To find one of Europe’s big fund management success stories of the past decade it is necessary to cast your attention on Milan, location of the headquarters of Kairos Partners. The firm has just celebrated its 10th anniversary after a resilient performance over the past year and is looking forward to the next few years with unalloyed optimism.
Though the firm’s flagship Kairos Fund long/short equity offering suffered a 28% drawdown in 2008, over 10 years it has returned just over 10% on an annualised basis. Among its largest fund of funds, Kairos Low Volatility fell 6% or about a quarter of the average for the sector in 2008, but has made back more than 7% in the year to August. With €4.2 billion in assets under management, including €2.1 billion in hedge funds, Kairos now spans six offices with more than 100 employees and has built a strong foundation for expanding its asset management offering.
“Today the situation has changed dramatically from when we founded the business in 1999,” says Paolo Basilico, Kairos’ CEO and one of its four co-founders. “We have a pretty crowded hedge fund industry that’s basically halved in size,” he says, while characterising the firm’s home market in Italy, which has 200 funds of funds, as mature. “Every important financial institution in Italy is running a fund of hedge funds today. The opportunity on this front is not there any longer. Where we see the opportunity for Kairos is that in the last two years the results of our competitors have been appalling and the banks have been a disaster. We have done pretty well in these tough times. Therefore we thinkwe can gain market share particularly in the onshore market in the next two or three years.”
Kairos is targeting two areas for near-term growth. One is the increasing demand for hedge funds compliant with Undertaking for Collective Investment in Transferable Securities or UCITS legislation. The second is the opportunity to raise assets through the amnesty programme that the Government of Italy has introduced for off-shore investors, particularly in Switzerland, to bring money home with minimal penalties.
Kairos, of course, isn’t the only manager to be exploiting UCITS structures for new fund launches. It is in good company with several big London fund managers, including Brevan Howard, AHL, Bluecrest and GLG Partners, among others. It is, however, a pioneer with its offering of the first European fund of funds that only invests in UCITS registered hedge funds.
“There are more and more hedge funds that are launching the same strategy into a UCITS vehicle,” says Basilico. “We see it being a strong area of growth.” UCITS rules limit concentrations and leverage, while providing daily net asset values and weekly dealing. They also impose eligible asset constraints and regulate counterparty exposure. For many investors, shell shocked with losses and the gates many funds of funds imposed last year, the liquidity guarantee could be highly attractive.
Fund liquidity is key
Basilico agrees. “There is one aspect of this which is key and that is the liquidity,” he says. “Even today when people realise the hedge fund world is not that bad and did better than other investment strategies in 2008, the idea that if you want your money back you can still get it is still key. In our view it will remain key for a long while. We are telling people that they can invest into a product with absolute return characteristics but with the liquidity that the hedge fund industry generally doesn’t allow.”
One thing in Kairos’ favour is that it didn’t gate or sidepocket investors over the past year. But even with a good track record, they and other managers that maintained liquidity have found that the financial climate made it tough to raise funds from investors to replace redemptions. “It is still very difficult for us to raise assets this year because investors are still paranoid of what they have seen or what happened to their own money with some other firms,” says fund of funds chief investment officer Fabio Bariletti. “The only way for us to capitalise on the performance of last year is to show to people we can do very well but at the same time guarantee that they can receive their money back. Thought we did that last year, the comfort for investors of a UCITS product is much higher.”
Kairos Long Short, the UCITS fund of hedge funds launched in May, has 20% concentration limits on investing in any underlying fund. It will invest solely in hedge funds that come in a UCITS structure. It is estimated that the universe of eligible single manager hedge funds is about 100, but that figure is growing rapidly as recent launches by managed futures giant AHL and Cheyne Capital attest. “It will change the whole picture” on the UCITS evolution, Basilico says. “Every single month you have new launches. All the major investment banks are now supporting strongly the creation of UCITS funds.”
“Today I can assure you that even firms which have not launched a UCITS product yet are all thinking about it,” says Basilico. “Some will decide not to do it because some strategies are difficult to replicate in the UCITS framework. And there are always concerns that you can jeopardise one business with the other. But there are many funds, particularly plain vanilla long/short funds, for which this will become an interesting new space. There are strategies which simply are not adaptable. There are also strategies which need to be fine tuned and there are strategies that can be converted instantly,” he adds, snapping his fingers for emphasis, “because they are very liquid and very diversified.”
