Few hedge fund managers running a successful firm with billions of dollars under management and enjoying the fruits of a successful investment career spanning two decades would be willing to start over. But that is exactly what Trafalgar Asset Managers co-founder and continuing partner Lee Robinson is doing.
He is financing the build out of Altana Wealth and has put $25 million of his own cash into its inaugural Altana Sovereign Diversity Fund, which opened to external investors on 1st July. The new firm, which is being run independently from Trafalgar, in early September just launched its second product, the Altana Inflation Systems Fund.
The timing of the new venture is characteristically opportunistic. US government debt has lost its ‘AAA’ rating, the euro zone is ricocheting from crisis to crisis, while inflation is advancing in many emerging market economies. With the aim of protecting investors, the launch of Altana earlier this year looks prescient.
To catch up on the developments and explore the rationale for the new venture, The Hedge Fund Journal visited Robinson at his airily spectacular Baker Street offices. The challenge of running client money amid the evolving financial crisis permeated a discussion which highlighted Robinson’s intellectual dexterity, close focus on risk management and multi-asset class tactical trading ability.
“I had to ask myself: what am I worried about?” says Robinson, recalling the thinking that led to the creation of Altana. “I’m worried about the tail of inflation and about how the sovereign credit crises play out. If there is no inflation, great. But at the moment investors are getting negative real returns on dollar, sterling and euro assets and many other currencies as well. The first step is to get out of that trap. To lose 5%, 6% or 7% on a real return basis over the next two or three years adds up to a lot of money. Altana Wealth is about making absolute real returns.”
Getting real returns
The focus on absolute real returns reflects Robinson’s critique of how the hedge fund industry came of age during a time when inflation tapered downwards over two decades. In consequence, managers focused on nominal returns because for investors inflation was largely a spent force. Now, however, with inflation high and interest rates low, it is very difficult to generate real returns. Added to this is the spectre of a vast morass of debt where what’s owed – just in the US – far exceeds the value of global assets. In sum, Robinson is decidedly downbeat about the prospects for investment managers generally and believes that making real returns in finance will be next to impossible over the next few years.
“I think a lot of people are confused,” Robinson says. “It is a difficult time for investments and will be for the next five years regardless of whether you are bullish or bearish. I hear it a lot from family offices that they want to know where a manager has his money and look at what he is doing.”
The initial impetus for Altana came from Robinson wanting to put together a structure to manage his own wealth. With operations headquartered in London and offices in Monaco where Robinson is based, Robinson saw a good opportunity to build up an American-styled multi-family office over time.
However, the immediate priority for the foreseeable future is to launch funds and manage money to make real returns from the troubled conditions afflicting sovereign credit and currencies. Robinson won’t speculate on how the pain of debt restructuring will be distributed among, for example, tax payers, pension funds and bond holders. But he believes that defaults are unavoidable given the low growth expected to materialise in the developed economies.
“I want to be one of the winners rather than among the losers and make real returns over the coming five to 10 years,” he says. “Hedge funds, more than private equity or long only, have the tools to take advantage of falling markets and rising rates: doing simple things like being short inflation-linked bonds and being long treasuries or taking a view on credit spreads. Hedge funds have the tools to make real returns. That is what we have to tell the pension fund industry: we can use the tools we have to help them. Come to us with a problem and we will solve it for you. The banks used to do that, but they lost sight of that with the scandals that hit structured products and everything else.”
Investing in bills
The Altana Sovereign Diversity Fund is to invest in the treasury bills of a number of sovereigns, including Canada, Australia, Norway, Singapore, Sweden, Switzerland, China, South Korea, Brazil and Mexico as well as a bit of gold. The fund is also looking at sovereign bills issued by Poland, Russia and India for possible future purchases. The fund won’t generally hold currency forwards owing to their vulnerability to bank counterparty risk.
The usual currency grounding for most investors is to have over 90% of assets lumped into their base currency and the dollar. However, even on a simplistic model of global GDP Robinson says investors should have no more than 55% of allocations in yen, sterling, the euro and the dollar. This leaves some 40% of the portfolio to be diversified across other G20 currencies. And it is in some of these currencies that real returns are offered.
