Difficult market conditions demand a pragmatic approach from portfolio managers. Guillaume Rambourg, the former star long/short equity manager who partnered Roger Guy at Gartmore, knows this and has moulded his team at Paris-based Verrazzano Capital with this quality upper most in mind.
In what is among the most successful launches so far in 2012, Verrazzano has already succeeded in raising $400 million for its first two European long/short equity funds. Yet Verrazzano’s pragmatism isn’t just confined to its investment style, but also applies to relations with investors and how the firm is likely to expand.
Named after the bridge in New York City where Rambourg grew up, and which provides the start point for the marathon in which he often competes, the new firm has similarly well anchored foundations. Central to this is Verrazzano’s high level advisory board which features Guy who is also an investor.
Even if the French elections serve up more bluster than concrete political change with the emergence of socialist President Francois Hollande, the environment for equities remains tough. Eurozone growth is non-existent, sovereign debt will remain an issue for years to come and a solution to the Euro’s woes remains elusive. Visiting Rambourg and his team in their offices on Avenue George V just off the Champs-Élysées, we began by discussing the difficulties of long/short equity investing given the risk-on, risk-off undercurrent to markets.
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“There is no denying that it is a difficult environment,” says Rambourg. “Since the Spanish and Greek situations have again reignited, Europe has again become a very macro-driven market. And I find myself, I’m a European stock picker after all, a hostage to the macro environment, and having to look at the Spanish bond yield or await the latest news out of Greece to see what direction equities are likely to take on the day. So, that’s the kind of market we have. In terms of more granular stock-picking in isolation and benefiting from lower correlations, at times it’s not been the most ideal environment.”
Verrazzano commenced trading on 1 March, the day after the European Central Bank’s second long-term refinancing operation or LTRO injected €529.5 billion into the banking system. By early May, however, the effect of the low interest lending to banks had dissipated.
Though the market conditions are tricky, Rambourg is sanguine. With nearly two decades’ experience he has traded through extreme market conditions, notably in 2008, but also in 2002-2003 when volatility spiked and macro uncertainty was also the order of the day.
“Over the course of my career, I’ve been through many different market phases where macro takes the front seat. Eventually the macro issues take a little bit of a backseat and that’s when you put more money on the table. However it’s important to respect the market” he says. “LTRO was a catalyst, but it was short-lived. It lasted for two months before the (Eurozone) problems came back to the front line. But 2008 was obviously more extreme, more volatile and more macro-driven; thankfully we’re not in that situation just yet, though there are certainly some (systemic) similarities.“
In 2008, for example, Rambourg was joint portfolio manager with Guy, running over $13 billion in long/short and long only equity portfolios. The way they survived the fourth quarter following the collapse of Lehman Brothers – doing what Rambourg now calls going into “a bunker position” – was to cut gross exposure to less than 20%. This helped the flagship Gartmore hedge fund make 1.4% in the fourth quarter of 2008, while the European equity market fell 22%.
Less than two years later, Gartmore suspended Rambourg for alleged breaches of internal trading rules. Rambourg was vindicated when both the internal probe and an external inquiry by the Financial Services Authority concluded there was no evidence of any wrong doing.
“First of all, the Gartmore experience was a great one,” Rambourg says. “It lasted for 15 years. Obviously, the first 14 were sensational in most ways, and the last year was sensational, I guess, for other reasons. Looking back it was a great privilege to join Gartmore when I did, to work alongside Roger, to learn the trade, and to be involved at an early stage of the European long/short space.”
From Gartmore, Rambourg took away prime investing experience. He also learned that a portfolio manager, regardless of his track record, can fall hostage to the demands of a big shareholder. In the event, after being out of portfolio management for a year, Rambourg relocated to Paris for family reasons, while taking with him the plan for a new investment business. The opportunity to start his own firm from a clean slate was enticing.
Two core strategies
Experienced investors will note that the two strategies Rambourg is managing now are similar to the two famous Gartmore products, AlphaGen Capella and AlphaGen Tucana which Rambourg co-managed and was responsible for honing alongside Guy over a long period of time. Not only are the exposures, concentration and stock universe of the new strategies very similar to the successful AlphaGen products, so too is the focus on risk management. That means very strict stop losses. It also means predefined time horizons to earn returns. One strategy will divide about half and half into trades based on long-term ideas and short-term catalyst-driven trading ideas.
In comparison, the higher conviction strategy will typically have an 80:20 long-term, short-term catalyst mix. The latter will let Rambourg and his team embrace market directionality through high conviction fundamental stock picks.