The second growth opportunity is the expected strong inflows from Italian high net worth investors bringing money home from Switzerland during the amnesty period that began 15th September and extends until 15th April. Kairos added more than €250 million in assets during the previous amnesties in 2002-03, but expects to bring in more allocations this time.
“What has changed dramatically is the environment,” Basilico says. “In 2002 and 2003 Switzerland was still a pretty solid place to leave your money. Today Switzerland is under severe scrutiny for a number of reasons. Therefore the real secrecy in Swiss banking has gone. The latest stories from UBS are dramatic in that respect. This will definitely cause a large sum of money to come back to Italy.” During previous amnesty rounds the Italian subsidiaries of the Swiss banks were the biggest beneficiaries when investors repatriated funds, but this time Kairos and other Italian wealth managers expect to supplant them.
“UBS Italia played the most important role in the repatriation last time,” Basilico says. “They got by far the largest market share of the repatriation in Italy. UBS is obviously very weak today. This time it will be much more fragmented repatriation by investors. It is an opportunity for the entire industry and it is an opportunity for us as well. The opportunity is huge.”
“It is not such much to do with our merit but because of the Swiss’ problems: no more secrecy, the exposure to Madoff and the famous Liechtenstein disk bought by the Germans,” he says. “The places where the Italians, German and French put their money – Switzerland and Liechtenstein, and Monte Carlo to a lesser extent – this world, which had been the real world for many European high net worth individuals since WW II, is basically disappearing. You are left with Singapore and Hong Kong, but it is a different game. There will be huge sums of money coming back. I haven’t got a clue how much money we will be raising but I would be surprised if it wasn’t double the figure we raised in 2002.”
During the previous amnesties, Kairos attracted investors owing to its strong performance during the bust that followed the new economy boom and the terrorist attacks of 2001. Like others in the hedge fund market, it benefited from the risk management that allowed absolute return funds to decouple from the equity market downturns suffered by tracker and discretionary long only funds. The founding partners knew each other and the opportunities in asset management from their time on the sell-side at Warburg in Milan servicing international fund managers. They had seen John Armitage depart Morgan Grenfell to set up Egerton Capital and before that Crispin Odey make a success of going independent with his own eponymous firm.
“We started seeing some of the best guys among our clients starting their own hedge funds,” Basilico says. “This was a new way of investing. Then we saw an enormous space for us in new legislation the Bank of Italy was planning that would allow hedge funds and funds of funds to operate in the onshore market.” The four founders left Warburg and set the new business with the first product being the launch of the Kairos Fund, a London-based long/short equity fund. Their sell-side role had also given them experience of prop desk trading and they had produced good performance during 1995-99 immediately prior to opening Kairos.
That team launched the flagship long/short equity fund with $60 million. The fund performed strongly and grew rapidly. In early 2000 Kairos opened an Italian long only business and then following protracted vetting with the Bank of Italy and hiring Fabio from Citco (where he had been running the US fund of funds business) inaugurated the first Italian fund of hedge funds in April 2001. “In Italy we pioneered this industry,” says Bariletti. “We were the first and for a long while we were almost alone in the market.”
The changes in Italian legislation were the key to the opportunity that Kairos seized. “It took a while to transform that into something real,” recalls Basilico. “We were the leading actor in this process. But the opportunity was there. Together with this opportunity which was very real and very visible we sensed that the market was extraordinarily expensive and driven by long only investors. There was a very strong market opportunity.” Kairos was the first independent asset manager to open in Italy in a country where banks still control some 97% of the asset management industry. “There was the opportunity to launch something independent and new with the legislation that was coming up with the skill we thought we had,” he says.
By 2003, Kairos was managing €1.5 billion and the post-dot.com boom performance of its funds allowed the business to put down deep roots with investors. Its offering consisted of the London-based long/short fund, four funds of funds and several long only discretionary funds. Today Kairos runs €1.6 billion in funds of hedge funds and €500 million in three long/short equity funds, including Kairos Hedge Italia (€75 million) and Kairos Eurasian (€50 million). There is also €2.1 billion in long only funds with an overall client breakdown of 60% high net worth and 40% institutional investors.
