The Interview – Sheriden Hure, Fortitude Capital: “Low-volatility positive performance stems from our risk management focus”
Sheriden Hure, a senior portfolio manager at Sydney-based market neutral multistrategy manager Fortitude Capital, says the firm is currently seeing great opportunities in the pricing of low risk and arbitrage-like deals, particularly in the yield and M&A strategies, and that tough conditions in 2008 have seen a rationalisation of competition in this area.
GFM: What is the background to your company and funds?
SH: Fortitude Capital, a market neutral fund manager, was established in Sydney in July 2004 as a partnership headed by managing director John Corr. Fortitude has experienced strong growth via managed accounts and domestic and offshore public funds with total assets under management of AUD90m, and the firm now employs a team of eight full-time staff with aggregate market experience exceeding 100 years.
Fortitude’s investment style is based upon the requirement for investors to make money through all market conditions. Our objective is to provide “strength through the investment cycle”, and we feel that to date we have delivered on this.
Fortitude Capital has been recognised as an industry leader in the Australian alternative investment industry, with our domestic fund earning the Australian Hedge Fund Manager of the Year award in both 2008 and 2009, in addition to the Best Market Neutral Fund award for 2009.
GFM: Who are your key service providers?
SH: Fortitude Capital uses a number of key service providers to ensure segregation of duties and external verification of performance and procedures. UBS act as our prime broker and custodian, and Kingsway Taitz Fund Administration provides monthly administration services. Ernst & Young is the auditor for our public accounts. Legal services are provided by DLA Phillips Fox for the Fortitude Capital Absolute Return Trust and Walkers for the Fortitude Capital Extension (Caymans) fund.
GFM: Have there been any recent key events such as fund launches or changes to the management team?
SH: We recently launched the Fortitude Australian Equities Income Fund, a buy-write product for Australian wholesale investors looking for index-like returns with lower volatility. It is an index-based strategy with an alternative twist intended to utilise the derivative skill set of Fortitude in a different way to the existing fund.
We had a key management change earlier in the year with the resignation of Tim McGowen, a founding partner alongside John Corr who had maintained a chief executive role for the 18 months prior to his departure, largely involving business management and marketing-related activities.
In early 2009, John and Tim saw the business growing in different directions and it was an amicable decision for John to buy out Tim’s stake in the management company. The team learnt a lot from Tim and it was with the confidence that the right people were in place that his decision to step back was made.
GFM: How and where do you distribute the funds? What is the profile of your current and targeted client base?
SH: Fortitude Capital has both a domestic unit trust and an offshore fund available to public investors, offering Australian and US dollar returns respectively. A euro class is also available but does not currently have any assets under management. We also manage one large separate account for BT, and have had up to four in operation at the same time.
Fortitude Capital holds a license that governs investments by financial institutions and high net worth investors. As yet, we do not provide any retail offering, but because of the difficult markets in 2008 investors have shown added interest in our fund because of our positive performance. We have been receiving positive approaches from private investors and from platform providers. Currently our assets are 90 per cent institutional and 10 per cent private client investments.
GFM: What is your investment process?
SH: Fortitude’s investment process uses risk management techniques at every stage. The process begins with our universe, which is limited to exchange-traded Australian listed equities and equity derivatives. We use criteria such as research, events, company announcements, liquidity, options and implied volatilities, price movements and sector comparisons to help us identify the key element, the catalyst, that is, a relative mispricing.
We assess the risk return equation and define a timeline. If the risk assessment and modelling suggests an adequate return relative to other areas of risk within the portfolio we then enter the trade phase, which leverages cheap execution and good investment bank relationships. Once entering a trade we revert to risk management and continual monitoring of positions for any change in risk.
GFM: How do you generate ideas for your funds?
SH: The market is dynamic and constantly provides opportunities. We use a broad range of listed equity and equity derivatives to find the best risk return scenarios at any given point in a market cycle.
Fortitude uses a derivatives overlay, employing long volatility, to provide protection against large market moves, a constant structure within our portfolio. We then consider the market environments and specific opportunities creating layered, offsetting risks.
GFM: What is your approach to managing risk?
SH: Risk management is our number one focus. Before looking at the upside and return of any trade, we try to assess the downside if things go wrong. This involves timely assessment of trading stops across both price and time horizons. We also look at liquidity, shareholder registers and the history of the company or trade developments to help formulate appropriate risk parameters. We are absolute return-driven, seeking to outperform cash, hence we have to protect against losses.
