Pierre Mirabaud

Looking back on more than 30 years of hedge fund investing

Stuart Fieldhouse
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It is not often one gets to meet a hedge fund investor who has been active in the market since the early 1970s. Pierre Mirabaud joined the Swiss private bank of the same name in 1974, and is now a senior partner. In 2003 he was also elected Chairman of the Swiss Bankers Association. As part of an independent Geneva-based private banking organisation that was founded in 1819, he was able to play a role in the bank's active and increasing participation in the hedge funds industry as an investor on the part of its clients. He has seen the industrygrow from the days when managers and investors were a small but adventurous community of financiers on first name terms with each other, to today's teeming market of 8000 plus hedge funds, large-scale institutional investment, and regulatory intrusions.

Mirabaud himself first become involved with hedge funds in the late 1970s, shortly after he joined the bank, when a client asked the firm to invest part of his assets in a hedge fund. At that time the sheer bulk of hedge funds were purely long/short equity stock-pickers, almost exclusively based in the US. It was the first step in a process that has seen the bank become one of the most experienced and respected hedge fund investors in Europe.

"The reason I got interested to start with, was because I was convinced that a bank of our size, a relatively small institution at that time, would find it impossible to attract enough analysts to work herein Geneva, in our office, to follow all the markets around the world," he explains. "I felt that, as a business plan for the bank, it would make sense to farm out money for more complicated and far flung markets." The bank was already considering the hiring of in-house analysts who could cover mainstream markets, like North America for example, but it was simply not cost-effective at that time to build a massive army of analysts to provide comprehensive global capital markets coverage.

"I invested with hedge funds for the wrong reasons," laughs Mirabaud. "But I quickly noticed that, if you were following three golden rules, you would do well to invest with hedge fund managers.

"His three guiding principles are as follows: invest with managers who have a substantial part of their wealth invested alongside yours; who pay themselves mainly from a performance fee; and who operate in either a specialised market or with an investment technique that you cannot trade yourself.

In the late 1970s performance fees were not widely levied by the first wave of hedge funds, and were certainly not the commonly accepted practice they are today, but Mirabaud saw them as a major vote of confidence for managers who were prepared to put their money where their mouths were. When he first started investing with hedge funds, the bank was not an experienced investor in futures and options, making derivatives specialists who ran their own hedge funds a natural fit. Back then, the predominant strategy on the market was still long/short equity.

"The most important evolutionary trend of the last 25 years has been that good managers, talented managers, seem to have started their careers as analysts of stocks, or as long-only or long/short equity investors," Mirabaud says. "Over the years, and with the evolution of the market, we have seen them change to macro investors, first in stocks outside their home markets, and later in instruments which we later called macro, and then in the bond and interest rate markets, using arbitrage and other investment techniques. The great hedge fund talent in the history of the last 25 years has been able to evolve their portfolios to meet the demands of the time, and to exploit opportunities. We had to follow that."

Not all the best managers used to be analysts or long-only managers, of course. The CTA world has produced a few stars of its own, like Bruce Kovner and Louis Bacon. "In thesecond half of the 1990s, a lot of new managers came off the prop desks," Mirabaud accepts. "But I don't believe in the 1980s there were a lot of prop desks for people to come off in the first place. Working on a prop desk is not a guarantee that someone will make a good hedge fund manager – I've seen a lot of cases in the last five years of very talented prop desk traders who did not make it as hedge fund managers. The reason I think is because they underestimate the fact that they will be alone, without the back-up of a big institution, and they don't have anyone looking over their shoulder in terms of risk control discipline."

With the expansion of the number of managers in the hedge funds market since the early 1980s, Mirabaud has seen both positive and negative aspects. The increased number of managers are definitely welcome from a capacity perspective, especially as many of the seasoned veterans are now hard-closed. New managers emerging into the market are good news, from his perspective, as they increase the choices he and his team have to make. The sheer number of hedge funds trading today also makes his life more difficult, as his team needs to be much more selective. It requires a larger and more sophisticated team of analysts to study funds.

