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Donald Pepper, Old Mutual

Old Mutual Global Investors launches Arbea hedge fund with USD50million of seed capital

Old Mutual Global Investors has launched an offshore Cayman hedge fund based on its 2009-launched UCITS-compliant Global Equity Absolute Return Fund. The fund is called the Old Mutual Arbea Fund and will be managed by the same team as the USD220million GEAR fund: Ian Heslop (Head Portfolio Manager), Amadeo Alentorn and Mike Servent.

The fund uses a systematic global market neutral strategy and since 2009 has generated annualised returns of 7.8 per cent with volatility of 5.4 per cent. It is already up an impressive 16.8 per cent YTD and aims to deliver genuinely uncorrelated returns.

Whereas the GEAR fund aims to return cash plus 5 to 6 per cent with a similar volatility target, the offshore Arbea Fund – which uses the same investment process - sets its sights higher.

Speaking at a press lunch in London on Tuesday 9 July, 2013, Donald Pepper, who joined Old Mutual as Managing Director of Alternatives last December, said: “We will keep this sensibly calibrated UCITS version for HNW investors, private banks and family offices. We have recalibrated the risk/return profile of the offshore Cayman fund to deliver higher expected returns that longer-term institutional investors are seeking. The aim is to target a higher volatility of 8 to 9 per cent for expected returns of cash plus 9 to 10 per cent.”

As well as wanting to deliver a higher risk/return profile for investors, another reason for launching an offshore version of the GEAR fund is that the alternative UCITS market only represents around 5 per cent of the alternatives marketplace. As Pepper added, the Arbea Fund will now “help us to target the other 95 per cent of the marketplace”.

This is the third hedge fund in the Old Mutual Global Advisors’ stable. The other two funds include: the UK Specialist Equity Fund, managed by Ashton Bradbury since inception in March 2003, and the Global Statistical Arbitrage Fund, managed by Paul Simpson and John Dow.

These hedge funds – and the GEAR fund - have delivered positive returns in 19 out of the 20 years or so they have been running. On aggregate, the three funds, along with the new Arbea Fund, run approximately USD700million of assets.

Since Pepper joined OMGI, the focus has been on recalibrating the funds to better reflect investor needs. As Pepper explained:

“When I joined there were things that needed fixing but the actual investment process for all three funds was excellent.

“Basically, volatility was too low, meaning the return target was too low as well. Also US investors, in particular, don’t like investing with managers who do not have enough ‘skin in the game’ so the decision was taken to use our own seed capital to demonstrate our commitment to the strategy.”

This has resulted in USD50million of seed capital from Old Mutual being used to launch the Arbea Fund, which Pepper said demonstrates the firm's commitment to its hedge fund business and, more specifically, “to the strategy of Ian's team”. A further USD15million of acceleration capital has been approved for the UK Specialist Equity Fund.

In addition, both hedge funds have been recalibrated. The Global Statistical Arbitrage Fund has increased its leverage from 300 per cent to 400 per cent (effective from 1 August, 2013), while gross exposure has been ramped up in the UK Specialist Equity Fund.

“Previously, it was using too small a gross capital base so we’ve raised that to 200 per cent. Already in the first half of 2013, the fund is up +6.2 per cent and we have increased our annualised target returns to 8 to 10 per cent, which we expect to attract investor interest,” confirmed Pepper.

The Arbea Fund is fully systematic, with Heslop and his team employing a rigorous bottom-up fundamental stock selection strategy. Said Heslop: “Alongside that fundamental stock selection is a recognition that everything you invest in is cyclical and it’s that cyclicality that you need to manage, for two reasons: to mitigate downside risk, and because the cyclicality of returns is driven by market timing, which leads to correlation.

Market neutrality alone is not sufficient to deliver uncorrelated returns. Any market neutral portfolio, if it wants to be successful, must deal with the correlation issue in the stock selection process; especially with intra-sector stock correlations and regional stock correlations remaining high.

Since the GEAR fund launched in 2009, the MSCI World Index has been down 18 of 46 months. The investment strategy, however, has been able to generate positive returns in 12 of those 18 down-market months, demonstrating its effectiveness.

The team does not try to forecast macro. Fundamentally, it looks at what type of stocks will outperform in any given market environment. “We want to buy stocks that are trading below their fundamental valuation and short stocks that are trading above their fundamental value,” added Heslop.

To deal with the correlation element and market cyclicality, the portfolio is diversified as much as possible into multiple stock selection categories. The investment process uses a number of inputs including dynamic valuation, sustainable growth, analyst sentiment, company management, to determine how and where to trade.

“We aggregate all of these things from the bottom up and also incorporate market dynamics (price characteristics), to isolate stocks that are trending and stocks that reversing. We use volatility to try and predict when trends might break, and short-term momentum signals to try and isolate whether or not we are still in a trending environment,” commented Heslop.

Currently, the portfolio has around 750 stocks. Returns are derived from all five stock selection criteria, as well as market sectors and geographies. “We build our market neutral positions across four global regions. We are not taking bets like long Japan short Europe; it’s all about finding mispriced stock selections within regions. Correlation to the market is just 0.07 so we’re really pleased about that.”

With Pepper at the helm, OMGI is looking forward to working with institutional investors and building its alternatives business.

“We aim to double our total hedge fund AuM to USD1billion during this year and to reach USD3-4billion within the next few years,” said Pepper.

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