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The Rise of Semi-Liquid Funds: A Gateway to Private Markets

Master

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October 16, 2024

The Rise of Semi-Liquid Funds: A Gateway to Private Markets

Private markets have gained popularity and appeal in the not-so-distant low-interest- rate environment, attracting investors with the promise of higher returns and portfolio diversification. What was once an exclusive universe for institutional investors is now becoming more accessible through semi-liquid funds, also known as open-ended evergreen funds. Schroders Capital offers its own range of semi-liquid solutions that provide exposure to private equity, infrastructure, and real estate.

Historically, access to private markets was restricted to closed-ended investment vehicles, which come with significant barriers such as high investment minimums, capital call drawdown structures, and long lock-up periods. In contrast, semi-liquid funds offer investors periodic liquidity while still allowing access to private equity, infrastructure, and other illiquid alternative asset classes. Structured as Luxembourg AIF, Schroders’ semi-liquid fund range offers “monthly liquidity for subscriptions and quarterly liquidity for redemptions,” explains Johan Strömberg, Director of Private Asset Sales at Schroders.

“[Liquidity] only becomes an issue when the redemption cap of five percent per quarter is reached.”Johan Strömberg, Director of Private Asset Sales at Schroders.

Investors can subscribe and redeem at regular intervals at the prevailing net asset value (NAV), with an annual redemption cap of 20 percent of NAV, equating to five percent per quarter. One of the challenges with semi-liquid funds is managing the liquidity mismatch between the underlying illiquid assets and the liquidity offered to investors. Strömberg explains that liquidity “only becomes an issue when the redemption cap of five percent per quarter is reached.” However, there are mechanisms in place not to reach the five percent quarterly cap.

These mechanisms vary depending on the fund’s underlying assets but typically involve liquidity sleeves composed of cash or liquid investments such as public equities. “We keep five percent to ten percent of the funds in cash, with a very low element of listed equities in some funds.” says Strömberg. For yield-generating asset classes such as infrastructure, the cash flows from the yield component further help liquidity management. More importantly, “the 90-day notice period for redemptions in all funds offer clarity into upcoming outflows, which can often be matched by monthly inflows.” In times of high redemption pressure, “there is a control mechanism in place to gate the funds when redemptions exceed 20 percent of NAV,” according to Strömberg. Semi- liquid structures, therefore, are designed to provide liquidity in a controlled manner.

Schroders’ Private Equity Funds: Focus on Co-Investments and Secondaries

A well-constructed portfolio across geography, sector, type, and vintage can also engineer a level of “natural liquidity.” For its three semi-liquid private equity funds, Schroders Capital focuses primarily on co-investments and secondaries rather than primary funds. “We prefer co-investments and secondaries due to the visibility they offer and the maturity of these investments,” says Strömberg. “If we do invest in primary funds, we prefer late-stage primaries with high visibility on existing investments, as primary fund investments create cash flow planning challenges,” explains Strömberg. The aim is to avoid J-curve effects as much as possible.

“We prefer co-investments and secondaries due to the visibility they offer and the maturity of these investments.”Johan Strömberg, Director of Private Asset Sales at Schroders.

While reducing costs is not the primary goal, the focus on co-investments and secondaries does help minimize fees for end investors. “In primaries, you face the full 2-and-20 fee structure, whereas co-investments generally have no carry fee, and secondaries typically come at half the fee level of primaries,” says Strömberg. Another advantage of focusing on secondaries, particularly in GP-led single-asset transactions where Schroders Capital focuses on, is the ability to purchase star assets with continued upside potential, offering both growth and risk mitigation properties. “The loss ratio on GP lead secondaries is only 2 percent, based on our measures,” notes Strömberg, adding that “while the upside still is there on GP-leds, the visibility and maturity of these GP-led secondaries also make them appealing from a risk mitigation perspective.”

In addition to preferring co-investments and secondaries, Schroders Capital targets lower mid- market businesses with enterprise values between $150 million and $500 million, focusing on sectors such as technology, healthcare, consumer, and industrials. “These are our four main sectors, although almost everything today has some kind of tech angle,” Strömberg says.

Final Thoughts on Semi-Liquid Structures

The rise of semi-liquid fund structures has largely been driven by demand from smaller investors seeking access to institutional-grade private market investments. “The popularity of the semi-liquid structure has definitely been influenced by retail and private banking clients,” notes Strömberg. However, institutional investors are also showing increased interest, particularly due to the flexibility these structures offer. In general, these structures represent a trade-off between liquidity, returns, and fees.

In contrast to traditional private market investments, which typically offer higher returns accompanied by limited liquidity, semi-liquid funds provide more frequent liquidity – often through quarterly redemption windows – while still delivering competitive returns. As Johan Strömberg, Director of Private Asset Sales at Schroders, explains: “A traditional infrastructure fund with a buy-and-hold structure might have a 20- year lifespan, but semi-liquid evergreen structures offering quarterly liquidity provide an easier way to access the asset class.” However, this added liquidity may come at the cost of slightly lower returns, as semi-liquid funds maintain slightly higher cash reserves to accommodate potential redemptions.

“A traditional infrastructure fund with a buy-and-hold structure might have a 20- year lifespan, but semi-liquid evergreen structures offering quarterly liquidity provide an easier way to access the asset class.”Johan Strömberg, Director of Private Asset Sales at Schroders.

On the cost side, Schroders’ semi-liquid funds feature a simplified fee structure. Unlike many private market funds that charge performance fees, these strategies apply only an annual management fee. “Our strategies don’t charge a performance fee at the fund level, though we may incur performance fees on a few underlying investments, such as primaries,” Strömberg notes. “Investors can simply focus on the NAV when investing, with no need for complex cash planning, gaining access to high-quality managers we have been collaborating with for years.”

At the same time, the semi-liquid structure enables investors to “ramp up investments to full exposure instantly,” according to Strömberg. “These funds represent a good gateway into private markets asset classes,” concludes Strömberg, “and for investors who want to expand their exposure to private markets, we help them on their journey, whether they choose fully closed-end structures or other options.”

