October 2016 AlphaFOR INSTITUTIONAL INVESTORS & ASSETQ MANAGERS

SEND IN THE CLOUDS POOLED INVESTMENTS Cloud platforms for Bfinance details the funds pooled approach

TECH-FOCUS TIMBER! PE turns on to Go with the grain tech firms and invest in wood

REAL ASSETS GLOBAL CARRY ...give real returns Carry on investing for risk-adjusted returns

PAAMCO profile Interview with managing director Alper Ince

www.AlphaQ.world

EDITORIAL

ctober’s issue of AlphaQ reflects caution from investors with risk-on investing top of an agenda that includes Odiversification among assets that might not be seen as typically risk-on, including emerging markets, carry trades and real assets. Institutional investors seem uneasy over central activity with a widely predicted rate hike looming in December in the US and the Bank of Japan’s admission that the QE process there is not going so well. This issue’s cover story is an interview with Alper Ince, managing

ELEANOR ROSTRON director at PAAMCO, which manages over USD10 billion in discretionary assets and advises on an additional USD11.8 billion in assets. Diversification has kept them out of the fund of fund doldrums and their latest venture is the launch of PAAMCO Miren, an emerging market firm that directly manages -only equity

Managing Editor portfolios in Europe, the Middle East and Africa (EMEA) and Latin Beverly Chandler Email: [email protected] America. Contributing Editor James Williams Email: [email protected] The emerging markets have had a fantastic year with Brazil out- Online News Editor Mark Kitchen performing even developed countries, reflecting the new investment Email: [email protected] Deputy Online News Editor world in which we are working. Leah Cunningham Email: [email protected] Real assets can be your friend too, argues CentreSquare Graphic Design Siobhan Brownlow Email: [email protected] Investment Management’s Scott Crowe who details how investment Sales Managers Simon Broch in global listed infrastructure and real estate can reduce Email: [email protected] Malcolm Dunn and increase income. Email: [email protected] Marketing Administrator Our regular columnist, Randeep Grewal, returns to Middle Earth Marion Fullerton Email: [email protected] again for investment inspiration, reporting on Elven investing, Head of Events Katie Gopal Email: [email protected] and, with the help of a little magic, conjures up a Keynesian list of Head of Awards Research Mary Gopalan investment rules. Email: [email protected] Chief Operating Officer And, finally, let’s take a look at physically real assets with our Oliver Bradley Email: [email protected] timber story. It’s hard to avoid the obvious puns here, but going Chairman & Publisher Sunil Gopalan Email: [email protected] with the grain does seem to offer a truly diversified return – can Published by GFM Ltd, Floor One, Liberation Station, you see the wood for the trees? St Helier, Jersey JE2 3AS, Channel Islands Tel: +44 (0)1534 719780 Website: www.globalfundmedia.com ©Copyright 2016 GFM Ltd. Beverly Chandler All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, Managing editor, AlphaQ in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the publisher. Email: [email protected] Investment Warning The information provided in this publication should not form the sole basis of any investment decision. No investment decision should be made in relation to any of the information provided other than on the advice of a professional financial advisor. Past performance is no guarantee of future results. The value and income derived from investments can go down as well as up.

AlphaQ October 2016 www.AlphaQ.world | 3 CONTENTS

October 2016 AlphaFOR INSTITUTIONAL INVESTORS & ASSETQ MANAGERS

SEND IN THE CLOUDS POOLED INVESTMENTS Cloud platforms for Bfinance details the hedge funds pooled approach

TECH-FOCUS TIMBER! PE turns on to Go with the grain tech firms and invest in wood

REAL ASSETS GLOBAL CARRY ...give real returns Carry on investing for risk-adjusted returns

13 20 22

PAAMCO profile Interview with managing director Alper Ince NEWS FEATURES FEATURES 05 An interview with Tristan Chapple, www.AlphaQ.world Director of the Aurora 11 Cover story: PAAMCO profile on their value approach to equities Beverly Chandler interviews Alper Ince, Managing Director, PAAMCO on the Companies featured in firm’s growth over recent years, approach this issue: 06 Interview with bfinance’s Sam Gervaise Jones on their recent hiring by The to investing in equities and launch of • AQR Brunel Partnership, an investment their specialist emerging market firm, • Aurora Investment Fund pooling project, to undertake an PAAMCO Miren • Bfinance independent review of the plans to 13 Cloud solutions • Campbell & Company pool the investment assets of ten How are cloud platforms changing the local government pension funds in the • CentreSquare way hedge funds run their businesses? Investment Management South West James Williams explores the new options • Dome Equities 08 USD1.27 billion Dome Equities’s CIO Eric • Hentsu 17 Tech-focused PE investment Jones explains how investors searching James Williams examines the trend for • Highlander Partners LP for yield should consider a US multi- PE firms to invest in data, telecoms and • Navatar Group family real estate allocation tech-enabled businesses • PAAMCO • Phoenix Asset 09 Timberland Investment Resources Europe 20 Carry on investing Management LLP (TIR) has just gone through its first Campbell & Company’s Susan Roberts • PivotalPath close of its TIR Europe Forestry Fund argues the case for why carry trades with an initial USD74 million of committed should not be viewed as an FX • Preqin capital. AlphaQ reviews the returns play but can produce enhanced risk • RARE Infrastructure on timber adjusted returns Limited • Richard Fleischman & 10 consultant PivotalPath says 22 Producing income from real assets Associates Inc the model is changing Scott Crowe, Chief Investment Strategist • Timberland Investment at CentreSquare Investment Management Resources Europe LLP outlines the case for income producing real assets

25 Busting the risk parity misconception James Williams explores why risk parity should not be viewed as a hedge fund substitute and busts come common misconceptions on how they should be used

27 A return to Middle Earth Randeep Grewal returns to Middle Earth, using a little magic to reveal Elven investment tricks, via John Maynard Keynes

AlphaQ October 2016 www.AlphaQ.world | 4 ALPHAQ NEWS FEATURE

Old-fashioned value investing gives new life to Aurora

egime change at the Aurora Investment Fundamental to the firm’s investment RFund has seen its approach is their approach to research. “The increase, while its portfolio achieved a 5.7 per portfolio is highly concentrated and that means cent return, against a market rise of 1.9 per that we need to stay very close to what we cent, in August. own,” Chapple says. “We monitor with a huge The change was the arrival of old fashioned amount of mystery shopping.” value managers Phoenix Asset Management Phoenix likes to be cautious, holding with GBP600 million under management in investments it can monitor at the front end of UK stocks that don’t at first glance appear the business. “We own whole companies and appealing, but that Tristan Chapple, Director of want to understand what all our individual the Aurora Investment Fund, says they never holdings are,” Chapple says. Tristan Chapple, want to sell. Director of the Aurora “We’re not contrarian because those are Phoenix became investment adviser to Investment Fund people who have made their mind up before Aurora in January 2016 when it was on its last looking. That’s not what we do and would be legs, in wind up mode with just GBP15 million dangerous in our portfolio. Our portfolio contains under management. August saw funds grown to lots of out of favour names and that is what our GBP42 million. Investors are drawn from a mix investment style ends up with as we look for high of institutional, , endowments and quality great businesses buying at a price at no wealth managers. more than 50 per cent of what they are worth. Chapple says: “We had a complete clear out We like to buy good quality companies cheap of the old portfolio and aligned it to our existing while they have term problems.” portfolio. We could then take our track record The portfolio holds companies where there and go out and meet investors who know us but is a strong distinction between how they are who have wanted a different structure, but also perceived as a consumer and how they are run. investors who haven’t met us before.” “Our businesses are very high quality indeed,” Phoenix’s track record shows a net annual Chapple says. return of 9.2 per cent since 1998, against the Sports Direct has been in their portfolio for FTSE All Share for that period, which saw a nine years and despite its recent disastrous return of 4.9 per cent. PR issues, Chapple says it is an incredibly well Phoenix hopes to take Aurora to GBP100 run company with a management team that is million in the next couple of years. Chapple among the best in the retail space. explains that their approach to investing is to “Some of the issues have been of their own invest in UK stocks when there is a short term making,” Chapple says, referring to recent problem or negative market sentiment. complaints of bad staff practices in their Firms in their list include Sports Direct, warehouses. “But now they have addressed J D Wetherspoon, Tesco and housebuilders them and changed the business to react to such as Barratt and Bellway Homes. Chapple that, where justified. We need misperception says: “We’ve been very familiar with the in our investments or we wouldn’t get the house building sector for 18 years and have opportunities that we get.” held Barratt Developments for a long time. While they aim to hold stocks forever as Pre-Brexit the housebuilders were more fully their starting point, they would sell if the actual valued, reflecting improving trading conditions price overtook the intrinsic value or if there so we had a lower weighting and then Brexit was something wrong fundamentally in the happened and we saw more bearishness about investment case. UK property, and got the opportunity of buying The firm uses a concept of intrinsic value for quite a lot more at lower prices. We think the every holding which allows them to measure share price impact post Brexit was dramatic, the portfolio in terms of intrinsic value. but long term, the impact on the business is Currently the portfolio is 120 per cent upside to negligible.” intrinsic value. n

AlphaQ October 2016 www.AlphaQ.world | 5 ALPHAQ NEWS FEATURE

Independent review of pension pooling project from bfinance

nvestment consulting business bfinance Ihas been appointed by the Brunel Pension Partnership, an investment pooling project, to undertake an independent review of the plans to pool the GBP23 billion in investment assets of 10 local government pension funds in the South West. Leading the Brunel Partnership contract at bfinance is Sam Gervaise-Jones, head of client consulting for the UK and Ireland. He explains that bfinance has grown since 1999 from its headquarters in London to five other locations and serves institutional clients in 32 countries. While it’s difficult to put a figure on how much money the firm advises on, their clients control something in the region of USD3.5 trillion in assets. Gervaise-Jones explains that bfinance has a long history of working with local government pension schemes as some of their earliest clients were local authorities and they have worked with over 40 LGPS funds to date. The debate over pooling pension assets “Over the last few years, and led by central in order to achieve economies of scale and government, there have been concerns that improved performance has raged for some time. local government pension funds weren’t “Over the last few years, and led by central government, there have been concerns that being managed as efficiently as they local government pension funds weren’t being could be.” managed as efficiently as they could be,” he says. “There have been concerns that the lack of Sam Gervaise-Jones, bfinance scale made fees and costs higher than they could be and that some didn’t have access to all the Having worked together on other projects, it investment asset classes that they could have.” was a natural extension to continue with that GBP25 billion is the portfolio size that has collaboration, Gervaise-Jones explains. been deemed ‘a sensible number’, to quote Each new prospective pool had until July Gervaise-Jones, and the result has been that 89 this year to put in a submission to central funds have talked and coalesced into a number government on how they would get to scale and of pools, of which Brunel is one. manage their investments going forward. They The Brunel Partnership is based on a group were also charged with making greater use of of funds in the south west which had previously infrastructure investments. worked together on joint procurement The deadline for this process was July of this exercises. It was established in 2015 to explore year and required a huge amount of work. the options for pooling the investment assets “Asset allocation decisions stay with the across 10 funds in the South-West, including funds but are implemented through the Brunel The Environment Agency , and Pension Partnership,” Gervaise-Jones explains. the Local Government Pension Funds of Avon, “They decided what building block portfolios Buckinghamshire, Cornwall, Devon, Dorset, they would offer, and next there will be some Gloucestershire, Oxfordshire, Somerset and expectations around what sort of fee savings Wiltshire. they would achieve and the likely costs of the

