Threadneedle Asset Management

Threadneedle's top alpha-generators combine to good effect

Originally published in the November 2007 issue

This is an interesting time to take a look at Threadneedle's hedge fund business. Until now Threadneedle Asset Management has ploughed its own furrow. The company has done its own thing, but has not come across as looking outside that much. So the funds that have been launched have emerged from their own talent pool. The marketing of hedge funds used to be treated as an extension of the pre-existing (long-only) business. All these elements have changed, exemplified in the acquisition of emerging market hedge fund company Convivo. The business manager and some of the key portfolio managers of Threadneedle Asset Management talked to The Hedge Fund Journal about where they are at.

Seven is the number

Threadneedle has seven hedge funds under the Crescendo name, as shown in Table 1. For most of the seven years that Threadneedle has been in the hedge fund business, Lorin Gresser has had a role in guiding the firm's efforts in this area. She is Head of Product Strategy at Threadneedle and oversees the company's Alternatives Team (Hedge Funds) and the Product Development Team. That Lorin Gresser reports to David Gasparro, Head of Distribution at Threadneedle, says that the firm thinks about hedge funds in a similar way to, say, Gartmore, but differently from Jupiter or New Star. Her role (using asset management business speak) is divided into 'product' and 'distribution' and that is how it will be covered here.


When Threadneedle entered the hedge fund business in 2000 the product universes were discrete. There was long-only product and there was hedge fund product. Relative return and absolute return. Going back further they used to be offered by different companies. Distinctions of product and provider were clear. Over the course of time as investors and regulators have become used to hedge funds and their investment strategies, some of the elements of hedge funds have been co-opted into other formats. And so asset management companies provide products across a spectrum that has passive long-only and low cost at one end and active, unrestricted, (sometimes higher risk) and higher margin at the other.



One of the cross-over products that is commanding attention in the asset management business is 13030 funds. A recent survey showed that assets in 13030 funds now top $53 billion, up 77% in six months. The majority of the assets managed are in quantitative strategies and are managed from the United States. Threadneedle Asset Management, whose very name and street address of St Mary Axe shout London, is entering the market with the Threadneedle American Extended Alpha Fund. It is a traditional long only portfolio of primarily North American equities enhanced with a short exposure to unattractive stocks set at around 30 per cent of the value of the fund. By design the short exposure is structurally offset by additional long positions in attractive companies, thereby raising the long exposure to around 130 per cent. The overall net exposure to the stock market will therefore remain around 100 per cent with a higher information ratio – more alpha than a traditional long only portfolio but for a similar amount of market risk.

It may seem curious that a London-based manager kicks off a 13030 product range with a US focussed product, but Threadneedle has a peculiar strength there. Threadneedle's nine-strong North American equity desk is one of the largest teams entirely based in London and manages a total of $9.9 billion (£4.86 billion) in hedge and long only assets.

Blackrock has described 13030 funds as high-conviction long portfolios. Threadneedle sees them similarly. The Head of Distribution at Threadneedle has described their 13030 product as "an aggressive long-only fund." Head of Product Strategy Lorin Gresser puts it that "This is a product that is managed relative to an index. It is a long-biased product. So it is not within the hedge fund world. It will not be bought by clients that invest in hedge funds. It will be bought by a wide range of client types – pension funds or IFAs or private banks."

She continues, "It will be bought by those that want full exposure to the market, but managed using different instruments to long only. There will be similar instruments to those used in hedge funds, but with different return objectives. For Threadneedle we have advantages in running 13030 funds from our experience of seven years running hedge funds. This gives us an understanding of shorting: the discipline required, the necessary understanding of time-frames and risk-controls within the firm to know how to run 13030 funds. And here I do mean us as a house – it is not just the portfolio managers that have exposure to this." Gresser also believes that when it comes to client servicing and distribution, 13030 will be different from hedge funds. It is thought that most of the sales to date have been to pension plans/institutions in the US (which to date has been the main market).

