Investment ManagementReview Europe

An Update for the Investment Management Industry

The Alternative Investments Edition

Apri l 2008

Mapping a changing landscape

Contents1 Introduction

2 Shifting Sands: Adapting to Change

7 The Changing Shape of the Alpha Space

10 Creating Opportunities in the Evolving EU Landscape

12 Making Liquidity Management Count

14 Citi: Supporting the Alternative Investment Industry Worldwide

In times of turbulence, it is useful to step back from the day-to-day and reflect on the way fundamental drivers of growth and profitability have altered.

Introduction

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n this edition of Investment Management Review Europe we focus on the impact a changed market environment is having on the asset management industry, and the hedge fund sector in particular. In

times of turbulence, it is useful to step back from the day-to-day and reflect on the way fundamental drivers of growth and profitability have altered. We seek to contribute to that process.

We analyse some of the key shifts in international fund flows and the opportunities they present. We look at product trends in the alternative investment sector and the scope for traditional managers to claim more of the alpha space. We assess the impact of new regulatory initiatives as the hedge fund industry responds to the demand for more transparency. And we look at the importance of effective liquidity management and a credit-worthy provider in maximising efficiency and minimising risk.

One theme emerges strongly: the importance of an international marketing strategy. Against this backdrop, we at Citi are ready to support firms in their international development – wherever that may take them. With our worldwide network of securities and fund services operations, we combine in-depth local knowledge with an ability to deliver complex solutions and best-in-class service across the globe. And when clients look to exploit volatile conditions and bring new products to the market quickly, we have the agility to respond swiftly and effectively.

All of these capabilities are backed by the scale and expertise of one of the world’s leading banks. Our strong presence in investment banking, equities, cash and treasury management – supported by global system sets and consistent worldwide delivery – is a powerful facilitator in helping clients turn their strategic goals into reality.

JervisSmith Managing Director, Financial Institutions Group Global Head of Managed Funds & Middle East, Citi

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The past year’s events have left an indelible mark on the investment landscape. An entire asset class – the collateralised debt obligation (CDO) and its kin – has almost certainly gone for good. With the closure of the leveraged debt markets, the private equity industry is having to find new paths to deploy its capital. Retail investors in the developed world have stampeded out of equity funds and poured record sums into money market funds.

How should asset managers respond to these changed circumstances? Where are the opportunities that will still sustain growth? ‘The collapse of the CDO market presents a void,’ says Jervis Smith, Global Head of Managed Funds and Middle East, Financial Institutions Group, Citi. ‘That is interesting because asset managers have increasingly been developing alpha/beta separation strategies. Now it is encouraging many to focus on their core business – be it in developed

or emerging markets, commodities etc. – rather than hire people to run new asset classes.’

Several other factors are combining to re-shape industry strategy. One is the maturity of the big US funds market. ‘Five years ago, a US mutual fund manager would have generated most of its business in the domestic market. Today, apart from 401K (employer-sponsored retirement plans) flows, the market has plateaued,’ says Mr Smith. ‘Funds must market internationally.’

TargetingthenewownersofglobalwealthThis message is reinforced by a marked shift in the ownership of global wealth to the Middle East, Asia, even Russia, and the rise of sovereign wealth funds (SWFs). While recent comment has focused on the SWFs’ high-profile, direct investments and their commitments to private equity, many employ

international asset managers to run their money in a traditional manner.

‘The largest, the Abu Dhabi Investment Authority, is not transparent,’ says Shams Butt, Managing Director, Financial Strategy Group, Citi, ‘But the fund has confirmed that 80% of its assets are managed by outside managers. Two new SWFs, China Investment Corporation and Korea Investment Corporation, have both said they intend to outsource asset management.’

The SWFs’ investment strategies tend to shift over time, he says: ‘Each fund has a different risk profile. But, as more money flows in, and the basic requirements of the state are covered, they tend to get more comfortable with the idea of investing a portion of it more aggressively – maybe in the alternative investment space.’ With funds under their control expected to more than double to US$7.5 trillion

Shifting Sands: Adapting to ChangeMajor shifts are occurring in the shape and direction of

world investment flows. Asset managers that look beyond

the current turmoil may find the shifting sands throw up as

many opportunities as challenges.