AlphaQ October 2016 www.AlphaQ.world | 6 ALPHAQ NEWS FEATURE

start looking at how they implement these 23 portfolios. We will be hoping to put forward a solution for that.” Across the UK there are other pools all going through similar exercises, Gervaise-Jones explains. “There will be a number of similar projects down the line as people face similar issues.” Different geographies have seen different versions of achieving scale over the years. “It has been well documented in the Netherlands,” he says. “The jury is out as to whether it has worked there. It was a different journey in the Netherlands, more focused on fiduciary management.” However, scale will enable local government pension funds to access investment classes that are not currently available to them, specifically infrastructure and hedge funds. “Those asset classes make more sense if you pool so you can improve diversification and risk management,” Gervaise-Jones says. bfinance is organised along four areas: public fixed income; public equities; private markets and liquid alternatives, which includes hedge funds. “If you look at our manager selection and search activity, we do one third equities one third fixed income and one third alternatives,” Gervaise-Jones explains. “Alternatives feature highly because, one, we’ve set up our teams to be staffed with investment experience in these areas, which is valuable when looking at the new structure, matched against expectations of alternatives investment areas where clients improvements in performance.” have typically have been less comfortable, Government response should be back in the and two, activity levels. Some 15 years ago Autumn, allowing them to push on with the institutional investors had small alternative project because, on the current timeline, this allocations, but fast forward to today where, on should be up and running by 2018. the whole, equities allocations have come down It was at the stage of looking for an and alternatives up gone up, we are able to help independent review of the investment and people with alternatives because that’s where business case, that they ran a tender asking the activity has been.” for proposals to help review the 23 portfolios. Gervaise-Jones explains that local “Through a competitive assessment of all the government pension schemes have been consultants we were appointed to provide an interesting to work with because there is a independent assessment and view on whether strong case for investigating whether things the business case, as it stands, is pragmatic and can be done in a more efficient fashion, while implementable,” Gervaise-Jones explains. always asking if it will end up with better results “At present nothing has changed in the way for pension funds. the money is being managed. Each authority “It’s not that bigger equals better on is managing their own investments in the performance,” he says. “There are plenty of same structures they had before and all the challenges, but it is an exciting time for the regulatory and other structure has to be put sector to make some positive changes to the in place next and then at that point they will way they run their investments.” n

AlphaQ October 2016 www.AlphaQ.world | 7 ALPHAQ NEWS FEATURE

Multi-family real estate gives Dome liquid returns

ome Equities is a USD1.27 billion US real Destate firm. CIO Eric Jones explains that the firm launched 16 years ago in the same Manhattan building they still inhabit and has always focused on US real estate. “The business model was started across the street when I was at Citibank Private Bank,” Jones says. “The genesis of the business came from a study that showed that 25 per cent of the assets at the largest non-Swiss private bank were in real estate. At that time Citibank wasn’t capturing that, so it was the catalyst for us launching and subsequently Citibank introduced investors to us.” Dome invests in multi-family real estate, largely apartments which are rented out. Its average holding period is three years. The liquidity issue, always an issue with property, is addressed through cash flow. “Liquidity is neither good nor bad, just expensive or cheap,” Jones says. “We believe the high cash flow from rentals paid out Eric Jones, CIO at our acquisitions. What we are following is quarterly mitigates the liquidity risk. The rental Dome Equities demographic growth.” business is high margin but with our relative The prime US renter is 20-34 with a job holding periods, we think of it with a value that pays well. By the end of that age bracket added perspective. We buy it, we fix it and we or in the latter half, they begin to get married sell it. We get an improvement with strategic and/or have children and are moving out of capital and then liquidate to the buyer who rentals. However the demographic is changing wants to own real estate longer term.” as Millennials, the children of the baby boomers, “We have a heavy cash flow emphasis so we are expanding by 500,000 over the next six years don’t really worry about the cyclicality that and demonstrably getting married and having people talk about, if only because we stick to their first child at the oldest age on record. Jones a very disciplined investment process that has thinks that the fund has broad appeal. Investors proved successful across a range of economic are currently dominated by ultra high net worths outcomes. We are agnostic to the condition plus there has been a move to recruit smaller of the economy because people have to live pension funds, endowments and foundations. somewhere.” “We think we have a yield orientated The somewhere that Dome focuses on is investment product in a world where there is no widespread across the metropolitan areas in yield which is non-correlated to public markets, the US. “There are 380 metropolitan areas and and at our strategy level, so much of it is we focus on the largest 100 and that portfolio demographic driven, we can have a lot of success is only in 19 of those metros and then 40 per regardless of the environment,” Jones says. cent is in four metros – Denver, Dallas, Houston “If rates rise, we will see tumultuous market and Orlando – and the rest spread across the 15 activity and a non-correlated yield strategy others,” Jones explains. provides a safety buffer. And if rates are rising, “We have prided ourselves on our long term it must mean there is economic growth and disciplined market selection process so those that economic growth must mean employment 100 metros we risk rank to figure out where growth which should parlay into good rental the growth is occurring and then we target growth rates for apartments.” n

AlphaQ October 2016 www.AlphaQ.world | 8 ALPHAQ NEWS FEATURE

Investors twig timber’s diversified returns

he TIR Europe Forestry Fund Time weighted average annualised return (1991-2015) Tfrom GBP1.5 billion Timberland Investment Resources Europe LLP has NCREIF Timberland executed a first close with an initial S&P 500 USD74 million of committed capital. FTSE All Share The investors were drawn from a Euro Stoxx 50 diverse, mostly European group of UK Property limited partners, the firm says, including Oil public and private pension plans, MSCI World companies and family offices. UK Gilts The fund is targeting 8-10 per Gold cent returns with 3 per cent annual GSCI distributions. Managing partner 0% 2% 4% 6% 8% 10% 12%

GianPaolo Potsios says: “We are Source: Bloomberg, NCREIF. Exceptions: Euro Stoxx 50 began in 1992 & FTSE UK Gilts Index in 1999 excited to be able to offer European institutional investors access to an asset class that is well established without the trade-off of higher risk, the return by possible downward amongst US investors in a time where firm says. movement in timber prices is mitigated the world economy continues on its Timberland also offers by volume growth; the effect of upward uncertain path. Real assets such as diversification, according to the price movement is compounded by timberland have a compelling role to firm. “Commercial timberland, by volume growth,” the firm writes. play in an investor’s portfolio given the its nature, is affected by a different In addition, over the life of an bond-like characteristics with a solid set of macroeconomic and market investment, timber continues to grow source of alternative yield.” factors than other asset classes. As a although at a slower rate as trees Fellow managing partner, Hugh result, there will be limited correlation mature. This allows the investor to Humfrey, says: “For our new investors, between returns from timberland and ‘warehouse’ timber ‘on the stump,’ we will continue to weight on our other asset classes such as equities, giving the investor greater flexibility to over two decades of experience in bonds and property.” harvest when prices are high and delay managing timberland investments and One of the unique advantages of sales if prices are weak. the network created to source the timber is that, as an asset, it literally Timberland portfolios can be best opportunities, whilst pursuing the grows, with trees growing in volume, structured to meet different objectives, highest environmental stewardship size and ultimately into increasingly with higher cash flows achieved by and expertise in managing the forests. higher-valued products. The firm gives buying more mature properties; if long- We have our in-house economic and an example, drawn from the south of term gains are more important, then this biometric research methodologies the US where individual trees begin goal can be achieved by acquiring young to inform and guide our investment as lower-value pulpwood, grow into a plantations, with high growth rates and decision-making process and remain combination pulpwood/saw timber tree enhancing the benefits of biological boots on the ground foresters while (9 to 12 inches in diameter), normally growth through intensive management assisting our investors achieve their referred to in the timber trade as ‘chip- techniques, the firm writes. portfolio objectives.” and-saw’, and then into saw timber The firm also suggests that Timber as an investment is most (trees that are generally greater than timberland can be viewed as a often measured by the Timberland 12 inches in diameter and of a high specialised long term bond. “A forest Index, published by the National quality) for construction products. will generate cash each year as timber Council of Real Estate Investment The firm writes that as a tree grows is harvested. This harvest can be Fiduciaries, or NCREIF. Returns from into these larger and higher product modelled and forecast with a good timberland investments – as measured classes, the monetary value of the tree degree of accuracy over many years, by that index – have been superior increases as well. “The negative impact even decades and since timber growth to the returns from other commonly of the time value of money and the risk is not effected by movements in held asset classes, such as UK Equities of negative returns can be offset by financial markets, a forest investment & Bonds, Gold, Commodities and UK the increasing volume and value of the can be structured to behave in many Commercial Property and achieved asset. In short, the effect on investment respects like a long-term bond.” n

