The Hedgeweek Interview: Building multi-manager hedge fund portfolios: Stenham Advisors Plc

HW: What is the background to the company?

SA: Stenham Advisors Plc is part of the Stenham Group, founded in 1901, an independent, privately-owned wealth management organisation, with offices in London, Switzerland, the Channel Islands, Luxembourg, Israel, South Africa and the Netherlands.  We offer a range of investment opportunities to private clients and institutions

In the asset management area, our strength lies in our 18 years’ experience of managing and advising multi-manager hedge fund portfolios. Over this time we have won or been short-listed for a number of prestigious industry Awards in Europe and the United States.

Our edge lies in manager selection; over many years we have developed robust quantitative and qualitative research techniques, the results of which are borne out in our track record. Our focus on research and investment process has helped us control portfolio risk and respond early to developments in the market place.

For instance, we have developed comprehensive investment guidelines, which have evolved into an invaluable tool in the asset allocation process. These guidelines ensure, for example, that our clients do not become exposed to risky, excessively leveraged strategies in a quest for high returns.

We identified early the rise of European long/short managers, giving us access to the top tier of managers and contributing to our out-performance in the mid 1990s.

We constantly monitor macro-economic trends and make opportune switches into and out of various strategies depending on our macro-economic view.

Our processes are also designed to help us identify increased manager risk at an early stage. In such cases, we will take steps early to replace managers who we believe present an increased risk relative to the expected return.

Stenham has a stable management team with a significant amount of their own personal investable funds managed by Stenham alongside those of our clients. We also enjoy the benefit of a loyal client base of many years’ standing – testament to the successful realisation of our investment objectives of capital preservation and consistent returns and reflected in the steady growth of funds under management.

HW: What are your products?

SA: We offer a range of funds, the Stenham Funds, and for larger clients we operate a managed account service called Pinnacle.

Stenham Universal & Stenham Universal II are both multi-manager globally-diversified balanced portfolios with an emphasis on minimising volatility and controlling downside risk.

Stenham Growth is a globally-diversified equity long/short portfolio aiming to outperform the equity markets with less volatility.

Stenham Trading & Stenham Quadrant are globally-diversified macro portfolios targeting equity type returns but independent of the equity markets.

Stenham Asia is a diversified portfolio of Asian managers aiming to capture the growth of the Asian economies with lower volatility.

Stenham Select is a focused special opportunities portfolio.

Stenham Emerging Stars is a nursery of potential future investments.

Stenham Gold is a globally-diversified gold portfolio investing in bullion, long only gold funds and long / short gold funds targeting a return in excess of the gold price with lower volatility.

HW: Have you had any recent launches?

SA: We have had three recent launches, as follows:

• Stenham Asia
• We see big opportunities in Asia and have been investing with Asian managers for some time in our Universal Funds and for our Pinnacle clients. Through this process and following several trips to Asia over the last twelve months, as part of an even more rigorous due diligence requirement, we have identified high quality managers. We put these together as a fund, Stenham Asia, in February 2005. It currently has USD50m invested with 8 managers.

• Stenham Select
• We launched Stenham Select March 2005 after we identified 5 quality managers, most of whom are now closed but with whom we were able to negotiate capacity because of our reputation and our relationship with these managers.

• Stenham Emerging Stars
• Stenham Emerging Stars was also launched March 2005.  It is funded by Stenham and makes small allocations to managers we wish to monitor more closely prior to transferring them to the main funds if they perform as expected.

HW: What is your investment process?

SA: We recognise that no single manager can excel in all investment arenas. Accordingly, our investment process is based on accessing the expertise of the best alternative investment managers globally. Client funds are allocated to a number of these carefully selected independent investment managers blended together as a portfolio to achieve consistent, superior returns with low volatility. Each manager represents ‘best of breed’ in a particular area.

We construct portfolios on a risk-adjusted basis focusing on extreme event risks and not only relying on standard deviation as a measurement of risk. Emphasis is placed on managing risk by diversifying geographically using non-correlated alternative strategies. We also consider the asset allocation within the hedge fund universe depending on the macroeconomic environment and outlook for different sectors.

