ABACO Financials Fund is a market-neutral equity fund with a European bias dedicated to investing in the Financial sector. The portfolio of long/short positions is structured to generate absolute returns by capturing relative value within the sector while targeting low volatility. The return stream produced for their growing list of investors has a high proportion of alpha in it, and the returns have low correlation to markets and to most equity hedge funds. Given the significance of the finance sector to the market turmoil of 2008/9 and to the prospects of European economic recovery since, the fund has been interesting to follow, not least because of the excellent market letter the managers produce.
The three investment professionals in the team have different overlapping roles: Inigo Lecubarri comes from the sell-side and spends the majority of his time on research; Louis Rivera-Camino has a background in portfolio management and works across all aspects of running the portfolio, and the following Q&A was conducted with Martin Deurell whose primary responsibilities include trading and risk control for the fund. The interlocutor was Simon Kerr.
Q. You had a very good performance in 2008, an excellent 2009 for a market-neutral fund and somewhat disappointing 2010 to follow. What happened last year?
Out of financial funds we did okay, but we were up only 2% after fees, and we are very far from happy about that. There are a number of reasons why financial funds did not do as well as other long/short equity strategies last year, and the biggest of them was the impact of the macro environment.
The over-riding theme for financials in 2010 was definitely macro, and teams like the ones we have really concentrate on financials from the bottom-up. That is where our effort is concentrated - in building our deep understanding of the individual companies and the drivers of stock returns. Yes, we'd like to think that financial specialists like ourselves would have a better chance of understanding the impact of macro factors on the universe of stocks we follow, but that is not the same as being any better at forecasting the macro-environment.
Post fund launch in 2003 the biggest macro driver was EuroLand convergence – that lasted through to 2009 in various ways. Making money for a sector fund was mostly about the attractiveness of one stock versus another up until 2009 - and then it changed.
From the environment of 2008 onwards, only the funding issue remains the same in 2010 – so the issue for financials is not the cost of funding. The markets treated stocks the same whatever their cost of funding – they all went down without discrimination.
The second headwind we faced in 2010 was the lack of consistent, strong long-only flows and outflows in our sectors of the stockmarket. These flows are important for the well-informed investors (such as hedge funds, and prop capital) to position against and take advantage of. Investors in hedge funds correctly buy into the idea that their (hedge fund) managers are able to anticipate investing institutions moving into sectors and stocks like tracking elephants moving in a forest. But in 2010 the investing institutions didn't move – flows went into ETFs and indices (country selection) dominated. If other categories of investors buy a banking ETF to take exposures that doesn't help a fund like ours which is market-neutral, and needs differential returns within sectors to drive returns. We are starting to see signs of flows out of bond funds and into equity funds as an asset allocation switch, and if that persists at the retail, or institutional level, that is going to help us.
Q. Was there anything you could have done differently last year to take account of this macro dominance?
If I was being hyper-critical I would say that we didn't put enough effort into tracking the impacts of macro factors in real time - you know, looking at the CDS market and what they say about our stocks. I have traded options in the past, so I know that looking at the implications of CDS pricing is like a put option determining the pricing of the underlying equity. The CDS market says something about where a stock might trade, but the CDS is structured around extreme events, and in any event the CDS market is a lagging indicator. So yes the equity has tended to move in a 1:1 relationship with the CDS, but that type of relationship may be unique to the time we have just been through.
At this point it seems the analysts who follow the financials sector are putting a lot of emphasis on their own take of the macro environment. This could even be at an extreme. There is so much emphasis being put on the macro component that the macro may still drive the individual equities in the first half of 2011.
Q. Does this have any implications to how you shape your portfolio?
Well it doesn't mean that I want to take a directional net long posture to equities, or the equities of financial stocks. As a generalisation, exposure to equity in financials is less attractive than fixed income at this point.
I think you can look for a rights issue to be a trigger for individual stocks. From the time when banks raise new equity they seem to outperform – Deutsche Bank is a case in point. It has out-performed since it raised fresh equity capital. The capital-raising by Nordic banks certainly helped their stocks to perform, though admittedly the operating environment they faced was not as adverse as for banks in some of the other territories. There is going to be a lot of issuance of capital in financials – some big equity raisings are coming in the next few months because they have to happen.
Q. Is capital raising good or bad for the bank stocks then?
The capital raising helps in a couple of ways. In raising fresh capital the banks are taking positive steps to meet the tougher capital adequacy rules. Also when banks raise equity they take big write-offs – so the asset value of the remainder of the assets is perceived as a harder (more credible) number. That said a number of the banks with investment banking business are still tight on capital – Barclays, Deutsche Bank and the French (universal) banks – the Swiss banks are probably okay for capital.
