Capital protection has become something of a mantra for funds of hedge funds (FoHFs). For Oakley Absolute Return (OAR), part of the Oakley Capital Group, it is not a mindless recitation.
The fund, launched in July 2005 with over 50% of the assets coming from the founding partners, has a strong incentive to ensure profits and - more importantly - not to lose any money. The two principals of the fund have managed direct portfolios or FoHF allocations for Rothschild, HSBC and K2 Advisors.
Like most funds and FoHFs, the theory did not quite work in 2008. Despite the rather clever construction of the portfolio (into core and satellite sections), the fund was down 4.16% due almost entirely to the inability to redeem some instruments in emerging markets, mainly Russia, which the fund tried to sell off in March 2008.
"The instruments let us down. We lost almost 5%. We were kicking ourselves for that. But despite this we were pleased that the core portfolio model worked," says Christopher Parkinson, portfolio and risk manager.
In general OAR has done well despite this 2008 hiccup. Since inception the FoHF has had an annualised return of 8.19% with an annualised standard deviation of under 5%. The fund's team manages over $180 million in the strategy.
The investment approach is based on capital preservation targeting returns of 8%-10% a year with low volatility and little correlation to other financial products. The FoHF invests across asset class, strategy, style and timing to create what it believes is "true diversification" across a concentrated group of managers, with a bias towards emerging managers in the satellite portion of the portfolio.
Standing out from the crowd
The core/satellite approach is one of the reasons OAR is different from its peers. The core part of the portfolio is fairly traditional. The core managers typically make up 80% of the portfolio; they are chosen to ensure diversity and are not structurally directional. The satellite managers generally make up the rest of the portfolio and comprise macro thematic managers. Typically, the entire portfolio is made up of 15-25 investments divided into a roughly 80%/20% core/satellite split.
"Our objective," says Parkinson, "is to make 8%-12% a year." Investors have the option to determine how their investment is split between the core and satellite parts of the portfolio. Those with a higher appetitive for risk can put more into the satellite section; or if an investor prefers a much more cautious approach, 100% can be put into the core section.
The core, explains Parkinson, is made up of managers with limited directional bias and dependency or a tactical and asymmetric directional bias and dependency. This means the 10-20 managers that comprise the bulk of the portfolio (the core), will probably give limited volatility. They will form a stable centre for the portfolio. Parkinson says these core managers will give what Oakley terms "logical correlations" between each other to ensure diversification.
The core is a "straight, stable basket giving incremental gains," says Parkinson. "It should perform well in all market conditions."
Talking about choosing these managers, Parkinson admits "it's an endless task, balancing different risk factors, finding the right managers. These are not necessarily the absolutely best 20 hedge funds in the world. But they represent the best possible profile we could invest in as a fund of hedge funds."
Once managers are put into the portfolio, it is still a lot of work. "We don't just put the portfolio together and leave it. There is a lot of work that goes into the selection but also into the monitoring of the funds once they are in the portfolio," says Parkinson. Together with chief investment officer Nick Hannan, former head of research for LCF Rothschild (London) Asset Management, Parkinson looks at the possibilities.
"We screen which ones to take a closer look at. We tend towards the slightly smaller managers in the $350 million size range. We want to know inside out what the manager does. We believe with the smaller managers there is more investor focus. We can also have a meaningful relationship with the fund if it is smaller and we believe the fund itself will be more focused on the downside."
This means that it will not be just about making money but about controlling risks. If a small fund with its own money invested suffers a loss, it is personal.
OAR believes this gives managers a positive edge in addition to their ability to create alpha. It is also a reflection of OAR's own philosophy. Having partner money invested gives an incentive to make money, not lose it, and for rigorous risk control.
Parkinson and Hannan look at a wide universe of potential funds for the core portfolio. Immediately thrown out are CTAs. Although Parkinson says there are undoubtedly good managers in that sector, OAR does not want the volatility which is the norm for these funds.
"Nick and I are very clear on the funds we target. That makes it easier to screen the funds," he says.
Directional risk is another concern. Parkinson says this is difficult to judge. "If you get it right you are fine, but if you get it wrong your head is on a plate," he says.
"We also tend not to invest in funds that have side pockets," he says. Liquidity is important. "We have a fiduciary duty, a statutory duty, to our investors. We cannot disadvantage them. So we make sure the whole portfolio is liquid and can be realised in 90 days. We stay away from the less-liquid strategies," Parkinson adds.
In addition, OAR conducts operational due diligence on all the funds in the portfolio. "Our chief operating officer has the power of veto over any fund we select," he says. "For us it is critical to understand how a manager thinks. We want to see integrity in our managers."
For Parkinson this means managers being able to answer detailed questions about why they do what they do, how they do it and how they time it. They can answer questions on when and why they have done trades and generally explain the strategy in detail. If a manager suddenly changes style or does something out of character, Parkinson and Hannan will notice.
The close relationship with the manager means that finding out what is behind that strategy shift should be a matter of a telephone conversation.
