Their aim was simple: to build an asset manager that would incorporate what they had learned at Goldman during their careers. Internally, this meant getting the culture right to attract talent and retain it. Further, it meant aligning the partners directly by investing their own money on the same basis as clients. Finally, institutional standards were put in place from the outset. As Fulcrum approaches its seventh anniversary, The Hedge Fund Journal visited Davies and Stevens at their Chesterfield Gardens office just off of Curzon Street in Mayfair.
“The vision for the firm was to combine some pension fund and family office style products for mixed asset allocation and then spin out of that some hedge fund or UCITS products which we could market as specific funds,” says Davies. “We’ve developed out of our original balanced mandate approach funds in each of the main asset classes. The unifying force behind it is that most are driven by macro-type factors and most tend to be model-based. We are a mix of human skill and systematic models. Some products veer more in one direction, some in the other. We think of ourselves as rigorous financial and economic modellers, mostly in the macro sphere and that is the unique selling point we think we bring to our products.”
A diversified offering
About 85% of Fulcrum’s $1 billion in assets under management is from institutions, including family offices. It runs seven single manager funds, including UCITS funds, targeting macro strategies, equities, Africa and commodities as well as an asset allocation product and a fund of hedge funds (See Fig.1). At the beginning in 2004 Fulcrum’s approach was an extension of what Stevens had done at Goldman, namely running long only globally diversified portfolios that held equities, bonds, commodities and currencies.
“What we wanted to do quite rapidly was to add to our core fundamental skill set, so we built up a skill set in behavioural finance,” Stevens says. “We looked at technical factors such as momentum, position, sentiment, mean reversion and liquidity. By combining the technical factors with the fundamental factors that you would expect from our backgrounds we wound up with what we thought was a much better overall approach to investing.”
In the early years, a lot of Fulcrum’s investment research was under-utilised since the funds they ran couldn’t short or use leverage. Launching Fulcrum Alpha, a quantitative global macro fund, in August 2006, saw the firm add hedging to its fundamental and technical research. Because neither Davies nor Stevens had absolute return backgrounds, they put their own capital into the strategy and started with a low risk budget. Over the next three years, the risk was dialled up with volatility and short-term trading strategies added to the core quant macro and trend following strategies (See Fig.2) to improve risk-adjusted returns.
The fund started steadily in a difficult environment for quant funds. It gained 6.9% in its first 16 months to the end of 2007, and achieved a 6.1% rise in 2008, despite the large falls in risk assets that year. Its reading of technical market flows helped the fund get short before fundamental macroeconomic data indicated the scale of the financial downturn to come. This meant the fund made money getting short of risk. At the beginning of 2010, risk was raised further to target a realised volatility of 12% which resulted in the fund more than doubling its previous best return with a gain of 17.5%.
“The reason we ran volatility at a lower level initially was that we wanted to test the strategy to see if it did in real life what it had done in the back test,” says Davies. “We also wanted to build more models that were more diversified than the ones that we had. When we started we had a dominance of macroeconomic fundamental models over three to 18 month horizons combined with mostly medium-term momentum type models. The research team, led by CIO Suhail Shaikh, has now built a much richer set of models over different horizons. As we have added new factors, the weight on fundamentals and medium-term momentum has been reduced, making the fund better diversified overall.”
Developing the models has introduced much shorter-term factors, especially concerning exits from positions. The realised Sharpe ratio of the fund since all the new models were introduced in November is 2.3 with a goal of being above 1.0. The programme’s relatively small size – AUM of $130 million – enables it to be more nimble than larger rivals.
“We think it is important as it gives an advantage in trading in and out more quickly than some of the verybig funds,” says Davies. “We feel we should take advantage of this. It has helped us and will continue to until we are much, much bigger.”
The fund is active in the liquid front end of volatility curve products. It uses models that take positions directly in volatility. In addition, hedging systems have become increasingly sophisticated. With hedges the primary aim is to reduce volatility, boost the Sharpe ratio and pare the cost of running portfolio insurance.