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by 2012, SWFs present a mouth-watering target for international asset managers.

This fact has not been lost on private equity firms. In recent months, both JC Flowers and TPG Capital have attracted SWFs as major backers of new funds. These moves have been seen as a clever response by the SWFs to the mixed sentiment that has greeted some of their more high-profile direct investments – in Wall Street in particular.

The moves have been a reminder that private equity is alive and well, despite the difficulties faced in securing bank funding for multi-billion dollar buy-outs. As in prior cycles, private equity firms are likely to adapt to the changed circumstances. The industry still has some US$300 billion of uninvested capital to deploy. Much of that is expected to go on smaller, and less leveraged transactions.

‘At the same time’, says Mr Butt, ‘The fund raising momentum is likely to continue. Private equity firms are raising new funds to invest in distressed debt and increasing their focus on emerging markets such as China and India. More deals to provide growth capital, as opposed to taking 100% ownership stakes, are likely – especially in the emerging markets. And assets such as infrastructure, which are easier to fund, have become increasingly attractive areas for financial sponsors.’

ChanginginvestmentflowsAs well as a shift in the ownership of wealth, there is also a big change afoot in the directional flow of investments. Figures from EPFR, the global fund flows and allocation service which tracks institutional and retail fund flows, indicates that net flows into emerging markets nearly doubled in 2007 to US$41 billion while developed markets experienced an outflow of US$51 billion. Increasingly, asset managers must demonstrate performance in markets such as Brazil, China or India to get their share of the fund flows.

One of the biggest areas of growth in recent years is Eastern Europe, where markets have delivered stellar returns. Rowena Romulo, EMEA Head of Market Management, Securities and Fund Services, Citi, says the inflows are reflected in Citi’s assets under custody and transaction volumes in these markets. ‘Over the period 2004 to 2007, we have seen rises of anything from 87 per cent for Poland to 300 per cent for Romania,’ she says. Figures from Lipper Feri put assets under management in these markets at the end of 2007 at €80 billion. They are clearly soaking up a disproportionately large amount of European fund flows.

‘Russia’, says Ms Romulo, is ‘The big one’. Last year, it lagged the likes of China, India and Brazil, but with a market capitalisation of US$1 trillion

A strong and efficient business model together with a well connected, local partner are doubly important in a global context.

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and a heavy weighting to energy, it is likely to pick up momentum in the wake of the recent elections. ‘There is a big pipeline of asset managers preparing to enter this and other Commonwealth of Independent State (CIS) markets,’ says Ms Romulo. ‘As a consequence, we are still investing in our Russian custody operation, have opened in Kazakhstan and are about to open in Ukraine.’

Perhaps the single largest growth opportunity for international asset managers is in China. A recent study by McKinsey & Co. (The McKinsey Quarterly, The Commonwealth of Independent States, October 2007) noted that the asset management sector had grown at an annual rate of more than 60 per cent for the past three years. ‘We estimate that assets under management will rise at a rate of 24 per cent annually for the next decade, making it the fastest growing segment of financial services in China – and the world,’ the firm concluded. The message is that international firms cannot afford to ignore this market.

China is now actively encouraging its investors to diversify abroad via international funds. In many cases, there is a role for a foreign asset manager to act as sub-adviser by lending its established investment management expertise, proven product design and broad experience in the global markets.

To encourage the take up of the Qualified Domestic Institutional Investor (QDII) scheme, Chinese authorities have sought to stimulate capital outflows to counter upward pressure on the Renminbi by loosening certain regulations, such as the limits on the amount QDII funds could invest in offshore equities and the entrance requirements of international firms in the QDII scheme. To date US$11 billion of a US$42 billion quota available to banks, insurance, asset management and securities firms has been invested. Given an expected investment in QDII funds of around US$20 billion over the next couple of years, the outlook is positive.

Chinese asset managers have so far launched five offshore equity mutual funds raising US$4.4 billion - three of the firms are joint ventures involving international firms. The other two appointed international asset managers as sub-advisers. To date, a further six to eight local firms have had their QDII license approved. ‘Advisory fees range between 50 and 80 basis points, so this is a lucrative role,’ says Cheeping Yap, China Securities Country Manager, Global Transaction Services, Citi, ‘However, international asset managers should act quickly if they are to partner with one of a limited number of domestic, Chinese fund managers and insurance companies.’

