Bedlam Asset Management | OneWorld Securities | ABS Investment Management | Gramercy Advisors
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| Scott Plummer, McCallum, Lesley Cartmell and Compton |
Dealing with market madness
Bedlam Asset Management’s Jonathan Compton is putting his money where his mouth is. He was, and still is, so appalled with the state of the asset-management industry that he left the security and comfort of his job at Credit Lyonnais Securities Asia to set up his own firm. In order to ensure that the managers’ interests are clearly aligned with those of their clients, Compton will earn precisely nothing, and his colleagues not much more, until the Bedlam funds hit specific return targets.
“Until we hit critical mass and make customers absolute gains we don’t get paid,” says Compton. All three Bedlam funds are based on a minimum absolute return of 1.25% a quarter before a management fee can be taken. Compton does not get paid until the firm is in profit. Other staff receive no bonuses either until that time. “This makes fund managers put their necks on the line,” says Compton.
Compton resigned from CLSA in April 2000, where he had been managing director for precisely 10 years. He says that, unusually, he had been on a fitness spree, including neither drinking nor smoking for four months following a New Year bet.
“Unfortunately I was thus completely irrational,” he says. “It would have been much easier to take the very good money and make nonsensical bullish noises on the markets as they imploded. But there comes a stage when you think ‘this is nonsense, there must be a less dishonest way of doing this’.”
He was sitting at home late one night in front of his computer with hundreds of unopened emails, watching the Nasdaq drop. “I realized ‘I don’t enjoy this bureaucracy any more’,” he says. Then and there he wrote a two-line email saying thank you and goodbye to CLSA. He was 47, had built up some capital in the firm and was certain much of it would disappear in the bear market to follow. He also wrote to all his institutional clients saying he was leaving as he expected “the mother of all bear markets” in which he had decided not to participate. He suggested his clients do likewise. He also wanted to take a break after 23 years of working.
Compton first contacted a lawyer to register Bedlam in October 2001. Part of the reason he didn’t set up sooner was because he felt he had to wait until return expectations came down. “There was complete gambling fever [in the markets],” he says.
Compton reminisces about an evening in December 2000 when he held a dinner party with four fund managers present. His wife played the stooge and asked these managers how much money they had made for their clients. “Out came ‘relative returns’ etcetera and it took them four attempts to answer the question in English. Three even said they had no clients,” he says, still somewhat appalled.
Utterly useless fund managers Now that the focus has come back to making money rather than making relative returns, Compton has been able to get his boutique off the ground. It was officially launched in July 2002. “I knew I couldn’t put the model in place until the bear market was established,” he says. He took the name for the firm from the lunatic asylum that first stood where Liverpool Street Station is now located, right at the heart of London’s financial centre. The name was suggested by one of the boutique’s seed investors, and Compton agreed there was no better way to describe the state of the financial markets.
The initial funding for the pre-launch phase of the business was Compton’s own. But, he says: “I couldn’t afford to fund the whole thing.” So he spent roughly six months going around to small firms to see how others had coped, created a public prospectus and managed to attract just over 60 outside private investors. “Private money acts as a huge outside discipline,” he says. Six of the 10 employees have money invested in the company as well as in the firm’s funds.
Compton says he completely underestimated how difficult it would be to set up a firm. “There were two challenges that both drove me ballistic,” he says. The first was getting the company regulated. He bemoans “the time and nonsense to get a company registered and approved by the FSA”. He recalls: “I had to fill in my name and address 29 times.”
The second process that annoyed Compton was trying to hire good people. “I interviewed 120 fund managers over February/March 2002 and 110 of them were utterly useless,” he says. “Half of the 120 had been sacked, and rightly so.” He gets even more forthright. “The average fund manager is a social and numerate inadequate,” he says. He adds: “Their money expectations were completely unreasonable and they have no interest in making their clients better off. To them it’s just a relative game.”
Clients hard to come by Despite whittling the candidates down, Compton still made the mistake of looking for the wrong mix of skills. He originally interviewed only fund managers, not analysts. “I underestimated the need for in-house analysts,” he says.
