NewSmith Capital Partners LLP is an independent investment management and advisory partnership. Wholly owned and financed by its equity partners, the partnership provides asset management services via NewSmith Asset Management LLP and structured capital markets expertise through NewSmith Financial Solutions Ltd.
The presence of the structured product advisory business is one atypical feature of NewSmith; the second is the Asian dimension that has been present from inception. Whilst quite a few major hedge fund firms, such as Och-Ziff and Tudor, have operations in Asia, they augmented existing operations, not forming part of the core, as at NewSmith.
An Asian Bias
NewSmith was founded in 2003 by Michael Marks, Paul Roy, Stephen Zimmerman, Check Low and Ron Carlson. Stephen Zimmerman says, “From the outset we planned to be an asset management platform offering a diverse range of products across the asset classes. Importantly, we always intended to be in European, UK and Asian products.” Paul Roy adds, “Our experience at Smith New Court (and then Merrill Lynch) taught us many lessons, particularly about operating in Asian markets. You have to have strong local businesses, staffed by local talent. So in starting NewSmith we have had a bias to running money locally in Asia.”
The local talent concept has been put into practice in several ways: founder Check Low, a well-known figure in Asian finance, having been Chairman of Merrill Lynch Asia Pacific and before that Chairman of Smith New Court Asia-Pacific, is based in Singapore (opened office in 2003), whilst the first Asian equity hedge fund is run out of Hong Kong (opened in 2005), and the new Japanese long/short hedge fund (launched in December 2006) has NewSmith’s Tokyo office as its delegated investment adviser.
In addition NewSmith has put further resource in place to sell product into Asia, with Jun Miyazaki as Head of NewSmith Japan a key appointment in this regard. Recent survey evidence suggests that 53% of Japanese corporate pension funds have some hedge fund exposure, and that a further 24% of them have investing in hedge funds under review.
“We also see a big opportunity to sell locally-managed hedge fund product to Japanese investing institutions,” says Jun Miyazaki.
The longer established Asian hedge fund product, the NewSmith Asia Absolute Fund, is managed by Low Seow Che and Chua Wan Hoon. The fund is a pan-Asian (not just greater China) ex-Japan, stockpicking fund, focused on fundamental and intense proprietary research. The portfolio is fairly concentrated with an average of around 40 stocks (long and short) and has an emphasis on smaller and mid-cap stocks where the portfolio managers feel research is inefficient. “We are looking to add value from stock selection not market beta,” notes Low.
Low prefers not to be compartmentalised in terms of style, but if pushed he describes the style as value-biased and somewhat contrarian in nature. Conviction comes from the deep experience of the two portfolio managers combined with support and insight from, currently, two analysts. As many long stocks have hit their price targets this year the managers have stuck to their discipline, exited from some longs and have started to add to the short book. Changes are driven from valuation and fundamentals of the individual fund positions rather than a top-down or market view. This enabled the fund to dodge some of the market bullets in March this year when many China related funds were in turmoil.
“We are currently cautious on the markets, especially in China and India, given valuations and the steep run up in share prices, but overall we are still constructive on the longer term picture of Asia.” He adds. This explains an average 60-70% net exposure to the markets over the longer term.
In contrast with the early commitment to Asia, NewSmith’s first United States presence – a representative office managing client relations from Manhattan – was opened in September 2006. However the background and connections of the Partner responsible, Jeff Hughes, illustrate another commonly observed point about the firm. Hughes had a 30 year career at Merrill Lynch, most recently he was Chairman of Merrill’s Global Markets and Investment Banking (GMI) business in Latin America and Canada, and Head of Global Relationship Management, coordinating coverage of the firm’s most important institutional investors and private clients. He was gently coaxed out of retirement by Marks and Roy, and he has bought into the idea of NewSmith as well as the partnership. “I’m as excited as hell to be part of this” he told The Hedge Fund Journal.
