Joseph Marren dates the beginnings of both his financial career and his friendship with Mark Kenyon to PriceWaterhouse & Co. in 1976. Thirty-five years later, he reconnected with Kenyon to help found New York-based KStone Partners, which now manages about $125 million across three funds of funds.
Marren, now president and CEO of KStone, spent the interim heading business development in mergers and acquisitions departments at Citigroup, Credit-Suisse, Donaldson, Lufkin & Jenrette and Sagent Advisors. FINalternatives Senior Reporter Mary Campbell spoke to Marren recently about the origins of the firm, the current environment for merger arbitrage and the future of funds of funds.
Tell me about the genesis of KStone Partners.
Mark Kenyon [now KStone's chairman and chief investment officer] and I have been friends since we started at Price Waterhouse & Co. together...He had also worked extensively with Joe Drohan, our third partner, at UBP, where Joe ran the private equity portfolio for Mark.
I will confess that Mark took me by surprise when he and I sat down in May of 2008 and he said, "Why don’t we do this?" I was, honestly, quite happily ensconced with guys that I liked a lot at Sagent Advisors, an M&A investment boutique. But one of the things that all three of us saw was an environment going forward where there was going to be lots of volatility in both the equity and the debt markets and an economic environment that was going to be very difficult. And in that environment, Mark’s arbitrage and relative value strategies should perform fairly well. Ultimately, that’s what attracted me to work with Mark, and so the three of us assembled in the summer and early fall of 2008 and put the firm together through the rest of 2008, and then launched a couple of funds on Jan. 1, 2009 -- KStone ARV LP and KStone MultiStrategy LP. We launched an offshore version of the ARV fund on Jan. 1, 2010.
About how much do you manage in those funds?
In the aggregate, $125 million. Roughly two-thirds of the assets are in the ARV funds and roughly one-third in the Multi-Strategy fund.
In 2008, you saw potential for your strategies. How have your funds done in last few years?
They’ve done quite well. We’re shooting for absolute returns, so we’re looking to make money in all economic environments. We achieved returns that were attractive in ‘09—a little bit less than 20%—and then in 2010 roughly 8% returns. Year-to-date 2011, we’re up in all three of our funds.
Looking at current market and current conditions—and it’s been a rough couple of months for hedge funds—what opportunities do you see?
When you have spreads widening like they have in the last couple of months, that actually is an environment that creates a tremendous amount of opportunities for our underlying hedge fund managers. We just view this as a point where they’re effectively reloading and reinvigorating their portfolios with very attractively priced securities and we’ll see the benefit of that in the next year.
How many underlying managers do you use?
Typically, we have between 25 and 33 managers in our portfolios.
How do you choose your managers? What criteria do you use?
We tend to look at managers that have excellent performance, institutional-quality risk management, highly-qualified individuals running the portfolios and that have been running the type of portfolio that they are managing for some extended period of time—and typically have meaningful investments in their own funds, so they are not some nameless, faceless, institutional manager, they’ve got real skin in the game. They’re [also] running the types of portfolios that we’re looking for, which is low-volatility, low correlation to the debt and equity markets and yet generating attractive, risk-adjusted returns.
How do you find managers—do you seek them out or do people come to you?
Quite honestly, it’s both. We certainly get quite a number of our managers through our industry contacts; the three partners here have extensive experience throughout the hedge fund community, and Mark Kenyon, given his 24 years in the business, has extensive contacts in the business, so that’s one way that we get managers. But we also do the normal blocking and tackling where we seek out managers through other means. It could be as simple as a database search where we find a manager who just hasn’t quite been discovered yet.
You often hear that funds of funds are on the decline, and that as investors become more sophisticated, they prefer to invest directly. What’s your take on that?
In my mind, there’s quite a number of cross currents in the marketplace, and the bottom line is that funds of funds have a role in the marketplace and will always have a role in the marketplace. Until you get to a very substantial size it’s quite difficult to take an alternative asset allocation and translate that into a diversified portfolio of investments in hedge funds without investing in funds of hedge funds. That, fundamentally, will keep many of the medium-to-smaller institutions interested in investing in funds of hedge funds as opposed to going direct.
I’d also tell you that while the flavor du jour in the larger institutions is for them to go direct, we would not be surprised, in many cases, to see people back off that because you need a certain amount of expertise to invest on a direct basis and it’s not apparent that all of those institutions are going to conclude over time that, in fact, they have the requisite talent to be able to invest on a direct basis.
Merger arbitrage was one of the few bright spots among hedge fund strategies in September, it’s also your specialty—can you tell me something about this strategy in the current market environment?
Merger arbitrage is something that we’ve been in from the beginning. It is a strategy that I certainly know personally very, very well—and my partners do, as well. You have an economic environment where corporate America and corporations throughout the world are flush with cash and they’re looking for growth opportunities and in many cases their base business is experiencing slow growth. In that environment, they are very much looking to invest to garner a higher growth rate and so acquisitions is top of mind for many, many corporations, and that is helping to drive the M&A volumes. In that environment, merger arbitrage can do fairly well because at the end of the day, if a higher percentage of deals close, you’re going to see merger arbitrageurs, as a category, do fairly well. They’ll never get outsized returns, but they’ll produce very steady, good solid returns that are uncorrelated.
Do your funds have a target size or maximum capacity?
We don’t, although I will tell you that we think we can get very much larger than we are today without changing anything significant in the way we manage our funds.
What sort of investor are you targeting?
With our pedigree and Mark's background, we’re talking to everyone from large institutional investors to the smaller and mid-sized firms, to foundations and endowments, to high-net-worth individuals and family offices. It’s a very broad cross section of people that we’re addressing. We’re trying to offer access to highly diversified, alpha-generating funds to the institutional and high-net-worth marketplace.