“We had discussions with the prime brokers and internally on whether we should just start with the one strategy,” says Rambourg. “For me it was difficult to choose one or the other – almost like picking between two children! Certainly, it is not twice the work because the ideas in the more concentrated strategy, which are, by definition, of the highest conviction, will be common to both. Thus, it’s just a question of how you package those same ideas but in different mandates.”
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Thus far, the lower volatility strategy is proving most attractive to pensions and endowments, whereas the higher volatility strategy is attracting more funds of hedge funds allocations.
“The lower volatility strategy is more one of compounding returns with a larger tactical trading element, more diversification, tighter stops and lower use of gross and net exposure,” says Tim Williams, head of business development. “Whereas the higher volatility strategy attracts those investors who want greater focus on fundamental investing, more concentration, wider stops and higher gross and net exposure.”
The investment process Verrazzano uses will certainly be familiar to investors who had allocated to Rambourg previously. When Rambourg joined Gartmore in 1995 the boutique manager already had a strong investment process in place for long-only. This got adapted to the long/short equity side when the first hedge fund launched in 1999. From this developed ‘the golden rules’ (see below) which they wrote in 1999, and which Rambourg has adopted unaltered.
From them, the sense of pragmatism that the firm embraces shines through quite clearly. Be rational, stay liquid, respect trends especially when considering crossing one and constantly re-evaluate positions in the portfolio.
Beyond the rules, what Rambourg thinks is unique about the approach is instructive. “What we do, I think, that may be different from others, is combine long-term fundamental ideas with a short-term tactical trading element,” he says. “Most managers tend to do one or the other and there are not many who combine both.”
Rambourg is also a keen advocate of using a macro overlay. He says that managing the gross and net exposures is akey ingredient in generating long-term performance and avoiding the big draw-downs that can take several quarters to recover from. Indeed, the biggest drawdown that AlphaGen Capella experienced over the 11 years to 2010, which covered a wide variety of very different market conditions, was -6%. “That’s a little bit of what we want to replicate,” he says, adding that “a very strong discipline of employing stop losses without exception can help the strategy avoid big hits to performance.”
The discipline Rambourg talks about also applies to his own role. He doesn’t, for example, meet companies. Being an analyst, he believes, is a full time job in its own right in terms of analysing the financials, coming up with price targets and writing recommendations. “It’s also a full-time job, I believe, to manage risk, to manage different exposures, to live and breathe the market and the portfolio,” Rambourg says. “I’m sure some people in this world can combine both roles, but I’ve not really seen it. Combining the analysis of companies and the portfolio management is very, very tricky. And, typically, when people try and do both, they can end up doing both in a mediocre fashion.”
Rambourg acts as Chief Investment Officer, and is aided by two senior investment officers with differing focuses. Karim Moussalem helps in managing the portfolios by bringing his market nous to proceedings as the former head of delta one trading at Goldman Sachs, while Tomás Pintó, who worked closely with Rambourg at Gartmore, is head of research. Continuity from the Gartmore days is prevalent with other close associates from there including Jennifer Wells who was one of the senior dealers on the European equity desk for over 10 years and Geoffrey Ayscough who was investment operations manager for the various products Rambourg managed.
The role of the analysts is to be away from the noise of the trading desk most of the time, speaking to companies on the phone and visiting them on location or when they come to Paris on a road show. They also see some sell-side analysts and look to canvass their best ideas. On sell-side research, Rambourg insists that there is value. “As in any other field of activity, there are 20% of people who do an outstanding job and who take a view versus consensus,” he says. “The key driver of our idea-generation on the long-term ideas is to find companies where our numbers are materially above or below the street. We want to interact with companies, but also with the top analysts wherever they may be.”
Longs and shorts
In the long book, a top holding is Imperial Tobacco. Recent quarterly results beat market expectations. Moreover, Imperial offers high visibility on both the top and bottom lines. Management has a strong record on shareholder returns; the dividend, yielding 4.6%, gets hiked every year and a £500 million share buyback has just been renewed. What’s more, Imperial has good pricing power, a pretty much captive client base and is somewhat insulated from a moribund European economic environment. Verrazzano has a price target about 15% above early May levels. Yet as the number four player in a consolidating global tobacco industry, Imperial could be acquired at a substantial premium by either BAT or Japan Tobacco as they seek to challenge sector leader Philip Morris.