Another product towards the hedge fund end of the product spectrum was launched by Threadneedle last May. The Threadneedle Crescendo Hedge Fund Portfolio Notes offer equal exposure to European Crescendo, UK Crescendo, American Crescendo, Global Crescendo and Emerging Market Opportunities Crescendo, and are offered in both leveraged and unleveraged versions. These are publicly-quoted debt instruments, with performance mirroring the underlying investments, and as such they are available within SIPPs and ISAs.

"The Hedge Fund Portfolio Notes have been successful in terms of returns," suggests Gresser. "They have some advantages to investors because they are tax efficient, and give a diversified hedge fund exposure that sits between Listed Funds and fund of funds and is cheaper than either of them. People buy what they are comfortable with, and for a particular type of investor the Portfolio Notes give some kind of hedge fund exposure but without the double layer of fees. They also have monthly liquidity."

It is thought that private banks and high-level IFAs will be target markets for the Threadneedle Crescendo Hedge Fund Portfolio Notes. "This is a good product," asserts Gresser, "and it is a question of letting the market mature enough to accept this sort of product." In addition it probably needs an effort put in to raise the comfort levels of the Threadneedle sales people with the product to make sales more significant for the company.


One reason for expecting more product sales than hithertofor is that Threadneedle Asset Management has spent the last couple of years structurally revamping its distribution capabilities. The long-term aim has been to broaden the firm's client base, and in particular to widen the distribution reach further outside of the UK. Geographically this has entailed opening offices in Spain, Italy, and the Nordic countries. There are expansion plans for Asia which are awaiting clearance. In addition Threadneedle has made appointments to deepen relationships with global financial institutions as key clients, trying to position Threadneedle as a core provider of investment products. "These are strategic goals that apply a lot in alternatives," discloses Lorin Gresser.

"We have made an effort to map the target organisations. These are large complex businesses and we might sell to one unit of them and buy from another in another capacity. We have been finding the right people to talk to, and identifying relationship counterparts in large financial groups. A good example of ours is in launching a number of specifically tailored products for exclusive distribution for a large Asian institution."

Gresser warms to her theme; "this is a two pronged attack – the people who buy hedge funds are not the same people who buy other funds, even if they work in the same organisation or office. We have got the right people that have access to the right level of the investing organisation. That is really important, and we have someone working for us that knows the key decision-makers well in the funds of funds and other investorgroups. You also need to be able to work with the people doing the analysis and due diligence at these organisations – I'd say that you need relationships with both, so the right information and positive feedback gets fed up the organisation. We have the resources to do both."

"We recognise that hedge funds are more difficult to sell," says Gresser. "They are more complicated to characterise, the buyer needs to have more understanding and detailed knowledge to take the decision. So we have found that to sell hedge funds you need to have staff focussed on that alone, and they need to have a deep knowledge of the products and markets. We have product specialists that only sell our hedge funds. From the other side the clients are different, family offices and funds of hedge funds want different levels of information for due diligence and transparency. They want exposures broken down in a completely different way than clients that buy other products, and you need to understand that." As part of the inward facing part of their role, the investment specialists at Threadneedle also tend to work with the general product sales staff on their requirements.

Mike Corcell on shorts and shorting

Mike Corcell, Manager of the Crescendo American Fund, approaches shorts differently from longs. Obviously they look for business deterioration rather than undervalued growth, but Corcell considers shorts are different for structural reasons. "I'd say that shorting is more difficult emotionally. To be short and right is fantastic. To be short and losing money is the most difficult thing emotionally. Given that markets go up most of the time, you have to be aware that the odds are that you will be wrong on a short. We just don't get dogmatic on investment ideas. People will give you 10 year views on things, and take a five-year view on an industry. I think that is incredibly arrogant – even the people who run the companies don't look out five or ten years. So for shorts we have 20% hard-stop levels and we have review levels inside that. We end up trading more on the short side, and doing things to reduce the emotional wear-and-tear on the short side," he confesses.