Says Mirabaud: "It means having a better staff of analysts to really be sure that the upcoming new manager is really going to do what he says he will, because that is the biggest risk, that one day you will wake up as an investor in a fund where the manager is not doing what he's good at, or what he told you that he would do. I have no problem with a manager changing his style, or changing his brief, or changing his scope of investment, but I want him to tell us that, to tell us he did it because he wanted to do it, and not because he got pushed by the market."

The problem, in his view, is that managers today are very much in the driving seat, and feel they can dictate their position in terms of fees and liquidity. It is becoming something of a problem for large-scale investors like Mirabaud, both those who have been investing in hedge funds for over two decades, and those institutions that are new to the hedge fund market, but might have been used to dealing with mutual fund complexes previously. "I think there's no difference between a hedge fund manager and any manager of third party money," explains Mirabaud. "When you have a client giving you money, then rule number one is to give it back to him when he needs it. I think it's a very sad tendency that managers have been able to lock in money, even on a quarterly basis. This has been one of the worst developments in the hedge fund industry over the last two or three years. This is unfortunately a direct consequence of institutional money coming into the market."

If anything, institutional money has encouraged this practice: it is being allocated by people with no personal interest in it, it is other people's money. Why should they worry about lock-ups? Institutions tend to think long-term, bringing with them notions which Mirabaud believes are, if anything, contradictory to the whole hedge fund culture. Being prepared to lock in their money for two years in order to earn lower fees is one: "If you want to have a good manager, you have to be prepared to pay him well," argues Mirabaud. "You get better performance from paying higher fees in my experience – higher fees have never been an impediment to performance with a good manager."

His other beef with institutional money is the perennial quest for lower volatility. Managers today shy away from mentioning volatility in their brochures, unless it is low. In Mirabaud's view, this is insane. This is not what hedge funds have been about historically. "Hedge funds should have volatility," he says. "The whole idea is to have volatility. Basically you have a lot of institutional money pushing for managers to make just a little bit more than a bond return, a market neutral type of strategy, which is fine with me, but I think good hedge funds, the real hedge fund industry, are directional, volatility-driven managers. That's where, long-term, you get really good returns, certainly not with low volatility funds."

He believes that, given the high fee structures prevailing in the hedge funds industry in general, investors need high returns as collateral. If the brief is to deliver low volatility, then high returns will never be delivered, and the high fee structure is therefore not justified.

Institutional money has its benefits too – Mirabaud accepts these. The liquidity these investors bring cannot be disputed. It helps to make hedge funds known and understood by the public, which was far from the case in the late 1970s, when hedge funds were distrusted by the bulk of private clients. Institutional awareness has helped to improve the industry's image.

Institutional investors also have a reputation as being long-term investors with managers, hence the enthusiasm for their business on the part of managers. Mirabaud, although not a classic institutional investor, has maintained some very long-term relationships with managers over the years. He has been invested with some for 25 years, including George Soros and Paul Tudor Jones. Being a long-term investor, he finds, often provides him with the advantage of being allocated additional capacity from closed funds, but he says it is not a given.Tudor Jones, for example, has never opened his BVI fund. However, sometimes it helps to be on the call list when a closed manager has a redemption and wants to replace it.

Relationship management – the key to hedge fund success?

"One tends to forget today, when people hire analysts for their organisations, they are quantitative people, they are brilliant, good analysts, number crunchers," Pierre Mirabaud says. "They are very good at their due diligence, but sometimes I feel they tend to forget the most important single judgement you canmake about a potential new manager for our portfolios, is the human relationship you can have with him or her. Managing money for third parties is a very difficult business, because nobody likes to lose money. If you are able to build up a real personal relationship with a manager, you will be able to bounce ideas off him, to stick with him if he has a difficult time, and this makes you as an investor better prepared to stay with him during those times – it happens to everybody. When you measure a fund with very objective but dry considerations, when the numbers talk, you will sometimes end up making mistakes, because you will give up on very good talent. My experience has been that good hedge fund talents are human beings, and sometimes it is much more important to know if the manager of the fund is about to divorce than to know what his exposure is."

