Tim Gascoigne describes the combination of intensive research and market pragmatism driving HSBC Republic Investments' funds of hedge funds.
Tim Gascoigne is the head of portfolio management and a member of HSBC Republic Investments Limited's (HRIL) investment committee. HRIL's role is to identify investment strategies within which there is a rationale for expected satisfactory absolute returns over time, combined with tolerable levels of volatility. Tim is responsible for the management of the funds of hedge funds and discretionary mandates that are administered from the London office. Tim has nine years experience in the hedge funds industry and joined HRIL in 1996 after spending three years as an equity researcher and member of the strategy team with Mercury Asset Management. Tim is IIMR accredited and earned the Chartered Financial Analyst (CFA) designation in 1997. Tim has an honours degree in monetary economics from the London School of Economics.
HW: What is the background to your fund?
TG: HSBC European Absolute Limited ('HEAL') is a Guernsey registered, closed-ended investment company. Inception date was 20 April 2001, with Euro and Sterling share classes. Following a re-classification of the company on 30th June 2005, a currency hedge was introduced on the sterling share class. The principal Portfolio Manager is Tim Gascoigne, and the AUM as at 31 March 2006 was EUR60.9m versus EUR32.1m of assets as at 31st August 2005.
HW: Have there been any recent events such as launches or changes/additions to the management team?
TG: Paul Dunning retired from the business as CEO in June 2005 and was replaced by Barbara Rupf Bee. Prior to her appointment, Barbara was global head of sales and business development for HSBC's Alternative Investments Group. She has worked closely with the senior management team, which remains unchanged, since 2003.
Barbara joined HSBC Republic Investments Limited ('HRIL') from Union Bancaire Privée, Zurich, where she had been in charge of the products and sales department since November 2002. Before that, she had spent nine years with the Julius Baer Group. In 1999, Barbara was appointed CEO of creInvest AG, a fund of hedge funds initiated by Julius Baer and listed on the Swiss Exchange. Prior to 1993, Barbara worked for Nomura Securities and J.P. Morgan.
A new issue of HEAL shares took place in February 2006 and raised EUR 25.5m.
HW: What is your investment process?
TG: The graphic below summarises HRIL's investment process:
HRIL believes in peer group analysis in similar strategies. What HRIL does, therefore, is conduct specific strategy searches e.g. European equities or US convertible arbitrage. Members of the team conduct these searches periodically, even if HRIL has exposures to these strategies already, to ensure good opportunities are not missed. Typically, HRIL's analysts use the material supplied by managers to filter to a short list on performance statistics (risk-adjusted returns, regression analysis amongst others) but also assets under management and investment style factors.
The more qualitative issues are covered in an on-site due diligence meeting. On the basis of both of these, HRIL selects those considered to be the strongest all-round investments.
Each manager is rated by the research committee at the completion of the primary due diligence. This does not mean that any investment will be made at this stage. Research projects are suggested by and conducted under the supervision of Tim Gascoigne. Strategy searches, quantitative analysis and the conclusions of due diligence visits are the basis for the suggestion of a new investment.
Multi-manager portfolios are constructed first of all, with regard to the investment objectives of the portfolio, which are usually described in their simplest form by a range of Absolute Return Assumptions including target return and a range of expected volatilities. These lead to the construction of internal risk controls, for example liquidity, maximum % in any one manager, maximum % in any one strategy, leverage limits, etc. to reflect the investment objectives.
Then, in conjunction with the client/the mandate concerned, HRIL decides on a range of appropriate strategies to be included in the portfolio, which could be used to meet the targets. The strategies should both be appropriate in terms of the actual strategy employed (e.g. a technology long/ short equity fund is not appropriate for an arbitrage fund of funds) and in terms of return targets and risk tolerance. The performance characteristics and expectations of suitable holdings in combination should be in-line with these. HRIL does sometimes "bar-bell" one or more high return/high risk investments with other less risky investments to achieve the desired characteristics at the portfolio level.
