Less Reverie, More Realism

Devet Capital is putting the business back into hedge funds

Originally published in the September 2017 issue

A recently published survey from the Alternative Investment Management Association (AIMA) and broker GPP has reported that, despite what might be considered relatively low levels of assets for a hedge fund, there is still scope for small funds to break even or indeed make a profit, with less than $100 million in assets under management.

Take Devet Capital: it was formed in 2014 when its founders, Irene Perdomo and Leonardo Marroni, created a product which they felt was of significant value and that they believed they could bring to the market themselves. Therefore, they created their fund, identifying from the outset that its ultimate success would be determined as much by the streamlined nature of their business model as by the strength of the product. The innovative nature of their product, combined with their enthusiasm and determination to create a modern and unique hedge fund, drew early interest.

Having met while working together at Barclays, and having co-authored a finance textbook published by Wiley (Pricing and Hedging Financial Derivatives: A Guide for Practitioners), Perdomo and Marroni launched the strategy with their own funds. And they remain invested.

Their objective was to allow the fund to blossom by minimising overheads. They recognised how much of a pitfall there was to over-spending at an early stage in their development and focused on achieving the correct balance between a robust and credible infrastructure, capable of gaining the confidence of investors, and an operating model that would be efficient and effective.

Asked to give her view on this, Perdomo says: “The last thing an allocator wants, after having gone through the (sometimes lengthy) process of assessing the managers and their strategy, is to have to withdraw money because the investment management company shuts down in the proceeding months. Similarly, in our experience, clients will be very reluctant to invest in a manager knowing that their (or somebody else’s) investment is key for the sustainability of the business. People don’t like being in a position whereby, if they have to withdraw, they will jeopardise the business and, in such a case, they will probably prefer avoiding the investment in the first place. They don’t like big concentrations.”

Therefore, at Devet Capital, there was to be no expensive office and the partners would control and manage overheads by not padding out their firm with unnecessary roles and by outsourcing non-core functions to third parties at competitive prices. However, even when roles and functions need to be outsourced, both founders maintain strong oversight, with strict control of their entire business.

On this particular topic, both founders are adamant: “Investors really value the structure that the partners choose and how they manage the company’s overheads: it’s not unusual to see managers who have spent a fortune on infrastructure ending up with investment vehicles that are almost empty, sometimes even completely empty,” says Marroni. “Emerging managers generally get bombarded with counsel about impossible-to-overcome barriers-to-entry and the need for infrastructure which goes well beyond their needs. Much of this ‘guidance’ comes from certain service providers that seem to care only about scaring the emerging managers, overstating the risks of not using them as a supplier. It is important to have a lean structure, calibrated on what existing investors and potential investors really need, in particular, those that are likely to be looking at the fund within the first five years of its life.”

This dedication and innate understanding of all aspects of their product and business may well explain the $115 million assets accumulated in the past two years of trading. Although Devet Capital has been operating for more than three years, they were initially closed to external assets and traded their own funds for the first 15 months of operation.

But how do allocators really approach such a product? “The assessment of the product goes hand in hand with the assessment of the business,” Marroni explains.

“When considering investing in new products, investors typically value the following features:

  • Low correlation with products that already exist in the market (especially if provided by big and well established asset managers). One example above all: the managed futures market is already flooded with trend-following strategies; an emerging manager offering a trend following strategy is likely to have a very tough time in selling it, especially if it is already quite correlated with existing strategies offered by the bigger houses. Emerging managers should be self-aware and ask themselves: why would somebody consider buying my product(s)?
  • Decent (and realistic) risk-return profile: investors are not impressed with a history of large gains where the risks are clearly not being managed well. And, as for fabulous back-tests… well, who has ever seen a bad back-test?
  • The fact that the manager is able to answer the “crucial” questions: investors will inevitably ask questions about the capacity of the investment strategy (or the lack of it), impact of transaction costs, the extent to which the managers will co-invest in their own strategies, demonstrating preparedness when answering these kinds of questions is vital.”

“However,” Marroni adds, “a good product has to convince not only the investors. A key aspect, often overlooked, is how convincing a good product (and its managers) is to brokers and key service providers: if they’re convinced that the team
and the products are there to stay, they will be much more supportive, especially in those early months when external help and support is
most needed.”

Another crucial factor, in Perdomo’s view, is targeting the right type of client at the right time in the right jurisdictions: “It is well known that certain types of clients are more emerging manager friendly than others. The usual examples, supported also by our experience and, frankly, a lot of common sense, are family offices and high net-worth individuals and, at the other end of the spectrum, large institutional investors. In terms of jurisdiction, the US in our experience, has been the friendliest (at least in the managed futures space).”

Investors are particularly wary about systematic funds, and especially those which claim that some level of artificial intelligence is used to help inform investment decisions. Academic qualifications are not enough to convince early-stage investors to back a heavily-systematic fund. Allocators to early- stage funds are mature investors and not likely to be easily impressed by the latest fad. Hence why it is important that a fund which relies on new technology is also supported with a tried-and-tested business infrastructure.

Devet is putting its money where its mouth is, launching a fledgling Capturing Talent Alpha program last year. They seek out talented systematic managers who are willing to be integrated into the business. Managers’ strategies are tested with the owners’ assets only and, if they prove successful, they are incorporated into the Devet Capital product suite as a new product. Since the start of the program, Devet has tested seven managers, of which two have passed the first testing phase.

In short, over the past three years, Devet has proven that a lean, down-to-earth and therefore sustainable business model can gain real acceptance within the investor community.