Martin Currie Investment Management

10 years in hedge funds caps a century in equities

Originally published in the September 2010 issue

Edinburgh is a big centre for institutional money management but only a couple of boutique firms have embraced the opportunity to add long/short equity skills to their traditional long only investment repertoire. The biggest is Martin Currie Investment Management, which launched its hedge fund range in 2000, over a century after it began investing in equities in 1881. With the spring acquisition of Sofaer Capital’s European long/short fund, Martin Currie raised its hedge fund assets under management to $1.3 billion and joined The Hedge Fund Journal’s Europe 50 group of leading managers for the first time.

Martin Currie suffered heavy investor withdrawals in the post-2008 pullback in hedge funds in the same way that bigger liquid managers like Marshall Wace and Och-Ziff also faced redemptions. But because the Scottish firm was conservative with risk and only invested in highly liquid securities, it honoured all redemption requests. Since January of 2009 it has steadily rebuilt AUM as hedge fund investors returned to the market. The recent 10th anniversary of the firm’s inaugural hedge fund – the Martin Currie ARF Japan Fund – offered an opportunity to discuss how the business and marketplace had evolved.

“I think a couple of things have changed,” says Allan MacLeod, managing director of sales, marketing and client service. “Most people would argue that we are in a lower return environment now. When we started 10 years ago investors were looking for mid-teen annual returns from an equity long/short fund. Now 8-10% is much more in the ball park. Overall, investment expectations have come down in every asset class. Also, the ability to protect against the downside became much more important and it is something we have done extremely well.”

Back in 2000, Martin Currie management could see that hedge funds offered an opportunity. After the launch of the Japan Fund, the firm realised that launching a whole range of hedge funds offered clear growth potential. It is important to recall that this was a time when markets had racked up stunning gains, especially in the technology sector. However, as the 2001-2003 bear market soon proved, demand suddenly soared for managers who could hedge gains and sidestep the broad plunges that most equities indexes experienced.


A distinct client base
Willie Watt, chief executive of Martin Currie since 2001, oversaw the expansion of hedge funds to target China and the resources sector in 2002-2003. He recalls that there were three main reasons to increase the hedge fund offering. “One was that a distinct client base looked for a more flexible and risk managed approach to investing in equities,” he says. “To access them you needed long/short products. The second reason was to increase the skill set of our people. We felt that over time there would be convergence between long-only and long/short investing. We felt we needed to build up the skills associated with long/short investing within the firm. The third aim was to diversify from the relative return focus of the firm into something that was more absolute return. As an equity only specialist, focusing on absolute and relative return gave us some diversification of risk while still being equities based.” The move also helped diversify Martin Currie’s client base and its fee stream at a time when there was relatively little cross over between hedge fund and long only clients.

Though it might be considered unusual for Martin Currie to begin its foray into hedge funds with a Japan long/short equity fund, the logic was straightforward. It was really a question of helping investors access leading companies like Sony and Toyota, while minimising exposure to a market that investors, even in 2002, had shunned for years. The Japanese fund hasproven a long term winner, gaining over 90% in ten years of trading against a market that has fallen a further 30%.

“The success in generating returns is what we are most proud of,” says Watt. “The difficulty, even now, is convincing investors to focus on Japan. We have produced significant positive returns through the cycle in Japan and it demonstrates that the managers, John-Paul Temperley and Keith Donaldson, have a lot of skill and are worthy of being in anyone’s portfolio. It is a way to give clients access to the equity investment opportunities in the market without carrying market risk. I think that’s what we continue to deliver.”

Bottom up stock pickers
The core of Martin Currie’s investment process is company research and bottom up stock picking whether in the long only or the long/short portfolios. Not only do the same teams operate both books but there has been remarkably good retention among staff. The way different teams run funds is similar. Gross exposure is generally capped at 200% with maximum net exposure typically between 50-75% on an absolute basis. Stock positions tend to be around 4-5% of net asset value initially with a limit of 7% in total. These limits have changed little over the years and the European long/short fund brought on board from Sofaer Capital has similar parameters to the Japan and Global Resources long/short funds. One exception is the China Hedge Fund where the lack of many shorting instruments means the portfolio tends to be long-biased.

“The limits we have today are fairly similar to the limits we had 10 years ago,” says MacLeod. “What’s different is that in the early days we were regarded as reasonably conservative and at times that would count against us as there were funds which were a lot more aggressive. I think today investors are much more comfortable with a conservative approach. If you look at the 10 years of the Japan fund and eight years of Global Resources the average net exposure in each case has been between 25% and 30%.”