In the decade since Kairos launched, the absolute return asset management sector delivered market beating returns and then gorged on an unprecedented boom in allocated assets. But in the past 18 months, it has been gored by the credit crisis and the market meltdown. During most of the decade the appetite for offshore products remained strong but, post-crisis, there are few signs yet of a pronounced rebound. “The opportunities have changed but I think Kairos can play an important role in the next few years in the onshore market,” Basilico says. “We are pursuing UCITS opportunities. We are very much focusing on this area more than the offshore area.”
Characteristic of the firm’s approach to designing funds is the recent launch of Kairos Centauro, a value fund, which displays characteristics of both public and private equity. Like private equity funds, it has a long lock up of three years and it will only charge performance fees once the profits are realised. “It is a formula that is closer to private equity than to public equity,” says Basilico (Kairos had a private equity fund but spun it off in 2006). “We are convinced with what happened in the market that in the next 12 to 18 months there an opportunity to invest in undervalued public companies.”
Being an onshore European fund operator Kairos is well versed in handling regulatory scrutiny. It worked closely with the Bank of Italy in setting up the country’s first fund of hedge funds and now has a decade of experience in designing, launching and marketing onshore products that provide investors with absolute return funds. The Bank of Italy may be a bit more bureaucratic than the Financial Services Authority, but the firm’s experience suggests that relations have been reasonably positive with both regulators.
“I must say we don’t have problems with either regulator,” says Basilico. “They are not that different. The FSA is less formal and quicker at giving you a certain response. But we can’t complain at all with the Bank of Italy. You need to realise we were the first to be authorised in Italy and we were almost a start-up, so it wasn’t obvious to give the first licence to a firm like us in those days.”
On the future of regulation, Basilcio is sanguine. After a decade of interaction with Italian and UK authorities, he believes that regulators are converging in how they behave and what they do. Surprisingly, perhaps, he sees little to fear in the EU’s proposed Alternative Investment Fund Managers Directive.
“If you apply certain rules to what you are doing and these rules are common sense, good discipline, prudency and so on (then) the new directive is going in exactly that direction,” Basilico says. “We think actually it is a good direction. They are only trying to introduce elements of common sense, prudence and less leverage, and these are all rules we have been following for 10 years. These are rules that any good fund manager should be following. In that respect the directive is a good directive.”
Basilico has some direct and perhaps controversial advice for some of the UK managers and the managers of US firms with operations in London, who have vilified the directive and its political backers. “If you get out of the political issue and you think about what technically they are trying to do, we are fine with it,” he says. “If you introduce political struggles and you start thinking about the possible aims, targets and goals of these guys which have nothing to do with what we are doing it is a different story.” The message to managers and their industry bodies is simple: ignore the rhetoric and focus on the technical aspect of the proposals. And. more importantly, work hard on being supportive of the process to get the details right. “But technically speaking a few more rules and guidelines about this business is good news, not bad news, for the industry,” he says.
Bariletti adds that of the 60 managers Kairos invest with, around 55 of them could do exactly what they are doing in a UCITS structure. “Our sense is that when the directive comes through the industry will adapt and move towards these types of products,” he says. “For us, we will invest in exactly the same funds we invest in today. It will take time but there is time. The directive will have a three year phasing in period so it is easy to adjust your offer.”
Basilico is caustic in observing what types of hedge funds will be threatened by the key measures in the proposed directive. “Clearly if you are a very leveraged fund, if you have no transparency, if you like to tell almost nothing to investors, you will find this directive is the end of the world,” he says. “Generally in Europe the business model has always been different. The Egertons and the Marshall Waces have always been pretty open and pretty transparent. Clearly there are the big US guys who have always been pretty closed in terms of information. They will fight. But I don’t think we are in the same game. Now the devil is in the detail. We will have to see what comes out. But the principles of the directive are fine.”
Unlike some UK managers who perceive London to be losing ground as a business centre, Basilico thinks the city has little to fear. “London combines the best range of service providers with being an information centre about companies, perhaps the best place in the world but certainly the best in Europe.” The advantage of London, he says, is that a firm can start a business rapidly, outsource practically everything and be sure that everything will function properly.
Though tax is an important factor in governing where hedge funds will base themselves, Basilico thinks other factors are at least as important.
“Taxation is obviously key, but it is not the only aspect,” he says. “You don’t go to another country without having the companies or the experienced people for the services you need. This remains a performance driven business and performance is a function of information.” In both respects, he adds: “London has got such a competitive advantage that to lose it…well, gosh, I mean it must be a revolutionary event.”