The UK Mainstay
The mainstay of NewSmith Asset Management are the UK equity products: a long/short hedge fund, and seven large segregated mandates for long-only UK equities from institutions. These products are managed by the team under the direction of Merrill Lynch Investment Managers (MLIM) alumnus Steve Thompson. Thompson, a long-time colleague of Stephen Zimmerman, was Head of the UK Specialist Team at MLIM, and ran a long/short hedge fund there. He brings from that firm the philosophy that returns should be driven by fundamental research and stock selection. To that end his team includes two dedicated analysts as well as a dealer and two PMs beside Thompson himself.
Steve Thompson sees several advantages for the team in running segregated long-only mandates as well as money in the hedge fund format. The first advantage of running money in the two forms comes in the understanding it gives the portfolio managers of how the different market participants are motivated and act in the market.
“There have been times when the UK markets have been driven by pension fund and insurance company actuaries, and it’s useful to have an understanding of that,” claims the 42-year old Thompson. “On the other side, the long-only management benefits from the managers knowing about the impact of hedge funds on market activity, most obviously in short squeezes. The second advantage is that the hedge fund benefits from the company access that the $5.5bn of long-only UK equities gives us,” he says. Some of the access currently enjoyed is a function of having talked to the managements of UK corporates for the last 15 years or more – so relationships have been built over the course of time. “We haven’t had a request for a company meeting turned down since we started here,” he states.
Company meetings are a key part of the process. So important are the nuances that may be picked up through sharp observation and listening that the whole team attends the company meetings. Yes, part of the research effort of the UK equity team will be in building financial models of the companies being examined (including analysing competitors), but the more subjective parts of the process are as important. “The time we spend with company management gives us an understanding of the motivation and strengths of the management at the company.” The perception of company management allows the managers to build positions with conviction – as large as 5% for a large cap name, or 3% for a mid-cap company.
This part of the research process, meeting management, can play a big part in retaining positions. Thompson’s funds were already big holders of shares in a small cap company supplying the leisure boating industry when the company announcedthat it was moving the whole of its manufacturing to Hungary from the UK. Will Piercy, one of the analysts, went to Hungary to meet the operational management there. This trip gave the team sufficient comfort to maintain the position, despite the shares having been a big winner already.
Idea generation for the UK team can come from applying screens to the universe of stocks, say, when the market begins to fixate on a particular characteristic (such as asset plays currently), but this is not a primary tool for the team. “What we do is look for change,” says Thompson: “it may be changes in the company in the sense of divestitures or other corporate activity, or it may be management change. The change could be in the operating environment for the sector in which the company operates.”
The sponsor or originator of the idea then considers how sustainable is the business and the growth characteristics it currently shows. At the weekly team meeting a short paper on the company containing the key bullet points of the investment hypothesis is distributed among the team. At this stage the analysis is on the fundamentals, and why the shares are attractive looking out a couple of years. Everyone in the team participates in discussion, but Thompson leads the investment decision-making. “When a team member has high conviction on an idea they get my backing to put it into practice,” says the leader.
The UK equity team at NewSmith has been put together from individuals with different skills according to Thompson. For example Mark Wharrier is considered to be very strong in value investing, whilst Jeremy Davies leads on market timing. Part of Davies’ role is to generate greater trading activity particularly on the short-book, and he has helped in applying discipline in locking-in profits on short positions.
Typically for a hedge fund management operation in Europe, the team add a lot of value in the mid-cap area of their particular market, reflected in 5 declarable stakes in companies (5% and above of the equity). Thompson is also interested in who the other holders of shares are. The share registers are examined for what the company directors are transacting in their own shares, looking for the materiality of the trades, and also to see what sort of investor are the significant holders.
“There may be a 20% shareholder selling down, and we want to know that,” says Thompson. “There may be a venture capitalist on the register, and it can be significant to the share price that the lock-up period is coming to an end. For example when we looked at a leading nursing home operator, there was a venture cap seller that was out of the way – that was a significant factor for us as a trigger,” he says.
