Odey Asset Management is Europe's longest established single manager hedge fund business. So it is natural that the offices of Odey occupy a town house near the American Embassy in Grosvenor Square, London. The surroundings are traditional and sedate: the paintings on the wall could come from Tate Britain, but would never qualify for Tate Modern, more Watteau than Whiteread. This suits the leader Crispin Odey, and the management team that have gathered around him often share his educational background if not his taste in office decor. The Hedge Fund Journal went along the calm thoroughfares of Mayfair to meet two of his senior executives, Chief Executive Officer David Stewart and Global Strategist Nicholas (Nick) Cam.

THFJ: How big an organisation is Odey Asset Management now?

David Stewart: We have 45 people and about $4.25bn of assets under management, up from $3.2bn when I joined in May last year. Though as an organisation we are not obsessed with asset gathering. We think we will accumulate assets without forcing it. Physically we have space for 50 people in our building and we have no plans to move.

THFJ: Hedge fund capital is very mobile, how do you as CEO make plans for the business with that characteristic in mind?

David Stewart: You're quite right that assets ultimately come and go with the returns of the funds we run. I conduct scenario planning to determine how we would fare with various amounts of assets under management. We are prepared for significant reductions or increases in management fees from the current levels.

THFJ: How do you see your role at the firm?

David Stewart: A big part of my role is as a gatekeeper in the recruitment of investment professionals. I carry out interim interviews with an awful lot of people to find people who complement the team here. I'm looking for people that are bright, that can think out-of-the-box, can implement our research model and want to be on risk. To succeed here as an analyst you have to be able to think thematically because macro views are a big part of the inputs to our investment process, so I act as a screen for potential recruits. I have to make sure that in particular the candidates are not brash – that does not play well here.

We are long-term thinkers – recruiting now for people who may not add value until a later cycle. Related to this is that I've taken responsibility for succession planning, as we expect that internal candidates will assume greater responsibility in the future.

THFJ: What ideas or ways of working did you bring with you from Fidelity?
 

 

David Stewart: I have been fortunate in having worked for several brilliantly run private companies – Swire Pacific and Fidelity Investments – and they have each had a commitment to long-term thinking. In terms of what I apply here, nothing really – I'm pragmatic in style and that has worked at each company where I've been.

THFJ: What changes have you made at OAM?

David Stewart: I'd say one of my biggest inputs has been our share scheme. This is operated with a three-year lock-up and will bind people in. The first tranche was in March this year. We are planning that after a decade the ownership of the firm should still be more commensurate with the contributions to profits made over those 10 years, but they won't just have come from Crispin.

THFJ: What development plans do you have at Odey Asset Management?

David Stewart: Strategically we want build on our Asian franchise. You know we have a very successful Japanese equity long/short fund run by Alex Griffiths [closed with more than $lbn in assets], and we want to build on that. Alex himself has handed over responsibility for our long-only Japanese fund to his analyst Nick Sharp and we have recruited a new analyst from Baillie Gifford to join us on the Japanese team.

In addition to our Odey Capital Strategies, we have seeded two other funds internally: an Asian fund and Suren Patel's short-term trading fund. We tend to do some internal testing of a new fund or strategy, and then soft launch with $10 or $15 million dollars. We can then push it (market the fund) after a few months of trading. Someone within the firm has to get to the point of screaming that they want to run a fund, then we look to do something about it. So our launch pattern is the result of emerging talent and is quite organic. We are never going to be filling a product gap in some kind of matrix, and we are never going to be marketing led.

THFJ: What kind of growth in assets under management do you see for Odey Asset Management over the next year or so?

David Stewart: Looking over the history of the firm the pattern has been that assets grow, then there is then a pause, then a spurt of performance and then assets start coming in again. If this pattern continues, we are expecting the next run of good performance.

We have an institutional sales team in place, and they know that their client base is a different audience than the high net-worth clients. The institutional investor in hedge funds has a different process of buying, and our sales team knows how to respond to that.