On the edge
The other half of the portfolio, albeit a much smaller part, is the satellite. Here there can be 0-10 managers with a focus on material directional bias or dependency. Exposures in these funds tend to be structural and less actively managed by the managers. As in the core portfolio, investments need to be highly liquid.
Combined, the portfolio construction must offer real diversification. According to OAR's own strategy, the aim is to diversify risks that actually matter such as directional bias, dependency, liquidity and correction, not just worry about the "superficial headline risk" such as manager numbers and strategy allocation. Correlation should be avoided. Logical correlation is far more important than historical correlation when understanding risk concentrations. An understanding of the symmetry of a manager's exposure and return profile is also important, particularly when incorporating the manager into the portfolio.
Another element taken into account when constructing the portfolio is position size. This is based on what a manager actually brings to the portfolio, not on indiscriminate limits or equal weightings. Again, this is a "real" rather than "superficial" consideration.
One area where OAR's selection process may stray from the norm is when it looks at historical performance. Parkinson and Hannan believe it is better to understand the manager rather than base selection purely on a performance record that could be misleading.
Manager selection is closely coupled with the investment process itself. Parkinson says OAR has a macro overview; this is is a broad-brush forecast that will tilt the portfolio where they think the opportunities will lie and give the portfolio exposure to the strategies they believe it should be taking on.
Now with what it sees as a solid offering for investors, OAR is beginning to look at a wider universe of investors. Efforts to attract more assets began at the beginning of 2009 and have already borne fruit. Assets under management (AUM) increased by 75% since the fund was formally opened to outside investors in January 2009.
"The surge in assets, which has come from a number of sources, demonstrates that our approach appeals to a wide range of investors. Our strategy remains straightforward: delivering consistent absolute returns while remaining focused on capital preservation," Hannan reported in a press statement issued by the fund earlier this year.
Parkinson says AUM in 2009 remained "pretty stable with some redemptions". He says overall investors stayed loyal to the fund. The liquidity ensured through manager selection meant it was able to honour any redemption requests. No gates or side pockets needed to be imposed.
"Over the last 18 months we have built solid relationships with our investors. Now people are starting to come to us. Before we were sort of below the radar, not very big. It has taken us four years to reach this size," says Parkinson.
He says no one at OAR is really interested in creating a multi-billion dollar fund. "Nick and I worked at big shops. We don't want to go back to that hierarchy. We want to focus on returns, not asset gathering. I could see this fund going up to $750 million, maybe $1 billion. This year we hope to reach $500 million but we suspect it is more likely we'll hit that level in early 2010."
Whether OAR attracts even more investors this year and next remains to be seen. Parkinson and Hannan believe the spotlight on the fund in 2008 has proved it is able to deliver what it says and is uncorrelated to any market. With numerous promotional trips around Europe and the US, Parkinson is confident the fund will not just attract more investors but will continue to deliver steady positive returns.
FUND FACTS: OAKLEY ABSOLUTE RETURN
Full name of fund: Oakley Absolute Return
Name of portfolio managers: Nick Hannan, portfolio manager and chief investment officer, and Christopher Parkinson, portfolio manager and risk manager
Name of investment/management company: Oakley Capital
Contact information: Caroline Abensour and Jennifer Kersis, investor relations, Eighth Floor, The Economist Building, 25 St James's Street, London SW1A 1HA (+44 20 7766 3059 or +44 20 7766 6930; [email protected])
Launch date: July 2005
Assets under management: $182 million (September 1, 2009)
Strategy: multi-strategy, global
Average annualised return: 8.19% (since inception to August 31, 2009)
Average standard deviation: 4.878% (since inception to August 31, 2009)
Share classes: US dollar, euro, sterling, Swiss franc
Administrator: Daiwa Europe Fund Managers Ireland
Custodian: Daiwa Securities Trust & Banking (Europe)
Bermuda counsel: Appleby
Management fee: 1.5%
Performance fee: 10% with a high watermark
Minimum investment: $250,000 or currency equivalent at manager's discretion
Redemption period: monthly with 90 days' notice
OAKLEY ABSOLUTE RETURN - KEY PEOPLE
Christopher Parkinson, portfolio manager
Parkinson was previously a vice president of K2 Advisors, a FoHF business with $7 billion AUM. While there, he was the sole European analyst and was involved with the selection of new managers, portfolio construction and carrying out due diligence and monitory managers. Before K2 he was a senior investment manager at HSBC Investment Management where he co-managed a discretionary absolute return service with assets of over $500 million.
Nick Hannan, chief investment officer
Hannan was previously head of research for LCF Rothschild (London Asset Management) with $3.6 billion AUM. While there, he was primarily responsible for European Capital Holdings, a FoHF with $1 billion AUM. He was also involved with the selection of new managers, performing due diligence and monitoring managers investing in Europe and Asia, specifically responsible for quantitative systems and the development of tailor-made portfolios. Hannan began his career as an emerging market equity analyst with SBC Warburg in 1996.
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