The Global Citizen’s Fund
Adrian Vanderspuy, Lead Portfolio Manager of the NewSmith Global Opportunities Hedge Fund, with some justification describes himself as “a global citizen”. An Australian born in South Africa, he has worked in Australia and Asia, and now lives and works in London. He was Head of Equity Trading for Merrill Lynch EMEA, and before that Co-Head of Equity Trading (and managing proprietary capital) for Merrill Lynch Asia. The markets have been his mentor in over 20 years of trading for a living. “In running proprietary capital it has really been sink or swim for me: I just had to develop my own style,” he says simply. “I learned that to make money you should not necessarily run with the pack, and I apply that now.”
In having a global brief, Vanderspuy sees his background of having operated in Asia as a big plus. “To get Asia right a market operator had to understand the whole world. What goes on in the US and Europe has a big impact in the Pacific region. You’re the tail of the dog in Asian markets. Also you get every kind of regime there – semi-fixed currencies, pegged currencies and freely floating ones; the economies are open to the influence of trade flows, and importantly the markets are higher beta. The experience of the higher beta characteristic really helps you to understand about risk control,” he says with a smile.
The Global Opportunities Hedge Fund is roughly 70% equities and 30% pure macro in style, though even the equity selection often has a macro element. Vanderspuy (and his co-portfolio manager, former Smith New Court colleague Rob Harley) gets strategy and research input from Sadiq Currimbhoy, the former Merrill Lynch Asia Pacific Strategist who works with them. So the inputs to position selection are 60-70% top-down and 30-40% bottom-up. The portfolio is deliberately diversified by style.”I’m trying to incorporate many different styles within the fund,” explains the Lead Manager,” and not just mitigating risk through diversification by geography or industry, but thinking about the possible correlations at the asset class level. For instance if we are long equities I would think about the bond hedge to go with that.”
His current world view encompasses a long term bull market in equities – though this longer term perspective can be moderated a times. So it was in February this year: “The markets didn’t feel right in February. The technicals on the S&P and other indices were not great – lower highs were showing up and we took down our equity exposures ahead of the drop at the end of the month. Sometimes risk assessment is as much of an art as a science.”
There is a value bias at work in the process. “BP was over-owned at £7, but down at £5 it was reasonably valued and no-one was interested,” says Vanderspuy. “The cheapness of the asset was known by everyone, so the requirement from an investment standpoint was to get the timing right. In this we often employ options.” Assets or shares that have gone down a lot may be inexpensive, and if they have been going down steadily the options on the shares may be cheap too. It then makes economic sense to take exposure to the underlying through the derivative. At cheap option prices it doesn’t cost much to be involved. “I will put 1% of the fund in an option, and have a few of them at any one time. So the fund could have 3% of NAV in option premium.” he says. “Most hedge funds sell volatility; we think implied volatility is cheap. So on a contrarian basis we think and act the other way.” This option-based tactic has a good risk/return profile, and paid off in crude oil options for the Global Opportunities Fund this year (long calls and short puts in this case
The Award-Winning Credit Fund
The third hedge fund launched by NewSmith in 2004 was the Credit Fund which runs a strategy of long and short credit. This fund has circa US$350m AUM, and won the EuroHedge award for European Credit Fund of the Year 2006. As ever assets and awards migrate to the better performers in the hedge fund world. The credit hedge fund team of PMs Nick Senn and Kevin Chattwell, three credit research analysts and two dedicated operations staff quite sensibly started with a lower risk profile in their first year than that used in the second.
At the time of writing, Senn and Chattwell have gone nearly two years without a losing month. The structure of the portfolio, with three sub-strategies, is designed to improve the probabilities of such a smooth return outcome. The fund engages in long/short credit selection, relative value strategies (primarily curve and basis plays) and capital structure plays (long and short different parts of the same company’s balance sheet). As with just about all credit funds, the strategies are not allocated to from the top down, but emerge from the bottom up as the opportunity set shifts with market conditions.
