Winner best alternative Ucits fund of the year A sharp market focus and new investment processes have helped Hadron Capital's Hadron Alpha Select Fund to recover from disaster in 2011. After achieving returns close to 15% in 2012, the fund's managers are looking forward to more interesting times. Launched in April 2010, the fund employs a bottom-up, long and short multi-asset class strategy within a Ucits structure. The fund is a near mirror image of an offshore Cayman structure launched earlier. The portfolio has a three to six months investment horizon and is broadly diversified across sectors and countries with a European bias. The fund has an unusual structure with the portfolio split into three ‘legs’: equity, credit and volatility. Each of these areas has its own portfolio manager. The three strategies are managed independently, almost as if they were separate funds in terms of the way risk is monitored and measured. "We like to divide the portfolio up this way because the asset classes need slightly different risk management and a different context for our counterparties, especially in Europe (where) the equity and credit spaces are independent," says Marco D’Attanasio, Hadron Capital’s chief investment officer and equity portfolio manager. This structure provides three different ways of looking at an event or company and means a decision can then be taken on the best way to implement an investment: through equity, credit or one of the non-linear options. "The company and the events are the same, (they are) just expressed differently in the portfolio. This creates a lot of efficiencies in terms of capital and in terms of what you are playing for," D’Attanasio says. In the second quarter of 2013, the fund's managers see more opportunities in corporate bonds, especially in high yield. Long/short credit, according to D’Attanasio, is becoming a more interesting strategy and the fund's approach reflects that. "We are fairly seasoned investors in the credit space. We think our processes and skills should (allow us) to generate very good quality and good returns in the future. We also think this process is irreversible and that you will see an increase in (related) products," he says. There are a few factors that should continue to contribute to this area of return within the portfolio. Low interest rates continue to encourage investors to look for higher returns from credit strategies, including corporate and financial high yield bonds. As European banks continue deleveraging, European companies are switching from bank loans and turning to the bond markets. This is creating huge potential for corporate activity in Europe, D’Attanasio says. "A few years ago (we were) more of an equity-based fund with a few bonds. Now it’s really balanced and it’s exciting. I can see a future where credit will offer more opportunities than equities." Companies have struggled for years to get funding. This has created a big backlog for credit in Europe as well as mergers and acquisitions that have not yet happened, he says. Although the macroeconomic environment has a limited impact on the decisions of the portfolio managers, it provides a "sanity check" and a framework in which to operate, says D’Attanasio. The fund seeks specialised single investment opportunities where the team's multi-asset class approach can give it an edge, rather than be driven by macro considerations. "We see a lot of managers come in with macro arguments but we think this is not the time to put so much emphasis on macro thinking. Bonds are a source of alpha (and) generate returns from good quality over time," he says. Ideas come from a variety of sources. With 15 years of experience in the industry, as well as meeting industry specialists and non-financial experts over that time, D’Attanasio believes the expertise of the managers provides plenty of opportunities. He says the team just “needs to open a drawer” filled with past ideas and research. Occasionally the team uses an idea from a broker but the vast majority of trade ideas come directly from the team. Nevertheless, the market remains a tricky place in which to play out the strategy. D’Attanasio says investors that do not have the time or do not want to think about their investment as long as it works are investing large amounts of money passively. This is causing some distortions. "It’s a market in which there are many forces at play. There is more activity from retail investors. Broker headlines move those guys and more investors invest short term," he says. Opportunities also bring risks. Balancing the two is complex especially for non-linear strategies. "The more you invest in hard events like M&A, the more [there is] a risk of a gap opening against you if something goes wrong. For non-linear strategies, you almost need to think ahead about how things could go wrong and decide on the size and timing for your investment accordingly," says D’Attanasio. This requires a proactive risk management capability. "You cannot react to prices. That’s already too late," he says. Long and short strategies do not have a precise exit point or timing, although they allow more ways to manage the risk in the position over different time horizons, he says. In the credit market it is necessary to think more about the potential downside. The fund is active in high yield bonds, which present more risk. However, D’Attanasio says he is satisfied with the performance of this part of the