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Thursday, 19 January 2017
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Jun 8 2012 | 3:53pm ET
Loren Katzovitz and Patrick Hughes have been—with one interruption—building multi-manager hedge fund businesses for Guggenheim Partners for a decade. And as with their first venture for Guggenheim, the duo are trying to carve out a niche for their second.
Guggenheim Alternative Asset Management, which was sold to the Bank of Ireland in 2006 before returning to Guggenheim in 2009, was a traditional fund of hedge funds, with one difference: It used managed accounts exclusively, a rarity at the time. Katzovitz and Hughes' latest plan, however, isn't really a fund of funds at all, but a multi-strategy hedge fund employing separate in-house trading teams.
Guggenheim Global Trading already has eight trading groups, and Katzovitz and Hughes plan to hire as many as 17 more. FINalternatives Senior Reporter Mary Cambpell recently spoke to the two about their new business.
Tell me something about the first business you developed at Guggenheim Partners, Guggenheim Alternative Asset Management?
Hughes: We initially developed a business which basically resembled a fund of funds except that the platform was built exclusively with managed accounts. It was very unique for its time—a "virtual trading desk"—where all the actual trading was outsourced to third-party hedge fund managers. We built a robust infrastructure, allowing us to monitor the trading activity of our third-party managers.
Guggenheim sold this business to the Bank of Ireland in 2006 and bought it back in 2009. What happened next?
Hughes: In 2010, another opportunity became apparent due to changes in regulation: Dodd Frank, etc. At this point, the barriers to entry to starting a hedge fund increased, and the opportunity to actually bring talented portfolio managers in-house became available. We went back to Guggenheim Partners with a new business plan to develop Guggenheim Global Trading.
We have spent the last year building the infrastructure, developing our risk systems, staffing the business and preparing the firm to begin trading. We built the trading floor in Purchase, New York, with about 30,000 square feet and 150 seats.
Katzovitz: Along with, obviously, recruiting all the teams, so far we have taken down $250 million of the initial commitment from Guggenheim Partners [$500 million with a longer-term goal of $2 billion over several years]. We started trading with that in the last week of January. As a brand new business, we took down the initial capital to begin test trading. We have been testing the systems and infrastructure to make sure that everything is working smoothly before we start to increase scale. We began truly trading at the beginning of February, and it has been a slow ramp up as we’re not fully invested at this time. We’re still going through and slowly rolling out capital and slowly ramping up all the infrastructure and systems.
Which strategies are you running now?
Katzovitz: We started with four, and there are now eight portfolio managers. Four of them are long/short sector equity specialists focusing on technology, media and telecommunications or TMT; financials; industrials; and real estate. The fifth one is a merger and event team, and then we also havethree quantitative equity strategies.
We are still actively recruiting portfolio managers in most major sectors, and we will begin to build Europe and Asia later in the year as we first look to identify the heads of those efforts.
Why these strategies? Was it a question of finding the right people or did you actively seek out people running these strategies?
Hughes: We evaluated nearly 500 trading teams to find these first seven portfolio managers. We’ll be moving on to other strategies, while continuing to focus on long/short and quantitative managers. We will always have a significant amount of the portfolio in low net liquid strategies and will also look at global macro, credit and aspects of the distressed market.
Katzovitz: The core of this fund, though, is always going to be fundamental long/short equity, merger event and quantitative equity, which we would expect to represent 50% to 60% of the fund at any given time. Initially, those are our two primary focuses. Fundamental long/short credit and relative value global macro are the other core components of the business plan, and we will look to build all of these businesses globally.
When you go through 500 resumes, what are you looking for? How do you narrow the field?
Hughes: There are a variety of things we’re focusing on. We’re looking for people who have been able to generate a consistent track record over time—in good and bad market environments—while controlling risk. And we’re concentrating on people who are running modest net exposure. We’re looking for people who have demonstrated stability in their jobs with the potential to become productive partners of the firm.
Katzovitz: We also want people who have a repeatable investment process. The process is important. We’re interested in how they go about constructing their portfolios.
Do they have to have been in the business for any minimum amount of time?
Hughes: No, but I would say that we are really looking for managers with long-term track records. The average person on the teams that we’ve hired has six-to-eight years of experience as a portfolio manager.
Katzovitz: So these are pretty seasoned people at this point.
Hughes: It takes a lot of time to perform proper due diligence and to make sure the person we’re speaking to is really the primary manager of the track record they’re showing us. Very often you encounter a senior analyst who takes credit for a track record they did not have control over. We have to do a thorough check to confirm whether they were actually instrumental in creating those returns.
You mentioned the stability issue. Why do you prefer people who don’t change jobs frequently? Finance is an industry with a lot of personnel turnover.
Katzovitz: We’re big believers in trying to build a stable core of people that we can build a business around. That’s how we’ve built our other businesses in the past. Traditionally, all of our other businesses have had low turnover. Obviously, not everyone you hire is going to work out, as is the case in any business, but we like to think that we’re finding PMs who plan to be here for the long term. We think it creates a level of stability in the business that you lose with high turnover in the chairs. We’ve also put a lot of thought into how we compensate people and we’ve built a compensation plan that encourages low turnover.