Early on China
In addition to its Japanese track record, Martin Currie’s presence in Asia is burnished considerably by its early move on China. It is licensed to hold Shanghai-listed ‘A’ shares and has built up funds under management of over $4 billion in Chinese equities since Chris Ruffle joined the firm from SG Warburg in 1994 and set up the country office in 1997. About $200 million of AUM is in the (closed) China Hedge Fund which specialises in small and mid cap stocks. Owing to the liquidity constraints of this approach, it has 90 day redemption terms compared with the 30 day notice required on other Martin Currie hedge funds.

“Until about 2003 nobody was interested in China and we had a couple of hundred million dollars from professional investors who subcontracted their Greater China exposure,” Watt recalls. “Chris used to say to me that he felt like John the Baptist in the wilderness because he would talk about how China was going to change and grow, but nobody was listening! That’s all changed in the last few years. It’s got a great track record, but it is not the most scalable thing we do.”

On a five year basis the China Hedge Fund has performed on par with its peer group, but significantly better than the market. In the past year it has beaten peers and is significantly better than the market [14.2% vs 7.5% figures as at 31st July 2010]. Even though Chinese markets are beginning to make it easier to use some of the tools at the heart of hedge fund investing, Watt dampens suggestions that the China offering could become a multi-billion dollar product in the foreseeable future.

“It probably will grow but it will never be a $2 billion fund,” he says. “Clients are much more interested in liquidity than they were. We didn’t have to gate during the crisis. But we are mindful of not putting investors into that position. For that reason we have to keep the China Hedge Fund small. It is very much the best ideas of the team and therefore I don’t think we want to load it up with stocks we don’t have conviction in.”

A broad take on resources
Martin Currie’s biggest hedge offering is the Global Resources Fund. It has AUM of $600 million and follows a broad mandate to invest in commodities. Though around half the portfolio is invested in energy, other allocations go into mining, paper and utilities stocks. Though the fund is very much focused on bottom up stock picking it also applies a macro outlook to exploit the connection between major commodities and share prices.

The Global Resources Fund launch in 2003 coincided with the rise to prominence of theories about the so-called resource super-cycle that saw explosive returns for savvy resource investors like RAB Capital co-founder Philip Richards. But Martin Currie’s approach is much different with its focus on risk adjusted returns and ample liquidity.

Watt says the fund managers, Chris Butler and Duncan Goodwin, would recoil at theorising about a commodities super-cycle. “They try not to look at the macro and the beta of the market,” he says. “It is not what they are trying to do. What they are looking for is individual stocks that are going to under or outperform on an absolute basis. The approach is very much bottom up.” Over five years the fund has beaten indexes and is in the top echelon of its peer group. In 2008, the fund suffered a 10% drawdown against a market down 40% though 2009 saw underperformance as the broad rebound produced an undifferentiated rally across the market.

Acquiring Sofaer Europe
Martin Currie plugged a hole in its product offering earlier this year with the acquisition of Hong Kong-based Sofaer Capital’s European fund. The deal brought in $210 million of assets as well as veteran hedge fund managers Michael Browne and Steve Frost.

“We wanted a European equities product because in equity long/short it is a very large part of the market,” says Watt. “The things we were best known for – China, Japan, resources – are smaller market segments. Strategically, it made a lot of sense for us to have a successful long/short European team,” he says, noting that the managers have a 10 year track of 8% annualised returns during a time when the overall market was negative. The aim now is to use Martin Currie’s distribution muscle to attract more investors and sell capacity around the world.

A similar focus is being applied to the Martin Currie ARF – Global Financials Fund. Managed by career financials specialists Paul Sloane and Len Riddell the fund recently passed its fourth anniversary. Its track record of 3.4% annualised performance compares with a 10.6% annualised drawdown for the MSCI ACWI Financials Index. “As the crisis unfolded, the managers really came into their own and they’ve read the post-crisis period particularly well,” says Watt. “They’ve built a track record and it is a fund we feel we can do a lot with in the coming years.”

A new decade
At the outset of its second decade in hedge funds, Martin Currie is soon to launch UCITS III funds for its European, Global Resources and Japan hedge strategies. “We feel that will aid the development of our business in Europe,” Watt says. “A major focus will be to build that to critical mass over the next few years. We also have a significant US client base but we need to develop more of an Asian client base for what we do. We want to ensure that our Asian centric product range finds more of a client base in that region.” He notes Martin Currieis among the first choice for investors looking for resources, Japan and China strategies, but adds that the firm needs to broaden that out to European equities and financials.

Watt says Martin Currie delivers a global perspective to investing through the linkage of its long/short business with a substantial long only business managing around $15 billion. “We have a significant integrating factor in the way we look at global sectors which benefits our long/short business,” he says. “We have a deep heritage, too, of being a multi-generational, independent and employee-owned company which combines hopefully the benefits of being a boutique with something that has been around and hopefully stood the test of time.”