The Hedgeweek Intervew: Coronation Fund Managers: "Doing fewer things better"

Charles Barnick, CEO, Anthony Gibson, Investment Manager & Ken Lewis, Senior Investment Manager, discuss Coronation's investment approach.

Charles Barnick, CEO, has eighteen years experience in the financial services industry.  He has been marketing hedge fund management solutions to institutional investors in continental Europe on behalf of Coronation since 2003, and in April 2005 he took over the CEO role of managing Coronation's fund of hedge funds business in London. Prior to his involvement in the hedge fund industry, Charles spent 5 years growing, developing and managing various financial markets IT solutions businesses and 7 years in Frankfurt as General Manager of Bloomberg LP. Charles' professional origins were in foreign exchange sales and trading.

Ken Lewis, Senior Investment Manager, has over 10 years experience in financial markets. Prior to joining Coronation, Ken was as director of Domain Capital where he was responsible for the management of hedge fund assets in the USA and South Africa. Previously, Ken was a founding director of Prodigy Asset Management where he was responsible for the development of a global fund of hedge fund operation. Here he also oversaw the overall investment philosophy and top down asset allocation process. Prior to that, Ken worked at Investec Asset Management where he was responsible for the management of institutional fixed interest portfolios and a bond hedge fund. In addition, Ken was responsible for the design and development of quantitative asset allocation models. Ken has had numerous research papers published and has been involved in part-time lecturing of Honours level Finance at the University of Cape Town for five years. Ken is a member of Coronation's Global Investment Committee.

Tony Gibson, Investment Manager, was responsible for setting up Coronation's hedge fund business in the mid-90's and introducing Coronation's pension fund clients to hedge funds at that time. Anthony focuses on equity long/short and overall strategy and has managed the Global Equity Fund since inception. Anthony has been in the fund management industry for over 20 years and is recognised as one of South Africa's most experienced fund managers. Previously, Anthony was one of the senior institutional fund managers at Syfrets, also managing the industry's top performing mutual growth fund for over seven years. Prior to this, Anthony was an institutional fund manager at UAL Merchant Bank, South Africa's then premier investment bank.

Barnick, Gibson and Lewis spoke to Hedgeweek at length about Coronation Fund's present and future strategies:

HW: What is the background to your business?

CB: Coronation Fund Managers is an independent institutional fund management business with funds under management in excess of USD 12 billion. The company was founded in 1993 and has become South Africa's largest listed fund manager. Tony Gibson, the manager of our Global Equity Alternative Fund, was one of the founders of the business and has 15 years experience managing large institutional portfolios in South Africa.
In 1996, Tony left South Africa to set up Coronation International. This business has grown into a USD 1.1 billion multi-manager business; managing fund of hedge funds and long only absolute return orientated fund of funds. The bulk of our assets are managed on behalf of large institutions, particularly pension funds. Most fund of hedge fund operations began life by investing money on behalf of high net worth individuals and are now gearing up for institutional investors. Coronation, however, began with a purely institutional client base and only later gained some private wealth mandates. This institutional heritage has had an effect on our process and approach to managing assets.

We subsequently launched the Coronation Relative Value Fund which is a low volatility fund of hedge funds and the Coronation Multi-Strategy Fund which is a 'best ideas' fund of hedge fund investing across all strategies and sectors. In addition, we have grown our long only multi-manager business. Here we are finding an increasing amount of opportunities with managers who are skilled investors and who we view as alpha seekers as opposed to being index huggers.

HW: Have there been any recent events such as launches or changes/additions to the management team?

CB: Recently, we have looked at our product offering and recognized that over the years, as with many multi-manager providers, we had introduced significant complexity into our business. For this reason, we have been looking at ways in which we can simplify our product range and operational support thereof. Our aim is to get to a point where we do 'fewer things better', allowing us to focus on the management of our core product offerings. We are already seeing significant  progress in this regard.

The management of the business has experienced some change over the last eighteen months and we have now consolidated the team with a strong focus on investment excellence and superior client service. Our investment team is broadly broken down into equity based strategies and non-equity strategies. The equity team, headed by Tony Gibson, has been working as a team for many years. The non-equity team is now run by Ken Lewis, who recently joined us from Domain Capital, a single hedge fund manager. Ken has over a decade of experience in applying quantitative techniques to financial markets and most asset classes.

In addition, we have created a Global Investment Committee, consisting of the two senior portfolio managers (Tony and Ken) as well as three senior investment professionals from our parent company in South Africa. As a large institutional manager and South Africa's largest manager of absolute return mandates, the business has significant depth and resource. We intend to make use of these resources to a greater degree in the management of our fund of hedge fund portfolios.

Many of these changes have taken place since I joined Coronation as CEO in April of this year, having previously worked with the company since 2003 as a consultant.