AlphaQ October 2016 www.AlphaQ.world | 9 ALPHAQ NEWS FEATURE

PivotalPath throws down challenge

he traditional hedge fund consultant role Hedge funds returns have not been so Tis under attack from PivotalPath, a New convincing for the last couple of years. Caplis York based hedge fund consultant, which finds says: “This is definitely a difficult period but the model antiquated. Managing principal Jon it’s a net positive for us as it causes investors Caplis came to the firm in 2013, having been on to continue to question the value of their the other side of the desk, most recently as the intermediaries, which today is namely their co-head of risk management and member of the consultants. investment committee at Campbell & Company, “Historically investing in the largest funds a multi-billion dollar CTA. generated adequate performance that investors “When I joined PivotalPath, one of the key rarely questioned it, but today people are trends was that funds of funds were in demise saying ‘we are spending hundreds of thousands and have continued to play a diminishing role Jon Caplis, managing of dollars with large consultants who provide principal at PivotalPath in hedge fund investing. The model was clearly little transparency and performance has been broken and we have been observing a similar well below expectations’. In fact, a third of our trend over the past three years with the large clients still utilise general consultants but have general consultants of the world,” he says. hired us to hold the consultants accountable. “In former roles within the research teams PivotalPath was founded in 2010 as a of large hedge funds consultants, for the most traditional boutique hedge fund advisory firm part, would call me in and I would answer a lot working mostly with single family offices of questions, allowing younger, smart people, looking to diversify. The firm is now advising on who might not be able to differentiate a CTA close to USD7 billion (over a 10-fold increase from a fund, to tick the box. Many since 2015) in assets for institutional investors, firms are not dedicating adequate resources from single family offices to multi-family offices, to comprehensive due diligence, instead often pension funds, endowments and foundations. relying on inexperienced analysts with ripe with Their client portal covers over 800 hedge biases. However, these ad hoc approaches to funds, or over 90 per cent of global hedge fund evaluating managers produce information and assets, with comprehensive research on 230, advice that many institutional investors, and who are deemed institutionally viable. They billions of dollars, rely upon. have offices in New York, London and travel to “In 2013, we decided that our approach is Asia at least three times a year. going to be different in a number of ways. We When evaluating managers, PivotalPath developed technology to enable large scale implements a 20 step due diligence process research along with the ability to deliver this and turns around a comprehensive assessment, information to clients, which historically has complete with ratings, within 30-40 business been cost prohibitive. days, well less than the 12-18 months common “A lot of our clients are fed up with the with many consultants. Funds are examined traditional consulting model in general and also through six factors from both a qualitative and with the lack of transparency and fee structure. quantitative perspective from the firm’s history; The pricing models out there are antiquated the strategy; the team; risk management; because the consultants were competing with performance and business considerations. the funds of funds, so it seemed like a bargain. “We approach it like an investigative A swathe of institutional investors are paying reporter, thoroughly reviewing fund materials, these fees and not getting value.” conducting in person interviews with multiple Caplis believes that institutions end up being decision makers, all the while looking for offered a very limited list of hedge funds that, consistencies and inconsistencies. At the end almost by design, must be able to scale across we apply a rigorous quantitative analysis that their client base. “Look at the funds we cover,” either supports or refutes what the manager he says. “A third is USD500 million or less and tells us and we synthesise it all into a format often times these are emerging managers or that our clients can easily consume and capacity constrained funds who have the ability compare strengths and weakness to other funds to generate returns on a forward looking basis.” with similar approaches.” n

AlphaQ October 2016 www.AlphaQ.world | 10 EMERGINGSTRAPLINE MARKETS

PAAMCO profile Beverly Chandler interviews Alper Ince, PAAMCO managing director and sector specialist, on its recent expansion into emerging markets.

he ’ industry has In addition, Ince is responsible for managing experienced difficult times since the relationships with certain institutional Tglobal financial crisis, but PAAMCO, investors. which manages over USD10 billion in Ince says: “We have been ahead of many discretionary assets and advises on an changes that the industry has gone through. additional USD11.8 billion in assets, seems When we set up, we were one of the few fund of to have survived and prospered where others fund providers asking for transparency from all have failed. underlying managers and in 2005 we set up our The firm was founded in 2000 and focuses own managed account platform.” on solutions to the PAAMCO’s advisory business is effectively world’s institutions. Alper Ince is a Managing a legacy business which they didn’t set out to Director and the Sector Specialist responsible plan. One part is for endowments generally, for the management of long/short equity and while the other part is a pension advisory event-driven hedge fund managers in the business, as famously, and according to public various PAAMCO portfolios. As a member of information, they advise the Californian the Investment Oversight Committee, he is pension plan Calpers on their investments. involved in all stages of the investment process. In their advisory capacity, PAAMCO helps

AlphaQ October 2016 www.AlphaQ.world | 11 EMERGING MARKETS

Africa (EMEA) and Latin America. The team is led by Yunus Emre Temiz, who has 19 years of industry experience and is joined by Federico Galassi and Felipe Gomez Bridge, who head the Latin American offices. The Miren team also includes Ali Yavuz Birdal, Head of Research, Buket Ince, Associate Director, Patricio De La Torre, Latin America Equity Analyst and Juan Diego Mejia Mendez, Latin America Equity Analyst. Soon after PAAMCO Miren’s launch, the Miren team re-established previous relationships and on 1 December, 2015, was managing USD1.1 billion, covering long-only, single-country mandates in EMEA and Latin America. “We put them under a separate division because we just felt that the hedge fund of fund business is different from just running direct assets in emerging markets,” Ince says. The emerging market sector has had a fantastic year, outperforming the old markets after years of underperformance. “If you look at the state of the world clearly what central are going to do matters a lot for asset classes “China is still a concern but it comes as you and if the Fed moves, we have seen episodes get more data and people are getting used where it has repercussions on emerging markets,” Ince says. to a slower Chinese growth than before “Europe is in such uncertainty and people but it is a softer landing than the market have doubts on the ECB programme,” Ince says. had feared.” “Also people feel emerging markets offer better value versus European allocations because of Alper Ince, PAAMCO the valuations and the growth profile you are getting exposure to compared with Europe with the strategic big picture using managed which is not growing.” accounts and securing transparency and Another strength for emerging markets negotiating fees. is that concerns over China have lessened “Over the years we have responded to the compared with earlier this year. “China is still needs of sophisticated institutions doing these a concern but it comes as you get more data interesting initiatives,” Ince says. and people are getting used to a slower Chinese Emerging markets have become a particular growth than before but it is a softer landing strength for the firm with the hiring of Belgian than the market had feared,” Ince says. bank KBC’s Asian fund of funds team in 2008 “You need some stability but you also see and then last year they took on an emerging quite a bit of divergence within the emerging markets team that emerged from Cargill’s Black markets. Clearly Brazil is the best performing River Asset Management. country in the world at the moment, including “We knew the team and we were able to developed countries. They have their own move those assets to us,” Ince says. political calendar going on and political The new venture is PAAMCO Miren, a uncertainty being resolved.” separate division from PAAMCO’s funds of The plan is to build the Miren business out of hedge funds business, with offices in London Latin America and expand further in the EMEA as well as Turkey, Mexico and Colombia. countries, beyond Turkey, and into South Africa PAAMCO Miren directly manages long-only or Russia, where they might offer a regional equity portfolios in Europe, the Middle East and rather than individual approach. n

AlphaQ October 2016 www.AlphaQ.world | 12 CLOUD TECHNOLOGY

Cloud solutions James Williams writes that cloud platforms are revolutionising the way hedge funds manage their businesses.

entsu is a cloud provider that in many Hentsu is the first managed service provider ways encapsulates the way that hedge built on the Amazon AWS cloud platform Hfunds are using the cloud to re-imagine, dedicated purely to supporting hedge funds and and in some cases, revolutionise their approach systematic trading strategies and is redefining to running a hedge fund business. the way that hedge fund trading technologies The cloud is nothing new, per se. Years ago, are delivered. Rather than be constrained by progressive hedge funds would look to establish staffing costs and the constant capital injections a private cloud environment, but this locked of maintaining a traditional IT infrastructure, them in to multi-year service contracts and Hentsu effectively uses the public cloud to free created a level of inflexibility and unnecessary hedge funds from their IT shackles, allowing capital expenditure. Now, however, the public them to scale up and scale down IT resources, cloud is rising to prominence, thanks in no pivot strategies, and adapt to changing market small part to the likes of Amazon Web Services conditions as they arise. and Microsoft Azure; cloud offerings with the This is helping hedge funds to become scale and resources of two of the world’s largest even more agile than before. And as Managing technology companies. Director and Founder of Hentsu, Marko Djukic,

AlphaQ October 2016 www.AlphaQ.world | 13 CLOUD TECHNOLOGY points out, agility equals opportunity. At a time “The biggest difference is that when hedge fund fees continue to compress, it is a message that is resonating across the hedge the public cloud goes further fund firmament. and delivers utility-based As a general trend, says Djukic, you don’t computing with far greater necessarily need an entire technology team if you have bespoke niche service providers breadth of services on top.” who can deliver expertise: “Which is what Marko Djukic, Hentsu we fit in as a wrapper around the underlying infrastructure, whether that is on AWS, Microsoft Azure or Google. We provide a level managing their investors. They don’t need to of white glove service for our hedge fund be running five different platforms, copying and clients, combining cloud expertise in an asset pasting data. We make things easier by offering management context, which means they don’t a one-stop-shop that handles all of a manager’s need to worry about running their own private needs for managing investors, investments and cloud infrastructure. They can just focus on so forth, providing a seamless experience,” trading the strategy.” says Misra. If a hedge fund CFO draws out a roadmap The concept of using the public cloud is still and finds that 70 per cent of their current IT a struggle for some hedge funds and perhaps infrastructure is locked in to agreements of one a step too far, at this stage. Concerns exist to three years, whereas a proposal with Amazon over the aspect, but in Djukic’s view, means that 80 per cent of the infrastructure is the whole debate over private versus public locked in to agreements of one year or less, the cloud is a moot point. At the end of the day, of using the public cloud becomes quite the cloud is, by its very definition, a shared compelling. infrastructure; even if people use a private “One client was looking to launch a cloud they are still sharing virtual servers with systematic CTA. They wanted others on that platform. something up and running to allow them to “The biggest difference is that the public commence trading by a specific deadline, and cloud goes further and delivers utility-based within two weeks we had created the first computing with far greater breadth of services iteration for them. That kind of set-up you just on top. You can add resources on demand cannot achieve in the private cloud,” asserts and remove them on demand when no longer Djukic. “Even if it costs more, the opportunity needed. All through code. You can’t do that with of being able to switch and change tack, as the private cloud, and you are mostly locked and when the fund manager needs to, is highly into long lease periods,” says Djukic. advantageous.” A hedge fund might choose to create Having the IT team identify the next best their own private cloud with the likes of IBM network router or switch might improve the or Microsoft, but the maintenance of the inner workings of one’s infrastructure, but infrastructure, and its security, is still taken this is increasingly becoming an unnecessary care of by IBM. “So whether it’s a public cloud focus for hedge funds. At the end of the day, or a private cloud, it’s the same infrastructure. questions Djukic, does it really add to a fund’s I don’t see how the private cloud can do much performance? more for a manager,” says Misra, who adds: Alok Misra is co-founder and CEO at Navatar “In fact, even if managers did build their own Group, a leading provider of cloud-based CRM private cloud environment, I would argue that solutions to Wall Street. Like Hentsu, it too it would be less secure than the public cloud. uses the public cloud and is designed to help The same applies to large global banks, which hedge funds reduce the complexity of running are still using old systems and security tools. multiple systems for managing their investors IT is not their core competence and I don’t see and investments. how they can make their systems safer with a “We use Salesforce, a leading cloud provider, private cloud. Hedge funds have fewer resources as well as Box and Amazon. Everything is than the large banks so they are in an even hosted in the public cloud. We solve the basic worse situation.” issues for fund managers when it comes to One firm that has been running a private

