That makes BlueCrest one of Europe’s top three managers by AUM. In a visit to BlueCrest’s offices in SW1 opposite the private gardens of Buckingham Palace, The Hedge Fund Journal sought to shed light on AllBlue’s allocation process to its seven different constituent funds, understand how the returns are generated as well as get to grips with the key aspects of the approach to risk management. The discussion also delved into BlueCrest’s outlook for markets and what lies behind the continuing growth in UCITS hedge fund strategies.
“The strength of AllBlue in many respects mirrors the strength of BlueCrest as a firm,” says Andrew Dodd, chief financial officer of BlueCrest who sits on the AllBlue allocation committee and who is a director of the listed AllBlue vehicle. “One of the things that makes BlueCrest different is that we have large scale and world class businesses in both discretionary trading and systematic trading. There are very few firms that have broadly equally sized businesses that have been so successful. In many respects the strength of AllBlue over the years it has been in existence has reflected that. Of the four full years it has been in existence, we’ve had a couple of years where trend following has been the best performer, we’ve had a year where emerging markets was the best performer and we’ve had a year where Capital International (the flagship discretionary fund run by Mike Platt) was the best performer. From that dual-pole business comes the fundamental strength of the fund.”
The current split between discretionary and systematic strategies in AllBlue is around 75%-25%. The current allocations are a product of the excellent opportunity set for traded strategies in the global macro space, which have coincided with a more challenging market environment for trend following strategies. Indeed, the paring back of AllBlue’s allocation to the BlueTrend managed futures fund to just 13% of AUM puts it around all time low levels of exposure. Though AllBlue doesn’t have formal allocation limits to the sub-strategies spelled out in its prospectus, the allocation to Capital International where Platt trades interest rate spreads is soft-capped at 40% compared with about 37% in early March.
“That’s at the upper end of its historical range,” says Dodd. “It’s more that we’ve given guidance to people in marketing over time rather than really operated hard limits on the different percentages. We say to investors that they should expect us to be allocating within ranges, but there aren’t really hard and fast limits and there certainly aren’t limits on systematic versus discretionary.” One reason there aren’t strict limits is that BlueCrest continues to introduce new strategies, the latest in the last quarter of 2009 being BlueCube, a systematic equity market neutral trading programme.
Multiple strategies but not multi-strategy
Traditionally, a multi-strategy fund is one making allocations to different styles and reallocating capital within those styles at the discretion of a single portfolio manager with reasonable rapidity and frequency. This doesn’t really reflect how AllBlue or BlueCrest operate. “I think AllBlue differs from that in a number of ways,” says Dodd. “It differs from that because the underlying strategies are themselves funds and so if investors choose to invest separately in some different combination or in different weightings then an investor can do that.” Nor is AllBlue an internal fund of funds, though many investors may label it as such. “AllBlue offers two distinct advantages over a fund of funds,” he says. “The first and most obvious is that there is no fee layering. The second, and almost certainly bigger advantage for the investor is that BlueCrest as the manager has complete transparency into the underlying funds. For the investor that is the advantage of AllBlue over a fund of funds.”
AllBlue’s asset allocation committee (See Figure 1) can adjust allocations monthly. The committee works on a consensus basis and although its chairman Mike Platt has a casting vote, in practice this is not required. Given the hands-on portfolio management of its members, the committee has bottom-up knowledge of the positions of different funds and, of overriding importance, the outlook of each fund.
In addition to the outlook, the committee considers market opportunities and how each fund is positioned from a risk/return perspective. “We start from a mathematically optimised set of allocations which are driven by expected returns and correlations in these funds,” Dodd says. “That throws up a mathematically generated optimal allocation and then we adjust that based on the opportunity set and our view of markets. As we’ve told investors, we have current concerns about the global markets situation and this led us to increase the allocation to Capital International (where the main exposures are G3 interest rate trading, fixed income relative value and FX volatility) because we see it being the least volatile and of all these funds being the least exposed to a double dip crisis.”
A risk management culture
Fund performance during 2008-09 brought much scrutiny to bear on risk management across the alternative investment sector. At BlueCrest, the mantra is that it is more a function of the risk management culture of the firm. Even so, BlueCrest’s approach to risk management has several key components. The first is a system of tight stop losses (according to Dodd, among the tightest in the industry) that come to bear on all the firm’s traders. This is combined with a policy of only trading the most liquid securities in order to avoid gap risk (and potential losses) when stop loss limits are rigorously enforced. “The reason for this is to make sure the funds cut loss making trades as soon as losses kick in,” he says. “It means that, relative to other funds or to bank prop desks, our traders aren’t sitting there with huge directional bets.”