There are cross currents in looking at investment banks. There are negative regulatory impacts for them – they have to raise fresh capital and/or cut the levels of leverage they employ. The margins in trading have to come down – not just outsourcing of trading, but the intermediation of exchanges in OTC will bring down margins through increased transparency. Where they do lending, the net interest income may be softer looking forward. But their commission income should be up, and the prospects for M&A are good so long as they don't get too competitive on fees. We have them in the Fund, but I don't have a strong view on them myself. I don't have to – my colleagues Inigo (Lecubarri) and Louis (Rivera-Camino) sponsor the investment holding-period positions in the investment banks into the Fund. I do trade them quite often, but as the trader of the team I can tap into the expertise of the others for a strong fundamental view.
Looking at universal banks with significant investment banking operations like Barclays is difficult – they have an investment banking operation as well as retail banking and an SME business. You can't look at your DCF model and say this is what Barclays Bank is worth. There are just so many parameters changing all the time, and such a balance sheet that you never quite know about the quality of assets. It is very difficult to pin down a risk/reward on a trade and say that this is worthwhile taking a position here, even doing peer group comparisons.
There are a lot of (sell-side) analysts working on investment banks, but they all seem to do the same thing. They want to understand how the business is doing in the next two quarters – but that only seems to be used to justify the current share price. And talking to management and reading Dealogic about issuance seems to be about as far as they go. Yes the deal flow is the gravy in the business model, but in the present environment in particular, investors have to understand the balance sheet. No -one pushes the management on the balance sheet, and management is reluctant to talk about it on a current basis.
Q. Given the American investment banks report quarterly, do they give you insight into the European banks, or they too much outside your scope?
For our scope of fund it is valid to look at Morgan Stanley and Goldman Sachs. Goldmans has proved to be a different animal than the others – it always bounces back. Their network amongst politicians is first class, and they deal for so many clients that they are right on top of what is happening in flows in sectors. So the trading record is outstanding for good reason, but then again proprietary trading will be wound down, and some top people there seem to be leaving. I have successfully traded GS shares last year, but I felt I was a child playing with fire in doing it, and I have less confidence in my risk taking there this year. In general we are not massive experts in trading things on that side of the pond.
Q. How do you work with the sell-side as an information source?
We use the sell-side analysts for generating and testing ideas on a theme, and for tactical level trading. The hedge fund world is not like private equity – so we don't have the luxury of fixing a fair value for a stock and waiting four years for that value to be realized. We have to deal with regular valuation and marking our P&L to market. That means we have to be more aware of what the market is doing to valuation in the shorter term, and what the market is thinking on a stock.
So we tap into what the sell-side comes up with for ideas – sometimes the brokers' analysts will highlight something that we have missed in our screening. Our role then is to filter what is a good idea and what is a bad idea, and do more work on them. Sometimes what you initially think of as a good long idea can turn into a short position once you have checked out the market positioning on a stock - if the idea reflects the consensus on a stock we might consider going the other way. So then it's a "Short" not a "Long" and we can investigate the timing of taking a position.
Q. So if you are not taking many recommendations what do you use the brokers' analysts for?
We think you have to know all the analysts in the sector to know where the consensus on a company is. They can tell you where "the market" is on a stock, analytically and in terms of market positioning (holdings). The brokerage analysts can plant a seed of an idea – something that could be developed. And if you can find a good analyst it is good to test our ideas with them – to bounce ideas off them. If you can find an analyst who takes the opposite view from you, that is also useful to an investor. You need to test your argument – if you are a bull you need to test out the case of a bearish analyst by talking through his thinking. So then you know whether it makes sense to go against him. That is very very useful for a sector specialist fund manager.
To give you an example in a tactical sense, when we are approaching a company's results announcement- say consensus is at one level and an analyst comes along with a forecast outside the consensus. We might look at it and say to ourselves that the non-consensus analyst is right and the consensus estimates are wrong. In that case we can go long, say, and when everyone upgrades their forecasts the stock will go up. Or maybe the nasty figures are already discounted, and again the stock will go up on the earnings release.
Q. How do you differentiate between the analysts?
Of course the longer you have been in the game the better you know which are the good, and which are the bad, amongst the sell-side analysts. Also with experience you can trust a certain analyst – I know he is good on that stock, and someone else is really good on that bank. To find the analyst that is the expert on the Street on a company is very powerful. If you know the one that has done the most work, that knows the company intimately from following them over a long period of time, it is worth a lot. You may be able to ignore the other analysts on the company. I admit that it is a rare thing, such confidence in an external analyst, where they are the clear number one or two in knowledge on a company. But it can have a good pay-off. It can put you as an investor in a psychological disposition where you can comfortably take bigger risk.
We are fortunate in that we have such an analyst working in our own team. Inigo has been the number one ranked analyst on Portugese and Spanish banks, and to some extent he can tell others about what is really going on! This gives us a genuine edge in some stocks compared to the market.