He continues: "There are a few mechanical things you have to pay attention to when looking at shorts. It goes beyond what is on the hard-to-borrow list, and what does it cost to borrow. For example, a few years ago the convertible bond arbitrage strategy was blowing up. We cleaned out any companies in the short book that had convertibles outstanding. If CB arb was being unwound the convertible bonds were going to be sold out and the stocks shorted against them were going to be bought back. Another factor is the coupon on a short. A lot of people are short tankers because there is a lot of capacity coming on. But there is a 10% or 11% yield. That is a hell of a carry cost. We won't go there from a common sense perspective."

According to Corcell it is has been an unusual year in markets in regard to shorting. "This year people have been paid to hold (got a return from holding) short positions that are on the hard-to-borrow list. More typically stocks on that list are 'crowded trades' where it is hard to make money. If stocks are on that list you have to think the stocks are going to zero to take out a fresh short, and let's face it, that doesn't happen often."

Like some seasoned European equity hedge fund managers such as Talal Shakerchi (Meditor) or Roger Guy (Gartmore), Mike Corcell does not consider scheduled corporate events to be business as usual for his style. Unlike them he does not embrace the risk of earnings releases or other 'events'. Rather, Corcell tries not to be short for an event, and in fact tends to be more defensive and conservative around events, or it would undermine his stance as a fundamental investor in his mind.

"If you just invest around events you don't give yourself enough ways to win," he opines. "You have to crystallise a loss if it is down and you haven't invested with a real investment idea (fundamental conviction) if you are forced to react like that."

Though he might participate in the weekly research meeting at Threadneedle Asset Management Corcell says that he picks up relevant information and insights from his colleagues through less formal channels. "I'm a big walker of the (investment) floor. I'll talk to our credit team, Paul Findley and Darrell O'Dea, and Vanessa Donegan who is Head of the Far East Equities team. For technology and consumer names you need to know what is going on in other regions. For example a recent discussion was on the valuations of large cap growth companies, and how they are treated differently by region in the markets.

Mike Corcell concludes, "I'm proud of what we have done this year. Though at the same time I know you can't be arrogant with the market or it will take your profits away. The team has done a good job and we have got a lot right, but it has been such hard work. It is too difficult to generate absolute returns without having a high level of intensity. That's something I really admired about Michael Karsch, his intensity. You can't do it at 80%, you have to be full on. We think it can continue from a process stand point, and hope the returns can continue. You have to take a risk to make money, so we hope to remain happy and nervous every day."

UK and US important markets

In terms of specific territories Threadneedle sees scope to sell more hedge fund product in the UK and, perhaps surprisingly, America – rather like exporting hamburgers from London to New York. "At the moment we see a massive opportunity in the UK," states Lorin Gresser, "and we are addressing that. It is not just the domestic investors that make it a good market. There are many international investing organisations that have offices here, and that is what makes it a great pool of assets for us to sell to, as well as recruit from for servicing roles."

When it comes to America, she says "we definitely see America as a very attractive market for our product, and the endowments there are perhaps under-penetrated by European-based managers. We have two London-based people dedicated to selling to potential clients in America, one of whom is there a week a month. We only started there at the beginning of the year, and have had some success engaging with some big name investors in the States. So we have done the first bit of investment there, but we expect to commit more resources to the American market over the next eighteen months, as we tap into new client types like family offices that we haven't addressed much yet."

Threadneedle has a number of hedge funds that have long enough track records and sufficient assets under management that even large seasoned investors in hedge funds should pay them attention. We shall now look at two of them, the UK and American hedge funds before turning to the newest addition to the Threadneedle stable, the Convivo funds.

Paul Findley – Head of UK Absolute and High Alpha Equities

Like Peter Davies of Lansdowne and John Innes of MPC Investors, Paul Findley is one of the better known of the managers of hedge funds specialising in UK equities, and his style and approach is very different from either of them. The selection of stocks long and short for all of them is driven by fundamentals, but the portfolios of each of them are structured differently. The four point "Investment Philosophy" in the Threadneedle pitch-book could have come from a Lansdowne or MPC presentation: "Fundamental research on sectors, industries and companies add value; Preference for high barrier-to-entry, difficult-to-replicate assets; Extensive company contacts sharpen investment stance; and an adaptable approach to valuation ensures no style bias." A key driver of the differences between them is in the research resource available.