The second component is dispersion of the risk across a range of portfolio managers. Capital International, for example, has some 40 traders with Mike Platt having the biggest book though it is just 10% of the fund. That’s a fraction of what some global macro principal traders run. With a stop-loss limit of 4.5%, the downside threat is capped. Indeed, the biggest ever peak to trough drawdown for Capital International is less than 5% in almost a decade of trading and it has never had a down year. “Our set up is really an institutionalised version of Mike’s own personal style of trading,” says Dodd. “He trades a very diversified book. Every trader that works for the fund has their own capital allocation and there is no ambiguity about who each trade belongs to. There is very clear accountability and tight stop losses. You’ll see Mike exit trades very quickly and the institutionalisation of that is through the stop loss rules.”
The third component of risk management is that portfolio managers don’t take leveraged relative value-type wagers. In addition, a cash stress test is used to ensure that even in extreme market conditions funds always have cash to continue to trade and to operate. Dodd explains: “A common thread in why hedge funds fail (in addition to a variety of other reasons) is that when they run out of cash they are forced to liquidate positions against themselves in difficult markets. Even in the extreme market conditions of the last couple of years, and when we had our funds hit by redemption waves, all our funds were still passing the stress test. Consequently, we had no forced liquidations of any positions.”
Should a fund run up against cash stress tests then risk is cut and margin is taken back from the counterparties to increase incumbent cash to pass the test. BlueCrest has a separate liquidity management desk and it aggregates up through the funds to the AllBlue level. It means that the AllBlue asset allocation committee focuses on risk at the AllBlue level but does so with look-down transparency into the risk management of the underlying funds. In sum, the AllBlue process is about aggregated risk, correlation and the opportunity set for allocations to the component funds.
The final process that underpins risk management at BlueCrest is an independent team of six which monitors desk heads and oversees the stop loss on individual traders. In short, the team ensures that traders are playing by the rules. It also aggregates risk at the fund level, at the AllBlue level and at the firm wide level.
“BlueCrest is based on desks of trading specialists,” Dodd says. “We don’t have generalist macro traders. We don’t have people here who will have a position in rates, a position in currencies and a position in equities to express a macro view. We have interest rate traders. We have FX volatility traders. We have relative value traders. We have credit traders. Everybody is specific and focused. That is quite an important part of our culture. Mike is very specialist. You won’t see Mike with big positions in markets he is not experienced in. He will typically have a view, but Mike is an interest rate trader. That is what he does.”
Different investor bases
Being both Cayman and LSE listed makes AllBlue a rare breed. Its two versions attract different shareholders. The Cayman offering has a higher proportion of institutional investors but both versions of AllBlue have major distribution through private wealth aggregators. In the case of the Cayman fund, BlueCrest did a distribution link-up with Man Group (which owns 25% of BlueCrest) when AllBlue launched in 2005.
“These listed hedge funds vehicles are attractive for UK private wealth institutions to get access to hedge funds at tax rates that are attractive,” says Dodd. “If you are UK tax payer and you invest in a Cayman fund you will crystallise a tax liability when you exit the fund and the rate you pay tax at will be the marginal rate.” It meansthat investors pay the 40% top rate which in April rises to 50%. But investors in the LSE-listed AllBlue pay tax at a capital gains rate of only 18%. “It is an important part of the rationale for a number of our investors to take advantage of that different tax treatment,” Dodd says.
When AllBlue listed in 2006 it raised £150 million. Since then it has raised a further £200 million in two separate capital raisings, the latest in December 2009. Certainly AllBlue’s record helps. It made a double digit return in 2008 with five of the six principal strategies making money. The fund also proved highly liquid in meeting redemption demands and not resorting to gates.
“I think that there were a lot of these so-called permanent capital vehicles set up in a short period of time with a very wide range of underlying strategies,” says Dodd. “A number of managers used the vehicles to facilitate their investing in some less liquid strategies. I think after what we saw in the summer of 2008 and post-Lehman it took about a year for investors to really appreciate what these different underlying strategies actually meant in terms of the real underlying liquidity profile and the nature of the different investments being made. We were pleased that come October 2009 our investors realised that AllBlue represented liquid underlying strategies that genuinely did offer an absolute return. That helped the shares return to a premium rating.”
BlueCrest has continued to evolve with the market and in 2008 launched a UCITS version of its flagship BlueTrend managed futures fund. There is solid evidence suggesting that the UCITS wrapper is drawing new investors to hedge funds. Dodd characterises investment flows into the UCITS fund as “steady and solid”, but notes that at less than 5% of AUM it hasn’t as yet been transformational to the business.
“I don’t think it is a function of the structure of the vehicle so much as the quality of the underlying investment capability,” Dodd says. “Whether it is a listed, UCITS or a Cayman open ended fund, doesn’t make much difference. The listed structure may prolong the life of some funds owing to the rules for winding it up, but I think investors’ preference for liquidity among hedge fund strategies and their focus on what liquidity they really have means that private equity or structured credit type structures – again whether Cayman, UCITS or listed – are going to find it much, much harder to get established.”