London’s ‘entrepreneurial village’ continues to produce high quality managers
By James Williams – Given London’s mantle as Europe’s leading hedge fund centre, it perhaps comes as a surprise that last year’s best performing UK hedge fund wasn’t based there at all, but rather a city more famous for its sleepy spires and cloistered colleges: Oxford.
According to Bloomberg Markets’ latest 100 Top-Performing Large Hedge Funds report, OxFORD Asset Management’s OxAM Quant Fund, managed by Andre Stern, Steve Mobbs and Steven Kurlander generated an impressive 16.4 per cent in 2011, placing them 12th in the list. Of course, the vast majority of UK hedge funds are based in the capital, but OxFORD Asset Management serves as a reminder that not all the best and brightest minds choose to locate their UK businesses there.
As for the London-based managers, Autonomy Capital UK and GSA Capital Partners were last year’s top performers according to Bloomberg, delivering 13.9 per cent and 13 per cent for their funds respectively.
Despite all the doom and gloom surrounding the Eurozone and the ever-challenging capital raising environment, 2011 was a good year for London hedge fund launches with one prime brokerage executive pointing out that somewhere in the region of “150 to 200 new funds” launched. Avantium Investment Management and Carrhae Capital were just two of a number of high profile launches, established by star traders Kay Haigh, the former head of global macro trading at Deutsche Bank and Ali Akay, a former trader at SAC Capital Management LLC respectively.
To underscore the wave of new hedge fund talent, a Financial Times article last November wrote that HSBC had employed its analysts to draw up a list of 10 to 15 of the most promising new managers. On that list were the likes of Denjoy Capital Partners, Apson Global, Avantium, Astellon Capital Partners and Benros Capital Partners: all are expected to do well in 2012.
Various factors take away some of London’s lustre – tax being the primary one – but there’s no obvious sign yet that the city is suffering from a ‘brain drain’. One hedge fund manager who established his firm last year and who wished to remain anonymous, says the reason for choosing London was simply the fact he and his team had always worked there. It was, he notes, a “linear transition”.
“London is an excellent location. From the point of view of service providers it gives you the widest choice of top quality firms. I think in all aspects of setting up a fund management business London remains the default choice in Europe,” he says.
Avantium’s team spun out of Deutsche Bank’s prop trading platform and whilst choosing London as its primary hub it also opened an operation in New York. There were obvious benefits to doing this, given that the fund is an Emerging Markets macro fund: principally that it gives Avantium better coverage of the Latin American economies.
“It’s not easy to move eight or nine people to a different location. A lot of IT integration firms, administrators etc are based in London and this makes it much easier to set up your infrastructure. The city also has a broad base of talent. Those who have moved their operations to Switzerland have found that it’s not as easy to find qualified people. It’s obviously feasible to relocate certain functions but to start a fund from any of these perceived alternative locations is very difficult,” comments Arnrd Sieling, CEO of Avantium Investment Management.
With everyone talking about increased regulation and focusing on what are legitimate, yet negative factors, it’s easy to overlook the positives of London’s hedge fund industry. Take the Hedge Fund Stability Board for example – chaired by Dame Amelia Fawcett, it’s doing a great job of promoting transparency and best practices among global hedge fund managers. Then there’s the Open Protocol Enabling Risk Aggregation (OPERA) initiative to provide a standardised ‘granular’ risk report template for hedge fund managers. Simon Ruddick of London-based Albourne Partners is co-chairman of the working group, which contains, among others, Lansdowne Partners Limited, one of London’s most successful hedge funds.
Such initiatives are forces for good and should be applauded. “I think London has done a huge amount. We’ve been a leader in establishing best practices, being transparent and all firms have always been subject to regulatory checks. The fact we straddle the Asia market close and the US market open also helps explain why we’ve been so dominant. It’s a perfect venue for global trading,” comments Melissa Hill, managing principal of Sabre Fund Management who rose to prominence as a CTA in 1982.
Being close to investors is essential for new fund managers, and indeed existing ones still in asset raising mode, and is still, by and large, the key reason why London continues to prosper. However, as Will Smith (pictured), Head of European Capital Introductions at Morgan Stanley observes: “There are still significant fixed costs in launching a hedge fund and it remains expensive to operate out of Mayfair, which adds pressure on managers to raise assets from day one. US investors have had a London presence for years but increasingly the most active investors in the start-up space are US FoFs with a European office.”
Not all managers have chosen to stay in London. Prana Capital, for example, relocated its entire investment management team to Singapore in March 2010, leaving only risk management and marketing conducted in London. According to a Prana Capital representative, the decision to relocate was to be closer to the Asian markets as opposed to having any issues with London per se.
No matter where managers are based, capital raising remains an uphill task. Scott Gibb, partner and portfolio manager at London-based Cube Capital, a FoF with approximately USD1.2billion in AUM, notes that asset raising in Europe last year was “very slow”. He says that while many mandates seemed to be on the horizon in 1H11, the majority were “put on ice as the political and economic issues in Europe and the US flared up. Nevertheless, for our Cube Global Multi Strategy (CGMS) fund, which is the only fund we’re actively marketing at present, we raised about USD40million.”
Gibb makes an interesting point with regards to the growth in popularity of UCITS hedge funds: “London is an attractive destination for managers to launch UCITS products. Growth has boomed since 2009, with assets climbing from approximately USD20billion to almost USD120billion.” This reflects the increased desire amongst hedge fund investors for regulated products.
