As Sussex Partners turns fifteen this year, the firm has broadened its offering to a continuum of hedge fund advisory services. These range from its long-standing stock-in-trade of individual, research-driven fund ideas to handling clients’ entire hedge fund portfolios in outsourced CIO fashion – and anything in between. “We always had clients who wanted more than just ideas, and as many of them asked for broader assistance, it was natural for us to expand our services,” says co-founder, Patrick Ghali.
Sussex now sits on the investment committee of several family offices and has an exclusive mandate to provide hedge fund research for a private bank. This includes putting together a platform of approved funds and designing bespoke portfolios for larger clients. It is also advising a commercial bank in Asia on investing part of its proprietary capital into hedge funds to diversify its core traditional asset holdings. Sussex is providing advice on “several billions” of client AUM and this figure, conservatively, only includes clients’ hedge fund portfolios, and not their total assets, which are many times greater. It has no direct responsibility for clients’ long only, real estate and private equity assets, but naturally is cognisant of how these interact and correlate with its own bailiwick of hedge funds. As part of its wider dialogue, Sussex is working with an external manager to help some clients to implement an “endowment-style” investing approach.
Sussex takes pride in “high-touch” service – and as such is the polar opposite of the current fashion for digital advice or “robo-advice”. The Sussex modus operandi is labour intensive, so the firm has made several hires in recent years, taking the team to 20, and expects to further augment the headcount as clients are on-boarded. The company spans London – where Sussex is regulated by the FCA – Zurich, Tokyo and New York, where Partner and CIO, Jim Neumann, spent seven years co-heading the Ramius Capital fund of funds. He also has experience in fixed income portfolio management, FinTech, and structured finance.
The investment team at Sussex, who have an average of over 20 years’ experience, combine research with client-facing roles. Languages spoken include English, German, Italian, Spanish and Japanese. “We can also offer British, American, German and Swiss humour,” jests Ghali, who spends about half the year on the road. He thinks nothing of flying to Singapore for a client lunch, while Neumann relishes rising before dawn, at 3am New York time, to do calls with Asian allocators. All clients get a Sussex Partners e-mail account and communicate in WhatsApp groups that copy in everyone at Sussex who works on the account. A policy of swift response to client requests means they are dealt with within 24 hours. Sussex is also quick off the mark in terms of manager oversight. If managers are performing outside expectations – either on the downside or upside – it will step up monitoring through frequent calls or meetings until the situation is resolved, which might include redemption.
70% of Japan’s 3,600 stocks have no analyst coverage.
Sussex tailors its services to clients on the basis of a mutually established mandate. “We become an extension of clients’ internal resources, and help them in whatever shape they need,” says Ghali. The Asian bank is investing via an unfunded swap to accommodate the bank’s capital constraints (something that insurance companies in Europe must also live with under Solvency II). A private bank has asked Sussex to train its product specialists and relationship managers to become conversant with the list of approved managers. Some clients appreciate quantitative analysis, for which Sussex uses both internal and external tools, such as AlternativeSoft. Certain clients also request risk aggregation, identifying and optimising exposures. The firm generally plugs its product recommendations into clients’ existing frameworks of service providers and platforms.
More requests for UCITS funds are coming in, so Sussex is working on a pure UCITS mandate. Though for now it is more typically being asked to provide offshore and onshore solutions in tandem. Of course, it is not always possible to replicate a Cayman strategy in UCITS format, so the two sets of lists will not be identical. The model is above all client-driven and Sussex has no affiliation with other service providers that could have conflicting objectives. For instance, as interest rates rise, investment banks have resumed selling capital-guaranteed structures, but Sussex clients currently have no interest in them.
Rather than trying to drive while only looking in the rear-view mirror, Sussex actively formulates a view on the environment, and endeavours to select appropriate strategies for the anticipated market climate. Sussex’s big picture view is that average valuations of equities, bonds and credit may be stretched, and that volatility is likely to pick up as central banks unwind their asset purchase and quantitative easing programmes. Sussex is not predicting imminent asset price correction, but expects that a recession has to happen at some stage. Sussex therefore thinks that many investors may have a sub-optimal weighting in alternatives, and has a preference for strategies with low or no equity beta, limited interest rate duration, and low credit spread exposure. On a recent trip to Singapore, Ghali found family offices and private banks wanted to diversify by increasing their alternatives exposure.
