Martin Currie Investment Management

Emerging as one of the UK's more successful hedge fund managers

Iain Morse

With an enviable reputation for being both conservative and aggressive, Martin Currie Investment Management are emerging as one of the UK's more successful equity hedge fund managers. This is not an easy feat. The firm has a strong, sometimes pungent corporate culture. "We are high conviction stock pickers," agrees Chief Executive Willie Watt," with a deeply embedded process. Picking up investment fads and fashions is not our style." The firm started out as a long only equity boutique. Over the last few years it has built its' hedge funds onto this existing framework, without any apparent problems.

Bear in mind that most long only UK based equity managers have not even set up long/short funds and you realise the import of Mr Watt's words. While other, often far larger long only managers lobby for greater regulation of the sector, and many clearly wish it would just go away, Martin Currie have established a verypermanent looking hedge fund operation.

The value of total funds under management at Martin Currie now exceeds $13.9bn, of which hedge funds account for just over $1.1bn or 7.7 % of total. This growth looks remarkably organic. Each of their seven hedge funds receive high levels of support from existing investors in their long only funds. Four funds are already closed to new money. Their most recent launch, the Daijiro Fund, which invests in Japanese equities, closed after raising $130m in less than twenty four hours.

Just as importantly, each hedge fund is run by an existing team of managers running long only funds in exactly the same equity space such as Japanese equities or global resources. "This is crucial to our success," thinks Chris Butler, co -manager of the Global Resources hedge fund. "The main driver of our returns is stock selection, we look for a process of change in companies that we go long or short on." Either this process of change drives a change of a positive or negative kind, and investment decisions are taken accordingly.

The debate over whether going short requires the same skill set as going long has been largely solved by Martin Currie. For them, the two require almost identical skill sets. But they don't trade using prescriptive models or by following short term market trends. Neither do they turn over their portfolios as often as most hedge fund managers. "Having ideas, and good ones, is the key to how we add value," says Richard Evans, co-manager of the Asia hedge fund, "and this is difficult to do on a recurring basis."

Most hedge funds effect large volumes of trades for small slices of Alpha. What differentiates Martin Currie is that they make far fewer, higher conviction bets, trading far less often than most hedge funds as a result. None of their hedge funds would ordinarily own more than 60 stocks, on either a long or short basis, and they prefer relatively opaque markets with large, built-in structural inefficiencies.

Not many long only houses have succeeded in evolving so rapidly. Part of the reason for this lies with the firm's private ownership structure. It is completely owned by directors and staff. And unlike the situation in a proprietary company, this leaves a very narrow gap between the product of calculations about the interests of the firm and those of its' staff. This help to foster an intellectual climate and attitude to risk where the interests of staff, firm and investors are very much in common. "What we do with hedge funds is an amplification of our existing expertise," says Alan MacLeod, head of hedge funds at Martin Currie, "we only start a new hedge fund if we believe that we can run it well and add value for our clients." Client reward and loyalty are important for Martin Currie. After all, if investors suffer, they may remove their money. No-one at the firm is too grand or greedy to forget this. "We are long haul managers," adds MacLeod, "here not just today or tomorrow but hopefully in the foreseeable future."

Martin Currie is one of a number of newly styled 'super boutiques', which eschew asset gathering as a legitimate or desirable business objective. In the late 1990's too many of their larger rivals focussed on just this at the expense of creating and preserving a strong, performance related in-house culture. The result, for the most part, was a high Beta style of 'closet tracking', low conviction asset management. Since 2000, most of these firms have suffered a rapid deterioration in their profitability as the value of their assets under management shrank, as did their profits and share prices. But over the same period, the boutiques have attracted a lot of new money often from institutional investors focussed on finding sources of sustainable Alpha. "And we have to be mindful of the dangers of this situation," adds MacLeod, "keeping a very clear focus on the sources of our performance, preserving strengths while minimising weaknesses. There are limits on how far and how fast we want to grow any part of our business."

With both institutional and retail investors clamouring for access to any spare capacity among proven hedge funds managers this might sound a little surprising. After all, new funds and fund of funds are being set up on a weekly if not daily basis. It sometimes seems as if anyone with a couple of years successful trading on the proprietary desk at an investment bank can find seed capital to set up shop. "The only question is will they still be there in three or five years time," cautions MacLeod,"just how good are their risk controls, and how sustainable are their business plans?"