Iivo Paukkeri to Leave Aalto University Endowment

Eugeniu Guzun

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October 1, 2024

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Iivo Paukkeri to Leave Aalto University Endowment

Iivo Paukkeri is stepping down from his role as Head of Investments at Aalto University’s endowment fund in Finland to join the family investment company of Finland’s wealthiest individual, Anttii Herlin, and his children. After more than 15 years at the endowment fund, Paukkeri will join the family office Security Trading Oy at the beginning of 2025.

“After 15 years at Aalto University, I’ll be moving on at the end of the year,” Paukkeri announced on LinkedIn. “It has been a unique opportunity to build the university’s endowment since its inception. Now the job is open for someone else to take it further,” he added. “On a related note, I’m looking forward to joining the team at Security Trading Oy, a family office, in January.” Before becoming Head of Investments in early 2020, Paukkeri spent a decade as a portfolio manager at Aalto University’s endowment, focusing on hedge funds and liquid alternatives.

Aalto University is now seeking a new Head of Investments to manage its €1.5 billion endowment fund. The Aalto University endowment builds its portfolio around several risk-based building blocks, including interest rate risk, credit risk, equity risk, and alternative risk. The “alternative risk” building block features market-neutral diversifying strategies such as trend following, systematic risk premia, equity market-neutral, global macro, relative value and arbitrage strategies, among others.

At the close of 2023, Aalto University’s endowment had 18 percent of its portfolio allocated to alternative risk. This segment delivered a return of 11.1 percent in 2022 and 2.2 percent in 2023, generating an annualized return of 2.1 percent from mid-2010 through the end of last year. Overall, Aalto University’s endowment portfolio achieved an annualized return of 5.4 percent from mid-2010 to the end of 2023.

Photo by Unto Rautio

RFP: Nordic Institution Eyes Opportunistic Private Credit

Eugeniu Guzun

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September 20, 2024

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RFP: Nordic Institution Eyes Opportunistic Private Credit

A Nordic institution plans to allocate approximately €10-15 million to a private credit fund focused on opportunistic or special situation direct lending. According to Global Fund Search, the investor is exploring opportunities within the European opportunistic and special situation private credit space, with a potential commitment to such a strategy in 2025.

Search Criteria

Strategy: Corporate direct lending strategies in the European opportunistic/special situation space. Preferably senior secured.
- Hard restriction: No exposure to tobacco producers.
Return target: Net IRR of 15% or higher measured in EUR (after hedging costs)
Timing: Funds that are targeting Final Close no earlier than Q2-2025
Geography: Europe
- Global funds are also possible of interest, but no pure Asian funds etc.
Fund term:
- Investment period: 2 – 4 years from Final Close
- Total term: 7 – 10 years

Investment vehicle

A traditional closed-ended structure (could possibly consider open-ended/evergreen with option to structure the investment as a closed-ended fund
- Hard restriction: Opaque fund structures

Deadline
October 10, 2024 (Cut-off: Midnight CET, Expiry date inclusive)

To review the search and apply, asset managers need to register here on globalfundsearch.com

Questions?

Please contact support@globalfundsearch.com

Pic (c) cosma—shutterstock.com

Annika Luoto’s Full-Circle Return to Ilmarinen

Eugeniu Guzun

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August 14, 2024

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Annika Luoto has joined pension insurance company Ilmarinen as senior portfolio manager, following a brief tenure of just over a year as a portfolio manager specializing in hedge funds at Finland’s largest pension fund, Keva. Prior to her time at Keva, Luoto spent seven years in a similar role at the smaller pension insurance company Elo.

“I’m happy to share that I’m starting a new position as Senior Portfolio Manager at Ilmarinen,” Annika Luoto announces on LinkedIn. Luoto’s return to Ilmarinen brings her career full circle, as she started her career at the pension insurance company as a trainee in 2007, later advancing to a risk analyst role. She then moved to Tapiola Pension as a portfolio manager specializing in foreign exchange and money markets. Following the 2014 merger of Pension Fennia and LocalTapiola Pension to form Elo, Luoto continued in a similar capacity at Elo. In early 2016, she transitioned to a portfolio manager role focused on hedge funds, a position she held for over seven years before moving to Keva in early 2023.

“I’m happy to share that I’m starting a new position as Senior Portfolio Manager at Ilmarinen.”

At Keva, Luoto served as a portfolio manager in alternative investments, working alongside senior portfolio manager Markus Frosterus, with a focus on hedge funds and other alternatives. She is expected to take on a similar role focusing on hedge funds at Ilmarinen, which manages a hedge fund portfolio of €5.2 billion as of the end of the first quarter. Partly influenced by the low-interest-rate environment, Ilmarinen has significantly ramped up its allocation to hedge funds, growing from under two percent in late 2017 to 8.6 percent by the end of 2023.

Keva also maintains a sizeable hedge fund portfolio, valued at about €4.7 billion or about 6.9 percent of its overall investment portfolio as of the end of the first quarter. The Finnish pension agency responsible for pensions of public sector workers in state, municipal, and state church positions increased its allocation to hedge funds from under four percent in 2013 to over seven percent in 2022. However, the percentage allocation dipped below seven percent in the first quarter of 202

Velliv’s Take on Private Markets: The Appeal of Private Credit

Master

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May 30, 2024

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Velliv’s Take on Private Markets: The Appeal of Private Credit

Institutional investors, including those from the Nordic region, have steadily increased their allocations to private market asset classes such as private equity, private debt, real estate, and infrastructure. Despite a general weakening in appetite for alternative investments in a higher interest rate environment, pension and institutional clients continue to explore private assets. This interest is driven not only by the long-term outperformance of private assets compared to public equivalents but also by the broader investable universe they offer, as noted by Christoph Junge, Head of Alternatives at Danish pension provider Velliv.

