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THE BUY SIDE - CQS Gets Energized

Renowned for its convertible arbitrage prowess, CQS stakes a claim in the global energy and natural-resources markets.

BUYING AN INVESTMENT BOUtique that focuses on energy and natural resources might sound like a strange pursuit for a hedge fund executive who specializes in convertible arbitrage and credit strategies. But Michael Hintze, 54, the founder, CEO and senior investment officer of London-based CQS, is keen to diversify his $8.7 billion business -- and his investor base. Since last December, when CQS launched its first publicly traded, long-only investment vehicle, the CQS Rig Finance Fund, on the London Stock Exchange's Alternative Investment Market, Hintze has been looking to add talent to CQS's energy team and to broaden its closed-end fund offerings.

This summer, in a chance encounter with his friend and fellow investment manager Richard Lockwood at a fundraising event for London's Trinity Hospice, Hintze had an inspiration. Although Lockwood, 64, wasn't necessarily looking to sell New City Investment Managers, the energy and natural-resources investing boutique he founded nearly four years ago, Hintze realized they shared a common ambition: To diversify and broaden their businesses through strategic development of new, highly specialized energy and natural-resources funds -- specifically closed-end funds, which aren't subject to the same potential redemption pressures as traditional long-short hedge fund structures. Lockwood agreed.

"It was just a classic moment," says Hintze. "I was telling Richard, whom I've known for years, that we had built a great operational platform for our business, but we were still looking for talented people to help us expand our investment activities. And Richard said -- putting it the other way -- that he had great people and aspirations to expand, but he needed a more robust operational platform and back office."

Announced in late September, the deal received swift regulatory approval, and was finalized earlier this month. Although Hintze declines to discuss the terms, the combined firm will have more than 200 employees and more than $9.3 billion in assets under management invested across an array of credit, convertible, asset-backed and even equity strategies. Hintze's desire to expand into adjacent, closely related investment strategies is not without precedent: Some of the biggest, most reputable multistrategy managers, like Chicago-based Citadel Investment Group and New York­based Highbridge Capital Management, began in convertible arbitrage.

As that once-arcane strategy has become increasingly commoditized, its practitioners have searched for new ideas, in part to shockproof their businesses. Investors, who are quick to reallocate their funds during times of economic stress, have punished convertible arbitrage managers during market dislocations. After managers got caught in spring 2005 by the downgrade of General Motors Corp.'s debt to junk status, the total invested in convertible arbitrage globally plunged from $48.5 billion in the second quarter of 2004 to $36.7 billion in the fourth quarter of 2005, according to Chicago-based Hedge Fund Research. The sector subsequently recovered. It is up by 17.6 percent in 2007, to $53.13 billion, according to HFR; however, no one quite knows how the summer's U.S. subprime contagion will affect investor sentiment.

CQS came out of the U.S. subprime crisis relatively unscathed. Its flagship Convertible and Quantitative Strategies Fund (for which the firm was named), down 1.5 percent in August, has rebounded and was up 2.0 percent net of fees in September; it is up 8.23 for the year to date. But Hintze, who has been quietly transforming CQS over the past several years, remains sensitive to the external business risk.

He has sought to complement the firm's two core portfolios -- the CQS fund and the CQS Capital Structure Arbitrage Fund, launched in 2002. Since 2005, Hintze and his senior portfolio managers have added an asset-backed securities fund -- up 11.82 percent net through August -- an aggressive directional opportunities fund in convertible arbitrage and credit, two collateralized loan obligation funds, an Asia-based convertible arbitrage and quantitatively driven market-neutral long-short equity fund and the CQS Rig Finance Fund, which helps finance the construction of deep-sea oil rigs by buying the companies' high-yield debt.

The oil-rig financing, led by Mark Conway, CQS's credit trading chief, also got the attention of New City's Lockwood, who was a partner in charge of the mining division at London-based stockbroking firm Hoare Govette before launching his own business. He and his co-founding partner, Andrew Ferguson -- a former mining engineer -- have earned a solid reputation in the City of London for their work designing highly unusual energy funds, including the first-ever fund dedicated to uranium and nuclear energy. Since its inception in July 2006 through August 2007, the aptly named Geiger Counter, which is listed on the Channel Islands Stock Exchange, has returned more than 87 percent.

The fact that CQS already had a team of energy analysts -- plus a back office worthy of an investment bank -- helped convince Lockwood the sale made sense. "We've been good at designing products that people want to invest in, but we've reached a crossroads," says Lockwood. "We only have seven people on staff, and -- if we were to expand -- we would have to take on a huge increase in our back office, which is not something we particularly want to do. Joining CQS will give us the staffing we need, but no one on our team is going to lose their identity."

Ultimately, Hintze says, consolidation is bound to continue, as managers find it harder to break into the ranks of the largest, multibillion-dollar hedge funds, and win all the advantages that size and scale can bring. For those who have the drive but not the back-office staff, help may be only a handshake away.


NAME: Michael Hintze

POSITION: Chief executive of CQS

APPOINTMENT: Founded firm in 1999

WHAT WE KNOW: A pioneer in convertible arbitrage and credit strategies, Hintze is bullish on energy and natural-resources investing.