In the back of the worst year ever for hedge funds, the timing may be less than auspicious for Gartmore Investment Management’s absolute return manager stars Roger Guy and Guillaume Rambourg to celebrate their 10th anniversary running the AlphaGen Capella Fund. But a closer look shows that Guy and Rambourg delivered in spades for investors in 2008, with Gartmore’s flagship hedge fund losing just 3.6% at a time when most equity long/short funds lost over 20%.
In November, Gartmore marks a decade in hedge fund management, with AlphaGen Capella showing an average annualised performance of 14% through the period. In 2009, that record is being extended with the fund bouncing back 12.7% for the first nine months, bookending the 2008 fall with the 46.9% rise that spectacularly launched the hedge fund careers of Guy and Rambourg in 2000. Since then, their success as stock pickers has impressed peers at some of London’s biggest hedge funds and underpinned their reputation with investors.
Since The Hedge Fund Journal last met Guy and Rambourg in 2005 the investment universe has experienced unprecedented change. The world economy boomed and asset prices, symbolised by pumped up real estate markets, soared before the credit crunch smothered Bear Stearns, Lehman Brothers and AIG. Then after months of declines came a dizzying surge in markets through the second and third quarters of 2009. With this backdrop, it seemed timely to revisit Gartmore at the investment manager’s Fenchurch Street base in the City. The discussion focused on the investing philosophy of Guy and Rambourg, their outlook as well as how the financial crisis has changed investment firms. We began with a review of how the AlphaGen Capella managers negotiated one of the most onerous years in investment history.
“In 2008 we started on the wrong foot,” Rambourg says. “We were a bit too net long at the start of the year and it was our worst ever month for the fund, down 2.1%. We were 20% net long into a market that came crashing down,” he says, recalling the sell-off sparked by the rogue trading scandal at Societe Generale. “We limited the damage because we work with a very strict stop-loss discipline on every single position. It was quite a difficult year with all of the dislocation from hedge funds and prop desks closing down, and people being forced into closing their positions. Fundamentals were pretty much secondary. But we ended the year a lot better. In the fourth quarter when all hell broke loose – post Lehman – our fund was up 1.4% net in a European market that was down 22%. We adapted, particularly to the fact that valuations were not too relevant last year.”
For value-biased investors with a long track record, this is a tough admission. The managers found, however, that the way to negotiate the market wreckage was to avoid stocks that had looming balance sheet problems. Though their net exposure wasn’t excessive for most market environments, it proved big enough for the fund to take a hit when the market crashed 20% in just a few weeks.
Low net exposure
“Our range is normally +10% to +25%,” says Guy, noting that the net exposure began 2008 in the higher part of the range. “We felt the year before had finished badly so we decided at the start of the year we would try and do well. But by the end of the first week we changed the fund and most of our losses were in that first week.”
Subsequent adjustments and the managers’ battling determination worked well during a vicious trading environment. Momentum, so often the trader’s friend, became a potential double-edged sword in an environment of extreme volatility. “The other thing that made the last year tougher was that everything was oversold,” says Guy. “Being short last year with everything going down and down and down made it quite hard to get net short because it always seemed like the market was oversold and was due to bounce.” Indeed, in the early part of 2008 the managers admit that they closed shorts too early when price targets and valuations soon proved to be irrelevant.
It wasn’t the first time that Guy and Rambourg traded heavily momentum-driven markets but 2008 still presented the managers with a unique set of circumstances. “If you look back to 1999–2000 we made a lot of money in a very momentum driven market on the way up,” he says. “I think last year the severity of the fall made us very wary. If you remember the Nasdaq falls you would get sharp rallies of 20% to 25% on a regular basis in 2000 and 2001. Last year we always felt that if we got net short the market would turn the other way and there would be a massive rally. Last year was a very tough year. It was our only ever down year.”