These thoughts neatly crystallise the anxieties felt by many at the rapid expansion of the hedge fund sector. But Martin Currie seems not to do it the way so many others do. They have plans to open two more hedge funds next year, one in UK equities and the other in emerging market equities, but these are already areas of proven expertise for the firm. However, they have no plans to open a fund of funds. They don't believe that they have the current expertise for this. Many potential investors might disagree, but they have taken their decision.

Talking to the hedge fund managers at Martin Currie one does detect a common cultural DNA that seems to owe at least something to the firm's home town of Edinburgh. For a start, their headquarters building is in the new, superbly designed Saltire Court, a site between the Usher Hall, the city's premier venue for visiting symphony orchestras on the one side and Edinburgh's castle, grim and more utilitarian, on the other side. But Edinburgh was also the place where the philosopher David Hume and economist Adam Smith wrote their respective master works, the Treatise on Human Knowledge and the Wealth of Nations. The intellectual climate is hard-nosed and sceptical. And the financial community includes little in the way of investment banking, commodity broking or derivatives trading. Not many £1,000 bottles of wine are sold in the city's usually muted and slightly dull restaurants. Most of the money run in 'Auld Reekie', whether in bonds or equities, is run long only and with an ethos of probity that can sometimes feel self-satisfied. This, as well as an ever present desire to show that a firm run in Scotland can do as well as any in London, is the ground from which Martin Currie has grown.

At the same time the firm manages to be remarkably cosmopolitan. It has offices in London and Shanghai. At present, 38% of its' funds under management are invested in Japan, 25% in the UK, 15% in Europe, 12% in Asia and just 4% in North America, with the remainder held in cash. Frequent company visits keep many members of their equity research teams abroad much of the time. The China and Asian teams include managers Shifeng Ke and Christine Zhang, their pan -European team, Dino Fuschillo and Dr Eric Woerhling. Needless to say, the firm attracts top talent and can afford to do so. A recent joiner, Richard Evans, is typical of the kind of manager that Martin Currie feels comfortable recruiting. Co-manager of their Asian hedge fund, he was head-hunted from London based Charlemagne Capital, another boutique, prior to which he was at Gartmore.

Not just cosmopolitan, the firm also carries a hint of real sophistication. No less than 70% of funds under management belong to institutional investors, the remainder in a variety of pooled retail products. Most demand for their hedge funds comes from institutional investors, pension funds, banks, and foundations. Duediligence by these investors is exhaustive. The same hedge funds now contribute 20% of the firm's operating income. And Martin Currie like it this way. Institutional money moves less often than retail. It provides a more solid foundation for the firm than say mutual funds. So the decision to go long short is a very considered one, intended to be strategic and long term.

GLOBAL RESOURCES

With oil, gas and materials, making up 12% of the MSCI World Index, Martin Currie's Global Resources hedge fund has wide opportunity set to exploit. "The sector was selected by us as suitable for a hedge fund for a number of reasons, explains the fund's co-manager Chris Butler. "It offers an attractive mix of low correlation and volatility. The supply side is also capital intensive and undergoing consolidation."

The firm's investment process starts by identifying sources of change. Top down, these include not just capital intensity and consolidation but also shifts in competitive advantage due to re-pricing on resources and the so-called China effect. "The latter is just a generic expression for the effect on demand and prices in the material sector of what is now a very rapidly developing, resource-hungry group of economies, China, in Asia and in Latin America." These are market calls. At a stock specific level, a new set of criteria moves into focus. "The quality of management, any re-structuring, any capital intensive projects underway, and merger & acquisition are all indicators of change," he adds.

At present the fund holds only 40 positions. "It is very concentrated," notes Butler, "reflecting our high conviction style of management." Meetings have been held with each of these companies and many more. Review of portfolio holdings is continuous. Butler and co-manager Wendy Anderson are looking for quality, value, growth prospects but above all a stock specific process of change driven by management. This change might be for the better or worse. "A weakening franchise is as potentially valuable to us as a strengthening one," adds Butler.

The portfolio is run on a fairly conservative basis. For example, on the 31st of August, 2004, it ended with a gross 48.9% exposure to energy and 49% exposure to materials. The energy exposure decomposes to 35.2% long and 13.7% short with a net sector exposure of 21.5%. Materials are 34.9% long, 14.1% short with a net sector exposure of 20.8%. High conviction was evident in the 4.8% of portfolio allocation to oil explorer Cairn Energy, 4.4% to materials company Arcelor, and 4.3% to oil company Ultra Petroleum. Short positions include -2.7% to material company Ashland and -2.7% allocation to energy company Unocal. The portfolio is also concentrated by region and currency exposure. Gross exposures for both energy and materials are 37.9% to North America, 42.1% to Europe and 18% to emerging markets. Net exposures are respectively 2%, 25.1% and 15.2% to each sector. "We are overweight emerging markets in part," adds Butler, "because we can find value in them; companies with listings on local exchanges which are under-valued."

