Monday, 23 January 2017
Last updated 2 days ago
Dec 9 2011 | 9:49am ET
Alternative Investment Management LLC debuted in 1999 as an extension of an office managing money for two families. Four years later, AIM opened its doors to outside investors and today counts wealth management firms, consultants, endowments, foundations and high net-worth individuals among its clients.
Jon Harris, Alternative Investment Management's president, has experience in both the private sector (with Goldman Sachs) and the public sector (from 1994 to 1996, he was responsible for the international finance subcommittee issues for the Republican majority on the U.S. Senate Committee on Banking, Housing & Urban Affairs). FINalternatives Senior Reporter Mary Campbell spoke recently with Harris to learn more about his firm, which today focuses on funds of hedge funds and private equity funds.
Tell me something about AIM’s investment philosophy.
We focus on protecting capital while seeking to earn attractive rates of return over the long term. We might not participate fully during rapidly rising equity environments, but we strive to outperform equity averages during declining markets. We are long-term investors, so we have a heavy emphasis on compounding capital.
On the hedge fund side, our managers tend to be single-strategy and fundamentally-driven, with a heavy emphasis on bottom up research with an appreciation for the top down. We seek to allocate assets among a variety of underlying portfolio managers we believe to be highly talented and motivated and that combine analysis, portfolio management expertise and sound business infrastructure. Strong risk management is also a common theme with our managers.
On the private equity side, we focus on small- to middle-market buyout, growth capital and turnaround strategies. The vast majority of our managers do not rely on leverage but rather look to add operational value-add expertise. They are generally owner-operators with sector-specific expertise in complex, highly-regulated sectors. Our portfolios are diversified across various industries and will also include some international focused managers.
I understand you have some pronounced views on the alignment of interests between managers and investors.
Considering the compensation structure of funds, we feel strongly that one of the most important items is to consider for potential investments is that there is an alignment of interests between the manager and the limited partners, especially these days. Looking across our funds, it is typical for the general partner to be one of the largest investors in the fund.
Do you think that doesn’t always exist? How does it become a problem?
From an economic standpoint, there’s obviously an incentive for managers to grow assets under management. With the way management and incentive fees are structured, it’s simply more profitable for a manager to have a $3 billion hedge fund charging 2 and 20 fees and producing 0% return, than to have a sub-billion dollar fund charging 2 and 20 fees and producing 20% return. However, if the GP is one of the largest investors in the fund, then the importance of the incentive fee far overweighs that of the management fee.
Do you cap your funds?
At our current size, capacity is not preventing us from executing on our strategy. However, if we were to believe that our size would limit to our ability to execute on our strategy or to maximize returns, then we would cap our size.
What else are you looking for in managers?
On the hedge fund side, we think there are some basic characteristics that make a good hedge fund manager. One, as I mentioned, is alignment of interests—why do they get up in the morning? Second is the ability to pick stocks on a long basis. Third is the ability to pick stocks on a short basis, which is obviously much more difficult than picking stocks on a long basis. With the lucrative nature of running a hedge fund, we feel many managers who might have gone into the mutual fund business 20 years ago have now gone into the hedge fund business instead, but they may not have the ability to call the shorts. Fourth is portfolio management—the ability to construct a portfolio that is hedged. Lastly, risk management—not only on the portfolio side, but also on the business side. Experience with all of these characteristics really counts. Above all, especially now, we value simple integrity, which reinforces our concern with alignment of interest.
How do you judge a manager’s integrity?
There is a great saying: “Past performance is not indicative of future performance, unless you are talking about one’s character.” This is why reference checks, especially warm reference checks, are more important today than they have ever been. As the saying goes, “Trust but verify.” We spend quite a bit of time reaching out to our network to verify.
Do you limit the number of funds you have in a fund of funds?
We don’t. But if we think about allocating to a new fund, we ask ourselves if it is better than one of our existing funds. With our existing funds, we continuously ask ourselves, “If we were not already invested, would we invest today?” It is a difficult question, especially when you’re with a manager who’s been successful for you for years, but we try to be honest with ourselves and evaluate each fund intellectually, objectively and continually.
How long do you tend to stay with managers or does it vary?
It varies. We’ve been with some managers for as long as 13 years, but we are willing to redeem from a fund quickly if we find a better risk-adjusted opportunity.
How do you find new managers?
We feel 10 years ago, it was a lot easier to find a hidden gem. With the proliferation of capital introduction and industry publications, it’s more difficult to find the undiscovered manager. In today’s environment, new funds generally approach us but we primarily rely on our network as well as our existing managers for sourcing. One of our favorite questions is, “If you were not managing your own money, who would you ask to manage it?” We’ve been able to source a number of managers that way. Also, we ask friends and other industry contacts—including trading desks—who they think mostly highly of.
Is size a criterion when you’re choosing managers? Do you invest in smaller funds?
It’s really on a case-by-case basis. Many people ask managers what assets under management their strategies can run, but what is more important is to then follow up and ask managers to quantify why and how. Every manager can readily answer the first question, but they haven’t necessarily been thoughtful regarding the number of analysts, market cap and the liquidity constraints that they have within their fund and team. Ideal size differs by strategy, and understanding why a manager is better today at a larger AUM than they were two, three years ago at a smaller AUM is key. Certain managers excel with a smaller asset base, while others tend to excel with a larger asset base and a deep research team. Each manager has their own sweet spot and when analyzing asset size, it’s our goal to determine that size.
Do you think funds of funds have a future?
We do. We have definitely seen more organizations enter the market and attempt to invest without the help of funds of funds. However, this can be a dangerous proposition. The benefits that funds of funds provide include diversification, access to top managers in some cases and initial and ongoing due diligence that underlying limited partners might not have time or resources to perform. Many people forget that ongoing due diligence is just as important and more time consuming than initial due diligence. Therefore, the majority of work that we do is focused on monitoring funds in our existing portfolio. I would suspect that after a few investment mishaps, you may see some of these organizations begin to understand the value of ongoing due diligence and return to investing in fund of funds, as they simply do not have the dedicated resources to effectively monitor investments themselves.
What opportunities are you seeing in this market?
We feel that opportunities with experienced managers, specifically those with experience on the short side, are presenting themselves in this market. With this market’s volatility, people have quickly realized that just getting short exposure through ETFs won’t necessarily always work. It’s finding those managers who have experience and the understanding to be able to pick the right shorts that is critical. It’s those managers who take a longer-term approach, riding out volatility and minimizing volatility by being strategically hedged—and I put the extra "d" on the word "hedged"—that I feel will provide opportunities going forward. We feel that the market will continue to be volatile, and we don’t know where the market will be a month, or a year, or five years from now. But by limiting the downside by tactically hedging, these managers will outperform.
With the current market’s volatility, we have been able to add to some of our best managers and build up their position in our portfolio. Volatility has also created opportunity in many markets, including emerging markets and possibly European credit.
In private equity, the environment of high levels of corporate cash and dry powder, combined with the clock running out on fund investment periods, may provide for increased M&A activity. This could benefit small to middle-market funds with opportunities to sell out to the larger funds.