The short book reflects several structural themes. Big telcos, for example, continue to suffer death by a thousand cuts, while every new iPad puts a customer potentially onto Skype. The top line is continually decreasing. Telefonica, the Spanish operator, was one short, a position that is now closed. Utilities have provided another short opportunity. In southern Europe, politicians raid them for funds, while some have huge debt burdens, but need to refinance each year at a higher interest rate. On the short book, discipline also applies. As shorts hit price targets on the downside, positions are covered.
Another short reflecting a variety of negative pressures is Philips, the Dutch electronics group. Its medical equipment business supplying hospitals is financed by fiscally constrained European governments. Meanwhile, its consumer product segment is getting killed by Apple and Samsung, among others, while demand growth in their core European market is extremely sluggish. Finally, its lighting business is facing a structural shift powered by Korean technology that is replacing light bulbs. Despite these problems, the stock is on a price/earnings ratio of 15, a rating that Verrazzano doesn’t believe is sustainable.
Staying clear of banks
For now, the strategies are on the whole avoiding both long and short positions in European banks. By some metrics, such as price to book value, price/earnings and expected dividend yield, banks are cheap. Yet it is telling that individual banks in Europe don’t trust peers. Proof of this is that the hundreds of billions of Euros lent through LTRO don’t circulate among banks but instead get deposited with the European Central Bank. Plus, the scale of some banks makes them impossible to analyse. The balance sheet of Deutsche Bank, for example, is bigger than Germany’s GDP.
“The problem with European banks is that they haven’t deleveraged enough,” says Rambourg. “If you look at these banks individually, the size of their balance sheet is just huge and it’s got bigger with LTRO, where they’ve been able to finance themselves without limitation, for three years, at 1%.” Unlike US banks, Rambourg adds that European banks have failed to deleverage and have largely unquantifiable risk exposure to sovereign debt and derivatives.
What underlines the ambition and underpinnings to Verrazzano is the experience and credibility of its advisory board. Chief among the high level advisors is Roger Guy, like Rambourg one of the leading European equity investors of his generation, who has invested in both strategies and has a stake in the company.
On Guy, Rambourg says: “He knows more than half the team here and knows the process inside out. He knows the whole set-up, so he’s happy to speak to investors and happy to be an investor himself.”
Alexander Ineichen, the renowned alternative investment author and former head of industry research for the hedge fund platform at UBS Global Asset Management, is an advisor. So, too, is James Aitken, the respected macro strategist who advises institutional investors worldwide. Rounding out the advisory board is Jean-Francoise Theodore, the former deputy CEO of NYSE Euronext who helped lead the creation of the trans-Atlantic exchange group in 2009.
Attracting hedge funds
The windy anti-finance rhetoric of French politicians, notably of freshly elected President Francois Hollande, and of various European Commissioners, has largely obscured the fact that it has been public policy in France to enhance the onshore hedge fund sector. Before moving to head the International Monetary Fund last year, Christine Lagarde, as French Finance Minister, acted to promote asset management. A government-backed seeding fund ‘Fond Emergence’ for new managers has been created, though Verrazzano hasn’t tapped it for capital.
“In some areas, like derivatives and fund management, the French, for varying reasons, have expertise,” says Rambourg. “And I think the French authorities think it’s a bit of a shame to see all the talent just go straight to other countries. That’s why they’re trying to create critical mass in those two specific fields.”
The Paris market boasts anumber of established alternative investment firms. Among them, Boussard & Gavaudan, Exane and CFM as well as a number of event driven UCITS funds, plus fund management giant Carmignac Gestion. In addition, fund of funds houses like Lyxor and Amundi are big players.
One consequence of setting up in France is that Verrazzano opted to register Irish-based qualifying investment funds, eschewing a Cayman listing. Rambourg says the Central Bank of Ireland’s regulatory focus on fees, transparency and liquidity dovetails with emerging European regulation through the Alternative Investment Fund Managers Directive and appeals to investors since it offers a much greater alignment.
Avenues of expansion
Verrazzano’s core business may be hedge funds, but some potential clients have already pushed for an actively managed long only product. This may well get added impetus should the woes afflicting the Euro intensify, making stocks even cheaper and directional plays all the more attractive.
Rambourg, of course, began as a long-only fund manager and throughout his time with Guy at Gartmore the pair ran multi-billion dollar long equity portfolios. “We’re completely focused on the two hedged strategies at the moment,” Rambourg says. “The current environment is difficult enough so we don’t want to come up with too many initiatives just yet.”