International Investment Underwriting

Convertible specialist evolves to meet new challenges

Originally published in the June 2007 issue

International Investment and Underwriting (IIU), the investment group founded by Irish entrepreneur Dermot Desmond, this month celebrated the 10th birthday of its hedge fund arm, IIU Asset Strategies. It is a major milestone for the firm, currently under the leadership of Managing Director Paul O'Reilly, who also manages its flagship Convertible Fund, along with his colleague Dara Marnell. Desmond, who set up IIU originally as a private equity enterprise in 1995, felt back in 1997 that there was a future for hedge fund management under the IIU umbrella as well.

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"Because we were involved in our own way in private equity, we could see hedge funds would go hand in hand with that," he says. He viewed hedge funds as simply a different approach to the asset management function, but one with inherent advantages. "It was an investment area I couldn't ignore," he says. With his background in stock-broking, he was well-positioned to recognise the potential hedge funds had for remunerating investment talent effectively. He therefore placed considerable emphasis on finding the right people to do the job, a team that could be trusted to get on with the business of running money effectively.

A multi-strategy approach

O'Reilly, who joined IIU from Schroders when the firm was founded by Desmond, is justly pleased with the 18% annualised return and Sharpe ratio of 2.75 that he and his team have been able to achieve. However, he is also at pains to point out that convertible strategies need not necessarily be all about convertible bond arbitrage. It is also possible to navigate the convertible universe using a multi-strategy approach.

Most hedge fund managers these days are selling a risk return profile, and at IIU the principals think it is important that the firm defines itself along these lines. It's no use disappearing into the crowded global long/short equity bucket, when you have some decent numbers to offer, they argue. Classic convertible arbitrage involves being market neutral versus both credit and equity, and extracting volatility from it, but that's a difficult business to grow consistently, due to the lack of the right opportunities. It is probably not enough to sustain a firm for a decade, and a level of willingness by IIU to venture out of this classic definition has led it to be able to deliver positive performance every year, including years like 2004 when many convertible strategies stumbled.

"In years where the MSCI has done very badly, this fund has done very well. It's not about being overly long hedged volatility, it's about being invested in equities, and showing those ideas,"says O'Reilly. IIU's Richard Burdon, a seasoned convertibles specialist who has helped to establish the firm's London presence, also plays down the arbitrage element. "This is more a multi-strategy fund in many ways than an actual convertible arbitrage fund," he says "There's very little gamma hedging to do in a lot of the convertible securities, so in that sense, it is not an arbitrage fund. It is not a volatility arbitrage fund, like a lot of convertible funds started off being."

Evolution equals longevity

"I think all strategies have to evolve over time," says O'Reilly. "It has evolved over the last couple of years to be much more balanced between risk and return, whereas in the early years we tended to run a much more directional approach. It is definitely evolving into a fund with a better risk/return profile."

The fund's historical volatility numbers don't lend themselves well to reflecting its current risk budget. In the last 12 months volatility of 3.5% has been matched by a 16.5% return. "Those kind of numbers reflect what we've been working on in the fund for the last 12 to 18 months," O'¢Reilly explains. "We were chasing the returns because they were there to be chased, and times have changed. When you think of the peak times in 1999-2000, our investors definitely wanted us to be chasing those returns at the time, whereas now perhaps they're a little bit more circumspect and they're quite happy [with the performance]."

Future plans

IIU is now planning the launch of an equity strategy, which has been in incubation for nearly two years, being groomed for a potential launch later this year. This will follow a market neutral approach. "The strategy which we've had for the past 18 months, has been seeded, has evolved as well, and I think we've been improving this over the past six months," says Burdon. "You can either go out with a very well-known name in the market, and try to raise a huge amount of money on the back of a launch, or you seed it, create a very good track record, build on that, and then go and talk to investors. That's what we've been doing."

IIU recently decided to put down roots in London in order to bring itself closer to investors and the investment banking community in the City. It is hoped this will help it to grow more rapidly going forwards, and there will be a serious effort to locate some of its day-to-day trading operations in London, in addition to the existing Dublin trading desk. With an investor base largely drawn from North America and continental Europe, IIU is now hoping to win new clients in the UK.

As with other hedge fund managers, the firm is aware of the fact that institutional capital, particularly from pension funds, is increasingly driving the culture within the industry. This has required it to make changes to the way it manages money, and the move to London can also be seen in this light. It is a house that has been able to move with the times, and recognise changes that are affecting investor demands on a fundamental level. Going forwards, Desmond himself says IIU is not a business that is run on the basis of future goals. He is confident that O'Reilly and his team will continue to be able to perform as managers of the firm's assets going forwards, as competently as they have done to date.