There are now 10 people working for Bedlam, four of whom (including Compton) are from CLSA. These are head of research Ian McCallum, sales director Charles Scott Plummer and Compton’s then secretary Sue Kelly. “The only deliberate CLSA lift,” says Compton, “was Sue who is now the office manager.”
The three Bedlam equity funds are the UK Fund, the Global Fund and the Emerging Markets Fund. Compton says one thing he had learnt was not to create funds that are too narrow in scope, such as single-country or single-industry funds. “General funds are always more stable,” he says. All three were launched on December 10 2002 and the investment philosophy is to take a “cash trade-buyer” approach.
The UK Fund is both the largest and best performing of the funds to date. It had £2.15 million under management and had returned 19.22% between launch on December 10 2002 and the middle of August 2003, compared with 8.58% for the FTSE All-Share. The worst performing is the Emerging Markets Fund returning 12.34% as of the middle of August. Compton says: “The thing that’s radical is what we don’t buy.” At the moment Bedlam’s screening model precludes investment in banks. “The industry sold itself by saying it will make you rich,” says Compton. “One of the keys to making money is discipline.”
It is taking Bedlam longer than Compton expected to attract clients. The boutique expected to have £5 million in funds under management by the end of June but had only managed to reach £3.24 million. Bedlam also acquired segregated accounts, a commitment from a pension fund and two high-net-worth individuals bringing total assets under management to £10 million at the end of June. “Our target is to build funds under management up to £20 million by Christmas,” says Compton.
It hopes to reach £30 million by May Day. “If this comes true we’ll break even then on cashflow,” he adds. Bedlam calculated that it could survive until March 2005 assuming no revenue at all.
So what advice would Compton give anyone looking to set up his or her own asset-management business? “Don’t do it,” he says. He explains that trivia such as sorting out faxes, phones and office space along with incessant calls from “every weasel and worm trying to sell you something” threatens to overshadow the management of funds and making money for clients.
“Cutting out the noise is difficult,” he says. “Whatever you’re thinking, triple the hassle factor.”
Julie Dalla-Costa
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| Sosa and Dali |
On song with a global view The Russian default in August 1998 and the Brazilian devaluation in February 1999 created the perfect opportunity to launch a hedge fund, David Dali and Ignacio Sosa decided. They had learnt while working at big institutions that the best time to buy was when everyone else was selling. They had also learnt that this wasn’t always possible in a big firm. “At a big institution people are forced to sell at lows when they should be buying because the firm is concerned about being seen to be piling in while others are rushing to get out,” says Sosa. “At a hedge fund you’re more governed by what makes sense from a risk/return point of view.”
The two had originally planned to set up a hedge fund within BancBoston Robertson Stephens where they had been working together for eight years.
Sosa says he was keen to leave the bank because he wanted to be his own boss. “It’s a bit like all actors wanting to direct,” he says. Sosa felt his choices within the bank were either to continue to trade or move into management, which didn’t interest him. “I didn’t want to be a 50-year old on a trading desk,” he says. “I was one of the few people on the trading desk with grey hair so I decided to look at something else.”
He was 43 at the time.
Far from feeling cheated, BankBoston was supportive when the two left, providing them with Bloomberg screens, helping them with their back office and giving Dali and Sosa their track record to use from their time at the bank.
Sosa says the most important thing to have as a start-up is a clear strategy. In addition, he says: “You have to be prepared to check your ego at the door and to roll up your sleeves to hunt for money.” Specifically for people moving from a prop trading desk at a big firm to setting up an independent hedge fund, Sosa says it’s important to be able to avoid volatility. “Big firms have more tolerance for some volatility compared to running a hedge fund,” he says. “Hedge funds these days seek low volatility.”
Check that closet In March 1999 Sosa and Dali left the bank, pooled a few million of their own money and began knocking on people’s doors. “Marketing an emerging-markets hedge fund in 1999 was like trying to sell property near Chernobyl,” says Sosa. They made a cold call to Capital Z in May 1999. “It was just months after the Brazilian devaluation and not long after the default of Russia. Capital Z was the one to recognize the opportunity and thought ‘this is the time we want to do this’,” says Sosa. “The others ran away from the risk.”