AlphaQ October 2016 www.AlphaQ.world | 14 CLOUD TECHNOLOGY cloud offering for several years, and which “In fact, even if managers did is now embracing the potential of the public cloud, is New York-based Richard Fleischman build their own private cloud & Associates Inc. (‘RFA’). At the end of the environment, I would argue summer, the firm announced the launch of the that it would be less secure RFA Multi-Cloud platform. The new cloud solution builds upon than the public cloud.” the success of RFA’s private cloud – an Alok Misra, Navatar Group infrastructure-as-a-service (IaaS) offering – which sees RFA partnering with Amazon and Microsoft. The aim is to give RFA’s clients the level of security that the likes of Amazon the flexibility to use public cloud services in are able to offer,” comments Djukic. tandem with private cloud services with the Asher explains that when clients connect same guaranteed level of performance and to the Multi-Cloud, they do so using a point- security. to-point line that RFA owns and operates; one Up until now, the problem with public cannot access the Amazon infrastructure, for cloud adoption was the security aspect. But instance, other than through the RFA line. as technology improves so does the ability to Because of this, RFA can monitor and manage encrypt client data. traffic security. Commenting on the security aspect, Michael “We have a number of prevention systems Asher, CIO at RFA, comments: running, we have a 24/7 security operations “On our cloud we use multiple layers of centre, and this allows us to guarantee that encryption and operating systems running on network security to the public cloud environment Azure or AWS are even encrypted separately. is as robust as possible,” confirms Asher. Were something to happen and Amazon wanted Another aspect of security relates to data to access your information, it would not be storage on the public cloud. Microsoft, Google possible because we escrow the encryption and others have all been in situations where keys, which are then held either by RFA or they’ve had to disclose information without the client.” necessarily being able to notify the end users. One of the key features of the RFA private In this situation, Asher says that RFA cloud is that it does not build multi-tenanted encrypts all the information that is stored on environments. RFA creates virtual private the public cloud, in addition to the encryption environments where there is no commingling security provided by the vendor. of data meaning each client is treated as a “We felt that it was important to provide an single tenant. additional layer of security that guarantees for “For the public cloud we took the same our clients that any data stored on the public approach,” confirms Asher. “We felt that clients cloud is only able to be made accessible by would refuse to adopt the Multi-Cloud platform them specifically and no one else,” he says. unless we could demonstrate that the public A final security consideration, says Misra, cloud is secure, and how we secure it.” relates to how fund managers actually use the Hentsu’s approach to security on the public public cloud. If they continue to run complex cloud was to come up with a solution that systems within the cloud environment they will allows it to manage a client’s infrastructure remain inherently insecure, irrespective of how with an API, which is granularly permissioned secure the cloud actually is. To be truly secure, and anything that relates to the operating he says, people should reduce the number of system and above is managed by the end client. systems; which is where Navatar comes in. “This is fully encrypted and they hold the “One client I visited recently is using various encryption keys. There is a clear separation of cloud platforms and had created a large number roles, authentication and security which is not of point applications for a lot of different possible with any other type of set-up. functions. They have a huge number of systems “Microsoft and Amazon spend a significant and there is a manual hand-off between every amount to make sure their clients stay secure system. Every time you download information on their platforms. That’s why we don’t bother from one system and transfer it to another with the private cloud; we know we can’t get to system you’ve already compromised it. The

AlphaQ October 2016 www.AlphaQ.world | 15 CLOUD TECHNOLOGY client in question thought they had built a very “We have a number of secure private cloud, but the reality is they have not. Not because of the cloud, but more prevention systems running, because of the complicated environment they we have a 24/7 security have built and must maintain. operations centre, and this “At most, fund managers should have two systems and there should be no manual hand- allows us to guarantee that offs,” says Misra. network security to the RFA’s established clients are not jumping wholeheartedly into public cloud adoption. public cloud environment is Indeed, there are some applications such as as robust as possible.” data warehousing that are yet to be optimised Michael Asher, Richard Fleischman Associates for the public cloud. But what the RFA Multi-Cloud platform now offers is the ability for RFA to extend its IaaS (it has eight data centres across the “At the same time, what was missing with globe) by leveraging Amazon Web Services and the public cloud was a security tier that Microsoft Azure, in so doing allowing financial ensures the cloud solutions being considered institutions to reduce IT costs and build a more were compliant with SEC regulation, UK and elastic IT infrastructure that optimises their European regulation and so on,” explains Asher. business model. The ability to scale cloud services in line As Yohan Kim, Chief Operating Officer at with one’s business needs is an attractive RFA, said when the firm unveiled the Multi- proposition for any financial institution. If a Cloud platform on 31 August 2016: “The release fund manager has operations in Europe and of the Multi-Cloud platform will provide clients Asia where RFA might not have data centres, at all stages – from start-ups to established, RFA will now be able to extend the cloud global firms – with the best of both worlds platform by launching a secure data centre on, when it comes to the cloud: lowered costs and say, AWS and connect it with the same level of increased flexibility, while still providing the security provided in the RFA private cloud. highest level of security and control.” Such is the pace of technology change that Both large fund managers and start-ups public cloud adoption has the potential to are embracing the potential of the cloud and change the hedge fund operating model going understand the benefit to having access to forward. Djukic is slightly more diplomatic. As data and applications in an instant, whilst on he says: “I don’t think we are changing it but we the move. Asher says that the Multi-Cloud are definitely responding to the market drivers; gives larger institutions “a clear transition into overheads and costs. The reality is, managers the future”. are finding it increasingly difficult to cover “At some point, public cloud adoption will them as their management fees come under reach critical mass in the alternative asset continued pressure. They need to come up with management space and we see that as the new ways to operate their businesses at a lower future. As such, the RFA Multi-Cloud offers a price point and if they need to tap in to a new clear path to get there, in terms of not only market in a month’s time, or even a year’s time, technology but also budget,” says Asher. they want the flexibility to pivot as and when For smaller fund managers, they are trying necessary.” to run leaner and meaner businesses, building Asked what the next cloud platform trend a performance track record using the least could be, Misra offers the following concluding amount of technology expenditure. Asher says remark: “I think in the next couple of years one that the public cloud component works well “as trend I expect to see is more vendors offering we are able to leverage the cost advantages of cloud services that are service-focused, like large-scale resource pooling offered by vendors Navatar group. Vendors offering cloud solutions like Amazon and Microsoft; the model enables are still tech-oriented today and less focused on substantial storage capacity expansion for a how to make the life easier and secure for fund fee that no medium sized service provider can managers so they can focus more on growing compete with. their businesses.” n

AlphaQ October 2016 www.AlphaQ.world | 16 PRIVATE EQUITY

Tech-focused PE investment James Williams examines the trend for PE firms to invest in data, telecoms and tech-enabled businesses.

rivate equity groups are increasingly ago, Bain Capital nearly doubled its investment gravitating towards buy-out when selling it to Symantec Corp for USD4.65 Popportunities in the technology and data billion in June. communications space as they seek to leverage That ability to identify strong performers not only attractive cash flows (given that many in the highly crowded technology sector and technology groups run subscription models) and capitalise on rising valuations is part of the growth opportunities, but also the potential to reason why there is so much attention. The lack quickly sell their acquisitions. of IPO activity in 2016 (just USD14.4 billion in Take Bain Capital LLC by way of example. Canada and the US) is adding further velocity As reported by the Wall Street Journal on 30 to rising valuations for PE-backed company June 2016, having only acquired Blue Coat listings. As Gillian Tan wrote in a Bloomberg Systems Inc – a leading provider of advanced article on 30 September 2016 (Private Equity web security solutions – just over 12 months Firms Nail IPO Timing), new issues of private

