The Hedgeweek Interview: Tracy Pearson, Head of Alternative Investment. Forsyth Partners: Rigorous reviews ensure alpha generation
Tracy Pearson outlines the investment disciplines that drive the performance of Forsyth Partners' funds of hedge funds.
HW: What is the background to Forsyth Partners?
TP: Forsyth Partners Ltd ('Forsyth Partners') was the first company to be established within the Forsyth Partners Group (FPG) and was incorporated in March 1991.
The company is authorized and regulated by the Financial Services Authority ('FSA') in the United Kingdom.
Forsyth Partners specializes in 'fund of fund' portfolio management. In constructing investment portfolios it aims to identify the finest investment managers operating in the different capital markets around the world and blend combinations of these managers to match client requirements and investment objectives. A robust research process is critical to the business and Forsyth Partners uses both quantitative (statistical) and qualitative (judgmental) analysis to determine its manager selections.
Over the last 15 years, Forsyth Partners has provided research, consultancy and investment management services to over 600 organisations in over 55 countries. Its clients are all 'market counterparties' or 'intermediate customers'. It does not deal directly with private clients.
Forsyth Partner's range of international offshore hedge, equity and bond funds are all managed on a fund of funds basis. Gross assets under management across these vehicles now amounts to USD 1.2 billion.
HW: Who are your key service providers?
TP: Custodian: HSBC Institutional Trust Services (Ireland) Ltd acts as Custodian.The nominal custodian is HSBC Securities Services (Ireland) Ltd.
Leverage providers: KBC Financial Products, London; Societies Generale; Barclays Capital; JP Morgan.
Legal Advisors: Irish Law - William Fry; English Law - Eversheds; Cayman Islands Law - Maples and Calder Europe; Bermuda Law - Conyers Dill and
Pearman; Auditors: PriceWaterhouseCoopers.
HW: Have there been any recent events such as launches or changes/additions to the management team?
TP: The newest fund launch is the Forsyth Multi Strategy Fund, which was launched in March 2006. The Fund aims to achieve capital growth through investment in a tightly controlled portfolio of between 25 and 35 hedge funds which will use a range of different investment strategies including convertible arbitrage, multistrategy, merger arbitrage, global macro, fixed income, CTA, long/short equity, equity market neutral, distressed and high yield.
The Forsyth Multi Strategy Fund is managed on a fund of hedge funds basis. Forsyth Partners' team of research analysts is responsible for manager selection and monitoring.
HW: What is your investment process?
TP: Our drive at Forsyth Partners has always been towards finding the 'best' managers in their asset class, achieved through a combination of quantitative and qualitative disciplines. Our quantitative research team undertakes the initial screening across various hedge fund databases, to filter out the best funds in each strategy from a risk/return perspective. Funds passing this relative screening are then reviewed in isolation - considering all relevant hedge fund statistics and ratios. Funds passing both quant screens are then researched thoroughly by our qualitative team to ensure full understanding of the manager, team, process and risks.
If the team is satisfied with the due diligence completed, the fund will be rated and added to our 'Buy List' if deemed appropriate. On a monthly basis, our proprietary optimizer is run, considering all rated funds under numerous diversification constraints - effectively attributing desired portfolio weights to our 'Buy List'. The Investment Committee then analyses the optimizer results, constructing a portfolio that fits as closely with the optimizer as possible.
Forsyth Partners offers an exceptionally diversified approach to fund of fund management - running the portfolio like an equity book with approx 50 - 70 positions. In effect, our underlying managers are our stocks. The Funds are generally managed on a 'core and nursery' basis. Well known managers, with whom we have established strong relationships, are the 'core' with the remaining portfolio consisting of a larger number of smaller or newer managers - the 'nursery'.
HW: How have your fund of hedge funds performed?
TP: See the chart below:
HW: How many funds/strategies are in your portfolio?
TP: All Forsyth fund of hedge funds have approximately 9 or 10 strategies within the portfolio, depending on investment objectives.
(With the exceptions of Forsyth Global Commodity Fund with an asset allocation split into three areas, including Natural Resources, Energy and Gold and Forsyth Equi-Beta Fund with a geographical portfolio composition including UK, Japan, Global and Europe.)
HW: Are you linked to any hedge fund indices or have you launched products linked to hedge fund indices or do you have plans to do so? If so, please provide details.
TP: We use HFR listed funds, for increased transparency in Forsyth Partners' newest fund, the Forsyth Multi Strategy Fund. For fund selection when assessing funds we use HFR, Eurekahedge and TASS databases.
HW: What makes a manager/strategy special enough for you to select him?
TP: We look for a number of key factors:-
- Strength of investment process over time
- Continuity of personnel
- Consistency of stated investment objectives and style
- Strong and consistent past performance relative to style adjusted benchmark
- Favourable risk adjusted returns relative to style adjusted benchmark
We combine both quantitative and qualitative analysis to make a fund selection:
- Quantitative screening includes proprietary investment, style classification system, risk simulation and utility modeling.
- Qualitative analysis includes interviews with fund managers, analysis of team/company, ongoing monitoring.
HW: What are your criteria for removing managers from the fund/s?
TP: We will conduct a full review on a fund if and when:
- It has suffered three successive monthly draw downs. This event implies to us that the Manager's strategy is not absolute return.
- Its risk return profile has significantly shifted and no longer meets our investment criteria.
- Our qualitative research raises concerns which cannot be addressed - ie group/managers change.
