Absolute Income UK Equity Market Neutral Fund: Insight Investment

Parallel Cayman Islands and Ucits structures are becoming a trend, but a few years ago they were an unusual addition to any portfolio. Margie Lindsay talks with Absolute Insight about its conservative approach to investment that offers steady returns

Playing it safe is not the traditional image of a hedge fund manager. Andrew Cawker, lead manager for the Absolute Income UK Equity Market Neutral Fund, is a bit outside the mould and certainly appreciates a cautious approach to investment. He believes his main job is preservation of capital while at the same time creating steady and repeatable returns.

Cawker is not aiming for double-digits returns but for a modest 7%-9% a year, regardless of what the markets are doing. His approach, he admits, was not all that popular with investors a couple of years ago. But the market volatility of 2008 is driving more investors into perceived safe havens and Cawker believes his fund is one of those.

The equity market neutral fund is unusual for another reason. There is an offshore Cayman Islands-domiciled fund with a parallel onshore Ucits fund for retail investors.

He, like others at Absolute Insight, believes there is a large group of investors, including wealth managers, who are attracted to this type of product. Having two distribution channels he sees as a benefit.

Insight Investment is an autonomous asset management company owned by Lloyds Banking Group. As a specialist provider of innovative investment solutions to the pension and insurance industry, it has £119.2 billion under management and is the third largest manager of UK pension assets. Its Absolute Insight funds invest in a range of uncorrelated absolute return strategies.

The objective is to deliver attractive, but unspectacular, returns in all market conditions. The funds, of which Cawker's is one, offer low volatility with high risk-adjusted returns, focusing on downside protection.

There is a combination of sub-strategies with five funds in the range: Europe Equity Market Neutral Fund, UK Equity Market Neutral Fund, International Equity Market Neutral Fund, Emerging Market Debt Fund and Currency Fund. These are to be joined by another a credit long/short fund expected to launch later this year.

At March 31, 2009 assets under management in the fund of funds structure totalled over £500 million with £247 million in the NURS (non-Ucits retail schemes) vehicle, £100 million in the qualified investment fund of funds and £282 million in the Cayman fund of funds.

Each fund has a Ucits onshore product with an offshore Cayman fund using the same strategy. This fund of funds structure gives a diversification while aiming to deliver consistently high risk-adjusted returns and at the same time minimising downside risk.

Absolute Insight has been designed to offer a broad opportunist set, not limited by geographical reach or asset class.

The ability to take short positions through the use of derivatives in unattractive assets and to go long in undervalued ones doubles the opportunities available to these funds.

Because Ucits funds are attracted to derivatives, the managers are able to precisely target specific investment opportunities and hedge any unintended or unwanted risk associated with that particular market, sector or asset class.

The UK equity market neutral fund run by Cawker was the best performing of the fund strategies in 2008 and so far this year has maintained its ability to produce positive returns.

Despite high redemptions in most funds, Cawker's remained steady, mainly, he believes, as a reflection of the conservative strategy followed by the fund. In a 47-month period, the fund only had six down months with negative returns rarely hitting 1% and averaging below 1%.

Cawker says the fund's success is through construction of market neutral pairs. The idea is to hedge out the market, stripping out risk but allowing some upside with a limited down. Cawker says his fund is different from a standard hedge fund because of his hedging techniques.

He explains that he is trying to improve the win/loss ratio of the portfolio by getting the majority of his ideas right. While that is not always possible, he thinks getting to losers early and having tight stop/loss parameters on pairs that get him out of market positions early, helps limit losses as well as producing good returns.

For both the Cayman and Ucits funds, Cawker follows the same strategy saying there is no need to modify the way the funds work. Although he would be able to use more leverage in the Cayman fund "we don't and never did" he says. The only real difference is that because of Ucits rules, the Cayman fund holds a large proportion of cash. The two funds more or less mirror each other, with around a 1%-2% difference due to the cash composition. The master fund in Cayman ran for around four years before the decision was made to launch the Ucits fund - a way to make this strategy more accessible to a wider investor base and to make marketing across Europe much easier. With roughly £120 million in the Ucits fund and £65 million in the Cayman structure, Cawker says he was not that surprised the Ucits fund was attracting more investors.

