It was the shock felt round the world. Ben Bernanke’s suggestion earlier this year that the Federal Reserve Board might begin to reduce its bond purchases roiled emerging markets. Currencies and stock prices fell sharply from Brazil to Indonesia as the prospect of tighter global liquidity prompted panicky investors to withdraw massive amounts of funds from those countries’ securities markets.
For Devan Kaloo the market’s indiscriminate reaction to a possible shift in U.S. monetary policy was a signal to buy, not a reason to rush for the exits. Kaloo oversees more than $60 billion in assets as head of global emerging-markets equities at Aberdeen Asset Management in London, and in recent months he and his team have been adding to existing positions in Brazil, India, Indonesia and Turkey, four of the countries hardest hit by the recent turmoil. It was a gutsy contrarian call considering the severity of the selling pressure, but the manager puts more faith in Aberdeen’s bottom-up stock-picking capabilities than in the sometimes violent swings in sentiment toward emerging markets.
“The most exciting times for us are periods of great volatility,” says Kaloo. “It means good companies and bad companies are getting dumped. There’s no distinction being made about the quality of companies. And that should ideally be an opportunity for us to capitalize on.”
Kaloo’s sangfroid in the face of market turbulence is emblematic of his firm’s fundamental approach to active equity management. It’s also the reason Aberdeen is the winner of Institutional Investor’s first-ever European Investment Management Award in the Emerging-Markets Equity category.
II screened hundreds of managers and picked the leading ones based on short- and long-term performance and Sharpe ratios, using data from fund information provider eVestment. We then consulted with a select group of European fund sponsors to identify the winners in 20 investment categories spanning equities, fixed income, alternatives and emerging markets.
For many of these companies, the secret of success is sticking with tried-and-true formulas and resisting the increasingly short-term focus of financial markets.
“If you change your process, you’re dead,” says Martin Gilbert, chief executive of Aberdeen, which is based in its namesake Scottish city but runs most of its £202 billion ($327 billion) in assets out of London. “We just have to weather the storm of fashion. We keep fully invested and don’t try to trade. Just buy good companies and hold them.”
The elevated volatility in equity markets since the 2008–’09 financial crisis has been a boon for Cevian Capital, an €8.5 billion ($12 billion) activist hedge fund based in Stockholm and the winner in the Hedge Funds category. “I see a lot of other people out there change their strategy: They become much more short-term,” says Christer Gardell, the firm’s co-founder and managing partner. “We stayed long-term, and with the capital base we have, we’ve been able to take advantage of the short-term panic that’s been out there in the markets.”
For other money managers the turmoil of recent years has prompted some strategic rethinking. Robeco Group, which wins top honors in Pan-Europe Fixed Income High Yield, has cut noncore areas and refocused its business around five strategic themes, including sustainability and quantitative strategies. Pioneer Investments, the asset management arm of Italy’s UniCredit, is seeking to buttress its fixed-income business against a possible bear market in bonds by developing absolute-return strategies. “It’s more difficult to build a diversified portfolio,” says Giordano Lombardo, Milan-based CIO at Pioneer. “We are going to be forced to go into the territory of alternative assets.”
Pioneer, winner in the Pan-Europe Fixed Income Corporate category, believes interest rates have bottomed out in most developed markets, bringing to an end a 30-year bull market in bonds. “It’s very unlikely we are going to see further declines in interest rates,” says Lombardo, a former head of equity research at UniCredit who took over as CIO of Pioneer in 2010. “That is the major challenge we have in front of us.” At the same time, institutional investors still have a strong appetite for fixed-income instruments to match their long-term liabilities.
In a bid to reconcile those two trends, Pioneer has been making a push into the absolute-return space. In December 2010 the firm launched the Absolute Return Bond strategy, which invests cash in Treasury bills or equivalents to preserve capital and then takes positions in derivatives markets, including foreign exchange and credit default swaps, in a bid to generate alpha. “You have to have confidence in the structure,” says Tanguy Le Saout, Pioneer’s Dublin-based head of European fixed income. “You should not be afraid of derivatives.”
The fund, which aims to deliver a return of Eonia (the European overnight interest rate) plus 3 percent before fees, has attracted more than €300 million, most of it coming in this year. The firm is preparing to launch sterling- and dollar-denominated versions of the fund shortly.
