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Wizards of Oz
With the launch of a new brand to unite its broad array of quantitative strategies, Australia’s Macquarie Bank is making a push to rule the rapidly evolving hedge fund landscape in Asia.
The inner workings of Australias Macquarie Bank are a mystery to most outsiders, but fee factory is the sobriquet that suits its business model best. Over the past decade the bank has built a profitable franchise by bidding aggressively for infrastructure assets such as toll roads and airports, which it packages into mostly listed funds and manages in exchange for hedge fundlike fees of up to 1.5 percent of assets and 20 percent of returns above a benchmark. In the fiscal year ended March 31, the Sydney-based bank derived A$1 billion ($711 million) in revenue from such deals. Given this track record, its logical that Macquarie would eventually seek to enter the fee-rich business of hedge funds.
That is what Greg Mackay, head of the banks equity markets group, had in mind when he planned an off-site meeting in March for about 30 staff members at Manly, a beachfront suburb and popular corporate conference center just a 20-minute ferry ride from downtown Sydney. To limit distractions, he booked his team into the unglamorous Radisson Hotel and reserved a conference room overlooking the parking lot.
Mackay needed his teams undivided attention. In October 2003 he had decided to make a variety of internal hedge fund strategies run by his group available to the banks high-net-worth clients. Last year the group had begun taking limited outside money. Now Mackay and his team wanted to make a strong push to open their single-strategy and multistrategy funds and funds of hedge funds to the broader retail and institutional markets, both onshore and offshore. To be successful, he and his team concluded at the Manly off-site meeting that they would need to create a single brand for their funds to replace the two clunky names that were then in use Macquarie Newton Specialist Funds Management and Macquarie International Capital Advisors.
Macquarie hired a consulting firm to devise a new name for the hedge fund business, but soon discovered that settling on one wasnt easy. After three months they hadnt come up with anything we liked, says Mackay. So we sat down in a room, and one of our team suggested M. Someone else said that was a bit short and suggested we add a Q. That gave us MQ. It sounded like a good name, and we figured we could rationalize that.
MQ was unveiled in July. Although it does not officially stand for Macquarie Quant, it certainly could. Most of the teams portfolio managers have quant expertise, and nearly all of their strategies are driven by quantitative stock selection and portfolio construction methodologies. With A$1.1 billion under management, MQ ranks among the five biggest hedge fund managers in Australia. The initiative is a natural extension of Macquaries specialized managed funds business, which accounts for more than A$94 billion and makes the Aussie bank the biggest nongovernment owner of infrastructure assets in the world.
Macquarie has a history of turning principal activities into specialist funds for bank customers, says Cathy Kovacs, who oversees domestic distribution of Macquaries hedge funds to institutional and retail investors. Hedge funds complete that puzzle.
Mackay and his team are certainly playing to their strengths. Their goal is for MQ to become the preeminent hedge fund brand in Asia, which Mackay says is fertile ground for the firms quant-driven strategies, given the volatility and growth trajectories of the regions economies and the differences in their local regulatory cultures. Compared with the U.S. and Europe, he adds, there is relatively little quantitatively driven hedge fund trading under way in Asia. That gives MQ a head start on its rivals and makes the anomalies it targets easier to exploit.
Australias hedge fund market is already taking off. According to Daniel Liptak, the Melbourne-based head of research at LCA Group, which tracks hedge funds in Asia, assets managed by Australia-based hedge funds and funds of funds quadrupled, to nearly A$60 billion, in the three years ended June 30. During that period the number of domestic hedge funds more than doubled, from 55 to 129.
The growth can be attributed in large part to Australias emergence as a low-cost regional hedge fund center. According to a survey conducted by accounting firm Ernst & Young, Sydney and Melbourne are on par with Singapore, about half as pricey as Hong Kong and one third the cost of Tokyo. In both Australian cities start-up costs may be as high as $195,000 and annual ongoing costs as high as $340,000, compared with $530,000 and $880,000, respectively, in the Japanese capital.
Australia is large, its sophisticated, and its legislated to grow, says Sydney-based Russell Maddox, cochief investment officer of Merrill Lynch Investment Managers, which has launched some Australian hedge fund products.
