Adrian Owens: Over the past 18 months, most notably since the collapse of Lehman Brothers, the global economy has shifted from a virtuous economic cycle to a vicious downward spiral. This is resulting in huge moves within interest rate and currency markets as investors come to terms with the new environment. Macro developments are driving markets and the Global Rates Hedge Fund, which incorporates macro economics at the heart of its process, is well placed to take advantage of these developments.
THFJ: The past year was a very difficult one for most money managers with hedge fund strategies down on average around 18% according to Hedge Fund Research. I thought that hedge funds were meant to be able to produce positive returns whether markets went up or down? Is it the case, that unless equity markets are rising most funds find it difficult to generate returns?
AO: The events of the past 12 months have uncovered a lot of shortcomings within the investment community, in particular the tendency of many managers to base their strategies on beta extraction; namely, simply owning bonds and currencies with the highest yield. A not dissimilar strategy has been to run structural longs in equities despite the claims otherwise of many long/short equity managers. The skill of a true hedge fund manager is alpha extraction and this means running strategies that will generate returns whether markets are going up or down.
The Global Rates Hedge Fund has close to a zero correlation with equity markets and very low correlation with the HFR Hedge Fund Index. Since the fund’s launch in January 2004 it has produced positive returns in two thirds of the months when the S&P has fallen and positive returns in two thirds of the months when equities have risen.
THFJ: It would appear that the events of 2008 have done a lot of damage to the hedge fund industry. Madoff is clearly an extreme case but the imposition of gates and lock ups have not helped investors trust. What is your view?
AO: There has most definitely been a loss of trust, and I believe that this has been justified. A number of funds have lost far more than many investors would have been led to believe was possible. Gates have been added and investors have discovered that they often own some highly illiquid and difficult-to-value securities.
Fund transparency and liquidity have become increasingly important. All of the JB Global Rates investments are in highly liquid securities (typically around 80% futures and currency forwards and 20% cash bonds, swaps and options) and we are happy to disclose all fund positions to investors with a one week lag. We have always offered this level of transparency but it is clear that this is increasingly appreciated.
As for “gates” we have always reserved the right to impose a gate if we believed it to be in the investors’ best interest. However, we are actually removing that right from March because the fund is in such liquid securities that I can adjust positions for any flows with limited cost to my investor base. We would only reinstate the right to apply a gate if we felt there was a compelling need and only upon sufficient notice to investors, giving them the opportunity to redeem first.
THFJ: In the early 1990s macro strategies accounted for around 40% of AUM and defined the hedge fund sector much like long/short equity has done subsequently. Do you see macro continuing to gain a higher proportion of hedge fund AUM in the coming years?
AO: Over the coming months I expect investors to adopt increasingly a barbell strategy. Certain distressed securities appear attractive if your time frame is long enough, but they are of course highly illiquid. I believe there is a case for owning selective distressed asset classes.
However, at the other end of the spectrum investors are increasingly demanding liquid, nimble, transparent strategies. It is this that the Global Rates Hedge Fund offers.
THFJ: The JB Global Rates Fund, which is focused on developed markets with opportunistic allocations to emerging markets, is billed as being diversified and primarily directional. How is portfolio diversity achieved and in what sense is it directional?
AO: Portfolio diversification is essential. But, at the same time, you do not want to diversify away your returns. By typically running six or so key themes we achieve a fund structure that is concentrated enough to deliver double digit returns while also providing diversification. The focus of the fund is on the more developed liquid markets with most of our currency risk typically in the G4 to G20. Most of our interest rate risk is in the developed markets, though we will venture into the emerging markets if we believe the global backdrop is supportive. This is not the case today and the fund is actually short a number of emerging market currencies.
THFJ: Please explain how leverage is incorporated into the strategy and what it adds in terms of potential returns? Also, how does the use of varying amounts of leverage impact on the fund’s risk budget?
AO: Since the fund started in January 2004, leverage has been on average around 2 to 3 times (defined as 10 year duration equivalent). For the past 12 months leverage has been closer to 1 times.
THFJ: The fund launched in early 2004 and thus has a five year track record. What’s the average annual return? What were your worst and bestever month/year?
AO: The fund has averaged double digit returns since inception with our worst year being down 0.6% in 2006 and our best year up 16.7% in 2005. Our worst month was down 5.25% in August 2006 and our best month up 7.5% in January 2009.
THFJ: Did you originate the JB Global Rates Hedge Fund? Who else has worked with you in running the fund? How has your thinking evolved over the course of the fund’s life?
AO: I have been the lead manager on the Fund since its launch. Originally I was supported by Andrew Snowball. He has since left and I am now supported by Mark Dragten who has particular expertise in the currency markets. I am responsible for the fund’s performance and run 90% of the risk. However I continue to draw on the wider expertise among the 13 other risk takers within Augustus. The style and process of the fund remains the same today as at launch. Of course my approach has evolved and I am probably more tactical these days. Over the years I have also placed greater emphasis on technical considerations to supplement my economic research.
THFJ: Where do you see the greatest opportunities over the course of 2009?
AO: I still believe that generally bullish interest rate structures are appropriate. The market has come a long way to pricing in rate cuts but it is still looking for things to get better during the latter part of this year. I believe that interest rates will remain lower for longer than the market is currently pricing. There are a number of ways of playing this theme over and above outright longs in the front ends of markets; most notably the UK and Europe. A particular strategy that I like is money market flattening trades in Europe where the ECB is still priced to hike rates twice between the summer of 2009 and mid- 2010.
Within the currency markets we are seeing a reversal of many of the trends and themes of recent years. As the global economy appeared to flourish, capital was put to work in riskier, less liquid markets. These trends are in reverse for the time being. This is particularly apparent in markets like the Czech Republic and Poland. We are short both currencies. We also favour short positions in the Singaporean dollar, which is being hit by the country’s reliance on manufacturing and trade. Because the Singaporean authorities have a managed but floating currency, any depreciation to date has been limited compared with many of Singapore’s neighbours. The Singaporean dollar is up between 10 and 20% versus most Asian currencies since the end of 2007.
From a risk diversification standpoint, short Swiss franc positions sit nicely with shorts in the Zloty, Czech crown and Singaporean dollar as they typically have a degree of negative correlation. The Swiss franc typically performs strongly during times of economic turmoil; however this time the crisis is focused on the financial sector. Finance accounts for around 15% of Swiss GDP. Switzerland is also very dependent on trade, with exports which account for over 50% of GDP (more than in Germany). Recent comments from central bank members Hildebrand and Jordan make it clear that the authorities are uncomfortable with the current strength of the currency.
Adrian Owens joined Augustus Asset Managers in 1995 from Yamaichi International (Europe) and manages the JB Global Rates Hedge Fund. Prior to that he worked for three years at HM Treasury. During 2001-2002, Owens was based in the New York office of Julius Baer where he oversaw US fixed income investments. He has an MA in economics from McGill University, Montreal.