The portfolio is generally hedged against significant tail risk. The managers seek to fund those costs by occasionally selling away upside. The greater activity in volatility trading is directly aimed at hedging the risk that the models have elsewhere. This aspect of Fulcrum Alpha is subject to direct human control day to day.
“What goes into the models is entirely determined by humans,” says Stevens. “People ask us if we are frustrated not trading this ourselves, but instead relying on models. The answer is ‘Not really’ – the models are systematic descriptions of what we believe works in markets. We think the models are less emotional than people and we think they are easier to measure and have a lot of advantages over people. I’m not one who says it should all be models or it should all be human. Both have a role. In this product, the role for humans is designing, building and hedging the system.”
With hedging, the managers are particularly alert to events in the macro environment such as economic data releases and assessing major macro risks. Fulcrum continues to develop its hedging strategies to dampen costs and open upside opportunities in particular situations. The fund’s relatively stable return profile is shown by a biggest ever monthly drawdown of 4.07% in July 2008 and a record of never suffering a losing year.
Now an asset manager, Davies was for decades among the world’s most influential economic analysts before he retired from Goldman to become Chairman of the BBC in 2001. His influence continues to be felt through regular commentary in the Financial Times. Davies concedes that the outlook for the global economy is highly uncertain as reasons for optimism about the recovery face some big question marks.
“The most important reasons for optimism are twofold: one is the most rapidly growing part of the world in the emerging markets is not subject to the financial and public/private debt issues that the US, Europe and Japan are subject to,” Davies says. “I still think we tend to overlook this. Second, in the developed countries we have had such a deep recession that the household sector and corporate sector have heavily retrenched and they can now afford to relax that to some extent while still paying down debt. What we are seeing in the US is debt being reduced but, in addition, we are seeing spending increase. What is happening now in the US is similar to what happened in Scandinavia after their banking crisis in the early 1990s, in the UK after its housing market crash in the early 1990s and to some extent what happened in Asia in the mid-to-late 1990s.”
This gradualist view implies a return to trend growth that eventually helps both governments and the financial sector recover. The exception to the rule, of course, is Japan where companies have maintained an extremely conservative financial position since the shock of the late 1980s and growth, instead of reverting to the long run trend, bumped along at negligible levels.
US avoiding Japanese path
“Japan is the exception we are all worrying about but at the moment it doesn’t appear that the US is going down that path,” Davies says. “Obviously in our money management we are trying to figure out if the US and Europe are going more down the Japanese path or will succeed in reverting to the long run growth trend. I am in the optimistic camp on thatbut not completely convinced. I am ready to change my view if it proves too optimistic. A lot of people are resistant to believing that the US economy can recover because they see the debt problems, the financial problems and the incredibly bad labour market position. But recovery is a bit more likely than non-recovery.”
Where Davies is concerned is with the challenge policy makers face in engineering a successful exit from their abnormal positions. “We’ve not really ever seen policy readings like we have today – massive increases in public debt, the monetization of much of that debt by central banks and 0% rates,” he says. “How we exit from this is a very big headache and it could go badly wrong.”
Davies expects interest rates in the cycle to peak at 100 to 200 basis points above current levels. He expects the Bank of England to make a small hike in 2011, which will slow the recovery. In his view, the Federal Reserve will go another year or two without raising rates since it is more convinced than the Bank of England that the labour market is abnormally slack. “That produces a strong bias towards easing in the US,” he says. “The markets are too pessimistic about the Fed tightening. They believe the Fed is going to tighten before it actually will tighten.”
In an unusual departure, Fulcrum has developed one large cap African stock picking fund running in a UCITS wrapper and a second fund, recently launched, to invest in companies with market caps of as little as $500 million. It is run by two experienced African investors, Alex Trotter and Senyo Dewotor, who joined Fulcrum from United Bank for Africa last year. The partners strongly back what they call “the African renaissance story.” The investment thesis is that domestic growth will drive demand for financial services and consumer goods. What is somewhat unusual about the approach is that it excludes South Africa completely, instead investing in 11 other countries, with Nigeria and Egypt getting the most exposure.