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In the 1980s Mirabaud's bank was already comfortable with investing directly in single manager funds, and also helped to co-found Hausmann Holdings, the fund of hedge funds. These days the bank tends to invest more via its own fund of funds structures because of client preferences: high net worth investors want to see smoother performance, something which funds of funds are better at achieving.

Statistically, it seems as if the average hedge funds business lasts five years or less, which would seem to make life harder for the dedicated hedge fund investor who is used to keeping cash with managers he likes for a quarter of a century. In the real world, however, the life cycle is much longer. On the bank's radar screen there are between 200 and 250 managers, and the average lifespan of these firms is far, far longer.

Although a long-term investor with some of the biggest names in the industry, Mirabaud is also enthusiastic about new and emerging managers. Frequently this will be a portfolio manager who is leaving a firm with which Mirabaud is already familiar, an individual the bank knows and rates already. Under these circumstances, it will help to seed such a manager when he founds hisown fund. Mirabaud himself has seen numerous managers who launch a fund and close it within a month when it reaches capacity: either youinvest with them immediately, or you don't invest with them at all. "That's very worrisome," he says, "because then you make more mistakes.

"Twenty years ago banks like Mirabaud would be able to invest a small slice of capital with a new firm in order to get to know it better, perhaps no more than $500,000. During the first year the bank would visit the manager,and monitor him closely, in order to understand him better, both as a person, and as a trader.It was typically referred to as "The Nursery." After a year with a given manager, the bank would either increase its position, or sell out. "Today it's impossible," he says. "You simply can't do that, because after one year you won't be able to add to your investment."

Pioneering hedge fund investment

In the mid-1980s there were very few banks in Switzerland that were actively involved in hedge fund investing – perhaps only three in Geneva. The Swiss banking industry tended to steer well clear of hedge funds as an assetclass. Europeans investing with US managers were also a rare commodity, and were treated as something special. By contrast, in order to build up a relationship with a manager today, you need to be one of his 10 largest clients. "I find that to be a very sad development," says Mirabaud. "It's yet another reason why you can't start small. If you want to build up a relationship, your investment has to be large enough to be meaningful to the manager. That's life, that's the evolution of the market.It means we're in a more material market."

Needless to say, like many other investors, Mirabaud steers clear of black box strategies and systematic traders. "I must confess that some have been very successful," he admits. "I hate it, because I don't understand it, but some have been very good." As a bank known for its expertise in the hedge funds space, Mirabaud has to have an extensive menu of strategies available for its clients, and would not rule out making an investment in a black box fund if a client was keen enough. But it would not recommend it.

As for the clients themselves, Mirabaud has tracked an increasing amount of interest in hedge funds. "They want to hear about it," he says. "Some come to us because they know we invest in hedge funds. As for institutions, it is completely different. There, the amount of knowledge is now very high. It has been a big change."

The turning point for the Swiss banking industry, the sea change from a situation where a small coterie of banks and family offices regularly invested in hedge funds, but the crowd stayed away, to today's situation where the bulk of private banks either invest actively, or indeed run their own funds of funds, took place in the 1990s. Swiss banks were active previously in a passive way, acting as custodians for clients who asked them to allocate to hedge funds. Only two years ago, one of the largest and most distinguished private banks in the country was still trying to discourage clients from investing in hedge funds. It has been the client base, rather than the institutions themselves, which have driven the migration into hedge funds. It is a market-driven phenomenon: private banks needed to have an in-house hedgefund capability, or lose clients.

"They had to be forced to do it," says Mirabaud. "Up to the mid-1990s, the asset allocation into hedge funds of the normal Swiss banks based on the three powers management, was under 10%."

