Permal Asset Management

Permal Asset Management

Maha Khan Phillips
Originally published in the March 2005 issue

It is one of the world's biggest and oldest managers of alternative assets, and now it may be up for grabs. Back in March Maha Khan Phillips met Isaac Souede, the man who oversees Permal Asset Management, the fund of hedge funds group which manages US$19.2 billion firm, making it the third largest hedge fund house in the world.

Permal runs a plethora of multi-manager and single manager funds, alongside customised separate accounts and structured products, and has been in the business since the 1970s. In the past six years, it has more than doubled assets under management, with 60% of assets coming from new business wins.

Unusually, Permal hasn't rushed straight into the institutional market, but has continued to focus on high net worth clients. It also remains very cautious about which managers it invests with, only placing money with a fraction of the managers it interviews each year. Sometimes it can take as long as two years before it makes a decision about a manager, and consequently shuns away from smaller start-up firms.

Says one US-based consultant, who has worked closely with the group: "Permal is an impressive company, but also a surprising one. It has not gone down the traditional route that most fund of funds have taken to make money, which is to focus on US and institutional clients, and is still at its hub conservative and pragmatic."

"We have a low key strategy," Souede himself explains. "We care about our clients, we put them first. If net subscriptions come, then they do."

Souede is a reticent man; he stresses that he is not one of the 'social' managers who spend their time on the publicity and conference circuit. "I don't participate in gossip," he says.

While critics have suggested that Permal has gone from being the only kid on the block to one of many, and hasn't coped with the onslaught of new managers, it is clear that Souede has his finger on the pulse of an expanding industry, regardless of how much time he spends chewing the fat with individual hedge fund managers.

Permal has never quite followed the herd. When Jeff Vinik quit Fidelity's Magellan fund in the mid 1990s after he was criticised for moving out of technology stocks and into fixed income, Permal gave him $80m to set up shop. The firm was impressed with his preparation and knowledge, and Vinik, who raised $800 million himself, was up 48% a year for five years. In fact, Permal has helped seed some of the industry's biggest stars, notably Soros, Robertson, and Steinhardt. Souede is a director of a number of offshore investment funds, including Steinhardt Realty Trust, Tiger Selection Holdings, and AIS Worldwide. Permal is now investing in the second generation of fund managers, the so-called "Tiger Cubs", the funds which tend to be closed to most investors who do not have the close association that Permal does. Souede, who has been in the business for 30 years, says he is unimpressed with the "flashier" hedge fund managers launching in the current alternatives boom, those who like to talk "only to hear the sounds of their own voices". It may explain why hedge funds enjoy the prestige of operating as part of Permal's stable of managers. "Managing money for Permal gives you legitimacy," says one fund of funds manager.

Another debutante at the ball?

Souede is not worried about Permal's reputation, but its future is certainly focusing minds. Parent company Worms & Cie, the French holding company owned by Italy's Agnelli family, is considering selling up. It is understood that the Agnellis are considering ways to release capital for investment into Fiat, the motor company it also owns. Souede says he is relaxed about the future of the company – it is 23% owned by management, and he makes it clear that whatever happens, Permal's management will be committed to the success of the firm going forwards. Be that as it may, Merrill Lynch has been hired to explore strategic options, amidst speculation that selling the business will not be an easy task.

"I know that [the] Merrill guys are finding this tough," says one consultant close to the industry. "This is an incredibly successful business, but possible buyers will be concerned about the premium attached to a sale. They will also be asking themselves how to grow the business from here. If they are going to get the kind of sales prices they want for the business, Permal need to be in the institutional space."

Others reckon that the way forward would be for Permal to ally itself with an institutional manager, for whom the business would be complimentary, and which could provide a large distribution network. This would certainly solve concerns about a lack of corporate clients.

Still, it is likely there will be a lot of fund of hedge funds businesses on offer for buyers to choose from in coming months. "This is going to be a year of consolidation," says another hedge fund consultant. "The fund of funds market is overpopulated – if you look at the billion dollar club, there are about 120 estimated members these days. And the independents have been happy to sell out for the right price."

Rumours abound that certain funds of hedge funds, like FRM and Olympia, are already open to offers, and suitors in the banking world may be starting to emerge. JP Morgan, for example, has already bought a controlling stake in Highbridge, the arbitrage specialist, for $1 billion, and Lehman Brothers has expressed interest in GLG, a larger multi-strategy firm.

Despite its private client bias, institutions make up about 20% of Permal's asset base. It recognises that the institutional side of its business has to grow gradually, and has explored various options to break into the market in the past. However, it has not wanted to change its approach too radically in order to facilitate this. "In a way, our institutional presence has not developed because it requires a different mind set," says Omar Kodmani, head of Permal's London operation. "Philosophically, we don't embrace a lot of things that institutions are attracted to, like arbitrage strategies. Our strategies are core to us."