Pioneer has also found strong demand for its short-term corporate bond fund, which seeks to minimize the risk of higher rates by investing in securities with durations of no more than three years. The fund has brought in more than €1 billion.
Le Saout, a former equity options arbitrageur at Dresdner Bank who came to Pioneer in 1999 and ran government bond trading and investment grade bonds before taking charge of European fixed income in 2010, says the firm needs to approach today’s market more like a macro hedge fund, such as Brevan Howard Asset Management, than as a traditional long-only bond buyer.
This sort of innovation is striking for a firm whose ownership was in doubt less than three years ago. UniCredit had put Pioneer up for sale in a bid to raise capital at a time when many European banks were looking to exit asset management, but the bank couldn’t find a suitable buyer or price. Although UniCredit halted the auction process and confirmed its ownership in 2011, Pioneer still needs to offset weakness in the Italian market, the source of nearly half of its assets. The debt crisis in Europe, which continues to haunt Continental bond markets and the overall economy even though the European Central Bank has averted the threat of a euro breakup, weighs heavily on the firm’s growth prospects in Italy and the region as a whole.
Three years ago Pioneer opened a London office to combine its emerging-markets equities and fixed-income teams, which it has been expanding. The firm has also stepped up its efforts to attract institutional clients in Latin America and Asia, including opening an office in Mexico City last year. “The idea is to diversify the source of business,” Lombardo says. “We really see ourselves as a global firm.”
The Netherlands hasn’t suffered anything like Italy in the euro crisis fallout, but Robeco faces plenty of its own challenges in trying to generate growth. The €189 billion-in-assets Dutch fund manager has sharpened its strategy since recruiting Roderick Munsters as CEO in 2009 to turn the firm around after years of subpar performance.
In 2010, brandishing the slogan “select, cut, grow,” Munsters adopted a five-year plan of slashing underperforming areas and focusing on strategies where he felt the firm had a distinct advantage. Robeco is targeting five: socially responsible investing, food and agribusiness, quantitative strategies, inflation products and investment solutions — the last a broad-based advisory service with multimanager investment capabilities.
The new emphasis “gave us more focus and more clout in those five strategic areas,” says Hans Rademaker, who as head of the investment division since 2010 serves as Robeco’s effective CIO. The strategy also should help Robeco achieve its goal of boosting its institutional business to 60 percent of assets from 50 percent in 2010, he adds.
Winning clients, of course, ultimately depends on performance. In its efforts to improve returns, Robeco is stressing the importance of its in-house research. The firm’s quants have identified a number of strategies geared toward specific factors, such as low-volatility equities, that are proving increasingly popular with investors. That kind of fundamental research is critical to helping the firm keep its eye on the long-term horizon and not be buffeted by the short-term turbulence in markets. “We think we can add value only if we can look through the cycle and not follow the herd,” Rademaker says.
Robeco has responded to market turbulence by strengthening the liquidity of its portfolios. The firm has increased the cash position in its high-yield portfolios, which totaled €3.2 billion as of June, to 10 percent currently from about 3 percent before the crisis. It has introduced so-called swing pricing in its funds, under which redemption prices for investors can fall if there is a surge in withdrawal requests. Such a mechanism helps protect remaining investors in the fund and reduces the risk that Robeco could be forced to dump assets at fire-sale prices to meet redemption requests.
“The liquidity element has become very important, especially in the fixed-income market,” Rademaker says. “These markets look liquid on normal days, but they can go illiquid quite rapidly.”
So far, the firm has had little need for such mechanisms, but that could change if markets turn more volatile. Rademaker believes the sell-off in global bond markets from May to July of this year offered a taste of what’s likely to happen when the Federal Reserve actually begins to reduce its bond purchases. “We will face some periods of high volatility going forward,” he says. “It’s wise to have some protection to preserve the wealth you have created over the past 30 years.”
At Legal & General Investment Management, an arm of the U.K. insurer, a big push into index-linked products has driven strong growth. Passive strategies make up a little more than 60 percent of the group’s assets under management, which have nearly quadrupled over the past decade, to £433 billion at the end of June from £114 billion at the end of 2002.