Our optimizer suggests an allocation should be amended (this may involve a reduction rather than a total sale).
If this review leads to a sell, the fund itself falls out of our 'investable' universe unless there is a strategy or a Manager change in which case the fund is treated as a potential new investment.
HW: How many managers do you have on the substitutes bench?
TP: We estimate our research universe to be approximately 5000 funds: Our quantitative team currently screens 3 databases - TASS (3000 funds), HFR (4000 hedge funds) and Eurekahedge (1500 hedge funds). We estimate the overlap between databases to be circa 40% - leaving us with a universe around 5000. We also manually add funds that do not appear in databases to our screens to ensure coverage.
Following the quant screening process of these funds, around 2000 will be picked for qualitative analysis. Of this number half will be analysed further and given an internal rating, leaving approximately 350 'qualified' funds to be constantly reviewed for possible investment.
HW: What events do you expect to see in your sector in the year ahead?
TP: There are a number of events which we believe will continue to engage the industry over the next year.
The debate surrounding the imposition of more regulation, on both sides of the Atlantic, will continue. It's a healthy and important issue, particularly as the industry gets more exposure in the retail space.
Allied to regulation is the matter of transparency within both hedge fund and fund of hedge fund portfolios. Some investors are demanding a greater level of transparency than many managers are willing to allow.
The issue of side letters has also come in for a greater level of scrutiny and we expect this will continue.
Capacity, as always, is an important issue, with many commentators believing the hedge fund industry is faced with increasing capacity constraints, such as the level of trading opportunities in a particular strategy, the total number of players in a strategy, as well as concerns at a fund level, such as resource constraints.
This year already we have seen more niche strategies emerging and we expect this to continue. At present new strategies include carbon trading, weather derivatives and direct lending. Hedge managers are also setting up in previously unchartered regions, such as in India, in a bid to create new opportunities.
HW: How will these changes/future events impact on your own portfolios?
TP: We follow a distinct non-directional bottom up approach in the management of our fund of hedge funds (FoHF). This approach is driven by the philosophy that manager identification is the most crucial element in the process.
We do not aggressively asset allocate across strategies as we have no evidence that such a subjective and directional approach adds value on a consistent basis. Our research highlights the difficulty of imposing a directional approach; therefore a number of issues that are emerging in the sector will not directly affect our portfolios.
On the issue of side letters, we are not aware of any side letters that have actually been taken to court and thus proved legally effective. We view side letters as a gentleman's agreement and do not really think they add too much value these days.
In terms of capacity, for us the managers that are smart in controlling their assets under management tend to prefer sophisticated investors, in preference to those who fail to understand the investment strategy. As a fund of hedge fund manager we do not view capacity as a major issue in our portfolio given the extensive due diligence we undertake when selecting managers. Similarly our diversified approach to portfolio construction means we are not over exposed to single managers therefore capacity is very rarely an issue for us.
HW: What differentiates you from other managers in your sector?
TP: We believe our approach to fund of hedge funds investment gives us a distinct competitive advantage. Typically, most fund of funds manage their books through asset allocation whereas we used the bottom-up optimised portfolio process outlined above.
Fund diversification is also a unique factor - we try to run our portfolios like an equity book by maintaining around 50-70 positions and viewing our underlying managers as stocks. This process helps diversify against operational risk. We maintain a rigorous review programme to ensure our managers are maintaining alpha generation - undertaking a full quarterly healthcheck.
Our team of strategy and regional specialists ensure coverage and selection of the best managers.
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?
TP: A recent and material risk for hedge fund managers has been exposed during the recent market corrections when a number of managers, who had taken a directional long approach to the market, were caught out when markets went into freefall. In our view hedge managers should stick to their knitting and manage genuinely hedged strategies, not chase the market for easy beta.
For risk in general, we believe that there are four key areas relevant to our business in relation to risk management - those relating to our internal financial systems, the fair treatment of Forsyth's customers, the protection of consumers and the use of the financial system in connection with financial crime. Risk management from an investment stand point is covered partly in formal fund documentation (prospectuses establishing investment objectives, guidelines and restrictions).
Risk can be measured in many ways. In the case of our fund of hedge funds we pay great heed to our own fund volatility levels. Each of the fund of hedge funds products has a typical/target volatility level associated with it. Part of the investment process reflects the approach of combining funds with different risk return profiles in constructing a portfolio.
We believe that fund of hedge funds investment is similar to private equity such that the selection of sufficient investments to create diversity will mitigate the effect of the inevitable investment failures. This is not diversity for diversity's sake. In our optimizer, we consider correlations of our underlying managers with 12 factors to ascertain position risk of funds.
HW: Are investors' expectations moving upwards and how do you deal with this?
TP: Forsyth Partners prides itself on very strong customer relations by ensuring regular and timely reporting, personal contact and working with clients to help them achieve their investment objectives. It is important for us to ensure the investor's expectations of their investment are in accordance with our investment objectives.
We have found that institutional investors are looking for a higher level of transparency in fund of hedge funds.
HW: How do you distribute your products?
TP: Forsyth Partners is focused on institutional investors and the company maintains close relationships with a large number of institutions globally via regional sales offices.
HW: Are you planning any further launches this year?
TP: Following our increased presence in the Far East and regulatory status with the DFSA, the company has been looking into investment opportunities such as a GCC fund.
(Tracy Pearson was interviewed on 6 July 2006)
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