By contrast, as a bank, Mirabaud has been making extensive use of hedge funds since the 1980s, setting it apart from many of its peers in Switzerland. If anything, it stood as one of the pioneer investors in hedge funds from the European market. Of the non-bond and non-cash portion of its overall investment portfolios, around 40% is now currently allocated to hedge funds. It is hard to be more bullish than that. When it started out, there were no European managers in the market: you had to invest with a US manager if you wanted hedge fund exposure. Since then, the bank has tracked the evolution of the European industry, has watched traders leave US organisations to set up their own funds on this side of the Atlantic. In the second half of the 1990s, the trend spread to Asia as well. It has been a welcome growth, as it has allowed Mirabaud to diversify its portfolios geographically: while in the 1980s, it was easy to obtain US hedge fund exposure, the bank had to rely on long-only for the non-US portions of its portfolio.

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Says Mirabaud: "Interestingly enough, the very good managers in the US became more interested in the European and Asian markets over the years. We are finding more and more very good firms that can specialise all around the world. You can now invest with very good firms based in America which are effectively global, although there are still not that many of them."

Since the end of the last century, the bank has started allocating some of its fixed income assets to hedge fund managers as well, but this has been a recent development. Making use of interest rate plays has been an activity of hedge funds since the late 1980s, of course, but the emergence of specialist bond hedge funds has been more recent.

Not surprisingly, the bank measures its portfolios from an absolute return aspect: in Pierre Mirabaud's view, "benchmarking is for cowards. The only thing that is interesting is absolute returns. When I am told that someone outperformed the market by six points, but was down, I think it's appalling. I'm not interested."

Mirabaud is also a fan of managed accounts, especially for funds of funds: "We like them a lot, because we can get immediate liquidity, and a better view of what's happening. It has become more difficult to get that frommanagers, because [the process] has become more cumbersome, and they are in the driving seat these days, and don't want it. Plus, the minimum amount required for a separate account is very large."

Another recent trend which Mirabaud welcomes is the increased recognition of hedge funds on the part of European regulators, translating itself into regimes which already allow limited distribution of hedge fund products to both institutional and private investors. "Hedge funds should be acceptable to not only very sophisticated and rich investors. This brings us to the regulation of hedge funds, and this is a very tricky question. Most funds are offshore, unregulated entities. It is very difficult to regulate a hedge fund, and very unnecessary – it would be foolish to try to start trying to regulate things like leverage at the hedge fund level. What needs to be regulated, and I'm very happy to see that some central bankers are now openly talking about this, are the banks and prime brokers which are financing them. These need to be highly regulated. There is no doubt we run a little bit of a systemic risk: that's myonly small cloud on the horizon for this industry. Only two firms have complete control of stock-lending activities for the short side, and very few big banks, albeit very well managed, are on the financing side. I think that is where we should look for regulation."

Mirabaud is hoping that the hedge fund industry will continue to evolve, particularly in the area of transparency. The high relative cost of separately managed accounts has already been touched on, but as a veteran investor in hedge funds, he still cannot see why there is such a high level of prevailing secrecy on the part of many managers. "I can understand why no fund manager wants to make his position known," he says, "but I can't see why they won't release their portfolio with a three month lag. I don't see any money managers who would be hurt by that."

Capital guaranteed products linked to hedge fund portfolios are another rapidly growing part of the market. Mirabaud sees the institutions that issue them as being the primary beneficiaries of this growth: "If clients want to give up part of their performance on a yearly basis in order to procure more safety, I'm perfectly happy with that. If banks are issuing these products, there is clearly a demand. It is very interesting, because you could make a comparative social study of it – that demand has come from very specific countries."

Switzerland is also the home of numerous family offices, of course, established to oversee the estates and investments of some of the world's richest dynasties. They have historically differed from banks like Mirabaud in that they have lacked the resource to set up dedicated in-house teams of analysts. Traditionally, they have relied on other banks and institutions to run these investments for them, funds of funds for example. But here too changes have been occurring in recent years.

"Now they allocate directly to managers," says Mirabaud. There is more awareness of the benefits of selecting individual managers, rather than handing a large mandate over to an institution and letting them allocate it. A level of sophistication is now present amongst family offices which Mirabaud finds very healthy. Like the private banks in Switzerland, the level of enthusiasm for hedge funds has been a more recent phenomenon. "Most people who run or work in family offices, used to be workingin a bank or an asset allocator," he says. "In the 1980s, our first clients were family offices or wealthy families. By definition, family offices represent the interests of very rich clients, and they could afford, at that time, to invest 5% in hedge funds. That has since grown to much more, of course, but they were amongst our best clients at that time."
 