Yet the firm has tweaked the investment process for its active strategies in significant ways since the great financial crisis, says Marion Stommel-Hatzidimoulas, head of credit at LGIM. In fixed income, which represents a little more than a third of assets, LGIM used to take a bottom-up approach, playing the credit spreads among sectors and trying to avoid areas that were troubled or overleveraged, such as telecommunications a little over a decade ago. The crisis prompted the firm to take a broader view.
“We realized that we had to move more into the macro space,” says Stommel-Hatzidimoulas. “It was about identifying the turning points in the cycle.”
The firm has beefed up its analytical capabilities. From just one economist back in 2000, the fixed-income department has grown to a team of four economists and three strategists. Their view on interest rates is a little more benign than Robeco’s. They see the global economy recovering at a very modest pace over the next 18 to 24 months, the Fed tapering later rather than sooner and interest rates rising very slowly. In short, the risk of a bond market rout is not great. “We don’t think we are in the same kind of situation that we were in in 1994,” says Stommel-Hatzidimoulas.
Structural forces should underpin the fixed-income market. Pension funds and other institutions continue to have a strong appetite for debt securities to fund their long-term liabilities, Stommel-Hatzidimoulas notes. Liability-driven investment strategies were a big factor behind LGIM’s net inflows of £8 billion in the first half of 2013. However, the search for yield in today’s low-rate environment will continue to push many of these investors into more-exotic sectors of the market. “We see more interest in higher-yielding assets or niche products like illiquid or high-yield assets,” says Stommel-Hatzidimoulas.
The crisis and its aftermath have simply confirmed some investors’ well-honed strategies. That’s certainly the case for Cevian Capital, winner in the Hedge Funds category.
Gardell and his partner, Lars Förberg, launched the hedge fund firm in 2002 to pursue an activist strategy in Scandinavia. Cevian opened a second fund in 2006 and invests across the Nordic countries, Germany and the U.K.
For Gardell the math is simple. Many investors fret over the implications of whether the world economic growth rate will be 3 percent or 4 percent next year, but he couldn’t care less. Cevian takes sizable positions in a handful of underperforming companies and seeks to work with management — or prod it — to take measures to boost returns. “If you have a potential to move an ebit margin from 4 percent to 10 percent, it’s always much more significant from a valuation perspective” than macro considerations, Gardell says, referring to earnings before interest and taxes.
Cevian runs a very concentrated portfolio and currently holds about a dozen positions, including hefty stakes in Denmark’s Danske Bank, Finnish engineering company Metso Corp., Swedish bus and construction equipment maker Volvo, and Vesuvius, as the U.K.’s Cookson Group was renamed last year following the disposal of its precious-metals-processing division. Gardell, whose activism propelled the divestment, holds a seat on the board of Vesuvius.
Gardell and Förberg’s latest target is G4S, a U.K. security services company that has faced financial pressure resulting from a number of recent missteps, including its failure to hire enough security staff for the London Summer Olympics in 2012. Cevian disclosed a stake of 5.11 percent in August and is believed to be pressing the company to hive off its cash solutions business, which provides armored cars and other services to help companies and banks distribute and manage cash. Last month the company rejected an offer for the cash business from Charterhouse Capital Partners, a buyout firm based in the U.K.
Cevian’s strategy echoes the approach of Carl Icahn, and for good reason. The American activist was an early backer of Cevian and has coinvested with the firm in a number of situations. But the Swedes eschew Icahn’s public, in-your-face manner, currently on display in his attempt to persuade Apple to do a massive, $150 billion stock buyback. “That’s not our style,” says Gardell. He has very red-blooded ideas about companies’ obligations to their shareholders, but he and his partner are reserved Swedes who prefer to negotiate directly with management. The pair decline to discuss their stance at G4S beyond confirming their stake, which was revealed in a regulatory filing.
The firm limits its activities to Northern European countries with strong corporate governance frameworks that allow shareholder activists to wield influence. Hence there is no bottom-fishing in any of the peripheral euro zone countries of Southern Europe, with their opaque ownership structures and political interference: “It’s a fundamentally different place to do our kind of business,” Gardell says.
Yet the European fiscal and economic crisis has been good for business because it has depressed the valuations of a wide range of companies with strong fundamentals. “Some of these companies have a big global business exposure,” says Gardell. “They happen to be listed on a European exchange, but the business is fundamentally global in nature. They’ve been punished more than they should be, thereby creating good investment opportunities.”
