Sunday, 1 March 2015
Last updated 2 days ago
Jul 14 2011 | 11:22am ET
Stephen Harper shares a name and a nationality with the prime minister of Canada, but the CEO of Saguenay Strathmore Capital has been a Londoner for 21 years. FINalternatives reached him there recently to discuss the merger of his firm (Strathmore) with that of his old Banker’s Trusts associates (Saguenay), his thoughts on the advantages of smaller fund managers, and how he overcame his cynicism about funds of hedge funds enough to run one.
What are the origins of Strathmore Capital?
Strathmore Capital started, really, on the back of conversations with a large pension fund that I’d known for a long time, who said, ‘We want to invest more in Europe…We get pitched by every fund of funds on the planet [but] we’d rather work with somebody we know…and if you want to be our eyes and ears in Europe and manage a European-focused portfolio for us we’ll commit to be your first client.’
That was really the background to Strathmore Capital and having always been a bit of a cynic about the fund of funds business, while it’s flattering that somebody wants to give you money to invest, my concern was—even back in 2002, 2003—it wasn’t obvious that the world needed another fund of hedge funds. [But] we liked the idea of having a fairly narrow focus, we thought it would allow us to avoid what we perceived as the ‘arms race to asset growth’ that plagued the industry. And, we saw institutions as becoming an increasingly important part of the business and if this made sense for this pension fund, perhaps it would make sense for others going forward.
How did the merger with Saguenay come about?
In the last year to two years, we were beginning to be pulled a bit by our clients to get a little more involved in the U.S. and one client very specifically, who was using us for Europe only at that point said, ‘We really like your due diligence process and your risk analytics…would you want to take on the U.S. portfolio?’ That really focused our attention on how would we do that properly. I was very loath to extend ourselves beyond what we could deliver and that brings us up to the Saguenay discussion.
Looking at the opportunities in front of us, we at Strathmore needed to make a significant investment in the U.S. and we saw this as an opportunity to fast-track that. From their point of view, Saguenay were about to make a big investment in infrastructure and systems and we were able to kind of fast-track that for them. In addition to the geographic synergies there’s also good synergy in that we think they’re very good at top-down, strategy allocations and we think that we’re pretty good at process and due diligence. But most importantly, in any kind of merger, the big risk is, what are the cultures like? How are people going to get along? Who’s going to do what? How’s that going to work? And because of the shared history [the Saguenay partners are guys that I’d known for all of my working career]…it was easy to come together and to get through the tough issues pretty quickly of who’s going to do what and how’s it going to work.
You run a fund of hedge funds yet describe yourself as a bit of a cynic about them, when it comes to institutional investors, why is that?
My issue with it has been I’ve never felt that the, what I would call Version 1.0 of the fund of funds business model, was an institutional model. It was designed more for high-net-worth individuals. The value proposition was more around things like, ‘Hey, I can get you into this fund,’ or ‘We have access to that fund,’ or ‘This is complicated stuff so you need us to help you navigate through these complicated strategies’ and I don’t think that’s ever what institutional investors have really been looking for from fund of funds or advisors.
People will describe this time line where a pension fund will start off, they’ll get approval from their trustees to invest in hedge funds, so they’ll bring in a consultant and they’ll run a beauty contest and they’ll hire a fund of funds or hire two funds of funds and use that as kind of training wheels. And then, as they begin to get more comfortable, they will begin to invest directly and they will stop paying fees and do it themselves. And we’ve definitely seen some of that trend but we think if all a fund of funds is doing is saying, ‘Hey, I can give you access to this big-name fund or that big-name fund’ that’s of zero value because, first of all, these pension funds are getting called on directly by those large hedge funds. If you were running a pension fund...you certainly don’t need Strathmore Capital to introduce you to a Brevan Howard, so what’s the added value?
…And I think you’ve seen that reaction over the past couple of years. I think the pension funds have basically rejected the traditional funds of funds [model]…They say, ‘You know what? We’ll hire a consultant and pick the funds ourselves.’ Over the last two years that has contributed to the big funds getting bigger and the smaller ones struggling to gain assets.
