Toscafund and Hughes Emerge Re-Energised

New risk metrics and funds power expansion

Originally published in the June 2010 issue

The explosive growth of London hedge funds over the past decade, the 2008 downturn and the subsequent rebound in form of many top managers is aptly illustrated by Toscafund. For the eight years up to 2008, Tosca’s compounded annual returns were among the very best for equity long/short funds anywhere. That followed Martin Hughes teaming up with Johnny de la Hey to launch the firm and the Tosca fund in 2000 with $28 million when the pair left Tiger Management Europe after an unparalleled three-year investment performance in Julian Robertson’s organisation.

Toscafund’s 10th anniversary on May 9th capped an 18-month period of wide ranging change across the group. That’s brought about fundamental changes in risk management and liquidity to the Toscafund portfolio of funds. Since the changes were made in late 2008 (after the then flagship fund suffered heavy losses in banks) risk adjusted performance has been good. Volatility across all funds has been dampened (see Fig.1 & Fig.2). The firm has also acquired a 6 person research team, now called Tosca Metrics, beefed up its back office (doubling staff) and appointed Chris Jones as chief risk officer. The investment product is also broader with the recruitment of the Credit Suisse mortgage team, leading to the launch of two mortgage funds as well as the Tosca MidCap Fund run by Hughes himself (with a UCITS III version now open).



It was against this backdrop that The Hedge Fund Journal visited Toscafund’s penthouse offices on Long Acre in Covent Garden. Hughes, an Essex partisan who long ago decamped to North West London, was in a forthright mood, keen to underscore both the changes and the abiding financial strength of Old Oak, the holding company for Toscafund, private wealth manager Cheviot and Penta, a private equity business. Together Old Oak manages over $6 billion, including $1.8 billion in Toscafund, and boasts an unblemished record of profitability as well as cash reserves well in excess of $200 million.

“Tosca was the bank fund that grew and grew and grew – compounding at 20% per annum over the eight years until 2008 went it went too early on the American banks,” Hughes says. “The first time it went long on American banks it went early on value grounds. We saw it before others saw it – the others couldn’t see it for nine months – but the timing was wrong. But it turned out to be very wrong because there was panic among investors and that damaged our franchise.”

Hughes isn’t the first hedge fund manager to mistime a play, of course. Suffering a 65% drawdown was testing in the extreme. Hughes speaks pragmatically about the difficulties of keeping the business running smoothly in 2008, but underscores that shuttering the fund – an easy option that some managers might take – was never a possibility.

2009 performance reward
“It took everybody a year to see the light,” says Hughes. “Our funds went up 50-100% last year. Those who stayed in and didn’t panic were fine.” One lesson learned is that Toscafund is now more careful screening investors. “You have got to make sure that they are what they say which means patient,” he says. “Returns aren’t monthly or yearly but over a decade. We’ve delivered over a decade and lost on a year. Now we are very careful with whom we let in. We are selective.”

Despite the brief performance set back 2008 was still transformational for the business. The infrastructure, Hughes says, is “grade A pension fund back office now.” Reporting has gone from one page on VaR to 25 pages every morning on each fund with breaches flagged (and dealt with immediately by the CRO) and with red flags reported to the board.

The re-launched Tosca, which still focuses on financials, has demonstrably lower volatility with risk dialled down, less positional concentration and much greater liquidity. De la Hey, now the lead portfolio manager, is attracting institutional inflows again. Hughes, who remains chief investment officer, is disappointed that the fund, despite topping league tables for returns and sharpe ratio, was ignored in 2009 performance awards since qualifying funds had to be within 10% of their high water mark. His critique of the criteria is that some investors are at their high water mark and that the system would seem to be rewarding those who closed funds, set up elsewhere and claimed a new record. He also notes that the methodology implicitly includes 2008 and not just 2009 data.