UK equities are a major asset class for an asset management company like Threadneedle that manages assets for UK insurance companies. So quite rightly there are a disproportionately large number of investment professionals in UK equities by international comparisons. So there are many analysts, several teams and relatively large number of portfolio managers for UK equities at Threadneedle. They share a common research platform directed at challenging the consensus, and working out what change means for companies. Paul Findley explains how the oft-claimed but less-commonly observed 'team-working' really does work at his own shop.

"For long/short funds, to a much greater extent than long only funds, you need to spend more time looking at what are the potential pitfalls for your investment idea than looking at how it can work out for you," Findley states. "What warning signs should you look out for to see if a story is developing not in the way you were hoping for? And how serious a loss could you sustain as a result? Unfortunately, sometimes in the traditional long only world there is often not enough analysis of what the ramifications are if an investor is on the wrong side of this trade. That is where the dialogue we have at Threadneedle is really good."

He expands, "there will nearly always be someone in Threadneedle that has a slightly different view or perspective. Therefore you will nearly always be able to get a view of what the other side of the trade may be, and get a constructive discussion. It may well be that the two sides may agree to disagree after that discussion. A consequence is that both sides will have thought through what they need to see to recognise that the idea isn't working. They will then be able to consider those risks as part of their normal evaluation of an investment hypothesis."

There is more to this than a one-off coffee machine chat. Paul Findley says that typically the constructive discussion that takes place is the first of a series on the topic. "As time goes on," he notes, "it is normal for the story to move one of the two ways. Hopefully that will encourage the person with a position the right way to have conviction. And, and I have picked up that this is one of the most important disciplines, it helps you to take losses early. The same outcome can happen if none of the catalysts expected turn out positively. This also helps contain losses."

A further benefit of the sharing culture at Threadneedle is to avoid taking parochial views where wider perspectives are required. Findley is clear on this: "Some of the big sectors are very regional. So trying to analyse telecoms without understanding technology in the Far East is meaningless, and it is impossible to look at pharmaceuticals without looking at drug pricing in the US." The cross-referencing was demonstrated on the day of the interview as Mike Corcell (who runs the US hedge fund) was briefly detained talking to Darrell O'Dea (who runs a European equity hedge fund) about Nokia. Findley's take is that "We are fortunate at Threadneedle in having so many people that have the demonstrable track-records in producing alpha that deserve respect. You are not going to dismiss their views."

Sharing investment ideas across the geographic regions or countries room can benefit each team. Paul Findley observes that "you often find that an interesting idea or trend will establish itself in one region and then roll out more broadly. The UK market is so politically open that the move for sovereign states to acquire infrastructure showed its hand in theUK equity markets more meaningfully before it started to spread globally." He says "people in our industry talk a lot and say very little. But in the asset management industry you can rightly be judged by the (performance) numbers. Ten years should be long enough to demonstrate whether a fund manager is producing alpha or not. And we have that calibre of person at Threadneedle. It is so useful having smart alpha generators around you. That cross sharing of ideas, having a constructive debate, helps reinforce conviction, and helps you back away when the position isn't working."


Many positions

At the end of September the UK Crescendo Fund had 70 positions in the 102.3% long exposure and 110 positions in the 77.6% short exposure. The net long of 24.7% then was towards the bottom end of the range seen over the life of the fund, though the fund was actually net short at the end of August. The net has been as high as 120% net long in the first half of last year, and the gross has been up to 330%. Suffice to say that the UK Crescendo Fund has been run with a very dynamic balance sheet. This rapid shifting of exposures also applies at the sector level, as Table 2 shows for energy sector exposure. Threadneedle describes this as active management of positions, and specifically that there is "an active, conviction-led short book".