Historically, Permal has been keen on macro managers, even during times when the strategy has been unpopular with allocators. It also offers clients a range of non-correlated strategies, including equity long-only, long/short equity, market neutral, macro-driven and event driven. It alters its allocation to different hedge fund strategies as it takes a view on various markets.

But critics still worry that Permal's approach is too closely correlated to mainstream market indices: "If you compare Permal's products with some of the classic fund of funds, you would see that there is a much higher correlation of some of their big products to the S&P 500 and some of the bond indices, which is difficult for some investors who want to diversify away from that," says a consultant for institutional money. He argues that to go to the institutional market, Permal will need more diversification of its products. "But for investors who want to capture the upside and restrict the downside, investing with Permal makes a lot of sense," he admits.

Permal has received an A-rating from Standard & Poor's for nine of its fund of hedge funds, which will go some way towards reassuring investors, particularly institutional ones with a short track record in hedge fund investing, and Kodmani himself reckons that as long as the Permal products continue to outperform, institutions will pay attention, particularly once they have tried their hand at hedge funds and become second tier investors. "If anything, we think institutions might come around to the core things that we do in a pure play kind of way," he says.

It is telling that a manager at one of the UK's largest pension funds says the name Permal rings a bell, but that he does not know anything about the firm. It is a problem Souede accepts. "We are the $20 billion player that many institutions may not know." Yet the firm's brand is strong amongst the leading families in Europe and Asia, thanks partly to its long track record in the private money sphere. Awareness of its capabilities in the institutional space may take time, unless it can hook up with a powerful banking brand.

Risk management and the art of quant

Expanding its institutional client base could also bring diversification benefits to the firm. Permal relies entirely on distribution channels to sell its products, and 30% of that distribution comes via a Merrill Lynch platform. "It is true that we have a very substantial relationship with Merrill Lynch, that relationship goes back to 1989, and it is largely because Merrill was the first major financial group to adopt open architecture and take on third party managers such as ourselves," explains Kodmani. But Permal has made it a priority to diversify away from the one relationship, and now has 10-12 additional banking relationships with major European and American firms.

Merrill was a majority asset gatherer for Permal for many years, but now the importance of that relationship has decreased, as Permal developed four or five core relationships elsewhere. It has been a valuable process of diversification that should stand it in good stead going forwards.

Josefin Aldell, vice-president responsible for marketing at Permal, thinks attracting institutions was one reason why it was important that the firm hired someone like Julian Shaw, the former global head of market risk at Barclays, who has taken control of risk management. "Institutions have a greater need for a quantitative view," Aldell says.

Shaw came on board in April 2004 to build up Permal's quant expertise. He had known Souede socially for almost twenty five years, and over time, the two had talked about their various businesses. "We'd exchanged different perspectives, so you could say we had been talking for many years!" Shaw jokes.

It has been suggested in the past that Permal does not have enough quantitative focus, and that technology needs to be improved. It is clearly an issue that irks at the firm. "Permal has done a damn good job without leaning heavily on quantitative techniques," Shaw says. "There is a tendency of some fund of funds to use quant in a very naïve and dangerous way. Permal doesn't use quant techniques unless they are applicable to the problem at hand."

Shaw can identify several problems with hedge fund of fund risk management. Among them is the tendency for hedge funds returns to be smoothed, and hence, the volatility estimates are too low. Hedge fund returns are also fat tailed, skewed to the downside, and have higher correlations in bad market conditions. Permal 'de-smoothes' returns to ensure accurate volatility and beta estimates, and uses extreme value theory to model the tails of hedge fund returns.

"In general, human beings and quantitative analysis, put too much weight on recent performance," Shaw points out. He cites the example of trying to distinguish between skill and luck. If one security has an expected monthly return of 1.0%, and a second security a return of 1.5%, and both have normal returns and standard deviation of 7%, it would be human instinct to pick the second security as the better security. But actually, you would need more than 26 years of data before you could make that assessment correctly.


Key Products

Permal has US$19.2 billion in assets under management. Eighty-five per cent of these are from its fund of funds products. Another 2% comes from Islamic products – Permal offers long-only funds that are Shariah compliant, largely because of its Middle Eastern client base, and has also launched a Shariah long/short fund.

The Alfanar US equity hedge fund employs long, and Shariah-compliant short investment strategies. It uses a salam contract, whereby a fund manager can create the equivalent of a short sale in the market. The firm worked with the Saudi Economic and Development Company (Sedco), on the product.