The message is that the successful players in the next few years will be those with an effective international marketing strategy and an ability to deliver the geographic diversification to capture the big flows on offer. Flexibility will be important, as the private equity industry is clearly demonstrating. So too will be the ability to structure the business effectively. Says Mr Smith: ‘In the last report from the consultancy, CREATE, sponsored by Citi, one in five managers said that going global had failed to boost profitability. A strong and efficient business model together with a well connected, local partner are doubly important in a global context.’

But opportunities abound. Many of the SWFs are clearly intent on drawing on professional third-party expertise in their investments. As they mature, they will increasingly seek out more aggressive investment propositions – to the benefit of the alternative investment industry. Worldwide, investors appear to have got a taste for emerging markets that is unlikely to go away. Business strategies built around emerging markets capabilities are likely to pay big dividends over time. While the shape and direction of investment flows may have altered fundamentally, the scope for exploiting them remains ever-present.

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ecently, the alternative investments advisory firm, Clontarf Capital, held a competition for the best

definition of alpha. The winning entry? “Alpha is what’s left over when your luck has run out.”

After the eclipse of so many credit strategies, and the tough conditions experienced by quant funds last summer, the heady growth of the alternative investment industry, not surprisingly, slowed in 2007. Net new money raised last year fell below the level seen in 2006 and redemptions and fund closures increased. By the end of January 2008 it seemed the equity market’s luck had run out. But, signs are that investor enthusiasm for new offerings continues undiminished.

'An uncertain outlook for equities is good for hedge funds,’ says Neil Wilson, Editorial Director of Hedge Fund Intelligence. ‘When the equity markets fell by 40 to 45 per cent over 2000-2003, our indices did not go

down. On average, hedge funds did a good job of protecting the downside.’

This is crucial to the industry’s new customer base – the big institutions. In the past half dozen years, institutional demand has come to dominate industry inflows. That is not expected to change, but it does have service, product and cost implications. ‘With the arrival of institutional money, providers face a different set of requirements,’ says Thomas Della Casa, Head of Research, Analysis and Strategy at Man Investments. ‘Investors want not just performance but top-notch service and transparency. The number of pre-requisites for staying in the business has increased.’

He cites three examples: ‘You need a large client service team spanning different regions of the world. The expertise required in product development and structuring, since this is constantly evolving. And, you have to be able to cope with new developments such as UCITS III.’

The Changing Shape of the Alpha Space

What are the key drivers now for the alternative investment industry?

What is the right strategy for the times?

Can traditional managers claim more of the alpha space?

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All of that is likely to drive consolidation. ‘You need to have at least US$10 billion under management to defray these costs,’ he says.

The institutionalisation of the business, combined with the increased dispersion of returns in the past year, is also changing the product offering. ‘There is demand for more low-volatility type products such as market-neutral or arbitrage funds,’ says Mr Wilson. ‘When you get a major dislocation affecting all markets – as we have seen recently – you get big directional moves. That is good for short-term traders, for macro funds (using top-down fundamental analysis) and for commodity trading advisors (which execute their strategies through the futures markets). More money is also going into long/short funds with the flexibility to go net long or net short.’

Clearly, UCITS III has the potential to open up a new retail marketplace for hedge funds in Europe. A number of markets have until now been effectively closed to onshore providers, but a trickle of offerings – from the likes of Marshall Wace and Pioneer – have emerged in recent months. ‘UCITS III gives us the opportunity to offer a fund on a broad front,’ says Mr Della Casa. ‘It could be very helpful for fund of funds providers in particular.’

The continuing strength of the fund of funds market continues to confound. Says Mr Wilson: ‘It has been said the funds of funds would ultimately be disintermediated because end-investors would not want to keep paying for a middleman to pick their funds. In fact, new investors turn to a fund of funds first. Most institutions do not have the skills or resources to identify the right single-manager funds.’

Mr Della Casa sees a new trend here – a readiness on the part of investors to shop around. ‘Putting together a diversified fund of funds is something a lot of people can do,’ he says. ‘We are seeing investment banks opening up their platforms, consultants offering due diligence on a whole list of funds, and other providers offering risk management at a low cost. The value chain is fragmenting, although whether all these providers will still be with us in five years’ time is another matter.’