For those confused that a fundamental-based approach should produce a lot of turnover, there are other elements. Specifically valuations play a large part of the process: changes in valuations drive changes in positions as opportunities are created, and, as targets are reached, valuations determine exit points. To be clear, chartism plays nearly no role in the management of the fund.

The UK hedge fund is quite thematic in style, so the number of ideas driving returns are a lot less than the number of positions. "There can be a hundred positions in the fund and often considerably more," explains Findley, "and one individual can't properly be on top of one hundred stocks. You as the fund manager can certainly have a view of why they are there in the portfolio. But one person can't meet a hundred competitors, and a hundred suppliers? You can't meet a hundred sets of divisional managers; you can't meet a hundred sets of regulators, and do the channel checking for each company, certainly not! You need experienced analysts for that. I tend to get a lot of other people to do my due diligence, and this involves me asking my fund managers and analysts the right questions. My view is that if you ask the right questions we certainly have the skill set within Threadneedle to get the right answers."



So though the fund has only one portfolio manager it is able to run with a lot of positions carried on a fundamental basis because of a combination of things. First idea generation and idea/theme monitoring can be carried out in part by another alpha-generating PM that Findley respects. Second due diligence is carried out by others including career analysts, and on-going monitoring of factors at work in companies/stocks can also be delegated. Findley remains ultimately responsible for positions, and the convictions embedded are his.

This way of working is unusual and probably works because of tenure at Threadneedle Asset Management. "All the analysts are graduates of our way of doing things," says UK equity maven Findley. "Only one in my team has been recruited from outside: they are my team, brought up the Threadneedle way (as investors). We have tried to hire people from outside to manage money here, but it hasn't worked. We have a lot of 30-something career analysts in the firm. They have been completely trained and learned their lessons here. All the analysts are expected to contribute and challenge." It seems that having had the rough edges knocked off them analysts know they can meaningfully contribute, and they merit the trust put in them by PMs. This may explain why Threadneedle has not lost a hedge fund manager – it would be extremely difficult to find an equivalent set-up elsewhere.



The results of the process are given in Table 3. Fig.1 shows the distribution of returns of the UK Crescendo Fund, and bar one outlier on the left-hand tail it is of the classic shape for a long/short equity hedge fund. The detail of the generation of the P&L are impressive. The performance attribution for this year covers 11 macro groups like financials industrials. Just about all of the YTD returns were profitable. Further, just about every element was profitable, whether long consumer staples or healthcare or short consumer staples or healthcare. It is unusual to have such diversified sources of profit, more typically profits are ultimately derived from relatively few successful positions. Threadneedle estimate that 60 positions generate about 80% of alpha.

Findley has a couple of pointers as to how it is done. "One lesson that has been learned by the hedge fund managers here with longer track records is that you need to have conviction. In my view there is no way that you can make money with reactive investing. To make money you absolutely must be pro-active, and it is hard to be pro-active unless you have conviction. So whilst it is great to have support around you and macro inputs to the investment process, unless you buy into the ideas personally it is hard to generate the returns investors want without that conviction."

The second pointer is that "we have a clear view of what we want from a stock when we put it in. We rehearse what can go wrong before we include a position and that makes us mentally prepared. We always have a view of what will drive volatility in a stock."

As ever, a successful hedge fund manager has to find a way of working that suits him. The large number of stocks in Findley's hedge fund works for him because he has the personnel and intellectual resources around him to help support the enormous effort required to carry 180 stocks with one decision-maker. In addition he expresses conviction in his portfolio, operates with discipline and is prepared. Asked what is required to be a good portfolio manager he responded: "Passion. You have to really, really care." And Paul Findley does.