Q. Would you say there are differences between how a hedge fund would use a buy side analyst and a sell-side analyst?
There is a substantial difference between the buy-side and the sell-side analysts on the risk/reward for a view on a stock. The sell side analyst has to live with his recommendation for a lot longer period of time. We have the luxury on our side of being able to moderate our view, as expressed in our position size, as we go along.
Q. Your presentation shows you as having specific responsibility for risk control. Are you the one that has to place the stops on positions?
It is not just my input on this. I carry out the dealing for the Fund but my colleagues put their own ideas into the Fund, and they propose how wide the stops should be. I don't apply a blanket hard stop. What I prefer to do is to place the stop in proportion to the volatility of the stock. So a more highly volatile financial stock will have a wider stop on it than a stock which acts in a less volatile way.
Also it is not as straight-forward as it sounds - looking at one position in isolation. We have related positions in our portfolio, so we may have put on two (hedging) short positions against one long position. So the catalyst for action can't be one share price in isolation, even if the P&L on that may be negative – there could be a long position down 40% and the shorts are down 35%, for a net loss of 5%. So the trigger level of an 8% loss has not been reached and so the stop would not be effective even if the three stocks are each down more than 30%!
There is another factor in the frequency of taking losses - the size of the P&L of the whole Fund has an impact. When the fund is doing well, and the P&L is positive, it is natural that the balance sheet of the fund is higher than when we have had to take losses. So it is much easier to run the profitable positions, and not be compelled to close the losers when the whole fund has a positive P&L (for the year).
Investors in the fund should also appreciate that there are some exit tactics to be deployed. So even where there is a stop level, not the whole of the position is changed all at once. I prefer to sell, say, half a long position at a level and then wait to see how it reacts for the remainder.
Q. Thanks for your time, Martin. You have given us a good insight into how you work with the Street, and how you manage the volatility of your fund so well. Good luck with the alpha harvesting in 2011.
Thanks.
Terms: Management Fee: 1.5%, Performance Fee: 20%, Redemptions: Monthly, Lock Up: No
The interview was conducted on the 12th January 2011.
Another article on ABACO Financials Fund can be found here.
Showing posts with label sector funds. Show all posts
Showing posts with label sector funds. Show all posts
Wednesday, 16 March 2011
Wednesday, 20 October 2010
Testing Time Ahead for Funds of Hedge Funds
Flows into the hedge fund industry turned positive in the third quarter of last year. There have been monthly blips, but a positive trend of quarterly inflows has been in place since. This year there was a net investment of $13.7bn into hedge funds in the first quarter, followed by $9.5bn of inflows in the second quarter. In the last quarter Hedge Fund Research calculate that a net $19bn of new capital came into the industry.
The third quarter of 2010 was also a period of decent return from hedge funds, most of the gains coming in September. The positive returns for the year to date on top of the recovery of assets through net subscriptions has taken industry assets back to their previous peak of one and three-quarter trillion dollars.
It has been well recognised that flows have turned positive and that the majority of those flows have been captured by the largest single manager hedge fund groups - those overseeing $5bn or more. Some funds of hedge funds received new money in the second quarter - nearly a third of funds of funds had positive inflows then - but still in aggregate funds of funds have been losing capital for two years. Up to now. In the third quarter just finished, funds of hedge funds had a net inflow of $250m, according to HFR.
The timing is indicative of the new reality of institutional investing in hedge funds. Just over a year on from net new subscriptions to single manager funds, multi-manager funds as a group received positive net subscriptions. The buyers of single manager hedge funds to this point were experienced institutional investors. If the first phase of taking hedge fund exposure is institutions getting exposure to the investment strategies through replication (not recommended, but it happens) or diversified funds of funds, then there are naturally other phases to follow. The second phase is likely to be the development of selection by the investing institution. This could be expressing a preference for a particular investment strategy, say distressed, or emerging market hedge funds, through selecting individual hedge funds, or allocating to a specialist fund of hedge funds.
Sometimes stage two is driven by a fee reduction exercise, or to utilise growing internal expertise, or sometimes even to put into practise an increase in allocations to alternatives or hedge funds specifically. Whatever the motivation, stage two is as likely to result in a reduction in the size of mandate managed by a fund of funds as an increase.
Institutions new to investing in hedge funds would be wise to utilise the services of a fund of hedge funds provider. So neophyte institutions and those adding to strategic allocations within their plans will have used funds of hedge funds in the growth phase of the industry to mid 2008.
In the last year we have moved from the trough of disillusionment* and are onto the slope of enlightenment for the hedge fund industry. In that time the investing institutions that are seasoned hedge fund investors have been pulling money from funds of funds to put the capital into single manager funds in aggregate.