AlphaQ October 2016 www.AlphaQ.world | 17 PRIVATE EQUITY

equity-backed companies have gained effectively be sold many times over, and “This is almost 10 times as much 34.5 per cent on average this year, at regular intervals, for no extra cost. capital as was deployed into the next compared to 28.2 per cent for all US These dynamics mean that investors see largest tech sector. and Canadian IPOs. a lot of value in these kinds of portfolio “This is partly because of the size In 2012, 22 per cent of private companies,” explains Elvin. of the market – there are thousands equity acquisitions involved technology The ability to grow revenues by of internet- or software-based companies according to Preqin data. extending software licenses into new companies operating – and as the Year-to-date that percentage has risen to markets makes technology companies internet becomes more common in 39 per cent of all buyout deals, having attractive, scalable businesses and the developing world, the potential already surpassed last year’s figure of 33 this is prompting new tech-focused market for these companies only per cent. Technology investments make growth funds to come to market with grows,” comments Elvin. He adds that up more than half the aggregate deal significant LP support. another factor for the volume of capital value this year (54 per cent) compared Chicago-based Thoma Bravo allocated is down to the size of some to 29 per cent in 2012. is the latest example, having just of the privately owned companies Network software and security raised USD7.6 billion for a new fund. currently operating in that space. company Infoblox Inc is just one of the The manager has made a range of “Some of the largest tech-related latest examples, having agreed to be acquisitions in recent times including private equity-backed deals of recent acquired by Vista Equity Partners for Qlik Technologies Inc, and Riverbed years have been public-to-private approximately USD1.6 billion. Technology, whose website refers to buyouts: that is, the firms being Christopher Elvin is Head of Private itself as being at the ‘centre of hybrid acquired have been large enough to Equity Product at Preqin and isn’t networking’. Indeed, on 28 September function as public companies in their surprised by the level of US buyout 2016, the firm announced that it had own right. The most high profile of activity in tech this year. Technology completed its acquisition of TRADER these is the recent Dell/EMC deal, companies have been a mainstay of Corporation, Canada’s leading digital which alone represents around USD67 the venture capital industry for some automotive marketplace and software billion of the total value of deals done time, and many of the technology solutions provider. in 2015.” companies being acquired (by private Affiliates of Siris Capital Group, The first announcement that Dell equity groups) have been high-profile LLC, a PE manager with a particular was planning to acquire EMC came in companies for some time. focus on investments in data, October 2015 and was finalised last “What has been changing over telecommunications and technology month. Dell EMC has since announced recent years is that companies such enabled business service companies, that Yair Snir, formerly the director as these have become targets for acquired Xura, Inc on 19 August 2016 of M&A and business development at larger acquisitions, moving from the in a transaction reflecting an equity Microsoft in Europe and Israel, will purview of venture capitalists to that of value of approximately USD643 million. head up Dell Technologies Capital, the private equity buyout fund managers, Describing the acquisition of Xura, group’s venture capital arm. corporate investors, and public markets. Hubert de Pesquidoux, Siris Capital One firm that has intentions of This is partly due to the increasingly executive partner and Xura’s new expanding their investments into central role that technology plays in executive chairman, said: “With its the technology and communications the lives of many: a very broad term, broad product portfolio and industry- sector is Dallas-based Highlander ‘technology’ used to be thought of renowned technology, which has Partners LP, which manages more than primarily as internet-based companies underpinned mobile messaging for USD1.2 billion of private capital. The and electronic gadgets, but now includes many years, Xura is well-positioned firm focuses on making direct private sectors as distinct as medical devices, to continue to bring value to the 300+ equity investments in middle market defence technologies and agricultural customers it supports and the broader companies and to support its foray into improvements. digital ecosystem.” the tech space it has just appointed “Beyond that, though, the Although the technology umbrella Rashid Skaf. revenue model of some sectors is now very diverse, it is still software “We continue to strengthen our team makes technology-related companies and internet companies that attract to enhance our sourcing capabilities, increasingly attractive to potential the largest number of deals and the execute transactions, and grow our acquirers. For instance, in the software highest aggregate deal value, according portfolio. Highlander remains one of the and cloud-based computing industry, to Elvin. He says that in 2015, this most active middle market firms in the there has been a general drive towards sector saw a record 579 deals involving country, and we intend to accelerate subscription-based models of leasing. private equity firms, for a total value of our growth over the next few years. This means that the same product can USD139 billion. The addition of Rashid will broaden our

AlphaQ October 2016 www.AlphaQ.world | 18 PRIVATE EQUITY

Top 10 largest technology-focused private equity-backed buyout deals announced in 2016

Portfolio Deal Deal Deal size Investors Bought from/ Location Primary company type date ($mn) exiting company industry ADT Security Merger 16-Feb-16 15,000 Apollo Global Management, US Electronics Services, Inc. Koch Equity Development LLC, Protection 1 / ASG Security MultiPlan, Inc. Buyout 05-May- 7,500 GIC, Hellman & Friedman, Ardian, Partners US Healthcare IT 16 Leonard Green & Partners Group, Starr Investment Holdings Playtika Ltd Buyout 31-Jul-16 4,400 CDH Investments, China Caesars Israel Gaming Oceanwide Holdings Group, Entertainment Giant Interactive Group, Corporation Hony Capital, YF Capital Rackspace Public To 26-Aug-16 4,300 Apollo Global Management, US IT Private Searchlight Capital Partners Emerson Buyout 02-Aug-16 4,000 Platinum Equity Emerson US IT Network Power Infrastructure Ultimate Fighting Buyout 11-Jul-16 4,000 KKR, MSD Capital, Silver US Media Championship Lake, William Morris Endeavor Entertainment, LLC Lexmark Public To 19-Apr-16 3,600 Apex Technology Co. Ltd., US Publishing International, Inc. Private Legend Capital, PAG Asia Capital Epicor Software Buyout 05-Jul-16 3,300 KKR Apax Partners US Software McAfee Buyout 07-Sep-16 3,100 TPG Intel Corporation US IT Security Qlik Public To 02-Jun-16 3,000 Thoma Bravo US Software Technologies Private Inc. Source: Preqin capability to develop new platforms in the B2B region were worth a combined USD23 billion,” collaborative technology and communications confirms Elvin. industry. Consistent with our core strategies, we Between them, North America and Europe desire control positions in established companies have recorded more than 1,000 deals YTD, within these sectors,” commented Highlander’s with the aggregate deal value in North America Managing Partner, Jeff L Hull. currently standing at USD90.5 billion. By Preqin’s Elvin says that, unsurprisingly, it contrast, Asia has recorded just 44 deals with looks as though North America is the largest an aggregate deal value of USD4.7 billion. market for private equity firms buying tech In terms of deal type, six out of the 10 largest companies. The region has seen sustained PE-backed deals involving technology firms so growth in the number of such deals over far this year have been buyouts, as shown in recent years, “and in 2015 it recorded a record the table above. Three have been three public- USD129 billion in aggregate deal value from to-private deals and one has been a merger: the sector. Similarly, Europe has also seen the this involved home security firm ADT Security number of such deals increase, and 2016 looks Services, Inc being merged with Protection 1 on track for the region to record the highest when global private equity firm Apollo Global number of private equity-backed deals in Management acquired it for nearly USD7 billion technology-focused companies. on 16 February 2016. “Asia, by contrast, has seen the number of As for primary industries, much of the deal private equity deals in tech companies fall over activity this year has centred on Information recent years, from 108 deals in 2012 to just Technology companies (483 deals YTD), 44 in 2016 so far. However, the value of these Healthcare (159 deals YTD) and Industrials deals has increased, and in 2015 deals in the (137 deals YTD). n

AlphaQ October 2016 www.AlphaQ.world | 19 CARRY TRADE Carry on investing Campbell & Company’s Susan Roberts argues the case for why carry trades should not be viewed merely as an FX play but can, when applied across multiple asset classes, produce enhanced risk-adjusted returns.

henever investors hear to generate returns purely from prices the term ‘carry trade’ they rising or falling. If the benefits exceed Wtend to immediately think the costs it is regarded as positive carry of FX carry, and the nasty left tail and vice-versa. In FX markets, this is unwinds that can sometimes arise. But achieved by exploiting the difference in conflating ‘carry’ solely with FX carry short-term lending rates between two and making certain assumptions about economies. the return distribution is a mistake. As As Roberts illustrates in her paper, Susan Roberts, Product Specialist at on 2 January, 2010, the three-month Campbell & Company, a US systematic, in Australia was 3.7 per quantitative investment firm, cent, while the three-month interest points out, there is “a fundamental rate in the US was 0.1 per cent. An misunderstanding” as to what carry investor who borrowed USD at 0.1 per strategies do. cent (cost) and invested the proceeds in “At Campbell, we have been trading AUD debt yielding 3.7 per cent (benefit) carry strategies in one form or another would have generated profits of 3.6 per for well over a decade,” says Roberts. cent (assuming the exchange rate was “Though many investors tend to “Though many investors unchanged during the investment). associate carry entirely with foreign The same concept applies to other exchange, it is a strategy that can be tend to associate asset classes: fixed income, equities, generalised across all asset classes carry entirely with and commodities. In equities, for (fixed income, equity, commodities). foreign exchange, it is example, provided the dividend yield is And furthermore, a multi-asset carry higher than the financing rate, it would portfolio can have a very different a strategy that can be signal an opportunity to go long; and if return distribution than a traditional generalised across all the opposite were true, it would signal FX-only approach. asset classes.” an opportunity to go short. “It is a return distribution that has “At Campbell, we have a standalone historically been complementary to Susan Roberts, carry programme that uses a trend following, and more broadly, to Campbell & Company directional implementation rather traditional asset allocations as well.” than a relative value implementation In a white paper written earlier demonstrate the advantages of multi- and therefore doesn’t require the same this year entitled An Introduction asset carry strategies. amount of leverage. It also trades five to Global Carry, Roberts set out to A carry trade will seek to derive major asset classes, including volatility, banish common misconceptions that, returns from the net benefit of rather than just FX. in addition to the FX characterisation, holding an asset in excess of the price “Actually, foreign exchange has not also include the idea that carry appreciation/depreciation associated with been one of the best-performing sectors strategies use significant leverage, and that asset over time. Carry strategies will for carry strategies in a number of that they tend to be relative value take long positions in markets with a years. We have found more compelling (that is, non-directional) in nature. positive net benefit and short positions opportunities in other asset classes, These are not absolutes, something in markets with a negative net benefit, such as fixed income and commodities. that Roberts was quick to address for instance, net cost. We let the systems determine where in the white paper written with the In this sense they are different the best risk/reward is at any given aim of helping educate investors and from directional strategies that seek time,” explains Roberts.

