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November 5, 2007
A hedge fund that actually hedges
One of the truisms of the investment industry in recent years is that hedge funds decreasingly seem inclined to, well, hedge.
High profile collapses such as those of Amaranth Advisors, which essentially gambled the house on a one-way bet on natural gas futures, may be extreme examples. However, this summer's dislocation in credit markets has brought a number of hedge funds to their knees, while the wider hedge fund universe lost money in August.
Funds of hedge funds, by definition, will offer greater diversification, but few of them are likely to be able to provide the hedging offered by London-based Culross Global Fund Management.
Culross's Global H Fund, a concentrated version of its flagship global vehicle, has more than a third of its assets in two "hedging" themes; Asian "dislocation" insurance and widening subprime and credit spreads, strategies that, unsurprisingly, came into their own during the summer's market volatility.
Nigel Blanshard, founding partner of Culross, which manages a little over $300m (£145m, €208m), describes his dislocation insurance as "hedge fund managers who believe the end of the world is nigh, if not tomorrow, then this afternoon".
These managers, who might typically be short copper and Indian equities, but long gold, are in place to protect against losses in the fund's Asian consumer power theme. According to Mr Blanshard this concept has worked impeccably.
"In August, the money we lost from our Asian consumer growth theme was almost exactly made up by the insurance theme, which is surprising given the ratio of positions is four-to-one."
Furthermore, before the summer wobbles the insurance funds "made small amounts of money every quarter. That is a tremendous form of insurance, if it doesn't cost you anything".
And while the concept of playing widening credit spreads has been an obvious winner in recent months, the process by which it came to be embedded in the fund is also symptomatic of Culross' approach.
"The way we arrived at the theme came from our risk management process, not our risk-seeking process," says Mr Blanshard. "It was a counterbalance, a built-in hedge to our portfolio. We were the first investor in the Paulson credit fund [one of the most high-profile winners from the credit squeeze] when it launched, and we put as much as we could into it."
Mr Blanshard states that the decision to short the sector was driven by a belief that there was excess leverage at play in the subprime and credit fields - "a big signpost of trouble".
These insights have helped all three of Culross' funds of funds to chalk up strong gains. The H fund, established in 2005, saw its net asset value rise 29.6 per cent in 2006 and 36.5 per cent in the first nine months of 2007, making gains throughout the summer. The Global and Global Arbitrage funds returned 27.8 per cent and 13.9 per cent respectively in the year to end-September, and boast Sharpe ratios of 1.00 and 1.28. These gains have been achieved without the use of leverage.
Mr Blanshard, who founded Culross in 1992 with Christopher Keen, does not believe the credit squeeze - and its ramifications for the swathes of the global economy - is over yet.
His two main funds still have exposure of 32 per cent to the widening credit spreads theme, and Mr Blanshard adds: "I see no reason why [US and UK house prices] can't go down by 20 per cent at least.
"The price of borrowing has not changed that much, it's the removal of the availability of mortgage money that I think is potentially going to be harmful to the real estate market.
"Confidence is the magic word. If those with a balance sheet lose confidence in what they are investing in, such as leveraged real estate, then their propensity to buy anything goes down."
But Culross' world view is not all doom and gloom. As with so many fund managers at present, in both the traditional and alternative communities, Messrs Blanshard and Keen are big believers in the decoupling of emerging markets from the lower growth industrialised world. More than half of the H fund's portfolio is invested in the related themes of Asian consumer power and independent growth and industrialisation in Brazil, India and China.
There is also significant exposure to small caps, and "technology digitisation change". "There will be losers who are trapped in old technology and winners who will be providers of the new. We can make money from being both long and short, it's heaven for hedge fund investors," asserts Mr Blanchard.
As an example, he cites the digitisation of security cameras. "There are cameras everywhere capturing analogue recordings. To interrogate the data is extremely time consuming. Digitise the whole thing and the interrogation then takes seconds. When that change occurs you are able to store far more data than you could with the old technology," potentially leading to rapid growth in demand for data storage.
Get this call right, and Culross itself might see a rapid growth in demand for its services.
-Financial Times-
Posted by su at November 5, 2007 4:37 PM