One other trend is clearly discernible: the emergence of new asset classes. ‘For some time we have been seeing the development of more ‘off-piste’ strategies,’ says Mr Wilson. ‘New asset classes such as environmental indices, carbon trading, new technologies or catastrophe insurance have all started to emerge.’ Many of these markets – such as alternative energy or weather derivatives – are small, though they have the potential to grow quickly.

Some of the strategies take years to develop and are tested in pilot form long before a manager seeks to raise outside money for them.

In some areas, hedge funds are now finding themselves in competition with private equity firms. The distressed debt sector is a case in point, with both groups of players raising new money to take advantage of opportunities presented by the credit crunch. Infrastructure is another.

Some of the new asset classes qualify as discrete commercial activities in their own right. Man’s Mr Della Casa gives an example: ‘Our clients have made €400 million of commitments to a fund which dedicates money to the recovery of methane from mining projects, principally in China. It receives carbon credits under the United Nations’ Clean Development Mechanism which it then sells. On top of that, it produces electricity from the methane, which goes into the Chinese grid. We expect a return of around 25 per cent. Importantly, that return is in no way correlated with the returns from either traditional or other hedge fund asset classes.’

Products that generate alpha in areas other than the equity or bond markets help to keep some clear water between alternative managers and their traditional, long-only counterparts.

Investor enthusiasm for new offerings continues undiminished.

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Many of the latter have been actively encroaching on hedge fund territory with absolute returns funds or high-conviction funds that are benchmarked in name only. And both traditional and hedge fund managers now rub shoulders in the 130/30, short extension funds market, where assets under management, mostly in the US, are now approaching the US$100 billion mark.

This is an area where some see a major battle brewing. ‘In terms of the US market, the product of the year, in my estimation, is 130/30,’ says Steve Bowman, Global Head of Hedge Fund Services, Citi. ‘This is the way for the major players in the long-only space to break into alpha territory. A lot of money is being positioned to move out of the traditional investment area. Savvy long-only managers that don’t want to lose their existing mandates have been quietly incubating 130/30 products – and telling their institutional clients what they are doing.’

The early movers in this area were the quant managers that already had market neutral products. It was easy for their systems to come up with the bottom ranked stocks that would make up the short component of a 130/30 portfolio. That approach, says Mr Bowman, has its limitations when market conditions do not favour a market neutral strategy.

‘Now the fundamental investment managers are gaining momentum in this area. Every major player is incubating a 130/30 product. They need to develop the ability to short and there is a lot of portfolio management expertise needed here. But this is where the product has the potential to outperform. If you had to back a horse that was just birthed, this is it,’ he says.

Recently, Citi became the first to provide a single-bank solution with an innovative blended service offering that leverages Citi’s expertise in both traditional securities and fund services, and in prime finance and other hedge fund services. The new offering provides clients with a streamlined solution that combines the benefits of a secure custodian with that of a transparent securities lending service, allowing clients to generate additional alpha.

One thing is certain: managers cannot continue to test their luck – if there is any left. The alpha space is becoming progressively ever more crowded. As the cycle turns and businesses recover from the effects of the credit crunch; the winners will be those who demonstrate consistency of performance and superior client service. Trust and stability are the keys to success in the current climate.

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arch 31 was a telling date for the UK’s hedge funds industry as managers

declared whether or not they were to sign up to a new, voluntary code of practice to be overseen by the Hedge Fund Standards Board (HFSB), established in late January 2008.

Comprising 14 leading figures from the hedge funds industry and chaired by Sir Andrew Large, former Bank of England Deputy Governor; the HFSB set out the standards of best practice for hedge funds. While the standards are voluntary, signatories commit themselves either to comply with them or explain why they cannot. The 14 firms represented on the working

group immediately signed up to the new code. A further 30 or so firms may still endorse the code. Together, those firms manage around 80 per cent of all UK hedge fund assets (worth around US$400 billion in total).

