Financial Intermediaries
On this website, Financial Intermediaries are investors that qualify as both a Professional Client and a Qualified Investor.
In summary, a person who can both be classified as a professional client under the Markets in Financial Instruments Directive II (2014/65/EU, “MiFID”) and a qualified investor in accordance with the Prospectus Regulation ((EU) 2017/1129) will generally need to meet one or more of the following requirements:
(1) An entity required to be authorised or regulated to operate in the financial markets. The following list includes all authorised entities carrying out the characteristic activities of the entities mentioned, whether authorised by an EEA State or a third country and whether or not authorised by reference to a directive:
(a) a credit institution;
(b) an investment firm;
(c) any other authorised or regulated financial institution;
(d) an insurance company;
(e) a collective investment scheme or the management company of such a scheme;
(f) a pension fund or the management company of a pension fund;
(g) a commodity or commodity derivatives dealer;
(h) a local;
(i) any other institutional investor;
(2) a large undertaking that meets two of the following size requirements on a company basis: (i) a balance sheet total of EUR 20,000,000; (ii) an annual net turnover of EUR 40,000,000; (iii) own funds of EUR 2,000,000;
(3) a national or regional government, a public body that manages public debt, a central bank, an international or supranational institution (such as the World Bank, the IMF, the ECB, the EIB) or another similar international organization;
(4) a natural person resident in an EEA State that permits the authorisation of natural persons as qualified investors, who expressly asks to be treated as a professional client and a qualified investor and who meets at least two of the following criteria: (i) he/she has carried out transactions on securities markets at an average frequency of, at least, 10 per quarter over the previous four quarters before the application, (ii) the size of his/her financial instrument portfolio, defined as including cash deposits and financial instruments exceeds EUR 500.000, (iii) he/she works or has worked for at least one year in the financial sector in a professional position which requires knowledge of securities investment.
Please note that the above summary is provided for information purposes only. If you are uncertain as to whether you can both be classified as a professional client under the Markets in Financial Instruments Directive and classed as a qualified investor under the Prospectus Directive then you should seek independent advice.
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Alternative strategies, such as hedge funds, are considered to be the liquid end of the alternative-investment spectrum. This is as opposed to privately traded alternative assets, such as private equity and property. However, there are a few issues to bear in mind when looking at the liquidity of alternative investments.
Hedge Fund: this a privately pooled investment fund that uses various strategies to optimise returns
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested
For new investors, we believe the process of identifying the right funds and minimising risk comes down to regularly communicating with fund managers and finding those who weigh up the need for liquidity both from their underlying investments and liabilities.
Liquid alternatives may offer substantial benefits from a risk management perspective and an absolute return, as their low market correlation means they minimise market exposure. However, investors may need to look beyond the Undertakings for the Collective Investment in Transferable Securities (UCITS) stamps and conduct their own research into whether a fund has the appropriate liquidity.
Absolute return funds: this is a fund that aims to provide a positive return regardless of an index return
Illiquidity, however, doesn’t have to be a bad thing. Long-term investors can tap into the income stream and capital growth illiquid alternatives, such as real estate, offer. In addition, you may benefit from an illiquidity premium (the expectation of higher returns from securities that may take longer to buy or sell).
Our panel weighs up the liquidity risks in hedge funds (An investment fund that uses alternative strategies to make a return).
Our panel:
Kelli Byrnes – Vice President within BlackRock’s Portfolio Analysis and Solutions team
Shane Balkham – Chief investment officer at Beaufort Investment
William Dinning – Chief investment officer at Waverton Investment Management
Alternative strategies, such as hedge funds, are considered to be the liquid end of the alternative-investment spectrum. This is as opposed to privately traded alternative assets, such as private equity and property.
Since the 2008 financial crisis, European investors have increasingly moved away from traditional fixed income and towards liquid alternative strategies that bring greater diversity to their portfolios (Citywire, October 2019). Rather than chasing returns, investors have shifted focus towards creating resilient portfolios that are perceived to be more equipped to withstand uncertainty. But are investors being overwhelmed by the choices available, the due diligence involved and some high-profile cases that have damaged public trust?
The investment toolbox available to retail investors has expanded enormously in recent years and continues to do so. The growth in passive alternative investments and the increasing growth in illiquid alternative assets (private equity and real assets, such as infrastructure) are two of the standout trends.