One thing that we’ve seen happening is, as a lot of pension funds invest directly, they end up all gravitating to the same big hedge funds and it’s a little bit of a self-reinforcing thing because they say, ‘Well, okay, I’ve got a small team of people on my staff—I don’t have an investment team of 10 people, I’ve got two people or three people so, we’ll come to London and we’ll meet the usual suspects and we’ll pick from one of those.’ And the difficulty with that is now all these bigger hedge funds have $20 billion, $30 billion under management and do you really believe that that’s all alpha? At the risk of sounding slightly flippant, if everyone is investing in the same big funds, how alternative is that?
But over the last few months I’ve started to hear pension funds beginning to complain...I am definitely picking up on people saying, ‘We have to be looking beyond this, finding smaller managers, managers in different markets,’ which to me is what hedge fund investing is all about. And that’s where I think funds of funds or advisors have to be adding value… Do I think we are smarter than pension investors? No, but I think we work with our clients to expand the bandwidth of things they would want to do if they had more resources to be able to do so. We want to be the eyes and ears that extend their horizons because it just takes time to cover managers, especially if you’re going to monitor them diligently, it just takes time and there’s no short-cutting the labor intensity and it matters when a manager starts to wobble or is suddenly too big, you want to be the first guy moving not the last guy.
Some commentators feel the hedge fund industry may not be able—or willing—to provide institutions the kind of transparency they require, what’s your take on this?
I’m more of a hard liner on this point—I don’t subscribe to the, what I consider to be more of an old school hedge fund view, that it’s not in my interest to tell my investors what I’m doing and it’s better for all my investors if I don’t tell anybody what I’m doing. What I always tell my colleagues is that history will be very unkind to all of us as hedge fund investors because I think people will look back at what we’ve been doing collectively in the same way we look back at dot.com investing now. We look back at that period and say, ‘God, what were people thinking? You gave a huge valuation to some 26-year-old with a business plan because he told you some story about hits and clicks and eyeballs and other non-financial metrics and you were okay with that?’ That seems so crazy. And we look back on it now and say, ‘What was going on?’ But I think people, quite legitimately, will look back at us and say, ‘Now, let me get this right—you put money in this fund, and this guy charged you 2% and 20% of all profits and now, first of all, you didn’t know what was in the portfolio? He wouldn’t tell you? And the 20%, how was the profit calculated anyway? Oh, the manager calculated that and the manager had an administrator so you took comfort because a clerk in Cayman or Dublin put his stamp on that, and you drew comfort from this administrator’s ability to determine both the fair market value of these complex securities or illiquid assets and so therefore were happy to pay 20% of the marked up value on that before the manager had sold them. And then when you wanted to get your money out the board could say no or restrict your funds.
The good news is that post-Madoff, most of the flows into the industry have been institutional. Institutions are demanding different terms…I think institutions have become much more emboldened—and they’ve begun to band together and be more consistent about what they will accept and what they won’t accept. And I think hedge funds, the more enlightened ones, are recognizing the need to change, not because they’re any more charitable but only because it’s a hard-nosed commercial decision that that’s where the money is and the perception that institutional money is more sticky and therefore helps their business model.
What are some of the dealbreakers for you when you’re considering investing in a hedge fund?
There are loads…If there weren’t an independent administrator, that would be a deal killer for us. If there weren’t some independent valuation of the assets—if that manager was essentially marking the book—that wouldn’t work for us. We would be uncomfortable if the board of directors weren’t truly independent and credible, because at the end of the day, we’re investing in a fund of which the documents allow the manager huge latitude, so we have to look to the board of directors to be our representative. Technically, the board of directors has the right to fire the investment manager and so we need to be able to rely on the board. So that’s an important consideration. Transparency, again, being able to have a sufficient level of transparency. If a manager said, ‘I’m not going to tell you what’s in the portfolio and I don’t have the time to talk to you each month to tell you about it.’ That would be a huge issue for us.
Jan 23 2015 | 1:00pm ET
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