Sussex clients realistically do not expect hedge funds to keep pace with a raging bull market in equities, and are targeting consistent mid-single digit returns through a full cycle. For example, in alternative credit, Ghali feels comfortable with risk profiles such as senior secured loans yielding 4%, or less liquid credit paying perhaps 6-7%, and a five-year lock-up to avoid liquidity mismatches. Ghali and his seasoned colleagues, who nearly all have first-hand memories of 2008, fear such mismatches are starting to re-appear in some products. A five-year lock-up for direct lending is in fact exceptional, as most Sussex clients are looking for liquidity terms between daily and six-monthly.
Asia is an equity culture and we prefer equity to credit strategies in Asia.
Patrick Ghali, co-founder, Sussex Partners
Sussex’s idea generation is open architecture. It does not create its own branded products, but selects a small number of single hedge fund managers running at least $100 million for use as single manager or multi-manager fund constituents, and funds of funds, managing at least $500 million, with multi-year track records. Nearly all operational due diligence (ODD) is done in-house, bar formal background checks, which Ghali finds straightforward in the US but more challenging in Asia. This is one reason why Sussex uses local funds of funds who know the universe well to access non-Japanese Asian hedge fund managers. Sussex clients are currently invested in 35 managers based on Sussex’s advice, and closely monitoring 50-60 more for clients, while screening as many as 500 each year.
The firm is remunerated by clients rather than managers. Ghali sees hedge funds charging a huge variety of fee structures, from 0 and 30 to 2.5 and 30, and is critical of managers charging fees of 2 and 20 on low single digit returns. His evenly balanced view is that while high fees are a handicap, he does not want to leave good risk-adjusted returns on the table. Sussex is aware of alternative risk premia (ARP) offerings, but has not recommended any yet. Its own fees are likely to be in the tens of basis points in ballpark terms, but should not be any incremental cost for investors. “In 99% of cases, hiring Sussex has no net cost. It is cost neutral or saves clients money, because Sussex’s fees, based broadly on assets under management, are covered or outweighed by fee discounts,” says Ghali. Sussex is essentially leveraging its clients’ collective bargaining power and aggregating its client base into share classes that charge lower fees for larger minimum tickets. The smallest client Sussex would contemplate taking on would allocate around USD 25 million to hedge funds.
Sussex has a long relationship with Skybridge, where Ray Nolte’s investment team are more like a multi-strategy fund, expressing conviction views on asset classes and strategies, such as selected US mortgage securities. The potential Chinese takeover of Skybridge would not have been a concern, because as Ghali says, “Nolte and his investment team are key. They have been together since Citi, and would have stayed together after the deal”.
Ghali sees a diminished future for standardised funds of funds that provide industry returns minus fees. However, he envisages longevity for certain variations of the much-maligned fund of funds/multi-manager model. This is partly because specialist funds of funds can add value in particular geographies, such as Asia, or in certain asset classes like commodities, where allocators can exploit quirks such as seasonality. Funds of funds can also work out to provide better value than building an in-house research team. Ghali argues that a senior team of at least four or five experienced analysts, and a reasonable travel budget to provide a global footprint, could cost at least $1 million a year. It is therefore more expensive than competitive fee levels on a multi-manager product for allocations of up to at least $100 million – even before factoring in the fee discounts that larger funds of funds can often obtain. Similar arithmetic can mean that hiring Sussex to manage hedge fund allocations is cost efficient for some allocators.
Asia is proving to be fruitful for business development as Ghali is having constructive conversations with family offices, multi-family offices, independent asset managers, private banks and commercial banks. Asia is also a fertile hunting ground for managers.
“Asia is an equity culture and we prefer equity to credit strategies in Asia,” says Ghali, who leads Japan research. This need not imply long-biased equity beta exposures however.