Approximately ten percent of Velliv’s €45 billion investment portfolio is allocated to alternative investments, including private equity, private credit, liquid alternatives such as trend-following CTAs and commodities, as well as infrastructure and timberland. Led by Christoph Junge, Velliv’s alternatives team manages about €4.5 billion in these assets, excluding real estate, which is handled by a different team. “Private equity remains the largest building block of our alternatives allocation and has been so for a long time,” says Junge. The second-largest component is illiquid credit, categorized into two segments: low-risk and high-risk illiquid credit.

“Private equity remains the largest building block of our alternatives allocation and has been so for a long time.”

“Illiquid credit with low risk typically includes credits such as commercial real estate debt, infrastructure debt, and asset-backed securities that are very senior in the capital structure with minimal risk,” explains Junge. “In contrast, high-risk illiquid credit can include anything from senior direct lending and mezzanine, all the way to CLO equity,” elaborates Velliv’s Head of Alternatives. Together, these two buckets form the second largest building block of Velliv’s alternatives allocation. The third largest portion of the alternatives portfolio consists of liquid alternatives, including CTAs and long-only commodities. This allocation has seen significant growth over the course of the past two years. Real assets such as infrastructure and timberland make up a smaller allocation, followed by an impact allocation.

Roles of Private Asset Classes in a Portfolio

Every asset class, including those in private markets, plays a distinct and defining role in the broader portfolio. “Each of these asset classes has its own distinct role in our portfolio allocation,” reiterates Junge. The primary role of both private equity and private credit in Velliv’s portfolio is to outperform their liquid counterparts. “In private equity, our goal is to achieve the highest possible returns and outperform listed markets over the long run,” explains Junge. Velliv targets a performance that exceeds listed markets by at least three percentage points per annum throughout a complete cycle. “Similarly, private credit also seeks to outperform the returns of liquid credit markets,” he adds. Low-risk illiquid credit aims to outperform investment-grade credit, while high-risk illiquid credit aims to pick up additional spread and illiquidity premium compared to their listed counterparts.

“In private equity, our goal is to achieve the highest possible returns and outperform listed markets over the long run. Similarly, private credit also seeks to outperform the returns of liquid credit markets.”

“Private credit is still credit, and private equity is still equity,” emphasizes Junge. “Both private and public markets are influenced by the same macroeconomic factors.” While diversification is not the primary objective of Velliv’s investments in private equity and private credit, “there is a bit of diversification to be had given that only a minor part of the global economy is publicly listed.” Private equity and credit offer a much wider investable universe. “We get a bit of diversification by gaining exposure to a broader range of companies that would otherwise be off-limits.”

Investing in real assets serves a distinct purpose. “With infrastructure and timberland investments, we are aiming for stable returns and inflation protection,” points out Junge. Real assets expose investors to a different set of risk premiums. “Timberland, for instance, grows each year; trees don’t stop growing just because the world is in a recession,” explains Junge. “Investors get more timber on the stump year after year, which is an attractive feature of timberland as an asset class.” In addition, there is no immediate need to harvest the trees if market prices are unfavorable. “Crucially, our own analysis and broader research show a strong positive correlation between timberland investments and the consumer price index, offering effective inflation protection,” Junge adds.

“With infrastructure and timberland investments, we are aiming for stable returns and inflation protection.”

“The same can hold true for infrastructure investments, but depends on the underlying investments and their structuring, so devil is in the details,” emphasizes Junge, adding that Velliv “deliberately chose to go for the core and core-plus segments, which are the lowest-risk areas.” While timberland and infrastructure are among the lowest-risk building blocks in the portfolio, “certain parts of private credit and private equity represent the more ‘high-octane’ building blocks.”

The Effects of Higher Interest Rates

The era of low interest rates in the decade post-financial crisis led to a surge of investment capital flowing into private markets. However, the recent shift towards a higher interest rate environment has dampened fundraising activities in this universe and has manifested varying effects on the appeal of different alternative asset classes. “There are some asset classes that should suffer from higher interest rates, with private equity being a prime example,” says Christoph Junge.

“There are some asset classes that should suffer from higher interest rates, with private equity being a prime example.”

He explains that with current interest rates significantly higher than before, the expected return from private equity could have declined from around 20 percent during the low-rate environment to approximately 15-16 percent today – all else equal. Junge suggests that leverage, a traditional driver of returns in private equity, will become less influential. “The focus has shifted to operational improvements,” he asserts. “In the future, the general partners who will survive and fare best are those who are masters of operational improvements. It’s not about financial engineering anymore.”

Junge draws a comparison to the 1980s, when interest rates were above ten percent and private equity still delivered solid returns despite relying heavily on financial engineering. “However, you cannot compare today’s private equity landscape to that of the 1980s, because markets were much more immature back then,” he observes. Despite this, Junge anticipates the higher interest rate environment to slightly reduce expected returns in private equity and the attractiveness of private equity as an asset class. “The same might hold true for some real assets, such as timber and infrastructure,” he adds, though the link is not as clear. “The discount rate is just one component of the equation.”

Private Credit: The Preferred Choice in Today’s Market

Private credit, on the other hand, has benefited from the rise in interest rates. “With its floating rate nature, the base rate has gone up from zero to 500 basis points, so we are currently earning 9, 10, or even 11 percent after fees on senior direct lending,” explains Junge. “This makes private credit more attractive than private equity,” he asserts. Junge questions the value of opting for equity when senior lending offers returns in the teens. “If private equity offers 15 percent returns and private credit yields 10 percent, is it worth taking on the additional risk in the capital structure for that extra return?”

As a result, Velliv is maintaining its current allocation to private equity while expanding its investment in private credit. “We are not halting our investments in private equity, we still make commitments due to the runoff in the existing portfolio,” says Junge. He notes that Velliv’s private equity portfolio would be worth only half its current value in five years without new investments. “We are focusing on maintenance commitments.”

“If private equity offers 15 percent returns and private credit yields 10 percent, is it worth taking on the additional risk in the capital structure for that extra return?”