LCA Groups Liptak says the Australian market is at the same stage of development as the U.S. hedge fund market in the mid-1990s. Today, Australian retail investors account for 65 percent of hedge fund assets. (Unlike their peers in the U.S., Aussie hedge fund managers can market themselves directly to retail investors, who may invest as little as A$2,000.) Just as U.S. pension funds followed wealthy individuals into hedge funds, Australias pension funds are beginning to embrace the sector, and their numbers could easily surpass those of existing retail investors.
This potential source of assets is huge. Australia is home to the fourth-biggest contestable pension fund market in the world, buoyed by a government-mandated pension savings scheme, established in 1992, that requires employers to invest 9 percent of their workers salaries in pension plans. As a result, the Reserve Bank of Australia expects the savings pool to leap from about A$1 trillion today to A$2.5 trillion by 2015, by which time it is projected to be twice the size of Japans pension fund assets, currently the biggest in Asia.
Liptak says that less than 1 percent of the total Australian pension pool is invested in hedge funds. But he sees that changing rapidly as investment consultants become familiar with the sector and the countrys four-year stock market run suffers the inevitable setback. (Australian stocks fell nearly 7 percent from May to the end of September.) By 2015, Liptak expects pension funds to allocate, on average, 7 to 10 percent of their assets to hedge funds. If that happens, the onshore Australian market will be worth A$200 billion to A$250 billion.
Macquarie Bank began life in 1969 as an
offshoot of London-based merchant bank Hill Samuel, now part of Lloyds TSB Bank. Macquaries growth into a full-service investment bank was steady, if unremarkable, until the firm listed on the Australian Stock Exchange in 1996. That year it launched its first fund, Macquarie Infrastructure Group, following its successful financing of a Sydney tollway, the M2, in a novel deal that awakened the bank to infrastructure investment.
Macquarie quickly undertook a flurry of deals. It purchased airports in Sydney, Brussels, Rome and Copenhagen; roads, including the Chicago Skyway and the Indiana Tollway; energy and media infrastructure; and such regulated or protected businesses as ports, parking facilities and nursing homes. Earlier this year the bank even made a pitch for the London Stock Exchange but balked at raising its bid when the LSE deemed the price too low. Today, Macquarie is a unique blend of investment bank, fund manager and facilities operator. It controls A$79 billion of infrastructure assets through a series of investment funds that as of September 14, the latest date for which figures are available, had delivered average annual returns of 17.8 percent since inception.
Macquarie CEO Allan Moss describes his bank as a federation of entities in which individual business managers are given freedom to work within strictly defined risk criteria. He says his approach encourages an entrepreneurial spirit one that is backed by the support of a large institution. Thus far it has worked: Macquaries market capitalization leaped from A$1.3 billion at the time of its stock market listing to A$17.7 billion as of September 28. The strategy is led bottom up, not top down, says Mackay. That risk control framework affords the opportunity to manage the business as you see fit. (For more on the banks push to seed managers through a new U.S.-based joint venture with M.D. Sass, see box.)
Asia is one of the 43-year-old Mackays areas of expertise. He majored in math and physics at the University of Adelaide and has been at Macquarie since his graduation 20 years ago, working first in risk management, then in equity options trading. In 1994 he moved to Hong Kong to establish the banks equity trading business before returning in 2000 to look after its Australian equity structured-products business and now its hedge fund aspirations. These have been bolstered by the banks 2004 purchase of Netherlands-based ING Groups regional brokering business, which spanned ten Asian markets. The acquisition gives MQ additional local knowledge and distribution capabilities.
MQs single-strategy funds are directed by Nicholas Bird, a 13-year Macquarie veteran who oversaw the banks Asian quant research teams for more than eight years before transferring to Macquaries nascent hedge fund operations in 2004. The 39-year-old chief investment officer leads a team of eight portfolio managers who run ten strategies, ranging from regional offerings such as an Asia long-short and an Asia statistical arbitrage fund to such country-specific ones as an Australian market-neutral and a Japan long-short fund. He cites his teams quant pedigree as the banks competitive edge. In the Asia space most of our peers have high beta, but we focus more on alpha, he says.
