Morley Fund Management and ORN Capital

Paving the way for pension fund flow

Philippa Aylmer
Originally published in the July/August 2006 issue

Morley Fund Management, one of the UK's largest fund managers, has clinched a deal with London-based hedge fund manager ORN Capital, that effectively doubles its alternative funds under management and considerably widens its hedge fund range.

The agreement between Morley and ORN is yet another in a growing list of fund manager acquisitions that are accelerating big firms' advance into alternative strategies through the purchase of smaller hedge fund managers. In the last year, Schroders bought London based, funds of hedge funds manager, NewFinance Capital; the Bank of Ireland Group acquired 71.5% of Guggenheim Alternative Asset Management for $184 million; Integrated Asset Management bought a 50.1% controlling interest in London-based Attica Holdings; and Close Brothers bought an undisclosed majority stake in Fortune Group. At the end of June, Morley received FSA approval for its 56% stake in ORN Capital.

ORN, which was founded by Harald Örneberg in 1999, manages funds on behalf of a wide range of institutional investors including foundations, pension funds, funds of funds, private banks and family offices. It now adds three funds to the Morley offering. ORN's funds under management total $650 million, bringing Morley's total hedge fund assets under management to over $1.2 billion. Morley's total funds under management currently stand at £155 billion.

Both parties claim that there will be no structural changes to the business although the ORN Capital board now includes three senior executives from Morley: James Tanner, Morley's managing director will be responsible for distribution; David Watson will act as CFO and Katherine Garret-Cox will act as CIO, while Örneberg will continue to run the business as CEO and Richard Ford as COO. "There will be no change for our fund managers and no change for our clients," confirms Örneberg.

If the cap fits

It is not only ORN's assets that have attracted Morley. The acquisition is seen by both parties as a good fit, both culturally and at a funds level. "We liked the single strategy nature of the business, and the fact that it is not funds of funds" says James Tanner. "It represents true alpha."

Tanner describes the acquisition as bringing together the Morley scale and reputation with ORN's talented team and track record. Within the organisations, Morley and ORN describe it as perhaps not love at first sight, but definitely love by the end of the first date.

However, both parties admit that they were not actively looking to create the partnership and see it more as the result of an affiliation and a meeting of minds over time. "Ultimately, this is a people deal – Morley and ORN Capital have spent many hours discussing our strategy and business plan, and we both know that these are people we can work well with," says Örneberg.

Aside from ORN's excellent reputation as manager and product developer, the business structure and management fit well with Morley's ethos. It strengthens the Morley brand and the Aviva parentage and both sides believe that it offers a credible hedge fund investment option to European pension fund clients. The funds themselves complement each other. Morley's G7 large cap relative value fixed income fund provides a good balance with the ORN distressed debt fund. While Morley does not manage any specific energy resource business, ORN has the ORN Global Resource Energy Fund.

However, there will be no interaction between the funds. Morley recognises ORN's strengths as a boutique organisation. "Over the past seven years, ORN has developed from an entrepreneurial start up into a full service, multi-strategy alternatives investment manager. Looking forward it is important that the boutique culture which has helped ORN to flourish be maintained whilst collectively we design and grow products for a much wider institutional client base," explains Tanner.

"The purpose of joining together is to give us another platform to grow our business. It would give us different positioning in the hedge fund space, and will accelerate our product offering for our clients. They will work closely on the strategic development and will be launching new products from both platforms in the near future. This will give certain investors access to a broader portfolio of our skills and discipline."

Both Tanner and Örneberg believe that their clients will get the best of both worlds via this agreement: talented fund managers from both sides combined with strict compliance, risk and accounting standards.

As the alternatives business grows, the two parties will asses how most appropriately to grow the two franchises in conjunction with each other. One strategy may be more appropriate for Morley and not as appropriate for ORN. "We will work to our own strengths," says Tanner. "Morley is a fund manager. It constructs funds, but does not develop them: that's where ORN comes in."

Morley believes it is now well placed to cater for increased investment inflows. "This deal accelerates our growth in the alternative space. Demand for absolute returns is increasing and together this move enables Morley and ORN to more quickly to respond to what our clients want, with a wider range of single strategy and multi-strategy hedge funds," adds Tanner.

Paving the way for pension funds

Tanner is right. Hedge funds are beginning to emerge as mainstream investments and more institutions are gaining confidence in investing in hedge fund strategies. A recent survey by Mercer Investment Consulting found that over 10% of the UK's large pension schemes with funds over £500 million now invest in hedge funds. And one in 10 schemes is expected to consider introducing some form of liability-benchmarked strategy, either through bonds or swaps.

Much of Morley's work is managing the longer liability types of businesses, in excess of 10 years, such as pension funds and life insurance products. Its own range consists of G7 Fixed Income; SRI Long Short Equity; Central European Long Short Equity, launched in June 2005 which predominantly invests in securities listed on the Warsaw Stock Exchange; Convertible Bond Arbitrage which takes long and short positions in global convertible bonds, equities, debt securities, futures, options, warrants, preferred shares, swaps and contracts for difference; and a fund of hedge funds, Alpha Optimum.