We seem to be entering a new phase now. The recent positive net capital allocations to funds of hedge funds suggest one of two causes: that new buyers are coming into hedge funds and/or the more conservative of those existing institutional investors in hedge funds have started to add to their allocations. It is widely appreciated that the due diligence process has lengthened. So if it took 6 months from first meeting to filling in subscription documents it now takes 9 months. Starting a new hedge fund investment programme for an institution via a fund of funds might take a year or more as there is double diligence to complete, at the fund of funds level and at the single manager level.
If this hypothesis is correct funds of hedge funds should have more and larger mandates heading their way from here on. This will be tested over the rest of 2010 (particularly in December, a key month for redemptions) and will be confirmed by positive flows in the first half of 2011.
Additional: Pictet & Cie, the Swiss private bank, confirmed that it had had net inflows of $340m into its fund of hedge funds this year bringing the total AUM to $8.2bn at the end of September.
*http://www.thehedgefundjournal.com/magazine/200907/manager-writes/through-the-trough-of-hedge-fund-disillusionment-.php
The third quarter of 2010 was also a period of decent return from hedge funds, most of the gains coming in September. The positive returns for the year to date on top of the recovery of assets through net subscriptions has taken industry assets back to their previous peak of one and three-quarter trillion dollars.
It has been well recognised that flows have turned positive and that the majority of those flows have been captured by the largest single manager hedge fund groups - those overseeing $5bn or more. Some funds of hedge funds received new money in the second quarter - nearly a third of funds of funds had positive inflows then - but still in aggregate funds of funds have been losing capital for two years. Up to now. In the third quarter just finished, funds of hedge funds had a net inflow of $250m, according to HFR.
Net Subscriptions for Funds of Funds
The timing is indicative of the new reality of institutional investing in hedge funds. Just over a year on from net new subscriptions to single manager funds, multi-manager funds as a group received positive net subscriptions. The buyers of single manager hedge funds to this point were experienced institutional investors. If the first phase of taking hedge fund exposure is institutions getting exposure to the investment strategies through replication (not recommended, but it happens) or diversified funds of funds, then there are naturally other phases to follow. The second phase is likely to be the development of selection by the investing institution. This could be expressing a preference for a particular investment strategy, say distressed, or emerging market hedge funds, through selecting individual hedge funds, or allocating to a specialist fund of hedge funds.
Sometimes stage two is driven by a fee reduction exercise, or to utilise growing internal expertise, or sometimes even to put into practise an increase in allocations to alternatives or hedge funds specifically. Whatever the motivation, stage two is as likely to result in a reduction in the size of mandate managed by a fund of funds as an increase.
Institutions new to investing in hedge funds would be wise to utilise the services of a fund of hedge funds provider. So neophyte institutions and those adding to strategic allocations within their plans will have used funds of hedge funds in the growth phase of the industry to mid 2008.
In the last year we have moved from the trough of disillusionment* and are onto the slope of enlightenment for the hedge fund industry. In that time the investing institutions that are seasoned hedge fund investors have been pulling money from funds of funds to put the capital into single manager funds in aggregate.
We seem to be entering a new phase now. The recent positive net capital allocations to funds of hedge funds suggest one of two causes: that new buyers are coming into hedge funds and/or the more conservative of those existing institutional investors in hedge funds have started to add to their allocations. It is widely appreciated that the due diligence process has lengthened. So if it took 6 months from first meeting to filling in subscription documents it now takes 9 months. Starting a new hedge fund investment programme for an institution via a fund of funds might take a year or more as there is double diligence to complete, at the fund of funds level and at the single manager level.
If this hypothesis is correct funds of hedge funds should have more and larger mandates heading their way from here on. This will be tested over the rest of 2010 (particularly in December, a key month for redemptions) and will be confirmed by positive flows in the first half of 2011.
Additional: Pictet & Cie, the Swiss private bank, confirmed that it had had net inflows of $340m into its fund of hedge funds this year bringing the total AUM to $8.2bn at the end of September.
*http://www.thehedgefundjournal.com/magazine/200907/manager-writes/through-the-trough-of-hedge-fund-disillusionment-.php
Saturday, 16 January 2010
Tosca Fund and Abaco Financials - Return Outcomes versus Portfolio Construction and Alpha Type
Preface
The following discussion and analysis looks at two equity hedge funds that specialise in the financial sector. Naturally the sector was stressed as the nexus of the Credit Crunch, and the dislocations within the sector have created gross opportunities which have been taken advantage of by both the funds covered here. The longer-established Tosca Fund has undergone a successful reorganisation in order to align the portfolio processes with investors' requirements. So, to be clear, the portfolio construction elements discussed here relate to the Tosca Fund after the reorganisation of the final quarter of 2008.