Besides managing the single-strategy team, Bird serves as portfolio manager for two of MQs offerings, including the Asia long-short fund, which took three years to develop and has a model that spans 13 countries. The fund has been running since October 2005 but only began taking outside money in June. Traditional quant factors havent worked [in Asia], particularly in emerging markets, until recently, says Bird. As Asian markets have matured, the quality of the financial data on which these strategies rely has improved.
With very little beta, no major size tilt and little sector or industry bias, the Asia long-short fund has a relatively low risk profile. Bird selects stocks by applying what he describes as a nonlinear quant factor meaning he looks for a specific combination of quantitative factors that work well together. The fund has about 450 positions that have been filtered using six different investment screens designed to exploit specific market anomalies. On the long side, for instance, Bird favors value and quality factors. We try to focus on cheap stocks that arent cheap for a valid reason, he says. On the short side he has been successful by screening for stocks that are relatively expensive compared with their peers and that exhibit poor short-term momentum.
Bird is happy with the funds performance. Returns since inception exceed 17 percent, and it easily beat its benchmark, the Eurekahedge Asia long-short equities hedge fund index, in tough trading conditions from May to July. With the benchmark showing losses in all three months, the Asia long-short fund was up slightly in June and July.
Bird also manages MQs Asia income-timing fund, which seeks to exploit pricing anomalies that emerge near the date when a stock goes ex-dividend in Asia. Equity investors tend to ignore the time value of dividends until the ex-dividend date approaches, he says, especially when it comes to high-dividend-paying stocks. But as investors wake up to the opportunities, share prices usually spike. Bird is also helping to reposition the banks Australian market-neutral fund, which combines quant-oriented and standard stock selection processes.
One of MQs newest strategies is a Japan market-neutral fund, run by the Amsterdam-born Michiel Swaak, who joined Macquarie last year from Sydney-based research house Aegis Equities Research, where he was a quant analyst and portfolio manager. The funds quant models are tailored to different sectors of the Japanese equity market based on the price behaviors they exhibit. For example, financial stocks tend to trade more on value metrics such as price-to-book and earnings multiples, whereas technology stocks are typically momentum plays.
There are not many Japanese market-neutral funds, says Bird. I see that as a marketing niche for us, a pure alpha process rather than a beta-plus-alpha process.
MQ has recently seeded two new strategies that will be managed by Macquarie staff who approached Mackay and Bird with new ideas. Kevin Leung, a principal trader in Macquaries Hong Kong office who previously worked with Mackay, has established an Asian volatility trading strategy. And Saurav Chatterjee joined MQ from the banks Tokyo brokering operations to launch a Japan long-short fund. Were always encouraging people who can offer something different rather than more of the same, says Mackay.
In March, MQ launched its first open-ended fund-of-hedge-funds product, MQ Absolute Return Strategies Asia, which it is pitching to domestic and offshore institutions as well as to high-net-worth investors. Suresh Singh, who heads MQ Capital, as the fund-of-funds business is called, oversees a team comprising seven investment professionals who have allocated capital to more than 40 managers worldwide. He says MQ Capital is one of the first Asia-specific funds of its kind to be made available to Australian investors. It will have a capacity of A$250 million, of which Macquarie Bank and Macquarie managed funds have committed nearly A$50 million.
Its a unique offering, says Singh, who joined the company in 1999 after Macquarie bought Bankers Trusts investment banking business in Australia. The breadth of strategies in Asia means that we can now design a well-balanced portfolio that is focused only on Asia and make it distinct from the conventional global offerings.
In Asia, Singh says he prefers single-strategy, single-country managers: We like to use people who have a deep market knowledge and experience of different market cycles and who can use the volatile and inefficient markets to generate higher alpha than managers in the U.S. and Europe. As demand arises, adds Mackay, MQ Capital may offer country-specific funds of hedge funds most likely focused on Japan, China and India. Singh says a more strategy-specific fund of hedge funds is also a possibility.