Indeed, Mirabaud is now involved in helping family offices to build their own fund of funds operations, to the tune of $50m-$100m in assets under management.

Like other pundits, Mirabaud feels that uncertainty in global capital markets is probably the biggest boost the hedge funds industry can hope for. A sustained equity bull market, like the rampaging beast that dominated the 1990s, would be a different matter entirely, but he sees the rapid growth of the industry since 2000 as a direct result of the post dot.com stock-market crash. So long as market uncertainty remains, he reckons, hedge funds will continue to find demand for their services. "Clearly people who had their money invested in hedge funds in the 1990s gave up a little bit of performance, but they were saved from much of the subsequent backlash. That's had a huge effect on people who are now investing heavily in hedge funds, because they lost so much money before. I think one of the biggest challenges in the years to come, is the fact that more and more hedge funds running different strategies are still correlated. This is a real problem."

Mirabaud doesn't have the answer to the correlation conundrum. It could be the influence of prime brokers, it could be the fact that managers communicate with each other, although the latter does not explain why managers who do not communicate still correlate. Market neutral, bonds, long/short equity, macro, merger arbitrage, they are all becoming increasingly correlated, and investors like Mirabaud are concerned. "This should raise questions," he says.

Mirabaud: traditional banking brand embraces new global identity

Mirabaud is not just about hedge funds.It is a private banking brand that originated with its foundation in Geneva in 1819, but which has diversified across a range of wealth management activities and geographical areas of operation. In 1857 it was amongst the founders of Switzerland's first ever securities exchange in Geneva, and in 1931 it co-founded the Geneva Private Bankers Association.

More recently, it has started building a presence in the institutional market. For instance, in 1990 it acquired a majority stake in London-based Mirabaud Pereire Holdings, which allowed it to offer brokerage services to institutional clients and investment management services for pension funds. In 2002 the creation of LLP Gestion SA allowed it to offer liabilities management services to pension funds, including advisory and administrative services, accounting, and technical support.

Geographically, it has been active in establishing itself in foreign markets since the opening of its Bahamas office in 1979. It entered the Canadian market in 1985, and set up shop in Hong Kong in 1997. Closer to home, other operations have included a Zurich-based portfolio management company launched in 1998, the opening of its successful Paris branch in 2003, and the acquisition of Banque Jenni & Cie SA in Basel in 2004. It claims to be considering yet further expansion in Europe over the next few years, and is currently the only Swiss private bank to be operating under its own name in Monaco.

All this activity has led it to create a single brand under which its ongoing international development can occur. It launched its unifying Mirabaud banking brand in Paris in April of this year in an effort to bring its diverse range of businesses under a single recognisable umbrella.

Outside its asset management activities, it is interesting to note the bank's focus on brokerage services. Through advisory and analysis, it brokers services for large institutions.Its advisory covers Swiss, European, North American, and Asian equities and bonds. Its securities business specialises in the placement of IPOs and capital issues in the renewable energies, oil, gas, and other commodity sectors.

It carries out all these brokerage activities as an agency broker: "Our independence guarantees our clients autonomous and personalised management," says Marc Pereire, partner and head of the bank's London office. "Mirabaud refrains from entering into any commercial business or own account dealing, ensuring that there is no conflict between our interests and those of our private and institutional clients."

On the research side, while doing most of its European research in-house, it works closely with Lloyd George Management on Asia and emerging markets, and has a relationship with WP Stewart in the US going back 20 years.

Currently, the bank has €12.6bn on deposit, and has seen an average annual growth rate of 15% since 1996. Over the last 10 years alone, its funds on deposit have increased fourfold. In 2005, funds on deposit grew by 33%, with net new money representing approximately one third of this amount. Private clients still constitute three quarters of its activity.