We are seeing a new business model emerging in the hedge fund industry, one that is tailored to match the alpha-generating ability of successful portfolio managers with the more robust infrastructure and support services investors come to expect from a large-scale fund management shop. Not for these firms the plug-and-play set up of hedge fund incubators. They are instead seeking talented managers to become partners in growing a successful multi-strategy business.

It makes a lot of sense. The firm is no longer wedded to a single strategy, or a single manager, by which it will live or die. It has a more diversified offering, coupled with the resources to satisfy the exacting due diligence criteria employed by institutional investors. A larger asset base, dedicated CEO and COO functions which can oversee the day-to-day operations of the business, and sales people who can sell across multiple strategies, all are key benefits for the new breed of multi-manager shop.And we’re not talking here about an established hedge fund firm diversifying into new areas, and coughing up nominal equity to the junior managers who come aboard; we’re talking about new investment management entities, guided by very experienced management, seeking to make a reputable name for themselves in the alternative investments space.

Partnership culture

One such is MPC Investors. Originally founded in 2000, it is a proponent of the partnership culture in hedge fund management. In MPC’s case, the firm was founded by Mark Hadsley-Chaplin (the non-exec chairman who ceded his executive responsibilities to Peter Harrison two years ago), and initially forged ahead with John Innes, the former Lazards and M&G fund manager. Innes had left M&G to manage total return, unconstrained funds, and launched the MPC Pilgrim Fund, now with over $1 billion under management, and one of the longer-standing hedge funds on the market.

Harrison’s arrival at the start of 2006 followed a desire by the founders to take the business to a second stage of its development. “There’s a polarisation [in the hedge funds industry] going on at the moment between things that are quite good, and things that are excellent,” says Harrison, Chief Executive. “Things that are quite good don’t get any money at the moment….I took the view that the industry is all about elephants, serious managers who raise money by dint of their experience, with their knowledge and their standing in the marketplace. You can waste a huge amount of talent trying to develop strategies which aren’t ready for development.”

In his view, the future of the business would be founded on the excellence of the strategies it would be able to deploy. It is an approach that is already paying dividends, as MPC’s reputation for selecting first class investment talent to bring into the business has meant that investing clients are more willing to look at them than perhaps if they had set up on their own. The added value of a successful brand is now making itself felt. “You create that kind of perception by being uncompromising,” Harrison says.

One of the first significant entrances to the MPC stable was Miles Geldard, formerly overseer of the multi-asset team at JPMorgan. He qualified as one of the ‘elephant’ names MPC was after, someone with an excellent track record and very significant standing within the industry, who could easily have joined one of the big ‘name’ hedge fund shops, but instead went with MPC because of the partnership culture it was offering. “We are run as a partnership, and the equity is all owned by us,” says Harrison. Unlike some other businesses, MPC has bitten the bullet in its preparedness to dilute the shareholding in order to take on the new investment talent it feels it needs to expand the business. This is about building a substantial, institutional-grade business, not a privately held boutique in which most of the equity is concentrated in the hands of the founders.

Apart from a stake in the business, MPC also offers its new partners what Harrison calls good governance. He sees governance as something of a bleeding ulcer for the hedge fund industry – yes, there is a lot of investment talent out there, but much of it is not wedded to the sort of good corporate governance that is needed to grow a solid and reputable business. This is why MPC has created CEO and COO roles that are separate from the fund management roles, and are filled by people like Harrison who have the pedigree to be taken seriously. “A risk manager doesn’t have a position by right, he has to earn it,” he says. “It makes managing a business like this completely different, and frequently it is done quite badly because senior fund managers also try to be the business managers, and they either compromise on being a business manager, or they compromise on their performance, but they can’t do both.”

Harrison himself is a veteran of the Schroders Organisation, and one of the founders of the Newton Fund Management operation. He helped to build the global equities business at Fleming (later acquired by JPMorgan), and also served as the CIO at Deutsche Asset Management, with responsibility for $500 billion in assets. It has meant that he has been able to win the trust and respect of the fund managers that are critical to the MPC business, while having the freedom to focus on the day to day business management issues.

Attracting the right investment talent

A big part of the role is continuing to expand the business by attracting the right investment talent, like Geldard, or AjayGambhir, another Flemings veteran and head of the European High Alpha team at JPMorgan who joined MPC in 2007 to launch its Samsara Fund, a European directional long/short vehicle.

Gambhir’s fund was launched in the torrid summer months when the markets were in turmoil and many hedge fund launches were scuppered by the stormy waters of the credit crisis. Harrison is pleased that his firm was able to go ahead with the Samsara launch, and to raise $950 million in very difficult market conditions. He puts this down to confidence on the part of his clients that MPC backs top class asset managers, and to Gambhir’s standing within the investment community. At JPMorgan, Gambhir was personally managing $6 billion in either absolute return or unconstrained funds. It might have been a very different proposition launching a fund with a less seasoned manager.

Awareness of some of the downsides of working within big name fund management shops has helped the senior executives within MPC to develop an environment that still allows their fund managers to exercise a high degree of control over their funds. It may be surprising to some investors, but the fact that an MPC manager can decide when he wishes to close his fund to new investment because he feels it will impact his performance to take on more money, is both an attractive quality for investment professionals joining the firm, and also something that is far from guaranteed in bigger firms. A large asset manager might continue to take on assets in a fund because its sales force has been incentivised to do so: sure, the portfolio manager might be consulted, but it would not be his decision to hard close the fund. This remains a consistent gripe amongst fund managers, and a key reason why many of them leave the larger groups where they cut their teeth.