Fortitude uses multi-level risk management systems, both internally and from external providers, to monitor the portfolio. Market neutrality is the big picture and within that it is important for us to structure offsetting risks.
To date we have a track record of strong risk management. Our annualised standard deviation for the Fortitude Capital Absolute Return Fund is 2.95 per cent and for the Extension (Caymans) Fund it is 2.68 per cent. Our Sortino ratios are 4.1 and 6.7 respectively since inception albeit from different launch dates). This shows not only our focus on risk but also that our process is repeatable.
GFM: How has your recent performance compared with your expectations and track record?
SH: We at Fortitude are proud of our performance to date because it has been consistent with our investors’ expectations. Our one-year returns net of all fees are 11.6 per cent in Australian dollars and 7.24 per cent in US dollars, the difference being predominantly the interest rate differential for currency hedging purposes. Since launch the respective funds have annualised returns net of fees of 11.39 per cent in Australian dollars and 6.8 per cent in US dollars.
Our performance targets are 5 to 10 per cent above cash rates and of course we would like to be at the higher end more often. Our major headwind, however, is risk, management of which is our major focus.
GFM: What opportunities are you looking at right now?
SH: We are seeing great opportunities in the pricing of low risk and arbitrage-like deals particularly in the yield and M&A strategies at present. After a tough year in 2008 there has been a rationalisation of competition in the space.
Despite historically high deal failure rates and large break-costs in 2008, Fortitude Capital managed to generate positive returns from the M&A strategy. Similarly, in an environment where corporate credit spreads were blowing out, we managed our yield exposure in a way that was able to provide positive performance and upside as market conditions settled.
GFM: What events do you expect to see in your sector in the year ahead?
SH: Within the M&A strategy, which I mainly focus on within our portfolio alongside John Corr, we have seen an increase in the number of deals in the second half of 2009 and there are reasons to believe this should continue in the year ahead.
Many companies have had either to raise capital or seek a tie-up with another industry player to shore up their balance sheet in uncertain economic times. Meanwhile, some good Australian companies have been targets for international acquirers as price-earnings premiums have contracted and they seek avenues for growth.
We would be delighted to see this play out. The M&A sector has been a solid performing strategy for our fund since launch. We are currently seeing better pricing of risk than in 2007 and if more deals do emerge, it will provide greater opportunities to focus on those that suit our process.
GFM: Are investors’ expectations shifting between capital preservation and growth? If so, how do you deal with this?
SH: We see investor trends shifting. A survey by Watson Wyatt indicates that equity target allocations among US pension funds have been falling. From 58 per cent in June 2008, their equity holdings fell to 51 per cent in August this year. The targeted equity allocation for 2010 is only 48 per cent, with the remaining portfolio in bonds and alternatives.
Anecdotal feedback from Australian investors and consultants reports a need to find alternatives that allow investors to make money in all market conditions, especially down markets. Our business statement encapsulates our emphasis on capital preservation and growth regardless of rising or falling markets.
GFM: What differentiates you from other managers in your sector?
SH: Low-volatility positive performance is a key differentiator and stems from our risk management focus. We assess the downside of our ideas before contemplating the available return. A lot of managers consider the return first and work back to look at the risks in a trade. We believe our process helps us make better portfolio decision since we are trying not let the market dictate what should be an acceptable return should be.
GFM: How have you found the environment for fundraising in 2009?
SH: Markets have risen sharply since the lows earlier this year. Government debt and low interest rates have created an environment of uncertainty in investors’ minds, which should make this a great time for better-performing managers to raise funds. The global financial crisis was a real test and should have provided a catalyst for investment managers and asset consultants to reassess their approach to risk and returns. It may result in a flow of funds into lower-risk asset classes and better-performing managers.
GFM: Are you planning any mergers or acquisitions?
SH: We are very much concentrating on business as usual. Currently we are in a business planning phase because of increased interest in our funds from new sectors. We are assessing a number of avenues for growing the business but they are preliminary investigations at the stage.
GFM: Do you have any plans for other product launches in the near future?
SH: Our market neutral multistrategy fund is our core offering and encompasses our broad philology of trying not to predict the market direction and providing protection plus consistent growth.
The various strategies within our existing fund are candidates to be stripped out to provide more tailored exposures to specific risk/return profiles. Another option is to expand the existing strategy into Asia at some point. Fortitude Capital is a flexible business. We have worked hard to build a reputation and it is important that we continue to capitalise on the brand by delivering what our investors tell us they want.
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