Based on the long-term expected returns, volatility and correlations of the different strategies, on both historic performance and expectations going forward, HRIL comes up with a strategy allocation for the portfolio. This is overlaid with both market views where it is believed a particular strategy class is likely to outperform in the medium term, but also with pragmatism to ensure there is real style diversification within the portfolio, even though an optimisation on historic numbers may give a different result.
HW: How has your fund performed?
TG: (All numbers to 31st March 2006)
The year to date performance (Euro) is 6.9%, with 10.2% for 2005. The portfolio has realised an annualised return of 7.0% since inception, and historic volatility of 4.3%. Total return is 39.6% since inception. The Sharpe ratio, with a risk free rate of 2.9%, is 0.95.
HW: How many funds are in your portfolio?
TG: There were 23 funds in the portfolio as at 31 March 2006.
HW: What makes a manager special enough for you to select him?
TG: Not all the points below show minimum requirements, but they will show the core points on which HRIL focuses when choosing a manager.
- Good idea generation
- Excellent risk management process evidenced
- Entrepreneurial business skill present
- Stable company/personnel background, including low historical staff turnover.
- Suitable number of staff with strong backgrounds and experiences for the roles they fill
- Understand motivations of the partners, their personal aims and ambitions to ensure they are aligned with that of investors
- Strong staff compensation process - does this attract and retain the best staff and does it mean their interests are aligned with that of investors
- Clear corporate structure
- Like to see ownership of management company by staff and personal investment in own fund
- Joint venture, partner or seed money, under what terms are they involved and how does this affect their business and ability to manage money
- Are they regulated/registered with a recognised and respected regulatory body? Are they in good standing with their regulators and is there any history of relevant litigation
- Suitable insurance cover
Assets under Management
- Focus on assets under management, how they have developed and how the company is planning to manage growth in the future
- Dislike funds that are too big to be nimble in adjusting exposures.
- Dislike funds that are too small to implement strategy effectively. Critical levels vary from strategy to strategy
- Breakdown of clients is important: by number and by type of client gives a good indication of how stable the investor base is
- Clear investment objectives allow monitoring of how the fund is performing versus our expectations
- Look at long-term return expectations and any benchmarks applicable (not generally applicable for alternative investment strategies)
- Look at shorter-term volatility and drawdowns, which investors should tolerate, in the short term. Also understand when the strategy will do well and when badly
- Understand in detail the investment process and how it has evolved. This helps to know how it might fit into a portfolio of other managers
- Is the process disciplined and does it make sense?
- Suitable coverage, infrastructure, counterparties and trade allocations
- Sensible and thorough monitoring and limitations in terms of exposures at position level, portfolio level, leverage, counterparties, financing, prospectus constraints
- A rigorous process that can stand up in severe market conditions
- Understand limits in terms of exposures to currency, asset, duration, geography, concentration and liquidity. This helps ensure that the fund fits the desired profile.
- These need to be in line with HRIL's own portfolio investment objectives. Knowledge of this assists monitoring going forward.
Administration and Back-Office
- Suitable choice of administrator, prime broker/ custodian, auditor.
- Adequate personnel and systems to ensure correct and timely trade settlement and valuation.
- Like to see administrators that price the portfolio. Where the manager has to price certain positions, they should have a disciplined process independent from the portfolio manager.
- Suitable to manage and implement strategy and keep investors informed
Client Servicing/ Transparency
- Like principals to be available for frequent and regular telephone calls and due diligence visits frequent client reporting
- Do not always think that full transparency is appropriate especially with a large fund with large illiquid holdings.
- Positive references from investors and previous colleagues
- Occasional use of background checking if comfort needed (new and independent firms)
- Do the performance numbers reflect the manager's style?
- Do the performance numbers reflect the manager's investment objectives?
- How do they compare to others in the same field? Peer group analysis
- Return, volatility (upside or downside), drawdown, consistency
- Correlation to other assets
- Correlation to indices/markets
- Regression relative to other relevant data series
HW: What are your criteria for removing managers from the fund?
