Furthermore, it is little exaggeration to say that many of its major competitors, mainly at the structured credit end of the fixed income field, find themselves in rather a spot of bother.
Tim Haywood, Chief Executive Officer at Augustus in London, says the company also has new funds on the way. It is planning a ‘mid-summer launch’ for an absolute-return UCITS III-compliant portfolio that will target Libor plus 1% (net of fees) returns. The portfolio will be managed and distributed under the Julius Baer moniker, as are the two other ‘Libor-plus’ absolute return products for which Augustus acts as sub-advisor. Augustus also has a systematic FX fund at the “family and friends” stage of development, adds Haywood.
The company’s planned UCITS III product can provide an alternative to bank deposit or enhanced money market funds, while its other Luxembourg-domiciled UCITS portfolios are a Libor plus 2-3% return target fund launched in 2004 and now with about €5 billion (as at 31 March 2008) – an alternative for bond allocations – and a higher octane Libor plus 4-5% vehicle, launched in 2006 now with around €500 million (as at 31 March 2008), which Haywood says makes a useful alternative for the duller fund of hedge funds.
While the planned Libor plus 1% fund can pursue all the strategies and asset classes of Augustus’ flagship JB Diversified Fixed Income Hedge Fund – namely duration and yield curve strategies, investment grade and high yield credit, emerging markets, convertibles and currency – it is not leveraged and does not physically short cash instruments. Additionally, its construction diverges sufficiently from Augustus’ JB Diversified Fixed Income Hedge Fund that their respective performance can sometimes see them heading in different directions, says Edward Dove, Augustus AM’s President.
“Investors should not expect one simply to be an unleveraged version of the other. The absolute return funds are un-geared and offer daily liquidity where JB Diversified Fixed Income Hedge Fund is geared and deals monthly,” says Dove. (JB Diversified Fixed Income Hedge Fund has returned its investors 8.42% annualised between launching in January 2002 and 31 March 2008, against a target of Libor plus 7%, according to Augustus). Dove says Augustus’ Libor-plus range had garnered particular interest from insurance firms – a relatively new market for Augustus – and also from the semi-retail audience, via European bank platforms.
These funds have daily dealing and, although their domicile Luxembourg’s interpretation of UCITS III provisions prohibits managers of the portfolios from physically shorting cash instruments, Haywood says they are still free to buy protection on bonds, sell futures, or purchase puts on baskets of instruments, for example.
Augustus’s FX fund is not the firm’s first involvement in systematic trading – indeed Haywood notes Augustus has been “investing in systematic applications for several years” – and the company was briefly running another FX portfolio with assets split evenly between systematic and discretionary approaches. Named the JB Currency Hedge Fund Combined Segregated Portfolio the systematic portion of this strategy was closed in November 2007 for performance reasons.
FX Discretionary has done well since launch last July, making 13.77% in its first 9 months.
The new currency portfolio, JB Currency Hedge Fund Quantitative Segregated Portfolio, is not simply the systematic portion of the old split fund, Dove says. He adds that recent market developments have provided a chance for Augustus’s managers to revise metrics for the systematic approach that sits behind the new currency fund. With new metrics now available, it has been “a good period to iron out any weaknesses, and put in place a more robust entry/exit process,” Haywood adds.
While the past years have been typified by some managers drifting beyond pure convertibles and into distressed, or out of fixed income and into multi-strategy, for example, Augustus’s focus has continued to revolve around fixed income, FX and debt instruments. Its key areas of focus are:
Augustus, formerly known pre-MEO as Julius Baer Investments Limited, launched into single strategy hedge funds back in January 2002, with the JB Diversified Fixed Income Hedge Fund. Thereafter followed JB Global Rates Hedge Fund (January 2004), JB Emerging Markets Hedge Fund (November 2004), JB Convertible Bond Hedge Fund (July 2005) and JB Currency Hedge Fund – Discretionary Segregated Portfolio (July 2007). With the new JB Currency Hedge Fund Quantitative Segregated Portfolio coming on stream Augustus will have six hedge fund portfolios. “We do not want to be a one-product shop, as arguably we were in the 1990s, and we want to be diversified by product, client and strategy,” says Dove.
Haywood adds, while Augustus clearly retains very amicable links with Julius Baer, advising on white labelled portfolios marketed under the latter’s name, his London team could also seek other such ventures beyond Europe which complement existing relationships.