AlphaQ October 2016 www.AlphaQ.world | 20 CARRY TRADE

The way that one defines carry have the same risk factors as foreign are implementations of carry that can is that it is an asset’s expected total exchange carry; however, that is not mitigate spot risk, but in doing so, new return assuming its price is unchanged. the case, with the possible exception risks are introduced. As such there is an inherent of VIX carry. Fixed income, equity and “For example, a relative value risk to carry, as an asset’s price will commodity carry have not historically calendar spread approach (for a fluctuate over time, either enhancing demonstrated the same vulnerability to particular market, go long the contract or diminishing the total return. One risk aversion. in the term structure with the highest way to address risk is systematically. “That is one reason,” says Roberts, carry and short the contract with the With respect to FX, carry trades tend “using a multi-asset class approach, lowest carry) will neutralise exposure to work when risk aversion is low. in addition to being thoughtful about to parallel shifts in the term structure, As it rises, and market sentiment portfolio construction, can lead to a but increases exposure to the shape of starts to deteriorate, there is a higher return distribution that does not have the term structure. probability that the FX carry trade the same type of tail risk we see in FX.” “We weren’t able to find any index will unwind. Roberts demonstrates using a that was representative of what we do “One of the systematic things we do Hypothetical Global Carry Strategy in our Carry program and that’s why to address that left tail, for example, presented in the paper that in negative we built a Hypothetical Global Carry is to use a Risk Aversion Indicator (in periods for FX carry, the correlation Strategy,” she says. our flagship managed futures portfolio, to fixed income carry was -4 per cent, What Campbell found when they which also trades carry) to monitor while the correlation to commodity added a 20 per cent allocation of the market sentiment. It looks at things carry was even lower, at -15 per cent. Hypothetical Global Carry Strategy to such as realised and implied volatility, The highest correlation was observed the Barclay CTA Index (again, using spreads, and a number of other with equity carry, at +9 per cent. the same historical data set) was that indicators that help us analyse the Using historical data between annualised returns, when compared to trajectory of market sentiment. January 1992 and November 2015, the 100 per cent CTA Index, increased “When the Risk Aversion Indicator even though FX carry generated from 4.7 per cent to 5.8 per cent. At rises above a certain threshold, average losses of -4.7 per cent, the the same time, annualised volatility fell exposure to FX carry will be Hypothetical Global Carry Strategy from 7.3 per cent to 6.6 per cent. systematically reduced. We use our actually generated average positive “We weren’t too surprised by the own proprietary indicator rather returns of +3.7 per cent. result. Many in the trend following than a bank-produced indicator. This One of the main reasons for space use carry as a component in has historically proven effective and using a generic Hypothetical Global their flagship portfolio, largely due to allowed us to dynamically adjust FX Carry Strategy, says Roberts, was the complementary nature of carry carry exposure to avoid some nasty due to the fact that there were no and trend. unwinds that were on the horizon,” publicly available indices that were “However, I don’t think people truly comments Roberts. a close enough representation of the understand the extent to which carry The flip side to this is that multi-asset carry approach used by can provide diversification and some occasionally the indicator creates Campbell. investors who read the paper might false positives. One can think of it as “Many publicly available carry be surprised at the portfolio benefits functioning much like an insurance indices focus on foreign exchange. of using a multi-asset class approach. policy on top of a carry strategy; it Furthermore, because the We encourage people to look at will step out of a trade from time to implementation of carry can differ carry as part of a diversified portfolio time when risk aversion is getting so widely, we observed a very low rather than on a standalone basis,” uncomfortably high, but the market correlation between the multi-asset suggests Roberts. may not experience a major unwind. class indices we did identify, and our Similar risk-adjusted return benefits “In which case, we leave money on the own. Carry is often thought of purely were discovered when the Hypothetical table. But we are more than happy to as a highly levered, relative value Global Carry Strategy was added to a make that trade in order to mitigate trade and I think many of the publicly traditional 60/40 portfolio. tail risk,” adds Roberts. available indices are based on that sort “The key point is that when A second way to address carry of definition,” says Roberts. investors experience stress periods in risk is by market and asset class There is, she says, unfortunately their portfolio, we think the inclusion diversification. a misconception that there is some of a moderate allocation to multi-asset “There’s a natural tendency way to access carry while also carry has the potential to help smooth for investors to assume that carry neutralising price risk but there is no out the ride and reduce the level of strategies in other asset classes will such thing as a risk-free trade. There volatility,” concludes Roberts. n

AlphaQ October 2016 www.AlphaQ.world | 21 REAL ASSETS

Management, points out, the growth of the global listed real estate investment trust (REIT) market – a far more liquid and accessible marketplace – has attracted institutions and found its way into their portfolios; firstly into the ‘alternatives’ bucket, but more recently into the ‘real assets’ bucket. However, as Crowe is keen to emphasise in a recent white paper he authored entitled The Case for Income Producing Real Assets, by including global listed infrastructure as part of an holistic allocation to income producing real assets, investors can achieve more attractive risk-adjusted returns and income generation. “When you think about what has happened over the last 10 years, prior to the financial crash in ’08 most people used a 60:40 equity/ bond allocation as the foundation for their allocation approach. Following the crash, there was an understanding of the need to have better diversification in the portfolio and this led to a growth in allocation into alternative assets; hedge funds, commodities, real estate, private equity. “What we’ve noticed in our client base over the last three years is that there’s been a defined allocation to what is termed ‘real assets’. These are defined as any asset that derives its value from tangibility and Producing permanence. That definition, though, was, in our view, too broad and failed the primary objective of why investors were investing in real assets in the first place,” says Crowe. income That goal was to reduce volatility and increase income. The most important real assets that help achieve this are income from real producing real assets that have a cash flow attached to them. A real asset such as a lump of coal, has high volatility and low, or even negative, income, assets whereas infrastructure and real estate share the benefits of being economically necessary Scott Crowe, Chief Investment Strategist – both are an intrinsic part of how we live our at CentreSquare Investment Management lives – and derive their value from long-term outlines the case for income producing identifiable cash flows, Crowe says. “We’ve been talking about this idea real assets. (of income producing real assets) a lot with investors. The paper was based on a ver the past 20 years, the size of presentation we had been using with investors allocation and illiquidity associated six months prior to writing it. Our intention was Owith investing directly in to real estate to re-define the conversation around real assets. and infrastructure tended to put off institutional “Investors were basically throwing everything investors. But as Scott Crowe, Chief Investment into their real assets bucket that was tangible Strategist, CentreSquare Investment and permanent. As a result, they owned a lot of

AlphaQ October 2016 www.AlphaQ.world | 22 REAL ASSETS

commodities and commodity-related equities and if you look at the performance of these investments, it hasn’t delivered. We didn’t think they were actually geared to achieving what they were investing in real assets for, which was income and low volatility,” explains Crowe. Together, listed real estate and infrastructure represent a USD5.3 trillion market capitalisation. Rather than focus on REITs, investors that include listed infrastructure have the opportunity to enjoy not only a wider universe of investments, which improves diversification and lowers volatility, but also to improve the income generating potential of their real asset bucket. In a world where safe haven assets such as US 10-year Treasuries are yielding 1.73 per cent, pension plans are not able to meet their “What you have right now is an investor long-term liabilities, says Crowe. “What you have right now is an investor community that is community that is searching for a searching for a replacement to these safe haven replacement to these safe haven assets assets and it strikes us that infrastructure and real estate, within the real asset bucket, are and it strikes us that infrastructure and real able to meet a lot of those needs.” estate, within the real asset bucket, are able Listed infrastructure enjoys a substantial to meet a lot of those needs.” existing investable universe with significant growth potential as governments look to Scott Crowe, CentreSquare Investment Management privatise existing infrastructure assets, and as the private sector increasingly undertakes new 2012. But a 2014 estimate by Cohen and Steers infrastructure investment. suggests that new infrastructure investments in Crowe says that the pace of structural developed and emerging economies could total development reminds CentreSquare of the REIT an additional USD40 trillion by 2030 (FTSE market from 10 or 20 years ago. Insight Newsletter, April 2015). “The unlisted infrastructure market is “The returns that infrastructure companies very illiquid and is only suitable for the very enjoy are multiples of the 10-year bond yield. largest SWFs and pension funds, but that There is, in my view, a tremendous growth is now changing with the growth of listed story here. I suspect we will see huge amounts infrastructure as a distinct asset class. If you being invested in infrastructure over the next look at returns in listed infrastructure, they’ve few decades. Many of the companies that we been very attractive. The FTSE Developed Core invest in our listed infrastructure strategy are Infrastructure Index has returned 15.4 per going to be the conduits of this investment. cent YTD, for example. It provides income and “In the US, a lot of projects recently have low levels of volatility but also tremendously tended to be related to the energy complex low levels of down market capture; half that of but you haven’t really seen a large-scale global equities,” explains Crowe. privatisation move in the US. In Europe and While there are other asset classes such as Australia, the infrastructure markets are ahead timber and agriculture that could also form part of the curve with respect to privatisation. of an IPRA approach, the listed markets are not A lot of big energy assets in Europe sit within yet evolved enough for those other asset classes. the regulated utility space. These are starting Just to underscore how much potential to be sold, however, such as energy grids in there is for listed infrastructure, according to the Nordics owned by Vattenfall and Fortum, RARE Infrastructure Limited, 75 per cent of the although the former is still largely owned by the USD20 trillion in global infrastructure assets Swedish government at present. was still government-owned as at 31 October As more European regulated assets are

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privatised, going forward, the easier it will be, from a legal and regulatory perspective, to commit to greenfield projects that can be backed with private investment. In the aviation space, European airports such as Toulouse, Nice and Lyon have all been privatised (or are currently in the process), not to mention Budapest airport. “It’s more than just a government cashing in its assets. What you tend to find is that when these assets are privatised the consumer enjoys a better experience because they are run with a consumer focus. All you have to do is compare Heathrow Airport to LaGuardia Airport. It doesn’t take long ascertaining which one is government-owned,” remarks Crowe. One of the main attractions of holding listed real estate and infrastructure within an IPRA allocation, is the attractive income generating potential they offer compared to other assets. As CentreSquare shows in its white paper, as of 31 March 2016, 10-Year Treasuries yielded 1.8 per cent, US equities yielded 2.2 per cent, global equities yielded 2.7 per cent, whereas income producing real assets (so both REITS and listed infrastructure) yielded 3.5 per cent. “We are used to thinking of yields of 3.5 per cent from an income producing real asset bucket as too low but the fact is that is more than two times the yield you get from a bond allocation. You would need to hold 2.3 times more bonds in the portfolio to “What we recommend to clients is that as an produce the equivalent yield and that is the initial starting point, they take 25 per cent of conundrum facing institutional investors today,” their real estate allocation and assign it to listed suggests Crowe. infrastructure,” says Crowe. When included in a portfolio of traditional If one was to run current government assets, the IPRA component (for simplicity and corporate bond yields through a long- CentreSquare assumed a 50:50 split) led to term liability model, based on a classic 60:40 improved risk-adjusted returns over a 20-year portfolio, one would need to assume that period: a 7.18 per cent return and a current equities are going to deliver low teens returns, yield of 2.60 per cent compared to a standard which is very aggressive at this point in the 60:40 portfolio that generated a 5.66 return and economic cycle, says Crowe. a current yield of 2.34 per cent. “Are you therefore better off replacing some Crowe explains that one of the things that of that allocation with assets that offer higher REITs do when included in a portfolio is to yields but not necessarily higher risks? We provide a slightly better growth component. would argue ‘yes’. “If you think about real assets in terms of the “The bigger picture,” he says, “is that equity, bond continuum, infrastructure tends to inflation is low, growth is elusive and there’s not be a little more bond-like and real estate a little much on the horizon that is going to change more equity-like. When it comes to including the overall low-level interest rate environment. IPRA in the portfolio, it really depends on the If you look at IPRA, and the yields on offer, I investor’s risk appetite and whether they want think we will see more and more assets flow more of an equity or bond-like outcome from in to this market as investors look for a bond their allocation. alternative.” n

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Busting the risk parity misconception James Williams explores why risk parity should not be viewed as a hedge fund substitute.