A more regulated offering

Another reason why firms constructed along MPC’s lines may be well-positioned going forwards is the rapid convergence occurring between hedge funds and regulated products. The introduction of the UCITS III directive in particular seems to be galvanising some larger hedge fund operations, and with the partners’ backgrounds in major institutional asset management houses, it is easy to see why Harrison and his colleagues see the use of regulated structures as a major future growth area for the firm. Geldard’s team, for example, launched two SICAVs first (MPC Global Convertibles and MPC Strategic Reserve). It was only six months later, in June 2007, that the same team launched its hedge fund, MPC Strategic Opportunities.

“We need to own and control our SICAV products and think about them in the same way we think about hedge funds,” says Harrison. “Ultimately, we need to fully utilise the UCITS framework because that will increasingly look and feel like hedge fund products. People will still choose between a regulated and an unregulated wrapper.”

Geldard sits in the steadily evolving new sector of regulated absolute return funds, and unlike many of his competitors, was able to remain in positive territory every month in 2007, despite the market problems in the summer. It is partly testimony to how he has been able to focus on running money, letting others worry about the business within which he sits.

“Fund managers operating in the right environment, and of the right calibre, really do differentiate themselves,” says Harrison. “In the UCITS space the market has become a little too focused on distribution. UCITS managers tend to be distribution-led managers…many of the big fund management houses today are distribution engines. They’re not led by the fund managers anymore.”

Consequently, some UCITS regulated hedge funds are coming into the market, the launch of which has been largely dictated by the sales forces of the companies involved, not the investment teams. A perceived demand for hedge funds is being met by back-tested funds that are not based on the realities underpinning current markets. With the growth of open architecture as a means for institutions to allocate money to third party managers since 2000, there has been a parallel growth in awareness within the investment community that brand is not everything. Seven or eight years ago, there was still a large degree of confidence in big brand money managers – now, investment intermediaries and consultants are becoming more agnostic in their tastes. This is good news for firms like MPC, who can deploy their big name managers, and create a reputation for solid and consistent returns and be taken seriously as a result.

Another factor favouring the ‘new model’ partnership-based hedge fund business is that it is not part of a larger asset management entity, particularly one that might, for example, control its own private banking or wealth management units, technically competitors to its investment clients. A firm that sets out to be a dedicated fund manager, and has no other conflicting interests outside its core function, is in a solid position in today’s money management environment. As Harrison himself observes, hedge funds are generating the alpha, and have the performance, but not necessarily the distribution capabilities of the larger fund management groups. On the other side of the fence, big financial groups have the distribution capabilities, but not necessarily the performance. MPC is seeking the happy middle ground between the twain: decent distribution coupled with high levels of investment performance.

It also looks as if fewer and fewer hedge fund firms are being allowed what Harrison calls “a seat at the top table,” namely being granted access to the big institutional players in this market. Part of that critical mass is assets under management: five years ago the benchmark was $1 billion; three years ago it was $3 billion. Now, it looks like being over $5 billion. There are very few firms with that kind of scale in the hedge funds sector right now, and MPC is aiming to be one of them. In Harrison’s view, MPC has the scope to expand rapidly to achieve this kind of scale by taking on new managers as partners. “It really boils down to the development of barriers to entry,” Harrison explains. “In the alternative world the barriers have been really quite low, I’d say. There’s been a lot of liquidity, a lot of money looking for talent, a lot of investment banks looking to get small people up and running.”

Now there is a lot of pain in the hedge fund world – investors are running scared, and are aware that there are single manager firms out there that have lost over 20% in 2007 and may not be in business within 6 to 12 months. A model that provides multi-strategy diversification has to remain a good selling point going forwards.

Conclusion

Investors can expect to see more firms like MPC emerging onto the hedge fund scene. They will offer managers, either those leaving big fund management or banking institutions or ‘second generation’ hedge fund managers leaving the leading hedge fund groups, the infrastructure and marketing muscle they will require to attract money credibly, plus the ability to own their own track record.

The key behind this is the willingness of the existing shareholders within the organisation to be diluted in order to attract the best investment brains. This is a precondition for those joining MPC, for example. Being successful going forwards involves having the right culture within the firm that will allow managers to flourish, and picking the right individuals to be a part of the team, and to perpetuate that culture. Harrison is very realistic, despite his firm’s recent move to new and larger premises, about the achievable dimensions for his firm. This is partly dictated by the size of the equity pool available, but also by the fact that at some point the partnership approach will be compromised if too many people are taken on.

MPC stands as a firm that is very outward looking – little energy is expanded on the sorts of internal issues and so-called ‘madness of crowds’ that can plague big organisations, there is no frustrating layer of middle management. “Everything is outward looking,” says Harrison. “In big companies, most of the view is often inward looking.”

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Biology

PETER HARRISON

Peter Harrison joined MPC as Chief Executive in February 2006 from Deutsche Asset Management where he was Global CIO. Before joining Deutsche in 2004 he was CIO – Global Equities of JP Morgan. Prior to that, he joined Newton Investment Management at an early stage and became a senior portfolio manager contributing to the firm’s asset growth from £800m to over £10bn. His career started at Schroder Investment Management where he was a UK equity analyst.