Large, branded hedge funds continued to attract the lion’s share of new assets in 2011. However, a few of the high profile launches like Avantium also fared well. “Investors we’ve spoken to have been very focused on identifying both high quality institutional infrastructure as well as differentiated investment approaches. We’re close to USD430million in AUM in less than three calendar months of trading so that would suggest we are doing well on both criteria,” explains Sieling.
Smith thinks that the ability to successfully raise capital also comes down to supply and demand. He says that “one of the most popular trading strategies of 2011 was trading-oriented equity strategies that can remain nimble and take advantage of market movements – and there are few players running this kind of strategy in London.”
2012 could actually be a brighter year for asset raising according to the latest Money Trail survey by Barclays Capital.
The survey found that investors were likely to allocate approximately USD80billion of new capital to hedge funds with Ajay Nagpal, Head of Prime Services at Barclays Capital saying that “2012 has the potential to be the most significant year for new capital allocations to hedge funds since 2007”. Moreover, the survey suggested an addition USD300billion of existing hedge fund assets could be re-allocated across strategies.
If true, that would mean approximately 20 per cent of the industry’s total AUM could be ‘in play’ this year.
Hopefully, hedge fund performance will also be better this year: there wasn’t a great deal to write home about in 2011. “Although the performance of CGMS was impressive relative to its peers, it was disappointing on an absolute basis as we ended the year down about 1.8 per cent which is below our target returns of 10-15 per cent over a cycle,” comments Gibb, adding that fixed income arbitrage (mortgage-backed) was the most profitable strategy. The firm’s Cube Asia Multi Strategy did slightly better; up +0.75 per cent.
Another hedge fund manager states that whilst satisfied, his team wasn’t happy with the fund’s first six months’ performance. Admittedly, launching last summer was far from ideal but he remains sanguine: “We have a confident outlook. Sometimes a crisis is good as it allows you to stress test your systems. In that respect we’re very happy with the way we’ve performed the last six months.”
It was largely the credit and macro funds that did well last year, says Smith. As for where the smartest investors are looking, he notes that there’s definitely been a pre-positioning for the M&A cycle, and this bodes well for event-driven managers. “Investors were allocating before there had really been a huge pick-up, particularly in the large-cap M&A space – you could argue that’s where the smart money has been going because they’re looking to get ahead of the curve,” says Smith.
A key reason why London saw so many launches in 2011 was the increased seeding opportunities that were available.
Increasingly, new managers are coming from existing hedge funds. They have the experience, the credentials, and seed investors seem to be responding to that. Smith sees the growing number of seed investors as a potential game changer. “Rarely have we seen a period like 2011 where the quality of new managers was so high. There is now a lot of day one capital available, coming from both established seed investors and non-traditional sources, which makes this a very buoyant new launch environment.”
On the one hand this is good as it means managers are able to build significant assets quickly, and ultimately attract institutional tickets. On the other hand, with increased regulation raising the barriers to entry, it runs the risk of squeezing out small- to mid-sized managers.
“One of the things that London was so good at was developing this entrepreneurial village of hedge funds. You used to be able to run a hedge fund with USD100million. Now it really has to be USD500million. If that goes to USD1billion how do we get that next generation of hedge fund managers to start up? Investors are going to potentially lose the chance to invest with smaller, more nimble managers who may be able to exploit a niche and possible higher alpha opportunities,” says Hill, agreeing that the institutionalisation of the industry could lead to greater homogenisation.
Although the AIFM directive is unhelpful to managers, those that have been running funds out of London for a long period like Sabre are potentially better equipped to understand what will be required of them because in recent times they’ve launched onshore UCITS-compliant versions ((Sabre All Weather fund) of their Cayman strategies.
“I’m more worried by things like transaction tax – regulation where it’s not well thought out, will not bring in the revenue predicted and will ultimately hit the end investor. If the FTT were to happen, and it didn’t happen globally across borders, it would be disastrous. You’d experience what happened to Sweden and businesses would re-domicile to places that didn’t put it in place,” asserts Hill.
Right now, the UK’s own tax regime remains a significant disincentive to managers, particularly second generation fund managers who might decide to look further afield. It poses a real risk to London maintaining its competitive edge.
As Hill says: “I think the government needs to look long and hard at this 50 per cent tax rate because it’s pointless for the amount of revenue it generates. What we risk is losing the next generation who can choose to work anywhere and that would be a great shame. Employers need to offer higher salaries if they want talented people to work here. Combined with the expense of buying/renting, London’s a tough city.”
Sieling admits the current environment isn’t conducive to operating a fund in a cost-efficient manner but in his view it’s not all about tax: “In alternative jurisdictions you have to be sure the infrastructure can support your fund. Moving an entire operation is a real challenge not only on the operational side but also in terms of keeping the team intact. Somewhere like Singapore might be great on individual tax rates but at the end of the day investors are investing with a team of investment professionals and keeping consistency within the firm is the most important thing.”
Granted, London’s regulatory and tax regime may not be perfect, but that’s a price most managers seem prepared to pay. However, as one manager warns: “That’s not to say the government or FSA won’t make bad mistakes. As it stands now, there’s no problem, but it’s a case of ‘watch this space…’ You never know.”
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