But liquid alternatives have fallen out of favour somewhat, despite hedge funds’ potential for low correlation to equity markets, which can minimise market exposure in uncertain times. Some of the public trust in liquid alternatives has been eroded by a series of high-profile cases where funds have apparently failed to adequately consider their liabilities and have been far more illiquid than advertised.
Risk. Due to its investment strategy an 'Absolute Return' fund may not move in line with market trends or fully benefit from a positive market environment.
Kelli Byrnes, Vice President, BlackRock’s Portfolio Analysis and Solutions team, has both a possible explanation and solution. “Finding strong and consistently outperforming alternative managers can be challenging,” she says. “The skill, time and cost associated with carrying out due diligence on such investments must not be underestimated. Retail investors can alleviate some of the cost and time demand in other areas of the portfolio, by using cost-effective, passive index strategies to invest in traditional equities and bonds.”
“This also allows investors to manage risk and use their risk budget for sourcing truly uncorrelated returns through alternative investments.”
Risk. While the investment approach described herein seeks to control risk, risk cannot be eliminated.
While liquidity could become an issue for alternative strategies considered liquid, many experienced investors point out that such issues are just as present in many traditional markets, such as the European corporate credit market (Citywire, October 2019). In addition, much of the press coverage tends to ignore the potential benefits that can be achieved through investing in alternatives.
“Funds doing things that people arguably wouldn’t expect them to do have definitely hit the headlines recently,” says Shane Balkham, chief investment officer at Beaufort Investment. ‘So now someone does a bit of research and goes: “These funds have a high level of unquoted stocks,” or “they’re highly illiquid,” and that’s damaging for the industry as a whole. Illiquidity, however, doesn’t have to be a bad thing. If you can get that income stream and potential return on capital and invest for the long term, you benefit from the higher returns that come with an illiquidity premium.”
Because of the potential returns from the premium offered by illiquid alternative assets and the opportunities they offer in unstable markets, investors feel there is an important regulatory balance that needs to be reached between preventing extreme scenarios and becoming overly stringent.
“One of the attractions of alternative assets is that they provide the potential for good returns, both in terms of income and capital, that, in my opinion, you don’t find in traditional assets,” says William Dinning, chief investment officer at Waverton Investment Management. “Whether it’s a pension fund, an individual systematic investment plan (SIP), or whatever it is, we need to encourage investors to be able to access that opportunity, rather than discourage it. So, I hope the industry doesn’t end up being overzealous. A lot of it perhaps comes down to education, and perhaps the regulator has a role to play there, rather than just saying no.”
One of the attractions of alternative assets is that they provide the potential for good returns, both in terms of income and capital, that, in my opinion, you don’t find in traditional assets.
William Dinning, chief investment officer at Waverton Investment Management
Understand the liquidity of your fund investments
Successful alternative investing is about striking a balance between maximising illiquidity premiums and the number of liquid vehicles required to offset this. For new investors, BlackRock’s team believe the process of identifying the right funds and minimising risk comes down to regularly communicating with fund managers and finding those who weigh up the need for liquidity both from their underlying investments and liabilities.
Risk. A Fund’s investments may have low liquidity which often causes the value of these investments to be less predictable. In extreme cases, the Fund may not be able to realise the investment at the latest market price or at a price considered fair.
“Just knowing what your fund’s actually doing is ever more important,” says Byrnes. “If all of the funds’ money is held up with a couple of investors, their potential demand on liquidity could be much larger than if there’s a very diversified set of investors who are holding that fund.”
BlackRock’s alternatives team believes liquid alternatives may offer substantial benefits from a risk management perspective and an absolute return (a positive return regardless of an index return), as their low market correlation means they minimise market exposure. However, they feel it is vital for investors to look beyond the Undertakings for the Collective Investment in Transferable Securities (UCITS) stamps and conduct their own research into whether a fund has the appropriate liquidity.
“This is definitely something we spend a lot of time thinking about,” says Alex Orr, a director within BlackRock’s alternatives specialists team. “Within that comes the capacity of these strategies as well. Not just to make sure that you’re running these funds at the right size so you can deliver the right returns, but that you have the right levels of liquidity.”
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or financial product or to adopt any investment strategy. The opinions expressed are as of June 2020 and may change as subsequent conditions vary.