One of the tenets of my consultancy business is that the portfolio construction and risk management used by a hedge fund should be consistent with the desired outcomes. The target returns are usually given as a range of absolute return per year, and sometimes come with a volatility of monthly return co-target or secondary target. The ranking of return versus risk assumption, whether it is volatility of return, downside risk, semi-variance, drawdown or worst monthly loss forecast is a primary element in understanding a particular hedge fund. Not just ex-post external measurement of risk versus actual monthly returns, but ex-ante from the perspective of the portfolio manager(s). What are they trying to achieve in terms of secondary risk characteristics other than absolute return, and how important are the higher moments in how they impinge on the investment process?
I have been looking at two hedge funds operating in the same speciality, and looking through their portfolio construction techniques. Both funds are financial sector specialists. Naturally, both the funds have had different portfolio shapes in the last 18 months than in the previous period.
Directional versus Market-Neutral
The Tosca Fund set up by Martin Hughes and now managed by Johnny de la Hay is a long/short global equity fund which is run with fund shape drawn from Hughes' experience at Tiger Management. Tiger cubs tend to have a net long bias, but to always have a significant short book. The shorts are there to make money more than hedge. The net varies between +30 to +50%. The gross used to be typically above a hundred and fifty percent of equity; the gross of Tosca Fund has been closer to 100% of equity this year. Tosca is a net-long bias, directional, and fundamentally-driven hedge fund. ABACO Financials Fund is self-described by the managers as a market-neutral equity fund. It is of critical importance that that label market-neutral is at the first level of description along with the dedication to financials. For Inigo Lecubarri, Louis Rivera-Camino, and Martin Deurell who run the fund the beta-based market-neutrality encompasses a net between 20% net long and 20% net short. Striving to achieve relative performance within the portfolio, shorts are in place to hedge much more than for profit. A typical gross exposure (not average) has been, say, 190 percent of equity. A year ago the gross was less than 100% of equity, and is now back to the typical levels.
So the ABACO Financials Fund has had a structurally constrained and smaller net exposure to markets than Toscafund, and a slightly larger gross through its life. The gross exposure of the ABACO product is thought to be nearly twice that of Tosca Fund at the moment. The ABACO Financials Fund is a structurally market-neutral, very slightly directional equity hedge fund in which returns come from both fundamental investing and trading. Not that Tosca doesn't trade around positions at all, rather trading has not historically been a major contributor to overall returns.
Mandate Scope and Thematic Similarity
ABACO is a pure financials hedge fund, with only a few positions being from outside Europe. The top-down elements of the ABACO investment process, the medium-term idea generation component, are very similar in outcome to those at Tosca. The knowledge base of the ABACO managers allows them to isolate the fundamental drivers for each sector and stock in their universe of more than 250 names. Drivers are of three classifications –a) Operational, b) Sector / Industry, and c) Macro-Economic. Companies financial performance is modelled based on the relevant drivers on the understanding that there is a trade-off between explanatory power and complexity. So for each company followed at Abaco the managers calculate an earnings sensitivity per factor. Earnings under various economic/sector scenarios can then be extrapolated, and then probabilities attached to the scenarios.
So for the top-down (longer time-frame) element both Tosca and ABACO are using a thematic approach. This means that in effect stock positions in the respective portfolios are knowingly related to a degree.
Time-Frames, Stops and Liquidity
The ABACO Financials Fund is managed with multiple time-frames as ABACO always has trading positions as well as core investments. The Tosca Fund is managed with a much greater bias to the medium term, and in hedge fund terms one could even suggest a long-term time frame. The Tosca process derives a target price based on internal analysis extending out two years or more. In the short term the stock market resembles a beauty pageant, and in the long term a weighing machine. The Tosca approach assesses the companies' worth on a rational multi-year basis (weighing machine basis) and looks through the fashionable or commonly held subjective biases. This can be very powerful in allowing the manager of Tosca to argue with the short term perceptions in the market, and hold onto positions. Historically Tosca would tend not to use stops on positions or the whole portfolio, having taken a fundamental position on a stock.
The Abaco Financials Fund is run by three Portfolio Managers with different type of backgrounds:
from research (Inigo Lecubarri),portfolio management (Rivera-Camino) and from a trading background (Martin Deurell). Capital is allocated as a function of expected risk/return and catalysts, the latter acting as triggers for timing. So the core of the process is a creating an orderly ranking of long/short candidates. Candidates for inclusion are assessed for their marginal contribution to portfolio diversification before they are added. Both Tosca and ABACO use a correlation matrix of names in their universe to understand the relationships between their holdings (and potential holdings) on a historic basis.
Both Funds pay attention to the liquidity of positions – for Tosca Fund it must be feasible to liquidate 90% of the portfolio within three months of normal trading. In practise all but 10% of the current Tosca portfolio could be liquidated in 5 days on 20% of the market volume. For the ABACO fund at least 80% of the portfolio can be liquidated in less than a day's trading, and the balance of the portfolio can be liquidated in 2 to 3 days' trading. There are two factors at play here – size and style.