The remaining industry members are thought to be waiting to see what emerges in the US, where a similar initiative is also coming to a head. Andrew Baker, Deputy Chief Executive of the Alternative Investment Management Association (AIMA), explains: ‘People are waiting for the President’s Working Group (PWG) on Financial Markets to report before committing. The PWG consists of the Secretary of the US Treasury,

the Chairman of the Securities & Exchange Commission, the Chairman of the Commodity Futures Trading Commission and the Chairman of the Federal Reserve Board. It has commissioned two reports on US hedge fund practices: one from an investor committee and one from a manager committee.

The PWG is not expected to issue a formal code of conduct and indeed there may be no formal regulatory changes but it is expected to come up with recommendations similar to those of the UK working group. However, there are likely to be subtle differences, and some firms want to be sure that signing up to one code

Creating Opportunities in the Evolving EU LandscapeIs the global hedge funds industry close to establishing a common code of best practice? The question is now being asked as parallel initiatives on both sides of the Atlantic, aimed at improving transparency and governance in the industry, bear fruit.

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will cover them for compliance under the other. ‘A lot of the larger funds are active in Europe and in the US,’ says Mr Baker, ‘They operate using different fund structures; usually using a corporate offshore fund structure in Europe and an onshore partnership structure in the US. There are important differences between these two approaches that will lead to subtle differences in emphasis between the PWG’s approach and the HFWG’s approach. Managers operating in both spheres will want to ensure that their operating practices are capable of complying with both sets of guidelines wherever possible.’

There have been a number of attempts to codify best practice in the hedge funds sector. Both AIMA and its US equivalent, the Managed Funds Association, have produced their own sets of guides to sound practices. Now there will be a big push to promote convergence. ‘We are thinking about the best way to do that,’ says Mr Baker, ‘We aim it to make life easier for managers and take away the confusion implicit in the proliferation of standards.’ Sir Andrew Large has stated that he hopes the UK standards could form the basis of an international code of practice for hedge funds.

There is clearly a new momentum to standards-setting. Neil Wilson, Editorial Director of Hedge Fund Intelligence, says the difference this time is the big firms are throwing their weight behind the process. ‘They are stating the positive case for the industry. They realise they need to stay in charge of the agenda to head off regulation that would potentially stifle the industry.’

The HFSB standards are certainly wide-ranging. ‘They cover many issues in the hedge funds world and provide a straightforward check-list to demonstrate whether a particular manager conforms to standards

of sound practice,’ says Mr Baker. Transparency is a common thread to many of them. For example, funds are expected to disclose fees, withdrawal terms and any material side letter agreements with investors; explain how the assets have been invested; and disclose potential conflicts of interest with lenders and prime brokers. Clear governance arrangements capable of dealing with conflicts between managers and their investors are a cornerstone of the new approach.

The standards also require managers to put a comprehensive risk management framework in place and disclose portfolio risk on a more frequent basis (the working group reports suggests this should be quarterly). The new code, says Mr Baker, ‘Invites funds to disclose the prism through which they see risk and report back to investors in a way that conforms with that approach.’

Signatories to the new code will also be expected to disclose what percentage of the assets are invested in ‘hard-to-value’ instruments. While the nature of the instruments deemed hard-to-value may change in line with market circumstances, the key is in letting investors know what proportion of the assets are valued off a standard price feed, and what proportion are dependent on model valuations, broker quotes or are so illiquid they are consigned to a ‘side pocket’.

A number of standards directly address issues that have been raised in the past by regulators. One of those is valuations. The new standard states funds should, if possible, use an external firm to value their assets. In the UK, most already do. But the report accepts there may be instances where, due to the nature of the assets, it is not possible. In such instances, in-house valuation must be conducted by a completely separate function to avoid conflicts of interest. However,

a good administrator – one with an independent pricing group made up of mathematicians, analysts, financial engineers and the like – should be able to provide fair-value pricing of even the most complex instruments. There should be no need to resort to in-house valuations.

During the consultation process, some managers of smaller firms – which make up the great majority of hedge fund managers – expressed concerns that the cost of complying with the standards would be unduly onerous. The working group took a number of those concerns on board. One example is on outsourcing risk. Originally, the working group had proposed that funds should employ more than one prime broker to diversify operational risk and funding sources. But they accepted that might not be relevant for smaller funds or new market entrants.

