Q&A: Investcorp Banks Growth On Fund of Hedge Funds, Single Manager Platform

Dec 20 2007 | 12:22pm ET

In a span of 11 years, Investcorp has grown its hedge fund business from $250 million to some $7 billion in combined assets in its fund of hedge funds and single-manager platforms. Along the way, the firm has been on the forefront of other alternative investment vehicles such as structured and alternative beta products.

FINalternatives recently spoke to Investcorp’s hedge fund co-head, Deepak Gurnani, about how he and his partner, Ibrahim Ghargour, have grown the firm’s hedge fund business and what they have in store for the upcoming year.

FIN: How did you get involved in setting up Investcorp’s hedge fund business?

Gurnani: I came from Citicorp and had a risk management background in trading. I understood derivatives and trading products and joined Investcorp to start on the risk management side for an internal trading operation that we had at that point from 1993 to 1994, which we closed down at the end of 1994.
Then I began to set up the firm’s hedge fund business with a colleague, Ibrahim, and the idea was to have a good understanding of the financial markets, derivatives as well as the risks involved in those products because a lot of the strategies really came from banks’ prop trading strategies.
FIN: Why did you start with fund of hedge funds as opposed to single-strategy funds?

Gurnani: We started the hedge fund business in 1996 with $250 million off of Investcorp’s balance sheet and at that stage we didn’t feel like we had the capital or reputation to set up our own hedge funds. So we started with a fund of hedge funds structure.
A lot of fund of hedge funds built their businesses around managers they knew such as Paul Tudor Jones or George Soros. We looked at it analytically as an investment problem in terms of the risk/returns of different strategies, choosing the managers within different strategies and monitor the investments.
FIN: Could you elaborate on the scope of your hedge fund business?

Gurnani: We have about 70 professionals dedicated to our hedge fund business and we have a team focused on alpha generation, risk management and asset allocation. Across the team, we probably meet about 1,000 managers per year and our portfolio today is about 80 managers.

We have access to all the databases out there and we talk to the prime brokers and third-party distributors. I just talked to someone looking to set up a pharma/healthcare hedge fund because they heard about us and wanted to see us. So we’re seeing people who are coming out or are thinking of coming out.
FIN: How important is transparency to you and what are some red flags that you have in place for prospective managers?
Gurnani: Transparency is very critical because for us to do the risk analysis, it’s very critical for us to get the underlying portfolios. Contrary to conventional wisdom within fund of hedge funds that good managers will not give you transparency, we don’t think that’s true at all. It’s not necessarily that we won’t invest with the manager if we don’t get it, but there’s a strong preference for that.
If a manager tends to underperform his peers irrespective of good times or bad, then we would tend to have a discussion with that manager. There was a high-profile manager that went out of business last year that was in every portfolio, but we weren’t invested in that manager. We had met with the manager several times and there was a clear case of excessive risk-taking and style drift. People thought that his style drift was innovative, but we didn’t think so because the manager did converts before but started doing commodities, and we didn’t see synergies between the two. And we felt that just looking at the returns showed that there was excessive risk taking.
FIN: So the fund of hedge funds platform was the basis for what other products?

Gurnani: We grew that business through different fund of hedge fund products and sometime in 2002, we started introducing structured products because we felt that investors, instead of looking at plain vanilla fund of hedge funds products, were looking to get principal protection through structured products. We did the very first collateralized fund obligation product, which has just matured in May 2007.
Around 2003 or 2004, we also embarked on something we call the alpha project whereby we look at understanding the return drivers of hedge funds by replicating hedge funds through passive computer models. Today, this is known as alternative beta.
Around the same time, we felt that with nine years into the fund of hedge funds business, we had built up a lot of reputation within the industry to set up our own hedge funds. But instead of using the models that banks use to bring traders in-house, we decided to set them up through our single managers’ platform because we found that the most talented managers were actually leaving investment banks or bigger hedge funds to run their own funds.
FIN: What’s the motivation behind the single manager platform and does it have any overlap with the fund of hedge funds platform?

Gurnani: The idea was to partner with them to make them feel like entrepreneurs in control of their own firms while having a partnership with them at the same time. We provide the initial capital, operations and risks oversight and let the investment professionals invest.
We try to sign two to three funds every year but that’s not a hard and fast rule. We’re not under pressure to sign up funds but, for example, we got Washington Corner and Stoneworks Capital at about the same time because we thought both of them were interesting. We have $250 million to $300 million of prop capital in single managers and there is an additional $500 million to $600 million of client capital on that platform.
Fund of funds and single manager platforms are kept separate unless a client asks for a customized product between the two and then they have the ability to interconnect. But we don’t move our single managers into the fund of funds platform.

FIN: What do you have in the works to spurt further growth?

Gurnani: As we speak, we’re seriously looking at launching alternate beta products using the research that we started in 2003.  We’re also establishing a presence in Europe. We have set up a person based in London focusing on marketing single managers to the fund of hedge funds and family office community. As we roll out this effort, we’ll also focus on other institutional investors for funds of hedge funds and other products.

We want to be known as innovators as far as hedge fund investing is concerned and don’t want to be restricted to a narrow mandate.

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