The Hedgeweek Interview - Nick England, CIA: "We avoid investing in managers that trade illiquid assets or that rely heavily on subjective valuations"
Nick England, founding director of fund of hedge funds manager CIA, says the firm's Hurdle Funds has continued to deliver positive returns over the past year - unlike most funds of funds - in part because of the experience that enables the team to seek returns outside the equity sector when required.
HW: What is the background to your fund and company?
NE: CIA (Channel Islands Alternatives) specialises in the search and selection of high-quality hedge funds to create bespoke portfolios tailored to clients' performance expectations, and is aligned with its clients by investing alongside them. CIA advises on USD60m in hedge fund investments.
The Hurdle Fund was launched in July 2006, as a natural progression from successfully managing an advisory portfolio of hedge funds since 2004. The multistrategy Hurdle Fund, which has USD15m in assets under management, has a defensive investment approach and has succeeded in producing positive returns even during the very difficult year of 2008. Its annualised return since launch is 10.19 per cent.
I am the founding director of CIA, and spent much of my trading career at the Liffe exchange in London as one of the largest liquidity providers in the FTSE index options market over a 12-year period, developing proprietary option and risk models and building one of the largest trading teams in the index and short-term interest rate markets. I worked for various City institutions including Salomon Brothers, Morgan Grenfell and NatWest Investment Bank.
A member of the investment team, Steve Brawn has 20 years' experience in banking and finance and is principal of Locus Capital Consulting and also head of alternative investments at Voltrex, a City-based financial services boutique.
He was previously executive director of Sanwa International, where he was responsible for volatility trading, running the proprietary activities and hedging strategies for the structured product group until 2002. Between 1987 and 1994 he worked for the derivative divisions of Bank of Nova Scotia and Midland Montagu.
CIA director Gregg Le Tissier began his career at Sheppards & Chase in stockbroking in 1986. During the 1990s he focused on providing dealing and investment management for trustees and institutional clients. Since 2000 he has specialised in providing independent oversight, guidance and reviews of investment accounts for trustees and family offices.
HW: Who are your key service providers?
NE: Trident Fund Services (Guernsey) is the fund's administrator. The legal advisor is Collas Day, the auditors are Deloitte & Touche, and banking is provided by Butterfield Bank.
HW: What is your investment process?
NE: The objective of the Hurdle Fund is to preserve and enhance capital through a portfolio of diversified hedge funds. The fund is specifically designed for investors that have a time horizon of at least three years.
When we create portfolios we aim to exceed both equity and hedge fund indices, with low volatility and insignificant drawdowns over the longer term achieved by maintaining a relatively focused portfolio. Selection is therefore a key part of our investment process. Investment is only encouraged in managers where CIA has intimate knowledge and confidence both in the underlying business and investment styles.
HW: How has your fund of hedge funds performed?
NE: The sterling feeder for the Hurdle Fund posted a return of 10.3 per cent in 2006 and of 10.97 per cent in 2007, and it was up 3.22 per cent in 2008 up to the end of November. These returns were achieved with very low volatility of 3.20 per cent and a handsome Sharpe ratio of 2.4.
The sterling feeder fund has a highly consistent record of positive performance, with 85 per cent months of positive returns and a maximum drawdown of 2.45 per cent in July 2006. The Hurdle Fund itself is denominated in US dollars, and there is also a Euro feeder available.
HW: How many funds and strategies are in your portfolio?
NE: The Hurdle Fund intends to achieve its investment objective by actively managing a diversified range of single-strategy hedge funds, potentially covering most asset classes subject to the investment adviser's outlook for each, and cash or near-cash instruments.
Currently we invest in 14 funds. We do not operate an approved list as such. We actively search for managers that fit with our investment objectives. We typically have four or five managers that we may be actively considering at any one time.
The fund's current strategy allocation is equity long/short 21.6 per cent, freight 18.0 per cent, property 13.4 per cent, natural resources, macro and CTA 7.7 per cent, 7.6 per cent and 6.60 per cent respectively, and currency, volatility arbitrage and commodities around 13.1 per cent. At present the fund is fully invested with zero per cent exposure to cash.
HW: What makes a manager or strategy special enough for you to select them?
NE: When we interview managers we use all of our trading experience to identify proven abilities to predict and withstand hard market conditions and to operate successfully under stress, and to determine their skill in adapting to new realities and profiting from challenges.