As part of the process of deciding whether to provide funding for OneWorld, Capital Z hired a private investigator to dig into Sosa and Dali’s background. Capital Z also had Merrill Lynch Investment Managers carry out due diligence and spoke to high-profile people at the banks where the two had previously worked. “You better not have anything in your closet,” says Sosa, “because it will come out.”
The process took around three to four months but obviously nothing too heinous was found as Capital Z became the hedge fund’s anchor investor, proving $50 million in funding.
Sosa and Dali avoided naming their firm after a Greek god, opting instead for a song by The Police. The two felt that their song One World (Not Three) was an ideal source for their firm’s name. “It captured our philosophy,” says Sosa. “We really need to have a global view. It’s not enough to just know about the emerging markets because they’re all interrelated.”
OneWorld’s first fund was launched in November 1999 with $53 million and two people operating in a 150 sq ft office on the outskirts of Boston. “We were sitting next to some guy selling some fly-by-night dot-com product,” says Sosa. “I didn’t even know how to do PowerPoint presentations,” he adds. Now, almost four years later, they have a total of $375 million in funds under management across a hedge fund, managed account and CBO and seven people in an office in Boston with a view of the harbour.
The initial fund’s strategy is to invest in dollar-denominated government bonds issued by emerging-market countries. OneWorld also runs a managed account for a fund of funds that has the same strategy and fee structure as the hedge fund. Together these two make up $160 million of the $375 million of total funds under management.
The remaining $215 million is invested in their collateralized bond obligation created two years ago. “We had an investor come in two years ago in the middle of the Argentine debt crisis who was smart and said it was so cheap that he wanted to buy an emerging-market CBO,” says Sosa. The investor gave OneWorld $200 million to set up and manage a CBO. “We were able, on a day that bond prices were down very significantly, to buy most of the paper for the CBO,” says Sosa. He says the CBO doesn’t require much management as it is invested in the same countries as OneWorld’s other funds and generates fees that the firm ploughs back into its business that are used, for example, to employ new analysts.
Although the SEC prevents OneWorld from disclosing its investment figures because it would be considered to be a direct marketing effort, it must be doing something right as their assets under management have grown by more than 50% this year alone.
Julie Dalla-Costa
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| Ribeiro do Valle, De Coster and Russian |
Fund of funds on an independent path Alain De Coster packed up and left his job as head of Credit Suisse Asset Management’s alternative investments group in August last year. He was fed up with working within the constraints of a large institution and joined two of his former colleagues – Laurence Russian and Guilherme Ribeiro do Valle – in setting up their own independent fund of hedge funds boutique called ABS Investment Management.
De Coster, Russian and Ribeiro do Valle had all worked together at Garantia, the Brazilian investment house acquired by Credit Suisse in 1998. The Swiss bank became focused on consolidating the business and growing assets. “We decided the path of a large financial institution was not the path we wanted to follow,” says Russian. By the middle of 2002 Russian and Ribeiro do Valle had decided it was time to say goodbye to CSAM and left a month before De Coster.
Setting up a fund of hedge funds was something that De Coster and Russian had done before while at Garantia and CSAM. In 1994 De Coster was given $3 million by the bank’s partners to set up three different funds of hedge funds within the bank. De Coster hired Russian that year to help. Ribeiro do Valle had been working in Garantia’s São Paolo office and joined them in New York in 1997.
De Coster and his team grew the funds from $30 million to $900 million between 1994 and 1997. Credit Suisse then bought Garantia and the fund was opened to clients. When they left CSAM the fund had $3.4 billion of assets under management.
However, the difference between setting up and running a fund within a bank and going it alone should not be underestimated. Things you take for granted at a firm, such as computers and phones that work, need to be dealt with. For example, “initially we all had Windows XP machines but nothing worked so we downgraded everything to Windows 2000”, says Ribeiro do Valle. “The main challenge was that we thought we could have a great platform in two or three months.” The principals thought they would be able to get their system completely set up by March but it wasn’t up and running until July. “You need to spend money and resources to have the right investment platform,” he adds.