”We wanted a broad mandate for this fund,” explains Chattwell, “because as we go through the (credit) cycle which we have seen over and again in our careers, we knew that we would see value appear in different buckets through time. And that has been borne out in practice – what we have done at any one time has changed a lot over the two and half years of the fund. As managers we can’t afford to be too one dimensional. ”
At this juncture Senn sees shifts in the investment environment for European credit. “We are through an inflexion point for investment grade credits,” he maintains. “From here on I can see a re-leveraging of corporate balance sheets is taking place, though as a whole those balance sheets are coming from a position of strength. We are in a period of exceptionally high event risk in credit markets,” he adds. Chattwell concurs, “A good deal of our focus has been on exploiting efficient ways of playing the increase in event risk utilising a variety of debt covenants. More recently we have seen a weakening of covenants on debt issues by corporates with increasingly leveraged balance sheets and often in cyclical industries. This ultimately provides the backdrop for a range of relative value, divergence and capital structure strategies that will perform over time.”
For the managers of the Credit Fund, operating within NewSmith has several advantages. “The quality of people here is very high,” says Kevin Chattwell. “There is a low head count but the typical person here is very good at what they do. We can look at managing the portfolio whilst the various support functions and technology infrastructure are all in place.” There are benefits on the investments side too, claims Nick Senn. “We have found the UK equity team to be great discussion partners – they know their companies so well. We’re looking forward to the arrival of the European event-driven team on the same basis,” he says.
Integrity of the Platform
It is significant that one of the founders of NewSmith was Ron Carlson, the COO. The integrity of the platform can sometimes go beyond being just a hygiene factor for potential investors. So it is here. “We think it might be unusual in a hedge fund business, but we try to operate with strong governance practices even in offshore jurisdictions,” he says. For example, the Boards of the Cayman funds have members that know how to operate at a highest level of serious organisations, such as an ex-CIO of Bermudan insurer XL Capital and a former Comptroller of the Currency in the US. In fact it was the latter that suggested the formation of an audit committee for the funds where he is involved. This suggestion was acted upon, and has been followed up with a valuation committee.
Carlson says he sees these sorts of initiatives as bringing plc-type standards to a fund Board. Analogously, he says that NewSmith is applying uniform standards for risk management and fund accounting across the firm – in each territory it operates in, including the offshore finance centres.
That NewSmith has segregated long-only mandates from institutional investors has been a benefit to the operational side of the business, according to Carlson. “Whilst funds of hedge funds due diligence might involve 3-4 hours at a time several times over, the due diligence people for the long-only mandates were with us for 3 or four days,” he notes. “On the operational side due diligence is getting more and more detailed. They are now asking not just what systems we have, but how the systems plug together. They also ask how we are preparing for regulatory change, such as the introduction of MiFiD. They have given us issues to think about and address. So we have introduced an Operational Risk Committee here that considers our response to these issues directly,” he continues.
Carlson has strong opinions about the need to manage relationships with third-party service providers. “Your service providers should be managed as if they are an extension of your own capabilities,” he says. “We have regular conference calls with all our service providers, and we meet their senior management quarterly. We want to know where they are going, as well as informing them of our plans.” He expounds, “we like to have a range of prime brokers, but we believe that you have to concentrate your business with fund administrators: we use Citco for equity funds and GlobeOp for fixed income. This allows us to manage the relationship properly. I’d say the third key relationship is with your systems integrator.”
Ron Carlson works closely with Matt Weir, the Risk Manager of NewSmith. Since Weir’s arrival two years ago the risk platform has been centralised on Riskmetrics. “This allows management to analyse all funds on the same platform in the same consolidated and disaggregated way,” states the Risk Manager. The long-only funds are also analysed regularly by UK quant firm Style Research to identify the style biases. “Having gone through putting in place the systems and routines for the necessary parts of the work of a Risk Manager, I’m now looking forward to contributing more added-value to the oversight processes and working with the PMs more closely, “ adds Weir.
