Private bank, consumer clients diversifying into hedge funds

Private bank and top-end retail clients are showing increasing interest in hedge funds and even more illiquid asset classes as they await a macro catalyst to re-enter equity markets, says Roger Bacon of Citi Private Bank.

Bacon runs Asia-Pacific managed investments and is responsible for selection of traditional and alternative funds across the region. He joined in September 2010, having previously built a discretionary and advisory customised hedge fund business at Union Bancaire Privée in London.

Citi Private Bank targets clients with $25 million and above, although it also engages with top-end clients from its consumer bank, which it has traditionally worked with very closely, as well as what it calls emerging ultra-high-net-worth individuals with upwards of $5 million.

“We are starting to see a lot of interest in hedge funds from the top-end of the consumer bank,” confirms Bacon.

This is a point that was alluded to by Ashley Alder, the recently installed chief of Hong Kong’s Securities and Futures Commission (SFC), at a recent conference.

In a review of changes in the regulatory landscape since the 2008 financial crisis, Alder noted that the SFC was now involved in hedge fund authorisation, which he described as “relatively new and to do with hedge funds interacting with retail”.

Bacon says renewed interest in hedge funds forms part of a trend over the past three years that has seen investors increasingly look to diversify beyond mutual funds and capital market trades.

“They are starting to introduce hedge funds, private equity and real estate,” he says of private banking clients, noting that they were especially active in the first seven months of this year.

From a multi-manager perspective, Bacon says Citi Private Bank has a focus list of around 170 mutual funds globally and 40-45 hedge funds, with the bank adding new strategies in the latter category.

He suggests the private bank’s clients have increased their hedge fund allocation from zero in some cases to 10-15% of their portfolio.

This development comes during a period that has seen a systematic reduction in equity risk, with investors overall now far more defensively positioned and sitting on large cash piles.

“Clearly there is a view among our clients that there needs to be some sort of macro catalyst for them to start being comfortable about redeploying a serious amount of money,” explains Bacon. “If that happens, you will see a large amount of money coming back into risk assets, specifically focused on equities.”

As for the private equity and illiquids side, Bacon concedes appetite depends on individual clients but in general describes them as surprisingly receptive to illiquid offerings.

“That is quite interesting, because it does not necessarily tie in with this short-term concern, unless it means that clients are becoming more strategic in their investment,” he notes, adding that the private bank typically looks at between six and 10 private equity and real estate offerings each year to show to clients.

In terms of a macro catalyst, Bacon argues that Asian investors are seeking confirmation of early signs that China has made good progress in slowing growth at a modest level and dealing with inflation.

“If we have passed the peak of inflation in China, which all the data suggests we probably have, that may also act as a macro catalyst to risk tolerance in this part of the world and it may see an extension of any rally brought on by some sort of European [debt crisis] resolution,” he says.

He also points to the potential impact of a positive earnings surprise over the next two quarters, likely triggering greater interest in equities from a fundamental, corporate perspective.

“Valuations have started to look quite attractive in parts of the world,” he adds, noting that clients have been latching on to Japanese equities both from a valuation and relative standpoint.

On a final point he stresses that investor expectations of returns have come down: “The reality is if your cash is earning zero and you have investments that are making 6-8%, you should be very happy.”