“It is an exception but an interesting exception to what we do generally,” says Davies. “It is driven by the belief that Africa is emerging from the doldrums in the same way Latin America did in the 1990s. In Africa we like the strong macro case based on the growth prospects, demographics and change in economic policy.” Key holdings include stakes in Nigerian financial sector players Skye Bank and Zenith Bank, Kenya Commercial Bank and support services operator Maridive & Oil Services.
Another recent launch is the Fulcrum Commodity Fund which opened in November. However, it has a four year trading record since it is a carve out of the absolute return commodity strategies that featured in the Fulcrum Alpha hedge fund from inception. The carve out, rebased to the desired volatility level and adjusted for risk controls and UCITS restrictions, has achieved compounded double digit percentage returns since May 2007. The fund uses swaps to invest in sub-components of the Goldman Sachs Commodities Index. A bank counterparty buys the futures and gives the fund delta one exposure via the swap to the underlying commodity future. This is probably the most common way for strategies to invest in commodities and stay within the UCITS rules that forbid direct investment in commodities contracts. An advantage is that liquidity is similar to the high levels found in mainstream commodities futures markets.
“We think the fund will have exposure to commodities most of the time,” says Davies. “But we don’t think most of our clients are ready to have exposure to that volatility in a down market. We want a strategy that can potentially protect against very severe down markets in commodities.” Davies professes to be more bullish about equities than commodities this year after being more bullish about commodities in 2009. The chief aim of the approach is to give a commodities hedge to investors who want it over time.
The UCITS fund draws on the same absolute return commodity strategies as found in the hedge fund. This includes four model types: one that is fundamental (looking at supply and demand) and three others that are based on market technicals. Fulcrum continues to work on developing the fundamental analysis between, say, macro leading indicators or industrial production growth and commodities prices, but is finding this tougher than developing fundamental models for equities, bonds and currencies.
“The things that have worked best in commodities in recent years have definitely been technical price driven models,” says Davies. “When we look at how commodities have performed recently, including the massive drawdown in the second half of 2008, we wanted to put in downside protection as drawdowns in underlying commodity prices are too big.”
Indeed, the fund drastically shrunk commodities exposure in the second half of 2008, so the drawdown was very limited. It also escaped a drawdown in early January 2011 during a time when many commodities indexes fell.
The Fulcrum Global Diversified Fund invests across the in-house fund range, index tracking funds as well as third party managers such as Winton Futures and Blackrock UK Absolute Alpha. The fund aims to achieve long-term capital appreciation through high diversification while looking to minimise downside risk. The fund of funds offering, Fulcrum Alternative Managers, has similar objectives but advances them by allocating solely to external alternative asset managers.
“If you look at the business today, it is an asset management company with a range of different strategies and inputs that tend to be fairly similar in terms of fundamentals, technical factors and risk management but the outputs aren’t that correlated to each other,” says Stevens. “The approach was to maximise all we were doing on the research side by adding relevant strategies, while keeping the investment process centralised and tightly controlled.”
Fulcrum’s highly diversified investment approach is a key part of its architecture. Combined with this is an all weather approach to investing that has guided the firm’s investment philosophy from inception. As its presence grows on the European investment scene, Fulcrum’s foundations look sturdy. It is noteworthy that over a period when the hedge fund sector went from go-go growth to severe retrenchment all of Fulcrum’s key original employees and subsequent hires remain.
“Everything is very much based on a blueprint put in place by the more senior people at Fulcrum, people like our partners Tom Dempsey (President of Fulcrum North America), Jeremy Bedford, and our COO Joe Davidson” says Stevens. “Gradually as our younger people become more experienced they are very much involved in that process. Process is the key word. We value everybody extremely highly but it is very much a collaborative team approach with that blueprint of the process. As a result we are a lot less susceptible, we hope, to star managers and other outcomes that might occur with a different investment process. We hope that focus will enable us to attract good people and also to keep them, and work in a much more collegial, collaborative fashion.”
“It comes down to culture,” Stevens adds. “Our experience at Goldman tells us that culture is most of what this business is actually about in the end. If you can get that right – it is a vulnerable thing culture – then people will stay with you.”