There is a ‘common sense feel’ to the standards – and to the ‘comply or explain’ approach that underpins them mentions Mr Baker. No big stick is being wielded over managers that fail to conform and indeed the HFSB intends to leave it up to investors to monitor compliance with the standards. Funds that sign up have until the end of the year to meet the new requirements – giving them adequate time to codify their policies and amend procedures where needed.

With so many of the leading firms in the sector committed to the new standards, there is clearly pressure on the remainder to follow suit. If the hedge funds sector as a whole is seen to embrace transparency and good governance, that can only be good for investor confidence. Given that the primary source of new inflows has, for some time, been institutional money, itself subject to rigorous due diligence procedures, that must be good for the industry at large.

Recent events have highlighted the

importance of good liquidity management. While the spotlight has been on hedge funds, all asset managers need to make their liquidity management count in the down-cycle.

Suddenly, liquidity issues are front of mind for asset managers. The combination of tightening credit markets, increasing spread between the various LIBOR sets and central bank rates and a spate of investor redemptions has thrown the spotlight on the availability and cost of cash. Most obviously, it is hedge funds that have been most acutely affected. While some prime brokers have been reviewing the margining terms and liquidity arrangements they offer their hedge fund clients, the clients in turn have been reviewing the changing credit profile of their prime brokers.

But there are issues here for all asset managers, and not just those in the alternative investment space, to ponder. Managing liquidity strategically, as part of a firm’s overall securities services relationships, can not only underpin liquidity access worldwide and improve yield, but it can cut costs, promote process efficiency and reduce operational risk. Ultimately, that may also present the opportunity to reduce regulatory capital.

Hedge funds currently face a variety of issues. ‘At a high level, after the events of 2007, managers are looking again at what sort of liquidity pool they should keep and how they can optimise their leveraging capacity to ensure there is sufficient liquidity in the portfolio,’ says Lou McCrimlisk, Managing Director with responsibility for relationship management at Citi Prime Finance. ‘Then they are asking themselves where they should leave surplus cash: creditworthiness is now a key issue’.

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Making Liquidity Management Count

Many hedge funds have been reducing their roster of prime brokers for the past couple of years. Now, says Mr McCrimlisk, many are concerned at the danger of over-concentration following high-profile losses sustained by some broker-dealers. ‘That is not just from a credit risk perspective,’ he says, ‘But it may affect their ability to negotiate margin rates, and get access to the financing they need.’

At a time of rising funding costs, larger hedge funds have been pushing for a ‘lock up’ on their margin rates – effectively a guarantee from a prime broker that it will not change its terms for 60, 90 or even 120 days, come what may.

Some hedge funds in the US have also voiced concern at where their end-exposures may lie. A lot of the cash left with a broker-dealer finds its way into money market funds. That is because, as non-deposit takers, broker-dealers face hefty collateralisation requirements under US regulations if they take the cash on their balance sheets.

Given that many money market funds are heavily invested in asset-backed commercial paper – which is hardly flavour of the month – hedge funds have been withdrawing cash and finding other homes for it.

One answer is to take advantage of a repo solution from a top-rated bank. Citi, for example, offers hedge funds a collateralised overnight financing solution that clearly affords greater protection than any money market fund. As a repo solution, not only are the underlying assets covered but the investor also benefits from the superior rating of Citi itself.

Access to liquidity is just as important an issue in current market conditions. In this regard, using a prime broker that is bank-owned offers added flexibility. Banks have ready access to central bank liquidity. Of late, central banks have expanded the range of approved collateral they will accept. That allows banks to migrate their clients’ collateral through to a central

bank if needed. ‘There is a cost because such a move grows the balance sheet,’ says Todd Johnson, Managing Director, Citi Prime Finance, ‘Which in turn demands added capital. But it is an incremental, and valuable, source of liquidity to clients.’

Moreover, global asset managers can reduce and simplify their day-to-day operational processes, and free up more time to manage their funds through the deployment of global pooling structures and liquidity tools. Steven Elms, Liquidity Products Manager, Global Transaction Services, Citi, explains: ‘Such structures offer the flexibility across a multibank and multi-currency environment and can be used to concentrate and fund both domestic and offshore coupon flows and payment activity. Through Citi’s trade and treasury solutions clients can create a single manageable cash position that can easily be arranged on a same-day basis, thus reducing any daily balance volatility from process mismatches (corporate action errors, payment fails, etc.) through

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Making Liquidity Management Count

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the pooling of such account structures and raising the visibility of these liquidity structures on a multibank level.’