TG: The circumstances in which a manager may be redeemed include:
- Bad absolute performance
- Returns inexplicably exceed expectations from the asset class
- Returns diverge from peer group without reason
- The returns diverge from targets suggesting that they are investing in other products
- The asset class goes out of favour
- Personnel changes
- Assets under management fall or rise markedly
- New strategies inconsistent with expectations
- Administration related problems - NAVs calculated too slowly etc.
- Changes in prospectus.
HW: How many managers do you have on the substitutes bench?
TG: There are 3 specific substitute managers that we believe could easily be added to the portfolio, should for any reason we believe a manager or strategy allocation change be required. In addition to this, we monitor a large universe of hedge funds supported by some 34 analysts in 4 locations continuing to present new ideas.
HW: What events do you expect to see in your sector in the year ahead?
TG: The first quarter of 2006 was witness to favourable conditions and strong performance from hedge fund strategies within Europe. European stock markets performed well during the first quarter, as M&A rumours, generally strong earnings results and higher dividends / buybacks drove stock prices higher. There are early signs of self-sustaining domestic growth in Europe providing momentum to markets - this has been supported by relatively cheap valuations, bullish earnings announcements and M&A activity providing a floor to valuations, indeed European M&A activity hit a record high in the first quarter of 2006, surpassing previous highs of 2000. This environment benefited equity related strategies such as equity long short and event driven.
We believe that high level of corporate activity within Europe is likely to continue for the remainder of the year and hence remain optimistic for these equity related strategies. Equity market neutral strategies have found the going a little harder, given the level of corporate activity and the impact of macro economic upon the market; we expect these conditions to continue and are therefore cautious for the strategy over the coming months. Credit strategies benefited from the continued tightening of spreads as well as opportunities surrounding corporate activity, however our outlook remains cautious given how tight credit spreads are. Within fixed income, opportunities have been limited, however in recent weeks opportunities have increased as the ECB becomes less transparent to market participants.
HW: How will these changes/future events impact on your own portfolios?
TG: HEAL's philosophy is predominantly bottom up therefore the above-mentioned events are not expected to markedly impact the portfolio.
HW: What differentiates you from other managers in your sector?
TG: The HSBC Private Bank and HSBC Group networks provide HRIL with great reach worldwide in sourcing interesting investment ideas. They also provide all of the benefits of a globally integrated bank with a very strong balance sheet, including the ability to offer tailored fund and product structures.
Advising on some US$29.5 billion (as at 31 December 2005) of client assets invested in alternative investments, HSBC Private Bank is one of the largest investors in the hedge fund world. This ensures that HRIL is a first 'port of call' for hedge funds seeking to raise capital, as well as being in a preferential position to invest in existing funds.
Also, through a leading internal hedge fund brokerage business in Geneva, HRIL has the ability to source paper from hedge funds with strong track records that may have been closed for a considerable period of time. Many portfolios include holdings of such funds. It is not unusual to find that 10% to 15% of portfolio holdings have been sourced through this free internal secondary market.
HRIL's team of analysts has vast experience in the hedge fund sector and has long and established links with the key industry players. This allows the group to stay abreast of any industry developments, including new manager launches, fund re-openings and manager changes.
HW: Some funds of funds have complained that managers are not taking enough risks in the current environment - what are your views on this, and on risk in general?
TG: We have had no cause to complain regarding the risk level of the underlying managers in the portfolio. HRIL monitors its underlying managers on a regular basis to ensure that risk levels lie within an expected range. On occasion risk levels have fallen below and indeed risen above those expected ranges, however there have been no occasions where this has not been accompanied with an explanation from the manager. Clearly increasing risk has been a challenge for hedge fund managers in recent years however whilst they operate within our expected levels we are able to use portfolio construction techniques to ensure that the volatility in the portfolio reaches its target level.
HW: Are investors' expectations moving upwards and how do you deal with this?
TG: In general, HRIL believes that our investors' expectations are moving in line with our own expectations.
HW: Are you planning any further launches this year?
TG: We launched a new tranche of HEAL shares in February 2006. Since then, we have noted continuing demand for the shares. We will therefore be monitoring this situation.
(Tim Gascoigne was interviewed on 4 May 2006)