For a hedge fund firm plying activist strategies, timing can be everything.
Consider the handsome payday that Toscafund Asset Management enjoyed last year, thanks to its stake in Esure, an online auto and household insurance company. Esure has been known for its caution, underwriting policies mainly for lower-risk female and older drivers and shunning flood-prone homeowners. During the financial crisis, though, Esure came under the umbrella of Lloyds Banking Group, which took a 70 percent ownership position.
By 2010, however, Lloyds was looking to offload its interest in the dot-com insurer. Enter London-based Toscafund, which provided financing to help Esure’s founder and chairman, Peter Wood, engineer a management buyout. By March 2013, when Esure undertook an initial public offering, Toscafund’s backing of the unabashedly self-assured Wood — who is depicted in Esure’s IPO prospectus as “the foremost general insurance entrepreneur in the UK” — looked like pure genius. When Toscafund cashed in on the IPO, partner Nigel Gliksten says, the hedge fund earned triple its original investment.
It was largely on the strength of such investments that Toscafund motored to the top tier in both performance and asset growth in Alpha’s annual Europe Hedge Fund 50 ranking. In 2013, Toscafund reported a 56.2 percent return for its $465 million Opportunity Fund, while its $225 million Mid Cap Fund appreciated 44.4 percent. Toscafund’s assets under management more than doubled, surging to $2.5 billion in 2013, a growth spurt that helped Toscafund climb up 11 places in the rankings to No. 37. (Both funds were closed in June 2014 to “protect performance,” Gliksten says.)
Total assets in the Europe 50 rose to $388.45 billion at the start of 2014, up from $343.5 billion a year earlier. The 13.1 percent increase is indicative of strong performances at European hedge fund firms with activist, event-driven and direct-lending investment strategies. Direct lender Chenavari Investment Managers, for example, was the greyhound of the group, expanding at a sizzling-hot pace of 193.3 percent. However, at the biggest European hedge funds — No. 1 Brevan Howard Asset Management (0 percent growth), No. 2 BlueCrest Capital Management (–7.6 percent), No.3 Man Group (–4.4 percent) and No. 4 Winton Capital Management (–3.9 percent) — asset size either remained flat or fell during the year, as macro strategies faltered, emerging markets weakened and short positions took a beating. Among the top five, only No. 5 GAM Holding had a good year in terms of asset growth, reporting a 24.5 percent increase in assets to $24.4 billion in early January 2014, up from $19.6 billion a year earlier.
In addition to Toscafund, activist firms that boasted absolute returns in the double digits included the Children’s Investment Fund Management, Cevian Capital and RWC Partners, all based in London. “Activists in Europe have been having good numbers,” says Alper Ince, managing director at Pacific Alternative Asset Management Co., a $9.5 billion, Irvine, California–based fund-of-funds firm. “If you look at the best-performing hedge funds, they’re well represented,” says Ince. “Activists are changing governance practices. They’re driving better allocation of capital, forcing managements to engage in strategic transactions and insisting on minority shareholders’ rights.”
Activist investing wasn’t the only moneymaking strategy last year, of course. Global equity funds with long-short and long-only strategies, and event-driven funds did well in 2013. Equity strategies earned 11.14 percent in 2013, while event-driven funds returned 13.86 percent and activist funds netted 19.22 percent, according to Chicago-based industry tracker Hedge Fund Research. Paamco’s Ince says that the firm injected some 7 percent to 8 percent of its assets into such investments. “We favored a long-short equity strategy in Europe last year, and we’ve maintained our allocations” this year, he says.
And hedge fund firms that employed direct-lending strategies, such as Chenavari, were magnets for money from pension funds, insurance companies, sovereign funds and family offices now that regulators have put bankers on a short leash. “We’ve seen several successful raises for direct lending as nonbanks step into the breach to provide critical capital formation to operating companies,” says Philip Masterson, London-based managing director at SEI Investments, an Oaks, Pennsylvania–based investment services provider and hedge fund manager. “There’s also strong demand in distressed real estate, particularly in Spain and Ireland.”