THFJ: What does Crispin Odey bring to the firm?

David Stewart: Crispin is an outstanding investor. He thinks differently from most investors, and he is unusual in being so comfortable in his contrarian trousers. Unlike most investors, he is prepared to stay contrarian and take the pain until he is proved right. Patience also extends to Crispin's approach to recruiting and he is prepared to wait a very long-time to see an individual shine. This creates tremendous loyalty both ways.

We are looking to bring in more talent as time goes on – we want to diversify the investment talent gene pool just as much as we diversify the sources of fees within the business. My 10-year task is to build a business that goes beyond our founder.

Alternative asset management as a sector is facing tougher times and it will be interesting to see how the many long-biased hedge funds cope with different market conditions. I think Crispin will help us to avoid the challenges and take advantage of the opportunities that lie ahead.

THFJ: What do you like about your job?

David Stewart: There is always variety. Also I like the fact that I can stay close to the investment side without being in it. Part of my job is to create the right kind of environment for people to flourish, and I don't just mean amongst the investment staff. We need to have good, talented people at all levels in the different functions. We want the business to progress with no surprises, and we want best practise in all business areas. But perhaps my greatest challenge is to keep our talented and often opinionated people together -working as a team.

THFJ: Has institutional involvement in the hedge fund industry affected you?

David Stewart: We are not beholden to any client group though it is clear that pension funds are well-suited to our approach. We are steadily building our pension fund client base and provided you explain exactly what they should expect pension funds can be your most loyal clients.

THFJ: How would you sum up your experience of coming to work at Odey?

David Stewart: This is a good entrepreneurial environment. It has been nice to work with bright, intelligent entrepreneurial people who know how and when to take risk.

THFJ: Thank you, David.

Co-Head of Research and Global Strategist Nick Cam joined Odey Asset Management in 2003 to lead Odey's institutional business. He is now co-head of research and is responsible for identifying the key macro issues and leading the investment debate at OAM's monthly Investment Strategy Meeting [see box]. From 2002 Odey has been developing an in-house research capability with the dual aims of supporting the portfolio managers and fostering talent. Cam was brought in to give some shape to the research effort, to provide intellectual leadership there, and develop a greater formality in the investment process in total.

"There are two principles of Odey on the investment side," states Cam: "We don't manage other people's money in a way that we wouldn't manage our own.

And second, the members of the Odey partnership are significant investors in our own funds. These principles inform everything we do." The research effort specifically is also run bearing in mind Cam's own take on traded markets and their efficiency.

According to the co-head of research, the most likely outcome is well-priced into markets. "The consensus is very good at pricing the most-likely outcomes, " he says. As shown in Fig.l 1 this means a lot of effort has to be expended to deliver the marginal gain relative to markets, and is uncommon compared to the market. Market activity occurs in the shaded overlap area in this conception. "Alpha is about anticipating surprises," says Cam, "and investment management companies have to be organised to do that."

He continues, "Our research effort is geared up to identify inflexion points in industries and markets. We mobilise our research efforts by what has the biggest potential payback."

There is no maintenance research conducted at the firm, rather "we use a special forces model, not a mass battalions approach to investment research." The 10 research analysts are nominally all generalists. "Of course the analysts are each familiar with the various sectors to different degrees," says Cam.

So the analysts use their accumulated knowledge in an industry, and the knowledge is shared amongst the team. There are typically few drivers of stock prices, and this is what such a research process relies on: "We have to figure out what we need to know more about for an industry or for a specific company," says the main man of Odey's research effort. Partly the research effort is directed from the top-down (macro views in the firm), and partly from the bottom-up (attractive company dynamics).