espite becoming an important component of Peter Hecht is Managing Director at AQR. Previously, investors’ portfolios, there are still some common when he engaged with institutional investors as to why they Dmisconceptions as to how risk parity strategies should were looking at risk parity, the common response went along be viewed, and used. the lines of: “I’m exploring whether a risk parity strategy Risk parity is a strategy that aims to diversify risk across could be a substitute or complement to my overall hedge global, liquid asset classes in order to create a portfolio fund programme”. that is not reliant on any single asset class for long-term “They were generally viewing risk parity through the performance. Over the years, different flavours of risk parity lens of a hedge fund programme. However, risk parity’s have emerged. One of the reasons for its appeal is that characteristics are very different from those of hedge funds. classic mean-variance optimisation relies upon expected risk After all, hedge funds involve shorting, they are dynamic, and return estimations. they try to offer differentiated, idiosyncratic returns and lean Expected returns are practically impossible to estimate. heavily on proprietary expected return views.” However, volatilities are much easier to estimate. This has “On the flipside, when I think of plain vanilla risk led to investors turning to risk parity, which does not rely on parity (there are various flavours) I think of it as a long- expected return inputs. only, static risk allocation to various public market betas. “Investors have been grossly overweight equity risk, and To me, comparing strategic risk parity to hedge fund risk parity is a way for them to reduce concentration in strategies is like comparing apples to oranges. A strategic equity risk without reducing overall risk (otherwise they risk parity fund isn’t a true hedge fund substitute. Instead, won’t achieve their target returns). I think that has been one its role in a portfolio can be seen as separate and distinct,” of the primary motivations behind investors turning to risk explains Hecht. parity strategies,” says Michael Mendelson, Principal and As such, the first misconception is that risk parity is portfolio manager of AQR’s risk parity strategies. a hedge fund strategy and can be incorporated into one’s

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alternative allocation bucket. It is not. exactly know the Sharpe Ratio of which I believe risk parity is one Rather, it should be thought of as a each asset, they are more similar than such example, is all about forming a rival to other public market, long-only they are different so the allocations of portfolio based on a long-term horizon. strategic asset allocation approaches. risk should also be more similar than If I had to hold this portfolio for the “When we first started managing different,” explains Mendelson. next 100 years, what would be my risk parity strategies almost 11 years A third misconception is that risk optimal allocation? There are no ago,” says Mendelson, “at that time parity concepts such as risk balancing tactical views; that is the definition of a there was no natural home for it in an are something new. They are not, and strategic asset allocation. institutional portfolio, so it commonly are merely a version of modern portfolio “What concerned me is that people ended up going into the alternatives theory first expressed in the 1950s. would criticise an SAA based on some allocation. We never thought of it as a Classic mean-variance portfolio short-term tactical view. It makes it hedge fund strategy, we always thought theory involves firstly identifying the seem like a criticism of risk parity of it as a fund. There is no notion highest Sharpe Ratio portfolio using a when it’s really just saying that if you of hedging, although there is a modest form of risk balancing to achieve the have a strong tactical view and you use of leverage. It was only in later lowest possible volatility for a given think you are right, you should always years that investors started having a level of expected excess return; and deviate from your strategic view. That’s carve-out allocation to risk parity.” secondly, using leverage (or T-bills to not something that you need to link A second misconception is that deleverage) to hit a target return. to risk parity. That’s applicable to any risk parity can deliver an optimal The reason why, in recent times, SAA approach. portfolio with the highest Sharpe Ratio. traditional portfolio construction has “If you have a tactical view When Hecht refers to ‘optimal’, what involved a 60:40 weighting to stocks that deviates from the underlying he is referring to is a portfolio that and bonds, with up to 90 per cent assumptions of your strategic long-term maximises expected excess returns of the risk budget held in stocks, is view you should change your portfolio (over and above the risk-free rate) for a because institutional investors have weights in a way that reflects that particular level of volatility (risk). tried to implement modern portfolio short-term view,” explains Hecht. He explains that the only way theory with one huge constraint: Mendelson adds that today’s low for risk parity to deliver an optimal no leverage. yield environment is a manifestation portfolio is if each asset has an “If you actually apply modern of low risk free rates and that this identical Sharpe Ratio, and also that portfolio theory without that affects everything an investor holds, each asset has identical pairwise constraint, it looks very different from not just bonds: “You can think of your correlations. Most explanations of risk a 60:40 portfolio. You will end up with total return as the risk-free rate plus parity, however, ignore the importance something that more closely resembles an excess return. We have very little of the equal correlation assumption, or risk parity,” explains Hecht. reason to believe excess return for incorrectly state that correlations must A final misconception is that holding bonds is any more challenged be zero. strategic asset allocations like risk than it is for stocks or anything AQR’s approach to risk parity parity should be fair game for criticism else. The optics are more obvious in strategies has been to minimise the based on short-term tactical views. bonds but that low risk-free rate is just assumptions and take a view that As mentioned earlier, risk parity as embedded in stocks.” the Sharpe Ratios of different assets comes in different flavours. Most The point of risk parity is that it are broadly similar, and that the risk risk parity assets tend to be held in makes no attempt to try and predict weightings should also be roughly the the strategic version of risk parity, where markets are going to go and same. Mendelson says that while one estimates Hecht, which is static in its in that sense it remains an attractive can apply some finer points to make (balanced) risk allocation, versus the proposition to investors. Regardless the portfolio more optimal, it requires tactical version which overlays some of the global macro events that shape heavier risk weighting assumptions, ie. short-term and medium-term views. markets, the answer, says Mendelson, which assets have a higher Sharpe Ratio Strategic risk parity portfolios tend is to build a good portfolio and be and which have a lower Sharpe Ratio? to have large dollar allocations to diversified. “We wanted to regard stocks, low risk assets, such as fixed income. Hecht concludes: “It’s not about bonds, commodities, credit etc, on a Given the perniciously low interest being able to try and predict what the similar Sharpe Ratio basis, and equal rate environment, this property of Bank of Japan is going to do, or what weight them in the portfolio. We don’t typical risk parity portfolios has been the consequences of Brexit might know what the perfect portfolio is; if criticised by investors, but in Hecht’s be, it’s about being able to do things we did we would create it. We made view, this is misguided. better than what is already reflected in the assumption that while we cannot “A strategic asset allocation, of current market prices.” n

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After the nuns, the site had become a Cambridge college – indeed it often claimed to have the oldest buildings in A return to town; though Elrand wondered if many appreciated precisely how old some of the buildings really were. Elrand himself had also changed Middle Earth over the years, for now he was none other than Chief Academician to Randeep Grewal returns to Middle Earth, using a the Court of King Elros, Lord of All little magic to reveal Elven investment tricks, via Elvenkind. He had dedicated himself John Maynard Keynes. to the study of Man himself and hence regularly ascended from Middle hush descended on Cloister the glowing fire. Its warmth was only Earth to consult with the Professor, Court as the tall cloaked figure exceeded by that of the Professor’s and before him, with many of his Astepped out from behind the greeting. predecessors. Indeed there were gnarled, antediluvian oak door. The As he briefly glanced into the coals, many academic papers and books pale, narrow, ghostly face was barely Elrand cast his mind back to the in the human world where, if one visible and the penetrating eyes were first time he had left the comforting tilted the front page just so, then one completely hidden by the thick fur embrace of Middle Earth to enter might see Elrand’s name, written in hood. The figure strode determinedly the world of Man. On the site of the Tengwar, shimmer briefly in gold before across the ancient cobbles. He passed College had stood a nunnery. Being vanishing. through archways and along corridors young he had been fearful of contact The Professor had recently been with easy familiarity till he reached the with Man; thus he had observed from appointed Bursar of the College. slightly ajar study door of the Professor. a distance. He remembered the piety As they settled he began to explain The Professor had clearly been and tenderness of the nuns as they the predicament he faced. Over the expecting his visitor and had a warm cared for the sick and poor. And how years his predecessors had built up tankard of the finest mead ready next times had changed. He remembered an endowment fund. It had been to the worn leather armchair. The the last two nuns – one was said to be a invested with apparently the finest visitor took off his heavy cloak and woman of ill-repute and the other was advice available at the time. Sometimes eased himself into position in front of rumoured to be a man. they had used active managers and

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other times passive funds. Sometimes they smiled for he remembered Keynes well – and had external advisors who organised a beauty perhaps some magic had indeed passed between parade of fund managers and sometimes the them as they had debated long and hard. College had selected managers itself. Sometimes Elvenkind have an ability to become invisible the portfolios had been benchmarked and at should they choose to; Elrand had used this other times they had been unconstrained. ability over the years to study men and had Sometimes they had invested in ‘long particularly enjoyed watching investment duration assets’ and accepted illiquidity (for committees of family offices and endowments in instance in forests and venture capital) and action. Furthermore he had put his insights into other times they had sought entirely liquid practice advising how to invest the wealth of the investments. Sometimes they had sought Court of King Elros in the world of Men. Having growth stocks and at other times defensives; been forewarned on the topic of discussion, sometimes value and at other times quality. Elrand pulled out a scroll with his notes. A little Sometimes the investments were in emerging magic has allowed AlphaQ to bring the list and markets and at other times solely in developed supporting notes to its readership… markets. Sometimes the College would use a large investment firm and other times a Write down the objectives of the endowment small firm. Sometimes they would diversify An investment committee should write down its and other times they would run concentrated investment objectives and test every investment portfolios. Sometimes the College had used decision against that. And a well-organised discretionary managers and systematic and experienced secretary needs to administer managers, macro managers and fundamental and manage the paperwork and execute on investors. Sometimes the College invested in decisions. equities, and then in fixed income, and in forex, and sometimes in derivatives and sometimes in Avoid ‘sometimes’ portfolios (and also avoid credit. Sometimes it owned assets directly and ‘everything’ portfolios) sometimes it owned synthetics. Investment ideas come and go – do not keep on The Professor/Bursar felt exhausted just switching. And there is no obligation or need to describing the various permutations and be in every style, strategy, asset class or type of combinations of investments the college had investment (ie. avoid an ‘everything’ portfolio) invested in. Traditionally the Bursar chaired – indeed too many strategies increases the the College Investment Committee. Having probability that strategies will be correlated. recently taken over the role he had diligently Thus both excessive diversification and frequent read through the notes of previous committees switching have costs. over generations. Each time the committee set Equally one should be aware of ‘sometimes’ out with lofty ideals and high hopes. As time and ‘everything’ fund managers – consistency of progressed, the tone of the notes would become approach has much to commend it. despondent and disappointment would sink in. The port consumption of the committee would Keynes did not believe in an efficient market increase as the performance of the endowment Keynes himself was an active investor and portfolio deteriorated and eventually a new commented that markets are ‘governed by committee would take over and the cycle would doubt rather than conviction, by fear more than start again. forecast, by memories of last time and not by Desperate not to be remembered as foreknowledge of next time’. the Bursar who finally lost the remaining Even Nobel Prize winner Paul Samuelson endowment and having no delusions that he himself invested in both Commodities had any expertise in the field of investing, Corporation and Berkshire Hathaway. And he had desperately sought advice throughout Warren Buffett has spoken out against the the university. Whilst wandering through the Efficient Market Hypothesis in his presentation Department of Economics he had been struck of ‘The Superinvestors of Graham-and- by a portrait of John Maynard Keynes – and Doddsville’. how from an angle he looked of Elvenkind. It is interesting to observe that some fund This had started a chain of thought which had managers and investors’ mental makeup culminated in the present meeting. Elrand compels them to seek out and find market

