GAM Delphic, a global long/short equity fund being run by ex-Marshall Wace portfolio manager Mark Hawtin began marketing to external investors in early February. GAM has made a significant allocation to the fund, understood to be in the tens of millions of dollars. Hawtin has also invested a substantial portion of his own net worth.
He joined GAM in October 2008 following a seven year stint as partner and portfolio manager of Marshall Wace’s Eureka Interactive Fund, once Europe’s largest technology, media and telecoms hedge fund. As the TMT boom turned to bust through 2000-2002, the fund returned an annualised average of 13.73%. In contrast, during those years the NASDAQ 100 fell by an annualised average of 36.14%.
“My focus has always been to generate absolute returns with low correlation and low volatility,” Hawtin says. “That is the style of management I like because I believe that leverage and concentration are the biggest enemies of hedge funds and that’s proven to be found out as the case over the last year and a half.”
During the little over six years Eureka Interactive operated it displayed monthly volatility of 3.1% and annual volatility of 10.6%. Correlation to the NASDAQ 100 was just 0.3.
“When NASDAQ was collapsing the fund enjoyed very good returns,” he says. “The thing for me was to always balance the protection of capital with the making of performance. I prided myself on broadly speaking not losing money in any year. That’s why what I wanted to do with setting up a new product was to target absolute returns with a 15-20% target return.”
Volatility range constricted
The fund is targeting about 1.8% each month gross and working on a volatility range of 6-9%. Hawtin says that if volatility is at the low end of 6% it will put the monthly two standard deviation event at between -1.5% and +4.7%. “I actually look at the fund like that to really focus on eking out the return month by month regardless of the market,” he says. “It is very much how we did it in the early days.”
An important point of departure for Hawtin with GAM Delphic is that the fund will be much broader in its investment scope than the TMT-focused fund he previously managed. On a structural level, it will seek to exploit market inefficiencies through individual stock picks as well astackling broader themes. A particular focus will be on companies and sectors going through a rapid pace of change and innovation, where Hawtin says the earnings delta is often high.
“Where industries are going through rapid change you get a dispersion of returns which is ideal for long/short investing,” he says. “You get companies that adapt quickly to that change and companies that are very slow to adapt. That gives you a very broad range of returns. The financials have been a good example of a sector that was fairly consistent in the way it operated but suddenly hit this period of extremely rapid change.”
The portfolio will juxtapose long and short stock selections based on ideas about specific companies while also investing in around five to 10 themes (see Table 1). The entire portfolio is expected to be spread over some 100 stocks with a limit of 10% on any given company and 20% on a particular theme. Short plays will focus on a range of companies that have modest one day risk levels to mitigate the damage from one-day share price pops to the upside.
“One theme is very cash rich, strong pricing power corporates,” Hawtin says. “A lot of those are in tech because they built up these huge cash buffers during the last downturn they had to endure during the early 2000s. That is a theme but there are one or two companies that I would have bigger positions in that I would classify actually as individual stock picks, so there is a cross over.”
Offered up the example of Microsoft, which has tens of billions of dollars in cash and a price/earning ratio of about 10, Hawtin is dismissive. He acknowledges the software giant’s defensive characteristics but is sceptical of its track record with acquisitions. “They have been late to move into one or two areas despite having the cash to do it,” he says. “I perceive a slowness in innovation now.”
Shorting financial services
The fund’s major short strategies are focusing on financials and financial services related companies. Hawtin says it is likely too late to short Royal Bank of Scotland, which traded at 12 pence in late January, and other UK banks (RBS had recovered to 22 pence in early February). “There is great risk now in shorting some of the bigger banks,” he says. “I suspect that the common equity of many of them is worth nothing. Depending on how governments and regulators chose to support these banks will dictate totally whether common equity holders get left with anything or not. The opportunity, therefore, to short is very risky.”
Hawtin has honed his shorting skills during his eight years as a hedge fund manger. His navigation of the TMT sectors during a tumultuous period in market history stood him as one of the more successful absolute return managers in that area during the period.
“To invest successfully in technology on the short side you need to have a great understanding of risk and volatility,” Hawtin says. “It is a skill set which many other managers I suspect haven’t got as they have been operating in sectors that don’t have that volatility. Knowing how to structure a portfolio of financial shorts and knowing how to manage through (rallies from shorting covering) successfully is an acquired skill.”
With the downturn in banking stocks having gone further than most had expected, he is wary about further significant downside. “Now we may have gotten to the point where people have almost given up on financials, but there were a lot of times over the past 12 months when people bought the financials thinking they had fallen too far without really understanding that the business models were completely broken,” Hawtin says. “I think one can move into other financial asset classes that have not suffered as much.”
One area he is actively exploring for short opportunities is commercial property. His primary rationale is that property companies have not taken sufficient write-downs to reflect the new economic environment even if share prices in the sector have partially priced this in.
“Companies have not yet come out and made sensible write-downs and I think there will be huge pressure on them from valuers and auditors who won’t want to take the risk of carrying potential liability. I think we will see further write-downs as results come through with a need for these companies to be in the market to raise capital in a market that is currently closed to raising capital.” He notes that the US and UK are the most overvalued property markets, but says some companies in Europe are also vulnerable.
Broader fund lowers correlation
Embracing a global equity long/short approach instead of a narrower focus on TMT allows Hawtin to target lower volatility with lower correlation. “I definitely suffered from having a TMT, Europe-centric fund after the technology market collapsed,” he says, acknowledging that the crash turned it into a short selling fund in an area of the market where liquidity had vanished.
GAM Delphic is a low-leverage, low correlation approach to portfolio management. “That’s the style of management I like,” he says. “I guess I have a natural paranoia. I always look at why I might have got something wrong. I don’t enjoy taking the view that I’ll put 10% of the fund in something because I know I’m right and the market is wrong. I like to be in a position where you aren’t as reliant on individual positions and you can change things when you to need to change them. You are respecting the market to allow the market to tell you when you are wrong and make a change when you need to make a change.”
“The idea is that I balance fundamental research skills with a trading skill set which I overlay,” says Hawtin. “Shares will only find their way into the portfolio on a fundamental basis but then can be traded actively. It meant that at the peak of the tech bubble there were a number of shares that clearly couldn’t be bought in spite of their share price momentum. However much you tried to stretch any valuation you couldn’t justify those valuations. Therefore I started taking down exposures in a lot of tech names probably earlier than others. That methodology continues here at GAM. Research goes into ideas but they can then be very actively traded once they are in the portfolio.”
Hawtin is using GAM’s operational management platform but has his own research team. It features Chris Woodcock, who joined from GAM, and Mark Ayling who has joined from Fidelity.