A system to be proud of He’s very proud of it now. Ribeiro do Valle compares the system they previously used at CSAM to the Mir space station. “It was good but it had a lot of patches,” he adds. ABS’s system enables the team to monitor all of its hedge-fund investments as well as the positions of other managers. For example, when Sears sold its credit card business to Citigroup the system allowed ABS to see which of the 300 managers currently in their system were short Sears. They were then able to see which of those managers they had money with.
The system allows the ABS principals to chart the performance and volatility of different managers. They can also look at how particular funds operating with similar strategies or in similar markets and sectors were performing when one had its best-performing period. This enables them to ensure good diversification among hedge funds.
The ABS principals advise those considering setting up their own businesses not to expect short-term gratification. “Mentally you have to set aside two years of your life: time, energy and not having the money [you’re used to],” says Russian. But, they wouldn’t have it any other way. Ribeiro do Valle says: “Just do it.” He explains: “You will find so many reasons not to do it – money, risk, etcetera – but it’s so much nicer to be out on your own.”
The ABS name comes from the formula in Excel for absolute value and the office is in Greenwich, Connecticut – the home of the hedge fund in the US – and only a 40-minute trip to Manhattan.
ABS opened its first two offshore funds of funds at the start of this year. The firm began the funds with $135 million to invest offshore for private investors. One is an offshore equity portfolio and the other is an offshore global portfolio. The size of these two funds has since grown to $162 million.
The main strategy utilized by ABS is equity long/short, which is what Russian and De Coster had run together for nine years at Garantia. Equity long/short has had a rough time over the past few years. “Some think it’s not interesting because other areas are generating better returns at the moment,” explains Russian. “But we outperformed the equity markets in a bull market and we protected money in the bear market.” He says that people have been disappointed in the past because they haven’t fully understood the aim of the strategy. De Coster believes the outlook for equity long/short is positive. “It’s a liquid market now,” he says. “Valuation has come back in Europe, while it’s still high in the US.” De Coster believes this will provide some good opportunities and the team is quite happy that money has been leaving this strategy. “The less money chasing opportunities the better,” says Russian.
In March ABS began to manage two separate institutional accounts. One is for a European pension fund, which now has $77 million under management, and the other is a $152 million account for a financial institution. The three principals at ABS have good relationships with hedge funds built over their many years in the business. These are often a source of new contacts, as well as introductions by prime brokers and cold calls from managers.
ABS is in fact in the process of providing $5 million to $7 million in funding for a US manager it first met six months ago so it can start up an offshore fund. Do Valle says: “If you can really find smart people it’s one of the best returns for the risk taken.”
Julie Dalla-Costa
Gramercy Advisors
Transparent about distress
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| Left to right: Koenigsberger, Seaman, Johnston and Rauch |
Most significantly, Helie himself is gone, fired by his fellow partners in July 2002.
The co-managing partners, Jay Johnston and Robert Koenigsberger, have no interest in being cowboys. Helie made a lot of noise for a very small fund manager. He was a lot louder and brasher, for instance, than the people who actually did most of the work on Ecuador, and who were happy to retain their anonymity and make lots of money while Helie hogged the limelight. In contrast, the new-look Gramercy Advisors is as orderly and professional a place as hedge funds get.
More than just a hedge fund “We’re trying to institutionalize ourselves,” says Koenigsberger, “making sure we’ll be a force in the future.”
Koenigsberger likens the state of the hedge fund industry today to that of Wall Street 30 years ago: lots of small firms, most of which either failed or ended up as bucket shops on Long Island. “There’s 5,000 hedge funds today,” he says, “and there’s not going to be 5,000 several years from now.”
So while investors might think of Gramercy Advisors as an emerging-markets hedge fund, or even as a vulture fund, Koenigsberger says that “we look at ourselves as a money-management firm. We’re in the money-management business, and hedge funds happen to be a vehicle that is popular today.”
