The Hedgeweek Interview: Shahid Ikram, Morley: "The sell-off in the US dollar is nearing completion"
Shahid Ikram, head of sovereign and G7 at Morley and manager on the G7 Fixed Income Fund, argues that there is a significant risk of equity and credit markets both underperforming this year as a result of the potential for further systemic risk over the coming months.
HW: What is the background to your single-strategy funds?
SI: Morley's single-strategy hedge funds, including the G7 Fixed Income Fund, are established as cells of Morley Alternative Investment Strategy Funds PCC, a Guernsey-domiciled protected cell company.
There are currently five cells: the USD56m SRI Long Short, a long/short equity fund managed by Derek Lygo; the USD857m G7 Fixed Income, a fixed-income arbitrage fund that I manage; the USD29m Central European Long Short fund managed by Rafal Janczyk; and the USD144m Convertible Bond Arbitrage fund managed by Dave Clott, Tom Wills and Shawn Mato. All four funds are listed on the ISE and on the Channel Islands Stock Exchange.
HW: Who are your service providers?
SI: Our auditor is KPMG (Channel Islands), legal advisors are Ozannes in Guernsey and Linklaters in England, our administrator is Mourant Guernsey, and the custodian is BNP Paribas Trust Company (Guernsey). The prime broker for the G7 Fixed Income fund is Barclays Capital Securities.
HW: How and where do you distribute the fund? What is the profile of your current and targeted client base?
SI: Morley's G7 Fixed Income fund, which is now closed to new business, has a broad client base including independent funds of hedge funds, wealth managers and institutions.
HW: What is the investment process of your fund?
SI: Morley's G7 Fixed Income fund normally runs five or six high conviction non-correlated themes. Each theme is likely to consist of three or four individual positions, meaning the fund will normally run around 20 trades concurrently. Position sizing is adjusted to ensure that the level of risk from each theme is largely equal, so the return of the book is well diversified and not dominated by any individual positions.
The fund will not normally have a material long or short bias, as the vast majority of the trades are relative value trades. If macro positioning is undertaken, it is conducted via options with a predetermined maximum downside.
Geographically, the G7 Fixed Income fund will normally allocate about 70 per cent of its risk to the UK and European markets. The remainder is allocated to other regions depending on profit opportunities.
HW: How do you generate ideas for your fund?
SI: Ideas for the fund are generated almost exclusively by our internal process. This is run on a weekly basis and revolves around a top-down quantitative scorecard. The scorecard incorporates a number of parsimonious models, back-tested for good IRs.
Alongside the scorecard, we do a large amount of bottom-up analysis of the various trade categories in which we are most active, such as UK curve trades, euro curve trades and cross-market trades.
All this quantitative output is discussed at length, along with various pieces of qualitative economic research, to establish the themes for the fund and potential trades that best fit the overall picture.
HW: What is your approach to managing risk?
SI: We apply a Value at Risk-based policy with a five-day 95 per cent VaR soft limit at 2 per cent and hard limit at 3 per cent. Breach of the soft limit would require rectification within five days while breach of the hard limit would require immediate rectification. Ninety-seven per cent of our positions are liquid, so that under normal market conditions they can be closed in a day without significantly affecting market prices. We also keep a sufficient level of net free cash flow.
The VaR policy is monitored by an independent risk manager for the fund, who is a member of our independent risk management team, reporting directly to the chief investment officer of Morley.
We also have a number of risk controls built into the daily management process of the fund. When building the portfolio, trade volatility, correlation, contribution to VaR, stop-loss and profit targets are all factors encompassed in the position-sizing decision. The fund has a stop-loss limit on any one position at 1 per cent of the fund value.
We generally run four to five high conviction themes that are by design lowly correlated, which helps keep the fund diversification high.
HW: Has your performance been as per budget and expectations?
SI: Since launch, performance has been distributed consistently across positions and from month to month. Consistency of monthly returns is of great importance, and our success in effective diversification can be best demonstrated by the fact that G7 has only experienced two negative months since its launch in February 2003. We don't expect performance or style to change significantly.
HW: What opportunities are you looking at right now?
SI: We rotate risk through the portfolio depending on the opportunities that exist at any one time. At present we believe in a long drawn-out global slowdown that should result in steeper yield curves and falling break-even inflation rates in most markets. We also believe that the sell-off in the US dollar is nearing completion and are buying into medium- to long-dated dollar upside exposure via options.
HW: What events do you expect to see in the year ahead?
SI: This year is shaping up to be an extremely interesting one as we have a large number of potential risk flares on the horizon. The equity and credit markets both have significant risk of underperforming this year, as we believe there is a reasonable probability of further systemic risk over the coming months. Ultimately we like the markets to move - as long as there is volatility in either direction, it offers us opportunities to enter positions.
HW: How will these developments impact on your portfolio?
SI: We rotate risk through different trade types depending on the opportunities available at any one time. In the past six months, we have taken more economic/fundamental trades than normal and expect this to continue in the medium term, given the macro-dominated market environment.
HW: What differentiates you from other managers in your sector?
SI: The instruments and trades we utilise are common to most fixed-income arbitrage hedge funds. However, the three factors that we believe primarily differentiate Morley's G7 Fixed Income fund from our competition are very low volatility, a primary focus on UK and European fixed-income instruments, and Morley's resource and market presence as one of UK's largest active fixed-income managers
HW: Do you have any plans for further product launches in the near future?
SI: We are always considering new ideas and product opportunities. We aim to capitalise on the skills of our most talented managers.
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