Cevian’s success is a mixed blessing for investors, though. This summer the firm closed its doors to new money for the first time.
Aberdeen’s Kaloo feels the same way about many emerging-markets equities following the recent sell-off. “You should really ignore the macro because it is in many cases confusing,” he contends. “A key focus for us is very much about stocks and understanding your companies and trying to ignore the noise, because there is so much noise.”
Kaloo and his team of 44 professionals — spread among London, Bangkok, Hong Kong, Kuala Lumpur, São Paulo and Singapore — visit some 1,900 companies a year. They want to gain a deep understanding of the underlying business and the quality of the management, and they are willing to be very patient in their pursuit of that knowledge. “It typically takes us about two years tracking a company before we feel comfortable that we understand the risks,” Kaloo says.
Once Aberdeen commits, it does so for the long haul. A typical portfolio will hold about 50 positions, and the average length of an investment is more than seven years. Turnover in the portfolio is less than 20 percent a year. The firm does adjust its positions tactically, tending to shave weightings during good times to take profits and to rebuild positions when markets and sentiment are weak. Recently, Aberdeen added to its position in Indian information technology company Infosys, regarding market concerns about recent management turnover and demand from U.S. corporations as overdone and the company’s underlying business as strong.
Buying into India and other hard-hit developing economies when the rest of the world is selling requires the courage of conviction, but Kaloo, who started managing emerging-markets equities at Martin Currie in 1994, just before the Tequila Crisis battered the Mexican market, is battle-tested. He’s learned that in turbulent markets it’s often advisable to run headlong into the crisis. “One of the great ironies in covering emerging markets is that, as often as not, countries with the worst macro give birth to the best-run companies,” he says. “Ultimately, it’s about the companies. You buy companies; you don’t buy a country. I’m not buying India; I’m buying Hindustan Unilever or Icici Bank.”
For some fund managers internal issues pose as much of a challenge as trying to figure out how to play the markets. That’s been the case recently at the U.K.’s Man Group, the world’s largest listed hedge fund firm. Man, winner in the Fund of Hedge Funds category, acquired FRM Holdings last year. The group’s combined $11.4 billion fund-of-hedge-funds business now trades under the FRM brand.
Keith Haydon — who took over as FRM’s chief investment officer earlier this year after long-standing CIO Luke Ellis was promoted to president of Man as part of a management reshuffle — has spent a good part of his time whittling down the combined group’s roster of hedge funds to about 110 high-conviction names from about 180 immediately after the merger. FRM’s average institutional client in a multistrategy fund will invest in about 25 managers.
The company is also working to develop synergies from the merger. One key attraction for Haydon is the ability to provide position-level data on a client’s holdings, which Man offers as part of its managed accounts business, to FRM’s fund-of-hedge-fund customers, who have never had access to that kind of granular information. Such a service could help FRM expand its U.S. market penetration, a key goal.
“It’s spectacular how much more you can do with efficient systems,” says Haydon. “I think institutional investors in the States would be better able to use that data than most anybody else.”
Improved technology will also allow the firm to better respond to investors’ potential concerns about liquidity, one of the most notable lingering aftereffects of the financial crisis.
“The managed accounts make it much easier to see what managers are investing in and to rule out securities that aren’t liquid,” Haydon says. “We have a pretty strong obligation to have a good answer going forward when clients ask, ‘How do you know you’re going to be able to give me back my money?’”
Customers, of course, want more than just their money back in return for the extra layer of fees in a fund of hedge funds. For FRM lagging performance in some areas — notably, commodity trading advisers, many of which were caught off guard by the market turmoil following the Fed’s tapering hints in May and June — produced modest investor outflows in the first nine months of this year.
“I don’t think anyone wants an average hedge fund,” says Haydon. “I would never tell you that you should invest in hedge funds if you were going to get the index return. Don’t bother.”
But the CIO takes heart from recent market movements. The likelihood that the Fed will taper its bond purchases, and do so earlier than the Europeans or Japanese, suggests an end to the risk-on environment and a drop in correlations among asset classes, giving hedge fund managers more to play with.
“One probably ought to be thinking about buying things which have a longer bias to volatility as we go into what is likely to be an immensely difficult period of trying to withdraw stimulus and normalize the rate structure,” Haydon says. • •