Reward Structures

One of the ways that hedge funds differentiate themselves from long-only managers is in reward structures. It is often claimed that the key decision-makers at hedge funds have their interests closely aligned with those of the investors in the funds through the performance fee (and the managers being invested in their own funds). At Odey an effort has been made to align the interests of the research department in an analogous fashion. It is written into the job description of analysts that they are there to originate money-making ideas which have a positive impact on client portfolios. "We keep score of the effectiveness of the analysts by tracking their ideas in a portfolio," says Cam. "They get paid by that, so it gets treated seriously."

 

There is a process that shadows the running of the real portfolios. There is a focus list, a notional best-ideas list, that is simply run on an equal-weighted basis.

"When it comes to bonus time," explains the head of research, "we ask a couple of key questions on a systematic basis for the members of the research department. "First, and the most important one, is 'how much money did you make for clients?', and then second 'how much did you assist other people in what they were doing?'" The intention is very much to drive down through the organisation the importance of making money for clients according to Cam.

Like most investment organisations Odey Asset Management has a morning meeting – in their case attended by all the professional staff available at the time. In addition the research department has two meetings a week. These tend to focus on short-term individual stock developments. The monthly investment meeting has been described as a "way of the world type-thing".

"The monthly meeting contextualises our decisions. To be clear we don't use Investment Strategy meetings to discuss particular portfolios but to examine different macro scenarios. They generate ideas for Odey Capital Strategies [the new macro fund run by Nick Cam], and through a view of the current cycle it generates investment ideas across the firm. For example, the low level of credit spreads and the availability of credit to consumers has pointed us towards taking a look at aggressive originators of mortgages. Our research eventually led us to look at Kensington in the UK and Countrywide Financial in the US."

This demonstrates where research followed the big picture idea. Cam neatly describes this exploration of the investment concept as "understanding the hinterland of an idea."

"We have to understand the moving parts (the dynamics) of a company and its industry to enable us to get involved with confidence. We asked ourselves how does Countrywide make its money?"

The next stage of adoption of an investment idea and its implementation is up to the portfolio managers at Odey. "We don't operate an approved list of stocks, and we are not aiming to construct a house view, as such. It is important that the portfolio managers engage in what suits their own investment psychology," explains Cam. "They have to do it in a way that plays to their own strengths."

An Asymmetric Payoff

This is exactly what Cam aims to do with his own fund, Odey Capital Strategies. "All investment is dealing with uncertainty," he states. "What we are doing at Odey is looking for an asymmetric pay-off, and for my newly-launched macro fund the risk/ reward has to be of the right order of magnitude. This rules out looking for potential investments in many markets. As much as 95% of the distribution of returns of a market are not suitable for us to look at to initiate a position." (see Fig.3). The remaining fat tails of distributions of returns, available for maybe only 5% of the time, are what patient macro investors have to wait for." It is only by fishing in these muddy waters, when pricing is stretched, or markets are acting in an extreme way, that the desired upside-to-downside ratio of 3:1 is feasible. "Out-performance is found along the road least travelled. The fact that it is often the less likely outcomes that are cheaply priced is a key point in our investment approach," says Cam.

Cam sees his opportunity set as including both outright positions and relative value trades. His framework of looking at the investment world sees three forms of risk-taking suitable for the macro vehicle: momentum, carry and mean reversion. The concept is that the fund is not just one investment idea replicated in several different forms, nor should returns be reliant on only one type of trade. Over the course of the l-2year investment horizon, by harnessing the best of OAM's macro ideas, it is intended that Odey Capital Strategies delivers equity-like returns with a volatility of around three-quarters of that of the equity markets. In future the fund will usually have three to eight positions, but today is more likely to have 5-6 positions.