Demonstrating the uncorrelated approach, the Asian fund of funds that Sussex employs for its clients is up 5% in 2018 to August, while some Asian equity markets are down 20%. This multi-manager vehicle allocates to the larger and more liquid Asian markets mainly of “Greater China” (China, Hong Kong and Taiwan) as well as Japan. Sussex avoids India partly because he views it mainly as a beta play, but also due to potential tax complications for clients. A lack of liquidity puts South East Asian markets off limits.
For many years, Ghali has been a big fan of selected Japanese equity long/short managers. The fact that some locals, such as the Nikkei newspaper – which now owns the FT – are surprised to see a foreigner showing such interest in their local market, suggests that Japan remains a contrarian choice. The overriding attraction is that the amount of alpha generated has historically been far greater than seen in US and European managers. Ghali has struggled to find good European long/short managers who can deliver decent returns, while demonstrating strong risk controls and thus limited drawdowns. Ghali ascribes the alpha opportunity set to the neglected nature of Japanese equities. These receive much less sell-side coverage (70% of Japan’s 3,600 stocks have no analyst coverage), and hedge fund attention (dedicated Japanese hedge fund assets may be less than 0.5% of Japan’s stock-market versus over 5% in the US and over 8% in Europe), than do US or European stock-markets. This is also apparent in specific sub-strategies. Whereas Ghali views US activist trades as often being overcrowded, he sees huge potential for activism in Japan, though the long-biased or long only stance of pure play activists is not ideal for Sussex clients.
Although some of Sussex’s favourite Japanese hedge funds have been hard closed, there is potential to access capacity intermittently by replenishing redemptions, while some other Japanese hedge funds remain open. Ghali is keeping abreast of some interesting new launches in Japan, though he is not sure if some of them have robust enough operational infrastructure yet to meet Sussex’s ODD criteria. Ghali observed wide dispersion of performance within the Japanese hedge fund space in 2018: trading-oriented Japanese hedge funds have performed better in 2018 whereas traditional fundamental long/short managers had a better year in 2017. Investors should not underestimate the scale of opportunities: the pullback in China’s equity markets means that Japan’s equity market capitalisation is second only to the US as of September 2018.
Japan can be a source of lowly correlated returns, and so too can various hedge fund strategies that invest globally. Neumann contributed an article to The Hedge Fund Journal called “Inflection Point Alpha”, which suggests that investors should look to build a basket of strategies with potential to profit from a market normalisation towards more volatile conditions. As well as the obvious volatility-centric strategies, examples include: systematic global macro; discretionary global macro; managed futures; trend and countertrend; non-trend and AI/machine learning; commodities including spread trading; and non-index approaches. Sussex is finding that systematic strategies, such as CTAs and macro, are really resonating with a wide range of investors at present. As part of the search for diversifiers, Sussex has been researching convertible managers, and Neumann has a preference for versatile ones who can adapt their style to the market environment. Currently, he favours those managers who can take a long position in vega, or implied volatility, and carry out gamma trading, profiting from realised volatility, whilst hedging credit risk. He also wants managers to have the flexibility to take on credit risk – and even distressed situations – at the appropriate point of the cycle. Neumann is finding US convertible markets most interesting as they offer the best liquidity and issuance; he is concerned about both liquidity and credit quality in European convertibles, while in Asia the level of activity can be episodic.
Though Ghali personally advocates the UK remaining in the EU, and reveals that he harbours hopes for a second referendum, Brexit is expected to have little if any impact on Sussex’s business, because the client base is mainly in Switzerland, Asia and the US. He acknowledges however that Brexit might make it more difficult for Sussex to push into Europe.
Sussex pays some attention to tactical and dynamic asset allocation, but this very much plays second fiddle to core, strategic and structural fund picks. “We have a constant debate about how often to rebalance. There is a risk of second-guessing managers and trading around elections or rate decisions to feel you are adding value when in fact you are detracting value. We are not macro guys and would rather stick to our views on strategies and environments with a preference for managers that are able to take advantage of market inefficiencies to generate alpha,” says Ghali.
Still, circumspectly he ends on a note of caution saying, “we do not know where the next crisis will come from but 2008 is part of our DNA now. Anyone who has been through 2008 has it in their bones and fears the next downturn”. His aspiration is “to continue running the business for another fifteen years, winning more loyal clients and becoming more global”.