Cazenove Capital

'Investment is as much about people as process'

Stuart Fieldhouse
Originally published in the February/March 2006 issue

Cazenove Capital arose out of the decision to incorporate the traditional British banking and stockbroking firm in 2001, ending the history of a 180-year partnership. At the time, its asset management business, although substantial, was still overshadowed by its corporate finance and stockbroking activities, and it was decided shortly thereafter to split the established investment banking and asset management organisms into two separate entities: JPMorgan Cazenove would continue to work in the corporate finance area as a joint venture with US banking giant JPMorgan Chase, while Cazenove Capital would focus on the firm’s existing investment management portfolio, including £4.5bn in private client assets, a £2.2bn charity division, and a £2.6bn specialist investment management division.

All has not been rosy for the investment banking division since the separation, losing 13 clients last year, including such highly prized accounts as BAA and Marks & Spencer. Cazenove Capital, however, has forged ahead, partly due to its established expertise in the UK asset management market, but also thanks to a series of appointments from HSBC Asset Management. Foremost amongst these was Andrew Ross, who took over as CEO in 2002, but other appointments since then have borne out Cazenove Capital’s mantra that “investment is as much about people as process.”

“Our basic philosophy was to create an organisation that fund managers would enjoy working for, and where they can earn equity in the business,” Ross says. “As long as we can preserve that, we can add other people to the business. Luckily, we’re in an area of investment that can be carried out by a relatively small team.”

A golden opportunity
At the time of Ross’ arrival, the firm had yet to compete as a stand-alone entity in either long-only or absolute asset management activities. It represented a significant challenge, particularly in the wake of the bursting of the dot com bubble and the onset of a bear market. A substantial slice of the firm’s institutional client base had already left. From the perspective of Ross, and his HSBC colleague Robin Minter-Kemp, who joined him as managing director responsible for specialist investment, it represented a golden opportunity to build the fund business they wanted to work for.

Ross turned back to HSBC for the investment team that would power the new business, and managed to hire Tim Russell, then head of UK equities at HSBC Asset Management. With him came fellow UK specialists Julie Dean and Wade Pollard, and European managers Chris Rice, and Steve Cordell. He also managed to acquire Neil Pegrum from Insight Investment. Russell was the only one to have managed any kind of hedge
strategy prior to joining Cazenove Capital, which led to a delay in gathering private client in-house money, but this was not a priority for the new funds. Currently, an estimated 10% of the assets under management are accounted for by existing Cazenove Capital private clients, as many existing clients wanted to see the managers put through a hedge fund ‘incubator’ period, but this has not stunted the growth of the hedge fund business one iota.

Since the de-merger, most staff have been given the opportunity to own shares in the newly-created firm, so that nearly 35% of stock in Cazenove Capital Holdings is on track to be owned by employees. This was simply not an option that was available prior to the demerger, but has been considered strategically essential for the firm going forward, in order to be able to tie in the award-winning fund managers it already possesses.

Ross, despite being a veteran of a large and established asset management organisation, is obviously enthusiastic about the potential for growth within this mid-sized fund manager, particularly in the alternative investment sector.

“Active fund management is best done out of a small organisation with a small team of people,” he says. “No one house can claim to be good at everything, and ultimately, it is easier to run relatively small pools of assets actively.”

Cazenove Capital had historically been set up as a balanced fund management business, splitting its client base into private money, pensions, and charities. Ross wanted to move away from balanced fund management to focus on a more specialist product offering for the firm’s single manager suite. “We wanted to run both long and long/short,” he says.

Cazenove Capital still considers itself to be a euro-centric manager, with core specialties in established European markets. The firm’s CIO is Anne West, who assumed this mantle in 2001, and can look back over 15 years with Cazenove. Tim Russell, Neil Pegrum, Julie Dean, and Paul Marriage run the firm’s UK investments, while Chris Rice and Steve Cordell look after continental Europe.

Ross is a fan of hedge funds: at HSBC he oversaw Russell’s market neutral strategy, and at Cazenove Capital he wants to see the firm running more non-correlated assets. He feels the business will be less vulnerable if it has a larger component invested away from long-only equities. And indeed, there is an increasing appetite for the absolute return investment case with many of Cazenove Capital’s existing institutional clients: keeping them happy involves creating long/short versions of the funds they are already invested in. It was this rationale that also lay behind the creation of a fund of funds product for charities that would be advised by Fauchier Partners].

“We looked to compete in areas where we could add significant advantage,” says Minter-Kemp. “If you’re going to charge fees over and above a tracking rate, then you need to be able to add value.”

The firm set out its stall in the UK and pan-European equities space, with some bonds coverage as a result of legacy assets still under management. Given its approach to running active money, which is much more risk-adjusted, rather than delivering returns or alpha above various benchmarks, it was decided to offer absolute return strategies in line with or integrated with long. “I think we’re quite unusual as a fund management house,” Minter-Kemp says, “as our fund managers usually have responsibility for both a long and a long/short model.”

From a starting point of slightly under £198m in Specialist Investment Management with external non institutional investors, Cazenove Capital managed to build its AUM up to over £2.4bn today, mainly by focusing its marketing activities on family offices, private banks, and some funds of funds. “We didn’t really pursue the very large institutions simply because the conversion rate is so long,” says Minter-Kemp. “As the market has continued up the risk momentum trade, it has also been harder to get business from the usual suspects, because there is a tendency to want maximum leverage, with higher volatility.”