Since then, however, the managers admit they have struggled to find good short ideas. This is in marked contrast to 2008 when the fund was long stock index futures to balance net exposure at a time when the market offered so many compelling short ideas. “We use index futures to manage the net exposure,” says Guy. “But that varies over time. We have found this year that on the short side it has been quiet difficult. It’s been a year where the lower quality companies have done very well. It is very hard to find an area of the market that looks very expensive.”
The comparison with a year ago is instructive. Take German firm Heidelberg Cement. In January 2009, a leading family shareholder committed suicide and the company looked headed for a bank-mandated asset sell off. In September, however, Heidelberg Cement completed a €2.5 billion rights issue and the share price has rebounded. The building products maker remains a holding for the fund as Guy and Rambourg have targeted (in late September) a further 50% appreciation in its share price.
“There is not one part of the market that you can say is really expensive,” Guy says. “Even the financials that have gone up a lot are still very cheap compared to historical valuations. All of the cyclical names have done OK, but there is nothing that strikes us as being in really obvious shorting territory.” On the long side, the fund has exposure to a mixture of banks, some cyclicals and defensives which have been left behind by the market’s strong rally. Defensives have also been held back, the managers believe, by long only funds being overweight until they began selling the positions to rotate money into cyclicals. “For an absolute return fund like us, it gives you an opportunity,” says Guy. “France Telecom didn’t do anything for a year, but with a 9% yield it didn’t really matter for an absolute return fund. If you are a long-only fund it is killing you if the market is going up and France Telecom isn’t. Sometimes with absolute return funds you can be a little bit more patient.”
Split of long and short term trades
Over time AlphaGen Capella is expected to have around a 50:50 split in long term strategic positions and short term investments. During a bull market such as 2004–2007, the weighting of long-term positions might edge up to around 60%. However, in the more volatile environment of the past year the short-term book came to the fore and accounted for about 60% of the fund.
“We recruited two dedicated analysts who focused a lot of their time on the long ideas at a time when the short-term men were being crowed out by prop desks and all the new hedge funds which really focused on the short-term catalyst driven ideas,” says Rambourg. “But that has changed over the last 12 months. The landscape, in terms of the competition, has changed tremendously. We have been swinging the bat a lot more on the short term opportunities – like placings, rights issues, stocks going in and out of indices – things that we haven’t done for the last four or five years and that we had given up on because it was so crowded by the prop desks. Now the prop desks are hopefully going to remain out of the game for a few more quarters so there will be a bit more low hanging fruit on the short-term side.”
AlphGen Capella, the main European long/short fund, generally has about 50 positions of weighing in at 1.5% to 2.5% each, while AlphaGen Tucana, the high conviction portfolio, is more concentrated. Top five positions in 2009 have included France Telecom, Enel and HSBC. The difficulty the managers see with shorting is shown by short exposure coming mainly from index futures. On a beta adjusted basis the fund can dip into net short territory using defensive long picks and shorting high beta stocks, but the portfolio is never net short per se. Even in 2001 and 2002, it was never net short. During those years, it made respective 12% and 8% gains in a market that fell around 20% each year. Currently the net exposure is around 30%, its highest level for 24 months, but it is unlikely to increase much from here.
“We called it pretty well in March when we took the gross and the net (exposure) up quite a lot,” Guy says. “We’ve always run Capella as a low vol fund. One of the things we’ve always tried to avoid is big net exposure. We have a few times been higher than the 30% level but we tend to regard 30% as a ceiling. I think we would both say at the momentthat whilst we are positive on the market because not many people are, we are well aware of the risks involved as well. I always think we are in the middle of the world’s biggest experiments, the biggest ever printing of money since WW II. Nobody really knows how it is all going to end up so I think it is not the right time to start being really aggressive.”
On balance, the managers feel that the pump priming efforts of government fiscal policy, central bank easing and continued low interest rates make inflation, a year or two out, a more likely eventuality than nearer-term deflation. But the balance between one scenario and the other is a fine one. “I find it very difficult to look out more than a year and a half or two years at the moment,” says Guy. “I just don’t think you can really know how it is going to turn out. You could end up like Japan or you could end up with inflation.”
