SGAM Alternative Investments

Making long-only hedge funds a reality

Philippa Aylmer

Innovation and maturity may make strange bedfellows but as the hedge fund industry grows older and wiser, tracking down alpha is becoming a challenge to even the most original thinkers. Many industry leaders are having to widen their parameters to incorporate this skill set, and are beginning to see alpha in a new light.

One such organisation that has begun to see alpha in a new light is the alternative investments arm of Société Générale Asset Management. Alpha should not only be synonymous with hedging and leverage, but can be achieved just as well from a long only fund says SGAM AI’s global head of hedge funds, Arié Assayag. Assayag and his team believe that the long only hedge fund is the next step in the inevitable evolution of this successful asset class.

There is no doubt that the hedge fund format has been successful, but the market is increasingly saturated. As more money floods in and quantitative models become more sophisticated, there is competition for fewer shorting stocks. Industry figures are showing a slowdown in returns. The Hennessee Hedge Fund Index for equity markets reported negative returns for the months of May, June and July, although there was an advance in August (+1.21%) and the general consensus is that the ‘easy money’ is over.

With traditional asset management houses fightinghedge funds for space, the launch of a long only fund by an alternative investment organisation may seem difficult to comprehend. But SGAM AI believes that the development of hedge funds is not mutually exclusive to the direction in which asset management houses are going. In fact, it sees the opening up of the hedge fund concept and the convergence of hedge funds with traditional asset management as the way forward.

As a result, SGAM AI is partnering with three of the world’s largest and most successful hedge fund managers, Renaissance Technologies, Caxton Associates and Highbridge and making the move into the long only space. They believe that they are the pioneers in two rapidly changing industries, both of which are heading in the same direction.

Breeding from success

SGAM AI is a relative latecomer to the hedge fund industry with its first foray in 2000, but latest figures show that in a six year time period, it has accrued almost $10 billion in hedge fund assets under management. Total alternative assets for SGAM represent 10% of the group’s $424 billion and the alternative investment arm of SGAM now manages over 30 funds of hedge funds worth $5.3 billion, over seven main single strategy funds: four equity; three relative value and one directional, totalling $2.3 billion and three major dedicated enhanced liquidity fund of funds, totalling $2.0 billion.

SGAM AI Premium is the flagship fund of funds. Set up in Sept 2003 it now manages almost $2 billion. It invests in the 20 best hedge fund names and is highly successful, producing consistently stable returns. Its sister funds, Optimum and Equilibrium, adopt the same strategy and invest in 30 managers and 50 managers respectively. “It is the relationships with these managers that is crucial to the running of the funds,” points out Assayag. There are also other funds which include a well-known retail fund of funds, Carrefour Optimal, which manages $150 million. The fund is a dedicated diversified fund of hedge funds launched in May 2002.

Aside from the flagship funds, SGAM AI has the full range of alpha generating funds including a recently launched portable alpha fund, the SGAM AI Portable Alpha Premium Fund. With access to some of the best fund managers, SGAM AI was able to launch this portable alpha fund in March 2005. The beta neutral fund provides premium alpha to investors through a process of rigorous investment and risk management. This method has resulted in a reduction of overall alpha volatility, an averaging out of individual beta behaviours and minimised hedging costs.

The success of the Portable Alpha Premium Fund prompted Assayag to take one step further. “We were very interested in the launch of the long only hedge funds that took place about two years ago,” says Assayag, “and combined with our experience of running the SGAM AI Premium fund of funds and having developed strong relationships with our fund managers, we have been able to gain support from the top performing funds.”

“Long only hedge funds provide a good source of alpha. They are a very interesting concept for the asset management industry and very appealing to our clients,” comments Assayag. “We already had external alpha, internal alpha and portable alpha and this was our next step.”

Assayag and his team have created a platform which will use premium hedge fund managers’ investment skills and apply them to long only funds.

The long and the short

Assayag does not take the concept of alpha generation lightly. Regardless of the success of SGAM AI’s hedge funds, he describes alpha as ‘precious and rare’ and is clear about the key to successful alpha generation. “Generating alpha needs flexibility and excellent risk management, but it is the sustainability of alpha that counts. A successful hedge fund will keep generating alpha over time,” he explains.

So far there are three funds on the SGAM AI Equity platform, all investing over a 3-5 year period and aiming to achieve returns well above the S&P 500 Index.Two of the funds are quantitative based (Highbridge and Renaissance) and one is stock selection (Caxton).