Modified risk parameters
“The bank fund is well managed by Johnny de la Hey,” Hughes says. “We are the lowest volatile global long/short fund with the highest returns (see Fig.3). The late 2008 re-launches relate to the risk parameters being put in place because they are different funds. There is a different structure now in all the funds than there was pre-Q3/Q4 2008. Some have different portfolio managers, all have different risk parameters imposed and more thorough ones governing depth, liquidity and concentration. We have the same intellectual capital here that did 20% annually compounded over eight years – but had one bad year. Now the same people are doing the same thing but with safety valves imposed, which is good.” Like other managers, Hughes found before 2008 that performance was the momentum for fund flow. Now safety and liquidity are the key drivers of flows with each fund offering monthly redemptions.


Prior to accepting Julian Robertson’s invitation to set up and chair Tiger Management Europe in London – Hughes was deputy chief executive of Credit Lyonnais Laing Securities. As a top ranked banking analyst in the early 1990s and head of research Hughes began broking for Robertson in 1988. In late 1996 Hughes and de la Hey decamped from CLL to Tiger to trade European financials. Hughes today characterises that market as under researched and subject to limited forecasting capacity. Confidentiality provisions prevent him from disclosing the returns. But he reveals that one reference suggested that his team made more money for Robertson in each of its three years of investing than any another team or trader had managed in any year.

Investment style
Hughes terms his investment style value based with a secular growth overlay. Micro-economic data is primarily focus on corporate and consumer sector cash flow. Current research suggests capital expenditure as a percentage of GDP is the lowest it has been for 40 years; Hughes is adamant that it will go up and is researching the areas where growth will be strongest. This last occurred in 2002 when the consensus underestimated capex growth (secular in Asia, cyclical in America and UK). “Since 2000 we’ve championed that notion that Asia is not correlated with America,”he says. “It took that hard landing, while India and China kept growing, for that message to register.”

Hughes and chief economist Savvas Savouri do broad thematic research, leaving managers to run their portfolios. “There is an umbrella offered which is the CIO and the chief economist but there is independence on the part of the portfolio manager,” he says. “There is no compulsion. That is the difference of Toscafund today from four years ago. We have different positions across all the funds. It is a broad, independent, uncorrelated set of five funds managed by different people which is a big improvement from four years ago when it was basically one fund managed by two people, Johnny and I.”

The firm’s approach to investing is straightforward. “We are fundamental stock pickers,” Hughes says. “Now we do it with less concentration and less size. Before we were high conviction without having the risk controls. On the short book there was a tendency to be too long term. Our shorts are laid on in the same temperament as our longs. They are multi-year. We don’t know where the market is going short-term but I can give you a diminishing value of a company based on new competitors and diminishing margins. What we look for is a 30% decline in the absolute price and with a profit warning on the downside to help us get there over 3 years, not immediately.” He adds: “We want to watch what companies earn. That’s all there is to it. It’s the same on the short side. Wait and see what the figures are.”

Here the Tosca Metriks research platform, developed when Hughes was at Laing and acquired in 2008, is a key development. He says Tosca Metriks is London’s biggest user of data from government sources across the globe. It uses global inputs to assess earnings, volumes and margins, aiming to assess where earnings warnings may occur. Applied to particular companies, Metrics has a predictive capacity. Since the research is proprietary and no longer sold to other investors, it is expected to give the UK mid cap fund and the Tosca Asia/Africa Fund a sustainable advantage over rivals.

Moving into the mortgage market
The recruitment of the Credit Suisse mortgage team, headed by Charles Schrager, led to the setting up of Tosca MOD. It is structured as a special purpose close-ended fund to selectively engage in mortgage lending. The fund acquires mortgages at a discount from lenders aiming to exit or trim mortgage market exposure. A portion of that discount is returned to the mortgagee who then re-mortgages at a lower rate. As this occurs cash is returned to Tosca MOD, which then releases it back to investors on a monthly basis.

The first mortgage book purchased was worth £141 million in July 2009 and bought mortgages at an average of 61 pence in the pound. The fund doesn’t do second lien or buy to let and has 30 check in points on each individual mortgage. The fund is expected to wind-up in the third quarter of 2010 with all monies returned to investors showing an expected internal rate of return of over 40%.

“It is a unique idea,” Hughes says. “That intellectual capital is the point of the group. It is effectively Robin Hood. We are taking off the bad bank that made the loan and giving the borrower a reduction and at lower interest cost. We’ve helped the people of this country.” At a time when bankers and hedge fund managers have borne the brunt of public opprobrium it is an important message.