With around US$13.5 billion (as at 31 March 2008) in assets, split about US$1 billion in hedge funds, about US$8.5 billion in low volatility absolute return strategies and about US$4 billion in long only (including EMD Local), Augustus is running more assets now than ever before. In late April Haywood said the firm had grown its funds under management by about US$5.5 billion in the preceding nine months alone and “could continue to grow at that pace for some time without capacity issues.”
Dove dubs the firm’s absolute return range “the right product at the right time” for investors who had been “drawn in by low volatility and tight credit spreads.” His words have been borne out by inflows into the Julius Baer Local Emerging Bond Fund, whose US$1 billion new assets in the six months to 31 March 2008 are in stark contrast to the flat inflows that have come into the JB Emerging Markets Hedge Fund over the same period. Both funds are managed by Paul McNamara and Caroline Gorman.
Dove attributes the mutual fund’s greater popularity of late to many investors’ current predilection for higher liquidity, no leverage and highest transparency for their portfolios.
The JB Emerging Markets Hedge Fund, with about US$96 million (as at 31 March 2008), targets Libor plus 10% and has returned 10.83% annualised between its November 2004 launch and 31 March 2008, according to figures from the group. It focuses on what Haywood describes as “the top end of the emerging markets debt space,” sovereign credit, interest rate swaps and inflation-linked debt and “the highest non-government alternative, rather than relying on credit analysis from London of small companies in emerging markets, for example.”
As such, in Haywood’s words, “it is not an equity product where investors should expect emerging market equity-like returns.”
At US$419.5 million (as at 31 March 2008), the Global Rates strategy is about four times larger than JB Emerging Markets Hedge Fund, targets a slightly higher Libor plus 15%, and has returned investors a respectable 10.21% annualised between its January 2004 launch and 31st March 2008, according to Augustus statistics.
While Julius Baer’s expertise in fixed income has helped it stand out from its more generalist peers in the past, the firm has nevertheless to a certain extent been tarred by the same brush that dirtied the name of some of its competitors, who turned out to be longer credit – sometimes to the exclusion of much else – than investors may have realised when the crunch came last summer. “We may have missed out a bit on the big credit contraction up to last summer, but now the market has turned, we have avoided – and indeed profited from – the severe credit pain,” Haywood says. Its peers, with some high profile inclusions, have not.
And investors, it seemed, were not the only ones trying to get out of fixed income-focused hedge fund houses. At GLG in London Greg Coffey, the trader reportedly responsible for 60% of GLG’s performance, announced he was leaving to set up on his own, following in the footsteps of his former colleague at GLG, Philippe Jabre.
“In our funds our goal is not to go and buy a load of instruments whose yield exceeds the return target, but to try to achieve target returns through FX, being long or short credit, long or short duration, and to explore derivative transactions to best express our views,” says Dove. “We were always rather sceptical of alphabet soup,” adds Haywood, referring to the three-letter financial acronyms that have become a millstone around many credit investors’ necks – CDO, ABS, CLO and MBS, among others.
“Our skill-set is based around FX, the discretionary application of macro-economic principles and interest rates, governments and sovereigns, and emerging markets. In the regional credit space, we are basis trading European investment grade, with modest exposure to European high yield,” Haywood adds. Dove describes Augustus’ trading as more relative-value in nature. “Relative-value is distinguished from complex derivative funds and CDO and CDO-squared funds, which were exposed to outright long credit when the train came off the track,” he says.
Admittedly Augustus’s JB Diversified Fixed Income Hedge Fund has profited from buying sub-prime protection, without a balancing long position, back in 2006 although Haywood said this trade was “moving nicely towards its end-game,” and it would not be transformed into a capital structure arbitrage trade in Augustus’s portfolio.On the risk-aversion front Augustus’s JB Emerging Markets Hedge Fund has also purchased protection, however Haywood notes this was a protective measure, one not taken for the sake of pure profit. Haywood says opportunities were presenting themselves in the unwinding of positions in structured credit generally, and Augustus had recruited staff to identify and exploit such occasions. (“You have to be able to analyse matters in great detail and have capital available to apply to them,” Haywood says.)
A key current risk for funds involved in structured credit, even if only tangentially involved, is of counterparties reining in credit extended, or changing the terms attached to its provision. Haywood notes counterparties have not pulled back credit for any of Augustus’s hedge funds, although costs of leverage have in some cases changed.
While banks’ increasing costs of gearing may reduce returns of hedge funds affected, this arguably does not have the potentially crippling effect of differing the haircuts on instruments in a typical credit portfolio. The changes in the industry in this area have been sizeable. The haircuts on AA corporate debt had blown out from between zero and 3% in March 2007, to 10-15% one year later, while the haircut required on BB-rated high yield had increased from 10-15% to 25-40% over the same period. And the case of AAA-rated ABS-based collateralised debt obligations has been the most extreme, its haircut increasing from 4% in March 2007 to notbeing accepted by prime brokers as collateral one year on.
