When Hugh Hendry is on a public platform he speaks in a series of epithets that stick in the mind to leave an impression of a bright, confident investor operating in their own radius of certainty. He spits out his observations and convictions like apolitician on the hustings. He cannot come across as a sober-suited scientist addressing a conference of like-minded peers talking about a statistically rigorous paper. This is not analysis based on the scientific method and "standing on the shoulders of giants". This is "like me, and please subscribe some capital to my fund", or at least "reinforce my ideas by putting your capital to work in the same direction".
Given he has ended up in the hedge fund world Hugh Hendry's first appointment in investment management may seem almost antithetical. He first had exposure to the money management business as an analyst at Baillie Gifford, doyen of the avowedly long-term Edinburgh investment companies. Baillie Gifford carefully manages investment trusts, and unit trusts, and latterly segregated institutional mandates, and equally carefully manages its own growth. A livewire such as Hendry may have found the place culturally stifling after eight years there, but what a great grounding professionally – seasoned investors, a thorough methodology and years of hard work before the payoff of partnership.
Of course an alternative to waiting for the elevation to the position of partner is to move to more stimulating environments. The first move South for Scotsman Hendry was as an associate director at Credit Suisse Asset Management in London, but his more significant step was to join Odey Asset Management in 1999. At this stage Odey Asset Management (OAM) consisted of a dozen people and between $500-600m in AUM, so the move had some risk on both sides.
It may therefore come as a shock to read that Hendry was intimidated for a period after his arrival at OAM. In the context of the time it is less surprising. The 29-year old Hendry was joining one of the very few hedge fund businesses in Europe that had been around in the earlier part of the 1990s. The principal of the firm, Crispin Odey, had made his name and newspaper headlines in 1993 with the success of his European equity long/short fund. The investment style of the firm was very much based in the macro view of the owner/manager. This has lead to the pattern of return of Odey's funds being different from other funds with the same strategy label – most of the peer group tend to be driven by bottom up (stock selection) factors. Odey has strong, well-informed and well-articulated views on economies and markets.
Hugh Hendry's time at Odey went through several phases. In the first phase it was very much "what have I done? I'm going to keep quiet, and soak up what is going on here."
"It was a 12-month tunnel for me, and I was paying my dues," explains Hendry.
The second phase could be characterised as "That is an interesting view you're giving me, here's what I think." A further stage was Hendry's realisation that, like himself, Odey could be wrong on markets, even when his macroeconomic argument was well constructed.
A key point here is the importance of technical analysis to both Hugh Hendry and OAM. For some years veteran chartist Brian Marber had provided a technical input on markets/stocks/sectors to the investment professionals at OAM. Through the course of time Hendry came to recognise that he was placing more reliance on the chart patterns and levels than his mentor Odey. Just as Hendry was increasingly relyingon technical signals to tell him he was right (or wrong) on the timing or correctness of his market and stock views, sometimes Crispin Odey's stance on the economic fundamentals was firmly fixed in his mind.
This difference of perception is not necessarily a problem. Sometimes an investment culture can sustain a multiplicity of views. Further there are investment management organisationswhere such differences are encouraged to generate internal diversification. However, to the extent that an organisation has a dominant investment philosophy, and varying with the degree of influence that a dominantindividual or pair of investors has in the firm, such differences can become an issue.
Hugh Hendry had assumed full responsibility for the long-only funds at Odey AM in the summer of 1999. The long-only funds he managed were run with consideration of the absolute returns – so the index decline of 28% in 2002 can be contrasted with the +3% return of the Continental equity fund run by Hendry. With this record and the backing of his largest investor he launched the Eclectica long/short equity fund in September of 2002. Thus Hendry had portfolios in which he could implement his style of investing and approach to markets. He also had successes which were externally acknowledged – Hendry was the Lipper Citywire All Stars 2003 Europe ex-UK Winner; and he won an award as Top Performing Newcomer in Hedge Funds in 2004 for the Odey Eclectica Fund. His style of management came out directly from working with Odey: " I am the "Frankenstein's child" of Crispin Odey," he chortles.
In 2003 Hendry generated terrific returns with the Eclectica Fund (see Table 1). Whilst there were a number of themes that paid off in contributing to the 49.9% return of that year (and the successes on the long-only side) the bet on gold was well publicised. There was some lobbying by competitors on the long-only side to have the fund de-classified as an equity fund because of cash and bond holdings. At the end of May 2003, after a 16.2% up month the top three holdings of Eclectica were Newmont Mining (17.5%), Royal Gold (11.9%), and Barrick Gold (5.0% of NAV). The next month the top equity holdings were Newmont Mining (13.8%), United Utilities (5.6%), and Agnico-Eagle Mines (2.6%).
Such activity around this time was indicative in a couple of ways. The stated investment objective of the Odey Eclectica Fund (as it was called then) in 2003 was "through investment, short and long, primarily in quoted equities, bonds and currencies in the United Kingdom. Investments may also be made in other quoted securities and related instruments including securities issued by companies not related to the United Kingdom."