Permal also has 1% of its holdings in private equity, and 12% are single manager funds branded under the Permal name but sub-advised by external firms. More than half of Permal's funds of funds assets are invested in the following six vehicles:

Permal FX, Financials and Futures Ltd:

A multi-manager portfolio of active traders who invest globally, seeking to profit from changes in the global economy. The fund has had an annualised return of 10% over the past five years.

Permal Investment Holdings:

A multi-manager, multi-strategy portfolio which has had an annualised return of 11% since its inception 13 years ago.

Haussman Holdings:

A US-focused multi-strategy fund which has had an annualised return of 19% year on year since its inception in 1973.

Permal Global High Yield Holdings:

A multi-manager, multi-strategy portfolio that seeks diversified exposure to global fixed income with a concentration of assets with fixed income long-only managers. The annualised return over the past five years is 12%.

Permal Japan Holdings:

A multi-manager portfolio that invests in Japanese equity strategies, (both long/short, and long only), fixed income and macro. The annualised return has been 12% since its inception seven years ago.

Permal Long/Short Global Equity Holdings:

A multi-manger single strategy portfolio seeking attractive long-term returns with a focus on long/short equity investment. The fund has a low beta and standard deviation.


"In the past, Permal was not an explicitly heavily quant firm, but the intuition in the way it ran its portfolios was actually in accord with a sophisticated quant approach," Shaw insists. Some time ago, when Caxton experienced disappointing returns, for example, Permal decided that the losses were not statistically relevant, given the managers' long-term stable track record. Permal bought scarce Caxton capacity from investors who were spooked by the underperformance.

While the investment process is run from New York, Permal's risk management team is based in London. "We wanted to disassociate the risk manager from the influence and charm of the asset manager," says Souede. It is also a problem he had to grapple with at Barclays. "There were 100 people reporting to me, but the perpetual trap was that if the risk managers were too close to the people they were risk managing, then they could become easily influenced."

Sitting in London, the theory is that Permal's risk team are in no danger of that. Shaw feels that the first line of defence in case of a blow-up is adequate due diligence, and the role of the risk manager and risk committee is to make sure the due diligence team are going through all the procedures. It does not require the team to be in the same location as portfolio managers. "On the systematic risk side, we have the entire portfolio here and it doesn't matter where the team is based. To be able to mount a successful or credible challenge, it's good to have that distance, because you haven't been sold the same story as the managers. It forces you to have your own opinion, and that is something that is important in an organisation."

Choosing the managers

When Permal invests in a new manager, it typically only invests 1% of assets. Itthen watches the manager very closely. Shaw identifies various "red flags" that come up. If a fund has exceptional performance, whether it performs much better or much worse than expected, then Permal will review it, because it has not understood the risks the fund has taken. Other flags include style drift, surprises in documentation, management turnover, and a big change in assets under management. The Permal investment committee, a group of six, all of whom with the exception of Kodmani are based in the US, discuss the portfolios daily. "It's very easy to drop a fund from the portfolio if we have to," says Shaw.

It helps that Permal does not allow its analysts to get too complacent. Analysts are both generalists and specialists – focusing on about 25 managers, but then rotating the rest. It means that an analyst inherits a new manager which he or she doesn't know anything about, and has to go back and go through the original check lists once again, asking the same irritating questions. Souede says hedge funds have had to get used to the idea. "Initially it did irritate some funds – people weren't happy when we first did it, but I think now they are used to it."

It has the added advantage of forcing analysts to keep their files in order. They know that sooner or later, somebody else is going to inherit the file.

It is easy to see why some managers would not find Permal's methods of operation the easiest to deal with. For one thing, the firm interviews up to 300 new managers a year, and only picks about ten. "We have every manager with a 12 month track record knocking on our door, we have to tell them to go away and come back when it's clear whether they have skill or they have been lucky," says Shaw. Permal rarely seeds new managers, and Souede points out that it is difficult to use quantitative methods on managers without track records.

As an investor, Permal subscribes strongly to the 'bigger is better' theory. "We like to be with bigger, more established managers, because this is still a business of a few good talented people," says Souede. "It's a lot harder to find that talent now, and you could argue that we missed 150 successful smaller managers as a result, but we certainly haven't missed 9,000."

The Making of Permal

Permal's conservative approach to the market may originate from its roots. The Permal group was created out of Worms & Cie, the French company whose origins date back 150 years. It was a trading house established in France in 1848, and Worms & Cie expanded overseas as a coal merchant and ship owner. Its development parallels that other hedge fund giant, the Man Group, which was founded by a humble apprentice barrel maker in the sugar trade, who set up his own sugar brokerage in 1783.

