Estlander & Rönnlund Group

Land of the midnight sumsLaurence Davison talks to Martin Estlander and Kaj Rönnlund founders of Estlander and Rönnlund Group, the Finnish CTA which manages approximately US$400m.

Laurence Davison
Originally published in the October/November 2005 issue

The hedge fund industry encompasses many unusual locations; there cannot be many other businesses in which names like the Cayman Islands, the British Virgin Islands and the Bahamas are considered conventional places to do business. Even so, one country that rarely makes the alternative investment map is Finland, home of commodity trading advisor Estlander and Rönnlund Group.

But E&R founder Kaj Rönnlund explains that the unusual location, despite not being a traditional hedge fund domicile, works as an advantage to the firm in finding and retaining talent. “It’s a quality of life thing,” he says. “Many of our people have families, children, a summer house at the lake and so on. They could double their wage, but the question is…what is their real quality of life? I’m not saying that we’re never going to lose anybody, but I haven’t so far seen it as a big problem.”

In fact, Rönnlund jokes that, as a firm that takes the majority of its staff from an academic background, E&R might be the only hedge fund in the world that runs the risk oflosing staff to lower paid jobs, as analysts head back to academia. Nonetheless, being positioned in an unusual market allows E&R to take its pick of the Finnish academic crop.

“The good thing about our location – the genius of the location you might say – has to do with the people and the people we can attract,” Rönnlund claims. “We are the only quantitative hedge fund in Finland so we can attract very good people; we can have the best from the universities. If you want to work in finance in Finland, with quantitative finance, you come to our address.”

The origins of the firm could be said to stretch back to the 1970s, when Rönnlund and his partner Martin Estlander met in primary school. Rönnlund says that the two were classmates throughout school, and subsequently spent their compulsory military service together. With at least one colleague having spent a portion of his time in the Finnish army braving temperatures of thirty degrees below zero in Lapland, it is easy to understand how a bond was formed.

As Estlander explains, “Kaj has been my best friend since I was a kid so obviously we know each other very well and know how the other one thinks. If one of us comes up with a new idea, it can be well chewed and analysed before presented, therefore minimizing time spent on many issues, which is very efficient.”

Rönnlund agrees, saying, “We discuss things, we come to conclusions. We have the mindset of: ‘yes, this was my idea – but I don’t need, ego wise, to drive it through. There are a hundred roads, why is my one necessarily the right one?'”

With Estlander being a computer scientist by training, and Rönnlund the most visible face of the fund – The Hedge Fund Journal met Rönnlund in London on one of his frequent road trips, while Estlander corresponded from Finland by email – it would be tempting to assume that there is a predictable breakdown between the mathematician and the marketer within E&R.

However, Rönnlund explains that that conclusion would not tell the whole story. He says, “Martin is very analytical – it’s no coincidence that he is a computer scientist. But he is very rare in that sense, in that he is also very outgoing; a very likeable guy I would say.”

Asked to describe Rönnlund, Estlander paints a picture of an easy-going, level headed partner. “Kaj is a very stable and honest person – which is a prerequisite for a 5050 partnership working so smoothly for so long,” he says. “And he is very funny and gives a good laugh every now and then, which is important as well!”

Student traders

While the two met in the Seventies and have remained close ever since, the progression from schoolmates to hedge fund managers was by no means a natural progression in a country with little tradition in alternative investments. Rönnlund explains that the pair started to trade the nascent Nordic options markets while studying different disciplines at university.

Later on, towards the end of 1986, Rönnlund says that he and his partner began considering the possibility of trading full time after graduation. However, he explains, “We did not go through the normal route, where you go through a bank and apply for a job as a trader. We had entrepreneurial backgrounds from our families, so we decided to go direct and acquire a seat in the option exchange in Stockholm.”

As market makers there, they traded a single index option and a handful of single stock options – but even Rönnlund admits that this get up and go approach was only made possible by virtue of the market being in its early stages.

He says, “Today, our approach would not work – it is a much more professional environment now. But in those days we had a pretty good education in derivatives from the beginning of the Eighties in Finland, and that was enough to get started.”

At this point, it seems that the pair had no guiding vision, and in fact did not even see their future in the derivatives world. “I used to challenge my professor,” Rönnlund recalls. “I’d say: ‘Isn’t it uninteresting to have this kind ofderivatives teaching in the school, because probably we won’t have anything to do with options and futures anyhow?’ But that was our destiny.”

Of course, the progression from relatively successful local traders to fully fledged fund managers is not an easy one to make, especially for two individuals from a country not recognized as a financial hub, with no background in institutional asset management or banking.

The breakthrough came, Rönnlund explains, because the pair had extended their own trading to advisory and brokerage activity to larger institutional clients in the Nordic region. From here, he says, it was a natural progression to move into fully fledged investment management. The move was made at the turn of the last decade, aided by seed finance from Commodities Corporation – later acquired by Goldman Sachs. Even so, it was only in 2001 that E&R decide to focus on the asset management business, leaving behind its previous core business of proprietary trading and market making. At the time, the decision was not necessarily clear-cut.

In the end, Rönnlund says, “We went for the asset management – we saw it was growing and we steered towards that. The interesting thing was that we could utilise the knowledge we had from the proprietary side; the platform and IT was always very important to us. For example, we were very early confronted with electronic trading in the Swedish market, so we started to develop our own systems for quoting, risk management and the like.

“That [has] become now something we can run on the hedge fund side. For example, the high frequency, intraday, models definitely need solid platforms because the hedge lies in how little slippage you have.”

On the strategy side, Estlander explains that E&R breaks its offerings down to a significant extent by trading duration. He says, “We divide our 15 different global models into four different categories; short term – intraday – price driven strategies, medium- to long-term strategies with volatility bias, fundamental/econometrical models, and finally volatility arbitrage looking at the relationship between option pricing and market activity.”