Junge observes significant optimism surrounding private credit. “There is certainly a trend of widespread bullishness on private credit at the moment,” he notes. While this enthusiasm often makes him cautious, he acknowledges the reasons behind its attractiveness. “I always consider if there are any overlooked risks that may bring down the bullishness, but it’s understandable why private credit is seen as attractive currently,” he continues. Nevertheless, he emphasizes that “the fun only lasts as long as borrowers can pay the debt and can sustain substantially higher interest rates.”

Junge and his team at Velliv are carefully monitoring borrowers’ ability to meet interest payments and maintain adequate coverage ratios. However, he notes that if “we are concerned about companies not being able to pay the interest rates as debt investors, we should be more concerned about equity positions due to their subordinate status in the capital structure.” Everyone is bullish on private credit, says Junge, and “I can fully understand why everyone is bullish.” Junge finds private credit to be relatively more compelling than private equity at the moment.

This article is part of HedgeNordic’s upcoming “Private Markets” p

Norwegian Trio Aims to Capture Bitcoin Momentum

Master

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March 13, 2024

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Norwegian Trio Aims to Capture Bitcoin Momentum

Three Norwegian friends, who have known each other since their school days and pursued their master’s studies at the same university, have come together to launch an algorithmic hedge fund that trades Bitcoin derivatives. The founding trio launched Anna Fund in mid-2023 and successfully capitalized on the Bitcoin rally since October of last year.

Ole Christian Wendel and Martin Helgheim, who pursued a joint engineering and finance program specializing in quantitative finance, wrote their master’s thesis in 2018 on the potential of algorithms to capture momentum in the cryptocurrency market. This research laid the groundwork for what would later become Anna Asset Management. The third co-founder, Ole Nordviste, holds a master’s degree in computer science with a specialization in artificial intelligence, serving as the Chief Technology Officer (CTO) of Anna Asset Management.

“Although we explored the opportunity of starting an algorithmic hedge fund in the crypto space back in 2018, we decided to start other corporate jobs as the regulatory landscape for such a fund was challenging in Norway at the time,” recalls Ole Christian Wendel, who serves as the CEO of Anna Asset Management. Ole Nordviste served as CTO at digital-physical healthcare operator Dr. Dropin, while Ole Christian and Martin Helgheim ventured into management consulting for three to four years at BCG and KPMG, respectively.

“…we explored the opportunity of starting an algorithmic hedge fund in the crypto space back in 2018…”Ole Christian Wendel

The starting point of Anna Fund stemmed from the belief that the Bitcoin market is dominated by investors who buy and sell solely based on recent price developments. “Our core investment hypothesis is quite simple: the world is unpredictable, but people are not,” notes Wendel. “If you can find an asset that has fewer ties to the complex nuts and bolts of the world we live in, but rather depends on fear and greed among the investors, it is likely easier to predict the next move,” he elaborates. “This is our motivation for entering the crypto space, and Bitcoin in particular.”

The Algorithm

In contrast to traditional assets such as stocks or bonds, Bitcoin lacks the typical characteristics necessary for valuation using conventional methods. Bitcoin does not generate any earnings or cash flows, pay dividends, or offer yields. While Bitcoin may share similarities with commodities, which are often cyclical and notoriously challenging to value, valuing Bitcoin presents an even greater challenge. “Bitcoin lacks a universally agreed upon method of valuation and that makes it very difficult to point the real-world value drivers for Bitcoin,” notes Martin Helgheim, co-founder and COO at Anna Asset Management. “Ultimately, we believe the ambiguity in valuation leads to a situation where a substantial portion of investors in the market base their decisions to buy or sell simply on the price development itself.”

“Ultimately, we believe the ambiguity in valuation leads to a situation where a substantial portion of investors in the market base their decisions to buy or sell simply on the price development itself.”Martin Helgheim

For that reason, the founding trio of Anna Fund has focused on developing predictive models using solely historical price and volume data. After acknowledging that investors trade Bitcoin primarily based on price movements, “the next step is to identify what triggers this bullish and bearish momentum, for which we have in-house simulation tools to iterate through market data minute-by-minute over the last 10 years,” explains Ole Nordviste, who serves as the CTO at Anna Fund.

Anna Fund employs inverse perpetual Bitcoin futures to execute its momentum strategy. Perpetual futures contracts lack an expiration date and are designed to mirror the spot price. “The ‘inverse’ aspect implies that the contracts use Bitcoin as base currency, settlement, and collateral while being quoted in U.S. dollars,” explains Wendel. Anna Fund opts for these contracts for two primary reasons. “Firstly, it’s a highly liquid market with low commission,” notes Helgheim. “Secondly, it enables us to optimize our exposure in a way that allows us to reduce our cost of trading significantly.”

“Our aim is to catch 2-12-week momentums, up or down.”Ole Nordviste

The algorithm is intricately designed across multiple layers on various timeframes, considering market bias and trends to create position recommendations. “However, the underlying concept is simple,” says Nordviste. The algorithm assesses whether “the current situation resembles past scenarios that have shown statistical significance in predicting a bullish or bearish momentum, which may trigger an action,” explains the CTO. “Our aim is to catch 2-12-week momentums, up or down,” further adds Nordviste. “Our analysis shows that this is the sweet spot for our strategy, as we can get rewarded handsomely when the market starts moving while being able to have a tight risk management regime on our positions.”

Bitcoin Rally and Main Risks

Launched in mid-2023, Anna Fund has successfully capitalized on Bitcoin’s rally since October, with 44 percent of Bitcoin’s gains occurring in February alone. This upward trend continued into March as Bitcoin surpassed the $72,000 mark for the first time, resulting in gains of nearly 70 percent for the year. “What we have seen so far with the spot ETF approval in January this year is a bump in demand in the spot market and an increase in volume across the board,” explains Ole Christian Wendel. “More importantly, the dynamics of the market appear to be similar to prior bullish periods with highly trending behavior followed by quick turnarounds,” he warns.