The credit crunch has refocused minds on the importance of managing liquidity strategically – rather than as a ‘must have’ utility. For traditional asset managers, the key issue is efficiency. For firms with international distribution, in particular, effective cash management can play a big role in driving down costs. Many firms will have experienced substantial redemptions in recent months. Those that managed the process through multiple banking relationships will have faced a significantly bigger operational challenge than those that relied on a single banking provider capable of supporting the activity wherever it arose.

Actively managing banking relationships can reduce the costs of collection and payment (transaction charges and banking fees) by exploiting scale benefits and better ways of working.

Additionally, best practice cash management can ensure that incoming cash is received, reconciled and applied to accounts at lower cost and as quickly as possible, so reducing working capital needs.

Cash management arrangements based on an historical mix of relationships with fund distributors and correspondent banks leave transfer agencies having to interface with multiple banks to receive subscriptions from investors and pay out redemptions for each fund under management. Each relationship will be subject to different price and service negotiations. Cross-border banking fees, extended clearing delays and lifting charges may be incurred on transactions. And different file formats may require separate interfaces to accounting systems.

‘Much of this can be avoided by establishing a strategic cash management relationship with a single bank that can deliver local banking services in each country through a single delivery channel,’

says Roger Brookes, Director of Financial Institutions Cash Management Sales EMEA, Global Transaction Services, Citi: ‘It can be achieved without significant disruption to the distribution network and may in fact simplify these relationships.’

Rationalising banking relationships may also provide an opportunity for asset managers to reduce regulatory capital, says Mr Brookes: ‘Caution has often led to large amounts of capital being held in-country for regulatory purposes with local banks. But asset managers that take advantage of the Single European Payments Area (SEPA) to consolidate euro accounts with a single bank, reducing this over the longer term to a single account, will find it easier to monitor and potentially reduce regulatory capital through the use of information tools that provide a detailed view of cash flows.’

SEPA certainly has a big role to play in helping asset managers streamline euro-denominated subscriptions and redemptions

Making Liquidity Management Count (continued)

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from retail investors. On the redemptions side, non-urgent euro payments can now be made across Europe from a single account using the new SEPA Credit Transfer service. That eliminates high-cost, same-day, cross-border transfers – and the effort of managing a domestic account structure.

On the subscriptions side, a new SEPA Direct Debit product, due to be introduced later this year, offers huge benefits for international asset managers. Not only will it promote process efficiency and automation by eliminating existing differences between national direct debit schemes but it will reduce the barriers to entering new markets and allow collection activities to be managed out of a single account.

In summary, there are both short-term and long-term reasons why managers should review their liquidity management policies. While the cost and availability of cash, combined with the need to invest it securely, may be the dominant issues for hedge fund managers right now, all firms can

gain from a strategic approach to liquidity management to drive down costs.

‘Market dislocations have understandably forced asset managers to concentrate on short-term considerations,’ says Mr Brookes, ‘But it is important that they don’t lose sight of the big gains on offer from a well structured approach to liquidity management as part of a broader strategy aimed at streamlining processes and maximising efficiency.’

Making Liquidity Management Count (continued)

TreasuryandTradeSolutionsCiti offers integrated cash management and trade solutions to multinational corporations, financial institutions and public sector organisations around the world. With a network spanning over 100 countries, Citi supports over 65,000 clients holding on average US$245 billion in liability balances (Q4, 2007). Together with our correspondent banking network of over 3,000 banks and the world's largest network of internal trade services processing sites, we support our client's businesses with world-class end-to-end cash management and trade services.

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Citi: Complete Support for the Alternative Investment Industry Worldwide

One of the top five administrators of alternative investment funds

globally with more than US$400 billion of assets under administration, Citi offers a comprehensive range of services to support all kinds of firms. Our commitment to the business is total – as demonstrated with the acquisition of Bisys in August 2007, the specialist hedge fund administration group.

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With more than 2,000 people worldwide dedicated to servicing alternative investment funds, and on-the-ground teams throughout Asia, Europe, North America, as well as Bermuda and Cayman, Citi is ideally placed to service clients in all the major markets and domiciles.