Profits from broadcasters
In recent quarters, stock valuations fell and became increasingly attractive. It was, in retrospect, the polar opposite of March 2000 when Guy exited all the fund’s technology positions (famously citing “gross miss-valuations”) and subsequently shorted the sector. This time around it has been a question of gauging how the banking system would fare and when stability would return. During this process valuations became incredibly cheap and opportunities mushroomed. Going against a years-long scepticism of the media sector, the fund made good money buying TV stocks like Spain’s Telecinco and German broadcasters Pro-Sieben and Sky Deutschland.
With the rally having been of historic proportions, the managers acknowledge that the easy money has been made. In addition to Heidelberg Cement, they still like defensives and stocks with high dividend yields like Vodafone. Guy is slightly wary about cyclicals noting that they have outperformed too much in the short-term because of investors pricing in a V-shaped recovery. “We believe there is going to be recovery in 2010 with 3% to 4% growth on a global basis but some stocks are pricing in an even more aggressive rebound in the economy,” he says. “We struggle to see that ourselves. A lot of what we had this year is governments and central banks providing us with oxygen, avoiding the worst. We believe that in the second half of 2010 it will be tricky to have a strong recovery at a time when interest rates might go up a bit and central banks might turn off the tap. We might have some decent short ideas in the second half of next year.”
Surprisingly, perhaps, Rambourg and Guy say they “are fairly relaxed” for the next two or three quarters. “Comparisons are easy,” Rambourg says, noting that corporate profits may even surprise on the upside of forecasts. Monetary and fiscal stimulus is also expected to support equities as should tactical asset allocations as investors seek to improve on the paltry returns accruing to cash.
Art versus science
Guy’s success over a 20-year investment career reflects a number of qualities, not least the ability to read market sentiment. He has said that managing money is part art, part science. “I’ve always believed that a fund manager is a bit of both,” Guys says. “If it was just a science people could run a computer programme and that would be it. But there is nobody in the history of the market that gets it right all the time. It’s the same with risk models. We’re very active in managing the risk. But there isn’t one model out there that tells you how much risk you have on. I always thought there was a bit of art to this, too. You have to appreciate correlated risks and a model might not say that Vivendi is a media stock but it behalves more like a telco. Thereare all kinds of little nuances. Fund management is an awful lot about art because there is sentiment in there, too.” That, of course, is the opening proposition for systemic trend followers. But it can also be effective in the hands of an astute discretionary manager who can consider whether an idea is original and how it may play in a particular market environment.
This is where gauging sentiment come in. But is there something about sentiment that can be measured? “You can try,” says Guy. “That’s what the VIX does but it changes quickly. I’m not sure you can really measure sentiment. You get the Merrill Lynch survey coming out telling you whether people are bullish or bearish but last year that didn’t help you very much. I think there is a lot of gut feeling with sentiment. Does the market want to hear this at this particular time? You can be right on valuation with tech in 1998 and say it is expensive, but you were very, very wrong by the time all the momentum played out. I feel you need valuation and a bit more of an arty side along with it as well.”
Hedge funds: post boom
A 10th anniversary of a hedge fund firm is a relatively rare event. The occasion offers an opportunity to both reflect on what has been achieved and ponder the future. Paul Graham, Gartmore’s Global Head of Alternatives, likens the hedge fund industry’s expansion over most of the past decade to the industry’s equivalent of the dot com boom. Given Gartmore’s performance record both in terms of returns and liquidity, he is sanguine about the firm’s prospects. For the hedge fund industry, however, Graham is less certain. “It is too close to call,” he says. “I think the asset management industry is on a knife edge. The surviving managers could double assets under mangement over the next decade or it could shrink further. One thing that is clear is that those funds and firms which acted ethically and did produce relatively decent performance, and have the necessary tools in operational standards, they will be the big winners out of this. And that is exactly how it should be. For the hedge fund industry, 2008 was a healthy cull.”