“What we have seen so far with the spot ETF approval in January this year is a bump in demand in the spot market and an increase in volume across the board.”Ole Christian Wendel

In February alone, Anna Fund recorded a 63 percent gain, reflecting the use of leverage within the strategy. “Our product has a high return potential, which naturally comes with a corresponding risk profile,” notes Wendel. One of the primary risks involves the accuracy of their algorithm in anticipating and capturing shifts in momentum. “There is always a risk that the algorithm is wrong when placing a long or a short position,” acknowledges Wendel. “In a highly volatile market like Bitcoin, coupled with up to 2X exposure that many of our positions utilize, there is considerable risk of losing money on a trade.”

“Our product has a high return potential, which naturally comes with a corresponding risk profile.”Ole Christian Wendel

However, the team relies on a multitude of mechanisms that may trigger a position closure. Anna Fund relies on a server-side stop-loss at the exchange, ensuring automatic closure of the position to prevent further losses. “These mechanisms usually kick in quite early, reflecting our 4.8 percent average loss on losing trades since the fund’s inception,” says Helgheim. “However, if none of these triggers a close, we have an absolute floor of 15 percent (30 percent at risk with maximum leverage) adverse price move,” he elaborates. “To date, we have never seen this being triggered either live or in simulations, but it serves as a protection of the potential downside on any position.”

Additionally, there are risks associated with trading on unregulated exchanges. “There is a heightened risk of using an unregulated crypto exchange as a counterpart,” points out Helgheim. In light of the FTX collapse in 2022, this concern remains on top of investors’ minds. The team behind the Anna Fund considers two main risks: the exchange being hacked or becoming insolvent.

“To mitigate the hacking risk, we only work with the market leader that has a strong track record on security and has refunded customers in the few breaches that have occurred historically,” says Helgheim. To address solvency concerns, the team requires exchanges to provide a public and regularly updated proof of reserves statement, confirming sufficient reserves to support depositors’ balances. The team also monitors the net flow of assets in and out of the exchange daily to detect a potential bank run at an early stage. “In case concerns are raised, we have backup accounts at regulated exchanges where we can transfer our assets in Bitcoins within an hour, 24/7/365.”

Private Assets: A Market in Transition

Master

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March 12, 2024

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Over the past decade, private assets have become a cornerstone of institutional investment portfolios. From private equity to private credit, infrastructure to real estate, these asset classes have provided diversification and strong returns, often outpacing public markets. However, as global economic conditions shift and financial markets recalibrate, investors find themselves navigating an increasingly complex landscape.

The recent HedgeNordic Round Table discussion, held in Stockholm in January 2024, brought together leading investors and asset managers to dissect the performance, challenges, and future prospects of private assets. The conversation was shaped by the perspectives of institutional allocators such as Ulrika Bergman of the Nobel Foundation, Magdalena Högberg of Swedish pension fund AP4, and Mikael Huldt of Afa Insurance, alongside asset managers including Nadia Nikolova (AllianzGI), Raman Rajagopal (Invesco), Olivier Keller (PineBridge Investments), and Zeshan Ashfaque (Man Varagon). Moderated by Jonas Andersson of Navare Invest, the discussion painted a picture of resilience, adaptation, and caution as private markets enter a new era.

The Evolution of Private Markets

The rise of private assets in institutional portfolios can be traced back to the aftermath of the 2008 financial crisis. With low interest rates fueling an abundance of capital, private markets thrived for more than a decade. However, in 2022, this environment began to shift as central banks raised interest rates in response to inflationary pressures. While this policy change slowed activity in many corners of the private market, it also created opportunities in others.

The year 2023 was, in many ways, a tale of two cities. Private credit emerged as a standout performer, benefiting from rising base rates and more lender-friendly conditions, while private equity faced mounting headwinds, including a sluggish M&A environment and difficulties in securing attractive exits. Meanwhile, infrastructure investments proved resilient, whereas real estate valuations came under pressure as higher interest rates reshaped market dynamics.

Private Credit: A Strong Performer

One of the most compelling narratives in the private asset space has been the rise of private credit. With banks retrenching from corporate lending, private lenders stepped in, offering capital under increasingly favorable terms. Mikael Huldt of Afa Insurance noted that private credit was the best-performing private asset class in 2023, a sentiment echoed by AP4’s Magdalena Högberg and the Nobel Foundation’s Ulrika Bergman.

According to Raman Rajagopal of Invesco, 2023 was a particularly attractive year for private credit investors, with direct lenders able to underwrite yields exceeding 11-12% on senior secured positions. However, despite strong fundamentals, one major challenge remained: capital deployment. The slowdown in transaction volumes made it difficult for investors to put capital to work at scale, particularly for larger funds looking to deploy significant sums. This divergence in opportunity underscored the importance of manager selection in the private credit space.

Private Equity: A More Challenging Landscape

Private equity, traditionally a high-performing asset class, faced a more challenging backdrop in 2023. The combination of rising interest rates, economic uncertainty, and reduced M&A activity led to slower deal-making and a tougher fundraising environment. Emerging managers, in particular, struggled to attract capital, as investors gravitated toward established players with proven track records.

Despite these headwinds, long-term private equity returns remained strong. Bergman noted that while 2023 was a muted year for private equity, the asset class still performed well over a three-to-five-year horizon. Similarly, Högberg explained that AP4 considers private equity as an extension of public equity, and while returns were not stellar in 2023, they did not experience significant downside either.

Olivier Keller of PineBridge Investments highlighted that while fundraising was slow, valuations did not decline as much as some had expected. Many investors found themselves over-allocated to private equity due to the strong performance of public markets, leading to an increase in secondary market activity. Looking ahead, private equity firms will need to rely less on financial engineering and focus more on operational improvements to drive returns.

Real Assets: A Divided Market

The real assets sector presented a mixed picture. Infrastructure investments, particularly those with inflation-linked revenues, remained attractive to investors. In contrast, real estate faced more pronounced challenges. Högberg observed that after real estate valuations held steady in 2022, a correction took place in 2023, particularly in office spaces impacted by the shift to remote work.