ORN brings a totally different set of funds into the mix: the ORN Event Fund, launched in December 1999, invests in special situations and risk arbitrage across European and Commonwealth markets; the European Distressed Debt Fund, launched in August 2002 which invests in distressed senior debt issued by European corporates; and the ORN Global Resources and Energy fund, launched in September 2004.

Morley's flagship fund, the G7 Fixed Income, was launched in February 2003 with $25 million of internal seed capital. Managed by Shahid Ikram and Trevor Welsh, the fund generated 15% in its first year of trading. After a period of soft marketing, the fund now stands at $350 million under management. Ikram anticipates capacity will reach $550 million, at which point he will soft cap. However, the fund could reach $1 billion, but as Ikram explains "Jim and I agreed that $500 million is a good size for a fund, and that $1 billion is more of a business, which carries certain infrastructure and developmental issues."

Ikram describes the portfolio as a classic fixed income relative value fund. Seventy percent of alpha and risk is associated with pure relative value such as yield curves, asset swapping and cross market trading. The other 30%, says Ikram, is "more directional positioning on rates and FX and there, we put these strategies through options structures."

In terms of managing the fund, the approach is to have 5-7 high conviction themes, and each one of these themes generates 0.2-0.3% NAV. No one trade or idea will have a structural bias within the portfolio.

Ikram and his team choose ideas from within their own selection process. "We do not need to get into consensus trades. Our screening process allows low correlation with the market, raising our alpha generation," he explains. "Our aim is to generate about 1% NAV every month. The fund has had one down month in 43 months of trading and is up 40% in 40 months of the portfolio, so we are definitely working along the lines of how we envisaged running the portfolio."

The fund allocates a 40% risk budget to sterling. "It is a market in which Trevor and I have cut our teeth over the years," explains Ikram. The rest is divided 30% in Euros and 30% rotating between dollars and yen. In terms of the types of instruments, says Ikram, "we are fairly active in swaps, cash, repos, exchange traded and OTC structures."

Ikram and Welsh believe that what differentiates the fund from its competitors is its greater focus on the longer parts of the yield curves. "Our hedge fund client base is different so our hedge fund business tends to focus on controlling downside risk and exposure," explains Welsh.

Changing traditional pre-conceptions

But the G7 Fixed Income Fund was not an immediate success with Morley's clients. "We started aiming this product at our existing client base and the pension fund market. However, what we discovered in 2003 and 2004 was that we were a little too early," discloses Welsh. "Our traditional marketing outlet, the consultants, had not really geared up their own resources in hedge fund research. Consultants are discovering that they need to generate a return in fixed income while pension funds want to chase alpha in a way that they cannot get from their standardised bond portfolios. We are having much more success in selling the fund to our original target market and are now seeing interest from long term institutional money rather than high net worth individuals and funds of funds," he explains.

There are a number of reasons for this: the European hedge fund market is expected to grow by around 20% to just under $400 billion over the next 3-4 years; pension funds are moving out of equities into bonds to cover their deficits, and still generate reasonable levels of return, and the regulatory structure has also changed with the introduction of UCITS III which has allowed much freer use of derivatives. "Clients are much happier for fixed income managers to employ a wider range of activities on both long only funds or cash standardised non-leveraged cash funds, but also to put a hedge fund within their bond portfolios. Not only do we believe that Morley are well placed to participate in this shift, but we are already getting a growing number of reverse enquiries," states Ikram.

Taking alternatives one step further

One area which Morley is looking at seriously, and which ORN has specialist knowledge in, is the energy sector. It is a more volatile market and has higher barriers to entry than other sectors. However, ORN's Global Resource and Energy Fund, although not operating with a large number of assets, is well established. It is primarily a long/short strategy fund, although it does take positions in the commodities market via futures and swaps.

Managed by Tal Lomnitzer, the fund has a directional bias, hedging out market risk using a variety of methods including ETFs, sub sector indices and sometimes commodities. With a combination of a top down and bottom up approach, its mandate is energy and resources in the broadest sense: from early stage exploration and production, refining, storage, and alternative energy, to energy technology. "The biggest opportunities and the best risk rewards are in the mid-caps space, where we are now focusing most of our efforts," explains Lomnitzer.

More funds in the making

Aside from the existing funds, Morley and ORN plan to broaden the distribution of ORN's products both in the UK and Europe. Tanner has seen a growing demand from institutions for single strategy and multi-strategy funds. "Having developed our existing hedge funds as a natural extension to our significant long-only footprint, we are now working on some exciting new products in the covered bonds space and Central European long/short. We are in the early stages of looking at a multi-strategy offering which Morley hopes will broaden its portfolio," says Tanner.

Morley and ORN have created a strong platform from which to grow their existing business and launch future funds. Bothentities are adamant that their primary focus is on the long-term. "We will be guided by one key principle: to offer products which have a medium to long term time horizon and not products that are driven by short-term fashion," affirms Örneberg, and he remains confident that ORN will be working with a company that understands how to create value and take both businesses through to the next level of growth.