Consider Australia. Investors in Australian bills get 4.75% whereas in sterling the comparable rate is 0.25%. Add in the higher inflation level in the UK and Robinson figures there is around a 7% swing between real returns on funds invested in Australia versus the UK in the short term.
“It gives you real rates of return,” he says, of the trade. “You are getting paid to be there and also you end up with more cash. If you want to be opportunistic and nimble, you have to have a hard currency base. It has to be impervious to bank default which frankly is coming with the sovereign default.”
The traditional investment model used by pension funds and others has advised diversification among bonds, equities, private equity and property varying over time. It worked when currencies were solvent. But in a world where some currencies may become insolvent the starting point for any investment is not just will the cash amount be repaid but what will be notional value of the currency an investor is getting repaid in.
Altana’s base investment proposition is that the risk/reward ratios are out of kilter on the major reserve currencies: the dollar, euro, yen and sterling. In a nutshell, they feature high risk, with little or no real return. In contrast, other sovereign currencies – the RMB, the Australian and Canadian dollars, the Norwegian kroner and a few others – are sounder both in terms of retaining comparative value and also immediately offering better yields.
With Altana Inflation Systems, the aim is to use a trend-following approach, but to limit the focus to a subset of products such as agriculture commodities, metals, energy, equities and long bonds. The plan is to deliver a return while inflation is low, but offer a big kicker when inflation really kicks in.
In the autumn of 2010, Robinson led a group of writers in publishing The Gathering Storm. The collection of essays analysed the financial crisis and charted future developments. At the book’s launch Robinson observed that he had never been more frightened than in May 2010. Just over one year on it seemed natural to ask Robinson whether he had become more or less frightened.
“The reason we made money in ’08 – not to be boastful but to give you an indication of where we were – is that as a credit house we saw it coming and we were prepared,” says Robinson. “We were worried. But we always felt that at the last minute the governments, mainly the US, would come around the corner and bail out Lehman or Merrill – or whoever it was. We always felt they were there. I never thought Lehman would go down. I thought it would be made a ward of the state and sold off very cheaply. I always felt that option was there. In early May 2010 Greek yields went to 18%. I just felt that the next stop was financial contagion because there was no one coming in to bail them out. There was no one left to bail out the Greeks. There was no Greek government behind it and the ECB at the time looked like it wasn’t coming in to bail them out. Suddenly the situation is that half of Europe defaults. If Lehman can bring down the system the way it did, there is no doubt in my mind that the UK, German or French banking system falling over would be a much worse case. It is quite a terrifying thought because the amount of money to save it would be so huge. I don’t know where we would end up, but we would be in a very, very bad place.”
“Am I less scared today?” Robinson asks rhetorically. “No. Yields are back at those levels. I do think the EU leaders realise it now. Last year France and the US didn’t think they had a debt problem. It was someone else who had a problem. Virtually most of Europe was in denial about the debt problem. I don’t think they are in denial today and that is a big positive step though it doesn’t mean they have solved the problem.”
Solving the euro crisis
As the euro crisis intensifies it’s possible that radical, yet relatively simple, measures may suddenly get scrutiny. Robinson and Patrick Young, executive director of DV Advisors and a co-author of The Gathering Storm, laid out a scheme in late August that would give the euro zone a market solution to reward prudent debt management, while providing a space for errant sovereign states to reorganise their finances.
Their proposal is to create two separate tiers of euro zone sovereign debt, senior and junior. The senior tranche would represent 30-60% of the debt to GDP in each nation. Given the high security of nations being able to service this debt, these bonds would likely receive a ‘AAA’ rating. The strong demand from global investors for yield would see this tranche priced with very low coupons, almost certainly lower than the yields being paid now. The rest of the debt above the GDP threshold would be assigned a lower rating and consequently trade at a yield premium.
The benefits of such debt slicing, according to Robinson and Young, would be significant. It would, at a stroke, break the destructive cycle of funding at ever higher interest rates, giving high debtors the chance and time to reform. It would also incentivise responsible moves towards fiscal responsibility. The security of the senior debt would mean that stronger countries wouldn’t be bailing out the more contentious or recklessly issued debt above the 60% threshold. Defaults would be on the junior tranches first, be of a smaller size, with less threat of contagion and permit a more controlled response among both the authorities and lenders.