Huldt shared a similar perspective, pointing out that capitalization rates—used to value real estate assets—were well below interest rates, putting downward pressure on valuations. Despite this, infrastructure assets continued to perform well, with their inflation-linked revenue streams providing stability in a volatile market.

The Growing Influence of ESG and Impact Investing

Another theme that emerged from the discussion was the increasing importance of ESG and impact investing. While ESG integration remains uneven across markets, it is becoming a more prominent consideration for institutional investors.

Nadia Nikolova of AllianzGI noted that impact private credit funds are gaining traction in Europe, supported by blended finance techniques that reduce risk for private investors. However, she highlighted the challenge of mobilizing capital toward sustainable investments in emerging markets. Despite significant pledges from global asset owners, actual capital flows have been slower than anticipated.

For institutional allocators, ESG is now a key factor in manager selection. Högberg emphasized that sustainability is deeply embedded in AP4’s investment strategy, not just as a compliance requirement but as a fundamental driver of long-term returns. However, Ashfaque cautioned that ESG implementation in private credit still faces hurdles, particularly in the U.S., where political factors and concerns over greenwashing have created resistance.

Looking Ahead: Key Trends in Private Markets

As investors look toward the future, several key trends are expected to shape private markets. In private equity, M&A activity and distributions are likely to pick up in 2024 as interest rates stabilize. However, Keller warned that the era of easy leverage is over, and private equity firms will need to focus more on operational value creation.

In private credit, while interest rate cuts may be on the horizon, the asset class remains well-positioned due to its attractive income profile and downside protection. However, Rajagopal pointed out that rising base rates will create increased dispersion in credit performance, making manager selection even more critical.

Another area of opportunity is distressed investing. Rajagopal and Ashfaque both noted that rising default rates could create openings for distressed credit strategies. However, these windows of opportunity tend to be short-lived, requiring managers to act quickly.

In emerging markets, impact investing is poised for growth, but Nikolova stressed that success will depend on structuring investments in a way that mitigates risk for private capital. Blended finance solutions, which combine public and private capital to fund sustainable projects, are likely to play a key role in unlocking investment opportunities in these regions.

The Importance of Manager Selection

One of the overarching takeaways from the discussion was the critical importance of manager selection. With private markets evolving rapidly, investors must be discerning in choosing partners who can navigate uncertainty and capitalize on emerging opportunities. Högberg noted that AP4 looks for niche strategies that offer differentiated exposures, while Bergman emphasized the value of strong, long-term relationships with managers.

Huldt summed it up best: “Rome was not built in a day. Successful private market investing requires patience, discipline, and a keen understanding of structural trends.”

As private markets continue to evolve, investors who remain adaptable and focused on long-term value creation will be best positioned to succeed.

Private Debt: A Compelling Alternative to Equities for AP2

Master

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November 15, 2023

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Private Debt: A Compelling Alternative to Equities for AP2

Following a change in legislation, the four Swedish national pension buffer funds, AP1-AP4, were granted the opportunity to invest in private debt starting in 2021 to capitalize on the illiquidity premium in this asset class and generate returns amid a low-interest-rate environment for traditional fixed income. In late 2020, AP2’s board decided to make a strategic allocation of two percent of its then SEK 386 billion portfolio to private debt.

Patrik Jonsson, who had been with AP2 since 2015 as Head of Manager Selection for Public Assets, was entrusted with the responsibility of building AP2’s private debt allocation. “At the time we had the legislative change allowing for investments in illiquid private debt, we were in a near-zero percent interest rate environment, and we thought this might be an interesting addition to our portfolio,” recalls Jonsson. He faced the challenge of initiating this allocation during the Covid pandemic when travel restrictions were in place and in-person meetings were impossible. “Was I supposed to do a huge allocation with managers I had never met?” Jonsson recalls asking himself at the time.

Jonsson started the process by engaging with existing managers in AP2’s portfolio who were involved in listed alternative credit, including high-yield bonds, leveraged bonds, CLOs, and structured credit. “That alternative credit allocation was managed by five external managers, which provided a starting point for building the private debt allocation during the pandemic,” says Jonsson. “It was easier to start the allocation process by working with managers with whom we had prior relationships,” he claims. The resumption of travel to the United States towards the end of 2021 made the allocation and selection process much more feasible.

“Allocation changes to this asset class take years and years to execute regardless of how much time you spend on this internally.”

Despite the relatively modest allocation target of two percent, AP2’s large portfolio size required deploying about SEK 8 billion into private debt. Jonsson emphasizes that building an allocation in the private debt space is a time-consuming process, unlike more liquid asset classes where changes can be made swiftly. “One thing that we have learned over the past years is that it takes time to build an allocation like this,” acknowledges Jonsson. “In the private debt space, even if I wanted to deploy that money tomorrow, that just cannot be done for practical purposes,” he says. “Allocation changes to this asset class take years and years to execute regardless of how much time you spend on this internally. We are working on finding ways to accelerate the ramp-up of our current portfolio.”

Illiquidity Premium – the Perfect Match

Liquidity is typically perceived as valuable and highly desirable for most investors. However, liquidity often comes at a cost. For long-term investors such as AP2, this lack of liquidity translates into an additional compensation known as the illiquidity premium. “In theory, there should be a premium for investing in illiquid instruments compared to liquid investments and there is definitely an illiquidity premium in private credit,” says Patrik Jonsson.

“In theory, there should be a premium for investing in illiquid instruments compared to liquid investments and there is definitely an illiquidity premium in private credit.”

“As an AP fund, this illiquidity premium is a really good match for us.” In comparison to many other asset owners, AP2 has the luxury of being able to foresee its inflows and outflows for years, if not decades. “That is a competitive advantage,” considers Jonsson. “The ability to accept illiquidity for the premium is something that we should try to exploit.”

Private Credit as an Alternative to Equities?