The Tosca Fund is more than $2.5bn in AUM, up to 20 times the size of the ABACO Financials Fund. As important is that the medium to long term holding period of the Tosca Fund is matched by fund liquidity terms of quarterly redemptions with 3 months notice. The ABACO Financials Fund has monthly dealing and it has a trading component as well as investment time-frame positions. So the liquidity demanded of the underlying positions of the ABACO fund is consistent with the style, just as it is for Tosca Fund.
Martin Deurell of ABACO has commented: "We are much more liquid (than Tosca) which can help us to execute the risk management efficiently. The drawback of this, of course, is that we can't capture certain alpha that Tosca can: they can take bigger positions in less liquid companies."
Some Diversification by Book for ABACO
One further difference to emphasise between the two financial specialists is that, consistent with a market-neutral mandate, the ABACO Fund is described by the managers as a relative value fund. The long book is conceptually held versus the short book as it is at Tosca, but at ABACO the long and short books will be more similar. When a long position is put on by ABACO it is likely that a couple of short positions will be put on to minimise country and sector factors for the long. So for the same return target the ABACO fund structure would require a bigger gross.
Having written that however, the Tosca Fund (a global financials fund) is much more diversified by country exposure than the ABACO Financials Fund. Maybe it is appropriate as European financial specialists that ABACO has more concentrated country risk. It is clear too that both fund managers spend a lot of time analysing and ranking country growth and credit worthiness, so the thematic top-down element is at least partly about expressing country biases. It is worth pointing too that Tosca Fund takes an active view on emerging market exposures – over a market cycle this should contribute to both risk and return relative to a fund that only invests in developed markets.
In terms of the activity levels, from all of the above one could infer that the holding period of Tosca Fund is a lot longer than that of the ABACO Financials Fund, and that names turnover a lot quicker at ABACO. It doesn't mean that the research effort is more or less intense at either; it is just applied differently.
So on balance the manager of Tosca Fund is trying to extract alpha over a longer time-frame than the managers of the ABACO Financials Fund, and given the larger bias to fundamentals has been more prepared to argue with the markets. Tosca Fund is net-long biased; ABACO Financials Fund is a market-neutral relative value fund. The target return of Tosca Fund is 15-20% net to investors over a full cycle - something it has achieved historically for most of its existence. I believe it will be achieved in future. The target return for ABACO Financials Fund is 10%, and just about as important to the managers is the lack of correlation to markets.
Outcomes from the Two Styles
Tosca C (since re-organisation) versus a Peer Group of European-Based Equity Hedge Funds
The Tosca Fund was up 43% in 2009, the fifth time it has posted annual returns in excess of 20% since its inception in late 2000.
Data Source: Eurohedge
The ABACO Financials Fund has had an annualized return since inception in June 2003 of 8.69% ($ version) achieved with a monthly volatility (annualised) of 5.99%, and is having its best year yet in 2009. However, given the mandate, it is just as significant that the returns of the ABACO Fund have an r2 of 0.01 with the S&P500, according to a hedge fund database. Further the return series for ABACO has a negative correlation with other hedge fund equity market neutral funds, at least at the hedge fund index level. The Fund also shows nearly no correlation with the European financial sector time series.
Monthly and Annual Return of ABACO Financials Fund (EUR)
2003 | 2004 | 2005 | 2006 | 2007 | 2008 | 2009 | |
| Jan | -- | 0.71% | 1.92% | 1.32% | -1.06% | 3.67% | 2.89% |
| Feb | -- | 2.20% | 0.85% | 3.64% | 1.61% | -0.46% | 3.07% |
| Mar | -- | 0.84% | 0.22% | -0.87% | 0.44% | -3.13% | -2.58% |
| Apr | -- | -1.54% | -1.02% | -0.50% | 2.49% | 4.01% | 0.56% |
| May | -- | 0.69% | -0.34% | 0.20% | 2.70% | 0.14% | 2.75% |
| Jun | 0.49% | 2.06% | -0.15% | 1.29% | 1.19% | 1.53% | -0.33% |
| Jul | 0.59% | -2.31% | 1.14% | 0.18% | -2.63% | 0.58% | 1.37% |
| Aug | 0.50% | 0.45% | -1.07% | 2.45% | 2.65% | 1.58% | 4.98% |
| Sep | 0.55% | 1.26% | 1.58% | 1.40% | -0.83% | -5.33% | 2.22% |
| Oct | 1.34% | -0.18% | 0.93% | 0.61% | -0.36% | 1.14% | -1.90% |
| Nov | 0.51% | -0.42% | 1.51% | 2.37% | -1.61% | 1.35% | 2.29% |
| Dec | 2.58% | 0.76% | -0.27% | -0.66% | 2.28% | 0.36% | 0.64% |
| YTD | 6.73% | 4.51% | 5.37% | 11.93% | 6.89% | 5.19% | 16.88% |
The top down processes and risk measurements used by the managers of the two financial equity hedge funds are similar. The risk management and portfolio construction of the two hedge funds are different, but each consistent with their respective sources of alpha and targets for return, and explicit (ABACO)and implicit (Tosca) higher moments of their return series. Investors in hedge funds should always evaluate the extent that the portfolio construction and particularly the money management element of running a hedge fund is consistent with the form and time-frame of insight into markets utilised by a manager. In these two cases they are.
