The Hedgeweek Interview - Colin McLean, SVM Asset Management: "Buyers of hedge funds need to re-examine what they look for from their underlying managers"

SVM Asset Management managing director Colin McLean says the SVM Highlander Fund he manages, which has returned an annualised 15.1 per cent since its launch in 1999, has avoided the problems of many long/short equity funds this year because it relies on long and short stock alpha rather a long bias or leverage to generate returns.

HW: What is the background to your company?

CM: I co-founded SVM Asset Management (then Scottish Value Management) with Donald Robertson and Margaret Lawson in 1990 with the intention of establishing a boutique that was very focused in its approach. We manage a range of specialist funds of funds, long and long/short funds specialising in UK and European equities.

As a business we currently manage approximately USD1.5bn in retail and institutional funds. We began managing long/short accounts in the mid-1990s with some success and decided to launch the SVM Highlander Fund, a variable bias long/short equity fund, in 1999. SVM Highlander has returned an annualised 15.1 per cent since launch up to June 30.

HW: Who are your service providers?

CM: We use Ernst & Young as the auditor for the SVM Highlander Fund and PNP Global Investment Servicing as administrator. UBS is the fund's main broker, and Dillon Eustace in Dublin is the fund's legal adviser.

HW: Have there been any recent changes to the management team of fund launches?

CM: I and the other two co-founders remain fully involved with the business and have been since 1990. We have continued to launch specialist fund of funds products primarily for the UK retail market, which have proved successful, and we recently launched SVM Global Opportunities, SVM Cautious Managed and SVM Balanced Managed.

HW: How and where do you distribute the fund? What is the profile of your current and targeted client base?

CM: SVM Highlander is primarily distributed in Europe. We have been particularly active in promoting the fund in Zurich, Geneva, Stockholm and of course London, and have developed an infrastructure to service a geographically diverse group of investors through regular web conference calls. We also visit these centres regularly to meet clients.

The fund's assets are currently a little under USD50m; the fund has had new subscriptions throughout the past 12 months from a combination of funds of funds and family offices, for which at the current level fund size was not an issue. The fund is well diversified, with no single investor representing too large a proportion of the fund.

HW: What is your investment process?

CM: We use our own proprietary fundamental stock research to generate long and short ideas for our portfolios, enabling us to avoid more crowded areas of the market. We aim to generate stock alpha long and short and use equity swaps (CFDs) as the instrument of choice. The fund employs less leverage than many funds with gross exposure of 160 per cent, and fully uses its net allowance of plus or minus 50 per cent. We have remained net short at close to limits for most of 2008 so far.

HW: How do you generate ideas for your fund?

CM: Ideas are generated internally, and I am supported by our investment team of six. Our long funds have an excellent record both in the UK and Europe, so Highlander will always have an overlap with what we are doing elsewhere in our portfolios. Shorts will often be opened after a long has been sold in our other long funds, or where the team has identified potential for negative earnings or balance sheet surprise. All decisions to go long or short for the SVM Highlander Fund are executed by myself.

HW: What is your approach to managing risk?

CM: We employ two risk managers internally who monitor a number of extensive proprietary spreadsheets. We monitor our portfolios in real time to ensure that we remain within gross, net and maximum position limits. We also monitor liquidity and sector positions. We believe value at risk is a less useful way of understanding risk, and we prefer to monitor the individual daily volatility of the portfolio, ensuring we understand how it behaves in totality.

HW: Has your performance been as per budget and expectations?

CM: Yes. We target 12 to 15 per cent per annum with a maximum monthly drawdown of 6 per cent. SVM Highlander Fund is currently performing at the top of that range with an annualised return of 15.1 per cent.

HW: What opportunities are you looking at right now?

CM: We are particularly negative on financials, consumer cyclicals, property and companies facing cost pressures from rising raw material costs. We continue to find opportunities in all of these areas to short. In addition in the current credit environment we believe many smaller companies will face challenges in refinancing and this has been an area of focus for us. Within resources, we continue to favour gold, utilities, and oil and gas.

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

CM: This year has proved a testing time for long/short equity funds and will require buyers of hedge funds to re-examine what they look for from their underlying managers. There are few IPOs to flatter results, and many now find that the long-biased model of less experienced hedge funds, leveraging market direction, can be volatile after a bull market has ended.

I believe that the fund of funds community will increasingly look to funds that have experience of risk management and of managing 'traditional hedge' portfolios, and that this type of fund structure will return to favour.

HW: How will these developments affect your own portfolio?

CM: Our fund has never relied on the long-biased model or leverage to generate returns, so we will not be changing any aspect of our style, which I think is increasingly attractive to investors.

I believe our record in short alpha is exceptional. I now have well over a decade of managing long/short funds. Investors do seem to be looking for managers with some 'grey hair' and who have invested through a down market and delivered.

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

CM: We focus on stock alpha long and short. I believe that our approach of shorting stocks not indices and our understanding of how to diversify risk both in the short book but also at portfolio level sets us apart.

Our stock selection approach focuses on sustainable measures of business performance. We focus more on balance sheet analysis and cash conversion, paying less regard to the simplistic ratios such as price/earnings and dividend yield. Superficial attractions based on these stock market measures have beguiled many investors into buying failed business models or risky balance sheets.

HW: Do you have any plans for other product launches in the near future?

CM: My efforts are very much focused on the SVM Highlander Fund and SVM Saltire Fund, our two long/short funds. We have no current plans for any other long/short products.



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