The firm also has a statistical arbitrage fund with a volatility focus in the equity space.

Options to futures

The other significant move E&R made was from an options trading environment to managed futures. The move was possible, Estlander says, because of the firm’s strategic approach.

“Volatility has always been the speciality of our firm, and volatility has been the focus of our research and trading since we started options market making some 20 years ago,” he explains. “Most people relate to daily equity market volatility when talking of volatility, but there is so much more to the concept. We look for volatility exposure in not only many different markets, but we also look for volatility over multiple timeframes ranging from intraday to long term volatility, always trying to buy volatility in the most efficient way.”

Even so, Rönnlund says that the firm has maintained separate expertise in both futures and options – even basing the two business areas geographically separately in Helsinki and university town Vaasa.

Being based outside conventional hedge fund circles, Rönnlund says, allows E&R to take an approach that avoids the traditional problems of managed futures funds, notably the high correlation to each other in times of market stress: “The skill set is not extracting returns in a favourable environment – that’s not the tough part of it. The problem is the cyclicality of returns, where you end up giving back money,” he says. “What we saw last year, and I think we’re going to see even more, is quite a big shift within CTAs generally. There is the old school still, and many of the bigger managers are still subscribing to that, saying ‘we have a model that works, why change it? It’s captured the trends and while there are periodsin which we suffered, over 20 years we’ve made money.'”

E&R, Rönnlund continues, is part of what he calls a “new school”. As part of this, “We ask why we always have to give away that money – can we do it in a different way, extract different things? What says that you should only look at mid- and long-term trends in the market? What says that you should only look at price?

“To do that you need completely different skill sets than you would normally find within a managed futures fund; you need guys with a global macro background looking at fundamental input, you need guys from a derivatives and options background and guys used to high frequency trading.”

Investor interest

One problem that a hedge fund based in Finland might be assumed to have is a difficulty in convincing investors that it is worth their while to look off the beaten track for a place to put their money. With hundreds of CTAs jostling for attention in the UK and US, it could be difficult for a Finnish firm to get noticed.

Rönnlund acknowledges that E&R’s early stage investment came, in the main, from pension funds and institutions in Scandinavia. He also admits that attracting investment from outside the region has its difficulties, with many potential allocators reluctant to perform due diligence in Finland unless they have already decided to invest.

However, he says, “This is very much the case from a UK or US perspective. But look at it from a Tokyo or Hong Kong perspective: it is the other way around because for those guys, the shortest connection to Europe is through Finland, and Finland has a very high pedigree in Japan in terms of technology. They can very much understand why a hedge fund can be situated in Finland, so the location is not so bad.”

Outside of managing money, it seems that Estlander and Rönnlund have a characteristically Scandinavian outlook on life. Asked why the firm remains based in Finland rather than fleeing to a tax haven, Rönnlund says, “It’s mindset: if you didn’t get anything for the taxes you pay then it would be different. But we get free education at a level that’s top notch – I think it’s important that you get that, as well as safety and the quality of life. When you know there is a good environment and good education, you are prepared to pay for it.

“Obviously you are never satisfied – you always want to have lower taxes – but that’s the model; of course it’s not the common one if you look at the rest of the world, but somehow it has been working out and we are part of it.”

Respect for the Finnish education system is one of the reasons that E&R takes many of its recruits from there. However, this should not be taken to mean that the firm targets Finnish nationals as employees; Rönnlund points out that more and more foreign students are being educated within Finland and that his firm sees these students as a major recruitment source.

As he admits, it is difficult to persuade experienced professionals to relocate to Finland. However, he anticipates the firm opening operations in both London and Hong Kong, covering both business development and investment research, and from there he would expect to broaden the recruiting base.

Future plans

Growth is not just being targeted geographically, though. With around $400m under management at time of writing, Rönnlund predicts that the firm could handle up to $3bn without sacrificing return. Over the course of time, he says, further expansion would be determined to a large extent by the emergence of new liquid markets.

The partners have plenty of time on their side for the firm to reach its full growth potential: both are a relatively young 42, and Rönnlund says that neither have any plans to leave the business in the near future.

“Should we go and play golf? Pretty boring! The interesting thing is that if we were in a business that was traditional we would both get bored very soon, but what drives us is that, even though we have been in this business for a very long time already, the company has never been as dynamic as now, and we have never had so many ideas for further development.” Nonetheless, he does like to foresee a vision of E&R existing as a firm after the departure of its principals. Once again, he refers to a sense of loyalty to his home country, saying, “We have been building this for a very long time. It is important: we are the only quant fund in Finland and it is very good that there is such a fund in Finland.”

In the mean time, the firm is prepared to change its approach and adapt to circumstances. Rönnlund describes a time, two or three years ago, when the firm decided to broaden its strategy base instead of focusing on its core business. More recently, he and Estlander have changed their opinion, and decided to try to specialise in the firm’s main competency and allow its strategy to develop organically.

“Is the best way to generate returns for our clients to say we offer 10 products, which may not all be so good?” he asks. “Many people do it that way, but we have decided to say sorry, we only have this one product – maybe it does not taste right for you but it is the best one.” This does not mean lack of diversification, though. Estlander explains, “There is obviously strategic value to broadening the strategy base. We operate multiple strategies within our funds which gives more possibilities to efficient allocation in changing market conditions.”

In an ever-more crowded market, E&R certainly provides a different perspective on a traditional hedge fund strategy, a perspective that has undoubtedly been shaped by the firm’s unusual geographical background. Whether or not the “houses by the lake” become more appealing to the firm’s founders, it can only be a good thing to see an unconventional cultural approach to alternative money management.

Laurence Davison is the Editor of Futures & Options Week