Private credit has served as a powerful complement to traditional fixed income, particularly in a low-interest-rate environment. “We were operating in a zero-interest-rate environment when we started allocating to private debt, so we thought this asset class might offer a good pick-up compared to listed credit,” recalls Jonsson. Yields on these private debt investments – which are largely based on floating-rate loans – have gone into double digits. “We find ourselves in a different situation all of a sudden,” says Jonsson.

“My opinion is that private debt currently could be viewed as a very good alternative to equities.”

“With the base rate in the U.S. above five percent and adding the spread on top of that, we are looking at expected returns that can compete with the expected returns from the equity market,” he elaborates. “Private debt as an asset class has undergone significant changes over the last three years since we started allocating and much of that has occurred in the last twelve months,” explains Jonsson. “My opinion is that private debt currently could be viewed as a very good alternative to equities.”

Diversification

AP2 started out building the allocation to private debt with plain-vanilla investments, such as senior direct lending in the United States and Europe. Jonsson has also left some room for an allocation to private debt in other regions of the world, but that is not particularly appealing in an environment with attractive opportunities in the U.S. and Europe. “There is no real need to go to other markets at this stage, as that would add more complexity to the portfolio.”

Private debt includes a wide range of strategies from senior direct lending and mezzanine strategies to higher risk-return non-performing credit strategies. Having so far mostly invested in senior direct lending, AP2 has considered diversifying the portfolio across more types of credits. “In the current interest rate environment, I don’t see the point of pursuing junior, mezzanine, or second-lien investments when the senior part is providing us with such great returns,” emphasizes Jonsson. “A senior loan in the U.S. right now yields about 12 percent, why would we be stretching out to try to get 15 or 20 percent.”

“In the current interest rate environment, I don’t see the point of pursuing junior, mezzanine, or second-lien investments when the senior part is providing us with such great returns.”

Jonsson does not see any reason to climb the risk spectrum in pursuit of higher returns. With a contracted return of 12 percent from senior debt investments, he notes that it is important to question how much return is actually needed to fulfill obligations. “If you cannot really fulfill your needs by achieving 12 percent, you have an asset-liability mismatch.” For Jonsson, “there is no need to stretch further. This environment is as good as it gets.”

Default Expectations

With higher interest rates and a slowing economy, there is a greater likelihood that the companies behind these securities may default on their loans. While the possibility of defaults is a valid concern for investors venturing into the private debt space, it shouldn’t dominate their perspective. “Could there be defaults? That’s a valid question to ask,” says Jonsson. “And yes, there will be defaults.”

“Could there be defaults? Yes, there will be defaults. Yet, if you are generating a 12 percent income, you can afford some haircuts on that and still perform well.”

According to Jonsson, the primary factor that could unsettle this market is substantial credit losses. However, scrutinizing historical loss rates is insufficient for meaningful insights, as they have essentially been at zero since the inception of this asset class. “But it’s unlikely they will remain at zero going forward. Yet, if you are generating a 12 percent income, you can afford some haircuts on that and still perform well.”

Should credit losses become the catalyst that tips this market over, “that would imply that private equity had been losing money hand over fist,” explains Jonsson. Given that private equity continues to support a considerable number of these companies, and the loan-to-value rations are typically well below 50 percent, “seriously contemplating the prospect of substantial credit losses within private credit should give one pause before committing another dollar to private equity.”

Harvesting the Crypto Vol

Crypto

Master

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October 22, 2023

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Volatility is a feature of most asset classes, as it is for cryptocurrencies. While most investors fear volatility, with the conventional view equating price fluctuations with risk, there are ways to profit from volatility. One such way is volatility harvesting through the systematic rebalancing of a portfolio.

Volatility harvesting involves a continuous process of buying low and selling high, and portfolio managers can harvest more returns through rebalancing as volatility increases. Due to high volatility, cryptocurrency markets are replete with opportunities to harvest volatility. Swedish digital assets investment firm Hilbert has been using an algorithmic model dubbed Caerus to capture alpha-generating rebalancing opportunities within the crypto space since 2017.

To illustrate the concept of volatility harvesting, picture a portfolio worth $200 that is equally allocated between Bitcoin and cash. Should the price of Bitcoin drop from a starting value of $30,000 to $15,000, the portfolio would now be worth $150 with $50 in Bitcoin and $100 in cash. In the next step, the portfolio is again equally weighted between Bitcoin and cash, with this rebalancing process requiring the use of cash to buy $25 worth of Bitcoin to arrive at a portfolio of $75 in Bitcoin and $75 in cash. If Bitcoin appreciates to $30,000, the entire portfolio would now be worth $225 instead of $200 for a buy-and-hold approach.

“The good thing about volatility harvesting is that it can work in upward trending markets, in sideways trending markets, but also in downwards trending markets exhibiting volatility,” explains Richard Murray, the CEO of Hilbert Capital. This year is an example of volatility harvesting outperforming a buy-and-hold approach. “Cryptocurrency markets clearly have been in a downward drift in 2022, so market directionality has been a drag on performance. Volatility harvesting has offset some of that drag.”

“The good thing about volatility harvesting is that it can work in upward trending markets, in sideways trending markets, but also in downwards trending markets exhibiting volatility.”

The best environment for a volatility harvesting strategy, on an absolute basis, is an upward trending and volatile market. “The constant rebalancing, buying low and selling high, adds additional returns both in an upward trending and range-bound market environment,” reiterates Murray. A volatility harvesting strategy, however, still remains a directional trade by providing exposure to the appreciation of cryptocurrency markets – in addition to taking advantage of price volatility through algorithmic trading.

Hilber Capital’s first fund, Hilbert Digital Asset Fund, has been entirely relying on the Caerus volatility harvesting strategy since launching in January 2019. “The fund offers exposure to the broader crypto asset class with an additional contribution from volatility trading,” explains Murray. The fund has “a mandate to be 100 percent risk-on at all times,” according to the CEO of Hilbert Capital. Despite outperforming on a relative basis, by design, the return profile of Hilbert Digital Asset Fund is volatile and can experience drawdowns along with the broader market.