Hendry clearly didn't feel constrained by this investment objective, and acted to protect existing capital/grow that capital as best he could. The same attitude applied on the long-only products (Hendry ran the pan-European and Europe ex-UK products at OAM). The important point is that Hendry was prepared to go his own way in an investment sense. Secondly, the small snapshot of top holdings (and indeed fund shape/asset allocation too) shows that the manager of the fund did not act as if he was constrained by holding periods of positions or turnover of positions or, in the case of the long only funds, index weightings. The turnover of the Eclectica Fund runs at about 25x a year. That turnover each month is roughly equivalent to twice the portfolio size.
2003 must have been a significant year in the psychology of Hugh Hendry as an investor in markets. He was vindicated by markets and validated by markets. The approach to investing he had been building over the previous four years had had the kind of pay-off that he felt his approach could generate. Whilst the returns produced by the Eclectica Fund in 2004 (+8.1%) and 2005 (+15.6%) did not grab the attention of external investors in the way that those of 2003 did, they did contain significance to the manager. "The returns of 2004 and 2005 for Eclectica were okay-to-good by most hedge fund measures," says Hendry, "but the way I look at them is that I got so much wrong in those years, and yet I still produced the positive absolute returns that we look to give our investors on a calendar year basis."
It is this burgeoning confidence in the investment process that was one factor behind Hugh Hendry and Simon Batten setting up Eclectica Asset Management. It was public knowledge in the first quarter of last year that the pair were in discussion with OAM management over the management contract of the Eclectica Fund. At that time the fund assets were about $330m.It turned out that Hendry and Batten had decided to own outright the management contract forthe Eclectica Fund: they both wanted to havetheir hands on the tiller for their respective spheres of activity – Batten on the business side and Hendry on the investment side. Eclectica Asset Management received authorisation from the FSA to operate in June last year.
Potential investors may not expect a fund that can lose 7% in a month and has a rolling 12-month standard deviation of return of 17.1% to be described by its manager as having a "disciplined approach" , but that is the reality. Most hedge funds are managed with one specific timeframe – weekly and monthly timeframes dominate the industry. The Eclectica Fund, like many high-end CTA funds, is run with multiple time frames of 1-month, 3-months and 1-year, though of course the CTAs are overwhelmingly systematic traders and Hendry's approach is judgemental. The key point is that Eclectica Asset Management seeks to build a long-term track record by stringing together a sequence of high absolute returns for discrete calendar years.
The performance fee arrangements are exactly aligned with this precept – a 20% performance fee paid out after the year-end, subject to a high water mark.
The dominance of the calendar year period comes out in several ways apart from the fee structure. "We aim to avoid calendar year losses: I'm desperate to be a survivor," says Hendry. "Once there is a cushion there, and for us that would be 10-12% return on the year to date, then risk (leverage) can be increased as we try to ratchet up returns to investors."
That risk inflexion point came in April of 2003 (2003 return 49.9%), it was not attained in 2004 until November and so was too late to affect risk appetite (2004 return 8.1%), and last year returns got above 10% on a YTD basis in February (return for year 15.6%). As Eclectica has been off to such a good start for 2006, Hendry has 11 months to commit more fully to markets to generate large absolute returns.
A second manifestation of a 12-month time frame is in investment management/risk management. Position sizing and stop loss levels are a function of opportunity at Eclectica. The decision rules Hendry uses to both assess the scale of the opportunity (profit potential) and the stop loss levels are functions of moving averages and scale of price change over time. It comes out in discussion of any traded market: "the Nikkei has traded at an average level of 17,000 over the last 25years," (copper is rather exuberant being 38% above its 1yr MA) says Hendry.
"When the NASDAQ peaked in 2000 it was running at 65% above its 12-month moving average," is a typical comment. These measurements and observations of how markets have traded historically feed into Hendry's expectations for how markets will trade in future. His target price for crude oil of $80 a barrel was based on a blow-off of 65% above the 12-month average price that would emerge.
There are other examples from Japan. "The Japanese personal sector displays more financial conservatism than the Victorians – they've lost 80% to 90% of the value of their homes and stock portfolios…Tokyo property prices fell over 80% after the bubble burst."
Hendry contrasts these statistics with boom times elsewhere to show the upside potential: "note that an investment in 1990 in the Californian based house builder, Toll Brothers, would have yielded an 80 bagger in price appreciation" ; and "just like Keynes bought bombed out steel companies for less than 10% of sales, we own a lousy Japanese metal basher that has revenues of $1bn that can be bought for $30m. These are 10-bagger opportunities. Or to put it another way, we consider that these trades have optionality."
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Hendry's long term target for the Nikkei index is 40,000 in the year 2015. This exemplifies his reference to the cyclical influences at workin traded markets. "It takes 35 years for stock markets to travel from peak to peak – for example 1929-66, and 1966-2000…Gold has been in a 19-year bear market which has destroyed the asset's credibility; the next 16 years are the benevolent ones for gold."
