GLG’s Pierre Lagrange first came up with the idea to monitor brokers’ ideas back in 2005. The European equity long-only strategy ran internally before a Sovereign Wealth Fund decided to commit approximately USD500million to the strategy in a managed account mandate towards the end of 2007.
Then, in January 2011, Man Systematic Strategies (MSS) partnered up with independent ETF provider Source to launch the Man GLG Europe Plus Source ETF. In just over 12 months the ETF has attracted USD530million, taking net assets in the strategy to USD1.2billion.
Last week, Hedgeweek met with Khalil Mohammed (pictured), a member of the MSS portfolio management and research team, to discuss the strategy.
HW: Could you explain the genesis of the GLG strategy?
KM: Certainly. Being a discretionary fund manager GLG consumes a lot of market information, which on the sell side comes in the form of analyst recommendations. As there are thousands of recommendations coming from brokers via email, phone calls etc, it can be difficult determining which brokers actually add value to the firm. In 2005, we decided the best way to do it was to monitor the brokers on a systematic basis with all recommendations placed on a web page. Every broker we use – around 65 in total – has their own log in and they enter their ideas into the system.
HW: Other asset managers use similar broker-driven strategies. Presumably the fact that GLG is such a big commission payer meant that brokers were happy to come on board?
KM: Yes, it’s in their best interests to give us their best ideas. In each of the brokerage houses we only use one senior key sales executive who is responsible for around 2,500 analysts. We ask them to give us their highest conviction ideas.
The brokers’ mandate is to give us medium-term fundamental ideas (60-90 days); we’re not interested in short-term price moves. The brokers aren’t forced to give us a minimum or maximum number of ideas – just the highest conviction ideas. On average we expect them to have 20 to 30 live ideas at any point in time, which comes to around 1,000 ideas spread over 65 brokers.
Once these ideas come to us we run them systematically to generate a long-only European portfolio. The issue with sell ideas is they don’t work as well. The worst thing that can happen with a buy idea is that you lose 100 per cent. With a sell idea your losses, theoretically, are infinite. We’ve analysed the data and we can’t find any easy way of using sell ideas.
HW: What information do you analyse when assessing brokers’ performance?
KM: Basically they have to enter a target price for the buy or sell, the stock identifier and explain why they’re making the recommendation. We want to understand the reason behind the idea. Ultimately they have to beat the market. We rank all 65 brokers at the end of the year and we review them every three months. Each quarter we systematically produce a 40-page document that looks at how brokers behave: if they have a buy idea do they wait for a price reaction before they buy? Do they hold the position too long or sell too quickly?
We analyse hit ratios but more importantly we look at the win:loss ratio. You’ve got to make sure that when you win you make more money than when you lose. This document covers every analyst, from energy to technology, so we can see who’s doing well and who isn’t. It’s therefore a useful feedback loop for the sales guys.
HW: And then presumably the black box applies various filters to create the Man GLG Europe Plus Index on which the portfolio is based?
KM: Yes, given that we have 1,000 ideas at any one time we narrow this down to a portfolio of 200 to 250 stocks. The beta relative to the MSCI Europe index is 1 so the strategy is essentially aiming to generate index plus returns. As for the ETF’s target returns, they’re 2-8 per cent above the broad European equity market with a tracking error of 2-5 per cent p.a. The types of filters we apply include country filters and liquidity filters to remove illiquid stocks.
When we construct the portfolio we look for patterns – for example if two brokers send a buy recommendation, and a third broker sends a sell recommendation we neutralise the position because we view that as a break with the consensus. We also avoid situations where too many brokers recommend the same stock. We call these ‘glamour stocks’, and they often end up doing badly, enjoying strong price momentum and then crashing. There’s also seasonality to brokers’ ideas: for example there are less ideas around year end during the holiday period compared to the first quarter of each year..
We also look for size neutrality. This strategy isn’t designed to predict whether large caps will outperform small caps and vice versa. To mitigate that effect we make sure large cap and small cap portfolio weights are exactly the same as the MSCI Europe. By the time we’ve applied all these filters we end up with around 600 ideas, from which we generate the portfolio of 200 to 250 positions.
HW: Do you create the Index yourselves?
KM: No, we use Markit, an independent third party. They then create the Index and adjust for cash positions, corporate actions etc. and this is then disseminated out to the market.
The five Authorised Participants who own Source also receive the file because they make the market. Given that it’s very transparent the spreads are very tight. If you go to the Source website, we’re pretty open about how we create the Index, how iNAV is calculated etc. You could have an amazing black box but if you don’t have the input you won’t generate anything useful.
HW: And how did the strategy perform last year amidst all the market volatility?
KM: 2010 was a fantastic year, we outperformed the index by almost 800 basis points with a low tracking error of 2.5 per cent. Last year, however, was more difficult. We underperformed by 81 basis points. Over the first six months, the market was pro-cyclical and we outperformed by around 284 basis points but the second half of 2011 was challenging as the market shifted to becoming more defensive. When the markets shift from one regime to another brokers take longer to change their recommendations.
Although we underperformed the MSCI Europe, a lot of other long-only European funds performed even worse so we were still in the upper quartile of Lipper funds. YTD we’re up around 338 basis points. January was a strong month: we gained 241 basis points.
HW: And presumably, the fact that the ETF now has a 12-month track record means investors are opening up a dialogue with MSS?
KM: Yes, investors can now see performance and are starting to set up a lot of meetings with us, helped by the fund’s good performance in January and February. Also, this is an ETF that tracks an active index and as far as we know it was the first of its kind when it launched in January 2011. It was the fastest growing ETF last year and is already one of the largest funds managed by Source.
HW: Was there anything you learned about the strategy during last year’s frothy markets that allowed you to tweak and insulate it against future market stresses?
KM: Really, one of the things you need to avoid is having a knee-jerk reaction and changing the model just because you’ve had a bad sub-period. We haven’t made any changes to the algorithms. Given that we review brokers on a quarterly and annual basis we changed a few brokers over but that’s all.
HW: Given that brokers are ranked it must make it awkward when you have to tell one that they’re being removed?
KM: The average turnover of brokers is around 5 per cent a year. We have long-standing relationships with a lot of them, many of whom have been with us since 2005 so we’re always reluctant to get rid of them. In addition to our live broker pool we also have a trial pool of brokers who want to get selected but who have to prove themselves. Every year, for those brokers that underperform we give them enough time to turn around performance but if they aren’t able to we remove them.
HW: And what was the reason for choosing Source to create the ETF and why even decide to launch the strategy in an ETF format?
KM: We wanted someone who already had expertise in that area. Although a relative newcomer, assets in Source are growing quickly, they’re around USD8-9billion. We wanted someone who was innovative in their approach and open to the idea of having active indices to create an ETF. We also wanted to increase the number of clients who can invest in the strategy. If you set up a managed account it can take months to do the paperwork whereas with an ETF it’s like trading a normal share, anyone can buy it.
HW: Finally, what are your thoughts on AuM growth for the strategy for 2012 and beyond?
KM: Even though Europe wasn’t popular last year we hardly had any client redemptions in the ETF – this shows that clients know what the return expectations are and are willing to stick with it. We’ve looked at the strategy’s capacity and we think it’s around USD5-10billion. In terms of growth we’re confident the strategy will continue to attract new investors.