The Convivo acquisition

Up to this year Threadneedle had pursued a strategy of internal development of the hedge fund business. In August it was announced that Threadneedle was buying Convivo Capital Management, an emerging market specialist boutique run by Julian Adams. One of the advantages of acquiring 100% of Convivo is that it comes with a good track-record in emerging markets going back to 1999 (see Table 6). Convivo itself was formed in 2003 to acquire the Guernsey-based emerging markets asset management business of Aberdeen Asset Management. At the stage of completion of the deal both parties pronounce themselves happy with it.

"It is a fantastic deal," says Gresser, "We are delighted with it for several reasons. One, we are very committed to the hedge fund business, and this adds $500 million and takes us to $3 billion of assets under management. This gives us more scale and visibility in the hedge fund business. Second, the great track record it brings will enable us to grow the assets under management of Convivo by using our distribution capability. Third, it gives us a chance to build on our existing skills in emerging market debt (which we believe will be increasingly important in the future) with a great name in the market." Julian Adams of Convivo will head Threadneedle's $1.5 billion alternative emerging market debt and currency business as it looks to grow that area outside of hedge funds.

The deal is viewed similarly from the other side. "It's exciting to be part of the Threadneedle's growth plans, "enthuses Convivo CEO Julian Adams. It is clear that he has not cashed out to achieve an exit route for the business he owned. "There are not that many people in the emerging market sector that have been around a long time. So I knew the Threadneedle specialists, and we have similar attitudes. Like us they are not in it for a fast buck."

He is positive about the potential for the combination. "Putting two good teams together gives us a chance to increase the reach of our research – we can cover more countries. Also we can deepen our research in the countries we do cover." It is such a good fit that Adams says that he couldn't imagine having done the deal with anyone else. The thought of a strategic shift at Convivo arose a year ago when co-founder Paul Luke resigned.

Luke had developed enthusiasm for other business opportunities. "Paul did the marketing for the Convivo funds, and although we do have a cap intro relationship that is not durable a solution for client support," says Adams. In the modern hedge fund industry clients demand a high level of information flow not just during the due diligence phase, but also after they have committed capital. So client or marketing support can be a key capacity in a hedge fund firm, particularly when it comes to client retention.

So marketing and distribution was one area where Adams felt a link with Threadneedle would be beneficial, and another was in management oversight. Owning a regulated business entails many trivial but necessary and some more onerous management duties. The burden of senior management responsibility related to compliance and governance has now been passed to Threadneedle.

Similarly administration and operational work can be smoothly handled by a larger resource under the Threadneedle banner. Money managers like to manage money, and by selling Convivo to Threadneedle Asset Management Julian Adams expects to be able to devote more time to the challenges of the markets rather than the challenges of running a business.

Two funds have come into Threadneedle with the Convivo acquisition – the $445 million bond fund Convivo Absolute Sovereign High Yield Fund and the $48 million Convivo Emerging Opportunities Fund that has a large equity component. The two funds have different risk and return profiles.

The Absolute Sovereign High Yield Fund is an emerging markets' debt fund that initially benefited from improving credit for external currency denominated bonds, but more recently has been playing on the trend for improving credit for local currency bonds. The credit worthiness of countries goes through stages, going from embargoed countries and young democracies through IMF and restructuring programmes to, eventually, full capital market access. The fund looks to take advantage of opportunities in any of these stages, and does so through several sub-strategies to give internal diversification, as illustrated in Fig.2.



The Convivo Absolute Sovereign High Yield Fund is diversified by country and region, and no single sovereign issuer can be more than 25% of the NAV. The current split by region is 40% Latin America, 23% Africa & Middle East, 8% Emerging Europe and 7% Asia. "Emerging market debt investing was focussed almost exclusively on Latin America in the late '80s," states Adams, "but it has evolved into a truly global asset class now." The two debt specialists at Convivo tend to come at markets with a macro perspective – so ask themselves the question "which markets and economies have the wind at their backs?"

One of the current answers may be those that have a petro-element in the economy and that has led to long positions in Nigeria, Dubai and Egypt, for example.

Since the formation of Convivo in 2003 the fund has had the capacity to go short as well as long, and may contain up to 25% in equities. "We use equities as a leveraged play on an improving sovereign credit situation," says Adams, "and occasionally we find a special situation we like where we can get exposure to mis-priced emerging market debt via a company."