A highly disciplined research and due diligence process, including in-house resources and external consultants, is used to select new managers and to monitor those already in the portfolios. Our independence allows us to include or replace managers in our portfolios based strictly on objective investment criteria.

HW: How frequently do you reallocate the portfolio?

SA: We carry out quarterly asset allocation reviews to identify early relatively inefficient market segments providing better opportunities to generate alpha. This is achieved by taking into consideration various macroeconomic factors such as cyclicality, liquidity and at a micro level each hedge fund strategy “risk premiums”.

Our cautious manager selection process has resulted in a low manager turnover of between 10 – 15% per annum. Most of these occur as a result of strategic re-positioning of the portfolios; for example we moved out of convertible bond arbitrage in 2002 and increased our exposure to distressed debt. Late in 2004 we reduced our distressed debt exposure in favour of multi-strategy event-driven strategies. We also repositioned the equity long/short section of the portfolios away from the active traders to deep-value managers who do well in difficult markets.

HW: What are your key reasons for hiring/firing managers?

SA: We identify any unexpected returns, either positive or negative, against trends in the financial markets and the macroeconomic outlook. This would lead us to undertake further investigation, often including site visits and independent reference checks. We also look at whether there have been any changes in key personnel, changes in strategy or failure to adhere to the stated strategy.

HW: How many managers do you have and how many are on the substitutes’ bench?

SA: Our multi-strategy portfolios consist of between 24 and 28 managers and we generally keep 8 to 10 managers on the substitutes’ bench.

The more focused funds have between 5 and 14 managers.  We are meeting dozens of managers throughout the year and we will be monitoring up to a further 10 for one of our more specialist funds.

HW: What trends do you foresee this year?

SA: We expect an increase in the volatility in global financial markets, specifically relative to credit issues. The risks in the financial system probably rest with the banking and insurance sectors because of the massive leverage that as been thrown at the markets. This could have a ripple effect through the hedge fund sector especially the more leveraged volatile strategies which this year we have already seen evidence of.

We have avoided these more highly-leveraged strategies in our capital preservation mandates and although these strategies, such as fixed income and convertible bond arbitrage, have added value on the upside we believe their potential drawdowns are too severe for our capital- preservation objective.

HW: Are you seeing evidence of style drift?

SA: We follow style drift very closely to see that managers keep focused on their core competencies. Where they do drift, we will generally redeem.

HW: Some of the funds have complained that managers are not taking enough risks on the current environment – what are your views on this and risk in general?

SA: We see this as an environment in which managers should not be taking risk, and feel it is a time to be conservative. Our experience has taught us that when selecting a manager it is far more important to focus on his risk controls and how much he could lose rather than on what returns he has achieved historically.

HW: What makes a hedge fund manager special enough for you to select him?

SA: The selection process has evolved into being far more qualitative than quantitative.  Prior to selecting a manager we will consider various factors, including identifying whether there is a sustainable edge, which is a subjective decision, and we will also look at the overall organisational strength of the fund manager.

HW: Are investors’ expectations moving upwards and how do you deal with this?

SA: No, we do not feel that investors’ expectations are moving upwards. We are currently in a low interest rate environment and returns are to some extent a function of that.  We continuously try to ensure that our clients’ expectations are realistic in relation to the current interest rate environment.

HW: How do you distribute your product/s?

SA: We do not attempt to grow our asset base too quickly. Fortunately, we are not under pressure from a parent company, nor do we have a share price to maintain. Our overriding aim is to preserve our excellent track record and continue to protect our clients’ assets.

We try to ensure that our clients understand our investment philosophy and will be committed to us for the long term. We do not fly a high flag or advertise but rely more on client referrals and a small internal marketing team.

Harry Wulfsohn is responsible for identifying and working with our UK and European institutional clients.

HW: Are you planning any further launches this year?

SA: A “Select” mark 2 and possibly 3 are planned when we identify new high quality managers.

We are also considering a commodity fund and a fund investing in a basket of Asian currencies with a capital guarantee.