| Man Group’s Luke Eliis |
When Man Group acquired rival fund of funds firm FRM Holdings last summer, the deal delivered an immediate—and sorely needed—boost. The target kicked in $8.3 billion in assets under management, bringing Man’s total to more than $67 billion and making it one of the world’s leading funds-of-funds managers. Top Man executive Luke Ellis took charge of the combined business, which he knew well. The former J.P. Morgan derivatives trader helped build FRM from its start up days in 1998 to his exit in 2007. (That year Ellis began a short-lived stint as a gentleman farmer). Today Man’s combined fund-of-funds group, operating under the FRM name, has about $18 billion under management, about 5.6 percent less than the $19 billion it managed at the deal’s closing in mid-July. The decline is less than Ellis had feared. “We haven’t seen many outflows since the merger,” says the 49- year old Ellis as he knocks on wood at a conference table at Man’s New York offices. “When we did the deal I made some assumptions about redemptions and they have been noticeably less than I’d assumed.”
The same cannot be said for Man’s overall business, which suffered net outflows of $2.2 billion in the third quarter, up from $1.4 billion in the second quarter. On Dec 10 Peter Clarke, CEO of the long-embattled firm, resigned under shareholder pressure, making way for chief operating officer Emmanuel “Manny” Roman to take the top job.
A 15-year veteran of the hedge fund business, Ellis likes to break with the crowd. While many investors believe macro strategies offer considerable promise in an uncertain, politically-driven investing environment, Ellis is dubious. Unlike most of its rivals, FRM does not include a macro option in its fund lineup. “The quality of returns you’re getting is not very interesting,” he says. That’s certainly the case for 2012 through November, when the Absolute Return Macro Index returned 2.33 percent, versus 5.3 percent for the Absolute Return Composite Index.
Ellis and his team are now working on new investment ideas and courting prospective clients. “The good thing is that today there are a lot of good ideas,” Ellis says. “There are still a lot of unloved hedge fund strategies and managers out there.”
Alpha Staff Writer Anastasia Donde recently caught up with Ellis to discuss the integration of FRM and the challenges of today’s investing environment.
Alpha: What do you think investors can reasonably expect from hedge fund returns nowadays?
Luke Ellis: If you’ve got realistic return expectations, the hedge fund business continues to deliver decent returns. Does it deliver double-digit returns? No. But I don’t think you should have double-digit return expectations in this type of economic environment.
If you looked at the hedge fund business in the 1990’s-2000, everybody liked to talk about all the billionaires that the business was creating. But I don’t see anybody getting rich in the same way out of running a hedge fund today. If you want to start a hedge fund today, you have to go into it knowing that all of what you’ll get paid… comes from your performance fee. That’s quite a healthy thing, I think. It’s definitely rebalanced some of the equation between investors and managers.
Returns overall haven’t been that great, but investors continue to pour more money into the sector. Isn’t this diluting some of the alpha?
I think comparing hedge fund returns to equity market returns is a bit of a stupid comparison. If you just want equity market returns, go off and pay one basis point for an index fund. Sitting here today, when we’re up 12 percent for the year, it feels like a smart thing to do. But we were flat on the year three or four months ago and (then) it didn’t feel like a very smart idea…If (investors) can make a steady 5 percent, that’s actually a pretty good investment for them.
But should they be paying two and twenty for 5 percent returns?
There’s no doubt that the average fee level in the industry is under pressure. And that’s probably fair enough. The thing is that the costs of being in the business have gone up. And there isn’t anything in the finance business where there isn’t fee pressure. In a deleveraging, low growth, low return environment, yes, there’s fee pressure.
Is there any way for your managers to play the fiscal cliff or are they just sitting on the sidelines?
If you try to guess outcome of the fiscal cliff, it’s a bit difficult. Politicians will do their thing and most people don’t try to trade politics because predicting what a politician will do tomorrow is close to impossible given that they don’t know themselves what they will do tomorrow.
What about the credit markets?
There’s been only good news in credit. So I would say there’s reasonable money to be made. The one thing is: you have to be careful on the way you set risk rules, so that you’ve adjusted for today’s environment rather than an old environment.
Where do you think the upswing in credit is going? Some think it’s headed for a correction.
That’s one of those cases where if it keeps going up, eventually it’s headed for a correction. But honestly it’s very hard to see what would create a correction given bond yields are so low and people need yield of one sort or another. And so buying credit is the way to get yield. There are two things. One: if government bonds sell off, that will make a mess of the credit market because the price is in and nobody hedges interest rate risk anymore. They’re all long and so that’s one risk factor.