The fund has an excellent track record (see Table 4) without having resorted to large amounts of leverage to juice returns. The Sovereign High Yield Fund has compounded at over 21% since launch with a standard deviation of less than 8.5% and a Sharpe ratio of 2.1. The worst drawdown of 7.96% and worst monthly loss of 4.95% both occurred in the period before the fund was able to short. Whilst some hedging does take place now, the "capital preservation mentality" claimed by the manager is implemented when risk is perceived to be high and/or the markets are perceived to be heading South through the oldest of protections. "We raise cash quite actively," says Julian Adams; "right through the life of the Fund it has been both expensive and inefficient to hedge in emerging market debt, so raising cash is the best defence (see Table 5)." The second Convivo fund acquired by Threadneedle is the long-biased Emerging Opportunities Fund. This fund aims to take advantage of the Convivo team's experience in all emerging market asset classes, by focussing on the best ideas in emerging market equity, debt and special situations. Table 5 shows that the exposures by asset class vary a lot, but it would be misleading to think of the fund as top-down driven. The lead portfolio manager on the Opportunities Fund is Stephen Johnston, and he works with fellow equity specialist Francois Mereau on the fund, under the watchful eye of Convivo's Chief Investment Officer Julian Adams.

The fund invests in several sorts of opportunities: deep value/valuation impaired investments, under-researched situations with low foreign ownership, event-driven and special situations, restructurings, and opportunities arising from markets in crisis. At the moment the managers like Malaysian property and palm oil plays. A special situation they like is in the ownership by stock brokers of the Korean Stock Exchange, where the distribution of holdings has created anomalies in implicit valuation. The current market in crisis that is commanding attention is that of Turkey.



The Emerging Opportunities Fund is sometimes hedged with short ETF positions and index shorts on the larger, more liquid futures markets in Asia (KOSPI and the HSI). The manager also buys index puts at times and individual stock options, for example on larger cap Chinese ADRs.

The returns of the Convivo Emerging Opportunities Fund are shown in Table 6. The long exposure bias comes out clearly in down months for markets, but overall returns are good. The types of ideas being played in the fund are quite macro orientated, rather in the way that John Horseman likes a macro driver for his positions.



For example, rising demand for thermal coal for the power industry in China has been behind several positions for the fund. Bottom-up analysis plays a considerablepart too. Julian Adams says that the bottom-up work done by Johnston and Mereau also benefits the larger Sovereign High Yield Fund he manages with Marcelo Saez. He describes their input to that fund as the equities overlay. A recent example is that the work done on Middle Eastern markets by Mereau pointed out the emerging value in Saudi Arabia and Qatar and rising investor interest in those markets.

As yet the Emerging Opportunities Fund is small, but the marketing power of Threadneedle will soon be behind it. The sources of return of the fund should make it of interest to family offices as well as investors that tolerate funds with a macro component. The Convivo presentations include the corporate objective of making the firm a top performing medium-sized asset management business. Julian Adams expects to fulfill the objective all the sooner with the full support of Threadneedle Asset Management.

A natural outgrowth

Threadneedle Asset Management has grown its hedge fund business as a natural outgrowth of what they do. Managing hedge funds has not been grafted on artificially to fulfil a corporate goal, or carved out as a separate business stream. Rather the fund returns are derived from the same investment research process as other products at the firm.

The research is interpreted in portfolios differently for hedge funds than long only, and by different portfolio managers, but it is the same source semi-refined input based on the 135 investment staff at Threadneedle. It is telling that the most commercially successful hedge fund managers make a point of talking to one another. Given the results-driven world of hedge funds, this can only mean that they derive a benefit from a doing it.