Today, Macquaries hedge fund INVESTOR base reflects local market dynamics. According to Kovacs, MQs head of Australian distribution, the more than A$600 million invested in Macquaries funds of hedge funds comes almost entirely from retail investors, and nearly half of the assets in its single-strategy and multistrategy funds are retail. But there are signs of growing institutional interest. InTrust Super Fund, a pension fund serving hospitality and tourism workers in the state of Queensland, has 18 percent of its A$780 million under management invested in alternative assets, of which two thirds is allocated to hedge funds. Last November, InTrust Super operations manager Chris Engelhardt was searching for a defensive strategy and invested A$26 million in MQs multistrategy fund.
Were happy with the risk-averse approach, Engelhardt says of MQ. We like the mix of a boutique-type arrangement within the resources of a large institution. We also like the fact that Macquarie invests in its own funds.
Still, Macquarie has more persuading to do. Jeremy Reid, founder and CEO of Everest Babcock & Brown, the third-largest fund-of-funds firm in Australia, with nearly A$2 billion under management, says one of the challenges facing investment banks like Macquarie as they enter the hedge fund space is that many potential investors, including his firm, arent attracted to offerings from major financial institutions. Their traders, he asserts, have a free call on the upside but no stake in the downside. We prefer to invest in boutiques, where the portfolio managers own the firm and have significant amounts of personal capital invested, Reid says. One additional challenge for big banks, he adds, is that if you have star traders, they might want to depart and start their own funds.
That began happening at Macquarie long before it unveiled MQ, which the bank hopes will help stem defections. Among the notable departures is Richard Jenkins, who left in 2001 after 21 years at the bank, most recently as head of the corporate advisory and institutional stock brokerage division. In 2003, Jenkins established his own Sydney-based global macro fund, Shell Cove Capital Management, which as of July had $67 million in assets under management. Many of his key staffers, including portfolio manager Peter Taylor, are also ex-Macquarie employees.
Another challenge for Macquarie is one that all local hedge fund operators confront: coaxing a critical mass of Australian pensions to become early adopters. These institutions have traditionally made big allocations to what they term alternatives, which mostly include property, infrastructure or private equity investments, according to a survey released last year by the Sydney office of consulting firm Russell Investment Group. At the same time, many Australian pension funds remain wary of hedge funds, especially in the wake of Amaranth Advisors fatal $6 billion losses on natural-gas bets. Even before Amaranths demise, West Perthbased Westscheme, a A$2 billion pension fund, had begun redeeming its A$10 million hedge fund allocation, which it deemed too risky.
Some clients wont touch hedge funds with a barge pole, says John Coombe, a Sydney-based director of JANA Investment Advisors, Australias largest pension consultant. We try and explain [the asset class], but if they dont understand it, we are not going to force them into it, he adds. JANA advises on some A$100 billion, of which only A$1.4 billion is invested in hedge funds.
As more pension funds take the leap, Macquaries relatively short history in the hedge fund space could put it at a disadvantage. Still, some industry observers believe size and institutional strength will be far more important assets over the long term. I think the industry growth could be punctuated by severe shakeouts, and there will be some significant aggregation down the track, says Shell Coves Jenkins. He predicts that the bigger players will dominate the Australian hedge fund industry.
The stirrings of consolidation may already be under way. In one recent transaction, for instance, Sydneys stock-exchange-listed Pengana Capital will be refashioned, its founding investors having sold out to NPH Funds. This new fund management group is led by Chris Mackay (no relation to Macquaries Mackay), who until recently was chairman of UBSs investment banking operation in Australia, and Hamish Douglass, who will step down as the co-head of banking for Deutsche Bank in Australia and New Zealand.
At Macquarie, Greg Mackay is happy with MQs progress in hedge funds so far. Although he declines to divulge MQs asset growth since its unveiling, he describes it as solid, if not spectacular. For a bank that prides itself on the independence of its businesses, creating a new brand under the Macquarie umbrella isnt something that happens overnight, says Mackay. But as more Australian pension plans plunge into hedge funds, his brand equity may rise sooner than he thinks.