The other thing is if people start levering lower yields to get the returns that they’re after. I was talking to somebody yesterday who was doing a CDO in emerging markets where the equity tranche (so the most levered bit) was heavily oversubscribed. So they were thinking about increasing the size of it. Those are the beginning signs that people are starting to lever. It’s like, hey, emerging market yields aren’t high enough now to get you the 6-8 percent return that everybody wants, so you just to put on some leverage and you turn 5 into 8-9, and that sounds exciting. And then history tells you that the leverage needs to get to the two or three times… and then it goes horribly wrong.
Have you done much with all the mortgage strategies that have been launching lately?
Yes, we’ve done a bunch in RMBS. The ulcer is that we wished we’d done more given that performance has been fantastic. There again, the easy money in that move has come out, but people are thinking there’s going to be a big sell-off. I honestly doubt it.
How come?
The sell-off (could be) caused by a big economic change, but it’s hard to see a big change in the outlook for property. And otherwise, it’s a flow of money question and money is still after yields. You just have to be more careful about security selection today. Six to 18 months ago, you could buy almost anything and the flow was in your favor.
Which strategies are you underweighting?
Actually, even though this disagrees with most of the world, we’ve massively underweighted macro. The world is macro driven, but that’s very different than saying that it’s a good environment for macro. The two things are quite different. It’s either all risk on or all risk off. So, you have one bet. What you really need in this environment is lots of bets with some edge in terms of what you’re betting on. Our target to macro is zero, but there are a couple of places where we have macro managers that make sense for us.
What do you think would be a good environment for a macro manager?
What you’re looking for is different economies and different asset classes to be behaving in different ways. And you’re looking for economics to be driving decisions. In the current environment where all of the main developed economies… are sort of all in the boat together, it doesn’t look very interesting.
Where are you finding opportunities these days?
There are some very good returns in the areas where banks were very active. We’ve gone from 30 times leverage to 12 times leverage, but I would think the regulatory pressure will continue to drive down leverage in the banks until it gets to the low single digits. The reason the returns have been so good (in mortgages) is because none of the banks dare own any of the stuff anymore. And they’re not going to change that in a hurry.
Where are you increasing exposure in your portfolios?
Relative value or equity market-neutral type of things. And the same equivalent in the credit market, for example, credit long-short. In equity hedge funds, when you find a specialist in healthcare, technology, etc., they’re almost all generically bullish on their sector. We tend not to have money with sector specialists in equities because that ends up being a bullish bet on that sector. Our clients pay us to make alpha, not beta.
In commodities, the generalists are almost all commodity bulls and tend to be either long or very long. Whereas the sector specialists—the people who just look at grains or just looks at industrial metals—tend to be very agnostic about whether to be long or short. And so in commodities, sector specialists are more interesting.
You mentioned there was a good pipeline of new client interest. Why do you think that is, considering that returns in the funds of funds world haven’t been stellar and investors are usually skittish about organizational changes?
The merger discussion is very much old news in all of our conversations with clients. It’s remarkable how quickly they stop worrying about it. The question (for clients) is about allocating money to hedge funds and allocating to a successful program. And that’s quite a big hurdle. The vast majority of clients know that they need help or want help. And that help might come in the form a consultant, an advisor or a fund of funds. It might be a fully discretionary comingled product. It might be just an infrastructure and risk management mandate. It doesn’t matter what label anybody puts on it. The vast majority of all the client inquiry today starts by someone who has a hedge fund program, or wants to have a hedge fund program, and effectively says, “Let’s have a chat.”
Which geographies will be lucrative in terms of economic growth and investment opportunities in the next few years?
If what one’s chasing is beta, then the economic growth question is incredibly important. If what one’s chasing is alpha, then what you need is the size of the market, the number of participants, liquidity and things like that. It’s a pretty easy thing to say that economic growth in China or other emerging markets is going to be a lot better than it is in Europe or in the U.S. And that the U.S. will be better than Europe and Europe will be better than Japan. It’s very hard to see what will knock us out of that set of dynamics. But the reason that so many hedge funds operate in the U.S. is because the legal regime is robust. Why do you get more distressed investing in the U.S. than you do in France or Spain? Because the legal rules around distressed investing in the U.S. are extremely clear. The outcomes are much less clear in France. The number of instruments and the efficiency of markets are very important.
We’ve done a lot of work on the domestic futures markets in China. And it’s an exciting opportunity apart from the fact that you can’t stick a bunch of money from a U.S. pension plan into the Chinese futures market because they won’t let you. There’s no such thing as a Chinese equity hedge fund. There are Chinese equity managers, which are a good way to play the region if you’re bullish on China. But they can’t really get out of the way when things get bad.