Further, the portfolio constructions used vary by manager depending on the degree to which they tap into the depth/breadth of the research platform and the individual investment style brought by the fund manager. There are several pre-conditions required for this to work. One, the research process has to work – Threadneedle employ seasoned 30-somethings who have something to say for themselves. Two, there has to be mutual respect between PMs and analysts, and also between fund managers. These desirable characteristics don't arrive over night; they develop over time and reflect the culture. That is, they are not replicable.

One of the managers may have put his finger on how it has happened when he said "Threadneedle is a nice place to work, and we like each other." The other necessary condition is that the fund managers have talent in two regards, in team-working and investment decision making. Results suggest that this condition has also been met at Threadneedle.

Threadneedle's best performing hedge fund manager

Another Threadneedle manager who cares passionately about what he does is Mike Corcell, the manager of the Crescendo American Fund. His is a rare success being a hedge fund focussed on North American equities run from London. The compound return of 21.5% he has achieved since inception in the middle of 2004 makes his fund the highest returning fund in the Crescendo range. There is some evidence in recent data (in Table 4) that returns are becoming higher, hinting that Corcell may be getting better (or may be taking more risk).

If experienced analysts of hedge funds recognise a classic profile for an equity hedge fund in the data in Table 5 it should not come as a surprise as Corcell applies a classic model in his investment approach.

"I run the fund on the basis of a watered-down version of the Tiger Management model," he explains. "Julian Robertson managed money with 150% long against 50% short. I've adopted a balance sheet of 75% long and 50% short for most of the last 31/2 years. I put an emphasis on the long/short ratio, and for me it must be below 2:1, though I'm most comfortable with it at under 1.5:1. I only use individual names in the short book for a good reason: passive selections (index hedges) on a short book don't go down as much in down markets. What I'm looking for is to preserve capital in down markets. To achieve this it is not unreasonable to expect fundamental shorts to fall with a beta of 1.5 to the market, but if you have a long:short ratio any higher you are implicitly relying on a larger fall from your shorts to bail you out. You see some hedge funds with much higher long exposures to shorts, and looking for shorts to fall at three times the rate of longs. That is just too much of a stretch."

Corcell says his formative experience as a hedge fund manager was the year he spent with Karsch Capital, a large New York-based hedge fund firm. "I learned a tremendous amount from working with Michael Karsch. He has great ability to analyse companies, and he is one of the best managers of risk around. What marks him out is that he shines in difficult markets. In fact he built his business in bad markets. A hedge fund has to first-and-foremost protect investors' capital. He taught me you should be consistent and protect capital."



Partly this is done when positions make losses. Corcell explains "I have a low pain threshold for losses. I believe that you have to cede credit to the market in short and medium term when prices are going against you."

Corcell expects to make money from correctly calling the fundamentals on companies in the medium to long term. "I apply a lot of discipline in the process when I'm losing money – in fact losers tend to go pretty quickly," he clarifies.

The balance sheet of the Crescendo American Fund has been ratcheted up since the start of the year. "I thought our research was good enough to taking on a more stock specific risk, so we have run with more concentrated positions," says Corcell.

So this year there have been 30 positions on the long book, and he has taken the average size from around 4% to more like 7% and some positions up to 8 or even 9%. He has considered himself forced to do the opposite on the short book because the private equity bid in the markets earlier this year made it too risky to run large position sizes on that side.

For shorts he has taken more of a basket approach and there have been 50 names at a time. "I don't have a problem with that," states Corcell, "we have shown ourselves capable of generating lots of ideas."

At launch and for the first six months, when showing good stewardship of the capital was important, the gross exposure averaged only 6570 %. This year the gross has been as high as 240%. Corcell notes that "the Sharpe ratio is not much different, but the fund was in second gear before and we have taken on more balance sheet risk now. I feel we can now have a down month or a down quarter and it won't impair our brand value. The only way to build a brand name in the hedge fund business is to have very good performance for a long period of time. That's what we are aiming for. It's important that investors understand that we don't manage returns for the month to month. We are on a good run right now and a lot has gone right for us, but we are not complacent. It was only in the second quarter of last year that we were down 6%, and had 3 down-months in a row."