Family offices and private wealth managers are attracted to Ucits products, he says, not just because of the daily dealing but also because of the distribution status. This, he believes, is a powerful combination.

Quantitative analysis

Cawker and his team spend a great deal of time on quantitative analysis. He believes an analysis must look at all the angles to see the differences in a company and to get a true picture.

"If you look out of a window you see only one picture. You need to look at a view from a lot of different points and angles to get the full picture," he explains. Understanding share price, technicals and fundamentals in a market and how these interact and impact the fundamentals of a business gives a true picture, he believes.

Cawker believes share price research gives the foundations of a company but the dynamics of the share price combine to give a picture of why the price moves up or down in the market. When the market is very fast moving, it is harder to find the right matching pairs to ensure the market neutral approach.

Trading varies on the stock. For some, positions are taken and held for two years while others could be only two days or less. "It depends on market conditions," Cawker says. "Turnover of stocks will be what turnover will be. It depends on market conditions."

Risk management is high on the agenda. In general the strategies consider a broad opportunity set, diversifying and using risk management and portfolio construction techniques to create optimal portfolios.

Absolute Return's investment committee (known as ARIC) sets internal risk and investment guidelines. Members of the committee include the Insight managing director and chief investment officer, head of alternatives and head of each investment department. The committee meets monthly.

The fact that portfolio managers, analysts and others work together on the same floor allows people to exchange information and bounce ideas around, to get opinions and ask advice.

The system relies on tools with both a flexible informal and formal approach to risk management. Stop-loss review triggers are applied at underlying sub-strategy level and monitored daily. If triggered, fund managers must explain their actions.

The company believes this approach helps to preserve capital by limiting downside risk. The risk management team monitors the activities of the funds at arms length, using various software packages and internally developed risk systems that ensure adherence to risk limits at the sub-strategy level. Separate risk functions ensure compliance to risk limits and reduce operational risks to investor.

The quantitative risk team analyses portfolio profiles, unintended biases and P&L, providing an independent review, stop-loss management and idea generation.

The team uses proprietary technology as well as external providers and the focus is on "continuous evolution". Specialised expertise is used continuously to challenge portfolio construction and the risk framework. Working closely together, teams can provide constructive criticism within a flexible and reactive environment while at the same time using bespoke ad hoc quantitative solutions.

This approach to risk and portfolio construction combined with the company's conviction that regulated and unregulated products can be managed and sold together, gives Absolute Insight a head start on the increasing trend towards Ucits and regulated products.

As the appetite for these low volatility, highly liquid products with modest but steady returns increases, the team at Absolute Insight believes it is well placed to gain more investors and significantly increase assets under management.

ABSOLUTE INSIGHT UK EQUITY MARKET NEUTRAL TEAM

Andrew Cawker - lead portfolio manager

Cawker joined the Insight UK equity team in April 2003 managing the portfolios of a number of segregated and pooled pension funds. Previously he was an associate partner at Invesco Global Asset Management where he was involved in developing specialist UK equity business alongside the management of a range of UK and global equity portfolios. He was also responsible for pan-European analysis for the retail, food, beverages and tobacco sectors. Cawker started his investment career at Prudential Portfolio Managers in 1988, becoming a director with responsibility for UK equities.

Iain Brown - portfolio manager

Joining Insight in July 2002 as a portfolio manger in the UK equity team, Brown previously spent six years at Norwich Union Investment Management, lastly as head of institutional investment. Prior to that he spent eight years at CIN/Goldman Sachs as a portfolio manager. Brown began his career as an investment analyst with Credit Lyonnais in 1987 following a number of short-term roles, including two years with stockbroker Charlton Seal.

Richard Howarth - portfolio manager

Howarth joined Insight in January 2002 as a portfolio manager in the UK equity team. Before coming to Insight he held a fund management role at Brewin Dolphin for five years. Howarth began his career as trainee portfolio manager with Capel-Cure Myers Capital in 1994.