After a cull it is usual that growth returns. Among its newer products, Gartmore has developed two UCITS III absolute return funds. One replicates AlphaGen Capella, the other Ben Wallaces’s AlphaGen Octanis UK equity long/short fund. For a large cap equity manager like Gartmore, the UCITS funds look to offer an ideal platform to attract new investors. “For a house like Gartmore it is very easy to replicate because what we do is as plain vanilla as it can possibly be,” says Graham. “For us as a firm it is a logical and natural next step in our evolution. We have some very good track records in hedge funds and we want to be able to offer them to retail investors in Europe.”
Gartmore has also used its established platform and brand to expand while others consolidated. It has hired John Bennett, a veteran manager from GAM, to run several European equity long-only mandates (taking over from Guy and Rambourg in January 2010) and has recruited Luke Newman to work with Ben Wallace. Bringing Bennett on board will leave Guy and Rambourg to concentrate on their growing list of alternative mandates, (the Capella, Tucana and Acamar hedge funds), two recently launched European absolute return mutual funds, the Gartmore European Investment Trust and several institutional mandates.
Hedge funds add intrinsic value
For the next few years, Jeff Meyer, the asset manager’s CEO, is aiming to build on the success Gartmore has had in the market and with protecting investor interests. “The first thing is to capitalise on the greater intrinsic value our hedge fund business has acquired in the last year,” he says. “It’s been very challenging for everyone but we feel our business held up well in that period. We lost assets due to redemptions but our performance by and large was superior to the median of the peer group. We met redemptions and we didn’t gate anyone. We are in strong position to take assets back on as investors begin to come back to the asset class.” He also wants to simplify the offer to clients by using the Gartmore name for all funds (and moving away from the AlphaGen moniker). With centralised risk management and hedge fund managers running long-only money successfully, Meyer thinks it makes sense to support one brand and invest in one clear brand promise.
Meyer’s immediate aim post 2008 was to recover assets lost through redemptions during the year. This goal has been partially achieved with significant inflows into the AlphaGen range year to date – assets are now up to $7.5 billion after bottoming out in January 2009. Meyer wants to diversify the hedge fund book both geographically and by investor type, and believes expanding the client base is one step in this direction. A second is selling existing capacity with Guy and Rambourg as well as with other managers.
Adding managers is an option, too. “It really comes down to finding good teams, good alpha generators,” says Meyer. “The areas we are talking about the most in terms of adding capability is US long/short equity and currency as an asset class,” he says, adding that the latter tends to be less correlated, has large capacity and fits with the macro type mandates that are currently in vogue. An Asia-Pacific equity long/short fund and sector funds, perhaps TMT, health care and natural resources, plus a return to fixed income funds (which were closed three years ago) are additional options. Gartmore, he adds, is also prepared to seed new funds with up to $100 million.
Returning to the anniversary theme, Meyer observes: “The achievement of Roger and Guillaume is tremendous. I think they are truly exceptional investors to have their record given the market environment over the past 10 years. It is a great milestone.”
With Gartmore, since its 2006 buyout, half owned by management and half owned by US private equity group Hellman & Friedman, there is a high likelihood of a future exit from the business. Meyer says an IPO is one possibility but adds that there is no rush. “Hellman & Friedman have been impressed with the hedge fund business in terms of its performance and of the development of the business,” he says. “It has generated more and done more than they expected. Last year took everybody by surprise, but the performance has been strong.”
Looking to the next decade, Meyer observes: “What do the next 10 years bring? Well, for Gartmore there is always going to be lots of opportunity. To the extent that the market continues to separate beta from alpha I think the alpha will continue to be a relatively fragmented industry with strong margins and strong growth potential. Where we are tending to go is more towards the alpha side of the industry.”