Meanwhile, activist investing has generated solid returns and asset growth across the board. One reason, say experts, is that the style — sometimes called “relational investing” in the more benign form employed in Europe — remains largely unexplored across the pond. “There’s been much less activist investing in Europe than in the U.S.,” says Paamco’s Ince. “Activism is definitely going to be here to stay, because European corporations are running high cash balance sheets.”
Daniel Mannix, chief executive at London hedge fund firm RWC Partners, said in a statement that U.S. institutional investors are increasingly placing their bets with activists in order to become “owners rather than renters” of company shares. RWC’s assets grew by 15.7 percent, to $1.9 billion, as it rose four positions, to No. 39.
Activist firm Cevian Capital also continued to prosper, placing a rung higher in the rankings at No. 9, its assets increasing by 47.1 percent to $13.292 billion. “Cevian takes advantage of short-term and irrational behavior in listed equity markets by being a long-term, focused investor,” senior partner Harlan Zimmerman wrote in an e-mail. The fund’s approach to activism, he adds, is “hands-on and constructive.”
Cevian holds ownership positions of 5 percent to 20 percent in 16 companies, including multinational conglomerate ThyssenKrupp, Danske Bank, Volvo Trucks, mining technology concern Metso, logistics provider Panalpina and Wolseley Industrial Group, an engineering and construction company that builds and maintains power plants. Five members of Cevian’s team — most of whom, Zimmerman says, “have backgrounds in management consulting or private equity — hold board seats at eight of the portfolio companies.” In addition, Cevian prides itself on being a long-term investor “with an average holding period of about four years.”
The compelling returns of activist funds came during a year when several of Europe’s largest hedge fund firms appeared to languish. At No. 1, Brevan Howard remained king of the hill; even so, the firm ended 2013 exactly where it began, with $40 billion in assets. “Brevan Howard shut down its emerging-markets fund,” noted Paamco’s Ince. “Macro funds are not having a good year and are facing withdrawals.”
The second-largest hedge fund firm, BlueCrest Capital Management, shrank to $32.6 billion. Its BlueTrend managed futures fund posted a performance loss of approximately 11.5 percent during 2013, ending the year with $12.554 billion in assets, down from $14.369 billion. Assets at Man Group, which maintained its grip on third place, dipped somewhat to $28.3 billion, down from $29.6 billion in 2012.
Some of the megafunds’ difficulties could be related to sheer bulk, says Amy Bensted, head of hedge fund products at Preqin, a research and consulting firm in London. “In the past few years, much of the focus of new investment from institutional investors has been in the largest funds,” Bensted says. “However, we have seen some shift towards the more mid- to large-size managers — those with approximately $1 billion to $5 billion in assets under management — as investors look for managers that have shown success in growing to an institutional size, yet can retain some nimbleness,” she adds. “As a result, some fund managers which had just reached the $1 billion-plus category have been able to expand rapidly.”?Winton Capital Management, the fourth-largest firm, also shrank in size, shedding 3.9 percent of its assets during 2013, ending the year at $24.7 billion. Robin Eggar, a spokesman for the firm, says that since last year, the firm’s assets have rebounded, standing at $25.5 billion at the end of June. “We have what is known as ‘the ATM effect,’?” he says. “There are always substantial inflows and outflows every month.”
All of Winton’s funds were solidly in positive territory last year, including the mammoth Winton Futures Fund, which reported a 9.4 percent return on assets in 2013 and ended the year at $10.05 billion. Eggar reports that 50 percent of its flagship fund’s performance was related in equal parts to trading in cash equities, “which makes us one of the biggest equity traders in Europe,” and to “other systematic trading strategies.” (Winton also announced opening new offices in Sydney in April and its first New York office in June, while consolidating London operations into a new headquarters).
