Over a few days in September, Man Group unveiled two moves to develop new products aimed at attracting allocations from fixed income investors. First up was a plan to launch a systematic fixed income product. Then Man announced it had engaged a former managing director of the Pacific Investment Management Company to develop discretionary fixed income hedge funds. Taken together the moves show Man is wagering that the decades old credit market rally isn’t about to suddenly go pop. The expansion also further develops a fourth business leg in credit, building on Man’s existing investment franchises in equities, managed futures and funds of hedge funds.
The Nomura Man Systematic Fixed Income fund is being set up within Man Systematic Strategies (MSS), a separate business unit with two quantitative long-only funds investing in equities and commodities as well as a tail protection strategy. Man is acting as the investment manager with Nomura handling distribution, something it does for some other Man products. The systematic fixed income fund has been seeded by an external investor with $50 million. It is being managed by Andre Rzym and Stefan Sluke who moved to MSS at its inception in late 2010 from Man’s managed futures flagship AHL. Andre Rzym is the lead portfolio manager, having worked previously as Head of Fixed Income at AHL.
Developing the merger
“MSS is a separate business from AHL,” says Sandy Rattray, the chief investment officer. “We are friendly but separate. We think we have a lot of resources in the firm to build this business,” he says, noting research produced by the Oxford-Man Institute as well as by AHL and GLG, Man’s discretionary fund management arm. “The aim with MSS was to develop the fruit of the merger with GLG,” Rattray says. “We have a strong technological infrastructure behind us. This would be hard to do for stand-alone individual funds. The people behind the funds are quant specialists so there is a common language behind the group as well.”
The timing of the fixed income push is interesting. One school of thought has it that the hunt for yield among liability-driven investors like pension funds will see a further bond market rally, particularly further out on the curve. What’s not a matter of conjecture is that global bond markets are double the size of global equity markets. Yet despite this there are far fewer fixed income hedge funds operating than long/short equity funds. Competition in the fixed income area has thinned as bank proprietary trading desks have cut activity,an area which, along with equities derivative trading, saw the greatest levels of bank prop desk dealing. The average daily value-at-risk of interest rate trading, according to Rattray, is down around 50% since 2008 (See Fig. 1). “That is why we are launching a fixed income hedge fund,” he says. “We don’t see the pressure reducing on banks to cut risk. The mere fact they have reduced so much already makes this a good place to be. For investors wanting yield in fixed income there is not a lot of it going around. This is particularly problematic for investors who are long to secure yield. That group of investors may be looking for other strategies in fixed income.”
The systematic fixed income fund has three main investment themes. One is directional rates trading; here the aim is to take advantage of the herding behaviour of market participants by predicting trends in interest rate markets. A recent play has been to go long the two-year Czech crown interest rate swap; with rates trending lower the trade has been profitable. The second approach is non-directional rates trading; it uses a mean reversion model to wager on relative movements of different maturities. Typically the five-year rate would get dislocated by new [debt] issuance,” says Rzym. “But over time it will revert compared with the two-year and 10-year rates. We will try to capture that and make money.” The third investment focus is active foreign exchange carry trading. One trade here is going long emerging market currencies relative to the dollar to benefit from the higher interest rates they offer. With this trade there is a strong focus on detecting periodic flights to safe havens. “We want to detect when there is a net outflow from emerging markets, which causes their currencies to weaken,” says Rzym. “At that point we seek to reduce our position. It is not that we are trying to make money in such flight-to-quality periods. What we are doing is trying to avoid losing money.”
The directional rates strategy dates back to about 2005 and was developed by AHL. The mean reversion rates trading strategy went live with AHL in 2008, while the active FX carry play is completely new. “We would expect that the risk contribution from each of the three strategies would be approximately equal over time,” says Rzym. “The strategies are betting on very different things and the correlation among them is very low.” The Sharpe ratio is around 1.35 covering the period from 1996 to 2012.
Mariappa to build fixed income
Man’s other foray into fixed income hedge funds is to hire Sudi Mariappa, a former managing director with leading bond investor PIMCO, to head and build a discretionary fixed income business. Organisationally, it will be part of the GLG single manager hedge and long-only fund franchise that Man acquired in 2010. It will build on the GLG credit platform run by Steve Roth which manages $7 billion through the GLG Market Neutral, GLG European Distressed and GLG Global Convertible funds as well as other long-only credit funds. Mariappa worked at PIMCO from 2000 to 2010 and was promoted to managing director in 2003. He ran the global portfolio team until 2008 and managed a team of investment managers worldwide.
“We are delighted to be hiring a professional of Sudi’s calibre,” said Manny Roman, CEO of GLG and COO of Man in a statement announcing the hiring. “We look forward to building our business in an asset class which has many attractions for investors in today’s volatile market environment.”
Under Mariappa’s oversight, assets in global portfolios increased from $10 billion to $85 billion. In 2009-10, he was a senior advisor to PIMCO and worked closely with founder Bill Gross on the firm’s suite of hedge funds. Mariappa alsodirected various risk, strategy and advisory projects.
Flows into fixed income products have remained strong as investors have chased yields amid high equity volatility. Some analysts believe the flows will continue for the foreseeable future as moribund economic growth makes bonds more attractive than equities, especially for liability-driven investors like pension funds.