Matt Weir’s role also brings him into regular contact with the other founders of NewSmith, as he shares risk information which is bespoke in format and content for each fund. Paul Roy is Chairman of NewSmith Financial Solutions, and having worked with Adrian Vanderspuy in the past Roy also takes an active interest in the Global Opportunities Hedge Fund. Stephen Zimmerman, along with COO Carlson and Risk Manager Weir constitute the Risk Oversight Committee (ROC) of the firm. The content of the ROC meetings vary each time – “Stephen might suggest we look at a type of exposure, or we might consider how we felt about the changes in a fund manager’s liquidity profile, “ says Weir. “Stephen may also articulate suggestions to the manager.” Part of Weir’s time is spent putting written commentary on the 15-page daily risk reports for each fund at NewSmith. It is intended that the reports and commentaries keep the managers fully briefed of the risks they are running. It is up to the portfolio managers ultimately to decide whether they have the right positions and fund shape. Weir has identified what should be “the core attributes” of the risk information at NewSmith: “Risk management has to be relevant, dynamic and flexible, accurate and timely,” he opines.
Positioning
COO Carlson sums up the firm’s commercial positioning, “We want to be seen by investors as a high quality shop at NewSmith. Further, our philosophy is that we want to work with people we can trust.”
For the most part the two elements have been combined by bringing on board the Merrill Lynch alumni, people who the NewSmith partners know already pass the two tests – quality and trustworthiness. The shared background of the principals is described by Risk Manager Weir as the firm being “intertwined at the top.” A major challenge for the partnership will be diluting the Merrill/Smith New Court contingent with new arrivals whilst still applying the two tests and keeping the whole coherent. So far so good.
The founders of NewSmith have proved themselves adept at spotting commercial opportunities. At this stage, as a four year old company with over $7bn under management, they have already over-achieved in some ways. The regard in which the founders are held, and their sheer nous has facilitated the firm punching above the weight of its balance sheet. Arguably the assets raised for the NewSmith hedge funds are ahead of competitors with similar track records. That is they are probably being very well pitched and positioned in the marketplace.
The firm as a whole reflects well one of the elements of the hedge fund zeitgeist. The capital managed by hedge funds used to come overwhelmingly from high net-worth individuals, now flows are dominated by institutional investors. Pension Funds, insurance companies and endowments require evidence of solid infrastructure and process before allocating capital to external managers.
NewSmith’s platform comes across as being constructed on the principles of best practice, and improved on the basis of what far larger organisations are implementing, the recent appointment of a Chief Technology Officer being the latest example. The investment in quality staff and systems puts the integrity of the NewSmith platform ahead of the size of assets under management. That shouldn’t last for long.
Looking Forward with a Welcome
Last October The Wellcome Trust, the UK’s largest charitable foundation announced that it will provide funding of over US$500m to NewSmith Capital Part¬ners to seed existing and new funds and to enhance NewSmith’s investment platform. The Aaa/AAA-rat¬ed Trust is itself broadly diversified including invest¬ments in hedge funds, buyout funds, VC and active currency and has experienced investment staff that are considered part of the thought leadership of the UK investment industry.
The availability of the Wellcome capital to new hedge funds at NewSmith will be a key component in attracting new managers to the firm. NewSmith seeded its Opportunities Fund with £15 million in 2004, but Chairman Michael Marks says: ”The business has changed. Now it is difficult to get attention with that amount of capital. Our ability to allocate up to $75m at inception, and draw in other day-one capital means that we expect our managers to start trading with $100m, a level that doesn’t preclude many external investors from taking a look,” he notes.
The NewSmith founders see a further advantage for them in the Wellcome Trust connection in assessing potential new fund managers. “It is not just a courtesy that we take potential new managers round to see the Wellcome Trust,” claims Marks. “We respect their professional opinions, and it is good to have an objective, experienced eye run over a strategic offering.”