Gramercy spends a lot of time and effort on transparency. It’s completely open about its investments, returns, and all other aspects of its funds, if anything swamping investors with more information than they actually want. So while it might not expose its short-term trading positions on an intraday basis, it’s very easy to tell where and how Gramercy is making – or losing – money.
The company’s core business hasn’t really changed since its inception with just four employees in 1999: it invests in distressed emerging-market debt, with the intention of getting out at a healthy profit within a time frame of between 12 and 18 months.
But Gramercy is in the middle of a major expansion at the moment, and fully expects to increase its staff from the present 24 professionals. That’s already twice the number a year ago.
The fund has a lot of experience in this small yet particular asset class. Indeed, Gramercy is the only fund in the world to devote itself to emerging-market distressed debt. Since there are so few other buyers, it can often acquire instruments very cheaply, and it’s often the first call that bankers make when one of their clients wants to offload a toxic position.
“If an insurance company wants to throw it out and leave it on the street, I’m happy to come along with a nail, pick it up, and take it to Food Emporium,” says Koenigsberger.
Once Gramercy enters into a position – something it only does in size – it then takes an active role in trying to work out the debt. Gramercy is happy to get its hands dirty: to fly out to foreign countries, meet the owners of the companies concerned, and try to find a mutually satisfactory solution.
A lot of this work is based in the real world, not in analysis of spreadsheets. After all, any creditor needs a credible threat to hold over its debtor, and there’s a good chance that’s not going to come from the courts.
“In most of the jurisdictions we work in, you don’t have the opportunity to have a lot of reliance on the legal system,” says Johnston. So other factors come into play, especially the ego of the owner.
“Personalities are a big part of the analysis we do,” says Johnston. Gramercy looks for people who want to do a deal, who want to retain control of their company, who want to avoid losing face in front of their golf-club friends.
On the other hand, says Koenigsberger, Gramercy is always willing to have its bluff called, too: “If you’re not willing to own the equity, the assets, typically you don’t want the bonds.”
Most of the time, however, Gramercy will try to take control of the restructuring process, often by chairing a public creditors’ committee.
It has a lot of experience in such roles, and knows what to do in order to bring debtor and creditors to agreement. Gramercy’s director of research, Robert Rauch, notes that taking such a position also helps with regard to Gramercy’s own business philosophy: “Transparency is a more endemic part of our model,” he says, “given that we’re running creditor groups.”
This is the kind of thing that Wall Street is bad at doing: banks always have relationships that can be more important than getting the highest recovery value on certain bonds. What’s more, within Gramercy’s 12- to 18-month time horizon, it’s possible that a typical investment bank’s emerging-market desk’s entire management team might change, with the new men in charge typically wanting to get rid of all their predecessors’ positions. “That’s a real risk on Wall Street,” says Koenigsberger.
Gramercy places a lot of emphasis on its trading desk, and is happy taking large short positions in sovereign bonds. “Two-thirds to three-quarters of what we do is putting Humpty Dumpty back together again,” says Koenigsberger. “But we will spend some of our capital expressing the view that Humpty Dumpty is about to fall off the wall.”
Grander designs ahead? The problem, of course, is that while Gramercy has a unique position in its main line of work, there’s an almost limitless number of traders taking positions on sovereign bonds. Gramercy has less of an edge here, and in fact a large short position in Brazilian debt contributed to a loss of more than 10% in the fund in the final quarter of 2002.
Gramercy has now revamped its risk-management systems to help ensure that such a loss is less likely to happen again. It also boasts a 117% total return, net of fees, since inception in 1999 – comfortably more than the 88% returned by the EMBI+ or the 6.3% returned by emerging-market stocks.
But even so, there are signs that Gramercy is moving away from its historical core competency. It’s not just the speculation in sovereign debt or the purchase of the Greenwich building. This shop clearly has ambitions beyond one small niche in the markets. Indeed, in the papers documenting the continuing litigation between Helie and Gramercy, Helie claims that Koenigsberger and Johnston told him in 2002 that they planned to turn Gramercy into a “full-service investment bank boutique”.
The transformation of Gramercy Advisors from the Helie days might have only just begun.
Felix Salmon