Long positions have recently included Norsk Hydro. Judged by Butler to own superior quality core oil assets with growth potential the company is also spinning-off a fertiliser manufacturing operation, with more change expected. XTO, a US mid-cap gas field owner is another prospect. Gas prices are expected to increase as it finds wider use as an alternative source of energy to oil. Meanwhile, XTO has traded at a discount to its peer group. Cairn Energy, one of the fund's key strategic holdings, bought an oil field in Rajasthan from Shell, which it is now exploiting. Butler believes there is still significant upside in the share. By contrast a recent short position in Norske Skog was prompted by the firm's weak balance sheet and policy of over distribution to shareholders.
 

Martin Currie – Company Profile

From their headquarters in Edinburgh, Martin Currie manages some £7.7 billion (US$13.9 billion) for financial institutions, charities, foundations, pension funds and investment trusts. As well as their range of hedge funds, collective funds include an OEIC and Luxembourg-registered SICAV.

The company originated in 1881 – with its first investment trusts helping to fund the expansion of railroads across the US. But until the 1980's the company remained a small, niche player in the investment trust market. Since then it has developed into a leading 'boutique', which offers investors a very focused range of specialist active equity products.

Given the rate at which small specialist asset managers have been bought by far larger ones, it seems surprising that the firm has remained independent. But while other boutiques like Edinburgh Fund Managers have foundered, Martin Currie has retained its investors' loyalty because of its consistent record of adding value.

Appointed as chief executive in 2001, Willie Watt implemented a strategy for the company's development as a 'big boutique'. What does this mean? On the one hand, being a 'big boutique' means having the solidity, professionalism of execution and robustness of process of a large company. On the other hand, this is combined with a strong internal culture, and a focus on investor returns, which is driven by staff and directors' ownership of the company.

100% owned and managed by its directors and staff, Martin Currie seems genuinely proud of its independent structure. Around two-thirds of the 220 employees own shares in the business. Martin Currie's independence is a key operational strength, allowing it to innovate very rapidly when the interests of investors call for this

Another advantage of independence is the ability to invest in the business for the long-term. "We have taken advantage of the business environment over the past three years to recruit proven talent," says chief executive Willie Watt. "By offering employees the opportunity to build an equity stake in the business, we have been able to attract and retain some of the best managers in the industry."

An important attraction for managers is Martin Currie's vibrant and entrepreneurial culture. In a survey sponsored by The Sunday Times, Martin Currie has been recognised as one of the 50 Best Small and Medium Sized Companies to work for in the UK. The award was based on a range of factors, including the quality of leadership and management, company culture, the opportunities for personal and career development and the company's involvement in the community.

The firm's 44-strong investment team works together on a single floor of their Edinburgh headquarters. The company finds that their relatively small size and short lines of communication allow them to make and implement decisions swiftly. Their investment process is all about genuinely active management with no 'index hugging'.

There is a focus on fundamental research to identify companies undergoing positive change, and this is supported by their proprietary stock screening system, the Dynamic Stock Matrix TM. Long-only and long/short funds are run alongside each other, both benefiting from the best ideas from the regional and sector research teams.

For developed markets across North America and pan-Europe, Martin Currie has established a sector approach, in which sector managers research and recommend stocks for each of the 10 MSCI sectors. Meanwhile, for Japan and the Asian and global emerging markets regions, the company has retained dedicated teams carrying out their own research and factoring in those markets' unique characteristics.

One factor on which they place particular importance is the ownership and accountability at every stage of their investment process, from sector research and the input of regional teams, to the selection of stocks by the product manager. The firm believe that this personal accountability is essential to a true 'advocacy' process. Another characteristic feature is a progressive remuneration structure which links the managers' rewards to investment performance in a direct and transparent way.

Martin Currie has completed a record financial year to 30 September 2004. In the last 12 months, the company has won £2.7 billion of new business, taking funds under management to £7.7 billion – a rise of 31% over the year.