The core of what Hendry does he describes as being like a code-breaker – seeking to identify what he sees as "a series of virgin bull markets". He says his aim is to "keep our sanity/solvency by investing exclusively in rising price trends. It's like walking past restaurants: I only want to go in if I can see it's busy."
Hendry uses long-term price data and charts to point out when bear markets have finished and when they are showing evidence of entering primary bull markets. A significant chartpattern may be as basic as a double bottom or a sequence of higher lows on a multi-year basis. Interestingly he uses relative price charts (performance against the index) for stocks for the same reason. A set up of observations over a couple of decades, and where price exceeds some long term moving average, gives potential for a multi-year upside, but short term timing may be difficult. In such circumstances Hendry may implement the view using options (which are in all likelihood cheap if the market is emerging from a bear). When a bull market has been established positions may be taken in futures (outright risk assumption).
Not that all the positions are directional. The Eclectica fund often has variance swaps or options to implement views of volatility, and an increasing though still small component of the fund is in matched positions. One such pair was long AMD versus short Intel, and recently Hendry has put on a long Sainsbury's position against a short in Tesco. "The way I see it," says Hendry, "in a world where all asset classes are expensive(equities/bonds/housing/collectables/some commodities), it's a way of avoiding taking market risk and it brings another facet to the fund."
Positions are cut and sold entirely when they breach the appropriate moving average of the price. All multi-year bull markets will have interim consolidations and corrections. The very longest moving averages are used to determine the primary position – long term bullish. The signal to take an interim profit (primary bull intact) will come when the traded price drops through a shorter term moving average. Hendry will take it that he was wrong on the primary bull market if the price drops through the longer term moving average (bull market signal aborted). Outside the MAV discipline the manager is also allowed to use option money to commit small amounts of capital.
It is the job of the Eclectica dealer Suren Patel to track the price versus moving averages across all 400 positions. Not all positions have hard stop losses, and none have price targets. There is some debate within Eclectica about the closing of positions. Sometimes an analyst, the dealer, or Simon Batten will throw their weight behind implementing a closing trade, but it is ultimately the decision of Hugh Hendry. The debates can last some time, extending over days and even weeks. Mostly Hendry has a bias to action. "If we start to consider a change to a position, I tend to cut a third and think about the rest. I've found acting first and philosophising later (to paraphrase Soros) to be the best approach."
There is a philosophical reason for the absence of price targets. "Yes we do have an idea of where a security should trade," confesses Hendry, "As we usually enter a position where there is a positive trend we look to stay in the position provided the trend remains unbroken." Internally this is summarised as "conviction is overruled if it lacks market confirmation." According to Hendry he bows down in acknowledgement of Crispin Odey's strength in this area: "Crispin says that within a trend I'm the best. I'd also say that understanding turning points was a big insight I gained from working with Crispin."
The portfolio manager and trader at Eclectica do not do any of the fundamental research. Consequently they have all of their time available for portfolio monitoring and construction. "The analysts speak to the protagonists on a company or industry," says Hendry. "I'm in my ivory tower, and we (the dealer and I) are governed by the markets. The analysts are there to validate my ideas – they get the detail, and are the ones getting grubby rooting around. They increasingly are coming forward with their own ideas. The combination of the dealer and the analysts are there for me to make sure we fulfil our overall mission as disciplined deviants."
What is Eclectica Fund? It is described by its management company as "an opportunistic fund investing in global equity, fixed income, currency and commodity markets," and it "aims to fully utilise the balance sheet." The last part expresses the risk appetite necessary to produce "superior risk-adjusted returns over the long term". The approach to risk control that is used has been developed "to contain the mistakes of the manager," according to the manager himself.
Eclectica Asset Management. The name ups the ante. It can't be associated with a "me too" European equity long/short hedge fund with a handle like that, and it isn't. It is quite appropriate that investors look to the US to find a comparison (see Q&A) because there is not another fund in Europe like the Eclectica Fund. The fund comparisons that come to mind are not even latter day American hedge funds: Hugh Hendry is on a path to re-create the funds that Steinhardt, Soros and to some extent Robertson became, funds that outgrew their equity-focussed beginnings, and that flowered to utilise the full scope of wide investment powers.
The European landscape of the hedge fund business is dotted with funds and individuals that produced large returns early in their track records and never again even tried to extend their balance sheets to produce top ranking performance. The yearly returns of the Eclectica Fund give a verisimilitude in this regard for Hugh Hendry. But it would be a mis-reading of the history of the fund. The return of 49.9% in 2003 represented success, but the returns of 8.1% in 2004 and even 15.6% in 2005 did not reflect success in the mind of the manager. The returns of the last two years have been described by him as those produced in badyears. When he is in gear with markets and makes fewer mistakes he expects to replicate the returns of 2003 and do better still. If CEO Batten is right and Hendry is getting better, then investors had better prepare themselves for some big numbers in the years ahead.