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inefficiencies – but such managers are few and management company’s point of view this far between – seek out such fund managers. diversification of course helps them hedge their bets, but if they are not truly committed Keynes performed badly as a macro/top- to a strategy or fund manager, should you be? down manager but well as a value investor One might ask if a fund management house Keynes’ performance in the early part of his has significant skin in the game by investing investment career was based on top-down alongside their managers. investing – in which he did badly. However by 1932 he changed his approach to being Avoid overly large investment teams a fundamental value investor. His returns Many funds will market that they have vast subsequently considerably beat the market. resources. But Keynes managed an endowment Each investor’s expertise, skill and temperament by himself. (And indeed Buffett and Munger have a market niche where it works well – and manage a considerable portfolio between many niches where it works poorly. themselves). The effectiveness of decision- making is inversely proportional to the size of Skin in the game: does the fund manager the investment team. As the team gets bigger invest his or her money in the same way? each member will want their ideas expressed in The best investment managers are those who the portfolio as that is what they are judged on. invest their own money – ideally in the fund The number of positions will increase as will they manage or in a similar way. Keynes the portfolio turnover – but the performance personal investments mirrored those of the may then converge to that of the market. Kings’ College Endowment. (Chambers, Dimson and Foo note that 81 per cent by value of the Beware of paying for performance on funds Keynes managed in the Kings College winners but without an offset for losers Discretionary Portfolio reflected positions he Some portfolios suffer by paying for winning held in his own personal holdings). So seek strategies without any offset for losing out those funds where the manager is willing strategies. The benefits of netting performance to invest a substantive part of his own wealth across strategies can be dramatic. in the fund and to reinvest a significant part of any future bonus back into the fund. A Understand the investment manager’s performance fee is an incentive but not skin in environment the game per se – fund managers with both skin Keynes resigned the chairmanship of the in the game and with appropriate incentives National Mutual Insurance Company because are likely to be more focused on attractive risk he tired of cross-examination of his investment adjusted returns. decisions and from the ‘Independent Investment Trust’ where he found difficulties agreeing a What is the motivation of the fund house? strategy with the other founders. Ian Rushbrook (manager of the Personal Assets Keynes said: ‘it is better for reputation Trust) once said: “The talent in a unit trust to fail conventionally than to succeed group is not usually applied to running the funds; unconventionally’ and also that a long term it is applied to expanding the unit trust group. investor should be ‘eccentric, unconventional Where investment trusts are run by merchant and rash in the eyes of average opinion’. The banks, you will usually find that the best trainees larger an institution the greater the tendency to gravitate to and the less recruit staff who conform and push out those successful end up on the investment side”. who appear eccentric, unconventional or rash. It is remarkable that those fund managers Hence the larger the organisation the more or investors (eg. Buffet, Soros, Klarman, conventional the performance. Robertson etc) who have become famed for An endowment has the opportunity to their performance have run a limited number of outperform by finding the fund managers with funds but with large numbers within the fund. the eccentric and unconventional views – but In contrast most fund management companies it must ensure that they are in a wise fund run large numbers of funds but generally management house that provides infrastructure without outstanding performance (there are to support the fund manager, not suffocate him of course exceptions to the rule). From a fund with bureaucracy.

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Is the investment manager’s attitude that of Is investing a passion or a job? an employee or is he mentally free? Ask what a fund manager does outside of If a manager is in attitude and role, an work and also what he would do if he was employee, then he will be imprisoned into not working in fund management. Far better making decisions that please his management to invest with one who is passionate, than rather than himself. Similarly some fund one who merely sees fund management as an managers, even when running their own occupation. business, focus on what will please their investors or is conventional rather than what Ask how the fund manager makes money will profit their investors – mentally they are and compare with your observations still employees. If you do not understand what a fund manager does then you should not invest. And does the Neither clothes nor labels reveal what is fund manager himself really have insight into underneath how and when he makes money? The ‘legend of the last two nuns’ applies to many walks of life – one ‘value’ investor or If it is too good to believe, don’t believe it ‘fundamental’ investor is not necessarily the The greatest fear of most investors is being same as another. Even two fund managers sitting swindled. Yet this is often trumped by the fear side by side with the same ‘label’ can have of missing out on exceptional performance. vastly different portfolios. Understand what the Ensure that fear of permanent loss of capital fund manager means by ‘value’ or ‘quality’ or remains your number one fear. ‘fundamentals’. And build a portfolio of fund managers with different skills, experience and Passive investing does not mean not making expertise – not a portfolio of styles. investment decisions – the issue is only that the decisions are different Ask what the fund manager really does It is amazing how passive investing is seen as during the day a panacea by many investors. Yet often such Keynes said: “It might be supposed that portfolios are filled with multiple different competition between expert professionals, passive vehicles. possessing judgment and knowledge beyond A number of issues arise: that of the average private investor, would • Who makes the decision on which passive correct the vagaries of the ignorant individual… funds to purchase? And how is the decision It happens, however, that the energies and skill made? Based on geography? Sectors? of the professional investor and speculator are Factors? What edge or expertise does the mainly occupied otherwise.” decision maker have? Many fund managers’ ‘energies and skill’ • Frequent switching between passive funds are spent marketing, writing reports or in has a cost. seemingly endless meetings. Others tend to be • Humans directly or indirectly ordain what screen watchers – spending their whole day the composition of a passive basket is – even mesmerised by flashing prices or newsfeeds. if there are ‘rules’ or a ‘computer model’. And yet others appear to spend the day • Some passive funds are highly concentrated. digesting ever increasing volumes of emails and • Not all passive funds are alike (for instance phone calls. In a world of information overload does the fund have liquidity constraints, there is risk that some fund managers are some hold assets via synthetics, etc). becoming ‘well informed but ignorant’. • Some ETFs have hidden counterparty risk. • There is a liquidity mismatch between some Never confuse the cost of advice with the passives and the underlying assets. value of advice • The overlap between passive funds may Select a fund manager on his skill, expertise, be contributing to overvaluation of some experience and temperament. Ensure that he is underlying assets. paid sufficiently that he focuses his ‘skills and • The growth of passives is probably driving energies’ on the task at hand; not on finding increased correlations. a new client. And always remember that bad • Many passive funds do not vote at all, or advice costs far more than good advice. rarely vote against management at AGMs

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and so overall corporate governance may be an endowment, family office, pension fund or deteriorating. . • The scheduled planned rebalancing or roll of Based on my experience being on the other certain passives open them to be gamed by side of various ‘allocation’ meetings, I thought other market participants. the above list would be useful for AlphaQ • Some passives suffer significant and regular readers who manage endowments or family roll costs. These reflect the cost of carry of offices. I drew heavily on an excellent paper the underlying instrument. Without being by Chambers, Dimson and Foo (“Keynes the aware of this a naïve investor can become Investor: A Quantitative Analysis” unstuck. Journal of Financial and Quantitative Analysis

• Some investors who have neither the Randeep Grewal is Vol 50, No 4, 2015 pages 431-449). experience, the inclination or the balance a portfolio manager There are many things to recommend from sheet to trade futures or use leverage are for the Trium Multi- the paper but one point struck me above all Strategy Fund. This inadvertently doing so via passives eg. article is written in a others. Independently of Benjamin Graham inverse levered ETFs. personal capacity; the (who published Security Analysis in 1934), views and opinions are Keynes was discussing stock selection on the those of the author basis of discounts to ‘intrinsic value’ in 1934 Do not confuse documentation and and do not necessarily reputation with due diligence reflect those of Trium and probably as early as 1932. A number of foundations and others invested In the checklist, Keynes’ discussion on in Madoff simply on reputation. Due diligence ‘skills and energies’ of professional investors requires not only receiving documents but is mentioned. At one point in my career I was checking every statement and comment and receiving between two and three thousand also observing a fund manager at work. And the emails per day and a couple of hours of most powerful detector of fraud is often not a voicemails (often before I even got to the office checklist but rather your nose. in the morning). I found I was spending much of my day clearing my inbox and dealing with Temperament and attitude phone calls. Meet fund managers and judge whether their Eventually I ended up changing my email temperament and attitude suits and fits with address and phone number and removing all yours. Once you have selected a fund manager direct contact details from my business card. feel free to speak to him regularly, but not It is likely that even today there are fund excessively. Indeed many fund managers managers literally ‘drowning’ in incoming delight in speaking with investors. Consider an unrequested information and data – and their investment with a fund manager the beginning energies are being diverted to deleting messages of a relationship – not a transaction. And the and emails. single greatest question to ask when selecting a I was also struck by the comment by fund manager is: ‘Will I trust him in a crisis?’ Ian Rushbrook quoted above from the book ‘Money Makers: The Stock Market Secrets Summary of Britain’s Top Professional Investment Use databases to screen and short list managers; Managers’ by Jonathan Davis. Comparing due diligence to study and understand managers notes with colleagues and friends, it seemed and personal meetings to select managers. to be apparent that the best fund managers Databases, checklists and personal relationships are increasingly seeking smaller intimate are three legs of a stool – all three legs are organisations or starting their own fund to required. obtain autonomy. Perhaps the greatest example of frustration Famously Keynes ran the Kings College of a larger organisation comes from Tolkien endowment for a number of years making himself who, on reviewing galley-proofs of investment decisions himself. It is unlikely that the first volume of The Lord of the Rings, nowadays many bursars would endeavour to wrote to his son, Christopher, to say that ‘the invest by themselves, but would look to find impertinent compositors have taken it upon fund managers to invest with. So I wondered themselves to correct, as they suppose, my what advice Keynes would give to his successors spelling and grammar: altering throughout… or indeed anyone tasked with investing for elven- to elfin’. n

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