Global long-short and long-only funds continued to perform well in 2013, no matter their size. A case in point is Insight Investment Management — the assets of which mushroomed by 138.4 percent to $5.767 billion as the fund vaulted 13 places to No. 19 in Alpha’s rankings. “Most of the growth over last year came from equity strategies,” says Matthew McKelvey, head of product management for specialist equities.
Insight, moreover, employs a range of strategies — including emerging markets, debt, and currency trading — and has begun focusing on direct lending. In a confidential fundraising letter to clients last year, the firm noted that more than $840 million of commercial real estate loans will be maturing in Europe by year-end 2016 “at a time when banks are still deleveraging. New investors are able to enter the market on favorable terms,” the note adds, including “higher spreads” and “lower loan-to-value ratios.” Insight projects returns of roughly 2.1 percent above investment-grade corporate bonds. “We like illiquid credit opportunities, including commercial real estate lending,” McKelvey says. “Tactically, with markets at pretty much an all-time high, we have to think about scaling back equity exposure.”
If credit is but one of a passel of investment strategies at Insight, it’s the raison d’être at Chenavari Investment Managers, which added just shy of $3 billion in assets last year, nearly tripling in size to $4.4 billion at the start of the year from $1.5 billion and leaping to No. 24 in the rankings, up smartly from No. 43. (It manages some $5.5 billion as of July 31.) Loïc Féry, the six-year-old firm’s 40-year-old founder, says the firm has been taking over loans in “bilateral transactions with European banks engaged in a huge deleveraging” campaign. Chenavari’s funds include dollops of corporate high-yield debt, subordinated debt of insurance companies and banks, mortgages, asset-backed securities and consumer finance obligations.
One key to the fund’s success lies with its roughly 90-person team of experts with unbeatable connections to top European financial institutions, Féry says. “Our latest deal was a half-billion-dollar investment in a credit card deal” hived off from a European bank, he explains, with borrowers paying an average annual rate of 10 percent in debt service. “We’re doing a lot of things that banks can no longer do — all those things they used to do but can’t because of capital restraints,” Féry says.
As the money pours in, though, direct-lending schemes have been getting a bad rap. Labeled “shadow banking” in the popular press, nonbank lenders are drawing unwanted attention from authorities like Europe’s Financial Stability Board.” Says SEI’s Masterson, “Investors and managers alike are keenly monitoring ‘shadow banking’ regulation, which could impact allocations to these funds.”
Commodity trading advisers have been faring less well. CTAs buy and sell futures contracts, options on futures or certain foreign exchange contracts, among other instruments. These funds had a difficult few years, averaging a 1.57 percent return in the three years 2011–2013, their stellar appreciation of 15.11 percent in 2010 but a dim memory. “Performance has been underwhelming since the end of 2010, and investors have begun to lose patience with the strategy,” says Preqin’s Bensted, who provided the figures. “Investors made some large redemptions in the space last year.”
That shows up in the numbers posted by such well-known CTA managers as Oxford Asset Management and Cantab Capital Partners, both based in the UK. Each tumbled down the rankings last year: Oxford to No. 25 from No. 23 while holding steady at $4 billion in assets; Cantab to No. 26 from No. 20, its assets falling by 17 percent to $3.9 billion, a loss of $800 million.
Along with fund withdrawals, one consequence of disappointing performance is that institutional investors are rebelling against the traditional 2 and 20 management fee structure, in which funds charge a 2 percent management fee and skim off 20 percent of any performance gains. It’s a trend that has accelerated this year not only because of CTAs’ unimpressive returns but also as the equity markets have been giving back some of last year’s gains.
“The management fee is often the most contentious fee for investors,” says Preqin’s Bensted. “We’ve seen fees move away from the standard 2 percent to a level closer to 1.6 percent on average. The fundraising environment is very competitive at the moment, and those funds which have lower fees may be at a competitive advantage.”