Worms & Cie turned to merchant banking in the early 20th century. While it continued to operate its shipping business, it also branched out into insurance in the 1930s. It now owns various companies, all of which focus on capital appreciation. It was a pioneer in multi-manager investment when it launched Haussman Holdings, the oldest fund of hedge funds in operation, in 1973. The fund was named after the street on which Worms & Cie was based, and launched because wealthy clients wanted to get into the pioneering hedge fund space in the US.

The $3 billion Haussman fund is a US focused multi-strategy fund. It has historically returned 19% year on year since its launch, although it has had periods of underperformance: it fell 2% in 2000, 1% in 2001, and 6% in 2002, for example.

After launching Haussman, Worms & Cie consolidatedits asset management under the Permal brand. The US operation of Permal started in New York 30 years ago, and trades as Permal Asset Management. Souede joined the firm in 1985. At the time, the firm had only $500 million in total assets under management, while Haussman Holdings had $8 million. Souede was formerly the chief financial officer for Chemical Fabrics Corp, and had held a number of other operating positions previous to that. He became president of Permal in 1996.

The fund of funds set up its UK office in 1999, through Permal Investment Management Services. Omar Kodmani was hired from the mutual funds industry. At this time, Permal began to grow assets rapidly. Shortly afterwards, it opened a Singapore office, and is soon to open an office in Dubai. The group is currently headquartered in Paris.

The best managers, he believes, are those that have left a strong house to set up on their own, and have already been tried and tested. He points to the study conducted by Ibbotson Associates in June 2004, which showed that the largest 1% of hedge funds ($4bn plus) returned 13.6% from January 1995-2004. In contrast, the smallest funds, which make up 50% of the market, returned just 9.2%. The implication is that on average, bigger funds may be more skilled.

Souede is clearly disillusioned by the current hedge fund market. When the CEO originally joined Permal, from a CFO's job with a public company in New Hampshire, it was because he wanted to be based in New York. He had no hedge fund experience – he had a degree in bio-chemistry. But ask anyone who has earned their stripes in the industry, they'll tell you that hedge fund investing at the time was not about credentials, but about market savvy. Souede himself is dismissive of the Goldman Sachs/Morgan Stanley "finishing schools" for hedge fund managers.

"In the old days, managers were characters," he reminisces. "They weren't even polished. They didn't come from these finishing schools. Now they are a lot more polished, but have a lot less substance. Then, you could get to their personalities a lot quicker."

With more Harvard MBA graduates now wanting to join hedge funds than any other business, Souede is concerned that the market is becoming homogenised. He is not alone in this concern, but at the same time he recognises the value of new talent, and prefers to hire young analysts who want to work, and "will not tell us how it was at their old company."

Souede also enjoys dissecting the psychology of the game. "If a manager can't explain their philosophy to you in simple words, then they aren't worth talking to." And if a manager moves into luxurious new offices with a great deal of pomp and ceremony, "it's usually more to do with having a bad year than a good one."

… which showed that the largest 1% of hedge funds ($4bn plus) returned 13.6% from January 1995-2004. In contrast, the smallest funds, which make up 50% of the market, returned just 9.2%.

Psychology aside, the point Souede is making is relevant. With the growing institutionalisation of hedge funds, and the multitude of new entrants, returns are inevitably levelling off. The Soros-style generalists are no longer in the market, the industry is much more specialised, process, and technology driven. It is more important now that investors spend the time searching for sustainable talent, rather than being tempted purely by high returns.

Cult of Personality

While a possible sale of Permal will offer challenges for its management team, so will the fact that eventually, its leadership will want to retire. The group of four, Isaac Souede, chief operating officer Tom DeLitto, chief investment officer James Hodge, and Larry Salameno, who is responsible for new business development, and key to making distribution agreements work, currently dominate the business. "These guys play very important roles," says one observer. "I don't know if they have considered what needs to come next in terms of the next generation of leadership, but succession is something that Permal needs to consider." Souede says his management style is about empowering others, and being hands-on. "I am not a manager who believes in long, strategic meetings. I also believe in measurement. We are very connected to markets and clients."

In the corner of Permal's meeting room in its London office sits a giant plasma screen television, undisturbed. Kodmani jokes about it being pointless. "Everyone told us we had to have it, but we don't really use it." It is a small point, but it says a lot about Permal's culture. The firm believes in substance, rather than style. And if it does not rush out to snap up the next big thing, missing an opportunity as a result, it will live by its decision, because ultimately, it believes in being cautious. "We have a humble approach," says Kodmani.

Admirers of the company say caution should not be confused with a lack of drive. "They have very loyal clients, and they are a smart, focused team. Ultimately though, they will succeed because unlike many competitors, they do exactly what they say on the packet," says one service provider.

In a constantly-changing industry, where new hedge funds are launching every day, perhaps there is something to be said about consistency, after all?