Thursday, 24 December 2009
A Creative Way to Build a Hedge Fund Brand Name – Broadwalk Asset Management
I was listening to trader trainer Michael Martin interview Jim Rogers on his excellent website (http://martinkronicle.com/), and I heard Jimmy Rogers say that investors should stay with what they know and are interested in. In working with portfolio managers I often ask them which sectors or types of stock they are good at investing in, and which they can't seem to get right. It may be they can't read retailers, or always seem to mis-time growth stocks, but it is very important to eliminate what you are not good at as a trader or investor. I think of it as playing defence to some extent – by eliminating a repeated error, and focussing on what you are provenly good at your returns have to improve.
There may be an element of ego involved – it may seem a sign of weakness on the part of a money manager to leave out a sector or type of stock from their universe. But investors, and ultimately the manager, will only be interested in the scale of returns achieved. So my conviction is to put the ego to one side, check the data, and eliminate areas of weakness. For example I worked with a manager who occasionally dabbled in the financial sector, but whose major strength was in consumer-related sectors. Analysis showed that the hit rate (percentage winning trades) was a lot lower in financial stocks than in other sectors, and I advised leaving the financials alone. Losses in the financial positions were slightly larger than those typically tolerated. If anything the stop-losses should have been tighter and positions sized smaller initially.
The ultimate specialism is sector funds, a strategy area I hope to return to shortly in more detail. In Europe we have begun to be used to hedge funds specialising in sectors, though they are a well established and successful phenomenon of the US hedge fund industry. Investor interest in sector hedge funds should be strong – the return data suggests they can offer enhanced return and lower correlation with markets if the funds have an appropriate framework for portfolio structure. The evidence for this contention is stronger at the manager level than at the index level - there is scope to add a lot of value to a portfolio hedge funds through manager selection in sector funds.
I came across an unusual sector fund this month. The Broadwalk Select Services Fund, run by Charlie Cottam, is Europe's first "Services" sector focused fund. The Fund has been going since June last year, and it has been going rather well. Most hedge funds made money in the first half of 2008 and lost more than their first half gains in the second half of the year. The Broadwalk Select Services Fund was up 1.3% over the last seven months of 2008 through putting in four down months and three up months. Obviously the average up-month in 2008 was bigger than the average down-month!
Charlie Cottam preserved capital well in the first few months of this year, and did better thereafter: through the end of November the Fund is up 44% for the year. The relevant market index for the fund is the FT-All Share Index (the Fund concentrates on UK companies), and that benchmark was down in four months of 2009, and the Fund managed by Broadwalk Asset Management was down in only one of those months. Over the whole life of the Fund the FT-All share has been down 14.6%. According to the manager he didn't get properly invested until February/March of this year, but once he did he made excellent returns through stock selection – the net is now about 80%, and the fund is concentrated (large position size).
The manager of the Fund claims two forms of competitive edge: better information and original analysis. The original analysis comes from Cottam's experience on the sell-side. As a chartered accountant himself he sees accounting issues not well understood by those analysing the service sector specifically. He may have a point as there are few sell-side analysts in the sector with similar tenure as an analyst. The manager himself sees an advantage in his ability to use his been-through-the-cycle experience to turn around his conception on a company and stock quickly – he can grab an emerging opportunity at the time when other analysts are getting out their apocryphal pen to write a research note.
Cottam is an experienced sell-side analyst, and in that may be a true edge as he was company broker to 33 UK corporates. This unique arrangement for UK quoted companies – a corporate brokership for each quoted company – gives the appointed broker a privileged position in terms of access to management. Cottam has kept his company network intact as he has moved to the buy side. His management contacts and experience of individual management teams based on their historic behavior helps Cottam to spot the early warning signs of change in outlook for companies and sectors. His sell side experience enables him to understand the flow information on stocks and their relative positioning in the market.