That worldwide presence and total time zone coverage is supported by a 24-hour processing capability and innovative, flexible reporting. We have invested in our systems to support frequent and sophisticated reporting. Our strength, scale and commitment ensure we will continue to invest to anticipate changing requirements.

With a 1,000-strong client list, Citi services many of the leading names in the alternative investment industry, from single strategy hedge funds, managed accounts and funds of hedge funds to real estate funds. As one of the largest third-party administrators of private equity funds worldwide, with a large client base in the US and Asia and plans to offer a full private equity fund administration service in Europe, the Middle East and Africa.

Clients benefit from full service capabilities in every asset class –

from long/short equity to distressed debt – robust platforms and expertise to deal with more complex, esoteric instruments. Our complex derivatives group, made up of mathematicians, qualitative analysts and financial engineers, has long experience of providing independent fair-value pricing to funds engaged in leading-edge strategies.

Citi’s Global Transaction Services’ span fund administration, transfer agency, corporate secretarial, custody for funds of hedge funds, tax reporting (for multiple jurisdictions) and the preparation of financial statements. We deliver complete, integrated solutions – which may also draw on the wider capabilities of our investment bank. Citi's Alternative Investment Services provides hedge fund clients with comprehensive and integrated financing, prime brokerage, consulting, administration and operational support. Clients can choose to access a complete range solutions right across the investment value chain with one single point of contact.

Citi’s high standards of client service are widely recognised with our client involvement going beyond the delivery of individual products or services. By working with our clients as their long-term partner, we help

them to exploit new opportunities as they arise and develop their business step-by-step. As strategies change, we are flexible enough to change with them – delivering innovative solutions tailored to particular circumstances. Our seasoned team is among the most experienced in the business. And with the ability to draw on the wider capabilities of our investment bank, it has a depth of resources unmatched in the industry.

Experience, product breadth, global reach – it all adds up to a powerful offering from a committed provider.

Acompleteend-to-endsolution:

Sophisticated portfolio analytics tools

Trade Order Management

Fixed Income, Equity, and F/X Prime Finance

Accurate and timely NAV calculations

Global Investor Servicing

Various active and passive short-term investment options

Full banking capabilities

Efficient safekeeping and clearing in any location around the globe

Integrated information and reports, via the Web.

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GlobalTransactionServiceswww.transactionservices.citi.com

© 2008 Citibank, N.A. All rights reserved. CITI and Citi and Arc Design are trademarks and service marks of Citigroup Inc. or its affiliates, used and registered throughout the world. The information contained in these pages is not intended as legal or tax advice and we advise our readers to contact their own advisors. Not all products and services are available in all geographic areas. Any unauthorised use, duplication or disclosure is prohibited by law and may result in prosecution. Citibank, N.A. is incorporated with limited liability under the National Bank Act of the U.S.A. and has its head office at 399 Park Avenue, New York, NY 10043, U.S.A. Citibank, N.A. London branch is registered in the U.K. at Citigroup Centre, Canada Square, Canary Wharf, London E14 5LB under No.BR001018 and is authorised and regulated by the Financial Services Authority. VAT No. GB 429 6256 29. Ultimately owned by Citi Inc., New York, U.S.A.

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Contacts

Jervis SmithManaging Director, Financial Institutions Group Global Head of Managed Funds & Middle East, Citi Tel: +44 20 7986 3132 Email: jervis.smith@citi.com

Dirk JonesManaging Director, Global Head Client Sales ManagementSecurities and Fund Services, Global Transaction Services, Citi Tel: +44 20 7500 5714 Email: dirk.jones@citi.com

Karen TyrrellManaging Director, Head of Alternative Services EMEASecurities and Fund Services, Global Transaction Services, Citi Tel: +353 1 436 7204 Email: karen.tyrrell@citi.com

Olga Sarmineto-MedinaProduct Sales Manager, Alternative Services EMEASecurities and Fund Services, Global Transaction Services, CitiTel: +44 20 7500 2896Email: olga.sarmientomedina@citi.com

This publication is produced by Citi's Global Transaction Services business.

We welcome your feedback and suggestions for future articles.

EditorsNadine TeychenneEmail: nadine.teychenne@citi.com

Gene PetersonEmail: gene.peterson@citi.com