The quality of the actual assets in fixed income portfolios is obviously of itself a key differentiator between one fund and the next, however it is also of prime importance to whether banks will extend leverage to fixed income managers.
“For those who still have spare capital to invest from their own reserves or from bank credit, the investment potential is bright,” says Dove. “The constrained outlook for risk taking within banks and chastened hedge funds means that arbitrage opportunities are alive for longer than would have been the case two years ago. The banks’ risk capital is being reined in and the hedge funds’ firepower may be somewhat reduced compared to before. Most hedge funds have not gone into the second quarter with the sort of gearing they had before as the violence of market moves had affected them, for instance in Japanese debt and the ABX market in the US.”
Gearing has been reduced on all Augustus’s funds, from the JB Currency Hedge Fund – Discretionary Segregated Portfolio which can gear up to four times but currently is un-geared, to JB Convertible Bond Hedge Fund which currently is slightly geared. The Augustus-advised convertible hedge fund portfolio has returned 9.3% annualised against a target of Libor plus 10% from its July 2005 inception to 31 March 2008, on Augustus’ figures. It was down 1.23% in 2008 (as at 31 March 2008).
The JB Emerging Markets Hedge Fund has also reduced its modest borrowings. “With hedge funds suffering so much volatility it is prudent to reduce leverage, and that is also what the funds’ boards want us to do,” Dove adds.
The new landscape has altered to an extent how Augustus views making profits in the markets, and its portfolios’ construction. “To make 10% in the past you may have had 100 trades each making 0.1%, now you may need 10 trades that each make 1%,” Dove says. “Corporate basis trades are better on a funded basis than on an unfunded basis because of the higher haircuts so it is better to put these trades into absolute return funds where they’re fully cash funded.”
Another difference now, Haywood adds, is that JB Diversified Fixed Income Hedge Fund is running at twice as much cash as it normally would, as are JB Global Rates and JB Currency, while JB Convertible Bond is limiting its involvement in private deals for reasons of liquidity.
Dove compares the current market conditions to the summer of 1998, with its dramatic moves, adding that those who get through summer will find themselves in an “exciting” market going into autumn.
While uncertain markets can encourage some investors to redeem from products, Augustus has been busy launching notes, with tenors of up to five years, creating ‘semi-permanent capital’ for the hedge funds, and advantageous vehicles for those investors who take a longer term perspective. This happy confluence of wishes helps obviate the concern at Augustus that other allocators may make sudden large withdrawals.
So, with US$13.5 billion (as at 31 March 2008) in aggregate assets, can Augustus take on more? On this topic Haywood notes capacity is a function of three main variables – the markets’ conditions, the funds’ sizes, and the state of one’s competitors.
While respectfully declining to comment on the latter, Haywood does, however, say Augustus has room to spare in all its portfolios.
“Our capacity to manage fixed income – that is government bonds, interest rate swaps, sovereigns and the like is far greater than what we are doing presently, and the opportunity set in this market area is particularly interesting. In the mandate arena we are far smaller than BlackRock and Pimco, for example, while in the absolute return space we are getting bigger in Europe but the global potential is vast,” Haywood says.
Timothy Haywood is Chief Executive Officer of Augustus Asset Managers Limited. He co-manages the JB Diversified Fixed Income Hedge Fund. Before this he was responsible for managing the emerging markets asset class. He joined in January 1998 from Orient Overseas International Ltd in Hong Kong where he was CIO for four years. Haywood has 20 years’ professional investment experience. He has an MBA from the University of Cranfield and is a graduate of Edinburgh University.
Edward Dove is President of Augustus Asset Managers Limited, a position to which he was appointed following the management buyout from the Julius Baer Group at the beginning of 2007. Before this, since 2003, he had been CEO of Julius Baer Investments. He has a fixed income portfolio management background having joined Julius Baer in 1992 as Head of Fixed Income and been CIO from 1999 to 2003. As CIO he was responsible for the fixed income investment process and strategy for the institutional business line of the Julius Baer Group. Previously, he was Director, Fixed Income at Chemical Global Investors. Dove started his portfolio management career in 1980 at Lazard Brothers in London, before which he worked for Cazenove & Co in a broking capacity. He attended Northwestern University’s Executive Development Program in 1996.