So Charlie Cottam uses his deep experience in service companies to extract alpha – staying with what he knows and is interested in. He has also taken steps to reinforce his edge by keeping senior management engaged with Broadwalk – last year he initiated the Broadwalk Business Services Awards. This is the second year of the Broadwalk Business Services awards to recognise outstanding achievements by quoted companies in the business services sectors. The UK often leads the world in business services -it is one of the less well-known success stories of the economy, and these awards are a step towards raising its profile. The categories and 2009 winners are: Company of the year (Aggreko), CEO of the year (Nick Buckles, G4S), Chairman of the year (John Peace, Experian), Deal of the year (Balfour Beatty - Parsons Brinkerhoff), Small company of the year (Hargreaves Services), and Entrepreneur of the year (Michael O'Leary, Ryanair).
I think this is a terrific example of creative thinking by a hedge fund manager, and Charlie Cottam's entrepreneurialism and unusual means of brand building are to be commended.
There may be an element of ego involved – it may seem a sign of weakness on the part of a money manager to leave out a sector or type of stock from their universe. But investors, and ultimately the manager, will only be interested in the scale of returns achieved. So my conviction is to put the ego to one side, check the data, and eliminate areas of weakness. For example I worked with a manager who occasionally dabbled in the financial sector, but whose major strength was in consumer-related sectors. Analysis showed that the hit rate (percentage winning trades) was a lot lower in financial stocks than in other sectors, and I advised leaving the financials alone. Losses in the financial positions were slightly larger than those typically tolerated. If anything the stop-losses should have been tighter and positions sized smaller initially.
The ultimate specialism is sector funds, a strategy area I hope to return to shortly in more detail. In Europe we have begun to be used to hedge funds specialising in sectors, though they are a well established and successful phenomenon of the US hedge fund industry. Investor interest in sector hedge funds should be strong – the return data suggests they can offer enhanced return and lower correlation with markets if the funds have an appropriate framework for portfolio structure. The evidence for this contention is stronger at the manager level than at the index level - there is scope to add a lot of value to a portfolio hedge funds through manager selection in sector funds.
I came across an unusual sector fund this month. The Broadwalk Select Services Fund, run by Charlie Cottam, is Europe's first "Services" sector focused fund. The Fund has been going since June last year, and it has been going rather well. Most hedge funds made money in the first half of 2008 and lost more than their first half gains in the second half of the year. The Broadwalk Select Services Fund was up 1.3% over the last seven months of 2008 through putting in four down months and three up months. Obviously the average up-month in 2008 was bigger than the average down-month!
Charlie Cottam preserved capital well in the first few months of this year, and did better thereafter: through the end of November the Fund is up 44% for the year. The relevant market index for the fund is the FT-All Share Index (the Fund concentrates on UK companies), and that benchmark was down in four months of 2009, and the Fund managed by Broadwalk Asset Management was down in only one of those months. Over the whole life of the Fund the FT-All share has been down 14.6%. According to the manager he didn't get properly invested until February/March of this year, but once he did he made excellent returns through stock selection – the net is now about 80%, and the fund is concentrated (large position size).
The manager of the Fund claims two forms of competitive edge: better information and original analysis. The original analysis comes from Cottam's experience on the sell-side. As a chartered accountant himself he sees accounting issues not well understood by those analysing the service sector specifically. He may have a point as there are few sell-side analysts in the sector with similar tenure as an analyst. The manager himself sees an advantage in his ability to use his been-through-the-cycle experience to turn around his conception on a company and stock quickly – he can grab an emerging opportunity at the time when other analysts are getting out their apocryphal pen to write a research note.
Cottam is an experienced sell-side analyst, and in that may be a true edge as he was company broker to 33 UK corporates. This unique arrangement for UK quoted companies – a corporate brokership for each quoted company – gives the appointed broker a privileged position in terms of access to management. Cottam has kept his company network intact as he has moved to the buy side. His management contacts and experience of individual management teams based on their historic behavior helps Cottam to spot the early warning signs of change in outlook for companies and sectors. His sell side experience enables him to understand the flow information on stocks and their relative positioning in the market.
So Charlie Cottam uses his deep experience in service companies to extract alpha – staying with what he knows and is interested in. He has also taken steps to reinforce his edge by keeping senior management engaged with Broadwalk – last year he initiated the Broadwalk Business Services Awards. This is the second year of the Broadwalk Business Services awards to recognise outstanding achievements by quoted companies in the business services sectors. The UK often leads the world in business services -it is one of the less well-known success stories of the economy, and these awards are a step towards raising its profile. The categories and 2009 winners are: Company of the year (Aggreko), CEO of the year (Nick Buckles, G4S), Chairman of the year (John Peace, Experian), Deal of the year (Balfour Beatty - Parsons Brinkerhoff), Small company of the year (Hargreaves Services), and Entrepreneur of the year (Michael O'Leary, Ryanair).
I think this is a terrific example of creative thinking by a hedge fund manager, and Charlie Cottam's entrepreneurialism and unusual means of brand building are to be commended.
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