment products. What best practices can BlackRock bring to alternatives and how do you see BlackRock positively shaping the alternative space?
BlackRock’s presence in alternative investment products is a function of two key factors. First, we have introduced absolute return products in response to client demand. Our first hedge fund, a global fixed income fund, was launched in 1996. Since then we have launched a number of additional alternative investment products utilizing the core competencies of our investment teams around the world. Second, BlackRock has acquired alternative investment products, including an energy hedge fund managed by State Street Research and Management, a series of hedge fund of funds managed by Quellos, a credit fund managed by R3, and several hedge funds managed by Merrill Lynch Investment Management and Barclays Global Investors, respectively. As of 31 December 2009, BlackRock managed over $45 billion in hedge funds, opportunistic funds, and fund of funds strategies.
We bring strong and sound practices to the alternatives space; however, we don’t think it is for us to declare them to be “the best.” Some of the practices we have focused on include: matching liquidity, providing transparency, and reevaluating each fund from a client perspective. During the recent financial crisis, we did not gate investors largely due to our discipline of tailoring redemption notice periods to reflect the liquidity of the strategy. Likewise, we have provided clients with regular reports on each strategy and we have kept an open line of communication. Finally, our Risk and Quantitative Analysis Group thinks about risk in the broadest possible way and is not afraid to ask managers the hard questions. In one case, such a review resulted in a decision to close a profitable hedge fund in which we had much optimism based on a view that we needed to put clients’ interests first.
As a leader in the alternatives space, BlackRock has taken an active role in engaging with policymakers and regulators globally. Issues from rules on short-selling, to the use of derivatives, to the Alternatives Investment Fund Management Directive, are critical to our industry. BlackRock has dedicated resources to bringing the “voice of investors” into these discussions.
Q2: Conventional wisdom in the hedge fund industry has been that long-only managers do not make good hedge fund managers because they lack experience running a short book. Do you agree? How can BlackRock attract and incentivize the best alternative asset managers?
I strongly disagree. Time has proven that many investment professionals can manage both long-only and long-short portfolios. Of course, I use the term “many” and not “all” for a reason. As with anything, it is important to evaluate the skill set of a specific manager and not generalize about the abilities of all managers.
At BlackRock, we have created an environment that enables managers to excel at managing benchmark-oriented portfolios as well as absolute return strategies and customized portfolios. Our environment combines talented investment managers and risk management professionals with an operating platform that supports the investment management process. Over time, we have paper-traded portfolios with managers who are going short for the first time, and we have seeded portfolios with modest amounts of capital before seeking client capital. Today, we have two award-winning equity hedge funds that began at $10 million each and are currently closed at $1 billion and $750 million respectively, which reflect the success of these products and the strong client demand for these strategies.
Attracting and retaining talented professionals is important throughout our organization. We strive to combine a competitive compensation philosophy with a desirable work environment. In the case of investment managers, this includes providing opportunities to learn from each other and share information with buy-side colleagues as well as providing an investment platform and resources that address many issues necessary to investment management, and finally, providing talented professionals with investment freedom to apply their ideas to different types of client portfolios. Today, our investment teams reflect a combination of “homegrown” talent (e.g. individuals who joined BlackRock from university and whose careers have evolved over time) as well as lateral hires and teams who have joined via acquisitions. All bring different and valuable perspectives to the investment debate.
Q3: BlackRock has developed an unassailable reputation as a long-only institutional manager, especially in credit. Will clients readily accept BlackRock as their alternative advisor as well? Is your scale a positive or a negative?
While BlackRock has an excellent reputation as an institutional fixed income manager, our business is much broader than that. As of 31 December 2009, BlackRock managed over $1.5 trillion in equities, over $140 billion in multi-asset strategies, over $1 trillion in fixed income, over $340 billion in cash strategies, over $100 billion in real estate, private equity, hedge funds and other alternative investment strategies, and over $140 billion in advisory mandates. Clearly, our clients are quite comfortable working with BlackRock on a broad range of investment strategies.
Within the hedge fund space, BlackRock directly manages over 30 hedge funds, encompassing strategies from fixed income and credit, to scientific and fundamental equity, to global macro. We constantly evaluate each existing fund as well as potential new strategies. As our overall business has grown, our hedge fund platform has also grown. In addition to these hedge funds, BlackRock Alternative Advisors (BAA), the firm’s fund of hedge funds platform, offers diversified commingled or customized vehicles structured to meet client objectives. BAA provides a turn-key solution to implement hedge funds in a portfolio by leveraging the hedge fund research and risk management capabilities of BlackRock, while also providing diversification across strategies and critical administrative support. The size and scope of both our hedge fund and our fund of hedge fund offerings are further evidence of the acceptance of BlackRock as an alternative advisor.
Our scale and our breadth of products make BlackRock unique in the asset management industry. We can invest substantial resources in people and technology. Our portfolio managers get excellent access to corporate management which helps them make better decisions. We are also able to command excellent terms of trade from the Street in purchase and sale prices, financing rates, haircuts and other commercials terms. In summary, we make our scale work for clients.
Q4: In a speech recently, you mentioned four lessons from the crash of 2008: liquidity, leverage and counterparty exposure, operational controls and communication. Please expand on these points.
Whenever there is an event of this magnitude, it is worth stepping back and reviewing what went wrong and how the same mistakes can be avoided in the future. While there are many lessons to take away from the crash of 2008, these four have the broadest applicability and many types of investors can adjust their behavior to improve their outcomes. Note that a longer list of areas worth exploring would include: hidden beta, fund of funds versus managed accounts, asset allocation and the sustainability of the endowment model, portable alpha, credit risk, and the effects of policy, media and headline news.