A new $500 million closed end fund launching this summer will add bank capital assets and second lien mortgages to the lending mix. It will target pension funds and aim to deliver a 15% cash return per annum with a four year lock-in.

UK mid cap play
Hughes is also gearing up for substantial inflows into the UK mid cap fund, which has performed well versus peers (see Fig.4). Its recently approved position on Deutsche Bank’s UCITS platform and Hughes stock picking credentials should make the fund a natural for private bank clients. Hughes manages it with some research input from Paul Compton, former head of capital markets at Collins Stewart, the Alternative Investment Market specialist that’s sponsored the listing of hundreds of companies. “Paul and I are very well known in London and I’m pleasantly surprised with the attention this launch has attracted,” Hughes says. “It will fill up quickly and we expect to soft close at $400 million.”


The UCITS fund will be the same fund as the original off shore fund, which has about $110 million in AUM. Both funds have an institutional and retail tranche. The on shore version will have weekly liquidity (the off shore is monthly) with an expected 90-100 basis point total fee charge over and above the off shore fund’s 1.5% management fee and 20% performance fee.

“I thought UCITS would be drip drip,” Hughes says. “But with the performance relative to peers – we have less volatility and double the market returns – we are getting bigger and bigger allocations.The UK is perceived to be an attractive investment opportunity because of sterling’s decline. It is the lowest rated developed market in the world. The value of UK assets have gone down too far.”

Tosca Mid Cap is expected to grow to $1 billion. The mid and small capitalisation target companies have market capitalisation from around £100 million to £2 billion. The fund’s investment universe spans about 1,000 companies with a total capitalisation of £160 billion. The fund currently runs 25-30 positions.

Career comes full circle
For Hughes, the mid cap Fund brings his investment career full circle. In 1985, he put £200 into mid-caps and compounded it to become a wealthy private investor before linking up with Julian Robertson over a decade later.

“Quite clearly my skill is investing as was the case pre-Tiger and is the case post-Tiger,” he says. “I take one very, very bad year as a knock, but not a fact. Bill Miller of Legg Mason had a bad year. He was good for many years then had a bad year. That doesn’t make him bad.”

He acknowledges that institutional investors are seeking absolute returns, not out performance, and are anxious their hedge fund managers avoid drawdowns. The aim is to make money but with less volatility, Hughes relates, perhaps missing out some of the upside but also much of the downside.

Tightened risk exposures
The net exposure of the four Toscafund long/short equity funds varies. The funds don’t use pair trades in putting on short positions and forex exposure is hedged out. Hughes says the tightened risk parameters on drawdowns, liquidity and concentration risk is the key message being communicated to investors. “It makes the net exposure irrelevant,” he says. “How the fund owns what (is in the portfolio), the volatility of those ideas and the liquidity of them is what’s important.”

In the aftermath of 2008 Hughes is rueful about events but has a clear conscience that the fund treated all investors fairly. In this respect, Toscafund stood up to pressure from the market mayhem in a forthright manner that wasn’t universally replicated across the hedge fund industry.

“We didn’t gate,” Hughes recalls. “We split the portfolio into investors who wanted their money back and investors who didn’t. (Hughes managed the former group, de la Hey the latter one.) “We did advise against selling as the positions were grossly undervalued owing to market stress and rumour mongering rather than value, and we reorganised.”

“We didn’t run away from our responsibilities,” he adds. “I felt I had a responsibility. I could have closed the fund and not the firm. But I didn’t do it. My view is that there wasn’t enough credit given to those who carried on compared with managers who just ran away. What we are meant to do is support the institutional clients to regain the high watermark. The different performance and risk metrics of the various funds post the 2008 reorganisation support our intention and show that we haven’t reneged on the promise to achieve that return.”

Hughes is particularly pleased with winning a recent long only mandate from a respected sovereign wealth fund. “To me it’s an award for the entire firm from the back office through to the investment process: everything was checked. They clearly believe we have specialist expertise. The opportunity is there for better performance if you have proper research.”