Lower Risk Exposure to Crypto

In response to increasing demand for cryptocurrencies from traditionally more risk-averse institutional investors, Hilbert Capital has launched a new investment product offering lower-risk exposure to the crypto market using the same Caerus volatility harvesting strategy. “A full risk-on volatility harvesting strategy goes up and down with the market despite adding a big chunk of trading alpha on top, so we asked the question of how to reconstruct the core trading approach to offer something that is more conservative,” reveals Murray.

“Hilbert Digital Asset Fund and Hilbert V1 Fund have common DNA in Caerus.”

The solution was Hilbert VI, which also uses the Caerus algorithmic trading strategy to build a volatility trading portfolio sized to limit the maximum drawdown to ten percent per year. “Hilbert Digital Asset Fund and Hilbert V1 Fund have common DNA in Caerus,” says Murray. “While Hilbert Digital Asset Fund is designed to be at 100 percent risk-on at all times, Hilbert V1 Fund has limited crypto-market directional exposure in the range of 0.1-0.15,” he elaborates. “V1 is by design more conservative with the goal of limiting the maximum drawdown to ten percent, and we size the volatility harvesting strategy according to that constraint.” Since its inception on the 1st of May 2022, Hilbert V1 has produced a negative return of 4.3 percent, compared to a loss of about 60 percent for the broad cryptocurrency market.

“While Hilbert Digital Asset Fund is designed to be at 100 percent risk-on at all times, Hilbert V1 Fund has limited crypto-market directional exposure in the range of 0.1-0.15.”

Hilbert V1 Fund allocates only a portion of capital under management to the Caerus volatility harvesting strategy to maintain its pre-specified risk-return profile, leaving the fund with ample liquidity. The unused liquidity is used to execute more opportunistic trades in the still nascent cryptocurrency universe. “The core volatility harvesting strategy gives us all the risk we want, all the return we need, but we then use some of the liquidity outside of that to take advantage of opportunities that come and go,” summarizes Murray.

Opportunities That Come and Go

The Hilbert team has two criteria for allocating capital to opportunistic trades. “First, the investment opportunity should not bring in additional drawdown risk, and second, it should provide a good level of incremental return,” explains Murray. One such opportunistic trade was the funding rate trade, which involved being long Bitcoin and short perpetual futures, according to Murray. Bitcoin perpetual contracts, which have no expiration date, have offered carry arbitrage opportunities for investors looking to exploit inefficiencies between the spot and futures markets. During a bullish stretch, a carry strategy that uses a long position in the spot market and a short position in futures can generate a nearly risk-free return. With markets more bearish in recent months, such carry opportunities have diminished significantly.

“It was a very attractive trade, but this year the funding rates have been flat or negative, so we have not used it,” says Murray. “The funding rate trade tends to work better in “risk-on” market periods when there are higher volumes of retails investors using futures to gain leverage,” he elaborates. “A conservative return expectation from these limited-drawdown trades is 5-10 percent per year, but there will be periods when little or no return is possible, given our criteria,” emphasizes Murray.

“…what you might marginally gain in incremental additional returns is not a good trade-off with the new execution risk that you bring in.”

The fully-systematized Caerus algorithm assesses trade opportunities every 30 seconds across 1800 possible cryptocurrency combinations. The more opportunistic trades, however, are exploited on a discretionary basis. “Our team has done a lot of research in terms of developing an algorithm that systematically trades carry opportunities,” says Murray. However, the conclusion out of the research has been that “what you might marginally gain in incremental additional returns is not a good trade-off with the new execution risk that you bring in,” he emphasizes. “So we don’t take that trade-off.”

Instead, the Hilbert team seeks to quantify every part of the decision-making process. “We are a quantitative investment group and we quantify everything,” says Murray, including the range of opportunities that can provide carry, the level of carry, the consistency of carry, the liquidity and counterparty risk, among others. “We quantify everything, but ultimately the team is making the choice of which opportunity to allocate to.”

While these opportunistic trades come and go, Hilbert’s volatility harvesting strategy is repeatable and scalable regardless of market conditions. It is not a “trade” or an “opportunity” or an “indicator,” according to Murray. “In 100 years’ time, if markets are 100 percent efficient given full information and we get to a state where no mispricings or indicators exist, Hilbert’s volatility trading approach will be the only way to generate excess returns over a buy-and-hold portfolio,” he concludes. “It’s just math.”

Danish Crypto HF Founder Gets Advisory Role

Eugeniu Guzun

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August 22, 2023

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Danish Crypto HF Founder Gets Advisory Role

Mikkel Mørch, a member of an all-Danish founding team that launched crypto hedge fund ARK36 out of Cyprus, has been appointed as strategic advisor at Maxwell Partners, a London-based algorithmic trading, blockchain and digital asset investment firm.

Mørch is the founder and Chairman of Cyprus-based digital asset investment fund ARK36, one of the first licensed funds in Europe investing exclusively in bitcoin and other leading crypto-assets. ARK36 was founded by an all-Danish team of four in October 2020.

Mikkel Mørch’s role as strategic advisor at Maxwell Partners will focus on business development and helping the London-based firm strengthen and expand its algo trading business for investors in the cryptocurrency markets. Maxwell Partners offers a long-short algorithm that uses technical analysis to identify the trading range of an asset and automatically produce buy and sell signals. The firm has grown its assets under management from $10 million to $194 million over the past one and a half years, according to a press release.

“I am delighted to be joining the firm as a Strategic Advisor to help management face these challenges head-on and ensure Maxwell can continue to scale without sacrificing the quality of its services.”

“Such a rapid pace of growth shows the strength of Maxwell’s offering but also entails significant challenges,” comments Mørch, the newly-appointed strategic advisor at Maxwell Partners. “I am delighted to be joining the firm as a Strategic Advisor to help management face these challenges head-on and ensure Maxwell can continue to scale without sacrificing the quality of its services.”