The Highbridge Statistically Enhanced Equity Portfolio (STEEP US) is a quantitative long only US equity fund that aims to achieve capital appreciation. It is based on statistical models developed by the Highbridge Statistical Arbitrage team which have been used over the last four years by the Highbridge multi-strategy hedge fund. The fund, which chooses from the 1,200 most liquid US exchange-traded equities, has been running since January 2005, yielding returns of 8.86% last year, double that of the S&P 500. So far this year, the fund has achieved returns of 6.13%. The fund trades 200-300 positions and the top 10 positions generally average 10-15% of the assets with an average holding period of 30-35 days.

The Renaissance Institutional Equity Fund (RIEF) is also a quantitative-driven, long biased US equity fund. Fully invested, it uses the Renaissance analytical, risk, cost and optimisation models and incorporates slowly changing predictive signals to mitigate the impact of trading costs on RIEF’s alpha generation potential. Stocks are chosen from between 3-5,000 companies all tracked by computer models, although it holds on average 3,000 positions, with the holding period usually exceeding one year. This year, REIF has produced returns of 12.33%, compared to 5.80% for the S&P 500.

The Caxton Equity Fund is a fully-invested long only equity fund providing exposure to the US equity market. This fund capitalises on Caxton’s stock selection expertise and relies on a combination of a fundamental growth and value-oriented approach. It holds on average 20 to 75 positions and a maximum of 10% of assets are invested in international equity. In this case, the stocks universe is a minimum of 1,000 companies with a large and medium capitalisation.

There are many good reasons to invest. Access to the expertise of three of the most successful hedge fund managers is certainly one major consideration, but SGAM AI has designed this platform to allow investment through a UCITS III qualified fund thereby broadening the range of potential investors and as Assayag explains, it benefits from a combination of pure alpha creation and robust risk management at both levels: the hedge fund managers and SGAM AI.

SGAM already has expertise in the long only area, in particular the SICAV (Société d’investissement à capital variable) format. Similar to open-ended mutual funds in the US, the open ended collective investment schemes are also very popular in Luxembourg and France and are increasingly being cross-border marketed in the EU under the UCITS directive.

But there are those who disagree with the concept of long only hedge funds. If hedge funds cannot generate returns independently of the underlying asset class, then can it be classed as a hedge fund? Will managing hedge fund risk be different from managing the risk of a long only fund? Long only funds tend to be more market correlated and beta dependent. But from a technical aspect, under the UCITS III Directive, SGAM AI funds can use investment techniques such as derivatives and swaps and there are already many legitimate hedge fund strategies that are long only.

But the SGAM launch represents something more comprehensive, believes SGAM AI and its partners: SGAM AI Equity Sicav opens the door to the authorised institutional market and the retail market.

“SGAM AI has created a vehicle that can access the domestic market and will lay the foundations of retail hedge funds. It is absolutely revolutionary,” enthuses Stefano Russo, CEO of Renaissance Institution Management, (the distribution arm of Renaissance Technologies), one of the funds on the platform, adding that “it will enable hedge funds to gain access to a pool of assets that were previously unreachable.”

Hedge fund theory of evolution

While market forces have played a large partin the decision to launch these long only hedge funds, Assayag’s reasons run deeper. “We have been looking into understanding what is really behind the ability of the hedge funds. By waiving hedge fund constraints, a company using the same people and the same process can generate sustainable alpha.”

These launches also reflect a wider, more evolutionary process, argues Assayag. There is a convergence taking place between the expertise of hedge fund managers and asset management houses. “We have been anticipating this move for quite some time and these products are a turning point in the hedge fund life cycle,” he explains.

“We share the same vision as Renaissance, Caxton and Highbridge, not only in the management of hedge funds but in where the industry is going. And we are the right partner for them because of our expertise in manufacturing and distribution of funds and our strong track record in financial innovation.”

SGAM AI has three managers on the platform currently, but there will only be a maximum of five, and additional funds will include a focus on Europe and Japan. The key to their success, believe Assayag and his team, is that there will be no second tier managers. Having such firm relationships with Renaissance, Capital and Highbridge has meant that the concept has developed over time with all four parties receptive to views and strategies of their respective partners.

“We could see that the deluge of assets was going to result in lower average hedge fund performance but through our business model we have identified specific opportunities. With Renaissance, Caxton and Highbridge on board, we know that it is a viable investment vehicle. Our aim of limiting this platform to the best managers only will ensure that higher returns will be achievable,” explains Assayag.

Looking ahead 10 years, he believes that asset management will have a beta and an alpha platform. “Hedge funds are now becoming more of an asset management style. It will not matter from where alpha is generated, but it will be the consistency of alpha as a skill which will be important. This platform will open up hedge funds as a new concept for a whole new market.”