“A very pragmatic approach”
In the early days of 2003/2004, which was probably the firm’s best year for subscriptions, both for the long/short and long-only funds, the firm was working hard to differentiate itself from its peers. It was advocating a philosophy of active management that set it apart from many of its competitors: it does not spend a lot of time on proprietary research, it does not have a team of analysts cutting and pasting data from other providers, but believes in strong relative value and the mispricing of securities.

“We have a very pragmatic approach,” says Minter-Kemp. “We don’t feel the need to have any permanent style biases in our portfolios, waiting for different times in the cycle to rescue performance. We will tilt the portfolio to where we think there’s value in the marketplace. We recognise that most stock selection will deliver the alpha over a set period throughout the cycle through a diversified approach, but what the market doesn’t often recognise is that all stocks have different financial characteristics, particularly in the area of financial and operational gearing. These are very cyclical and interest-rate sensitive companies, and when you go through an inflection point in the economy, be it a slow-down, an expansion, or a recovery phase, that’s usually where you get the best mis-matching in securities prices. Even though technically we’re a long/short product, we are broadly, through the cycle, market neutral.”

Deeply discounted cyclical examples include when Cazenove Capital bought steel-maker Corus when it became a penny share in 2003, a classic operationally geared play. The firm worked out Corus’ break-up value alone equated to approximately 11p/share, on the back of excessive down-grading by various analysts. Cazenove Capital went overweight in Corus, and saw its share price rise to 26p in four months.

When the cycle becomes more directional, the Cazenove Capital managers seek to lock down the risk, with a lower beta net position. “Our consensus to risk is proportional to the market,” says Minter-Kemp. “People ask us for a sector view, but we really don’t think like that. We break the stock universe up into different style groupings, and you have to accept the fact that there will be stocks that will migrate from one style grouping to
another in assessing risk premiums.”

For example, Nokia was a growth stock in the dot com era, but has since moved over to a more growth/defensive profile. As one of the most over-researched stocks in the market, it is capable of being just as volatile during the cycle.

“If you know where you are in the economic cycle, you’re probably paying the right price for the assets, and more importantly you’re taking profits at the right time for your clients,” Minter-Kemp explains. “Our conviction we tend to express through our gross position. Our current gross positions for most of our core portfolios, beta-adjusted, is about 130%, and represents reasonable conviction.”

At the time the firm launched its first alternative funds, the Gulf War had already happened, and the recovery was well underway. Sentiment had suddenly changed, with what seemed like the whole world underweight high beta stocks, and overweight large defensive companies. Loose US monetary policy was a key catalyst for the global economy going up a gear as it entered a recovery phase. Business cycle positioning dominates performance for the funds at turning points in economies and markets, but this was not the case for the fund launches in the autumn of 2003 with the high beta plays well entrenched in pan-Europe.

Cazenove Capital determines its net long or net short beta-adjusted stance, based on the mean reversion between large defensive, low-beta stocks and mid-to-small domestic stocks. The stock universe is broken up into different style groups, each with specific sensitivities to certain macro drivers, which, along with standard fundamental analysis, allows the managers to identify mispriced securities.

It is an approach that does not need a personnel-intensive or bureaucratic approach, it is fundamental that decisions are made quickly. Investment committees are anathema to Cazenove, although the fund managers will meet to discuss their portfolios once a week.

The managers try to deliver absolute returns of 10% net on a calendar basis, with the emphasis on delivering a low risk-adjusted return. The aim is to provide about a third of the market volatility with a minimal level of market correlation. Many of the firm’s clients find the funds of interest, because they help them to diversify and reduce volatility within core portfolios that are likely to be more correlated. “That’s where we think hedge funds should be,” says Minter-Kemp. “We believe in low correlation to the respective indices despite the temptation of this high beta momentum trading environment, driven by global liquidity. The problem with liquidity is that it distorts methodologies or logic: it is not loyal, it creates hot money, which can inflate your fund, but it does not have long duration. At the first sign of trouble it goes. We try to be very careful about building up a book of business with our clients, because we want duration.”

Cazenove Capital is currently happy with its capacity situation, given that most of its strategies rely on large to mid cap companies. It is confident that, relatively speaking, its funds are capable of taking on more assets than many of their competitors. It maintains a maximum single client exposure of 20% in its funds, with most of them in the $2-5m range, providing a reasonably well-diversified client book. There’s no doubt that when the funds were launched, if they had pursued a high direction, high correlated, leveraged approach, the firm would have garnered greater assets, but this was never its intention. The funds have also been priced at 1.25% and 20%, which is not excessive, and was based on the expectation that there would be downward pressure on fees for multi-strategy funds. The only exception to this is Neil Pegrum’s fund, which levies 1.5% and 20%. The firm also avoids using side letters on fees or capacity.

“From experience, I’ve found that you don’t generate earnings bringing in assets,” says Minter-Kemp. “You deliver operating profits through retention. I would rather have half the money that I know is going to be there for the next five years than hot money today. Managing the assets becomes difficult for existing shareholders, if a large proportion of the book retains a short term perspective with assets more likely to “jump ship” in pursuit of alpha elsewhere whatever the risk.”