At the end of the day, there’s definitely something to be said for low turnover in the investment team, as over time you understand the way the portfolio managers think. You understand how they build a portfolio, and you understand the kind of risks they take and how they behave through different market environments. If the seats continuously turn over, you have no academic history with the new person who comes in. You’re starting from scratch, and so when markets get difficult, you don’t know how that person is going to behave. If you have a history with people, then you know how they conduct themselves in difficult markets, and you know who will be quick to cut risk and vice versa, so there’s definitely a benefit.
We’re really trying to build something culturally that doesn’t have a transient nature. Someone who is continuously willing to leave a job to go somewhere else for a payout that’s half a percent or a percent higher, is making a statement about the short-term nature of how they think. To some extent, I think that’s part of what’s going on in the industry. There has been a lot of short-term thinking, and it causes people to make bad career decisions, bad regulatory decisions and bad personal decisions. We are looking for a certain type of character, where somebody who has worked with an organization for a long time, thinks of themselves as a partner within that firm, and has a long-term view of building something versus a short-sighted view.
Hughes: If you take a look at the profiles of the portfolio managers that are here, several have had their own hedge funds before and had very good track records. For one reason or another, however, they found it challenging to grow their assets under management. Since Bernie Madoff, institutions have been hesitant to give capital to smaller funds or funds that don’t have a complete infrastructure. Years ago, if you had $20 million and a decent track record, there was a good chance you could grow. Nowadays, if you have less than $200 million it is very difficult to grow your asset base. Institutions are very concerned about the stability of the hedge fund management company. There are many portfolio managers that are caught in this type of situation—they have very good track records, but were simply unable to scale their assets either because they were too small or do not have a proper infrastructure, and therefore need to be part of a larger organization where there are economies of scale.
What are some of the advantages of having portfolio managers in-house?
Katzovitz: There are a variety of benefits. One, the business model is more efficient from the funding and financing standpoint when you run it with one portfolio because you get the benefit of cross-margining and cross-netting all the portfolios. Two, it gives you much more direct control over what’s going on with the money. For example, you can put in much tighter risk controls because the people work directly for the fund. A lot of those risk controls can be automated into the system so you actually have control over what’s happening with the capital and how rules and guidelines are enforced. To some extent you lose that when you’re outsourcing the capital. Also, there’s fee efficiency in the model—a multi-strategy fund ultimately saves you a layer of fees.
Hughes: Overall, you have more control over the portfolio managers when they’re sitting here on one trading floor. For example, we have pre-trade compliance and we perform pre-trade risk on any of their executions. We allocate capital to our portfolio managers after negotiating guidelines and risk constraints based on their trading style. We can monitor their activity continuously. Most importantly there is a common culture when the portfolio managers are employees of the fund. That culture gets lost when you shift to an outsourced model.
What are the advantages to running a multi-strategy fund as opposed to single-strategy fund?
Katzovitz: I think it’s partly the diversification of the portfolio and the stability of the returns. It’s difficult to have a single-strategy fund and consistently have stable returns. It’s much easier to do it with a broader portfolio, with more securities, and more PMs. You get broader diversification in the portfolio. It creates a more stable, scalable business model.
What is your outlook for the market in 2012?
Katzovitz: GGT's business plan is to run with modest net directional market risk, so we are not attempting to call the direction of the market on a day-to-day basis. Instead, we try to create alpha at the security level.
That said, it is our opinion that the market will remain volatile and range bound for the summer and most likely through the November election. The issues in Europe are complex and will take years to solve as this is just another step in the de-leveraging process that began in 2008 and will be with us collectively for years to come.
I think the bigger question is “why build this now?” If you take a step back and look at what’s going on in the world, and the industry, every bank prop desk was putting money to work, booking trading assets as long as a trade had a positive carry or spread. If it was a profitable trade, it got booked on banks’ balance sheets without a consideration for cost of accessing the balance sheet. In light of the Volcker Rule and Basel III, a lot of those trades are now being taken off, and it’s not clear going forward what banks will or will not be allowed to do in the way of proprietary trading. But certainly it would appear that if the banks are forced to reduce their activity, it should increase the opportunity set in the market for hedge funds to deploy capital. Hedge funds will no longer be competing with the banks to put on trades. And so, the profitability of these trades should improve over time, and that sets up a good environment for hedge fund investment looking forward.
For recruiting talent, the environment’s just never been better. I think a great way to think about it is ’08 and ’09—and even parts of 2010—assets were undervalued. Now with all the liquidation of proprietary trading desks, and with the small hedge funds unable to raise money, what we’re finding is it’s not the assets that are necessarily trading cheap, it’s the human capital; people are the mispriced asset. There’s an over-supply of high-quality people, and it’s created an opportunity to hire very high-quality teams.
Who is your target investor? What is the optimal size for the fund?
Hughes: Initially, the money is coming from Guggenheim Partners, along with a select group of shareholders and affiliates. Longer term, we plan to potentially take additional money from unaffiliated investors. In fact, we are looking for a head of marketing as we speak. We haven’t decided how much money we’re ultimately looking to raise, and we only just decided in the last couple of months to focus on outside capital. The primary reason for pursuing outside clients is to assist in sizing up portfolios and attracting additional portfolio managers.
Katzovitz: We are currently looking to hire a head of marketing so that when we start formally marketing, they’ve been here for awhile and they’re fluid with the business plan. We don’t want to hold off on that, we want to actually get that person seated so they grow with the business as the business evolves.