“Ultimately the separation of debt into senior and less senior tranches may be the best option ahead of the very real threat of the euro zone itself splitting at the seams,” write Robinson and Young. “This plan gives solvent economies a window to reform and return to growth. Swiftly.”
Short-term investment horizon
To avoid taking on interest rate risk, Altana Sovereign Diversity will invest only in short-term bills. The investment thesis is that currencies will be driven over the next several years by sovereign credit worthiness and repayment ability. By limiting investment positions to ‘AAA’ sovereigns with willingness and ability to repay, the aim is to avoid mark to market or jump to default pricing. From there, the portfolio managers look at the sovereigns with the best growth prospects.
Two trades predominate. One is short and medium-term to produce real returns. The other trade looks to exploit the end game where various governments have to devalue their currencies. Here sterling and the dollar are key targets as their respective governments devalue by stealth as the only alternative to entering default.
Among potential investors, the primary focus is on pension funds and family offices. As the credit crisis has morphed into a period of profound financial upheaval, these investors realise they have too many dollars and are on tap to earn substantial flows in a declining dollar for years to come. There is thus an acute need to recycle the incoming dollars to an array of currencies as well as property and other real assets. Indeed, symptomatic of perceptions about the dollar’s vulnerability is that without solicitation Altana has already been approached by several US endowments.
Setting up Altana
The setting up of Altana followed Robinson’s decision to return money to the investors in the Trafalgar Catalyst Fund which he had run for over a decade. At one point Trafalgar ran around $3 billion and the group is still managing over $800 million, mainly in Theo Phanos’s credit fund and the smaller Azri equities fund. Robinson’s success as a portfolio manager is underscored by giving annualised returns of 9% over a decade and never posting a drawdown over 7%.
When Goldman Sachs raised the private equity-styled Petershill fund with backing from sovereign wealth funds to take stakes in top notch hedge fund management companies, Trafalgar became one of its first investments. Petershill bought a 20% stake in Trafalgar in early 2008 and has received a stake in Altana, while Goldman is serving as both prime broker and administrator to the new funds. The logic of selling a stake to Goldman is straightforward.
Robinson recalls that at the time Goldman acquired the stake the overriding aim was to attract allocations from US pension funds and Middle East investors, notably sovereign wealth funds. Several of the latter were unapproachable for hedge fund managers. But the timing of the deal just months before the credit crisis exploded severely hampered a quick increase in assets. But post-Madoff the reputational benefit of having Goldman both as an investor and prime broker has helped reassure investors.
“The fact Goldman have been prime broker since 2001 and then became an investor shows that your operations are well run,” says Robinson. “It was a plus in 2009 and 2010 and is a big plus in the US with pension funds. It is very hard to say that it is bad that a prime broker like Goldman, or one of other major banks, has bought a stake. They wouldn’t buy a stake in a firm where the operations were poor. That helps. Would I do the deal again? Yes, quite frankly.”
The new venture may share Trafalgar’s Baker Street offices but it is very much a separate business. The most recent recruit is Stella Dang who became head of operations in mid-September, rounding out a hiring spree that saw Ian Gunner, the former head of FX research at BNY Mellon, join as a fund manager and former UBS prime broker Antony Lingard become chief operating officer. Neil Panchen, a former head of commodities and currencies technology at Deutsche Bank, has been hired as chief technology officer. Risk and marketing personnel are also being added.
Altana’s approach is somewhat different from a typical hedge fund. For a start, as well as traditional hedge fund investors, the firm is also looking to target large corporate and pension funds. It will also provide risk advisory services for clients and look to give them better tools, including early warning systems.
“We want to be a series of funds focused on inflation, focused on making money for Lee Robinson as well as for the clients,” says Robinson.
“Whatever I’m investing in we are offering out to everyone else with a lot of transparency. What has come out of the last three or four years is that it is essential to be liquid and to be transparent. I think we have always been good with investors in terms of closing funds because we believe that alpha is not scalable beyond a certain size. With closing Trafalgar Catalyst we always felt it was their money and we should treat it in that way. Doing the right thing pays off in terms of your reputation in the long run. You have to believe that. That is the way we want to be as a firm. Not everyone is going to like the inflation story. But everyone knows that if they don’t hedge their exposure on it, the pain could be very great indeed. Everyone wants to know what can be done and I think we have some good ideas.”