Liquidity. In the years preceding 2008, many investors consciously gave up liquidity in their quest for higher return. Given the experience of 2008, investors need to reevaluate how they think about liquidity. In a new paradigm, it is necessary to be able to answer even basic questions such as “Do you have enough CASH to meet liabilities for this month? And for the next six months?” As we saw in 2008, many investors misjudged their liquidity position and then scrambled for cash to cover their operating costs. We think about the “alignment of liquidity” at various levels of the investment process. First, clients need to better match their assets with their liabilities, especially their short-term liabilities. Second, the redemption terms of products need to reflect the underlying liquidity of the assets. Finally, managers need to be cognizant of the liquidity of each individual security.
Leverage and counterparty exposure. During the crisis, collateral haircuts on borrowed money widened dramatically. For example, investment grade bonds went from haircuts well under 5% in April 2007 to often over 10% by April 2008. Likewise, higher risk securities gapped out even more significantly with asset-backed going from under 5% to as high as 60% depending on the type of collateral. In looking at recent hedge fund failures, leverage appears to be a common underlying cause to what became “the perfect storm”. As asset values fell and volatility increased, resets of collateral haircuts exacerbated the problem. And, of course, investors both needing liquidity and fearing further declines submitted massive redemptions which magnified the problem even more.
Operational controls. Everyone agrees that investment strategies must be sound to attract investors. Given the various problems that have occurred, there is growing consensus that operational controls must also be robust. Everything from checks and balances, to independent valuation of assets, to risk management, to transparency with investors is getting more scrutiny which is a positive development.
Communication. Communication starts with clearly defined products and clear disclosure language in order to best match clients’ needs and expectations with the appropriate product. Likewise, an ongoing dialogue between managers and clients is beneficial. For example, in certain situations, a deeper understanding of liquidity needs and available liquidity enabled managers to work through problems and deliver a better outcome for clients.
Q5: How does Blackrock view the growing movement of investing in hedge funds via managed accounts?
Following the events of 2008 and 2009, investors are broadly seeking increased transparency and less operational risk in their hedge fund investments. It is therefore no surprise that managed accounts have become a hot topic across the hedge fund industry. While we think that BlackRock’s commingled hedge funds score highly in both regards, we too are seeing requests for separately managed accounts of our existing strategies.
Perhaps because BlackRock already provides a high level of transparency to its hedge fund investors, we currently manage only a small number of managed accounts across our hedge fund business. One of our equity strategies is also delivered through a major bank’s platform.
We regularly consider new propositions for managed accounts, however, we always consider the impact of such an account on the underlying fund and its investors. We always seek to ensure an alignment of interests: is the liquidity of the account consistent with its redemption terms? Are the account’s redemption terms consistent with those of the fund? Failure to ensure such consistency would be discourteous to existing investors. Similar analysis is being used as we consider responding to the growing demand for UCITS III strategies. It is our plan to deliver certain hedge fund strategies in both Cayman and UCITS form.
Q6: Does BlackRock have a view on the financial regulation that is winding its way through the Congress, and in other markets? Do you expect all hedge funds to be registered?
In the wake of the recent financial crisis, there is significant focus on hedge funds both in the US and globally. It is important to look at all of the proposed regulations, and ideally to have regulators develop a global framework rather than take a different approach in each market. Today, many financial products are managed and invested in without regards to borders giving investors tremendous choice to select investment managers and investment strategies that meet their needs.
Some of the hedge-fund specific issues under consideration include: registration, transparency, short-selling, derivatives, the liability of service providers to the investors in the fund, the locale of the manager, domicile of the fund itself and compensation. We expect the US will require investment advisors to be registered, much as they are registered in the UK under the Financial Services Authority. Although some in the industry have spoken out against registration, BlackRock operates its business in many different legal jurisdictions and has worked with regulators around the world, making us comfortable with registration for hedge fund managers.
Likewise, requirements for transparency are beginning to appear. The requirements for transparency (or reporting) to regulators need not be onerous to provide regulators with the information they need to oversee managers assuming this information is kept confidential. And importantly, transparency may be helpful in providing factual information. BlackRock participated in the UK FSA’s end October 2009 survey of the 50 largest hedge fund managers they regulate. The survey was intensive and we proposed ways in which it might be streamlined in the future. The survey results were then compiled and some interesting facts emerged. For example, a mere 0.9% of European equity market capitalization was owned by the funds in the survey, suggesting that hedge funds are perhaps not the large source of the systemic risk implied by the extensive regulation being developed. As the debate heats up on sovereign CDS and other topics, greater transparency may be helpful to understanding the problem and the relevance and value of various proposed solutions.
There has been much debate about the role hedge funds have played in the recent crisis with views ranging from “short sellers are the canary in the coal mine” to “short sellers have undermined companies” . The SEC has recently announced new short selling rules that include a price trigger. With regard to equity short selling, we unsuccessfully argued in Europe for disclosure to the regulator (rather than to the market) who would aggregate and put anonymous data back out to the market for all to see.
We are actively engaged in discussions related to the Alternative Investment Fund Managers Directive (AIFMD). We have had extensive dialogue with many of the parties involved with the goal of preserving choice for investors without regards to domicile of the fund, the manager, or other service providers to the fund.