portfolio. "We’ve had a fairly balanced allocation of equity long/short, credit long/short both this year and last . The team has had good results on shorts. So from this point of view, we are finding the strategies equally attractive," he says. In the wider market the appetite for corporate bonds carries its own dangers. Investors are buying corporate bonds for the coupon and ignoring the risks, he believes. "The universe of corporate bonds, especially high yield, investment risk-grade bonds, is growing at a pace that is not matched by a growth in the skills required and expertise needed to understand these products," he says. "I can easily see at some point a situation in which you have the credit cycle reversing and there will be no buyers and lots of sellers. That’s how the market destroys you. It forces you to be long. You have to make money and then when the tide changes, you are alone. How can a fund with a billion or more in assets under management reverse its position? Absolutely no chance," he says. Being small gives some protection and flexibility. "Credit funds can be tricky and liquidity can disappear very quickly," he notes. In 2011 the fund did not do well with returns dropping 13.75%, although performance returned in 2012 with the fund returning 14.93%. D’Attanasio says the fund suffered from a series of idiosyncratic accidents in 2012. Five or six positions went against it in a spectacular way. Most of the fund’s bad fortunes happened before August, when European markets went into their worst crisis in decades. "We had a handful of situations, important positions for us, which ended up badly for different reasons." These included a large investment in uranium mines when the Japanese earthquake and tsunami, which caused the nuclear disaster at Fukushima, happened. That was a costly event, he says. The fund also had core positions with companies with profit warnings and which were going through management changes. "These five or six big losers caused the losses," he says. The fund managers could not compensate for the losses with some winners because the markets were in a spin. "It was a very difficult year for us," he says. Since then the managers have reviewed investment processes, made some other changes and hired more analysts. "The markets changed over the past few years and we hadn't. We had to adapt and we freshened our processes." The portfolio is now run with slightly lower levels of concentrations to reduce reliance on four or five big core positions. "We used to run a super high conviction position of 5%-6% of net asset value. Now we spend 3%-4% maximum. The 2012 results reflect these changes," he says. The fund now aims to keep single positions below 4% of assets under management. The Ucits fund was created in response to reverse enquiries from investors in Hadron Capital's offshore fund who wanted a regulated European onshore product. Since it was launched, the Ucits fund has performed slightly better than its offshore relative. "We are very bullish on Ucits," D’Attanasio says. Although D’Attanasio is keen on the Ucits structure, he is concerned about expected Ucits regulation. "It depends on how regulations develop. [The EU Commission] could kill alternative Ucits tomorrow if it puts in too many constraints," he says. He has similar concerns about the European financial transaction tax, a version of which has already proved disastrous in Italy. D’Attanasio fears such a tax across 11 eurozone countries could reduce volumes and investor appetite. Nevertheless, looking ahead to the rest of 2013 and into 2014, D’Attanasio sees a favourable investment environment and opportunities from market inefficiencies and lower competition in the aftermath of the financial crisis. He expects lower tail risks, reflecting political progress in Europe and rising market confidence. He believes the biggest risk would be a sharp rise in asset prices. But for now the outlook is positive. "In terms of the risk of us losing money, I’m happy with the portfolio. I don’t think we’re running a particular macro risk or exposed to any particular theme," he says. "We would like to see more volatility. The party for us hasn’t started yet. We haven’t seen a lot of corporate activity in Europe or M&A. If things normalise we should see new opportunities,” he adds. Fund facts Name of fund: Hadron Alpha Select Ucits Fund Portfolio managers: Marco D’Attanasio, Massimiliano Ciuchini, Giuseppe Di Cecio Management company: Hadron Capital Contact details: Hadron Capital, 5 Royal Exchange Buildings, London EC3V 3NL (+44(0)20 7469 5900. Fax +44(0)20 7469 5901; firstname.lastname@example.org; www.hadroncapital.com) Strategy: bottom-up, long/short multi-asset class with a relative value and event driven investment style Launch: April 15, 2010 (Ucits version; offshore launched October 2004) Return year to date: 0.55% (at March 28, 2013) Assets under management: €100.287 million (fund); $242 million (strategy) (at April 1, 2013) Share classes: euro and US dollar Domicile: Ireland (Ucits IV) Custodian: Northern Trust Fiduciary Services (Ireland) Sub-custodian: Morgan Stanley & Co International Auditors: PwC Legal advisers: McCann Fitzgerald Fund administrator: Northern Trust International Fund Administration Services (Ireland) Stock exchange listing: none Minimum investment: €/$100,000 Management fee: 2% Performance fee: 20% equalisation credit applied...
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