Highlights of the year to 30 September 2004 include:-
 

  • Institutional mandates awarded in Asia ex Japan, China, Japan, EAFE, UK Active, Europe and charity portfolios.
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  • 10 new institutional 'buy' ratings achieved for the company's UK active, Asia and China specialist products.
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  • Based on excellent performance across the company's range of institutional pooled funds, Martin Currie won Best Overseas Manager in the 2004 Professional Pensions Pooled Funds Awards.

Recognising effective capacity and acting on it is an important aspect of what makes Martin Currie different. "As a 'big boutique'," says Watt, "we don't want to be the largest. But, by meeting or exceeding the expectations of a finite number of clients in a selected range of 'best of breed' products, we do want to be the best."

In order to optimise returns for existing clients, from January 2004, Martin Currie stopped taking on any new segregated mandates for their core Japan product. And in August 2004 they decided to accept no more segregated Greater China business after building up US$1billion in assets in this mandate.

Meanwhile, Martin Currie is proving increasingly attractive for pooled fund buyers. The emergence of fund platforms, the trend towards open architecture and the introduction of depolarisation are all favouring specialist boutiques with distinctive products. Martin Currie now has a total of 10 fund manager ratings from Standard & Poor's and Citywire – including UK Growth, Japan core, Japan mid-cap, Europe, North America, China and Asia. One popular fund is the S&P AA-rated Martin Currie UK Growth Fund, run by Jeff Saunders and John Monnelly. It continues to be a consistent top-quartile performer and, following strong retail support, the fund size grew by 92% to £138 million in the year to 30 September 2004.

The growth of Martin Currie's hedge fund business has been an integral part of its development as a specialist equity manager. Its entrepreneurial outlook and outstanding reputation among clients and peers have enabled it to grow a $1 billion hedge fund business from a standing start in just four years.
 

Martin Currie – Risk Management

Risk management is built into the structure and day-to-day operation of Martin Currie's hedge funds. "I would expect to have contact with the managers of each fund on a daily basis, "says Dan Gardner, the firm's risk manager," close co-operation is vital, we have no tolerance for error and our clients expect us to meet rigorous standards."

Working closely with the product managers, Gardner develops realistic performance and risk objectives, agrees controls and monitors formal risk limits, providing regular risk reporting and pre-trade decision support. Most crucially, he helps managers with their portfolio risk budgets and provides quantitative evaluation of their ideas. Formal meetings with product managers are held on a monthly basis, ensuring high visibility and full understanding of current and anticipated risk exposures. "I then go on to discuss any conclusions we have drawn with the chief investment officer at regular intervals" he adds, "which ensures that priority is given to risk management throughout the investment process."

For hedged portfolios, Martin Currie set a fund-specific risk budget which forecasts tracking error and stock and sector bets. Just as importantly, limits will be agreed on the ratio of long to short positions, and on gross and net portfolios. The firm avoids derivatives where possible, preferring to use physicals and borrowing and lending to establish their required exposures. "It is very important that managers, however experienced and successful, do not drift into riskier positions than meet our investment mandate," says Gardner," if they want to increase exposure, we need to know why."

The firm uses two third-party risk forecasting models, both giving a different perspective on portfolio risk and its decomposition.

EM Applications and Style Research generate forecast tracking errors and attribute active risk across a range of risk factors. EM Applications measures top-down macro factor exposures (e.g. sensitivity to interest rates, oil prices etc) whereas Style Research generates style profiles (e.g. value/growth characteristics). In addition, EM Applications supports the portfolio construction process, facilitating pre-trade scenario analysis and optimisation routines.

STRAP (Short-Term Risk-Adjusted Performance) analysis is a tool charting aspects of a portfolio's historic risk profile. The emphasis is on recent behaviour. It charts realised tracking error, portfolio beta and market volatility over rolling periods of up to 100 days. It also highlights stock weights with the largest positive and negative contribution to performance alongside those with the greatest impact on the observed tracking error. The system provides fund managers with up-to-date, high-quality information regarding the behaviour of their products, enabling a quick response to changes in market conditions if necessary. The monitoring system also ensures that actual risk is consistent with the budget objectives originally agreed with the client.

Daily performance attribution. They also have an in-house system that provides stock level attribution on a daily basis. Product managers therefore always have a comprehensive understanding of performance. A daily summary report spanning all products ensures management is aware of performance; a powerful risk control mechanism in its own right.

Voyager is the core system used by product managers to view their portfolios on a daily basis. Portfolios can be dissected in a number of ways (region, country, sector and stock) against any benchmark index.

RAPS. The risk adjusted performance summary is a tool providing an overlay analysis of medium to long term portfolio performance measured by the correlation of return to risk in the portfolio.