HW: What is your investment process?

CB: We believe that there are managers who are skilled investors and that this skill allows them to consistently outperform. On that basis, we look to build portfolios from the bottom up and pride ourselves on the depth and insight of our research. At portfolio construction level we overlay our bottom up manager work with our own specific top down view in order to construct the mandated portfolio. We tend to build focused portfolios with core holdings in managers with whom we have high conviction. We prefer to hold fewer managers whom we understand deeply, rather than holding a multitude, believing that we are diversified.

Within Global Equity Alternative we actively seek managers who can demonstrate stock-picking skill. Both of our senior portfolio managers have managed institutional portfolios and hedge funds themselves. This, we believe, gives us a significant edge in understanding not only the assets that we invest in but what drives the managers themselves. We are not trying to create a market neutral or 'alpha only' product and are happy for the managers to take some directional exposure to the market and to manage this exposure in line with their own view of where markets are going. This ability to manage the balance sheet effectively is something we look for.

We have a strict process that analysts must follow in order to take a prospective allocation from discovery and monitoring to final investment. Our due diligence team, who do in depth work at the organizational and structural level, retain an 'investment veto' before any investment allocation can take place. The process requires analysts to rank each manager and the investment team meets each morning to discuss markets, managers and the industry. As our understanding of a manager develops we generate a clearer picture of the possibility of investment. This understanding develops after a few meetings with the manager and at each stage the analyst is ranking different attributes of the prospect. Ultimately, we have built a full picture and the process is moved on to portfolio construction.

HW: How has your fund performed?

CB: The long standing Global Equity Alternative Fund is unique in the sense that it holds exposure to a basket of currencies as opposed to being fully hedged into a single currency. The fund is denominated in USD but, in fact, has diversified currency exposure. This makes it quite difficult to compare the long-term track record to other similar fund of hedge funds. However the track record has been good and our clients have received an average of 11.78 % with an annualised volatility of 11.77% since inception in July 1996 to the end of December 2005. More recently, since June 03, we have run a fully hedged EUR denominated fund (the more conventional approach to fund of hedge funds) and that portfolio is directly comparable to the Euro class of other fund of hedge funds. In that portfolio we have managed to achieve an annualized return of 9.39% with an associated volatility of 4.44% in Euro terms. Over the last 12 months the fund has managed a return of 11.40% in Euro terms.

HW: How many funds are in your portfolio?

KL: We like to build portfolios with fewer positions in underlying managers and to rather ensure that we have great understanding and high conviction in those chosen managers. The Global Equity Alternative Fund invests in only one hedge fund strategy, albeit the largest of the strategies, and we would typically hold fewer managers than we would in a multi-strategy portfolio. Currently, we have exposure to 15 managers (although this is held through 19 funds). Our target would be to retain that number in this fund, whereas in a multi-strategy type fund we would seek to hold between 20 and 25 managers. From our research, this puts us on the low end of holdings within the fund of fund spectrum, illustrating our belief in the construction of focused portfolios with high conviction positions.  

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

KL: There are so many aspects to look at when investing with a manager and the key is to understand which factors you prioritise and value most. Many fund of fund managers are quite mechanical in their approach and would have quantitative data as their key decision-making input. We differ in the sense that we see quantitative data as verification for other work that we do. For the Global Equity Alternative Fund we tend to like managers who are 'investors' as opposed to 'traders' and we like to assess their portfolios in order to fully understand their thinking and their performance drivers. Both of our senior portfolio managers have successfully managed significant amounts of money in direct security portfolios, as well as managing hedge funds. This, we believe, gives us an edge in understanding the portfolios into which we invest. There is also the softer side of allocating investor capital to other managers: at the end of the day, you are entering a business and fiduciary relationship with another business and you need to know as much as possible about the business and the people. Ultimately, you need to be able to trust them.

HW: What are your criteria for removing managers from the fund?

KL: This is always a very difficult one. We do believe that some managers can demonstrate skill on a consistent basis. However, even the best managers have periods where their ideas are under pressure. We do not set hard and fast quantitative triggers or stop-losses but rather try and fully understand underlying reasons for poor performance of any given manager. One of the clear warning signs is when we receive incomplete or reduced information from managers who have experienced a difficult period and this does not allow us to fully understand the reasons for the poor performance. Clearly, this makes us uncomfortable and we would review our holding.

We are also very cognisant of capacity for alpha. In the long/short equity space we do believe that there is a size where it becomes difficult to generate the expected returns. This size may be different for different managers with different approaches or operating in different markets. We typically like the underlying managers to have a similar approach to ourselves and to have focused portfolios with high conviction stock holdings. If a manager has got to a size where we believe it will be difficult to generate the expected return, we will review the holding. This is quite a difficult decision as these managers would not necessarily be losing money and would typically experience a drop in total volatility. We always have to be sure that we have the right combination of return generation potential and overall risk management.  