Hyper-inflation and absolute returns
Part of the research that has informed the approach taken by Altana has been the investigation of periods of so-called parabolic inflation, notably Germany after WWI, China in the late 1940s and the former Yugoslavia in the early 1990s. What often happens is that when a currency falls sharply, the stock market moves higher, but often not enough to make up for the severe paper money losses.
One strategy that might have worked in the 1920s would have been to buy calloptions on an equity index, say, 10% in the money and have 90% in hard currency denominations. With the index rising, returns would be generated, providing more funds to transfer into hard currencies. In a highly inflationary environment like 1920s Germany this would have produced a net return. By contrast, keeping the money in German assets might have seen nominal values jump dramatically but with a currency sharply lower the result would be very debilitating losses.
“I think you are going to see it with gold options and with some equity markets where they go parabolic,” says Robinson.
“In a hard currency they will be flat but in nominal currency they will go through the roof. You could see that in Japan or the UK where the currency gets annihilated but the stock market flies.”
Like Zimbabwe in recent years, perhaps? “Like Zimbabwe, but maybe not as extreme as that. You could, for example, see the Nikkei double and the yen go from 90 to 180, for example. That wouldn’t be impossible. The way to trade that is to have call options on the Nikkei with the remainder put into a hard currency. You might say the hard currency is gold and silver. What we are saying is that an investor should put it in a diversified portfolio that works for them over that period.”
Another trade Robinson is keen on is betting against the Hong Kong dollar peg. He acknowledges that the trade hasn’t worked yet but says that the price of keeping it on is so cheap – 25 or 30 basis points per year – that it is worth retaining it on for the eventual pay off that could be 20-30 times the premium risked.
“At some point Hong Kong has to revalue to the RMB level,” says Robinson. “With the debt issuance in the RMB having gone from 3-4% to 17-18%, the bigger currency is going to swamp the smaller one. It is just a matter of time.”
He adds: “There are lots of those trades that you can put on with low risk, high reward. I think hedge funds need to go out to their customers and tell them: ‘We have more tools to help you than anyone else. Please sit down with us and let us solve your problems. We may not get the perfect solution but we have more tools to get closer to it.’ This is a better approach than trying to do 4X convertible arbitrage leverage or fixed income, which goes straight over the head of many people and frequently goes wrong.”
Robinson realises it is a difficult time to be starting over, all the more so given his changed investment strategy. Investors have been scarred by the combination of Lehman, Madoff and the losses that emerged among most structured products. Not only has trust for private wealth advisors gone into virtual free fall, but hedge funds and private equity have disappointed a lot of investors. The reputational damage of the crisis lingers.
“We need to get out there and work harder on our image,” he says. “This is about what a bunch of smart guys are doing with their own money and what they are committed to doing over the next few years. We are running our own money. I do think it is a door opener that we are targeting real returns as opposed to being a hedge fund that is just targeting absolute returns. Investors are interested in this and we are getting meetings with people.”
In coming months, more funds will launch to broaden the offering beyond Sovereign Diversity and Inflation Systems. Like the two existing products, most new funds will have monthly liquidity, but use different asset classes to focus on safeguarding wealth in the face of inflation. An equity fund expressing this theme is in the works and a distressed fund is being explored. The new funds will run over six to 12 months to develop track records and then be marketed to investors. The aim is to attract long-term investors and keep well within a particular strategy’s capacity limit.
“We look at firms that have scaledup well, getting investors to buy into a six to 12 month view,” says Robinson. “Over the longer term the investors will be there; short-term noise doesn’t derail them.”
“One of the things I liked about being at Tudor is that you had many managers in the room talking,” he says. “It helps you to scale back or sometimes to bet more boldly. Hedge funds are about finding out information before others and filtering it and executing it before others. That is ultimately what it is. The more information you have in the room, ultimately, the better. I like that about the Tudor model and that is something we aim to do very well.”