Risk Assumption in the Macro Fund

Modern era macro managers typically analyse the correlation between positions in their portfolios -something for which George Soros would rely on his intuition is now measured by those that have come after him. A key insight into a manager is how they turn risk measurement into activity. In what way do they utilise the information on their portfolio risk characteristics? For Cam's macro fund, portfolio construction is carried out using an optimiser, so he not only measures the historic correlation between his positions, he explicitly forecasts it too. In using an optimiser in traded markets across the asset classes it is not usually the forecast of correlation, or volatility, that is the major input that determines the outcomes. Analysis of correlation is done using a long time-series, typically years of data. The co-variance matrix in optimisers is thus fairly stable. Volatility might be calculated for a data window of months, though sometimes long-term volatility measures are used by managers. Estimates of volatility are the next most stable element in using an optimiser. The estimates that have the most error in them and which determine the utility of optimisers in portfolio construction are forecasts of return. Cam says: "Optimisation procedures are sensitive to small changes in the estimates of return. So what I do to take away the spurious accuracy of the output is to optimise the position sizes for different levels of return at the portfolio level, say, 15% or say 25%. I'm looking to be approximately right rather than accurately wrong." The positions are scaled to a target risk level.
 

Scenario testing of the portfolio(s) then allows Cam to appreciate how the combinations of positions will work in normal and atypical market conditions. "This testing is particularly important where we are transferring from a market environment of one set of correlations or volatilities to another," he says.

Taking a commercial perspective, the Odey Capital Strategies Fund is not being run with a full-blown level of risk assumption from the off. New hedge funds can't afford to lose much in the early stages of building a track record, and Cam is fully aware of that, so the fund is operating at about two-thirds of the risk level anticipated for the mature stage. The target monthly VaR (99% confidence interval) will be 10% or less, and it is expected that the track record will eventually exhibit a volatility of around 34 of that of equity markets. The fund is run to have a fairly consistent level of risk assumption through time, fitting in with the concept that hedge fund managers are paid their (large) management fees to be committed to markets. It is particularly difficult for macro managers to do otherwise as they have the widest choices of markets/assets/strategies and essentially fix their own parameters in ways that CB arb or equity market-neutral managers cannot.

Current Views and Positioning

Cam's current take on the world is that global growth remains at its strongest since the 1970s while, for the present, the industrialised world exhibits few extremes in terms of growth, employment or inflation. He warns that beneath this calm surface, however, are conditions which are "extreme in any historical perspective." He says that "the US personal sector is an enormous borrower from both the corporate and foreign sectors. Global asset prices remain 'elevated' to use Mervyn King's word. China is excessively dependent on both capital spending and exports. In spite of talk about a nascent consumer society, China's personal sector accounts for the smallest proportion of activity since 1978. Financial market volatility is very low, credit spreads are very tight, and commodity prices and corporate margins are very high."

With this world view it is unsurprising that the positions held in the period since launch at the end of September have largely been shorts. In the middle of November the fund was short 9.8% European equities (via futures contracts), short 10-Year Treasuries for 22.7% of fund NAV, and short copper futures equivalent to 7.2% of the NAV. There were no FX positions at that time.

The Significance of Macro at Odey Asset Management

Macro views have always played a large part of the investment thinking and indeed fund positioning at Odey Asset Management. This has distinguished the firm since inception. As more and more competitors have entered the hedge fund world in Europe there remain still few funds that explicitly take macro views in running long/short equity portfolios. OAM has been unusual in ignoring benchmarks in running its long-only funds too. For allocators to hedge funds this means that Odey funds have the potential to be terrific diversifies within funds of hedge funds. When other long/short funds do well those at Odey do not necessarily perform, and vice versa.

David Stewart, CEO at OAM, was asked whether Nick Cam was recruited with the intention of him running money at the firm. The answer was "No, at the time we were trying to bring our macro thinking into one place." This made a lot of sense for a firm that emphasises the macro-economic framework for investment decision-making to put more resource and structure in place. If new hedge funds "emerge" at OAM, then it seems long overdue that the firm has nailed its macro colours to the mast explicitly in the hedge fund format. As described, the Odey Macro Strategies Fund has started off taking risk differently to most in the global macro space.

Should the risk assumption increase as planned, and the returns match the high quality macro debate at Odey Asset Management, then the firm will have its much desired diversification by manager and mandate.