HW: How many managers do you have on the substitutes bench?

KL: We believe the decision should be about what an underlying manager can bring to a portfolio and that is something that is dynamic rather than static. In other words, if a specific manager in the portfolio is underperforming, our decision is not 'who is the next manager of the same label on our list?' but rather 'what are the current exposures in the portfolio, are we happy with those and if not, which manager on our monitor list will bring our portfolio in line with our expectations'. We have a broad monitor list of managers with different styles, strengths and corresponding drivers. Being mid-cap in size allows us to have an integrated discussion on portfolio construction, as opposed to having a room of analysts simply churning out fund ratings.

HW: What events do you expect to see in your sector in the year ahead?

TG: Importantly, as we move into 2006, we need to look at what are the present consensual views held by the investment community are.  Psychologically, the strongest belief at present is that the trends of 2005 will endure as we move forward.  When as powerful a force as the liquidity-driven trend into cyclicality of 2005 unfolds, it becomes more compelling for investors to extrapolate this into the future.  What are some of the potentially dangerous consensual views for 2006?  The five that spring to mind are the following:

  1. High single digit growth from China is a permanent feature.
  2. Japan is a 'no-brainer' investment for the next number of years.
  3. The oil price will stay high or higher as demand (from China) grows.
  4. Emerging markets and currencies, while having performed very well, are not expensive relative to their growth potential.
  5. US equities will perform poorly in 2006, largely due to potential earnings disappointments.

The key point to make is that we intuitively agree with these points of view from an analytical, medium-term perspective.  Our concern however, relates to the fact that most of these views are based on the premise of continued easy liquidity.  If we however assume a different scenario, things could turn out quite differently in the short-term. That scenario could turn out to be one whereby a global interest rate tightening cycle gathers momentum in 2006.  This would be due not just the effects of the current well communicated tightening from the US Fed, but also due to a growing demand for domestic funding in Japan and other Pacific-Rim countries.  This could easily tip the balance in favour of more competition for global funding, with the resultant pressures on both the US Dollar and emerging currencies.  Just as in 2005 we experienced a strong US Dollar and strong emerging currencies, 2006 could see the complete reversal of this.  

As ever, the overriding question mark for 2006 will again be the US economy.  Our view on the US economy is that the risk lies more with the potential fall of the US Dollar than with the share market. As was pointed out to us recently, consumer spending in the US is in fact a surprisingly non-cyclical phenomenon, having shown an actual decline from the previous year only once over the past 50 years. Therefore, despite the strong probability that US consumer spending will slow materially during 2006, the US consumer is in all likelihood going to continue spending. At the same time it is unlikely that the politicians in the US will endorse a level of interest rates, which push the US economy into a recession.  It therefore seems most likely that the USD will resume a further downswing some time in 2006, in response to growing debt and deficits.

HW: What differentiates you from other managers in your sector?

CB: We are not one of the largest fund of fund managers by a long way but we have one of the largest fund of funds investing exclusively in long short managers. The Global Equity Alternative Fund also has a long track record and was the first fund of hedge fund launched by Coronation nearly ten years ago. This pedigree in this narrowly defined space I think differentiates our offering.

In terms of managing the portfolio I think we differ in that we are quite comfortable to take a view with regard to positions in the portfolio. Our top down overlay may include a view on regions, sectors, styles or market cap and we are comfortable implementing those views. We see ourselves as portfolio constructors as well as manager selectors.

I have also mentioned our institutional roots, which differentiates us from the typical fund of fund group.

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

CB: It is quite difficult to generalize about the levels of risk being assumed, however we do sometimes see a manager structurally change their risk profile. Very often, this change in profile comes as a necessity due to inflows of assets making it harder to be as nimble and to implement strong views. As a fund of fund manager I think it is something that one has to be aware of and something one should manage.

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

CB: Whenever equity markets have a good run, the demands of our clients get slightly tougher. I think that equity market performance is a good inverse indicator for hedge fund demand and investor satisfaction. Having said that, I think we are lucky in that the bulk of our client base is institutional where I think there is a great understanding of what these hedge fund vehicles are supposed to do within their total portfolio. This has made our client base very stable over the years.

HW: Are you planning any further launches this year?

CB: As mentioned above, we are actually in the process of simplifying our product range and rationalising what we do in order to assure a focus on portfolio management. I think that many fund of fund businesses have introduced complexity into their businesses and their product ranges. We felt that it made sense for us to concentrate on what we do best and to simplify issues such as product management and distribution.

One of the areas of our business where we are experiencing demand for new product is in the long only absolute return orientated space. We have built a strong track record in this area and have recently won some large mandates. We are also finding more interesting opportunities for investment in this arena so we do expect that to continue into next year.

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