The fund invests only in single-strategy managers that can trade their capital comfortably while managing growth in assets under management. No third-party databases are used to identify these managers, as the information is entirely proprietary and gathered from a network developed since 2002 and in some cases earlier.
Geographically, a large portion of the fund is currently invested in European-based managers, which enhances the due diligence process and enables a greater depth of qualitative research. Quantitative and qualitative due diligence is carried out by investment team members, all of whom have established and successful investment track records.
HW: What are your criteria for removing managers from the fund?
Each fund we select for the Hurdle Fund has a particular diversification objective and targeted return profile as a component of the fund. If a fund fails to perform to its target, it will be considered for removal. If there is a style shift or a change in key fund managers, we will also remove the fund where necessary.
We generally avoid investing in managers that trade illiquid assets and ones that rely heavily on subjective valuations. We only invest in managers whose strategies we fully understand.
HW: How many managers do you have on the substitutes bench?
NE: We actively screen several hundred managers a year and normally invest in only between five and eight new managers a year, so we always have some pretty reliable substitutes lined up if something doesn't work out with any of the current managers.
HW: What events do you expect to see in your sector in the year ahead?
NE: Even though 2009 promises to be a challenging year for the hedge fund industry overall, we expect considerable growth in assets as investors move their capital from failing funds into funds of funds that have been able to providing decent returns and, more importantly, add alpha, even in the face of the severe current severe market conditions.
Performance in 2008 is very relevant for survival in 2009. Those managers who have shown they can manage money well last year will become very attractive to the marketplace. A challenge for funds of funds will be to choose appropriate allocations in the new deleveraging environment.
HW: How will these developments affect your own portfolio?
NE: We believe we are well adjusted to withstand harsh market conditions and still generate positive returns. Overall smaller funds of funds, like ours, are more nimble at exploiting niche markets that can offer higher risk-adjusted returns. When many larger funds of funds deploy their capital, they can suffer from illiquid and gaping markets, whereas favourably-positioned, dynamic and nimble smaller fund of funds can achieve better risk-adjusted returns.
HW: What differentiates you from other managers in your sector?
NE: One of the key differentiators is our ability to seek returns outside the equity sector as and when required. For example, we invest in some niche strategies that require a specialist level of knowledge, which many typical fund of hedge funds managers who had previously worked in a long-only environment would not have.
As global markets spiralled downward over the past few months, managers that were overly reliant on equity and emerging markets strategies have had to look at other strategies to generate returns. The problem has been that many of them simply do not have the relevant skills to function efficiently in a fragile post-crisis market environment.
In addition, we do not use employ leverage and our exposure to cash is low to zero.
HW: What is your attitude toward risk in the current environment?
NE: This year proved very difficult for most hedge funds and funds of funds, and managing risk and exposure to it has been crucially important. Understanding the nature of potential risk is crucial as well as being heavily diversified in terms of sectors, strategies and asset classes. We rely on our extensive trading experience to minimise risk and generally try to maintain high levels of liquidity of our assets with low exposure to leverage.
Drawing on years of trading experience in derivatives has taught us to invest and redeem with a forward-looking perspective. Together with a focus on providing low volatility, this means we seek to minimise beta correlation with markets, both on the upside and the downside. In the current situation, an understanding of fat tail risk has proved very important as well.
HW: How would you assess investors' expectations, and how do you deal with them?
NE: One of the fundamental principles of conducting business for us is constantly to maintain clear communication with both existing and potential clients. We are always in touch with our investors, we talk to them as much as we can, explaining situations and getting feedback from them constantly.
One of our features that has proved attractive in the current environment is our hurdle fee structure. By applying a hurdle rate before we charge our management and performance fees, we attract investors who are seeking to benefit from the upside of better returns without having to pay over the odds for the first few percent.
HW: How do you distribute your products?
NE: We distribute our products through a number of channels. Our main clients at this stage are family offices and ultra-high net worth individuals. We are looking to increase distribution of our products through some bigger institutional investors, such as pension and insurance funds, as well as via private banks and more family offices.
HW: Are you planning any further launches in the near future?
NE: No, but we are currently working on plans to increase distribution of our funds, making them available to a wider investment community in various geographical areas.
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