NewSmith Asset Management recently announced the appointments of Jean Maigrot and Jeremy Silewicz as partners in the firm who will work on a European event-driven strategy. Jean Maigrot has worked in European equity markets since 1986 and was formerly Head of Equity Proprietary Trading at ABN AMRO. Jeremy Silewicz was, until March last year, at Goldman Sachs, as a senior member of the pan-European Equity Research Sales team. He has worked in European equities since the mid-1980s. Their arrival is keenly anticipated by the founders looking to fulfil their diversification by strategy (“they know how to make money shorting,” says Roy admiringly).
The strong opportunistic element in the senior management of NewSmith comes through in considering new teams to be brought in to the firm. ”Last week we looked at a credit strategy. The previous week we talked to some US-based traders in short–term volatility,” discloses Paul Roy. The cor¬porate wish list has at least one element commonly expressed elsewhere: they are looking to bring in some specialists in resources, should one of suf¬ficient quality be available. The firm also is a great believer in high performance long-only, so expect an outbreak of 120/20 strategies at some point.
Newsmith Financial Solutions
NewSmith Financial Solutions (NSFS) is an independent, debt-focused adviser to institutional and corporate clients specialising in structured, non-vanilla finance. It was formed in 2003 when debt specialists TJ Lim, Glenn Barnes and Kevin Krespi joined NewSmith Capital Partners.
Initially NewSmith offered the team some office space whilst they were putting their business plan together, but that soon turned into the idea of doing something together. “After all,” comments NSFS Chairman Paul Roy, ”people of that quality don’t walk through your door every day!” TJ Lim, the NSFS CEO, is a well-known name in the City, having operated across the spectrum of the fixed income markets in his 20 years in the business – he has held a number of senior positions in trading, origination, sales, and structuring, including a track record in running complex derivative trading groups.
He was formerly Managing Director and Head of Merrill Lynch’s International Debt Markets and a member of the Executive Management for Merrill Lynch EMEA. Prior to joining Merrill Lynch, Lim was Co-Head of the Global Markets Division of Dresdner Kleinwort Benson and a member of the Management Board.
Over the past three years the firm has focused on value realization activities through CDO Workouts and Event-Driven Structured Finance. Recent transactions include approximately $4 billion of CDO portfolio workouts for major insurance companies and around $1.3 billion of debt arrangement via structured finance mandates. This year, it has been increasingly investing alongside clients in these activities, as well as broadening the application of its skills to include additional complex asset classes such as distressed debt and other “special situations”.
“We see plenty of opportunities as the credit cycle unwinds over the next couple of years,” says Lim.
As an example of a recent mandate, NSFS completed an innovative capital markets transaction for insurer Pearl Group. The transaction involved the early redemption of Balthazar CSO I BV (“Balthazar”) – a complex, hybrid collateralised debt obligation (CDO) issued in January 2003, and which had been scheduled to mature in 2011. Early redemption, completed in April, more than doubled the realisable value for Pearl’s with-profits policyholders and other investors in the equity portion of Balthazar.
In common with many complex securitisations, the restrictive wording of the trust deed governing the bonds, together with other factors, meant that the optimum value of the equity tranche was not reflected in prices indicated by the secondary market. Newsmith’s role in this transaction was to engineer an early redemption of the bond, thus releasing the optimal value of the equity tranche. On completion of the deal, the gross consideration for the equity notes was more than 145% of nominal value, compared to just over 60% of nominal value that had been indicated in the secondary market. For Pearl policyholders, the deal represented a windfall of approximately €12.5 million.
Lim says of the transaction, “We were pleased to have helped Pearl and its policy holders in overcoming the obstacles that had been preventing them from enjoying the benefits of the currently strong credit cycle.” He added, “There are many similar outstanding securitisations in today’s market, where fair value of the equity component is not reflected in the secondary market. We are continuing to see huge potential in unlocking value from similar collateralised debt obligations and other complex financing instruments held by institutional clients.”
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